Unisa Module Acc

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University of South Africa
Muckleneuk, Pretoria
FAC1601/1/2010
98480960
3B2
ACN-style
CONTENTS
INTRODUCTION AND OVERVIEW OF THE MODULE (iv)
STUDY UNIT 1
Introduction to the preparation of financial statements 1
STUDY UNIT 2
Establishment and financial statements of a partnership 13
STUDY UNIT 3
Changes in the ownership structure of partnerships 37
STUDY UNIT 4
The liquidation of a partnership 57
STUDY UNIT 5
Close corporations 71
STUDY UNIT 6
Introduction to companies 110
STUDY UNIT 7
Statement of cash flows 135
STUDY UNIT 8
Analysis and interpretation of financial statements 188
STUDY UNIT 9
Branches 198
FAC1601/1/2010 (iii)
INTRODUCTION AND OVERVIEW
OF THE MODULE
1 Word of welcome
Before proceeding with a discussion for the objective of FAC1601, we, as the lecturers for this
module, would like to extend a sincere welcome to you as a student in this challenging module.
As you may have been told by fellow students or by a lecturer, this module requires a great
deal of dedication and practice if you intend to pass well, especially if you do not have a
significant related academic background.
We hope that you will experience this module as challenging, but we must caution you that you
will have to put in a great deal of time to prepare thoroughly for the examination. There are
many reasons why students find it difficult to pass FAC1601, or to obtain the mark they are
aiming at. One of the major reasons why students are unsuccessful is that they do not allow
themselves enough time to cover the tutorial matter thoroughly and revise the exercises and
examples. FAC1601 is a practical module, and therefore requires as much practice as
possible. However, without a sound theoretical background, it is likely that you will experience
problems with the practical sections. It is not possible to study FAC1601 through rote learning.
Therefore, it is extremely important that you obtain a sound understanding of the theory before
you try to apply it by doing the examples and exercises. Students often skip these critical
theoretical discussions, and opt to prepare for the examination by memorising the solutions to
the given examples and exercises. Obviously, this approach will be unsuccessful because the
theory relates to an infinite number of possible practical scenarios which cannot all be studied.
By approaching FAC1601 in a positive, proactive manner, you will improve your chances of
success. Hopefully, you will become interested in the subject of Accounting, and gain
knowledge and skills that you will find very useful later on.
We, the lecturers for FAC1601, will do our very best to assist you as far as possible with your
studies. Do not hesitate to contact us with any queries regarding the content of this module.
Lecturers: FAC1601
`Ìt is difficult to say what is impossible,
for the dream of yesterday is the hope of today
and the reality of tomorrow.''
Robert Goddard
2 Overview
FAC1601 concerns itself with the issues of accounting reporting, as indicated in paragraph 3 of
this study unit, and builds on the learning outcomes of FAC1501. In turn, this module serves as
the basis for more advanced studies in financial accounting at Unisa, namely FAC2601 and
FAC2602.
(iv)
This module is divided into 9 study units. The topics of these study units are presented in the
Contents section at the beginning of the study guide, and should give you an overview of the
syllabus. In addition, the contents of each study unit are shown at the beginning of each study unit.
3 Module objective
The main objective of the module FAC1601 is to teach you certain aspects of financial
accounting and reporting so that you are able to do the following:
. discuss specified aspects of the Framework for the Preparation and Presentation of
Financial Statements
. understand and apply the concept of Generally Accepted Accounting Practice
. prepare financial statements for sole proprietors, partnerships and close corporations
according to certain of the requirements of International Accounting Standard 1 [IAS 1
(AC101)]
. apply the accounting procedures to record changes in the ownership structure of
partnerships on the admittance, retirement or death of partners
. apply the accounting procedures to record the simultaneous and piecemeal liquidation of
partnerships
. record transactions pertaining to the capital structure of companies
. prepare statements of cash flows for sole proprietors, partnerships and close corporations
according to certain of the requirements of International Accounting Standard 7 [IAS 7
(AC118)]
. analyse and interpretate financial statements
. explain how a business entity with branches operates, and record the transactions between
head offices and their branches
4 Tutorial Letter 101 and prescribed textbook
Before you start studying, please read the discussion in Tutorial Letter 101. This tutorial letter
contains valuable guidelines on how to go about studying this module, as well as suggested
time specifications pertaining to each study unit in order to ensure that you cover the whole
syllabus in time. Tutorial Letter 101 also contains information about the prescribed textbook
(About Financial Accounting, Volume 2, 3rd edition; Berry PR, de Klerk ES, Doussy F,
du Plooy SM, Jansen van Rensburg JS, Ngcobo RN, Rehwinkel A, and Scheepers D) that you
must purchase. The prescribed textbook forms the major learning content of this module, and
must be used according to the directives given in the study guide. For example the guide will
indicate that certain sections of the prescribed textbook need only be read, whereas other
sections must be studied thoroughly.
5 Learning outcomes and self-assessment
Learning outcomes are presented at the start of each study unit in the study guide. At the end
of each study unit there is an elementary self-assessment questionnaire which you must
complete in order to evaluate your knowledge of the learning content of each study unit and to
monitor your progress. These questionnaires are presented in the form of questions to which
you must answer either ``yes'' or ``no''. If you have answered ``yes'' to all the questions you may
proceed with the next study unit. If you have any ``no'' answers, you must study that particular
section of the work again. Since a clear understanding of certain aspects in a study unit may be
essential for your further understanding of the course, you are advised not to go on to the next
study unit until you have resolved all your problems in the preceding one.
FAC1601/1 (v)
6 Interpretation of terminology
6.1 References to the prescribed textbook
The prescribed textbook is referred to throughout the study guide. Such references usually
include action words. In this regard, the following action words should be interpreted as follows:
Action word Interpretation
Read Read so as to obtain a broad and basic background knowledge of

the subject under discussion.
Read attentively Read the theory that needs to be clearly understood. You may be
assessed on this theory by means of short questions in the
assignments.
Study Learn with a view to gaining the highest level of understanding

which is necessary to solve problems in exercises, assignments
and in the examination. This level of knowledge will also be
necessary for further studies in financial accounting and/or your
career.
You will never be required to give a definition of a concept or to
discuss theory in the examination. You will, however, be required
to apply the theory in the correct accounting format and to apply
the correct steps/procedures. For example, the layout and
terminology to be used in the preparation of financial statements
are prescribed by the International Accounting Standards. You
may not use any other format.
Prepare Compile or complete what is required on the basis of previous

study.
6.2 Examples, exercises, self-assessment criteria, assignments
and examination questions
To indicate the length, scope and format of answers to questions, action verbs have been
deliberately applied. An analysis of the action verbs in a question should enable you to
. plan the answer systematically
. ensure that you comply with the lecturer's/examiner's requirements
In order for you to correctly interpret the examples, exercises, self-assessment criteria,
assignments and examination questions, a clear understanding of the meaning of certain
words is required.
For the purpose of this module, the following interpretations are given:
(vi)
Word Interpretation
Adjust To adapt to new conditions/environment; to put in order; add;

change
Apply Use in a practical manner; use as relevant or suitable
Calculate Ascertain by mathematical procedure/exact reckoning
Clarify Make clear the meaning of; explain the intention of; show by
reasoning/evidence
Compare Examine in order to observe resemblances, relationships and
differences
Complete Finish/add what is required; show the necessary detail
Define State precisely the meaning/scope/total character of; make clear
(especially the outline of); give a concise description of the
distinguishing features of
Describe Give clearly the distinguishing details or essential characteristics
of
Discuss Examine by argument, debate, hold conversation about
Explain Set out in detail (interpret); the meaning of account for something;
make something understandable
List Record/itemise names or things belonging to a class
Mention/name/state Specify by name; cite names, characteristics, items, elements of
facts
Prepare Make ready/complete for a particular purpose; to put together
using parts; compose, construct
Reconcile To make compatible or consistent with each other
Record Put in writing; set down for reference or retention
Show To make or become visible, noticeable; to exhibit or present; to
indicate
7 References to calculations
It is very important that you show all your calculations in your answers to exercises and
questions. In the study guide and the prescribed textbook, short calculations are disclosed in
brackets after an entry in a journal, ledger account or financial statement. Note that these
calculations do not form part of the actual accounting entries. They are disclosed as such for
practical illustrative purposes only. More elaborate calculations are referred to by encircled
*
symbols, for example `` 1 ''. Subcalculations are referred to by shaded encircled symbols, for
*
example `` 1 ''. You may follow the same or a similar approach when preparing your answers.
8 References to cash transactions
You should be aware that the books of first entry in respect of cash transactions are the cash
receipts journal and the cash payments journal. However, to simplify matters in this module,
cash transactions are disclosed in the general journal.
FAC1601/1 (vii)
9 Feedback request
If there is anything discussed in the prescribed textbook or the study guide which in your
opinion needs to be explained in more detail or in a different fashion, please notify us
accordingly by post or e-mail. The postal and e-mail addresses of the lecturers are given in
Tutorial Letter 101.
(viii)
1
STUDY UNIT
Introduction to the preparation of financial

statements
CONTENTS
Learning outcomes 1
Key concepts 2
1.1 Introduction 3
1.2 Framework for the preparation and presentation of financial statements 3
1.3 Generally accepted accounting practice, Statements of Generally Accepted
Accounting Practice, and International Accounting Standards 5
1.4 Presentation of financial statements: IAS 1 (AC 101) 5
1.5 Financial instruments 7
1.6 Practical applications of IAS 1 (AC 101) 8
1.7 Exercise and solution 8
Self-assessment 11
Learning outcomes
After studying this study unit you should be able to
& describe what the concept ``the `Framework' '' entails
& listfinancial
the specific purposes of the Framework regarding the preparation and presentation of
statements
& explain the main objective of financial statements according to the Framework
& explain
the Framework
the underlying assumptions when preparing financial statements as discussed in
& discuss the qualitative characteristics of financial statements according to the Framework
& describe
statements
what the Framework means when it refers to the constraints in preparing financial
& discuss the elements of financial statements as explained in the Framework, and indicate
which elements pertain to the statement of financial position and which to the statement of
comprehensive income
& discuss the concepts of recognition and disclosure of the elements incorporated in the
financial statements, as explained in the Framework
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& explain what is meant by the measurement of the elements of financial statements by
referring to the measurement methods that are discussed in the Framework
& define the acronyms, GAAP, IFRSs, APB and SAICA, and know what they entail
& explain what type of business ownership must comply with the IFRSs
& explain what each of the following terms imply according to IAS 1 (AC 101):
Ð fair presentation
Ð going concern
Ð accrual basis of accounting
Ð materiality and aggregation
Ð offsetting
Ð frequency of reporting
Ð comparative information
Ð consistency of presentation
& listset theof financial

individual statements that, according to IAS 1 (AC 101), together form the complete
statements of a reporting entity
& explain what the identification of financial statements means
& explain what reporting period means
& explain according to IAS 1 (AC 101), which items current assets and current liabilities
generally consist of
& liststatement
the items that must, according to IAS 1 (AC 101), be presented on the face of the
of financial position and the statement of comprehensive income
& liststatement
the items that can, according to IAS 1 (AC 101), be presented on either the face of the
of financial position and the statement of comprehensive income or in the notes
to these statements for the particular reporting period
& discuss the purpose of notes, according to IAS 1 (AC 101)
& discuss, according to IAS 1 (AC 101), the order in which items are disclosed as notes to
financial statements
& define
Ð a financial instrument
Ð a financial asset
Ð a financial liabililty
Ð fair value
Ð a contract
& distinguish between the four categories of financial instruments
& recognise and initially measure financial assets and financial liabilities
& subsequently measure financial assets at fair value through profit or loss
Key concepts
& Framework
& Underlying assumptions
& Qualitative characteristics
& Components of financial statements
& Elements of financial statements
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& Recognition and disclosure
& Measurement of elements
& Capital
& Capital maintenance
& Overall considerations
& Reporting period
& Financial instruments
& Financial assets
& Financial liabilities
& Fair value
& Categories of financial instruments
1.1 Introduction
Each business entity usually has some sort of accounting system that it uses to collect data
and process information about its financial performance, position and cash flows. Such
information is then communicated to the users thereof by means of financial reporting, of which
financial statements form an integral part.
The purpose of this study unit is to explain the key concepts regarding the preparation and
presentation of financial statements according to the Framework for the Preparation and
Presentation of Financial Statements and International Accounting Standard 1.
Read paragraph 1.1 of the prescribed textbook which highlights the learning outcomes of an
introductory study of the preparation of financial statements.
1.2 Framework for the preparation and presentation of
financial statements
1.2.1 Introduction
The Framework for the Preparation and Presentation of Financial Statements (hereafter
referred to as the Framework) is a document issued by the International Accounting Standards
Board (IASB) and is a group of interrelated objectives and theoretical principles that serves as
a frame of reference for financial accounting. The contents of the Framework is discussed in
sufficient detail in the prescribed textbook and for the purpose of your studies it is unnecessary
to obtain a copy of the Framework.
Read paragraphs 1.2.1 and 1.2.2 of the prescribed textbook to determine the purpose and
relevance of the Framework.
1.2.2 Objective of financial statements
The objective of financial statements is to provide information about the financial position,
performance and changes in the financial position of an entity to the users of such information.
You must study paragraph 1.2.3 of the prescribed textbook and ensure that you understand the
objective of financial statements, as well as the information that is provided by each component
of the financial statements.
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1.2.3 Underlying assumptions when preparing financial
statements
The Framework sets out two underlying assumptions that must be taken into consideration
when preparing financial statements. These two assumptions, namely the accrual basis and
the going concern , make it possible to prepare financial statements that will meet the needs of
the users of financial statements. Study paragraph 1.2.4 of the prescribed textbook which
explains these assumptions in detail.
1.2.4 Qualitative characteristics of financial statements
Qualitative characteristics refer to those aspects, applicable to all information contained in

financial statements, that make the information in financial statements useful to users. The four
principal qualitative characteristics are:
. understandability
. relevance
. reliability
. comparability
Study paragraph 1.2.5 of the prescribed textbook, which explains these qualitative
characteristics in detail.
You should also read paragraph 1.2.6 of the prescribed textbook, which explains the
constraints that affect these qualitative characteristics.
1.2.5 Elements of financial statements
The necessary information for preparing the financial statements of a business entity is
gathered from book entries that are made during a financial period in the journals and ledgers
of the business entity. This information is grouped into elements, which are in turn grouped
under two headings, namely those elements that pertain to the , and those
financial position
that pertain to the financial performance of the entity.
Paragraph 1.2.7 of the prescribed textbook discusses these elements in detail. Study them
carefully.
1.2.6 Recognition and disclosure
Read attentively through paragraph 1.2.8 of the prescribed textbook, which explains the
meaning of recognition and disclosure. The important thing to understand is that before an item
can be disclosed in a financial statement, it must first be recognised. However, all recognised
items need not be disclosed. Take note of when an element of the financial statements should
be recognised, and what the criteria for the recognition of each element are.
1.2.7 Measurement of the elements in financial statements
In this respect, measurement means the process of determining the monetary amounts at
which the elements of the financial statements are to be recognised and disclosed. The
Framework lists four bases of measurement, namely historical costs, realisable value, current
costs and present value. Take note that fair value is also regarded as a basis of measurement.
Paragraph 1.2.9 of the prescribed textbook explains each of these measurement bases. Read
through it attentively.
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1.2.8 The concepts of capital and capital maintenance
The measurement basis and the concepts of capital and capital maintenance determine the
model according to which financial statements are prepared. There are two basic concepts of
capital and capital maintenance, namely the and the
financial concepts.
physical
The financial concept is synonymous with the net assets or equity of a business entity. The
physical concepts pertains to the productive capacity of the entity, for example, the units of
production per day.
Read attentively through paragraph 1.2.10 of the prescribed textbook, which explains these
two concepts in detail.
1.3 Generally accepted accounting practice, Statements of
Generally Accepted Accounting Practice and Interna-
tional Accounting Standards
GAAP is the acronym for Generally Accepted Accounting Practice. Generally accepted accounting
practice refers to practices (recording and reporting) that are deemed by accountants to be
acceptable when reporting on the financial position and financial performance and changes in the
financial position of a business entity. The Statements of Generally Accepted Accounting Practice
are the documented generally accepted accounting standards and practices as approved by the
Accounting Practices Board in South Africa (APB) and are issued by the South African Institute of
Charted Accountants (SAICA).
The Statements of GAAP need only be applied when the financial statements of entities that
are incorporated under the Companies Act 61 of 1973 are prepared because the Companies
Act, in paragraph 5 of Schedule 4, requires compliance with the Statements of GAAP. The fact
that such compliance is not required by any other form of business ownership does not mean
that the requirements of these statements cannot be applied when the financial statements of
business entities other than companies are prepared. The South African Statements of GAAP
were recently revised to comply with the International Financial Reporting Standards (IFRSs).
These revised statements had to be complied with as from 1 January 2005.
In South Africa we apply a dual numbering system to simultaneously refer to the IFRSs and the
Statements of GAAP. For example, IAS 1 (AC 101) refers to International Accounting Standard
1 and to the corresponding South African Statement of GAAP, AC 101.
Read paragraph 1.3 of the prescribed textbook, which presents an interesting background and
facts about GAAP as it is currently applied in South Africa. Ensure that you understand why a
dual numbering system is used in South Africa.
1.4 Presentation of financial statements: IAS 1 (AC 101)
1.4.1 Introduction
The objective of IAS 1 (AC 101) is to prescribe the basis for the presentation of general
purpose financial statements so as to ensure comparability with
. an entity's financial statements pertaining to previous financial periods, and with
. the financial statements of other comparable entities.
Read paragraph 1.4.1 of the prescribed textbook to learn more about the objective and
purpose of IAS 1 (AC 101).
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1.4.2 Definitions
Certain accounting terms are used in IAS 1 (AC101). Paragraph 1.4.2 in the prescribed
textbook lists some of the terms with their definitions. Read through this paragraph attentively
and refer back to it when you encounter a term during your studies.
1.4.3 The purpose of financial statements
The main purpose of financial statements is to provide useful information to the users thereof.
To meet this purpose, financial statements must provide information about each of the
elements as listed by the Framework in a specific format. Read attentively through paragraph
1.4.3 of the prescribed textbook, which explains the elements that need to be reported on, as
well as what IAS 1 (AC 101) regards as a complete set of financial statements.
1.4.4 General features of financial statements
IAS 1 (AC 101) lists the following eight items that must all be considered when preparing
financial statements:
. Fair presentation
. Going concern
. Accrual basis of accounting
. Materiality and aggregation
. Offsetting
. Frequency of reporting
. Comparative information
. Consistency of presentation
Paragraph 1.4.4 of the prescribed textbook explains each of these items in detail and must be
studied carefully.
1.4.5 Structure and contents of financial statements
1.4.5.1 Introduction
Structure and contents have to do with the format in which financial statements must be
presented and with the items that must be disclosed. Structure and contents are essential
aspects that pertain to the preparation of financial statements and need to be studied carefully.
Read paragraph 1.4.5.1 of the prescribed textbook.
1.4.5.2 Identification of financial statements
Each financial statement and component thereof must be identified by giving it a name that
pertains to its particular function. Study paragraph 1.4.5.2 of the prescribed textbook.
1.4.5.3 Statement of financial position
Study paragraph 1.4.5.3 of the prescribed textbook. This paragraph highlights the classification
of assets into non-current and current assets, and liabilities into non-current and current
liabilities. It also indicates
. which information must be presented on the face of a statement of financial position, and
. which information must be presented either on the face of the statement of financial position
or in the notes to the financial statements
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1.4.5.4 Statement of comprehensive income
Study paragraph 1.4.5.4 of the prescribed textbook, as it indicates which items must be
presented on the face of the statement of comprehensive income and which items can be
presented either on the face of the statement of comprehensive income, or in the notes to the
financial statements.
Note that, for the purpose of studying FAC1601, expenses will be disclosed in a statement of
comprehensive income according to their function, and that IAS 1 (AC 101) requires certain
minimum disclosures when this method is applied.
1.4.5.5 Statement of changes in equity
Paragraph 1.4.5.5 of the prescribed textbook indicates the items that must be disclosed on the
face of the statement of changes in equity, and the items that can be disclosed either on the
face of the statement of changes in equity or in the notes to the financial statements.
Note that the format (layout) of the statement of changes in equity depends on the type of
business ownership for which it is prepared. Also note that if this statement is prepared for a
close corporation, the name of the statement is shown as: ``Statement of changes in net
investment of members.''
1.4.5.6 Statement of cash flows
Although a statement of cash flows forms part of the financial statements, statements of cash
flows are discussed separately in study unit 7. Read paragraph 1.4.5.6 of the prescribed
textbook to determine the reason why statements of cash flows are dealt with separately in
FAC1601.
1.4.5.7 Notes
Paragraph 1.4.5.7 of the prescribed textbook indicates which items must be presented as notes to
the financial statements. One of these notes must be an affirmation that the financial statements
were prepared according to the requirements of GAAP (IFRSs). A summary of the significant
accounting policies must also be given in a note. Furthermore, as mentioned previously certain
items can be disclosed either on the face of a financial statement, or as notes, depending on the
instructions given to the preparer of the financial statements. Study this paragraph.
Please take note that a calculation, for example the calculation of depreciation, is NOT a note
to a financial statement and must not be indicated as such.
1.5 Financial instruments
1.5.1 Introduction and definitions
Financial instruments are defined as IAS 32 (AC 125) .11 as any contract that gives rise to a
financial asset of one entity and a financial liability or equity instrument of another entity. Read
paragraph 1.5.1 of the prescribed textbook where the references to IAS 32 (AC 125), IAS 39
(AC 133) and IFRS 7 (AC 144) that deals with financial instruments are given. In paragraph
1.5.2 the definitions of the elements of financial instruments, fair value and a contract are given.
Study these definitions to enable you to identify the elements and know what fair value and a
contract is.
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1.5.2 Identification, recognition and measurement of financial
instruments
In paragraphs 1.5.3 and 1.5.4 the identification of financial assets and financial liabilities and
the recognition and measurement of financial instruments are explained. Read these
paragraphs attentively to ensure you can identify financial assets and financial liabilities,
distinguish between the four categories of financial instruments and know how financial
instruments are initially and subsequently measured.
Study example 1.1. It is very important to understand the entries as explained in this example
and be able to record the necessary entries given in similar exercises.
1.6 Practical applications of IAS 1 (AC 101)
In paragraph 1.6 of the prescribed textbook the theory discussed in this study unit is applied in
the preparation and presentation of financial statements. Although IAS 1 (AC 101) requires a
specific order in which financial statements must be presented, FAC1601 presents the
statements in a different order. The reason for this is that for study purposes it is easier to make
it clear how statements are linked to each other when they are presented in a different order.
The following table indicates the order of presentation as required by IAS 1 (AC 101), and the
order in which the financial statements are presented in FAC1601:
Order of presentation Order of presentation

[required by IAS 1 (AC 101)] [as illustrated in FAC1601]
1. Statement of financial position as at the 1. Statement of comprehensive income for
end of the period the period
2. Statement of comprehensive income for 2. Statement of changes in equity (sole
the period proprietors, partnerships and compa-
3. Statement of changes in equity (sole nies)/Statement of changes in net invest-
proprietors, partnerships and compa- ment of members (close corporations)
nies)/Statement of changes in net invest- 3. Statement of financial position as at the
ment of members (close corporations) end of the period
4. Statement of cash flows for the period 4. Notes
5. Notes For the purpose of FAC1601, the state-
ment of cash flows, although part of the
financial statements, is dealt with sepa-
rately and will also be examined sepa-
rately from the other financial statements.
Study the example in paragraph 1.6 of the prescribed textbook.
1.7 Exercise and solution
REQUIRED
Answer the following:
(a) List the main users of financial statements.
(b) Name two specific purposes of the Framework.
(c) What, according to the Framework, is the objective of financial statements?
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(d) Discuss briefly what is meant by the accrual and the going concern assumptions of
accounting. Refer to the textbook.
(e) List the qualitative characteristics of financial statements.
(f) When will each of the following elements be recognised in the appropriate financial
statement?
Assets
Liabilities
Income
Expenses
(g) Name five measurement bases.

(h) What does GAAP stand for?
(i) When are items considered to be material?
(j) When are assets regarded as being current in nature?
(k) When are liabilities regarded as being current in nature?
(l) Which items must, as a minimum requirement, be disclosed on the face of a
statement of financial position?
(m) On 1 March 20.2 Louis CC purchased 100 ordinary shares of R100 each in Marble
Ltd, a company listed on the JSE Securities Exchange. The purpose of this
investment was speculative in nature. The transaction costs amounted to R500.
On 28 February 20.3, the end of the financial year of Louis CC, the shares were
trading at R125 per share on JSE Securities Exchange.
Record the above transactions in the general journal of Louis CC.
Solution
(a) Present and potential investors, employees and people seeking employment with the
entity, lenders, trade and other creditors, customers, the government and its agencies, as
well as the general public.
(b) To assist the accountant in the preparation and presentation of financial statements and to
serve as a general guideline to the users of financial statements in the interpretation
thereof.
(c) The objective of financial statements is to provide information about the financial position,
performance and changes in the financial position of an entity that is useful to a wide range
of users in making economic decisions.
(d) The accrual assumption of accounting entails that the effect of transactions and other
events are recognised when they occur and that these transactions are recorded in the
accounting records and reported in the financial statements of the periods to which they
relate. `Òccur'', in this respect, means when a transaction initially takes place and not
necessarily when cash or a cash equivalent was received or paid. The going concern
assumption means that the financial statements of an entity are prepared on the basis that
it will continue in operation for the foreseeable future. This means that the business has
neither the intention nor the need to liquidate or curtail the scale of its operations materially.
(e) Understandability, relevance, reliability and comparability.
(f) Assets : An asset is recognised in the statement of financial position when it is probable that
the future economic benefits thereof will flow to the entity, and when the asset has a cost or
a value that can be measured reliably.
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: A liability is recognised in the statement of financial position when it is probable
Liabilities
that an outflow of resources embodying economic benefits will result from the settlement of
a present obligation, and the amount at which the settlement will take place can be
measured reliably.
Income : Income is recognised in the statement of comprehensive income when an
increase in future economic benefits related to an increase in an asset or a decrease of a
liability has arisen that can be measured reliably. This means that the recognition of
income occurs simultaneously with the recognition of increases in assets or decrease in
liabilities, for example merchandise sold for cash.
Expenses : Expenses are recognised in the statement of comprehensive income when a
decrease in future economic benefits related to a decrease in an asset or an increase of a
liability has arisen that can be measured reliably. This means that the recognition of
expenses occurs simultaneously with the recognition of an increase in liabilities or a
decrease in assets. Expenses are recognised in the statement of comprehensive income
on the basis of a direct association between incurred costs and the earning of specific
items of income. This process, commonly referred to as the matching of costs with
revenue, involves the simultaneous or combined recognition of revenue and expenses that
result directly and jointly from the same transaction, for example, matching revenue with
the cost of sales (in respect of trading merchandise), where the revenue is derived from the
sale of such merchandise.
(g) Historical costs, realisable value, current costs, present value and fair value.
(h) Generally Accepted Accounting Practice.
(i) Items are material if they could, individually or collectively, and as a result of their omission
or misstatement, influence the economic decisions of users taken on the basis of the
information in the financial statements. Materiality depends on the size and nature of the
omission of misstated judgement in the surrounding circumstances. The size or nature, or
a combination of both, could be the determining factor.
(j) An asset is classified as current when it satisfies any of the following criteria:
. It is expected to be realised in, or intended for sale or consumption, in the entity's normal
operating cycle.
. It is held primarily for the purpose of being traded.
. It is expected to be realised within twelve months after the statement of financial position
date.
. It is cash or a cash equivalent unless it is restricted from being exchanged or used to
settle a liability for at least twelve months after the statement of financial position date.
(k) A liability is classified as current when it satisfies any of the following criteria:
. It is expected to be settled in the entity's normal operating cycle.
. It is held primarily for the purpose of being traded.
. It is due to be settled within twelve months after the statement of financial position date.
. The entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the statement of financial position date.
(l) . property, plant and equipment
. intangible assets
. financial assets
. inventories
. trade receivables
. cash and cash equivalents
. trade and other payables
. financial liabilities
. issued capital and reserves attributable to owners
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FAC1601/1
(m)
LOUIS CC
GENERAL JOURNAL
Debit Credit
R R
20.2
Mar 1 Investment: Shares in Marble Ltd (R100 6 100) 10 000
Investment expenses (transaction costs) 500
Bank 10 500
Initial recognition of investment at cost and recording of
investment expenses
20.3
Feb 28 Profit or loss account 500
Investment expenses 500
Closing off of investment expenses
Investment: Shares in Marble Ltd (R25 6 100) 2 500

Gain on financial asset at fair value through profit or
loss 2 500
Gain on subsequent measurement of investment in the
shares of Marble Ltd at the financial year end
Gain on financial asset at fair value through profit or loss 2 500

Profit or loss account 2 500
Closing off of gain on financial asset at fair value through
profit or loss
SELF-ASSESSMENT
After having worked through this study unit, are you able to
Yes No
. describe what the concept the ``Framework'' entails?
. list the specific purposes of the Framework regarding preparation
and presentation of financial statements?
. explain the main objective of financial statements according to the
Framework?
. explain the underlying assumptions when preparing financial
statements as discussed in the Framework?
. discuss the qualitative characteristics of financial statements
according to the Framework?
. describe what the Framework means when it refers to constraints
when financial statements are prepared?
. discuss the elements of financial statements as explained in the
Framework, and indicate which elements pertain to the statement of
financial position and which to the statement of comprehensive
income?
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FAC1601/1
Yes No
. discuss the concepts of recognition and disclosure of the elements
incorporated in the financial statements as explained in the
Framework?
. explain what is meant by the measurement of the elements of
financial statements by referring to the Framework?
. explain what the acronyms: GAAP, IFRSs, APB and SAICA stand
for?
. explain what type of business ownership must comply with the
IFRSs?
. explain what each of the following terms means by referring to IAS 1
(AC 101)?
Ð fair presentation
Ð going concern
Ð accrual basis of accounting
Ð materiality and aggregation
Ð offsetting
Ð frequency of reporting
Ð comparative information
Ð consistency of presentation
. list the individual statements that, according to IAS 1 (AC 101),
together form a complete set of financial statements of a reporting
entity?
. explain what the identification of financial statements means?
. explain what items are current assets and current liabilities,
according to IAS 1 (AC 101)?
. list the items that must be presented on the face of a statement of
financial position, statement of changes in equity and a statement of
comprehensive income, according to IAS 1 (AC 101)?
. list the items that can, according to IAS 1 (AC 101), be presented on
either the face of the referred to financial statements or in the notes
for the financial period?
. discuss the purpose of notes to financial statements, according to
IAS 1 (AC 101)?
. discuss the order in which notes are normally presented, as
indicated by IAS 1 (AC 101)?
. define a financial instrument, financial asset, financial liability, fair
value and a contract?
. distinguish between the four categories of financial instruments?
. subsequently measure a financial asset at fair value through profit or
loss?
If you answered ``yes'' to all of the above assessment criteria, you can move on to study
unit 2. If your answer was ``no'' revise that section before progressing to study unit 2.
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FAC1601/1
2
STUDY UNIT
Establishment and financial statements of

a partnership
CONTENTS
Learning outcomes 13
Key concepts 14
2.1 Introduction 15
2.2 Reasons for the formation of partnerships 15
2.3 The legal position of a partner 15
2.4 Establishment of a partnership 15
2.5 The partnership agreement 15
2.6 Dissolution of a partnership 15
2.7 Accounting procedures and specialised accounts 15
2.8 Financial statements of a partnership 16
2.9 Exercises and solutions 16
Self-assessment 36
Learning outcomes
& define a partnership
& explain the reasons why partnerships are formed
& discuss the contents of a partnership agreement
& explain the ways in which a partnership can be established
& explain the factors which can lead to the dissolution of a partnership
& record the transactions of a partnership in its books
& prepare the financial statements of a partnership in accordance with the requirements of
Generally Accepted Accounting Practice, appropriate to the business of a partnership
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FAC1601/1
Key concepts
& Partnership
& Partners
& Partnership agreement
& Profit-sharing ratio
& Dissolution
& Legal approach
& Entity approach
& Equity
& Appropriation account
& Financial statements
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2.1 Introduction
Because a sole proprietorship (tradership) has only one owner, and therefore usually a limited
capital resource, persons often decide to form a business entity with more than one owner.
Should these persons opt to establish a business entity with the minimum of complicated legal
proceedings, the natural choice of business ownership would be a partnership. Read
paragraph 2.1 of the prescribed textbook attentively. Pay special attention to the definition of a
partnership and the difference between a business entity with and without legal status.
2.2 Reasons for the formation of partnerships
The main reason for the formation of a partnership is to start a business entity with a stronger
capital structure than that of a sole proprietorship. Read attentively through paragraph 2.2 of
the prescribed textbook, which explains the reasons for the formation of a partnership.
2.3 The legal position of a partner
In South Africa there is no specific legislation which pertain to partnerships. The operations of
partnerships are mainly conducted according to common law. A partner in a partnership has
the same legal status as the owner of a sole proprietorship. Read paragraph 2.3 of the
prescribed textbook. This paragraph discusses the legal position of a partner and a
partnership.
2.4 Establishment of a partnership
Read paragraph 2.4 of the prescribed textbook. Note how a partnership can be established by
action and agreement.
2.5 The partnership agreement
In order for the business operations of a partnership to run smoothly, certain rules of conduct
which form the basis of a partnership agreement must be decided on. A partnership agreement
should preferably be in written form. Read paragraph 2.5 of the prescribed textbook attentively
and pay special attention to the appropriation of profits and losses between partners.
2.6 Dissolution of a partnership
The dissolution of a partnership can be caused by a number of circumstances. Being an

unincorporated form of business ownership, a partnership has a lifespan which is limited to the
constancy of its ownership structure. For example, if a partner dies or retires, or if a new partner
is admitted, the existing partnership is dissolved and a new partnership may be formed. From a
technical point of view, even a change in the profit-sharing ratio between partners changes the
ownership structure of the partnership and causes the dissolution of the partnership. Read
paragraph 2.6 of the prescribed textbook for more information on the dissolution of a
partnership.
2.7 Accounting procedures and specialised accounts
Having more than one owner in a business makes it necessary to adopt accounting procedures
and records that will suit the needs of multiple ownership. Basically, there are two approaches
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FAC1601/1
when an accounting system is developed for a partnership, namely a legal and a (business)
entity approach. Study paragraph 2.7 of the textbook carefully, and ensure that you understand
the difference between these two approaches. In FAC1601 the legal approach is followed.
Study paragraphs 2.7.1 to 2.7.4 of the prescribed textbook carefully, taking special note of the
application of the accounts referred to. In paragraph 2.7.4 the recording of salaries and
bonuses to partners are explained. It is very important to take note of the entries as explained
in this paragraph.
Study example 2.1. Note how transactions that are unique to a partnership are recorded in the
journals and ledgers of a partnership.
2.8 Financial statements of a partnership
Since a partnership has more than one owner, its financial statements differ slightly from the
financial statements of a sole proprietorship. You must remember that the financial statements
of a partnership are prepared according to the legal approach. Read paragraph 2.8 and study
example 2.2 in the prescribed textbook. (If you experience difficulties with the adjustment
entries, please revise the section on adjustments in the FAC1501 study guide.)
After having worked through example 2.2, you must study example 2.3, which represents the
accounting procedure to be followed when a partnership has been trading at a loss.
2.9 Exercises and solutions
Exercise 2.1
Preparation of the financial statements of a partnership
Work through the following, taking special note of how to make year-end adjustments and to
prepare the financial statements of a partnership by utilising your knowledge of FAC1501, the
Framework, IAS 1 (AC 101), GAAP and partnerships in general.
Given information
The undermentioned information was taken from the accounting records of Bluered Traders, a
partnership with B Blue and R Red as partners, at 30 September 20.1, the financial year-end of
the partnership.
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BLUERED TRADERS
PRE-ADJUSTMENT TRIAL BALANCE AS AT 30 SEPTEMBER 20.1
Debit Credit
R R
Capital (fixed):
B Blue 20 000
R Red 5 000
Current accounts (1 October 20.0)
B Blue 1 060
R Red 2 800
Drawings (during the year):
B Blue 9 000
R Red 3 000
Mortgage 10 000
Creditors control 24 150
Bank overdraft 6 160
Land and buildings at cost 19 500
Equipment at cost 19 840
Accumulated depreciation: Equipment (1 October 20.0) 5 000
Motor vehicles at cost 900
Accumulated depreciation: Motor vehicles (1 October 20.0) 500
Office furniture at cost 350
Accumulated depreciation: Office furniture (1 October 20.0) 50
Inventory (30 September 20.1) 21 069
Debtors control 16 020
Allowance for credit losses (1 October 20.0) 600
Petty cash 32
Sales 340 628
Cost of sales 306 000
Advertising costs 4 409
Office salaries and wages 12 189
Administrative expenses 622
Insurance expense 364
Delivery expenses 2 203
Interest on mortgage 450
415 948 415 948
Additional information
1 Terms of the partnership agreement
1.1 The partners B Blue and R Red share profits and losses in the ratio of their (fixed) capital.
1.2 Interest at 5% per annum is to be allowed on the opening balances of the partners'
capital and current accounts.
1.3 Interest is to be charged at 5% per annum on the average monthly amount outstanding
on the partners' drawings accounts. (Amounts are given, see paragraph 2.7 under ``Year-
end adjustments'' below.)
1.4 R Red is entitled to a salary of R1 000 per annum plus a management commission of
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FAC1601/1
10% on the comprehensive income for the financial year after his salary has been
debited and after adjustments for the interest on the capital, current and drawings
accounts.
2 Year-end adjustments
2.1 An outstanding debt of R20 is irrecoverable and must be written off.

2.2 The allowance for credit losses must be adjusted to R800.
2.3 Depreciation is to be provided for as follows:
Equipment: 15% per annum according to the diminishing-balance method. (NB: A
new machine was purchased on 1 April 20.1 for R1 560.)
Motor vehicles: 20% per annum according to the straight-line method
Office furniture: 10% per annum according to the diminishing-balance method
2.4 Interest on the mortgage up to 30 September 20.1 amounts to R600.

R4 000 of the loan is repayable during the 20.2 financial year. The loan is secured by a
mortgage over land and buildings. The loan was granted by Corner Bank on
1 October 20.0. The terms of the loan provide for interest on the loan to be charged at
a rate of 6% per annum.
2.5 Office salaries of R69 have not been paid or taken into account.
2.6 The following expenses have been prepaid:
Insurance R62
Advertising R948
2.7 Interest calculated on the partners' drawings accounts amounted to R320 for B Blue and
R80 for R Red.
2.8 In terms of the partnership agreement, the following must still be provided for:
Ð interest on the partners' capital and current accounts
Ð R Red's salary and management commission
REQUIRED
(a) Prepare the following in respect of Bluered Traders to comply with the requirements
of Generally Accepted Accounting Practice (comparative figures are not required),
appropriate to the business of the partnership:
(i) Statement of comprehensive income for the year ended 30 September 20.1
(ii) Statement of changes in equity for the year ended 30 September 20.1
(iii) Statement of financial position as at 30 September 20.1
(iv) Notes for the year ended 30 September 20.1
(b) Prepare the current accounts of the partners, properly balanced, in the general ledger
of Bluered Traders for the year ended 30 September 20.1. Show the correct contra
ledger accounts.
NB: Show all calculations.
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Solution 2.1
(a)(i)
BLUERED TRADERS
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 SEPTEMBER 20.1
Note R
Revenue 2 340 628
Cost of sales (306 000)
Gross profit 34 628)
Distribution, administrative and other expenses (21 385)
Salaries and wages R(12 189 + 69) 12 258)
Advertising costs R(4 409 ± 948) 3 461)
Delivery expenses 2 203)
Administrative expenses 622)
Insurance expense R(364 ± 62) 302)
Credit losses 1 220)
Depreciation 2 3 2 319)
Finance costs (600)
Interest on mortgage R(450 + 150 )
3 600
Profit for the year 12 643)
Other comprehensive income for the year Ð
Total comprehensive income for the year 12 643
* In FAC1601 an item may be excluded if it has no value. General Accepted Accounting Practice requires us to show a
complete statement of comprehensive income and for this reason other comprehensive income will be indicated
throughout this study guide without any value.
(a)(ii)
BLUERED TRADERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 SEPTEMBER 20.1
Capital Current accounts
Appro- Total
B Blue R Red B Blue R Red priation equity
R R R R R R
Balances at 1 October 20.0 20 000 5 000 1 060) 2 800) Ð 28 860)

Total comprehensive income for
the year 12 643) 12 643)
Salaries to partners 1 000) (1 000)

Interest on capital 4 1 000) 250) (1 250)
Interest on current accounts 5 53) 140) (193)
Interest on drawings (320) (80) 400)
Commission to partners 6 1 060) (1 060)
Partners' share of total compre-
hensive income 7 7 632) 1 908) (9 540)
Drawings (9 000) (3 000) (12 000)
Balances at 30 September 20.1 20 000 5 000 425) 4 078) Ð 29 503)
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(a)(iii)
BLUERED TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20.1
Note R
ASSETS
Non-current assets 32 721
Property, plant and equipment 2, 3 32 721
Current assets 37 311
Inventories 21 069
Trade receivables R(16 000 ± 800) 4 15 200
Prepayments R(948 + 62) 8 4 1 010
Cash and cash equivalents 32
Total assets 70 032
EQUITY AND LIABILITIES
Total equity 29 503
Capital R(20 000 + 5 000) 25 000
Current accounts R(425 + 4 078) 4 503
Total liabilities 40 529
Non-current liabilities 6 000
Long-term borrowings 5 6 000
Current liabilities 34 529
Trade and other payables 5 24 369
Current portion of long-term borrowings 5 4 000
Other financial liabilities 5 6 160
Total equity and liabilities 70 032
(a)(iv)
BLUERED TRADERS
NOTES FOR THE YEAR ENDED 30 SEPTEMBER 20.1
1. Basis of presentation
The financial statements have been prepared in accordance with Generally Accepted
Accounting Practice appropriate to the business of the entity. The financial statements have
been prepared on the historical cost basis, modified by the revaluation of financial assets and
financial liabilities at fair value through profit or loss.
2. Summary of significant accounting policies

The financial statements incorporate the following significent accounting policies which are
consistent with those applied in previous years except where otherwise stated.
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2.1 Property, plant and equipment
Property, plant and equipment are initially recognised at cost price. No depreciation is written
off on land and buildings. Equipment, vehicles and furniture are subsequently measured at
historical cost less accumulated depreciation and accumulated impairment losses.
Depreciation on equipment, vehicles and furniture are written off at a rate deemed to be
sufficient to reduce the carrying amount of the assets over their estimated useful life to their
estimated residual value. The depreciation rates are as follows:
Equipment: 15% per annum according to the diminishing-balance method;
Motor vehicles: 20% per annum according to the straight-line method;
Furniture: 10% per annum according to the diminishing-balance method.
Depreciation is charged to profit or loss for the year. Gains or losses on disposal are
determined by comparing the proceeds with the carrying amount of the asset. The net amount
is included in profit or loss for the year.
2.2 Financial assets

Financial assets are recognised in the entity's statement of financial position when the entity
becomes a party to the contractual provisions of an instrument.
Financial instruments are initially measured at cost which is fair value plus transaction costs,
except for ``Financial assets at fair value through profit or loss'' which are measured at cost,
transaction costs excluded.
The entity classifies its financial assets in the following categories: at fair value through profit or
loss and loans and receivables. The entity's classification depends on the purpose for which
the entity acquired the financial assets.
Cash and cash equivalents are classified as ``Financial assets at fair value through profit or
loss''. Cash and cash equivalents consists of cash on hand.
2.3 Inventories
Inventories are initially measured at cost and subsequently valued at the lower of cost or net
realisable value. Cost is calculated using the first-in, first-out method. Net realisable value is the
estimated selling price in the ordinary course of business less any costs of completion and
disposal.
2.4 Financial liabilities

Financial liabilities are recognised in the entity's statement of financial position when the entity
becomes a party to the contractual provisions of the instrument. The classification depends on
the purpose for which the financial liabilities were obtained.
2.5 Revenue
Revenue is measured at the fair value of the consideration received or receivable. Revenue
from the sale of goods consists of the total net invoiced sales excluding settlement discount
granted. The entity is not registered as a VAT vendor. The revenue from sales is recognised
when the ownership is transferred to the customer.
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3. Property, plant and equipment
Land and Equip- Motor Office
buildings ment vehicles furniture Total
R R R R R
Carrying amount at
1 October 20.0 19 500) 13 280) 400) 300) 33 480 )
Cost 19 500) 18 280) 900) 350) 39 030)
Accumulated depreciation (Ð) (5 000) (500) (50) (5 550)
Additions Ð) 1 560) Ð) Ð) 1 560)
Disposals* (Ð) (Ð) (Ð) (Ð) (Ð)
Depreciation for the year Ð) (2 109) (180) (30) (2 319)
Carrying amount at
30 September 20.1 19 500 ) 12 731) 220) 270) 32 721)
Cost 19 500) 19 840) 900) 350) 40 590)
Accumulated depreciation (Ð) (7 109) (680) (80) (7 869)
The partnership has pledged land and buildings with a carrying amount of R19 500
(20.0 : R19 500) as security for the mortgage obtained from Corner Bank.
* Included for ilustrative purposes. If there were no disposals, this item must be excluded from the note. Disposals are
disclosed at their carrying amount.
4. Financial assets
20.1
R
Current financial assets
Trade receivables: 15 200)
Debtors control 16 000)
Allowance for credit losses (800)
Other financial assets:
Financial assets at fair value through profit or loss:
Cash and cash equivalents: 32)
Petty cash 32)
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5. Financial liabilities
20.1
R
Non-current financial liabilities
Long-term borrowings: 6 000))
Mortgage: The mortgage was acquired from Corner Bank on 1 October 20.0 )
at an interest rate of 6% per annum. According to the terms of
the loan R4 000 is repayable during the 20.2 financial year. This
loan is secured by a first mortgage over land and buildings
(refer note 3).
Mortgage 10 000)
Current portion of loan (4 000)
Non-current portion 6 000)
Current financial liabilities
Trade and other payables: 24 369))
Creditors control 24 150)
Accrued expenses: )
Office salaries payable 69)
Interest on mortgage 150)
Current portion of long-term borrowings 4 000
Other financial liabilities: )
Financial liabilities at fair value through profit or loss 6 160))
Bank overdraft 6 160)
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Calculations

1 Credit losses
R
Credit losses written off 20)
Increase in allowance for credit losses 1 * 200)
Credit losses 220)
* Increase in allowance for credit losses

1
R
Allowance for credit losses (30 September 20.1): 800)
Allowance for credit losses (1 October 20.0) (600)
Increase in allowance for credit losses 200

2 Depreciation
On equipment: R
Old equipment R(19 840 ± 1 560) = R18 280
R(18 280 ± 5 000) x 15% = R1 992 1 992)
New equipment R1 560 x 15% x 6¤12 2 117)
On office furniture: R(350 ± 50) x 10% 30)
On motor vehicles: R900 x 20% 180)
2 319)

3 Interest payable on mortgage
R(600 ± 450) = R150

4 Interest on capital accounts
R
B Blue Ð R20 000 x 5% 1 000)
R Red Ð R5 000 x 5% 250)
1 250)

5 Interest on current accounts
R
B Blue Ð R1 060 x 5% 53)
R Red Ð R2 800 x 5% 140)
193)

6 Management commission: R Red
R
Total comprehensive income for the year 12 643)
Less : Salary to R Red (1 000)
Interest on capital (1 250)
Interest on current accounts (193)
Add : Interest on drawings 400)
Comprehensive income before commission 10 600
; R10 600 x 10% = R1 060

7 Partners' share of total comprehensive income R
Comprehensive income before commission (calculation )
6 10 600
Commission (1 060)
Comprehensive income available for distribution 9 540
B Blue Ð R9 540 x 20 000/25 000 = R7 632
R Red Ð R9 540 x 5 000/25 000 = R1 908
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FAC1601/1

8 Prepayments
R
Advertising costs 948
Insurance expenses 62
1 010
Comment
Note that when preparing financial statements for a partnership business entity, the format and
the terminology used must comply with the requirements of GAAP for study purposes.
(b)
BLUERED TRADERS
GENERAL LEDGER
Dr Current account Cr
B Blue R Red B Blue R Red
20.1 R R 20.0 R R
Sep 30 Interest on draw- Oct 1 Balance b/d 1 060 2 800
ings 320 80 20.1
Drawings (for the Sep 30 Salary to partner 1 000
year) 9 000 3 000 Interest on capital 1 000 250
Balance c/d 425 4 078 Interest on cur-
rent account 53 140
Commission 1 060
Appropriation
account 7 632 1 908
9 745 7 158 9 745 7 158
20.1
Oct 1 Balance b/d 425 4 078
Comment
The current accounts were prepared in columnar format. If you prepared a separate account for
each partner, this is also acceptable.
Exercise 2.2
Work through the exercise, taking special note of how to make year-end adjustments and to
Given information
The information provided below were taken from the accounting records of Toypork Traders, a
partnership with T Toy and P Porky as partners, at 28 February 20.3, the financial year-end of
the partnership.
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FAC1601/1
BALANCES AS AT 28 FEBRUARY 20.3
Debit Credit
R R
Sales 100 000

Settlement discount received 1 450
Purchases returns 850
Administrative expenses 33 750
Sales returns 860
Purchases 44 000
Settlement discount granted 2 400
Credit losses 2 440
Drawings: T Toy 3 880
Drawings: P Porky 1 800
Depreciation: Furniture and fittings 940
Depreciation: Motor vehicles 3 000
Land and buildings 20 000
Motor vehicles at cost 36 000
Furniture and fittings at cost 12 000
Inventory (1 March 20.2): 21 530
Allowance for settlement discount received 400
Current account balances (1 March 20.2):
T Toy 500
P Porky 600
Capital account balances (1 March 20.2):
T Toy 40 000
P Porky 20 000
Accumulated depreciation:
Furniture and fittings 5 298
Motor vehicles 14 800
Allowance for settlement discount granted 500
Allowance for credit losses 2 300
207 620 207 620
1 T Toy and P Porky share profits and losses in the ratio of 2:1 repectively.
2 On 28 February 20.3, salaries for services rendered according to the partnership
agreement were paid to the partners as follows: T Toy: R6 000, and P Porky, R4 000.
Both these amounts were recorded as administrative expenses.
3 Inventory on 28 February 20.3 amounted to R19 100.
4 Interest calculated on the partners' capital accounts amounted to R2 140 for T Toy and
R1 070 for P Porky.
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FAC1601/1
REQUIRED
(a) Prepare the following in respect of Toypork Traders to comply with the requirements
of Generally Accepted Accounting Practice (comparative figures are not required),
appropriate to the business of the partnership:
(i) Statement of comprehensive income for the year ended 28 February 20.3
(ii) Statement of changes in equity for the year ended 28 February 20.3
(iii) Statement of financial position as at 28 February 20.3
(iv) The note pertaining to property, plant and equipment for the year ended
28 February 20.3
(b) Prepare the appropriation account, properly closed off, in the general ledger of
Toypork Traders for the year ended 28 February 20.3. Show the correct contra ledger
accounts.
(c) Prepare the partners' current accounts, properly balanced, in the general ledger of
Toypork Traders for the year ended 28 February 20.3. Show the correct contra ledger
accounts.
Solution 2.2
(a)(i)
TOYPORK TRADERS
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 20.3
Note R
Revenue R(100 000 ± 860 ± 2 400) 96 740)
Inventory (1 March 20.2) 21 530)
Purchases R(44 000 ± 850 ± 1 450) 41 700)
63 230)
Inventory (28 February 20.3) (19 100)

Administrative expenses R(33 750 ± 10 000) 23 750)
Credit losses 2 440)
Depreciation 2 3 940)
Profit for the year 22 480

Total comprehensive income for the year 22 480)
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FAC1601/1
(a)(ii)
TOYPORK TRADERS
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.3
Appro- Total
T Toy P Porky T Toy P Porky priation Equity
R R R R R R
Balances at 1 March 20.2 40 000 20 000 (500) (600) Ð 58 900)

the year 22 480) 22 480)
Salaries to partners 6 000) 4 000) (10 000)
Interest on capital 2 140) 1 070) (3 210)

hensive income 1 6 180) 3 090) (9 270)
Drawings 2 (9 880) (5 800) (15 680)
Balances at 28 February 20.3 40 000 20 000 3 940) 1 760) Ð 65 700)
(a)(iii)
TOYPORK TRADERS
STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.3
Note R
ASSETS
Property, plant and equipment 3 47 902
Inventories 19 100
Trade receivables R(23 520 ± 2 300 ± 500) 20 720
Total assets 87 722

Total equity 65 700
Capital R(40 000 + 20 000) 60 000
Current accounts R(3 940 + 1 760) 5 700
Trade and other payables R(17 500 ± 400) 17 100
Other financial liabilities 4 922
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FAC1601/1
(a)(iv)
TOYPORK TRADERS
NOTE FOR THE YEAR ENDED 28 FEBRUARY 20.3
Land and Furniture Motor
buildings and fittings vehicles Total
R R R R
Carrying amount at 1 March 20.2 20 000 7 642) 24 200) 51 842 )
Cost 20 000 12 000) 36 000) 68 000)
Accumulated depreciation (Ð) (4 358) (11 800) (16 158)
Depreciation for the year (Ð) (940) (3 000) (3 940)
Carrying amount at 28 February 20.3 20 000 6 702) 21 200) 47 902)
Cost 20 000 12 000) 36 000) 68 000)
Accumulated depreciation (Ð) (5 298) (14 800) (20 098)
Calculations

1 Partners' share of total comprehensive income R
2
T Toy: R9 270 x ¤3 = 6 180
P Porky: R9 270 x 1¤3 = 3 090
9 270

2 Drawings
R
T Toy: R (3 880 + 6 000*) = 9 880
P Porky: R (1 800 + 4 000*) = 5 800
* Salaries paid to partners.
(b)
TOYPORK TRADERS
GENERAL LEDGER
Dr Appropriation account Cr
20.3 R 20.3 R
Feb 28 Interest on capital: T Toy 2 140 Feb 28 Profit or loss account 22 480
Interest on capital: P Porky 1 070
Salary: T Toy 6 000
Salary: P Porky 4 000
Current account: T Toy 6 180
Current account: P Porky 3 090
22 480 22 480
29
FAC1601/1
(c)
TOYPORK TRADERS
GENERAL LEDGER
Dr Current account Cr
T Toy P Porky T Toy P Porky
R R R R
20.2 20.3
Mar 1 Balance b/d 500 600 Feb 28 Interest on capital 2 140 1 070
Salary: T Toy 6 000
Salary: P Porky 4 000
20.3 Appropriation
Feb 28 Drawings 9 880 5 800 account 6 180 3 090
Balance c/d 3 940 1 760
14 320 8 160 14 320 8 160
20.3
Mar 1 Balance b/d 3 940 1 760
Exercise 2.3
Given information
Hunting Friends Trading is a partnership with partners F Fox and J Jakkals, who share profits
and losses equally. The information below pertains to the business activities of the partnership
for the year ended 31 March 20.1.
BALANCES AS AT 31 MARCH 20.1
R
Capital (fixed): F Fox 50 000
Capital (fixed): J Jakkals 60 000
Current account: F Fox (Dr; 1 April 20.0) 2 000
Current account: J Jakkals (Cr; 1 April 20.0) 5 000
Long-term loan: J Jakkals 40 000
Accumulated depreciation: Furniture and equipment (1 April 20.0) 3 500
Furniture and equipment at cost 35 000
Allowance for credit losses (1 April 20.0) 2 000
Credit losses recovered 105
Inventory (merchandise) (1 April 20.0) 80 500
Purchases 200 500
Interest expense (long-term loan) 1 800
Stationery consumed 600
Salaries and wages 6 500
Rental expenses 2 000
Bank (favourable) 53 405
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FAC1601/1
1 Make provision for the following according to the partnership agreement:

. interest on capital at 9% per annum
. interest on current accounts (opening balances) at 7% per annum
. a managerial salary of R6 000 per annum to J Jakkals
. a bonus of R1 952 to F Fox
2 Credit losses to be written off, R300.
3 The allowance for credit losses must be increased with R650.
4 It was agreed that interest on the long-term loan from J Jakkals would amount to R4 800
per annum.
5 Provide for depreciation at 15% per annum on furniture and equipment according to the
diminishing-balance method.
6 Inventories on hand at 31 March 20.1: R
Merchandise 61 000
Stationery (stationery purchased is recorded in the stationery consumed account) 100
7 The profit mark-up is 20% on sales.
REQUIRED
Prepare the following in respect of Hunting Friends Trading to comply with the
requirements of Generally Accepted Accounting Practice (notes and comparative figures
are not required), appropriate to the business of the partnership:
(a) Statement of comprehensive income for the year ended 31 March 20.1
(b) Statement of changes in equity for the year ended 31 March 20.1
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FAC1601/1
Solution 2.3
(a)
HUNTING FRIENDS TRADING
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 MARCH 20.1
R
Revenue 1 275 000 )
Inventory (1 April 20.0) 80 500)
Purchases 200 500)
281 000)
Inventory (31 March 20.1) (61 000)

Other income: Credit losses recovered 105 )
55 105)
Stationery consumed R(600 ± 100) 500)
Salaries and wages 6 500)
Rental expenses 2 000)
Credit losses R(300 + 650) 2 950)

Depreciation 3 4 725)
Finance costs (4 800)

Interest on long-term loan 4 800)

Total comprehensive income for the year 35 630 )
(b)
HUNTING FRIENDS TRADING
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 MARCH 20.1
Appro- Total
F Fox J Jakkals F Fox J Jakkals priation equity
R R R R R R
Balances at 1 April 20.1 50 000 60 000 (2 000) 5 000 Ð 113 000

the year 35 630) 35 630
Salary to partner 6 000 (6 000)

Interest on capital 4 4 500) 5 400 (9 900)
Interest on current accounts 5 (140) 350 (210)
Bonus to partner 1 952) (1 952)
hensive income 6 8 784) 8 784 (17 568)
Balances at 31 March 20.1 50 000 60 000 13 096) 25 534 Ð 148 630
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FAC1601/1
Calculations

1 Revenue
Given: The profit mark-up is 20% on sales.
Therefore, the cost price is 80% on sales. (Remember that Cost price + Mark-up = Selling
price; thus 80% + 20% = 100%. Sales are equal to 100% because the mark-up is
calculated on the sales.)
Therefore, 80% x Sales = R220 000
Sales = R220 000/.80
Sales = R275 000

2 Credit losses
Refer to additional information 2 and 3.

3 Depreciation R
Accumulated depreciation (3 500)
Carrying amount 31 500
Depreciation = R31 500 x 15% = R4 725

4 Interest on capital
F Fox: R50 000 x 9% = R4 500
J Jakkals: R60 000 x 9% = R5 400

F Fox: R2 000 (dr) x 7% = R140 (receivable)
J Jakkals: R5 000 (cr) x 7% = R350 (payable)

6 Partners' share of total comprehensive income
R35 630 ± R(6 000 + 9 900 + 210 + 1 952) = R17 568
R17 568/2 = R8 784
Exercise 2.4
Given information
Shoestring Corner Shop is a partnership with S Shoe and S String as partners. The information
below pertains to the business activities of the partnership for the year ended 28 February 20.2.
33
FAC1601/1
BALANCES AS AT 28 FEBRUARY 20.2:
R
Motor vehicles at cost 99 000
Inventory 135 000
Bank (Dr) 98 000
Accumulated depreciation: Motor vehicles (1 March 20.1) 49 000
Allowance for credit losses (1 March 20.1) 1 000
Capital (fixed): S Shoe 240 000
Capital (fixed): S String 160 000
Current account: S Shoe (Cr; 1 March 20.1) 50 000
Current account: S String (Dr; 1 March 20.1) 40 000
Drawings: S Shoe 55 000
Drawings: S String 11 000
Trading account (gross profit for the year) 200 000
1 The partnership agreement stipulates the following:

. Interest is to be calculated at 7,5% per annum on the opening balances of the capital
accounts.
. Interest is to be calculated at 10% per annum on the opening balances of the current
accounts.
. Interest on drawings, as per partners' decision.
. S String is entitled to a monthly salary of R1 250.
. Profit/losses are to be shared equally.
2 The following must still be accounted for:

. Depreciation on motor vehicles. Provide for 30% per annum according to the
diminishing-balance method.
. Credit losses to the amount of R2 000.
. Interest on drawings. In respect of the current financial year, the interest amounted to
R5 000 for S Shoe and R1 000 for S String.
3 An investigation indicated that credit losses could be R4 000 during the next financial
period and the allowance for credit losses must be adjusted accordingly.
REQUIRED
Prepare the following in respect of Shoestring Corner Shop to comply with the
requirements of Generally Accepted Accounting Practice (notes and comparative figures
are not required), appropriate to the business of the partnership:
(a) Statement of comprehensive income for the year ended 28 February 20.2 (Start with
the gross profit.)
(b) Statement of changes in equity for the year ended 28 February 20.2
34
FAC1601/1
Solution 2.4
(a)
SHOESTRING CORNER SHOP
R
Gross profit 200 000 )
Depreciation (R50 000 x 30%) 15 000
Credit losses 1 5 000

Total comprehensive income for the year 100 000 )
(b)
SHOESTRING CORNER SHOP
Appro- Total
S Shoe S String S Shoe S String priation equity
R R R R R R
Balances at 1 March 20.1 240 000 160 000 50 000) (40 000) Ð 410 000)
the year 100 000) 100 000)
Salary to partner 2 15 000) (15 000)

Interest on capital 3 18 000) 12 000) (30 000)
Interest on current accounts 4 5 000) (4 000) (1 000)
Interest on drawings (5 000) (1 000) 6 000)
Drawings (55 000) (11 000) (66 000)
hensive income 5 30 000) 30 000) (60 000)
Balances at 28 February 20.2 240 000 160 000 43 000) 1 000) Ð 444 000)
Calculations

1 Credit losses
R
Written off (refer additional information 2) 2 000
Increase in allowance for credit losses 1 * 3 000
5 000
* Increase in allowance for credit losses
1
R
Closing balance (refer additional information 3) 4 000)
Opening balance (1 000)
Increase in allowance for credit losses 3 000
35
FAC1601/1

2 Salary to partner (S String)
R1 250 x 12 = R15 000

3 Interest on capital
S Shoe: R240 000 x 7,5% = R18 000
S String: R160 000 x 7,5% = R12 000

S Shoe: R50 000 (Cr) x 10% = R5 000 (payable)
S String: R40 000 (Dr) x 10% = R4 000 (receivable)

5 Partners' share of total comprehensive income
S Shoe: R60 000 x 12 = R30 000
S String: R60 000 x 12 = R30 000
SELF-ASSESSMENT
Yes No
. define a partnership?
. explain the reasons why partnerships are formed?
. discuss the contents of a partnership agreement in general?
. explain the ways in which a partnership can be established?
. explain the factors which can result in the dissolution of a
partnership?
. record the transactions of a partnership in its books?
. prepare the financial statements of a partnership to comply with the
requirements of Generally Accepted Accounting Practice, appro-
priate to the business of the partnership?
If you answered ``yes'' to all of the above assessment criteria, you can move on to study
unit 3. If your answer was ``no'' revise that section before progressing to study unit 3.
36
FAC1601/1
3
STUDY UNIT
Changes in the ownership structure of

partnerships
CONTENTS
Key concepts 38
3.1 Introduction 39
3.2 Valuation adjustments 39
3.3 Goodwill 39
3.4 The calculation of profit-sharing ratios 40
3.5 Recording a change in ownership structure by way of a personal transaction 40
3.6 Recording a change in ownership structure by way of a transaction with the
partnership 40
Self-assessment 56
Learning outcomes
& briefly describe what a change in the ownership structure of a partnership entails
& mention events that cause a change in the ownership structure of a partnership
& calculate the new profit-sharing ratio of a partnership
& record a change in the ownership structure of a partnership by way of a personal
transaction
& record a change in the ownership structure of a partnership by way of a transaction with the
partnership as a business entity by applying the accounting procedure which is based on
the legal perspective
& prepare a statement of financial position for a new partnership at the date of its formation
according to the requirements of GAAP, appropriate to the business of the partnership,
based on the legal perspective
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FAC1601/1
Key concepts
& Change in ownership structure
& Dissolution
& Valuation adjustments
& Goodwill acquired
& Adjustment of profit-sharing ratio
& Personal transaction
& Transaction with a partnership as a business entity
& Accounting procedure based on the legal perspective
38
FAC1601/1
3.1 Introduction
A change in the ownership structure of a partnership is regarded as a change in the business

relationship between the partners of a partnership. For example, the ownership structure
changes when a partner is admitted to a partnership, when a partner retires or dies, or when
the profit-sharing ratio of a partnership changes. When a change in the ownership structure of
a partnership takes place, the existing partnership is dissolved. When a partnership is
dissolved, 1) a new partnership may be formed subsequently, or 2) the partnership may be
liquidated. The liquidation of a partnership means that its business activities are being
terminated. In this study unit, only the dissolution of partnerships that pertain to the subsequent
formation of new partnerships is addressed.
A change in the ownership structure of a partnership can take place as a result of 1) a personal
(direct) transaction by one or more of the partners, or as a result of 2) a transaction entered into
by the partnership as a business entity. Two accounting procedures are suggested according
to which a change in the ownership structure of a partnership as a result of a transaction
entered into by the partnership as a business entity is recorded, namely a procedure based on
a legal perspective and a second procedure based on a going-concern perspective.
From the legal perspective, each partnership [that is the existing and the subsequent new
partnership] is regarded as a separate business entity, and the activities of these partnerships
are therefore accounted for and reported on independently. From the going-concern
perspective, the activities of an existing and a subsequent new partnership are accounted
for and reported on as though the two partnerships are operating as a single going-concern.
(The going-concern perspective does not form part of the syllabus.)
Paragraph 3.1 of the prescribed textbook addresses these issues and provides some
perspective on the scope of this study unit. Read through the paragraph attentively.
3.2 Valuation adjustments
In respect of valuation adjustments, the most important point to take note of is that the selling
price of a partnership is determined by the fair value, and not the cost price or any other kind of
value of the partnership. (Recall that fair value is the amount for which an asset can be
exchanged or a liability settled between knowledgeable, willing parties in an arm's length
transaction.) As the prescribed textbook indicates, the fair value of a partnership refers to the
fair value of the net assets (including goodwill) of the partnership. (Net assets = Assets ±
Liabilities)
Often, the assets and liabilities of a partnership are not recorded at fair value. When a change
in the ownership structure of a partnership takes place under such circumstances, the assets
and liabilities of the existing partnership must first be valued. Any differences between these
valued amounts and the recorded amounts must then be recorded. The recordings of these
differences are referred to as valuation adjustments. For the purpose of FAC1601, valuation
adjustments are made in a valuation account. Read paragraphs 3.2 and 3.2.1 in the prescribed
textbook attentively so as to broaden your understanding of valuation adjustments and the
recording thereof in the books of an existing partnership. Study example 3.1 in the prescribed
textbook.
3.3 Goodwill
Read paragraphs 3.3 and 3.3.1 of the prescribed textbook attentively. Make sure that you know
what is meant by the term ``goodwill'', and more specifically ``goodwill acquired''.
39
FAC1601/1
Study paragraph 3.3.2 of the prescribed textbook, and memorise the formula for the calculation
of goodwill acquired. Do not work through examples 3.10 to 3.12 at this stage.
Study paragraphs 3.3.3 and 3.3.4 of the prescribed textbook. You will be required to create
(record) goodwill acquired.
3.4 The calculation of profit-sharing ratios
Paragraph 3.4 and sub-paragraphs 3.4.1 to 3.4.3 deal with the calculation of new profit-sharing
ratios under different circumstances. Read through these paragraphs attentively and do all the
examples.
Note that there are various methods according to which the profit-sharing ratio of the partners in a
new partnership can be calculated. After you have mastered the method that was applied in the
prescribed textbook (refer to examples 3.1 to 3.7), you may attempt the other methods which are
included as exercises in paragraph 3.7 of the study guide (refer to exercises 3.2 and 3.4).
3.5 Recording a change in ownership structure by way of a
personal transaction
Study paragraph 3.5 of the prescribed textbook. Make sure that you know what is meant by a
personal transaction, and that no valuation adjustments or goodwill acquired are recorded
when a change in the ownership structure of a partnership takes place by way of a personal
transaction. Take note of the entries that are recorded under these circumstances, and study
examples 3.8 and 3.9 of the prescribed textbook.
3.6 Recording a change in ownership structure by way of a
transaction with the partnership
Paragraph 3.6 of the prescribed textbook discusses two accounting procedures according to
which a change in the ownership structure of a partnership can be recorded when such a change
resulted from a transaction that was made by the partnership as a business entity. These
procedures are each based on a distinct perspective, namely the legal and the going-concern
perspective. The legal perspective is summarised in paragraph 3.6 of the textbook, which you
must read attentively. Do NOT study example 3.14 as it does not form part of the syllabus.
3.6.1 Accounting procedure based on the legal perspective
This procedure is discussed in detail in paragraph 3.6.1 of the prescribed textbook, and can be
applied to record the admission, retirement or death of a partner. Study this paragraph, and
note that the steps are intended to enable you to understand and systematically apply this
accounting procedure.
It is important to note that steps 1 to 6 are carried out in the books of the existing partnership,
and that steps 1 to 5 are carried out to prepare for its dissolution. It will not be required of you to
apply step 1. Steps 7 to 9 are recorded in the books of the new partnership, and are carried out
mainly to record the formation thereof. Also take note of the dates on which these entries are
recorded.
40
FAC1601/1
Note that the calculation of the ratio according to which the assets and liabilities of the
dissolved partnership are apportioned in the books of the new partnership (step 7), is based on
the closing balances of the capital accounts of the previous partners as determined in step 6.
Examples 3.10 to 3.12 of the prescribed textbook illustrate the recording of changes in the
ownership structure of partnerships from the legal perspective. Study these examples.
3.6.2 Accounting procedure based on the going-concern
perspective
For the purpose of FAC1601, you will not be required to study this procedure.
Exercise 3.1
Recording valuation adjustments in the books of an existing partnership
Work through the exercise, taking note of how valuation adjustments are recorded in the books
of an existing partnership in preparation of its change in ownership structure.
Given information
Stevie and Bob are in a partnership, Wonder Traders, and they share profits and losses in the
ratio of 3:2 respectively. They decided to admit Tina as a partner as from 1 March 20.6. The
profit-sharing ratio for Stevie, Bob and Tina will be 3:2:1 respectively. The statement of financial
position of Wonder Traders, immediately prior to the recording of any valuation adjustments, was
as follows:
41
FAC1601/1
WONDER TRADERS
R
ASSETS
Property, plant and equipment (Land and buildings) 30 000
Inventories 44 000
Trade receivables (Debtors control) 26 000
Cash and cash equivalents 20 000
Total assets 120 000

Total equity 100 000
Capital (Stevie: R60 000; Bob: R40 000) 100 000
Trade and other payables 20 000
To prepare for the change in the ownership structure of Wonder Traders, the following
agreement was reached on 28 February 20.6:
1 An allowance of R2 600 must be created for credit losses.
2 Inventories must be valued at R50 000.
3 Land and buildings must be valued at R50 000.
REQUIRED
Prepare the following accounts, properly balanced or closed off, in the general ledger of
Wonder Traders to record the valuation adjustments on 28 February 20.6:
. Land and buildings
. Inventory
. Debtors control
. Allowance for credit losses
. Valuation account
. Capital: Stevie
. Capital: Bob
42
FAC1601/1
Solution 3.1
WONDER TRADERS
GENERAL LEDGER
Dr Land and buildings Cr
20.6 R
Feb 28 Balance b/d 30 000
Valuation account 20 000
R(50 000 ± 30 000)
50 000
Dr Inventory Cr
20.6 R
R(50 000 ± 44 000)
50 000
Dr Debtors control Cr
20.6 R
Dr Allowance for credit losses Cr

20.6 R
Feb 28 Valuation account 2 600
Dr Valuation account Cr
20.6 R 20.6 R
Feb 28 Allowance for credit Feb 28 Land and buildings 20 000
losses 2 600 Inventory 6 000
Capital: Stevie (3¤5 ) 14 040
Capital: Bob (2¤5 ) 9 360
26 000 26 000
43
FAC1601/1
Dr Capital: Stevie Cr
20.6 R
74 040
Dr Capital: Bob Cr
20.6 R
49 360
Exercise 3.2
Adjustment of a profit-sharing ratio
Work through the exercise, taking special note that when partners relinquish a profit share
according to their existing profit-sharing ratio, the new profit-sharing ratio between these
(existing/previous) partners remains the same. In addition, note how alternative methods can
be applied to calculate the new profit-sharing ratio.
Given information
Joe and Boe were in partnership; they shared profits and losses equally (1:1). They decided to
admit Zoe to the partnership, and to relinquish 1¤5 of the profits and losses to her equally.
REQUIRED
Calculate the profit-sharing ratio of the partners of the new partnership.
44
FAC1601/1
Solution 3.2
Joe = 1¤2 ± (1¤5 x 1¤2 ) = 1¤2 ± 1¤10 = 5¤10 ± 1¤10 = 4¤10 = 2¤5
Boe = 1¤2 ± (1¤5 x 1¤2 ) = 1¤2 ± 1¤10 = 5¤10 ± 1¤10 = 4¤10 = 2¤5
Zoe = 1¤5
The profit-sharing ratio of Joe, Boe and Zoe is 2:2:1 respectively.

The above calculation can also be done in percentages:
Joe = 50% ± (20% x 50%) = 50% ± 10% = 40%
Boe = 50% ± (20% x 50%) = 50% ± 10% = 40%
Zoe = 20%
40% : 40% : 20%
= 20% : 20% : 10%
= 2:2:1
Alternative method of calculating the profit-sharing ratio:
Given: Zoe will obtain a 1¤5 profit share, which is going to be relinquished by Joe and Boe
according to their existing profit share.
Since Joe and Boe will relinquish a 1¤5 profit share to Zoe, Joe and Boe will together have a 4¤5
profit share (that is 5¤5 ± 1¤5 = 4¤5 ). Joe and Boe will relinquish Zoe's profit share according to
their existing profit share (1:1). The profit-sharing ratio between Joe and Boe in the new
partnership thus remains the same (1:1 or let us say `èqual''). Joe thus receives 1¤2 of the 4¤5 ,
and Boe receives the other 1¤2 of the 4¤5 . Thus:
Joe = 1¤2 x 4¤5 = 4¤10 = 2¤5
Boe = 1¤2 x 4¤5 = 4¤10 = 2¤5
Zoe = 1¤5
Exercise 3.3
Work through the following exercise, taking note of how to calculate a new profit-sharing ratio
when the existing partners relinquish a portion of their profit share to a new partner according to
a different ratio from their existing profit-sharing ratio.
Given information
Dickson and Erikson were in a partnership and they shared profits and losses equally; they
decided to admit Frederikson as a partner and to relinquish 1¤5 of the profits and losses to him
according to the ratio of 1:5 respectively.
REQUIRED
45
FAC1601/1
Solution 3.3
Dickson = 1¤2 ± (1¤5 x 1¤6 ) = 1¤2 ± 1¤30 = 15¤30 ± 1¤30 = 14¤30 = 7¤15
Erikson = 1¤2 ± (1¤5 x 5¤6 ) = 1¤2 ± 5¤30 = 15¤30 ± 5¤30 = 10¤30 = 5¤15
Frederikson = 1¤5 = 3¤15
The profit-sharing ratio of Dickson, Erikson and Frederikson is 7:5:3 respectively.
Exercise 3.4
Work through the exercise, taking note of how the profit-sharing ratio of a new partnership can
be calculated when the new profit-sharing ratio (in the new partnership) is given for the
previous partners.
Given information
Goya and Picasso were in a partnership and they shared profits and losses equally. They
decided to admit Renoir as a partner and to relinquish 1¤5 of the profits and losses to him in
such a way that the profit-sharing ratio between Goya and Picasso in the new partnership
would be 3:2 respectively.
REQUIRED
Solution 3.4
Given : Renoir will obtain a 1¤5 profit share. The profit-sharing ratio between Goya and Picasso
in the new partnership is 3:2 respectively.
Conclusion: Goya and Picasso will share in the remaining 4¤5 according to the new profit-
sharing ratio of 3:2 respectively. Thus:
Goya = 3¤5 x 4¤5 = 12¤25
Picasso = 2¤5 x 4¤5 = 8¤25
Renoir = 1¤5 = 5¤25
The profit-sharing ratio of Goya, Picasso and Renoir is 12:8:5 respectively.
Exercise 3.5
Recording a change in the ownership structure of a partnership by
applying the accounting procedure which is based on the legal
perspective
Work through the following exercise, taking note of how to create goodwill and to record
valuation adjustments in the books of an existing partnership.
46
FAC1601/1
Given information
Mahatma and Lerato were trading as The House Care Specialists, and they shared profits/
losses equally. They decided to admit Enoch as a partner as from 1 July 20.6, and to trade as
Home Care and Butler Services as from this date. According to the partnership agreement of
Home Care and Butler Services, Enoch had to deposit a capital sum of R6 500 into the
partnership's bank account for a 1¤3 share in the net assets (equal to the equity) of the new
partnership, the partners will share in the profits/losses equally, and the capital ratio of the
partners must be in the same ratio as their profit-sharing ratio. On 1 July 20.6 Enoch deposited
R6 500 into the bank account of the partnership, and in order to ensure that the capital ratio of
the partnership is in the same ratio as their profit-sharing ratio, the capital account balances
were adjusted by means of cash refunds and payments.
At 30 June 20.6 the books of The House Care Specialists were closed off. At this date the
following items appeared in the preliminary statement of financial position of the partnership,
and the assets of The House Care Specialists were valued in preparation of the change in its
ownership structure:
Items in preliminary statement of financial position and valued amounts
Items Statement of Valued

financial amounts
position
R R
Capital: Mahatma 4 200
Capital: Lerato 3 200
Current account: Mahatma (dr) 100
Current account: Lerato (cr) 200
Asset replacement reserve (equipment) 1 000
Land and buildings 4 500 7 500
Goodwill Nil 2 100
Inventory: Cleaning materials 1 500 1 200
Debtors control 2 000 2 000
Allowance for credit losses Nil 300
REQUIRED
(a) Prepare the journal entries on 30 June 20.6 in the general journal of The House Care
Specialists to prepare for the admission of Enoch as a partner and to record the
dissolution of the partnership. (Apply steps 2 to 6 of the accounting procedure based
on the legal perspective.)
(b) Prepare the journal entries on 1 July 20.6 in the general journal of Home Care and
Butler Services to record its formation and to give effect to the decisions which pertain
to the accounting policy and/or the new partnership agreement. (Apply steps 7 to 9 of
the accounting procedure based on the legal perspective.)
(c) Prepare the statement of financial position of Home Care and Butler Services as at
1 July 20.6 according to the requirements of GAAP, appropriate to the business of
the partnership. Notes and comparative figures are not required.
47
FAC1601/1
Solution 3.5
(a)
THE HOUSE CARE SPECIALISTS
GENERAL JOURNAL
Debit Credit
R R
20.6
Jun 30 Capital: Mahatma 100
Current account: Lerato 200
Current account: Mahatma 100
Capital: Lerato 200
Closing off the balances of the current accounts of
Mahatma and Lerato to their capital accounts (step 2)
Asset replacement reserve (equipment) 1 000

Capital: Mahatma (R1 000 x 1¤2 ) 500
Capital: Lerato (R1 000 x 1¤2 ) 500
Asset replacement reserve apportioned to the capital
accounts of Mahatma and Lerato according to their
profit-sharing ratio (step 3)
Land and buildings R(7 500 ± 4 500) 3 000

Inventory: Cleaning materials R(1 500 ± 1 200) 300
Allowance for credit losses 300
Recording the valuation adjustments (step 4)

Capital: Mahatma (R2 400 x 1¤2 ) 1 200
Capital: Lerato (R2 400 x 1¤2 ) 1 200
Closing off the balancing amount of the valuation
account to the capital accounts of Mahatma and Lerato
according to their profit-sharing ratio (step 4)
Goodwill 2 100
Capital: Mahatma (R2 100 x 1¤2 ) 1 050
Capital: Lerato (R2 100 x 1¤2 ) 1 050
Recording goodwill in preparation for the admission of
Enoch (step 5)
Transferral account 13 300

Goodwill 2 100
Inventory: Cleaning materials 1 200
Bank 500
Closing off the balances of the asset accounts to the
transferral account to record the dissolution of the
partnership (step 6)
48
FAC1601/1
Debit Credit
R R
20.6
Jun 30 Capital: Mahatma 1 6 850
Capital: Lerato 1 6 150
Allowance for credit losses 300
Transferral account 13 300
Closing off the balances of the equity and allowance
accounts to the transferral account to record the
dissolution of the partnership (step 6)
Comment
The steps are indicated for illustrative purposes only.
Calculation

1 Capital account balances of partners
R
Mahatma: R(4 200 ± 100 + 500 + 1 200 + 1 050) = 6 850
Lerato: R(3 200 + 200 + 500 + 1 200 + 1 050) = 6 150
13 000
(b)
HOME CARE AND BUTLER SERVICES
GENERAL JOURNAL
Debit Credit
R R
20.6
Jul 1 Land and buildings (R7 500 x 6 850/13 000) 3 952
Goodwill (R2 100 x 6 850/13 000) 1 107
Inventory: Cleaning materials (R1 200 x 6 850/13 000) 632
Debtors control (R2 000 x 6 850/13 000) 1 054
Bank (R500 x 6 850/13 000)* 263
Allowance for credit losses (R300 x 6 850/13 000) 158
Capital: Mahatma 6 850
Recording the capital contribution of Mahatma (step 7)
Land and buildings (R7 500 x 6 150/13 000) 3 548

Goodwill (R2 100 x 6 150/13 000)* 993
Inventory: Cleaning materials (R1 200 x 6 150/13 000) 568
Debtors control (R2 000 x 6 150/13 000) 946
Bank (R500 x 6 150/13 000) 237
Allowance for credit losses (R300 x 6 150/13 000) 142
Recording the capital contribution of Lerato (step 7)
Bank 6 500
Capital: Enoch 6 500
Recording the capital contribution of Enoch (step 7)
49
FAC1601/1
Debit Credit
R R
20.6
Jul 1 Capital: Mahatma 1 350
Bank 1 350
Recording the cash repayment to Mahatma so as to
bring the capital account ratio in the same ratio as the
profit-sharing ratio (step 9)
Bank 1 350
Recording the contribution of Lerato so as to bring the
capital account ratio in the same ratio as the profit-
sharing ratio (step 9)
Comment
In the above first two journal entries, the amounts allotted were rounded off to the nearest
Rand, with exception of those indicated with an asterisk. The reason why the R263 and the
R993 were not rounded off, is because the allotted amounts in each journal entry must add up
to the amount of the capital account in that journal entry.
Calculation

1 Adjustment of capital account balances of Mahatma and Lerato
Calculation of capital account balances according to profit-sharing ratio.
R
Capital: Mahatma * 1
R19 500 1 x ¤3 = 6 500
Capital: Lerato *
R19 500 1 x 1¤3 = 6 500
Capital: Enoch *
R19 500 1 x 1¤3 = 6 500
19 500
*1 Total amount of capital in the new partnership

R(6 850 + 6 150 + 6 500) = R19 500
or
Enoch's capital contribution x the inverse of his share in the net assets of the new
partnership (R6 500 x 3) = R19 500
Difference between recorded and calculated capital account balances:
Calculated capital
account balance
Recorded capital account according to profit-
balance sharing ratio Difference
R R R
Mahatma 6 850 6 500 350

Lerato 6 150 6 500 (350)
Enoch 6 500 6 500 Ð
50
FAC1601/1
The balances of Mahatma and Lerato differ. Mahatma's capital account must be reduced by
refunding R350 to him. Lerato's capital account must be increased by receiving a cash
contribution of R350 from her.
(c)
HOME CARE AND BUTLER SERVICES
STATEMENT OF FINANCIAL POSITION AS AT 1 JULY 20.6
R
ASSETS
Property, plant and equipment R(3 952 + 3 548) 7 500
Goodwill R(1 107 + 993) 2 100
Inventories R(632 + 568) 1 200
Trade receivables R(1 054 + 946 ± 158 ± 142) 1 700
Cash and cash equivalents R(263 + 237 + 6 500 ± 350 + 350) 7 000
Total assets 19 500

Total equity 19 500
Capital R(6 850 + 6 150 + 6 500 ± 350 + 350) 19 500
Exercise 3.6
Recording the capital contribution of a partner who was admitted to
a partnership
Work through the following exercise, taking note of how the formula for calculating a new profit-
sharing ratio can be used to calculate other related ratios, and that a partner who is admitted to
a partnership does not necessarily have to contribute cash in order to purchase a share in the
net assets (equity) of the partnership.
Given information
Lucky and Packet are in a partnership, and they share profits and losses in the ratio of 3:2
respectively. They decided to admit Surprise to their partnership as from 1 January 20.5. The
new partnership will trade as Sweet Sensations. Surprise will acquire a 1¤4 interest in the profit-
sharing ratio of Sweet Sensations. The profit-sharing ratio of Lucky, Packet and Surprise will be
2:1:1 respectively. Surprise is a sole trader and is going to contribute the assets and liabilities,
at fair value, of his business to the partnership on 1 January 20.5. The only asset that the new
partnership is not going to take over from Surprise is the debtors. On 1 January 20.5 the
following pertained to the business of Surprise:
51
FAC1601/1
Carrying Agreed upon
Asset/Liability amount value
R R
Motor vehicle 6 500 5 200
Furniture and equipment 1 600 1 300
Goodwill Ð 3 000
Inventory (merchandise) 8 000 7 800
Allowance for credit losses Ð 600
Creditors control 5 100 5 100
REQUIRED
(a) Prepare the journal entries on 1 January 20.5 in the general journal of Sweet
Sensations to record Surprise's capital contribution to the partnership.
Solution 3.6
(a)
GENERAL JOURNAL
SWEET SENSATIONS
Debit Credit
R R
20.6
Jan 1 Motor vehicles 5 200
Furniture and equipment 1 300
Goodwill 3 000
Inventory (merchandise) 7 800
Bank 800
Capital: Surprise 13 000
Recording the capital contribution of Surprise
52
FAC1601/1
Exercise 3.7
Preparation of partners ' capital accounts and valuation account in
preparation of the change in the ownership structure of a
partnership
Work through the exercise; note that when goodwill is created, it is not recorded in the valuation
account, since goodwill that was previously unrecorded, cannot be revalued. Also note of how
the valuation and capital accounts are closed off to a transferral account when an accounting
procedure based on the legal perspective is applied. Take note that a retired partner's capital
account is closed off to a loan account on the last date of the existing p\artnership if the capital
account was not settled by the partnership.
Given information
Kally, Rocky and Mike are in a partnership, trading as Fighting Fists, and share profits and
losses in the ratio of 2:2:1 respectively. Kally decided to retire from the partnership. His last day
as a partner in the partnership will be 31 May 20.6, which is also the financial year-end of
Fighting Fists. The new partnership will pay out Kally's capital in cash on 30 November 20.6.
Rocky and Mike decided to admit Gerrie as a partner as from 1 June 20.6. The new partnership
will trade as Fighting Fit. The profit-sharing ratio between Rocky, Mike and Gerrie will be 3:2:1
respectively. Gerrie will contribute R80 000 in cash for a 1¤6 share in the equity (net assets) of
the new partnership.
The statement of financial position of Fighting Fists as at 31 May 20.6, immediately prior to the
recording of valuation adjustments in preparation of the change in the ownership structure of
the partnership is as follows:
FIGHTING FISTS
STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20.6
R
ASSETS
Property, plant and equipment (Land and buildings) 80 000
Inventories 48 000
Trade receivables (Debtors control) 36 000
Capital (Kally: R56 000; Rocky: R74 000; Mike: R38 000)) 168 000
Trade and other payables (Creditors control) 14 000
53
FAC1601/1
1 To prepare for the change in the ownership structure of Fighting Fists, the following
agreement was reached on 31 May 20.6:
1.1 Goodwill must be recorded in the books.
1.2 An allowance for credit losses must be created at R3 600.
1.3 Inventories must be valued at R60 000.
1.4 Land and buildings must be valued at R140 000.
2 The change in the ownership structure of the partnership is viewed from a legal
perspective.
REQUIRED
Prepare the valuation account and the capital accounts of Kally, Rocky and Mike, properly
closed off, in the general ledger of Fighting Fists at 31 May 20.6.
Solution 3.7
FIGHTING FISTS
GENERAL LEDGER
Dr Valuation account Cr
20.6 R 20.6 R
May 31 Allowance for credit losses 3 600 May 31 Land and buildings 60 000
Capital: Kally 1 27 360 R(140 000 ± 80 000)
Capital: Rocky 1 27 360 Inventories 12 000
Capital: Mike 1 13 680 R(60 000 ± 48 000)
72 000 72 000
Dr Capital: Kally Cr
20.6 R 20.6 R
May 31 Loan: Kally 182 144 May 31 Balance b/d 56 000


Goodwill 2 98 784
182 144 182 144
54
FAC1601/1
Dr Capital: Rocky Cr
20.6 R 20.6 R
May 31 Transferral account 200 144 May 31 Balance b/d 74 000

Goodwill 2 98 784
200 144 200 144
Dr Capital: Mike Cr
20.6 R 20.6 R
May 31 Transferral account 101 072 May 31 Balance b/d 38 000

Goodwill 2 49 392
101 072 101 072
Dr Loan: Kally Cr
20.6 R 20.6 R
May 31 Transferral account 182 144 May 31 Capital: Kally 182 144
182 144 182 144
Comment
The loan account was not required, and is given as an additional illustration.
Calculations

1 Apportionment of the balance of the valuation account to the capital accounts of
the partners of the existing partnership
Balance of valuation account to be apportioned: R(72 000 ± 3 600) = R68 400
Kally: R68 400 x 2¤5 = R27 360
Rocky: R68 400 x 2¤5 = R27 360
Mike: R68 400 x 1¤5 = R13 680

2 Goodwill
Goodwill acquired: = (Capital contribution of new partner x inverse of new partner's
share in the equity [net assets] of new partnership) ± Equity of
new partnership.
= (80 000 x Ï6/1 ) ± (101 360* + 51 680* + 80 000)
= 480 000 ± 233 040
= 246 960
*Balances of capital accounts:
Rocky = Opening balance + apportionment of profit of valuation account
= R(74 000 + 27 360)
= R101 360
*Mike = Opening balance + apportionment of profit of valuation account
= R(38 000 + 13 680)
= R51 680
55
FAC1601/1
Please note that the capital account balance of Kally is excluded from the calculation of
goodwill, because Kally will not be part of the new partnership. Kally will however be
included in the recording of the goodwill in the books of the old partnership, as he is still
viewed as a partner.
Goodwill apportioned to the capital accounts:
Kally: R246 960 x 2¤5 = R98 784
Rocky: R246 960 x 2¤5 = R98 784
Mike: R246 960 x 1¤5 = R49 392
SELF-ASSESSMENT
Yes No
. briefly describe what a change in the ownership structure of a
partnership entails?
. mention events that cause a change in the ownership structure of a
partnership?
. calculate the new profit-sharing ratio of a partnership?
. record a change in the ownership structure of a partnership by way
of a personal transaction?
. record a change in the ownership structure of a partnership by way of a
transaction with the partnership as a business entity by applying the
accounting procedure which is based on the legal perspective?
. if an accounting procedure is based on the legal perspective,
prepare a statement of financial position of a new partnership at the
date of its formation according to the requirements of GAAP,
appropriate to the business of the partnership?
Revise the criteria indicated with a ``No''. Once you have answered ``Yes'' to all of the
above assessment criteria, you may proceed to study unit 4.
56
FAC1601/1
4
STUDY UNIT
The liquidation of a partnership
CONTENTS
Key concepts 58
4.1 Introduction 59
4.2 Liquidation methods 59
4.3 The liquidation account 59
4.4 Accounting procedure to record the simultaneous liquidation of a partnership 60
4.5 Accounting procedure to record the piecemeal liquidation of a partnership 60
Self-assessment 70
Learning outcomes
& describe the meaning of the term: ``liquidation'' from the perspective of this study unit
& distinguish between a simultaneous and a piecemeal liquidation
& apply the accounting procedure in the case of a simultaneous liquidation of a partnership
Ð with a profit on liquidation
Ð with a loss on liquidation, where all of the partners have sufficient personal funds to
cover the shortages on their capital accounts
Ð with a loss on liquidation, where one or more of the partners do not have sufficient
personal funds to cover the shortfalls on their capital accounts and where the capital
deficits must be apportioned to the remaining solvent partners according to their profit-
sharing ratio
& apply the accounting procedure in the case of a piecemeal liquidation of a partnership, and
to calculate the interim repayments of available cash between partners according to the
loss-absorption-capacity method
57
FAC1601/1
Key concepts
& Dissolution
& Liquidation
& Liquidation account
& Simultaneous liquidation
& Piecemeal liquidation
& Loss-absorption-capacity method
58
FAC1601/1
4.1 Introduction
Read paragraph 4.1 of the prescribed textbook attentively. Ensure that you understand what a
liquidation, for the purposes of this study unit, entails.
Note that, for the purposes of this study unit, a liquidation is regarded as a form of dissolution
which results in the termination of the activities of a solvent partnership, whereas a
sequestration is regarded as a form of dissolution of an insolvent partnership. The accounting
procedures that pertain to sequestrations fall beyond the scope of this syllabus.
Also note that the liquidation of a partnership basically implies that the assets of the partnership
must be converted into cash (in other words, the assets must be liquidated), the liabilities must
be settled, and the remaining cash be paid to the partners in keeping with the closing balance
of their capital accounts. After the balances on the capital accounts have been settled, there
are no remaining accounts in the books of the partnership.
4.2 Liquidation methods
Read paragraph 4.2 of the prescribed textbook attentively. Ensure that you understand what
the differences between a simultaneous and a piecemeal liquidation are.
4.3 The liquidation account
Read paragraph 4.3 of the prescribed textbook attentively.

Note that a liquidation account can also be referred to as a dissolution or realisation account. In
this study unit, the term `'liquidation account'' is used because the term pertains specifically to
the liquidation of a partnership, which makes it less confusing than the term ``realisation
account'', which is used by a going-concern when an asset is sold.
Take special note of the function of a liquidation account; it is used to determine the net profit or
loss on liquidation, and it aids in the closure of the ledger accounts of the partnership. The
balancing amount thereof is closed off to the capital accounts of the partners according to their
profit-sharing ratio.
In paragraph 4.3 of the prescribed textbook, two methods are presented according to which a
liquidation account can be prepared in the case of a simultaneous liquidation. If you are asked
to prepare a liquidation account in an assignment or in the examination, you must prepare the
account according to Method 1.
Liquidation accounts are also prepared for piecemeal liquidations. With piecemeal liquidations,
a separate liquidation account can be prepared for each liquidation transaction, in which case
the balancing amount of the liquidation account is the profit or loss made on the liquidation
transaction. A liquidation account can also be prepared for more than one liquidation
transaction. For example, all the liquidation transactions that took place on a specific date can
be recorded in a single liquidation account, in which case the balancing amount of the
liquidation account is the net profit or loss made on all the recorded liquidation transactions.
59
FAC1601/1
4.4 Accounting procedure to record the simultaneous
liquidation of a partnership
Read paragraphs 4.4 and 4.4.1 of the prescribed textbook attentively. Then, whilst referring to
the steps in paragraph 4.4, work through example 4.1. Note that you will not be required to
prepare a theoretical answer in respect of the steps. The object of using the steps is simply to
guide you towards a systematic approach in the preparation of solutions to practical questions
on simultaneous liquidations.
Read through paragraph 4.4.2 of the prescribed textbook to determine how to record a loss on
a liquidation. As a matter of interest, you can read the discussion pertaining to the Garner
versus Murray rule. You will not be required to apply the Garner versus Murray rule in the
assignments or in the examination. Study examples 4.2 and 4.3(b) in the prescribed textbook.
4.5 Accounting procedure to record the piecemeal
liquidation of a partnership
Read through paragraphs 4.5 and 4.5.2 of the prescribed textbook attentively, and study
example 4.6. Take note that the calculation of interim repayments by applying the surplus-
capital method does NOT form part of the syllabus.
Study example 4.7 in the prescribed textbook. Note how the recordings in the solution to
example 4.7 can be summarised in columnar format. Also note that each column represents a
ledger account, or a group of ledger accounts. Remember to apply the double entry principle
when a piecemeal liquidation is recorded in columnar format. Remember that when a
piecemeal liquidation is recorded in columnar format, debit balances and debit entries are
disclosed without brackets, whereas credit balances and credit entries are disclosed in
brackets.
Exercise 4.1
Recording of a simultaneous liquidation
Work through the exercise, taking special note of how the required accounts are recorded
according to Method 1 as discussed in paragraph 4.3 in the prescribed textbook. Also note that
the remaining cash after liquidation is not apportioned to the capital accounts of the partners
according to their profit-sharing ratio, but according to their outstanding capital account
balances.
Given information
Penn and Penzil were in partnership for 38 years, trading as Manual Accounting Services
and sharing in the profits and losses of the partnership equally. Owing to a steady decline in
their clienteÂle and profits, they decided to liquidate the partnership at a public auction on
30 June 20.5. On this date, prior to the auction, the following trial balance was prepared by
them for Manual Accounting Services:
60
FAC1601/1
MANUAL ACCOUNTING SERVICES
TRIAL BALANCE AS AT 30 JUNE 20.5
Debit Credit
R R
Land and buildings at valuation 500 000
Furniture at cost 102 000
Vehicles at cost 215 000
Accumulated depreciation: Furniture 20 000
Accumulated depreciation: Vehicles 15 000
Goodwill 120 000
Inventory 45 000
Capital: Penn 150 000
Capital: Penzil 80 000
Current account: Penn 30 000
Current account: Penzil 10 000
Asset replacement reserve 60 000
Revaluation reserve of land and buildings 210 000
Mortgage (in respect of land and buildings) 300 000
1 087 000 1 087 000
On 30 June 20.5 the following transactions took place:

1 The land and buildings were sold for R849 500, cash.
2 The furniture was sold for R60 200, cash.
3 The inventory was sold for R50 050, cash.
4 All the debtors (as recorded in the above trial balance) settled their accounts, and
received a discount of 20% on their accounts.
5 A previous client, whose outstanding debtor's account of R650 was written off as
irrecoverable, paid R500 to the partnership.
6 There were two vehicles in the partnership. Penn took over one of these vehicles at a fair
value of R60 000, and Penzil the other at a fair value of R70 000.
7 The liquidation costs amounted to R10 000 and were paid.
8 The mortgage was paid in full.
9 All the creditors were paid. A settlement discount of R29 000 was received on these
payments.
10 Penzil paid R250 for a farewell luncheon out of the funds of the partnership.
REQUIRED
Prepare the liquidation account, the bank account, and the partners' capital accounts in
the general ledger of Manual Accounting Services in order to record its liquidation at
30 June 20.5.
61
FAC1601/1
Solution 4.1
MANUAL ACCOUNTING SERVICES

GENERAL LEDGER
Dr Liquidation account Cr
20.5 R 20.5 R
Jun 30 Land and buildings at Jun 30 Accumulated depreciation:

valuation 500 000 Furniture 20 000
Furniture at cost 102 000 Accumulated depreciation:
Vehicles at cost 215 000 Vehicles 15 000
Inventory 45 000 Mortgage 300 000
Debtors control 75 000 Creditors control 145 000
Bank (Liquidation costs) 10 000 Allowance for credit losses 7 000
Bank (Mortgage) 300 000 Bank
Bank [Creditors control 116 000 (Land and buildings) 849 500
R(145 000 ± 29 000)] Bank (Furniture) 60 200
Bank (Luncheon) 250 Bank (Inventory) 50 050

Capital: Penn 2 137 000 Bank (Debtors control) 1 60 000

Capital: Penzil 2 137 000 Bank
(Credit losses recovered) 500
Capital: Penn 60 000
Capital: Penzil 70 000
1 637 250 1 637 250
Calculations

1 Cash received from debtors
Discount = R75 000 x 20% = R15 000
Cash received = R(75 000 ± 15 000) = R60 000

2 Apportionment of profit made on liquidation
* *
R(1 637 250 1 ± 1 363 250 2 ) = R274 000 3 *
Penn: R274 000 x 1¤2 = R137 000
Penzil: R274 000 x 1¤2 = R137 000
* The total of the credit side.
* The total of the debit side before the apportionment of the profit.
1
* The balancing amount of the liquidation account that must be apportioned to the
2
3
partners according to their profit-sharing ratio.
62
FAC1601/1
Dr Bank Cr
20.5 R 20.5 R
Jun 30 Liquidation account Jun 30 Balance b/d 90 000

(Land and buildings) 849 500 Liquidation account
Liquidation account (Mortgage) 300 000
(Furniture) 60 200 Liquidation account
Liquidation account (Liquidation costs) 10 000
(Inventory) 50 050 Liquidation account
Liquidation account (Creditors control) 116 000
(Debtors control) 60 000 Liquidation account
Liquidation account (Luncheon) 250
(Credit losses recovered) 500 Capital: Penn* 272 000
Capital: Penzil* 232 000
1 020 250 1 020 250
* The settlement of the outstanding balances on the capital accounts of Penn and Penzil. The capital accounts must
first be prepared in order to determine these balances. Note how the balance of the bank account (prior to this
settlement) is equal to the sum of the outstanding capital account balances (R272 000 + R232 000 = R504 000).
Dr Capital: Penn Cr
20.5 R 20.5 R
Jun 30 Current account: Penn 30 000 Jun 30 Balance b/d 150 000
Liquidation account Asset replacement reserve 30 000
(Vehicle) 60 000 (R60 000 x 1¤2)
Goodwill (R120 000 x 1¤2) 60 000 Revaluation reserve of
Bank* 272 000 land and buildings 105 000
(R210 000 x 1¤2)
Liquidation account 137 000
422 000 422 000
* Balancing amount (outstanding balance)
Dr Capital: Penzil Cr
20.5 R 20.5 R
Jun 30 Liquidation account Jun 30 Balance b/d 80 000

(Vehicle) 70 000 Current account: Penzil 10 000
Goodwill (R120 000 x 1¤2) 60 000 Asset replacement reserve 30 000
Bank* 232 000 (R60 000 x 1¤2)
Revaluation reserve of
land and buildings 105 000
(R210 000 x 1¤2)
Liquidation account 137 000
362 000 362 000
* Balancing amount (outstanding balance)
63
FAC1601/1
Exercise 4.2
Piecemeal liquidation: Calculation of interim repayments according
to the loss-absorption-capacity method
Given information
Sause, Age and Roll are in a partnership, sharing in the profits and losses in the ratio of 5:3:2
respectively. The following is relevant statement of financial position information pertaining to
the partnership at 31 December 20.8:
SAUSE, AGE AND ROLL SERVICES

STATEMENT OF FINANCIAL POSITION INFORMATION AS AT 31 DECEMBER 20.8
R R
Equipment 42 000 Capital: Sause 7 000
Goodwill 3 000 Capital: Age 14 000
Bank 5 000 Capital: Roll 18 000
50 000 50 000
The partners decided to liquidate the partnership piecemeal as from 1 January 20.9. The net
proceeds will be apportioned amongst the partners in such a way that no partner will find it
necessary to repay any amount which was received.
Liquidation of assets Carrying amount Proceeds

R R
1 February 20.9 13 000 9 000
2 July 20.9 29 000 33 000
REQUIRED
(a) Calculate the amount of cash that is available for an interim repayment after the first
liquidation of the assets and the settlement of the liabilities on 1 February 20.9.
(b) Calculate how the cash as determined in (a) must be repaid to the partners by
applying the loss-absorption-capacity method. Disclose the calculation in a columnar
format.
64
FAC1601/1
Solution 4.2
(a)
CASH AVAILABLE FOR DISTRIBUTION
Bank = Opening balance + Cash sales ± Payment of liabilities
Bank = R(5 000 + 9 000 ± 11 000)
Bank = R3 000
(b)
CASH REPAYMENT (LOSS-ABSORPTION-CAPACITY METHOD)
Step* Bank Equipment Capital: Sause Capital: Age Capital: Roll
R R R R R
A 3 000 1
29 000) 1
(3 500) 1 (11 900) 1
(16 600) 1
C
(29 000) 1
14 500) 2 8 700) 2
5 800) 2
3 000 1 Ð 11 000 ) 1 (3 200) 1 (10 800) 1
D (11 000) 1 6 600) 3 4 400) 3
3 000 1 Ð Ð 3 400 ) 1 (6 400) 1

D (3 400) 1 3 400 ) 1
3 000 1 Ð (3 000) 1
* The steps, as discussed in paragraph 4.5.2 of the prescribed textbook, are referred to for illustrative purposes only.
Comment
Since the anticipated capital accounts of Sause and Age went into a deficit, the amount of
available cash, namely R3 000, must be paid solely to Roll. Note that the amount of available
cash is equal to the amount that must be paid to Roll.
Calculations

1 Balances before first interim repayment
SAUSE, AGE AND ROLL SERVICES
GENERAL LEDGER (EXTRACT) (SUMMARISED IN COLUMNAR FORMAT)
Creditors Equip- Capital: Control: Capital:
Transactions Bank control ment Sause Age Roll
R R R R R R
Balances at the com-

mencement of liqui-
dation
1 January 20.9 5 000 (11 000) 42 000 *
(5 500) 1 (13 100) *1 (17 400)* 1
Payment of creditors (5 000) 5 000
Sale of assets 9 000 (13 000) 2 000 * 2 1 200 *2 800 * 2
Payment of creditors (6 000) 6 000
3 000 Ð 29 000 (3 500) (11 900) (16 600)
65
FAC1601/1
*
1 Capital account balances on 1 January 20.9 (after the apportionment of the
goodwill)
Sause: R7 000 ± (R3 000 x 5¤10) = R5 500
Age: R14 000 ± (R3 000 x 3¤10 ) = R13 100
Roll: R18 000 ± (R3 000 x 2¤10 ) = R17 400
*
2 Allocation of loss on first liquidation
R
Proceeds (selling price) 9 000
Carrying amount (13 000)
Loss on liquidation (4 000)
Sause: R4 000 x 5¤10 = R2 000
Age: R4 000 x 3¤10 = R1 200
Roll: R4 000 x 2¤10 = R800

2 Apportionment of the anticipated loss as a result of the remaining equipment being
assumed to be worthless
Sause: R29 000 x 5¤10 = R14 500
Age: R29 000 x 3¤10 = R8 700
Roll: R29 000 x 2¤10 = R5 800

3 Apportionment of the anticipated capital deficit of Sause, who must be assumed to
be insolvent, to Age and Roll
Age: R11 000 x 3¤5 = R6 600
Roll: R11 000 x 2¤5 = R4 400
Exercise 4.3
Recording piecemeal liquidation transactions in columnar format
(loss-absorption-capacity method)
Given information
Patrys, Pine and Promise are in partnership, trading as African Timber and sharing in the
profits and losses in the ratio of 5:3:2 respectively. The following statement of financial position
information in respect of the partnership was prepared at 30 June 20.9:
AFRICAN TIMBER
STATEMENT OF FINANCIAL POSITION INFORMATION AS AT 30 JUNE 20.9
R
Property, plant and equipment 18 000
Capital: Patrys 8 000
Capital: Pine 5 000
Capital: Promise 2 000
Due to increasing liquidity problems the partners decided to liquidate the partnership piecemeal, as
from 1 July 20.9. As soon as cash becomes available from the liquidation of assets, it must be paid
to the partners in such a manner that no partner will have to refund money to the partnership at a
later stage.
66
FAC1601/1
The property, plant and equipment was liquidated as follows:
Carrying amount Cash received
R R
First liquidation 2 500 2 500
Second liquidation 5 600 5 000
Third liquidation 6 000 6 000
Fourth liquidation 3 900 4 000
18 000 17 500
REQUIRED
Record the liquidation of African Timber in columnar format according to the undermentioned outlay.
Disclose the credit balances of the ledger accounts and the credit entries in the ledger accounts in
brackets. Apply the loss-absorption-capacity method to calculate the interim repayments to the partners.
REQUIRED OUTLAY:
AFRICAN TIMBER
GENERAL LEDGER (SUMMARISED IN COLUMNAR FORMAT)
Property,
Creditors plant and Capital: Capital: Capital:
Transaction Bank control equipment Patrys Pine Promise
R R R R R R
Balances at 1 July 20.9
67
FAC1601/1
Solution 4.3
AFRICAN TIMBER
GENERAL LEDGER (SUMMARISED IN COLUMNAR FORMAT)
Property,
Creditors plant and Capital: Capital: Capital:
Transaction Bank control equipment Patrys Pine Promise
R R R R R R
Balances at the commence-

ment of liquidation:
1 July 20.9 Ð (3 000) 18 000) (8 000) 1 (5 000) 1 (2 000) 1
Sale of assets (1st liquidation) 2 500) (2 500)
Payment of creditors (2 500) 2 500)
Sale of assets (2nd liquidation)
and allocation of loss 5 000) (5 600) 300 ) 1 180 ) 1 120 ) 1
Payment of creditors (500) 500)
4 500) Ð 9 900)
(7 700) 1
(4 820) 1 (1 880)
1
1st Interim repayments (4 500)
2 688 ) 2
1 812 ) 2
Ð 9 900) (5 012) 1 (3 008) 1 (1 880)
1
Sale of assets (3rd liquidation) 6 000) (6 000)
6 000) 3 900) (5 012) 1 (3 008) 1
(1 880) 1
2nd Interim repayments (6 000) 3 062) 3 1 838) 3
1 100 ) 3
Ð Ð 3 900) (1 950) 1 (1 170) 1 (780) 1
Sale of assets (4th liquidation)
and allocation of profits 4 000) (3 900) (50) 4 (30) 4 (20) 4
4 000) Ð Ð (2 000) 1 (1 200) 1 (800) 1

Settlement of capital accounts (4 000) 2 000 ) 1 1 200 ) 1 800 ) 1
68
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Calculations

1 Allocation of loss (R600)
Patrys: R600 x 5¤10 = R300
Pine: R600 x 3¤10 = R180
Promise: R600 x 2¤10 = R120

2 Interim repayments (loss-absorption-capacity method)
Property,
plant and Capital: Capital: Capital:
Step* Bank equipment Patrys Pine Promise
R R R R R
A 4 500 1 9 900) *
(7 700) 2 *
(4 820) 2 *
(1 880) 2
C (9 900) *
4 950) 1 *
2 970) 1 *
1 980) 1
4 500 1 Ð (2 750)* (1 850)* 100)*
62)* 38)* (100)*
2 2 2
D 2 2 2
4 500 1 Ð (2 688)* 2 (1 812)* 2 Ð )

1
* Allocation of the loss as a result of the remaining property, plant and equipment
1
being assumed to be worthless
Patrys: R9 900 x 5¤10 = R4 950
Pine: R9 900 x 3¤10 = R2 970
Promise: R9 900 x 2¤10 = R1 980
* Allocation of the anticipated capital deficit of Promise, who must be

2 assumed to
be insolvent, to Patrys and Pine
Patrys: R100 x 5¤8 = R62 (Rounded off to the nearest lower R)
Pine: R100 x 3¤8 = R38 (Rounded off to the nearest higher R)

3 Interim repayments (loss-absorption-capacity method)
Property,
plant and Capital: Capital: Capital:
Step* Bank equipment Patrys Pine Promise
R R R R R
A 6 000 1 3 900) *
(5 012) 2 *
(3 008) 2 *
(1 880) 2
C (3 900) *
1 950) 1 *
1 170) 1 *
780) 1
6 000 1 Ð (3 062)* 2 (1 838)* 2 (1 100)* 2
* Allocation of the loss as a result of the remaining property, plant and equipment
1
being assumed to be worthless
Patrys: R3 900 x 5¤10 = R1 950
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Pine: R3 900 x 3¤10 = R1 170
Promise: R3 900 x 2¤10 = R780

4 Allocation of profit (R100)
Patrys: R100 x 5¤10 = R50
Pine: R100 x 3¤10 = R30
Promise: R100 x 2¤10 = R20
SELF-ASSESSMENT
Yes No
. describe the meaning of the term: ``liquidation'' from the perspective
of this study unit?
. distinguish between a simultaneous and a piecemeal liquidation?
. apply the accounting procedure in the case of a simultaneous
liquidation of a partnership with a profit or loss on liquidation?
. apply the accounting procedure in the case of a piecemeal
liquidation of a partnership, and to calculate the interim repayments
of available cash between partners according to the loss-absorp-
tion-capacity method?
If you answered ``no'' to any of these questions, it would be in your best interest to
revise the relevant section(s) of the study material thoroughly before proceeding to
study unit 5.
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5
STUDY UNIT
Close corporations
CONTENTS
Key concepts 72
5.1 Introduction 73
5.2 Attributes, advantages and disadvantages 73
5.3 Prescribed forms and registration 73
5.4 Membership 73
5.5 Internal and external relations 73
5.6 The tax position of a close corporation and its members 74
5.7 Accounting records and financial reporting 74
5.8 Conversion of a private company into a close corporation 74
5.9 Deregistration 75
Self-assessment 109
Learning outcomes
& briefly discuss the Close Corporations Act in respect of matters concerning the attributes,
registration, internal and external relations, accounting records and annual financial
statements, joint liability of members and others for certain debts of a close corporation, tax
positions of a close corporation and its members, conversion of a private company into a
close corporation, as well as the deregistration of a close corporation.
& prepare the financial statements (with the exception of a statement of cash flows) of a close
corporation according to the provisions of the Close Corporations Act and the requirements
of GAAP. Where applicable, the guidelines as presented in the Guide on Close
(as issued by SAICA, December 2001) must be applied.

& journalise
Corporations
the conversion of a private company into a close corporation in the books of the
close corporation if the accounting records of the converted company will continue to be
used by the close corporation.
& prepare a statement of financial position of a close corporation immediately after its
conversion from a private company according to the provisions of the Close Corporations
Act and the requirements of GAAP.
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Key concepts
& The Close Corporations Act, No 69 of 1984
& Juristic person
& Unlimited existence
& Limited liability
& Member's contribution
& Member's interest
& Accounting officer
& Financial statements
& Profit distribution
& Loan to member
& Loan from member
& Retained earnings
& South African Revenue Service (SARS)
& Profit before tax
& Conversion
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5.1 Introduction
In view of the disadvantages of a partnership as a business entity, such as dependent

corporate status and restricted capital resources, the close corporation as a form of business
entity was introduced when the Close Corporations Act, No 69 of 1984, was legislated. In terms
of this Act a business entity, registered as a close corporation, is allowed to acquire
independent corporate status and unlimited existence (among others).
Read through paragraph 5.1 of the prescribed textbook for further background on the
establishment of close corporations as business entity.
5.2 Attributes, advantages and disadvantages
The attributes, advantages and disadvantages of a close corporation are discussed in detail in
the prescribed textbook. Please read through paragraphs 5.2 to 5.4 of the prescribed textbook.
5.3 Prescribed forms and registration
As mentioned in the prescribed textbook certain prescribed forms must be filed with the
Registrar of Close Corporations. More information on these forms is given in paragraph 5.5 of
the prescribed textbook.
To register a close corporation the requirements of the Close Corporations Act have to be
complied with. A CK7 form has to be completed to register the name of the close corporation
with the Registrar of Close Corporations after which a founding statement (CK1) has to be
completed and submitted to the Registrar for approval. Upon the registration of the founding
statement a registration number is allocated to the close corporation concerned.
The registration procedure of a close corporation, and the application of its name and
registration number, are discussed thoroughly in paragraphs 5.6 to 5.7 of the prescribed
textbook. Read through these paragraphs.
5.4 Membership
The Close Corporations Act sets specific requirements in respect of the number of members that
a close corporation may have, and the qualifications for membership. A close corporation may
have one or more members, but at no time may the number of members exceed ten. With certain
exceptions, only a natural person can become a member of a close corporation. Read more about
the legal requirements pertaining to membership in paragraph 5.8 of the prescribed textbook.
5.5 Internal and external relations
The internal relations of a close corporation pertain mainly to the fiduciary relationship of
members and their liability in the case of negligent conduct. The minimum legislative
requirements exist in respect of the managerial duties of members. Therefore, the members
may decide to manage the close corporation within a more formal framework by means of a
written association agreement, which may be entered into at any time. Another important
aspect that must be taken note of is the fact that the granting of loans and the providing of
security to members and others by a close corporation may only take place when certain
legislative requirements have been met. Read more about the internal relations of close
corporations in paragraph 5.9 of the prescribed textbook.
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FAC1601/1
The external relations of a close corporation pertain mainly to the carrying on of the business
thereof. Each member of a close corporation has an equal right to take part in the business of
the close corporation, and is considered to be an agent of the close corporation with regard to
dealings with the corporation by persons who are not members. Read more about the external
relations of close corporations in paragraph 5.10 of the prescribed textbook.
5.6 The tax position of a close corporation and its members
Read through paragraph 5.12 of the prescribed textbook attentively. Please note that you will
not be required to calculate the provisional tax or the tax for a financial year of a close
corporation. You will only be required to know how provisional tax payments are recorded, and
how matters pertaining to tax are disclosed in the financial statements of a close corporation.
Such recordings are illustrated in the prescribed textbook as well as in the examples in this
study unit.
5.7 Accounting records and financial reporting
The keeping of accounting records and financial reporting in respect of close corporations
make up the most important section of this study unit. Read through paragraph 5.13 of the
prescribed textbook attentively and take note of the statutory requirements in this regard. Note
that in FAC1601 the financial statements of a close corporation are prepared in terms of the
provisions of the Close Corporations Act and the requirements of GAAP. Study examples 5.1
and 5.2. Take note of the following:
. A close corporation discloses its normal income tax expense in the statement of
comprehensive income.
. The statement of changes in equity, which you studied in the section dealing with the
preparation of the financial statements of partnerships, is replaced by a similar statement,
namely the statement of changes in net investment of members. Take note of how the
outlay of the statement of changes in net investment of members differs from the outlay of
statement of changes in equity. Note how the profits of a close corporation can be retained
in a retained earnings account, and how the statement of changes in net investment of
members does not distinguish between the members as the statement of changes in equity
distinguishes between the partners.
. Note how the total equity section of the statement of financial position of a close corporation
differs from that of a partnership.
The reason for the above differences in disclosure between a partnership and a close
corporation is that a partnership is not a legal entity, whereas a close corporation is.
Study the notes to the financial statements of a close corporation. Notes are also a component
of financial statements, and they form an important part of the FAC1601 syllabus with regard to
financial reporting.
5.8 Conversion of a private company into a close corporation
In terms of the Close Corporations Act, a private company can be converted into a close
corporation or For the purpose of your studies, you only need to be able to
vice versa.
. explain the provisions of the Close Corporations Act with regard to the conversion of a
private company into a close corporation
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FAC1601/1
. journalise the conversion of a private company into a close corporation in the books of the
close corporation in the case where the accounting records of the converted company will
continue to be used by the close corporation
. prepare a statement of financial position of a close corporation immediately after its
conversion from a private company according to the provisions of the Close Corporations
Act and the requirements of GAAP
Read about the statutory requirements in respect of conversions in paragraph 5.14.1 of the
prescribed textbook, and study the accounting procedures in respect of conversions in
paragraph 5.14.2. Pay special attention to example 5.3.
5.9 Deregistration
To round off your studies of close corporations, read more about the deregistration of a close
corporation in paragraph 5.15 of the prescribed textbook.
Work through the following exercises, taking special note of how to make year-end
adjustments and how to prepare the financial statements of a close corporation by utilising
your knowledge of FAC1501, the Framework, IAS 1 (AC 101), GAAP, the Close Corporations
Act and the Guide on Close Corporations.
75
FAC1601/1
Exercise 5.1
Preparation of the financial statements of a close corporation
Given information
Mr L Left and Mr R Right are the only two members of Centre CC with an equal interest of 50%
each. On 30 June 20.2, the end of the financial year, the bookkeeper presented the following
trial balance, together with additional information, to you the accounting officer.
CENTRE CC
TRIAL BALANCE AS AT 30 JUNE 20.2
Debit Credit
R R
Member's contribution: Mr L Left 10 000
Member's contribution: Mr R Right 10 000
Loan to member: Mr L Left (30 June 20.2) 18 000
Loan to member: Mr R Right (1 July 20.1) 6 000
Machinery at cost price (30 June 20.2) 51 000
Accumulated depreciation: Machinery (1 July 20.1) 7 000
Mortgage (1 July 20.1) 40 000
Improvements to buildings (31 January 20.2) 55 000
Telephone expenses 1 260
Petrol 4 000
Services rendered 382 000
Water and electricity 5 800
Salary: Mr L Left (paid) 24 000
Salary: Mr R Right (paid) 36 000
Remuneration: Accounting officer 12 000
Deposit: Petrol 1 500
Retained earnings (1 July 20.1) 9 200
Bank 6 260
SARS (income tax) 21 000
458 200 458 200
1 Provision must still be made for depreciation on the machinery at 10% per annum
calculated according to the straight-line method. Machinery with a cost price of R16 000
was purchased on 30 September 20.1 and recorded in the books.
2 The members decided to capitalise the improvements to the buildings. Land and buildings
consist of Plot 166, Op-die-plek, purchased on 1 August 20.0 for R200 000. No
depreciation is provided for on land and buildings.
3 Interest on the mortgage (from T Bank) at 20% per annum must still be taken into account.
The interest is payable on 1 July 20.2. The loan was obtained on 1 July 20.1 and is secured
by a first mortgage over land and buildings. The loan is repayable on 1 July 20.9.
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FAC1601/1
4 The following accounts were received and were payable at 30 June 20.2:
Telkom, for telephone expenses, R150
Pen & Pencil Stationery, for stationery, R120
These accounts must still be recorded in the books and were not paid timeously.
5 Mr D Down, a debtor of the close corporation, had a balance of R2 500 on his account at
30 June 20.2. This amount has to be written off as irrecoverable.
6 The members decided that as from 1 July 20.1 interest at a rate of 18% per annum will be
taken into account on their loan accounts. A new loan of R10 000 was granted to Mr Left at
31 January 20.2. Interest on these loans are capitalised. Both loans are unsecured and
immediately callable.
7 The actual income tax for the year amounted to R83 044 and must still be recorded.
8 The members decided to distribute R60 000 of the total comprehensive income of the
close corporation, for the year ended 30 June 20.2 equally between them. These amounts
will not be paid out in cash but will be left in the close corporation as loans to the
corporation. These loans are unsecured and an interest rate of 20% per annum is
applicable. It was further decided that 50% of these loans must be repaid on
31 March 20.3. The balances on these accounts are repayable on 31 December 20.9.
9 The members' contributions were paid in full and no additional contributions were made
during the year.
REQUIRED
With regard to Centre CC:
(a) Prepare the statement of comprehensive income for the year ended 30 June 20.2.
(b) Prepare the statement of changes in net investment of members for the year ended
30 June 20.2.
(c) Prepare the statement of financial position as at 30 June 20.2.
(d) Prepare the notes for the year ended 30 June 20.2.
Your answer must comply with the provisions of the Close Corporations Act, No 69 of
1984, and the requirements of GAAP. Comparative figures are not required.
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FAC1601/1
Solution 5.1
(a)
CENTRE CC
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 20.2
Note R
Revenue 2, 5 382 000
Other income 3 270
Interest income: Loans and receivables: Loans to members
1 4 3 270
385 270
Administrative and other expenses (90 910)
Depreciation 2 2.1, 3 4 700
Telephone expenses R(1 260 + 150) 1 410
Stationery consumed R(380 + 120) 500
Petrol 4 000
Salaries to members 8 60 000
Credit losses 2 500
Interest on mortgage 1 5 8 000
Profit before tax 286 360
Income tax expense (83 044)
Comment
Because there is no cost of sales, there can be no gross profit or any distribution expenses.
Remember that this is a service entity and not a retail entity.
(b)
CENTRE CC
STATEMENT OF CHANGES IN NET INVESTMENT OF MEMBERS FOR THE YEAR
ENDED 30 JUNE 20.2
Members' Loans
contribu- Retained from Loans to
tions earnings members members Total
R R R R R
Balances at 1 July 20.1 20 000 9 200 Ð (14 000) 15 200
Total comprehensive 203 316 203 316
income for the year
Distribution to members (60 000) 60 000
Loans to members (13 270) (13 270)
Balances at 30 June 20.2 20 000 152 516 60 000 (27 270) 205 246
Non-current liability 30 000
Current liability 30 000
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(c)
CENTRE CC
STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20.2
Note R
ASSETS
Property, plant and equipment 2, 3 294 300

Trade receivables 3 4 13 500
Other financial assets 4 27 270
Cash and cash equivalents 4 7 760
Members' contributions 20 000
Retained earnings 152 516
Long-term borrowings 5, 7 70 000
Trade and other payables 4 5 8 270
Current portion of long-term borrowings 5, 7 30 000

Current tax payable 5 62 044
(d)
CENTRE CC
NOTES FOR THE YEAR ENDED 30 JUNE 20.2
The financial statements have been prepared in accordance with Generally Accepted
Accounting Practice appropriate to the business of the entity. The annual financial statements
have been prepared on the historical cost basis, modified by the revaluation of financial assets
and financial liabilities at fair value through profit or loss.

The financial statements incorporate the following significant accounting policies which are

off on land and buildings. Machinery is subsequently measured at historical cost less
accumulated depreciation and accumulated impairment losses.
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FAC1601/1
Depreciation on machinery is written off at a rate deemed to be sufficient to reduce the carrying
amount of the assets over their estimated useful life to their estimated residual value. The
depreciation rate is as follows:
Machinery: 10% per annum according to the straight-line method.

loss''. Cash and cash equivalents consists of cash in bank and short-term deposits.
2.3 Inventories
disposal.

2.5 Revenue
Revenue is measured at the fair value of the consideration received or receivable. The revenue
is recognised when net income is received for services rendered.
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Land and
buildings Equipment Total
R R R
Carrying amount at 1 July 20.1 200 000 28 000 228 000
Cost 200 000 35 000 235 000
Accumulated depreciation Ð (7 000) (7 000)
Additions 55 000 16 000 71 000
Depreciation for the year Ð (4 700) (4 700)
Carrying amount at 30 June 20.2 255 000 39 300 294 300
Cost 255 000 51 000 306 000
The land and buildings consist of offices on Plot 166, Op-die-plek, and was purchased on
1 August 20.0. The CC has pledged land and buildings with a carrying amount of R255 000
(20.1: R200 000) as security for the mortgage obtained from T Bank.
4. Financial assets
20.2
R
Trade receivables: )
Debtors control 3 13 500)
Other financial assets: )
Loans and receivables: Loans to members: The loans are unsecured and
carry interest at 18% per annum. The loans are
immediately callable. 27 270)
Financial assets at fair value through profit or loss: )
Cash and cash equivalents: 7 760)
Bank 6 260)
Short-term deposit: Petrol 1 500)
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20.2
R
Long-term borrowings: 70 000)
Mortgage: The mortgage was acquired from T Bank on 1 July 20.1 at an )
interest rate of 20% per annum. This loan is secured by a first
mortgage over land and buildings (refer to note 3) and is repayable
on 1 July 20.9.
Mortgage 40 000)
Current portion of loan 0)
Loans and receivables: Loans from members: The loans are unsecured )
and carry interest at 20% per annum. Fifty percent
of the loans are repayable on 31 March 20.3 and
the remainder on 31 December 20.9.
Loans from members 60 000)

Trade and other payables: 8 270)
Accrued expenses: )
Interest on long-term loan 8 000)
Telephone expenses 150)
Stationery 120)
Current portion of long-term borrowings: Loans from members 30 000)
6. Loans to members
Mr L Left Mr R Right Total
R R R
Balance at 1 July 20.1 8 000 6 000 14 000
Advances during the year 10 000 Ð 10 000
Repayments during the year Ð Ð Ð
Interest capitalised 2 190 1 080 3 270
Balance at 30 June 20.2 20 190 7 080 27 270
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7. Loans from members
R R R
Balance at 1 July 20.1 Ð Ð Ð
Advances during the year 30 000 30 000 60 000
Balance at 30 June 20.2 30 000 30 000 60 000
Current portion (15 000) (15 000) (30 000)
Non-current portion 15 000 15 000 30 000
8. Transactions with members

R R R
Salaries 24 000 36 000 60 000
Interest earned on loans to members (2 190) (1 080) (3 270)
21 810 34 920 56 730
Calculations

1 Interest on loans
Loans to members
Mortgage
Mr L Left Mr R Right
R R R
Balance (1 July 20.1) 40 000 8 000 6 000
Interest
(R40 000 x 20%) 8 000
(R 6 000 x 18%) 1 080
(R 8 000 x 18%) 1 440
(R10 000 x 5¤12 x 18%) 750
Interest expense 8 000
Interest income 2 190 1 080
R(2 190 + 1 080) = R3 270
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2 Depreciation
Old New
Machinery Machinery
R R
Cost price 35 000 16 000
Depreciation
(R35 000 x 10%) (3 500)
(R16 000 x 10% x 9¤12 ) (1 200)
Accumulated depreciation (1 July 20.1) (7 000)
Carrying amount (30 June 20.2) 24 500 14 800

3 Debtors control R
Debtors control: 30 June 20.2 16 000
Credit losses written off (2 500)
13 500

4 Trade and other payables
The amount on the statement of financial position was calculated as follows: R
Interest in arrears on long-term loan 8 000
Telephone expenses in arrears 150
Stationery in arrears 120
8 270

5 Current tax payable R
Income tax expense for the year 83 044
Current tax paid during the year (21 000)
Current tax payable 62 044
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FAC1601/1
Exercise 5.2
Given information
The bookkeeper presented you with the following information relating to Note Book CC for the
financial year ended 31 December 20.2:
NOTE BOOK CC
BALANCES AS AT 31 DECEMBER 20.2
R
Member's contribution: N Note (60%) 120 000
Member's contribution: B Book (40%) 80 000
Accumulated depreciation on equipment (1 January 20.2) 12 000
Accumulated depreciation on vehicles (1 January 20.2) 72 000
Bank (Dr) 14 000
Fixed deposit 80 000
Mortgage 320 000
Retained earnings (31 December 20.1) 18 000
SARS (income tax) (Dr) 52 000
Loan to N Note 40 000
Loan from B Book 60 000
Sales 670 000
Purchases 210 000
Inventory (1 January 20.2) 30 000
Stationery consumed 2 900
Carriage on purchases 6 500
Telephone and fax expenses 8 200
Insurance expenses 4 000
Maintenance of vehicles 4 400
Credit losses 800
1 The inventory on 31 December 20.2 amounted to R42 000.

2 An additional amount of R2 000 must be written off as irrecoverable. The allowance for
credit losses must be adjusted to R1 650.
3 The land and buildings consist of a shop and offices on Plot No 157, situated in Mainland,
and were purchased on 8 January 20.0 for R560 000. It is the policy of the close
corporation not to depreciate land and buildings.
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FAC1601/1
4 Depreciation must be provided for as follows:
Vehicles: 20% per annum according to the diminishing-balance method
Equipment: 10% per annum (fixed) on the cost price
5 All the settlement discounts that were provided for at 31 December 20.1 were claimed.
On 31 December 20.2, a trade debtor who owes R1 600 will be entitled to a 10% discount
if he settles his account before 15 January 20.3.
6 Provision still has to be made for interest on the fixed deposit at 14% per annum
receivable on 1 January of each year. The fixed deposit was made on 1 January 20.2 at
Fair Bank for a period of three years.
7 During the financial year an amount of R15 000 was paid to member N Note as
remuneration for specialised services rendered to the corporation. This amount was
included in salaries and wages.
8 Interest on the mortgage from CT Bank at 12% per annum must still be taken into
account. The interest is payable on 2 January 20.3. The loan was obtained on
2 January 20.0 and is secured by a mortgage over land and buildings. The loan is
repayable on 2 January 20.9.
9 The loan to member N Note was granted on 1 April 20.0. Interest is calculated at 12% per
annum and has to be paid by the member in January. The loan is unsecured and
immediately callable.
10 On 1 July 20.2 an amount of R60 000 was borrowed from member B Book. The first
repayment of R20 000 will be made on 30 June 20.3 and the remainder on 30 June 20.6.
Interest is calculated on 31 December at a rate of 10% per annum and is paid in January.
The loan is unsecured.
11 Provision must be made for a distribution of 80% of the total comprehensive income for
the financial year to the members.
12 The actual normal income tax for the financial year amounted to R79 515 and must still
be recorded.
REQUIRED
With regard to Note Book CC:
(a) Prepare the statement of comprehensive income for the year ended 31 December 20.2.
31 December 20.2.
(c) Prepare the statement of financial position as at 31 December 20.2.
(d) Prepare the notes for the year ended 31 December 20.2.
1984, as well as the requirements of Generally Accepted Accounting Practice.
Comparative figures are not required.
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FAC1601/1
Solution 5.2
(a)
NOTE BOOK CC
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.2
Note R
Revenue R(670 000 ± 1 860 )
13 2 668 140
Cost of Sales (204 500)
Purchases 210 000
Carriage on purchases 6 500
246 500
Inventory (31 December 20.2) (42 000)
Gross profit 463 640
Other income 16 000
1 8 4 800

Interest income: Loans and receivables: Fixed deposit 2 4 11 200
479 640
Salaries R(96 000 ± 15 000) 81 000
Salaries to members 8 15 000


Stationery consumed 2 900
Telephone and fax expenses 8 200
Maintenance of vehicles 4 400
Insurance expenses 4 000

Interest on mortgage 5 38 400
Interest on loan from member
6 8 3 000
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(b)
NOTE BOOK CC
ENDED 31 DECEMBER 20.2
Members' Loans
contribu- Retained from Loans to
tions earnings members members Total
R R R R R
Balances at 1 January 20.2 200 000 18 000) (40 000) 178 000)
Total comprehensive
income for the year 194 675 194 675)
Distribution to members (155 740) (155 740)
Loans from members 60 000 60 000)
Balances at
31 December 20.2 200 000 56 935) 60 000 (40 000) 276 935)
Current liability 20 000
(c)
NOTE BOOK CC
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.2
Note R
ASSETS
Financial assets 4 80 000
Inventories 42 000
Trade receivables 4 47 190
Long-term borrowings 8 5, 7 360 000
Current portion of long-term borrowings
9 5, 7 20 000

Distribution to members payable 10 155 740

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(d)
NOTEBOOK CC
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.2
The financial statements have been prepared in accordance with generally accepted
accounting practice appropriate to the business of the entity. The financial statements have

The annual financial statements incorporate the following significant accounting policies which
are consistent with those applied in previous years except where otherwise stated.

off on land and buildings. Equipment and vehicles are subsequently measured at historical cost
less accumulated depreciation and accumulated impairment losses.
Depreciation on equipment and vehicles are written off at a rate deemed to be sufficient to
reduce the carrying amount of the assets over their estimated useful life to their estimated
residual value. The depreciation rates are as follows:
Equipment: 10% per annum on the cost price;
Vehicles: 20% per annum according to the diminishing-balance method.

except for ``Financial assets at fair value through profit or loss'' which is measured at cost,
loss''. Cash and cash equivalents consists of cash in bank.
2.3 Inventories
disposal.

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FAC1601/1
2.5 Revenue
granted. The entity is not registered as a VAT-vendor. The revenue from sales is recognised

Land and Equip-
buildings Vehicles ment Total
R R R R
Carrying amount at 1 January 20.2 560 000 128 000 28 000 716 000
Cost 560 000 200 000 40 000 800 000
Accumulated depreciation Ð (72 000) (12 000) (84 000)
Depreciation for the year Ð (25 600) (4 000) (29 600)
Carrying amount at 31 December 20.2 560 000 102 400 24 000 686 400
Cost 560 000 200 000 40 000 800 000
Accumulated depreciation Ð (97 600) (16 000) (113
600)
The land and buildings consist of a shop and offices on Plot No 157, Mainland, and were
purchased on 8 January 20.0. The CC has pledged land and buildings with a carrying
amount of R560 000 (20.1: R560 000) as security for the mortgage from CT Bank.
4. Financial assets
20.2
R
Non-current financial assets
Loans and receivables: A fixed deposit was made on 1 January 20.2 for a
period of three years at Fair Bank at 14% interest
per annum. The deposito is callable at
31 December 20.4. 80 000)
Current financial assets )
Debtors control 7 32 840)
Allowance for credit losses (1 650)
Accrued income: )
Interest on loan to member 4 800)
Interest on fixed deposit 11 200)
Loans and receivables: Loans to members: The loans are unsecured
and carry interest at 12% per annum. The loans are
immediately callable. 40 000)
Bank 14 000)
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20.2
R
Long-term borrowings: 360 000 )
Mortgage: The mortgage was acquired from T Bank on 1 July 20.1 at an )
interest rate of 20% per annum. This loan is secured by a first
mortgage over land and buildings (refer to note 3) and is
repayable on 2 January 20.9.
Mortgage 320 000)
Loans and receivables: Loans from members: The loans are )
unsecured and carry interest at 10% per annum.
R20 000 of the loans are repayable on
30 June 20.3 and the remainder on
30 June 20.9.

Trade and other payables: 89 400 )
Accrued expenses: )
Interest on mortgage 38 400)
Interest on loan from member 3 000)
Current portion of long-term borrowings: Loans from members 20 000 )
6. Loans to members
N Note B Book Total
R R R
Balance at 1 January 20.2 40 000 Ð 40 000
Advances during the year Ð Ð Ð
Balance at 31 December 20.2 40 000 Ð 40 000
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N Note B Book Total
R R R
Balance at 1 January 20.2 Ð Ð Ð
Advances during the year Ð 60 000 60 000
Balance at 31 December 20.2 Ð 60 000 60 000
Current portion Ð (20 000) (20 000)
Non-current portion Ð 40 000 40 000

N Note B Book Total
R R R
Salaries 15 000 Ð 15 000
Interest incurred on loan from member Ð 3 000 3 000
Interest earned on loan to member (4 800) Ð (4 800)
10 200 3 000 13 200
Calculations

1 Interest on loan to member
12
R40 000 x 100
= R4 800

2 Interest on fixed deposit
14
R80 000 x 100
= R11 200

3 Credit losses R
Original amount written off 800
Additional amount written off 2 000
*
Increase in allowance for credit losses 1 150
2 950
* New allowance
1 1 650
Old allowance (1 500)
Increase in allowance 150

4 Depreciation
Vehicles = R (200 000 ± 72 000) x 20%

= 20
R128 000 x 100
= R25 600
Equipment = 10
R40 000 x 100
= R4 000
Total = R (25 600 + 4 000) = R29 600
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5 Interest on mortgage
R320 000 x 12
100
= R38 400

6 Interest on loan from member
10 x
R60 000 x 100 6
12
= R3 000

7 Debtors control R
Balance given 35 000
Additional credit losses written off (2 000)
Allowance for settlement discount granted (R1 600 x 10%)
12 (160)
32 840

8 Long-term borrowings R
Mortgage 320 000
Loan from B Back 60 000
Portion to be repaid in 20.3 financial year (20 000) 40 000
360 000

9 Current portion of loans from members
The current portion of loans from members represents that portion of the loan of R60 000

that will be repaid in the 20.3 financial year (refer to calculation 8 ).

10 Distribution to members payable
R194 675 6 80¤100

= R155 740

Income tax for the year 79 515

SARS (income tax) (52 000)

12 Allowance for settlement discount granted
R1 600 6 10¤100
= R160

13 Settlement discount granted R
Settlement discount granted for the year 1 700

Allowance for settlement discount granted
12 160
1 860
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Exercise 5.3
Preparation of the annual financial statements of a close corporation
Given information
After the bookkeeper had recorded the transactions during the year, he handed you the
following trial balance and additional information with regard to Trade Acc CC.
TRADE ACC CC
TRIAL BALANCE AS AT 31 DECEMBER 20.1
Debit Credit
R R
Accumulated depreciation: Furniture and equipment
(1 January 20.1) 6 700
Accumulated depreciation: Vehicles (1 January 20.1) 8 400
Inventory (31 December 20.0) 54 600
Mortgage 50 000
Allowance for credit losses (31 December 20.0) 955
Bank 24 000
Sales 321 300
Purchases 224 700
Import duty on purchases 1 550
Railage on purchases 2 500
Repairs and maintenance 1 315
Assessment rates 1 710
Commission on sales 1 500
Delivery expenses 650
Credit losses 460
Loss on sale of equipment 220
Dividends received 450
Settlement discount received 1 000
Investment 10 000
Loan from member: A Adam 10 000
Loan from member: C Charles 8 000
Interest expenses (iro loans) 9 660
Member's contribution: A Adam 40 000
Member's contribution: B Ben 35 000
Member's contribution: C Charles 25 000
Retained earnings (31 December 20.0) 6 220
Forfeited settlement discount granted 200
550 325 550 325
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1 The interest of the members in the CC is in the same ratio as their contributions.
2 The land and buildings consist of a shop and offices on Plot No 32, situated in Dorpshuis,
and were purchased on 15 March 20.0 for R95 000. It is the policy of the close corporation
not to depreciate land and buildings.
3 The investment in Vicks Limited consists of 10 000 ordinary shares of R1 each and was
acquired in 20.0. On 31 December 20.0 the fair value of the investment was determined at
R10 000. On 31 December 20.1 the fair value was determined at R11 000 and is still to be
recorded.
4 Included in salaries and wages is an amount of R10 000 which was paid to member B Ben
as remuneration for his special contribution to the management of the enterprise.
5 Provision for depreciation of R1 650 on furniture and equipment and R2 100 on vehicles
must still be made.
6 The interest paid includes R2 160, which represents 12% interest paid to A Adam and
C Charles in respect of the loans they made to the close corporation. The loans are
unsecured and are repayable on 31 December 20.5.
7 The mortgage was acquired on 2 January 20.1 from Bug Bank at 15% interest per annum.
Interest is payable on 31 December. The loan is secured by a first mortgage over land and
buildings and is repayable in five equal annual installments as from 2 January 20.4.
8 The allowance for credit losses must be adjusted to R1 025.
9 On 31 December 20.1 the inventory on hand amounted to R58 300.
10 The actual normal income tax in respect of the financial year amounted to R11 166 and
must still be recorded.
11 A distribution of income of R20 000 must be made to the members.
12 On 31 December 20.1 a trade debtor who owes R1 500 is entitled to a 5% discount
provided he settles his account before 10 January 20.2.
13 Trade Acc CC was offered a discount of 6% on an amount of R 1 200 owing to a supplier
provided the supplier is paid before 15 January 20.2. The close corporation intends taking
advantage of the discount offered.
REQUIRED
With regard to Trade Acc CC:
(a) Prepare the statement of comprehensive income for the year ended 31 December 20.1.
31 December 20.1.
(c) Prepare the statement of financial position as at 31 December 20.1.
(d) Prepare the notes for the year ended 31 December 20.1.
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Solution 5.3
(a)
TRADE ACC CC
Note R

Revenue R(321 300 ± 1 425 1 + 200) 2 320 075
Purchases R(224 700 ± 1 072 3 ) 223 628
Import duty 1 550
Railage on purchases 2 500
282 278
Gross profit 96 097
Other income 1 450
Dividend income: Financial assets at fair value through profit
or loss: Held for trading: Listed investment 450
Gain on financial assets at fair value through profit or loss:
Held for trading: Listed investment 1 000
97 547
Repairs and maintenance 1 315
Assessment rates 1 710
Commission on sales 1 500
Delivery expenses 650
Salaries and wages R(36 615 ± 10 000) 26 615
Salary to member 7 10 000

Credit losses 5 530
Loss on sale of equipment 220

Interest on mortgage 5 7 500
Interest on loans from members 5, 7 2 160
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(b)
TRADE ACC CC
Members' Retained Loans from
contributions earnings members Total
R R R R
Balances at 1 January 20.1 100 000 6 220 18 000 124 220
Total comprehensive income
for 27 336 27 336
the year
Balances at 31 December 20.1 100 000 13 556 18 000 131 556
(c)
TRADE ACC CC
Note R
ASSETS
Inventories 58 300

Long-term borrowings 5, 6 68 000
Distribution to members payable 20 000

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(d)
TRADE ACC CC
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.1
been prepared on the historical cost basis, modified by the revaluation of financial asssets and


off on land and buildings. Vehicles and furniture and equipment are subsequently measured at
historical cost less accumulated depreciation and accumulated impairment losses.
Depreciation on vehicles and furniture and equipment are written off at a rate deemed to be
sufficient to reduce the carrying amount of the assets over their estimated useful life to their
estimated residual value. The depreciation is as follows:
Vehicles: Over a period of 10 years at R2 100 per annum. There is no scrap (residual)
value anticipated.
Furniture and equipment: Over a period of 20 years at R1 650 per annum. There is no
scrap value anticipated.
determined by comparing the procees with the carrying amount of the asset. The net amount is
included in profit or loss for the year.

2.3 Inventories
disposal.
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2.5 Revenue
granted. The entity is not registered as a VAT vendor. The revenue from sales is recognised

Furniture
Land and and
buildings equipment Vehicles Total
R R R R
Carrying amount at 31 January 20.1 95 000 26 300 12 600 133 900
Cost 95 000 33 000 21 000 149 000
Depreciation for the year Ð (1 650) (2 100) (3 750)
Carrying amount at 31 December 20.1 95 000 24 650 10 500 130 150
Cost 95 000 33 000 21 000 149 000
The land and buildings consist of a shop and offices on Plot No 32, Dorpshuis, and were
purchased on 15 March 20.0. The CC has pledged land and buildings with a carrying
amount of R95 000 (20.0: R95 000) as security for the mortgage from Bug Bank.
4. Financial assets
20.1
R
Debtors control 20 425)
Held for trading: Listed investment: 10 000, R1 ordinary shares in
Vicks Limited 11 000)
Bank 24 000)
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20.1
R
Long-term borrowings: 68 000)
Mortgage: The mortgage was acquired from Bug Bank on 2 January 20.1 )
at an interest rate of 15% per annum. The loan is repayable in
five equal annual instalments as from 2 January 20.4. This loan
is secured by a first mortgage over land and buildings.
Mortgage 50 000)
Loans and receivables: Loans from members: The loans are unsecured )
and carry interest at 12% per annum. The loans
are repayable on 31 December 20.5

Trade and other payables: 37 028)

A Adam B Ben C Charles Total
R R R R
Balance at 1 January 20.1 10 000 Ð 8 000 18 000
Advances during the year Ð Ð Ð Ð
Repayments during the year Ð Ð Ð Ð
Balance at 31 December 20.1 10 000 Ð 8 000 18 000

A Adam B Ben C Charles Total
R R R R
Interest on loans from members 1 200 Ð 960 2 160
Salaries Ð 10 000 Ð 10 000
1 200 10 000 960 12 160
100
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Calculations

1 Settlement discount granted
Settlement discount granted for the period 1 350

Allowance for settlement discount granted 2 75
1 425

2 Allowance for settlement discount granted
5
R1 500 x 100
= R75

3 Settlement discount received
Settlement discount received for the period 1 000

Allowance for settlement discount received 4 72
1 072

4 Allowance for settlement discount received
6
R1 200 x 100
= R72

5 Credit losses
R[460 + (1 025 7 955)]

= R(460 + 70)
= R530

6 Depreciation
R(1 650 + 2 100)

= R3 750

7 Trade receivables
R
Allowance for settlement discount granted 2 (75)
20 425
19 400

8 Trade and other payables

Allowance for settlement discount received (72)
37 028

9 Current tax payable

Current tax paid during the year (6 900)
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Exercise 5.4
Given information
The bookkeeper has provided you with the following trial balance and additional information
with regards to Loga CC for the year ended 28 February 20.4:
LOGA CC
TRIAL BALANCE AS AT 28 FEBRUARY 20.4
Debit Credit
R R
Member's contribution: L Lock 72 000
Member's contribution: G Gate 65 000
Inventories (28 February 20.4) 172 080
Loan to G Gate 12 000
Investment (fixed deposit at ABC bank) 25 000
Bank 6 956
Accumulated depreciation: Equipment (1 March 20.3) 3 600
Sales 1 168 236
Cost of Sales 778 812
Retained earnings (28 February 20.3) 6 420
Advertising expense 4 800
Income from investment 1 500
Credit losses 540
Interim profit distribution to members 48 000
Interest income 720
1 400 780 1 400 780
1 A debtor cannot be traced and his debt of R184 must be written off as irrecoverable. The
members decided to create an allowance for credit losses of R1 000.
2 The electricity account for February, R785, was received on 20 March 20.4.
3 On 1 June 20.3 an insurance contract was entered into. The premium of R800, payable
annually on 1 June, is included in administrative expenses.
4 The loan to G Gate was made on 1 March 20.3 at 12% interest per annum, payable every
six months. The loan is unsecured and immediately callable.
5 Included in salaries and wages is an amount of R20 000, paid to L Lock as remuneration
for his special contribution to the management of the enterprise.
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6 The investment in ABC Bank was made on 1 May 20.3 for 60 months at 12% interest per
annum, which is receivable every six months on 31 October and 30 April.
7 Provision must still be made for the following:
. Depreciation on the vehicle and equipment at 20% per annum on the diminished
balance. The vehicle was acquired on 1 September 20.3.
. Actual normal income tax for the financial year amounted to R51 494.
. An additional distribution to members of R36 000. Members share profits equally.
REQUIRED
With regard to Loga CC:
(a) Prepare the statement of comprehensive income for the year ended 28 February 20.4.
28 February 20.4.
(c) Prepare the statement of financial position as at 28 February 20.4.
(d) Prepare only the following notes for the year ended 28 February 20.4:
. accounting policy
. property, plant and equipment
. transactions with members
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Solution 5.4
(a)
LOGA CC
Note R
Revenue 2 1 168 236
Other income 3 940
1 1 440

Interest income: Loans and receivables: Fixed deposit 2 2 500
393 364
Advertising expense 4 800
Salaries and wages R(168 020 ± 20 000) 148 020
Salary to member 4 20 000

Water and electricity 3 9 425

Administrative expenses 5 2 068

Insurance expense 6 600

Depreciation 7 3 8 280
(b)
LOGA CC
ENDED 28 FEBRUARY 20.5
Members' Retained Loans to
contributions earnings members Total
R R R R
Balances at 1 March 20.3 137 000 6 420 (12 000) 131 420
Total comprehensive income 126 073 126 073
for
the year
Distribution to members 12 (84 000) (84 000)
Balances at 28 February 20.4 137 000 48 493 (12 000) 173 493
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(c)
LOGA CC
Note R
ASSETS
Financial assets 25 000
Inventories 172 080

Trade receivables 8 50 720
Prepayments 9 200
Other financial assets 12 000

Distribution to members payable
12 36 000

(d)
LOGA CC
NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.4


Property, plant and equipment are initially recognised at cost price. Equipment and vehicles
are subsequently measured at historical cost less accumulated depreciation and accumulated
impairment losses.
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Depreciation on equipment and vehicles are written off at a rate deemed to be sufficient to
reduce the carrying amount of the assets over their estimated useful life to their estimated
residual value. The depreciation rates are as follows:
Equipment: 20% per annum according to the diminishing-balance method;
Vehicles: 20% per annum according to the diminishing-balance method.
except for ``Financial assets at fair value through profit or loss'' which is measured at cost,
2.3 Inventories
disposal.
2.5 Revenue
from the sale of goods consists of the total net invoiced sales excluding value added tax and
settlement discount granted. The revenue from sales is recognised when the ownership is
transferred to the customer.
Equipment Vehicles Total
R R R
Carrying amount at 1 March 20.3 14 400 Ð 14 400
Cost 18 000 Ð 18 000
Accumulated depreciation (3 600) Ð (3 600)
Additions Ð 54 000 54 000
Depreciation for the year (2 880) (5 400) (8 280)
Carrying amount at 28 February 20.4 11 520 48 600 60 120
Cost 18 000 54 000 72 000
Accumulated depreciation (6 480) (5 400) (11 880)
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L Lock G Gate Total
R R R
Salary 20 000 Ð 20 000
Interest on loan to member Ð (1 440) (1 440)
20 000 (1 440) 18 560
Calculations

1 Interest on loan to member
R12 000 x 12% = R1 440

2 Interest on investment
R25 000 x 12% x 10¤12 = R2 500

3 Water and electricity
R (8 640 + 785)
R9 425

4 Credit losses R
Original amount written off 540
Further amount written off 184
1 724

5 Administrative expenses
R(2 868 ± 800) (R800 = insurance premium)
= R2 068

6 Insurance
The R800 was paid for a period of one year starting on 1 June 20.3. Only 9 months of this
period falls within the current financial year. Therefore only R800 x 9/12 = R600 of the
expense was incurred during the current financial year. The R200 that falls outside this
financial period must be shown in the statement of financial position as a prepayment for
the next financial period.

7 Depreciation R
Equipment 18 000
Accumulated depreciation (3 600)
Diminished balance (carrying amount) 14 400
14 400 x 20% = R2 880

Vehicle
R54 000 x 20% x 6/12
= R5 400
Total = R(2 880 + 5 400) = R8 280
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8 Trade receivables R
49 000
Accrued interest on loan to member 720
R(1 440 ± 720)
Accrued interest on investment 1 000
R(2 500 ± 1 500)
50 720

9 Prepayments
Prepayments represent insurance prepaid

(refer to 6 ) R200

10 Trade and other payables R
Accrued expenses (water and electricity) 785
84 089

SARS: Income tax paid during the year (30 000)

12 Distribution to members payable R
Distribution to members R(48 000 + 36 000) 84 000
Interim distribution paid to members (48 000)
36 000
108
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SELF-ASSESSMENT
Yes No
. briefly discuss the Close Corporations Act in respect of matters
concerning the attributes, registration, internal and external rela-
tions, accounting records and annual financial statements, joint
liability of members and others for certain debts of a close
corporation, tax position of a close corporation and its members,
conversion of a private company into a close corporation, as well as
the deregistration of a close corporation?
. prepare the financial statements (with the exception of a statement of
cash flows) of a close corporation according to the provisions of the
Close Corporations Act and the requirements of GAAP and, where
applicable, the guidelines as presented in the Guide on Close
Corporations (as issued by SAICA, December 2001)?

. journalise the conversion of a private company into a close
corporation in the books of the close corporation in the case where
the accounting records of the converted company will continue to be
used by the close corporation?
. prepare a statement of financial position of a close corporation
immediately after its conversion from a private company according
to the provisions of the Close Corporations Act and the require-
ments of GAAP?
If you answered ``yes'' to all of the above assessment criteria, you have completed your
studies on close corporations and can move on to study unit 6. If you answered ``no'' to
any of the above criteria, you must revise that section before progressing to the next
study unit.
You have now completed your studies on close corporations. Do you think that you
would prefer to establish a partnership if you had the opportunity or establish a close
corporation instead?
109
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6
STUDY UNIT
Introduction to companies
CONTENTS

Key concepts 111
6.1 Introduction 112
6.2 Formation of a company 112
6.3 Shareholders and the rights of shareholders 112
6.4 Share transactions 113
6.5 The issue of shares 114
6.6 Conversion of shares 115
6.7 Issue of capitalisation shares 115
6.8 Underwriting of shares 115
6.9 Dividends 116
6.10 Debenture transactions 117
6.11 Financial statements of companies 118
Self-assessment 134
Learning outcomes
& distinguish between authorised and issued share capital
& distinguish between par value and no par value shares
& explain what a share premium is and the application of the share premium account
& distinguish between ordinary shares and preference share
& record transactions pertaining to the issue of shares
& prepare an allotment schedule
& record the issue of capitalisation shares
& record the underwriting of shares
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& explain dividends and the calculation thereof
& record dividend transactions
& record transactions pertaining to the issue of debentures
& calculate and record interest on debentures
Key concepts
& Companies Act
& Public company
& Private company
& Shareholders
& Authorised share capital
& Issued share capital
& Par value shares
& No par value shares
& Share premium
& Share capital account
& Stated capital account
& Ordinary shares
& Preference shares
& Capitalisation shares
& Underwriting share issues
& Interim dividends
& Final dividends
& Debenture issue
& Debenture interest
111
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6.1 Introduction
Sole traders, partners of partnerships and members of close corporations provide their own
capital or borrow money from financial institutions to finance their businesses with. Such
financing methods are limited, and therefore entities that need large sums of money, such as
mines, establish public companies in order to issue shares to the public so as to increase their
financing resources.
Companies came into existence during the Industrial Revolution to meet the following needs:
. to acquire more capital
. to ensure the continued existence of the entity
. to limit the financial liability of the owners
To help you learn more about the way companies work, a theoretical background on
companies is given in chapter 6 of the prescribed textbook. We do not expect of you to
memorise the theory as there will be no theoretical questions in the examination. However, you
will have to apply certain of the theoretical aspects when you are required to prepare practical
questions, such as the recording of transactions that pertain to the issue of shares, preparing
allotment schedules, calculating and recording dividends, etc. In general, a company can be
described as an association of persons who work together with the aim of making a profit. You
can read more about the characteristics of companies as a form of business ownership and the
differences between sole traders, partnerships, close corporations and companies in
paragraphs 6.1 and 6.2 of the prescribed textbook.
6.2 Formation of a company
A company is established by complying with specific legal requirements. The first step in the
process of establishing a company is to apply for the registration of its proposed name by the
Registrar of Companies. Once the name has been approved, the memorandum of association,
the articles of association and other prescribed forms and declarations must be submitted to
and approved by the Registrar. Read paragraph 6.3 of the prescribed textbook to acquaint
yourself with further details pertaining to the procedure that must be followed to register a
company, and with regard to the information that must be disclosed in the required documents.
The main reason behind the formation of a company usually determines the type of company
that will be established. If the aim of the company is to make a profit, a private or a public
company can be formed. You can read more about the different types of companies in
paragraph 6.4 of the prescribed textbook.
After a company has been registered by the Registrar, it can start trading.
6.3 Shareholders and the rights of shareholders
To enable members of the public, who generally have limited financial resources available for
investment, to invest in a large business enterprise such as a public company, the capital of a
company is divided into more affordable units, called shares. Shares of public companies are
traded on securities (stock) exchanges. Share prices fluctuate according to supply and demand.
The supply and demand of shares are determined by various factors, such as the financial
performance of a company, the future prospects in the marketplace, legislation, etc. The financial
statements of a company should be meticulously analysed when choosing a company to invest
in. The riskier the investment, the higher the proceeds on the investment usually are because of
the high degree of uncertainty involved in an estimate of future business performance. An
investment in a company is usually perceived as an investment with a relatively high risk.
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FAC1601/1
Prospective investors in companies are usually advised not to fund their investments with money
that they cannot afford to risk. The analyses of financial statements are complex, and the general
public usually do not have the knowledge to perform such analyses. For this reason, a
prospective buyer of shares may prefer to make use of the services of a financial analyst in order
to decide which company to invest in and how much money to risk.
The shareholders of a company may share in the profits of the company, and under certain
circumstances they have voting rights in relation to the number of shares that they have
purchased. For instance, ordinary shareholders may vote on the directors to be appointed in
the company.
Since a company is regarded as a legal person, the trading of shares, which changes the
ownership of a company, will not influence the continued existence of the company, as is the
case with a sole trader or a partnership. You can read more about shareholders and their rights
in paragraphs 6.5 and 6.6 of the prescribed textbook.
6.4 Share transactions
To enable a company to attract the public as investors, it issues a prospectus. A prospectus

must contain a reasonable representation of the affairs of the company and it must comply with
certain requirements prescribed by the Companies Act 61 of 1973, as amended (hereafter
referred to as the Companies Act). Read more about the prospectus and how shareholders
obtain proof of their shareholdings in a company in paragraph 6.7.1 of the prescribed textbook.
6.4.1 Authorised and issued share capital
The founders of a company will, as part of their preparation for the establishment of the
company, estimate how much money is required to expand the company to its maximum
potential. The Registrar must approve the maximum amount of money that may be obtained
from shareholders by means of issuing shares. Such approved amounts of shares are referred
to as the authorised share capital of a company. A company must disclose its authorised share
capital in its memorandum of association. The authorised shares are issued, that is sold to the
shareholders, according to the financial needs of the company. All of the authorised shares do
not have to be issued immediately. The shares which are sold to the public represent the
issued share capital of a company. The monetary value of the issued share capital is used in
the calculation of the total equity that is disclosed in the statement of financial position.
Read through paragraphs 6.7.2 and 6.7.3 of the prescribed textbook attentively.
6.4.2 Par value and no par value shares and share premium
A par value (PV) share has a nominal value assigned to it. For instance, an ordinary share may
have a par value of R1. Such a share will be referred to as an ordinary share of R1. When par
value shares are sold for a higher price than the par value thereof, the difference between the
selling price and the par value is referred to as a share premium. When par value shares are
sold at less than the par value thereof, the difference is referred to as a discount. Ordinarily, par
value shares are not sold at a discount.
If shares do not have a nominal value assigned to them, they are referred to as a no par value
(NPV) shares. A no par value share will simply be referred to as an ordinary share. Since a no
par value share does not have a par value, no difference can be calculated between the selling
price and a predetermined value of the share. A no par value share can thus not be issued at
par, a premium or a discount.
Read through paragraphs 6.7.4 and 6.7.5 of the prescribed textbook attentively.
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FAC1601/1
6.4.3 Classes of shares
Companies usually distinguish between two main classes of shares, namely ordinary and
preference shares. The ordinary shareholders are in effect the owners of the company and
usually have more rights than the preference shareholders. Preference shares can be
classified as either ordinary preference shares, cumulative preference shares, non-cumulative
preference shares, participating preference shares or redeemable preference shares.
Read through paragraphs 6.7.6, 6.7.6.1 and 6.7.6.2 of the prescribed textbook attentively.
6.5 The issue of shares
The reason for the registration of a public or private company is that the founders thereof are of
the opinion that the company will be a successful and sustainable business. For this reason,
the first issue of share is usually made to the founders of the company. However, public
companies usually obtain the greater part of their capital by inviting the public to buy shares in
the company by issuing a prospectus.
Read more about the general aspects on the issuing of shares in paragraph 6.7.7.1 of the
prescribed textbook.
6.5.1 Recording the issue of shares
When a prospective investor wants to buy shares in a company, an application form must be
completed and the money for the number of shares applied for must accompany the application
form. A company may not issue or even allocate any shares unless the full issue price (selling
price) has been received by the company. Since a company can only allocate the number of
shares it offered, the shares will have to be allotted according to a predetermined formula if more
applications have been received than the number of shares advertised (offered) in the
prospectus. The money received from the unsuccessful applicants must be refunded to them.
The prospectus must indicate the last date on which applications for the purchase of shares will
be considered for acceptance. Since the applications are received over a period of time, the
money that accompanies the applications must, for security reasons, be banked in the name of
the company. Because the company does not know how many applications will be received by
the closing date, the money received must be recorded in an interim account before it can be
recorded as capital in the books of the company. Once the shares have been allotted, the
interim accounts are closed off by recording the issued capital or by recording the repayment of
funds to unsuccessful applicants.
The accounts used to record the applications received from the founders of the company are
different from the accounts used to record the applications received from the public. Because
shares may only be allocated and issued after the full issue price has been received by the
company, the money received will be recorded in the cash receipts journal (CRJ).
From the CRJ money received from the founders will be

. debited to the bank account and
. credited to the subscribers to the memorandum: Ordinary shares account
From the CRJ money received from the public will be

. debited to the bank account and
. credited the application and allotment: Ordinary shares account.
If ordinary and preference shares are issued simultaneously, separate accounts must be
opened for the subscribers to the memorandum, and for the application and allotment of
ordinary and preference shares.
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Read paragraph 6.7.7.2 of the prescribed textbook attentively, and study examples 6.1, 6.2
and 6.3.
Pay special attention to the following:

. Where par value shares are issued, the subscribers to the memorandum and the
application and allotment accounts must be closed off to the share capital account.
. Only par value shares can be issued at a premium. Premiums are recorded in a share
premium account.
. Where no par value shares are issued, the subscribers to the memorandum, and the
application and allotment accounts must be closed off to a stated capital account.
6.5.2 Schedule for the allotment of shares
When more applications have been received than the share offering, it becomes necessary to
make use of a formula to allocate the shares in an objective manner. This is referred to as the
allotment of shares. Read paragraph 6.7.8 of the prescribed textbook and study example 6.4.
6.6 Conversion of shares
Under certain circumstances companies are allowed to convert shares from par value to no par
value shares or vice versa. A company that had registered shares at a par value of R1 each at
its incorporation, say a few years ago, may find that its shares are currently trading well above
par. When deciding to issue more of the authorised shares, the shares may be converted into
no par value shares prior to the share offering. These shares, when issued, will be recorded as
stated capital. Since companies are not permitted to have a combination of shares of the same
class at par and no par value, any shares of the same class that were first issued as par value
shares must also be recorded as stated capital when the same class of shares is converted to
NPV shares at a later stage. Such a conversion is recorded by transferring the balances on the
applicable share capital and share premium accounts to a stated capital account. Read
paragraphs 6.7.9, 6.7.9.1 and 6.7.9.2 of the prescribed textbook attentively and study
examples 6.5 and 6.6.
6.7 Issue of capitalisation shares
Occasionally companies retain income for future use. The ``Retained income'' can be used to
pay dividends, but the payment of dividends can adversely affect the cash position of a
company. However, the retained earnings can be capitalised by distributing them among the
shareholders in the form of capitalisation shares. No cash is paid out, but each shareholder
receives his rightful share of the retained earnings in the form of additional shares given to him
as a bonus. The shares are issued in the same proportion as the existing shareholding and the
recording of such share issues requires only a book entry which converts the retained earnings
into share capital. The share premium can also be used for the issue of capitalisation shares.
Read paragraph 6.7.10 of the prescribed textbook attentively, and study examples 6.7 and 6.8.
6.8 Underwriting of shares
When a company offers shares, they would normally avail themselves of the services of a
financial institution to underwrite the offering. An underwriter guarantees that if the whole issue
of shares is not taken up by the public, the financial institution will itself take up all of the shares
that were not subscribed. For furnishing a guarantee to a company that the whole offering of
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FAC1601/1
shares will be taken up, the underwriter receives a commission. The commission is calculated
on the total value of the shares underwritten, irrespective of whether the underwriter has
personally taken up some of the shares.
Read paragraph 6.7.11 of the prescribed textbook attentively and study example 6.9.
6.9 Dividends
One of the reasons why a shareholder invests his money in a company is to share in the
growth and profits thereof. If a company has made a significant profit and the directors are
satisfied that the cash flow position of the company can bear both in growth and its dividend
declarations, they may decide to declare dividends. Dividends on ordinary shares are
calculated per share, whereas dividends on preference shares are calculated on the monetary
value thereof. Dividends need not necessarily be paid out in cash. Capitalisation shares, as
discussed in paragraph 6.7 of the prescribed textbook, can be issued instead of paying
dividends in cash to shareholders.
Read more about dividends in paragraph 6.8.1 of the prescribed textbook.
6.9.1 Preference dividends
If dividends are declared on preference shares, a preference shareholder will receive a fixed
dividend on his share. Such a fixed dividend is disclosed as a percentage in the description of
the share, for example, a 10% preference share. Preference shareholders therefore know in
advance what the amount of dividends would be that they would receive if dividends were
declared.
With preference shares, the calculation of dividends is done on the same basis as the
calculation of interest, taking the period that the shares are in the possession of the
shareholder into account.
Read paragraph 6.8.2 of the prescribed textbook attentively, taking special note of how
dividends are calculated on preference shares.
6.9.2 Ordinary dividends
No surety is given by a company to an ordinary shareholder about whether dividends are going
to be declared, or what the dividend per share will be. Dividends may not be declared on
ordinary shares if dividends on preference shares have not been declared. The risk attached to
the investment in a preference share is therefore less than the risk attached to the investment
in an ordinary share. For this reason, ordinary shareholders have more rights than the
preference shareholders with regard to participating in certain of the business activities of a
company.
Read paragraph 6.8.3 of the prescribed textbook attentively, taking special note of how
dividends are calculated on ordinary shares.
6.9.3 Interim, final and annual dividends
An interim dividend is usually declared during the financial year when the interim financial
results of the company are favourable, such as when the interim results exceed the expected
norm. To determine the annual dividends declared, the interim dividends are added to the final
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dividends which are declared at the end of a financial year. If a company did not declare interim
dividends, the dividends declared at the end of the financial year will be equal to the annual
dividends declared.
Read paragraph 6.8.4 of the prescribed textbook, and study examples 6.10 and the
comprehensive example 6.15.
6.10 Debenture transactions
A company can, apart from acquiring capital from the public, also borrow money from the public
by issuing debentures. Debentures are, like shares, divided into affordable units that enable
the public to lend money to a company at a fixed interest rate. The interest on debentures is a
financing expense and must be paid, irrespective of whether a company is making a profit. A
dividend, on the other hand, is usually only declared if a company is making a profit and, even if
a profit has been made, the directors are under no obligation to declare a dividend.
Debentures do not form part of the equity of a company, but are classified as non-current
liabilities, if repayable after the end of the next 12-month period or as a current liability if
repayable within or up to the end of the next 12-month period.
Read more about debentures in paragraph 6.9.1 of the prescribed textbook.
6.10.1 Types of debentures
Different types of debentures exist, depending on the rights attached to them. Read about the
different types of debentures in paragraph 6.9.2 of the prescribed textbook.
6.10.2 The issue of debentures
Debentures have a nominal value, which indicates the face value of a single debenture unit.
The nominal value is not necessarily the same as the issue price of the debentures. The
prevailing market interest rate usually has an influence on the price of a debenture. One
example of a method of calculating the prevailing market rate is to take the interest rate paid by
a bank for an investment of the same value invested for the same period, and the risk of buying
debentures in a specific company, into account.
If the interest rate offered by the company on the debentures that it wants to issue is the same
as the prevailing market rate, the debentures will be issued at the nominal (face) value thereof.
If the interest rate on the issued debentures, referred to as the nominal interest rate, is higher
than the current market interest rate on the date of the issue, the debentures will be issued at a
premium. For example, if the nominal value of a debenture is R100, and the debenture was
sold for say R105, the debenture was sold at a premium. As in the case of par value shares that
were sold at a premium, the R5 will be recorded and disclosed as a premium on the issue of
debentures. The premium on debentures must, however, be ``written off '' over the borrowing
period of the debentures. In accounting terms, we refer to the writing off of the premium on
debentures as the amortisation of the premium.
When the prevailing market interest rate is higher than the interest rate offered on the
debentures (in other words, the nominal interest rate of the debentures is lower than the
prevailing market rate), the debentures will usually be offered to the public at a discount in
order to make it more attractive for the public to purchase the debentures. A R100 debenture
could, for example, be sold for R95.
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Irrespective of whether the debentures are sold at par, at a premium or at a discount
. the interest is always calculated on the face value of the debentures, and
. the face value is repaid after the term of the debentures has expired.
Read paragraph 6.9.3 of the prescribed textbook attentively, and study examples 6.11, 6.12
and 6.13.
6.11 Financial statements of companies
The financial statements which a company prepares can be divided into two categories,
namely:
. Internal statements
Internal statements are detailed financial and cost statements that pertain to a company and
that are intended for managerial use (internal use) in the company.
. Published statements (or external) statements
These statements are not as detailed as internal statements. The Companies Act requires that
these statements
. be prepared at least once a year and be presented to shareholders, and that they
. include the minimum information as specified in the Companies Act.
The fact that the Companies Act requires companies to disclose certain minimum information
is in the interests of the external users of financial statements of a company, such as its
shareholders, investors, creditors, bankers, etc.
Schedule 4 to the Companies Act regulates the contents of financial statements in detail.
Further disclosure and format requirements are addressed in IAS 1 (AC101).
The Companies Act ensures that companies disclose their latest financial statements (and
preliminary financial statements) and interim reports to external parties. Companies have to
send copies of their financial statements to their shareholders, the holders of their debentures,
and to the Registrar of Companies. They also have to discuss their financial statements at the
annual general meeting of their shareholders.
Read paragraphs 6.10.1 and 6.10.2 of the prescribed textbook.
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Exercise 6.1
Preparation of the general journal entries and the general ledger
accounts to record the process of the issue of ordinary and
preference shares at par
Work through the exercise, taking special note of how to record the
. applications for par value ordinary shares received from the founders of a company
. allotment of par value ordinary shares applied for by the founders of a company
. applications for par value ordinary shares received from the public
. applications for par value preference shares received from the public
. allotment of par value ordinary shares applied for by the public
. allotment of par value preference shares applied for by the public
Make sure, too, that you know how to post the above journal entries to the relevant general
ledger accounts.
Given information
Doby Limited was registered on 1 July 20.6 with an authorised share capital consisting of the
following:
100 000 ordinary shares of R2 each
10 000 10% preference shares of R10 each
The company offered 20 000 ordinary shares at par to the founders of the company, all of
which were taken up and paid for on 1 August 20.6.
The company offered the following shares for subscription to the public:
40 000 ordinary shares at par
5 000 10% preference shares at par
The application closed on 1 September 20.6. The public took up the full share offering. The
shares were allotted on 5 September 20.6.
REQUIRED
Record the application and the allotment of the shares in the general journal of Doby Ltd
for the period 1 August 20.6 to 5 September 20.6. Post these general journal entries to the
relevant general ledger accounts. Balance/close off all the ledger accounts. Assume that
the public applied for the shares on 1 September 20.6.
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Solution 6.1
DOBY LTD
GENERAL JOURNAL
Debit Credit
R R
20.6
Aug 1 Bank (20 000 x R2) 40 000
Subscribers to the memorandum: Ordinary shares 40 000
Receipt of application money from the founders of the
company

Ordinary share capital 40 000
Allotment of 20 000 ordinary shares of R2 each to the
founders of the company
Sep 1 Bank 130 000

Application and allotment: Ordinary shares (40 000 x R2) 80 000
Application and allotment: 10% Preference shares 50 000
(5 000 x R10)
Receipt of application money from the public
5 Application and allotment: Ordinary shares 80 000

10% Preference share capital 50 000
Allotment of 40 000 ordinary shares of R2 each and
5 000 10% preference shares of R10 each
Comment
. Remember that the term ``share capital'' is used when par value shares are allotted.
. Cash received will actually be entered in the CRJ. The general journal was used as a book
of first entry for the cash transactions to simply illustrate all the accounts that are involved.
. The figures in brackets are calculations.
DOBY LTD
GENERAL LEDGER
Dr Bank Cr
20.6 R 20.6 R
Aug 1 Subscribers to the Sep 30 Balance c/d 170 000

memorandum:
Ordinary shares 40 000
Sep 1 Application and allotment:
Ordinary shares 80 000
Application and allotment:
10% Preference shares 50 000
170 000 170 000
Oct 1 Balance b/d 170 000
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Dr Subscribers to the memorandum: Ordinary shares Cr
20.6 R 20.6 R
Aug 1 Ordinary share capital 40 000 Aug 1 Bank 40 000
Dr Application and allotment: Ordinary shares Cr

20.6 R 20.6 R
Sep 5 Ordinary share capital 80 000 Sep 1 Bank 80 000
Dr Application and allotment: 10% Preference shares Cr

20.6 R 20.6 R
Sep 5 10% Preference share Sep 1 Bank 50 000

capital 50 000
Dr Ordinary share capital Cr

20.6 R
Aug 1 Subscribers to the memo-

randum: Ordinary
shares 40 000
Sep 5 Application and
allotment: Ordinary
shares 80 000
120 000
Dr 10% Preference share capital Cr

20.6 R
Sep 5 Application and allot-

ment: 10% Preference
shares 50 000
Comment
The subscribers to the memorandum and application and allotment accounts are interim
accounts that close off once the shares have been allotted.
Exercise 6.2
Preparation of the general journal entries and the general ledger
accounts to record the process of the issue of ordinary shares at a
premium
. applications received from the public for ordinary shares issues at a premium
. allotment or ordinary shares issues at a premium
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ledger accounts.
Given information (continuation of exercise 6.1)
On 1 April 20.7 Doby Ltd decided to offer 20 000 of its unissued ordinary shares at a premium
of R0,50 per share.
When the date for the applications closed on 1 June 20.7, applications for 25 000 shares were
received.
On 3 June 20.7, 20 000 shares were allotted to the public and the excess application money
was repaid.
REQUIRED
Record the application and the allotment of the shares in the general journal of Doby Ltd
for the period 1 April 20.7 to 3 June 20.7. Post these general journal entries to the relevant
general ledger accounts. Balance/close off all the ledger accounts. Assume that the public
applied for the shares on 1 June 20.6. It is not necessary to carry forward any balances
from exercise 6.1.
Solution 6.2
DOBY LTD
GENERAL JOURNAL
Debit Credit
R R
20.7
Jun 1 Bank (25 000 x R2,50) 62 500
Application and allotment: Ordinary shares 62 500
3 Application and allotment: Ordinary shares 50 000

Ordinary share capital (20 000 x R2) 40 000
Share premium (20 000 x R0,50) 10 000
Allotment of 20 000 ordinary shares of R2 each at a
premium of R0,50 per share

(5 000 x R2,50)
Bank 12 500
Cash refund to unsuccessful applicants
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DOBY LTD
GENERAL LEDGER
Dr Bank Cr
20.7 R 20.7 R
Jun 1 Application and allot- Jun 3 Application and allot-

ment: Ordinary shares 62 500 ment: Ordinary shares 12 500
30 Balance c/d 50 000
62 500 62 500
Jul 1 Balance b/d 50 000

20.7 R 20.7 R
Jun 3 Ordinary share capital 40 000 Jun 1 Bank 62 500

Share premium 10 000
Bank 12 500
62 500 62 500

20.7 R
Jun 3 Application and allot-

ment: Ordinary shares 40 000
Dr Share premium Cr
20.7 R
Jun 3 Application and allot-

ment: Ordinary shares 10 000
Comment
Although the share premium forms part of the total equity of the company, it must be shown in a
separate account. The share premium can, inter alia, be used to write off share issue
expenses.
Exercise 6.3
Preparation of the general journal and general ledger to record the
process of the issue of no par value shares
. applications for no par value ordinary shares received from the founders of the company
. applications for no par value preference shares received from the founders of the company
. allotment of no par value ordinary shares applied for by the founders of the company
. allotment of no par value preference shares applied for by the founders of the company
. applications for no par value ordinary shares received from the public
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. applications for no par value preference shares received from the public
. allotment of no par value ordinary shares applied for by the public
. allotment of no par value preference shares applied for by the public
ledger accounts.
Given information
Molo Ltd was registered on 1 February 20.8 with an authorised share capital consisting of the
following:
200 000 no par value ordinary shares
100 000 9% no par value preference shares
On 1 February 20.8 the company offered 20 000 no par value ordinary shares at R10 each and
10 000 no par value preference shares at R15 each to the founders of the company. All the
shares were taken up and paid for on 5 February 20.8.
On 9 February the company offered 100 000 ordinary shares at R10 each and 50 000
preference shares at R15 each for subscription to the public.
By close of business on the closing date, namely 1 May 20.8, applications had been received
for the full number of shares that were offered. On 8 May 20.8 all the shares were allotted.
On 31 May 20.8 the company paid R15 000 towards share issue expenses.
REQUIRED
Record the application and allotment of the ordinary and preference shares in the general
journal of Molo Ltd for the period 1 February 20.8 to 8 May 20.8. Record the payment of
the share issue expenses in the general journal of Molo Ltd. Post the journal entries to the
relevant accounts in the general ledger. Assume that the public applied for the shares on
1 May 20.8. Balance/close of all the ledger accounts.
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Solution 6.3
MOLO LTD
GENERAL JOURNAL
Debit Credit
R R
20.8
Feb 1 Bank 350 000
(20 000 x R10)
Subscribers to the memorandum: 9% Preference 150 000
shares (10 000 x R15)
company
5 Subscribers to the memorandum: Ordinary shares 200 000

Subscribers to the memorandum: 9% Preference shares 150 000
Stated capital: Ordinary shares 200 000
Stated capital: 9% Preference shares 150 000
Allotment of 20 000 no par value ordinary shares and
10 000 no par value 9% preference shares to the
May 1 Bank 1 750 000

Application and allotment: Ordinary shares 1 000 000
(100 000 x R10)
(50 000 x R15)
8 Application and allotment: Ordinary shares 1 000 000

Stated capital: Ordinary shares 1 000 000
Stated capital: 9% Preference shares 750 000
Allotment of 100 000 no par value ordinary shares and
50 000 no par value 9% preference shares
31 Share-issue expenses 15 000

Bank 15 000
Share-issue expenses paid
Comment
Remember that the term ``stated capital'' is used when no par value shares are recorded as
capital.
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MOLO LTD
GENERAL LEDGER
Dr Bank Cr
20.8 R 20.8 R
Feb 5 Subscribers to the memo- May 31 Share-issue expenses 15 000

randum: Ordinary Balance c/d 2 085 000
shares 200 000
Subscribers to the memo-
randum: 9% Prefer-
ence shares 150 000
May 1 Application and allotment:
Ordinary shares 1 000 000
Application and allotment:
2 100 000 2 100 000
Jun 1 Balance b/d 2 085 000

20.8 R 20.8 R
Feb 5 Stated capital: Ordinary Feb 5 Bank 200 000

shares 200 000
Dr Subscribers to the memorandum: 9% Preference shares Cr

20.8 R 20.8 R
Feb 5 Stated capital: Feb 5 Bank 150 000


20.8 R 20.8 R
May 8 Stated capital: Ordinary May 1 Bank 1 000 000

shares 1 000 000
Dr Application and allotment: 9% Preference shares Cr

20.8 R 20.8 R
May 8 Stated capital: May 1 Bank 750 000

Dr Stated capital: Ordinary shares Cr

20.8 R
Feb 5 Subscribers to the memo-

randum: Ordinary
shares 200 000
1 200 000
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Dr Stated capital: 9% Preference shares Cr
20.8 R
Feb 5 Subscribers to the me-

morandum: 9% Prefer-
ence shares 150 000
900 000
Dr Share-issue expenses Cr
20.8 R
May 31 Bank 15 000
Comment
The subscribers to the memorandum and application and allotment accounts are temporary
accounts that close off once the shares have been allotted.
Exercise 6.4
The issue of capitalisation shares by utilising the share premium to
have the minimum effect on the utilisation of retained earnings
Work through the exercise, taking special note of how to

. calculate the number of shares that must be issued
. utilise the share premium
. calculate the effect on the retained earnings
Given information
The following balances appeared, inter alia, in the books of Zodiac Ltd on 30 November 20.3:
R
Ordinary share capital (R2 shares) 400 000
On 1 December 20.3 the directors decided to issue capitalisation shares at par in the ratio of
one capitalisation share for every four ordinary shares held by the shareholders as on
30 November 20.3. The directors decided that the issue of the capitalisation shares should
have a minimum effect on the retained earnings.
REQUIRED
Record the issue of the capitalisation shares in the general journal of Zodiac Ltd.
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Solution 6.4
ZODIAC LTD
GENERAL JOURNAL
Debit Credit
R R
20.3
Dec 1 Share premium 40 000
Retained earnings R(100 000 ± 40 000) 60 000
Ordinary share capital 1 100 000
Capitalisation issue of one share for every four shares
held
Calculation

1 Calculation of the number and value of shares to be issued
Number of ordinary shares issued on 30 November 20.3
R(400 000 7
2) = 200 000 shares
Number of capitalisation shares to be issued:
200 000 7
4 = 50 000 shares
Value of shares (per value of R2 each)
50 000 x R2 = R100 000
Exercise 6.5
Preparation of the allocation table, journal entries and general
ledger accounts to record the application and allotment (the issue
of shares)
Work through the following exercise, taking special note of how to

. prepare an allotment schedule,
. record all the transactions related to the issue of shares in the general journal
Make sure, too, that you know how to post from the journal to the relevant general ledger
accounts.
Given information
SA Cement Ltd is a company which was registered on 1 January 20.7 with an authorised share
capital of 200 000 ordinary shares of R10 each.
The company offered 20 000 of the shares at par to the founders of the company, all of which
were taken up and paid for on 15 January 20.7.
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On 16 January 20.7 the company applied to the JSE Securities Exchange for a listing and
appointed General Merchant Bank as the underwriters of the share issue at a commission of
2%. On the basis of favourable prospecting reports, the directors decided to offer 100 000 of
the shares to the public at R12 per share.
By 1 March 20.7 applications were received for 180 000 shares. The JSE Securities Exchange
granted the listing and during the first week the price of SA Cement Ltd increased to R13. The
shares were received as follows between 15 January 20.7 and 1 March 20.7:
Number of shares Number of applications Number of shares

per application received applied for
100 400 40 000
200 100 20 000
500 20 10 000
1 000 30 30 000
2 000 20 40 000
4 000 10 40 000
Total 580 180 000
In order to retain control and to ensure an active market for the shares, the following allotment
schedule was approved and ratified on 10 March 20.7 at a meeting of the board of directors:
Group A: Applications for 100 to 200 shares will be granted in full.
Group B: Applications for 500 to 1 000 shares will be granted at 50% of the shares applied
for.
Group C: Applications for 1 000 and more will be granted at 25% of the shares applied for.
At the beginning of 20.9, owing to the boom in the building industry, the shares were trading at
R25 per share on the JSE Securities Exchange. Additional capital was urgently needed to
expand the business. On 20 March 20.9 the board of directors decided to convert the shares
into no par value shares and to offer the 80 000 unissued shares at R25 per share to the public.
Underwriting was arranged with General Merchant Bank at a commission of 4% which had to
be settled by 31 May 20.9. Applications were received for 75 000 shares on 30 April 20.9, the
closing date for applications. All the transactions were finalised by 31 May 20.9.
REQUIRED
(a) Prepare the allotment schedule for the share issue in March 20.7.
(b) Record the issue of the shares and the related transactions in the general journal of
SA Cement Ltd for the period 1 January 20.7 until 31 May 20.9.
(c) Post the journal entries in (b) to the relevant general ledger accounts of
SA Cement Ltd for the period 1 January 20.7 until 31 May 20.9. The financial year
of the company ends on 31 December.
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Solution 6.5
(a)
PREPARATION OF THE ALLOTMENT SCHEDULE FOR THE SHARE ISSUE IN MARCH 20.7
Allotment schedule: For ordinary share issue
Num- Cash received Cash repaid
ber of Total
applica- number of
tions in shares Capital Premium Total Shares Capital Premium
Group group applied for R R R allotted R R
A 500 1 60 000 2 600 000 3 120 000 4 720 000 5 60 000 6 Ð Ð

B 50 7 40 000 8 400 000 9 80 000 10 480 000 11 20 000 12
200 000 13
40 000 14
C 30 15 80 000 16 800 000 17 160 000 18 960 000 19 20 000 20 600 000 21 120 000 22
Totals 580 180 000 1 800 000 360 000 2 160 000 100 000 800 000 160 000
Calculations
1 400 + 100 = 500

12 40 000 6 50% = 20 000
2 40 000 + 20 000 = 60 000
13 20 000 6 R10 = R200 000
3 60 000 6 R10 = R600 000
14 20 000 6 R2 = R40 000
4 60 000 6 R2 = R120 000
15 20 + 10 = 30
5 R600 000 + R120 000 = R720 000
16 40 000 + 40 000 = 80 000
6 60 000 6 100% = 60 000
17 80 000 6 R10 = R800 000
7 20 + 30 = 50
18 80 000 6 R2 = R160 000
8 10 000 + 30 000 = 40 000
19 R800 000 + R160 000 = R960 000
9 40 000 6 R10 = R400 000
20 80 000 6 25% = 20 000

10 40 000 6 R2 = R80 000
21 60 000 6 R10 = R600 000

11 R400 000 + R80 000 = R480 000
22 60 000 6 R2 = R120 000
(b)
SA CEMENT LTD
GENERAL JOURNAL
Debit Credit
R R
20.7
Jan 15 Bank (20 000 x R10) 200 000
company

Allotment of 20 000 ordinary shares of R10 each to the
16 Underwriter's commission (100 000 x R12 x 2%) 24 000

General Merchant Bank 24 000
2% underwriter's commission due on R1 200 000 in
terms of the underwriting agreement
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Debit Credit
R R
20.7
Mar 1 Bank (180 000 x R12) 2 160 000
10 Application and allotment: Ordinary shares 1 200 000

Ordinary share capital (100 000 x R10) 1 000 000
Share premium (100 000 x R2) 200 000
Allotment of 100 000 ordinary shares of R10 at a
premium of R2 per share

(80 000 x R12)
Bank 960 000
Cash refund to unsuccessful applicants

Bank 24 000
Underwriter's commission paid
20.9
Mar 20 Ordinary share capital 1 200 000
Converting the par value shares into no par value shares
Underwriter's commission (80 000 x R25 x 4%) 80 000

4% underwriter's commission payable on R2 000 000 in
terms of the underwriting agreement
Apr 30 Bank (75 000 x R25) 1 875 000


General Merchant Bank (5 000 x R25) 125 000
Allotment of 80 000 ordinary no par value shares
May 31 Bank R(125 000 ± 80 000) 45 000

Settlement by the underwriters
131
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(c)
SA CEMENT LTD
GENERAL LEDGER
Dr Bank Cr
20.7 R 20.7 R
Jan 15 Subscribers to the memo- Mar 10 Application and allotment:

randum: Ordinary Ordinary shares 960 000
shares 200 000 General Merchant Bank 24 000
Mar 1 Application and allotment:
20.9
Apr 30 Application and allotment:
May 31 General Merchant Bank 45 000

20.7 R 20.7 R
Jan 15 Ordinary share capital 200 000 Jan 15 Bank 200 000

20.7 R 20.7 R
Mar 1 Ordinary share capital 1 000 000 Mar 1 Bank 2 160 000
10 Bank 960 000
2 160 000 2 160 000
20.9 20.9
Apr 30 Stated capital: ordinary 1 875 000 Apr 30 Bank 1 875 000
shares

20.9 R 20.7 R
Mar 20 Stated capital: Ordinary Jan 15 Subscribers to the memo-

shares 1 200 000 randum: Ordinary
shares 200 000
Mar 1 Application and allotment:
1 200 000 1 200 000
Dr Share premium Cr
20.9 R 20.7 R
Mar 20 Stated capital: Ordinary Mar 10 Application and allotment:

shares 200 000 Ordinary shares 200 000
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Dr General Merchant Bank Cr
20.7 R 20.7 R
Mar 10 Bank 24 000 Jan 16 Underwriter's commission 24 000

20.9 20.9
Apr 30 Stated capital: Ordinary May 31 Underwriter's commission 80 000
shares 125 000 Bank 45 000
125 000 125 000
Dr Underwriter's commission Cr
20.7 R 20.7 R
Jan 16 General Merchant Bank 24 000 Dec 31 Profit and loss 24 000
20.9
May 31 General Merchant Bank 80 000
Dr Stated capital: Ordinary shares Cr

20.9 R
Mar 20 Ordinary share capital 1 200 000

Apr 30 Application and allotment:
3 400 000
Comment
Only the transactions relating to the issue of the shares for the two periods were recorded in the
general journal and the general ledger.
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SELF-ASSESSMENT
Yes No
. distinguish between authorised and issued share capital?
. distinguish between par value and no par value shares?

. explain what a share premium is and are you able to record the
issue of shares at a premium?
. distinguish between ordinary and preference shares?
. record transactions pertaining to the issue of shares?
. prepare an allotment schedule?
. record the issue of capitalisation shares?
. record the underwriting of shares?
. explain dividends and the calculation thereof?
. calculate dividends?
. record dividend transactions?
. record transactions pertaining to the issue of debentures?
. calculate and record interest on debentures?
If you answered ``no'' to any of these questions, revise the applicable section of the
study unit and work through the relevant exercise(s).
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FAC1601/1
7
STUDY UNIT
Statement of cash flows

CONTENTS

Key concepts 135
7.2 Main objective and advantages of a statement of cash flows 136
7.3 Format of a statement of cash flows 136
7.4 Relationship between a statement of cash flows and other financial
statements 137
7.5 Identification of non-cash entries in financial statements prepared on the
accrual basis of accounting 137
7.6 Preparation of a statement of cash flows from financial statements prepared
on the accrual basis of accounting 137
7.7 Comprehensive examples and summary 143
Self-assessment 187
Learning outcomes
After studying this study unit you must be able to
& discuss, in general terms, the purpose and importance of a statement of cash flows
& explain the relationship between a statement of cash flows and the other financial
statements
& prepare a statement of cash flows and the note in respect of non-cash transactions
pertaining to investing and financing activities of a sole proprietor, partnership and close
corporation according to the requirements of Standard IAS 7 (AC 118) by utilising
information which is mainly obtained from the other financial statements and any relevant
notes thereto
Key concepts
& Cash and cash equivalents
& Non-cash transactions
& Operating activities
& Direct and indirect method
& Investing activities
& Financing activities
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7.1 Introduction
According to the IASB Framework for the preparation and presentation of financial statements,
the objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an entity that is useful to a wide range of
users in making economic decisions. The information reported on in a statement of
comprehensive income, a statement of financial position and a statement of changes in
equity (in respect of a sole trader or a partnership) or a statement of changes in net investment
of members (in respect of a close corporation) cannot meet all the informational needs of the
users, and especially cannot provide all the necessary information in respect of the liquidity of a
business entity. A liquidity analysis of a business entity,inter alia,indicates how a business is
managing its cash flows. Such information is of great importance, since it shows, for example,
from which resources the transactions of a business entity is financed. The sustainability of a
business, for example, will be questioned when its operating activities is predominantly
financed with external funds (such as long-term loans) over too long a period. The purpose of a
statement of cash flows is to disclose information on such aspects. Read paragraph 7.1 of the
prescribed textbook to see how the financial results of an illustrious American company were
misinterpreted, mainly because the cash flows and the financing sources of the business were
overlooked.
7.2 Main objective and advantages of a statement of cash
flows
Read about the main objective and advantages of a statement of cash flows in paragraph 7.2
of the prescribed textbook.
7.3 Format of a statement of cash flows
The statement of cash flows is dealt with by IAS 7 (AC 118). Similar to a statement of
comprehensive income, a statement of changes in equity (in respect of a sole trader and
partnership) and a statement of changes in net investment of members (in respect of a close
corporation), a statement of cash flows contains information in respect of a financial period.
Therefore, the heading of a statement of cash flows also indicates that it is prepared ``for the
year/period ended ...''
A statement of cash flows is divided into three activity-based sections (elements), namely the
cash flows from operating, investing and financing activities. The net result of these three
elements determines the net movement in the cash and cash equivalents for the period. By
adding the cash and cash equivalents at the beginning of the period to this net movement, the
cash and cash equivalents at the end of the period are disclosed. The cash and cash
equivalents at the end of the period should be equal to the cash and cash equivalents as
disclosed in the statement of financial position in respect of the financial period which is
reported on.
It is important to take note that in a statement of cash flows, cash outflows and bank overdrafts
are shown in brackets. Cash inflows are shown without brackets.
Read paragraph 7.3 of the prescribed textbook attentively, and study the format of a statement
of cash flows. Note that the format shown in paragraph 7.3 is a comprehensive illustration of
the entries that can be included in a statement of cash flows (all further references to the format
of a statement of cash flows pertain to the format in this paragraph of the prescribed textbook),
and that the section can be disclosed according to either
``Cash flows from operating activities''
the direct the indirect method.

or
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FAC1601/1
7.4 Relationship between a statement of cash flows and
other financial statements
The statement of comprehensive income, the statement of changes in equity, the statement of
changes in net investment of members and the statement of financial position are prepared
according to the accrual basis of accounting, which implies that income is accounted for when
it is earned and expenses when they are incurred. In other words, income and expenses are
recorded when a transaction is entered into, and not only when cash is received or paid. For
example, a sales transaction will be recorded when merchandise is sold on credit, and not
when the debtors pay their accounts. These financial statements may thus include amounts
that result from non-cash transactions.
The statement of cash flows, however, discloses only received and
cash cash paid the
during
financial period under review, regardless of whether the receipts or the payments pertain to
another financial period. For example, when a prepayment was made in respect of a 20.6
expense during the 20.5 financial year, the prepaid amount will not be disclosed in the
statement of comprehensive income (a prepaid expense account would have been debited and
the bank account credited) for the year ended 30 June 20.5, but it will be disclosed as a cash
outflow in the statement of cash flows for the year ended 30 June 20.5.
Read more about the relationship between a statement of cash flows and other financial
statements in paragraph 7.4 of the prescribed textbook. If you understand how recordings are
made on the accrual basis of accounting you should easily grasp the adjustment of an accrued
to a cash amount.
7.5 Identification of non-cash entries in financial statements
prepared on the accrual basis of accounting
Non-cash entries are those entries that do not pertain to any movement in cash or cash
equivalents during a specific financial year or period. Since a statement of cash flows discloses
only cash transactions, these non-cash entries must be omitted when a statement of cash flows
is prepared from financial statements that were prepared on the accrual basis of accounting.
Examples of non-cash entries/non-cash transactions
. depreciation
. the profit or loss made on the sale of property, plant and equipment
. property, plant and equipment purchased on credit
. the recording of credit losses
. the creation of an allowance for credit losses
. year-end adjustments where accrued expenses and income are taken into account and
prepaid amounts and amounts received in advance are deducted
. credit purchases and credit sales
. settlement discounts granted or received
To obtain a clear understanding of the identification of non-cash entries, read paragraph 7.5 of
the prescribed textbook attentively.
7.6 Preparation of a statement of cash flows from financial
statements prepared on the accrual basis of accounting
In order to prepare a statement of cash flows from the other financial statements which are
prepared on the accrual basis of accounting, the following information is required:
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FAC1601/1
. the statement of comprehensive income and the statement of changes in equity (or the
statement of changes in net investment of members) for the current financial period
. the statements of financial position at the beginning and the end of the financial period
under review
. the notes to the financial statements
. any relevant additional information which may be required, for example, the method
according to which the purchases of non-current assets were financed. Applicable journals
or ledger accounts can also be used to ease the preparation of a statement of cash flows.
Read paragraph 7.6 of the prescribed textbook attentively.
7.6.1 Cash flows from operating activities
Operating activities represent the main activities that a business entity performs to generate
revenue, and therefore profits. For example, a partnership of accounting officers mainly earn
revenue by rendering services to clients that pertain to the preparation of bookkeeping records,
financial statements and tax returns of close corporations, partnerships and sole traders,
whereas a supermarket earns revenue by selling a variety of products to clients. The payments
received from clients are referred to as the cash receipts from customers, and the payments
made to perform the operating activities of a business, for example the payments made in
respect of the purchases of inventories and the payment of salaries, are referred to as thecash
paid to suppliers and employees.
As mentioned previously, the cash flows from operating activities section of a statement of
cash flows can be reported on according to either the direct or the indirect method. You must
be able to apply either. Read paragraph 7.6.1 of the prescribed textbook attentively.
7.6.1.1 Reporting on cash generated from/used in operations according to the
direct method
According to the format, when the direct method is used to report on cash generated from/used
in operations, the cash receipts from customers and the cash paid to suppliers and employees
must be disclosed separately.
Should the cash receipts from customers be greater than the cash paid to suppliers and
employees, cash was operations, and is therefore disclosed as a (net) cash
generated from
inflow:
NAME OF BUSINESS ENTITY

STATEMENT OF CASH FLOWS FOR THE YEAR/PERIOD ENDED ...
Note R R
CASH FLOWS FROM OPERATING ACTIVITIES
Cash receipts from customers (all entities) Inflow
Cash paid to suppliers and employees (all entities) (Outflow)
Cash generated from operations Inflow
Should the cash paid to suppliers and employees be greater than the cash receipts from
customers, cash was in operations, and therefore disclosed as a (net) cash outflow:
used
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Note R R
Cash receipts from customers (all entities) Inflow
Cash paid to suppliers and employees (all entities) (Outflow)
Cash used in operations (Outflow)
The calculation of cash receipts from customers and cash paid to suppliers and employees is
explained in detail in paragraph 7.6.1.1 and subparagraphs 7.6.1.1(a) and (b) of the prescribed
textbook. Study these paragraphs and work through the examples. Take note that the financial
period during which an accrued or prepaid amount was recorded, plays an important role when
cash receipts and cash payments are calculated.
7.6.1.2 Reporting on the cash generated from or used in operations according
to the indirect method
According to the format, the disclosure of cash generated from or used in operations according
to the indirect method must be as follows:

Note R R
Profit/(Loss) for the year
(sole proprietor/partnership) or
Profit/(Loss) before tax (close corporation) Profit/(Loss)
Adjustments for:
Non-cash expenses add*
Non-cash income subtract*
Expenses disclosed after cash generated
from/(used in) operations add*
Income disclosed after cash generated from/
(used in) operations subtract*
Profit/(Loss)
Decreases in applicable current assets add*
Increases in applicable current assets subtract*
Decreases in applicable current liabilities subtract*
Increases in applicable current liabilities add*
Cash generated from/(used in) operations From/(Used)
* Adjustments in respect of a profit.
When the indirect method is used to report on cash generated from/used in operations, the first
figure that is needed for the disclosure is the profit (or loss) for the financial year (in the case of
a sole proprietorship/partnership) or the profit (or loss) before tax (in the case of a close
corporation). This figure is then adjusted on the face of the statement of cash flows to omit
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FAC1601/1
. any non-cash entries
. any items that must be disclosed on the face of the statement of cash flows after the cash
generated from/(used in) operations section has been prepared.
Hereafter, the relevant changes in the working capital (that is the changes in the current assets
and current liabilities that pertain to these operating activities of the business entity) are
disclosed. Read paragraph 7.6.1.2 of the prescribed textbook attentively.
Examples of non-cash entries that are disclosed in a statement of comprehensive income and
therefore included in the calculation of the profit (or loss) are depreciation and the profit or loss
made on the sale of a non-current asset. If the amount that must be added back is an expense
(such as depreciation), it must be remembered that it was subtracted from a profit amount
when a statement of comprehensive income was prepared. Assume for example, that
depreciation (a non-cash entry) was disclosed in a statement of comprehensive income. When
the depreciation must be added back, the opposite of subtraction must be done.
Depreciation must therefore be added to a profit (or subtracted from a loss). If a non-cash entry
that must be added back is an income, such as a profit made on the sale of a non-current
asset, it must be subtractedfrom a profit (or addedto a loss). Credit losses is another example
of a non-cash entry which is disclosed in the statement of comprehensive income. Credit
losses, however, do not have to be added back. Study paragraph 7.6.1.2(a) in the prescribed
textbook, which amongst others, explains why.
Examples of entries that are disclosed in a statement of comprehensive income and therefore
included in the calculation of the profit (or loss), but of which the cash flows must be disclosed
afterthe cash generated from/(used in) operations in the statement of cash flows, are dividend
income, interest income, finance costs and the income tax expense (if applicable). As in the
case of the non-cash entries, these items must also be omitted from the profit (or loss) figure.
Read paragraph 7.6.1.2(b) of the prescribed textbook attentively.
Paragraph 7.6.1.2(c) of the prescribed textbook discusses the disclosure of working capital.
Read through this paragraph attentively and study example 7.4.
7.6.1.3 Reporting on the operating activity items that must be disclosed after
the cash generated from or used in operations
According to the format, the operating activity items that must be disclosed after the cash
generated from or used in operations are:
. Dividends received (all entities)
. Interest received (all entities)
. Interest paid (all entities)
. Income tax paid (close corporation)
. Drawings (sole proprietor/partnership)
. Distribution to members paid (close corporation)
. Proceeds from the sale of financial assets at fair value through profit or loss: Held for trading
(all entities)
. Purchase of financial assets at fair value through profit or loss: Held for trading (all entities)
In this regard, read paragraph 7.6.1.3 of the prescribed textbook attentively and study
example 7.5.
7.6.2 Cash flows from investing activities
According to the format, the disclosure of the cash flows from investing activities section must
be as follows:
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Note R R
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in property, plant and equipment to
maintain operating capacity 1 (Outflow)
Replacement of property, plant and equipment
(all entities) (Outflow)
Investments in property, plant and equipment to
expand operating capacity 1 (Outflow)
Additions to property, plant and equipment
(all entities) (Outflow)
Proceeds from the sale of property, plant and
equipment (all entities) Inflow
Acquisition of investments ± such as available-
for-sale financial assets, and loans and
receivables (all entities) (Outflow)
Proceeds from the sale/collection/maturity of
investments ± such as available-for-sale
financial assets, and loans and receivables
(all entities) Inflow
Net cash from/(used in) investing activities In/(Out)
The cash flows from investing activities result primarily from the acquisition or disposal of non-
current assets, for example, property, plant and equipment and available-for-sale investments.
The cash flows from investing activities can be calculated by using the relevant information
given in the statements of financial position for the current and the preceding financial year. If
there is a difference between the amounts of an entry from year to year, it is possible that a
cash flow took place. Such a difference must be analysed further to determine whether a cash
flow occurred.
As far as the disposal of an investment is concerned, note that only the must be
cash receipt
recorded. Profits or losses made on the sale of property, plant and equipment, or on the sale/
collection/maturity of investments are non-cash entries and are therefore not taken into
account. Also note that, for the purpose of your studies, you must disclose interest and
dividends received in the cash flows from operating activities-section.
7.6.3 Cash flows from financing activities
. According to the format, the disclosure of the cash flows from financing activities section
must be as follows:
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Note R R
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from capital contributions (sole
proprietor/partnership) Inflow
Proceeds from members' contributions (close
corporation) Inflow
Proceeds from loans from members (close
corporation) Inflow
Proceeds from loans, debentures, mortgages, etc.
(all entities) Inflow
Repayments of short-term borrowings (all entities) (Outflow)
Repayments of long-term borrowings (all entities) (Outflow)
Repayments of the capital elements of finance
lease liabilities (all entities) (Outflow)
Net cash from/(used in) financing activities In/(Out)
As mentioned in paragraph 7.3 of the prescribed textbook, financing activities are activities that
result in changes in the size and composition of contributed equity and borrowings ( that is
) of a business entity. The cash flows from financing activities

mainly the non-current liabilities
can be determined by comparing the statements of financial position of the current year and of
the preceding year and/or by using the information given in the statement of the changes in
equity (or the statement of changes in net investment of members). Read paragraph 7.6.3 of
the prescribed textbook attentively.
Note that the current portion of a long-term borrowing is regarded as a financing activity. In this
study unit, short-term borrowings, except where indicated otherwise, are also regarded as
financing activities.
Study example 7.7. Bear in mind that transfers to reserves do not indicate cash outflows, as no
cash was paid to external parties.
7.6.4 Cash and cash equivalents
Once the cash flows from the operating, investing and financing activities-sections have been
prepared, the net increase/(decrease) in cash and cash equivalents is calculated (by adding
the net cash flows of the operating, investing and financing activities sections). The cash and
cash equivalents at the beginning of the financial period must then be added to this net
increase/(decrease). The answer of this calculation is equal to the cash and cash equivalents
at the end of the financial period. This amount must be equal to the cash and cash equivalents
as disclosed in the statement of financial position pertaining to the same period for which the
statement of cash flows is prepared. In other words, if the statement of cash flows is prepared
for the year ended 31 December 20.6, the cash and cash equivalents at the end of the period
must be equal to the cash and cash equivalents as disclosed in the statement of financial
position as at 31 December 20.6.
According to the format, the disclosure of the cash and cash equivalents (excluding any
referrals to notes) must be as follows:
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R R
Net cash from/(used in) operating activities Inflow/(Outflow)
Net cash from/(used in) investing activities Inflow/(Outflow)
Net cash from/(used in) financing activities Inflow/(Outflow)
Net increase/(decrease) in cash and cash equivalents Inflow/(Outflow)
Cash and cash equivalents at beginning of year Asset/(Liability)
Cash and cash equivalents at end of year Asset/(Liability)
7.6.5 Notes pertaining to a statement of cash flows
Read paragraph 7.6.5 of the prescribed textbook attentively. You only need to be able to
prepare the note in respect of a non-cash transaction pertaining to an investing or financing
activity.
IAS 7 (AC 118) does not require a reconciliation note pertaining to cash generated from/(used
in) operations. However, Schedule 4 to the Companies Act requires the disclosure of such
information. For the purpose of your studies, you will not be required to prepare this note, since
it is the same as when the cash generated from/(used in) operations is prepared according to
the indirect method.
7.7 Comprehensive examples and summary
Study examples 7.9 and 7.10 in the prescribed textbook. Thereafter, read through the summary
in paragraph 7.7 of the prescribed textbook.
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Exercise 7.1
Preparation of a statement of cash flows in respect of a sole trader
Work through the exercise, taking special note of how to

. calculate payments to creditors when the purchases figure was not given
. disclose an investment in property, plant and equipment to expand operating capacity
Given information
The following financial statements were prepared for a sole trader, trading as Cat Services:
CAT SERVICES
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 JULY 20.2
R
Revenue 30 000
Administrative and other expenses (14 800)
Consumable inventory consumed 7 000
Wages 3 100
Telephone expenses 300
Depreciation 1 500
Finance costs (625)
Interest on long-term loan 625
CAT SERVICES
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 JULY 20.2
Total equity
20.2 20.1
R R
Capital
Balances at 1 August 20.1 40 625 30 000
Capital contribution 5 000 Ð
Total comprehensive income for the year 14 575 13 625
Drawings (5 000) (3 000)
Balances at 31 July 20.2 55 200 40 625
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CAT SERVICES
STATEMENT OF FINANCIAL POSITION AS AT 31 JULY 20.2
Note* 20.2 20.1
R R
ASSETS
Non-current assets 98 500 90 000
Property, plant and equipment 98 500 90 000
Current assets 30 000 23 625
Inventories (consumable) 9 000 6 000
Prepayments 1 525 Ð
Total assets 128 500 113 625
Total equity 55 200 40 625
Capital 55 200 40 625
Total liabilities 73 300 73 000
Non-current liabilities 55 000 50 000
Long-term borrowings 55 000 50 000
Current liabilities 18 300 23 000
Total equity and liabilities 128 500 113 625
* All notes are excluded.
1 The revenue figure represents services rendered:

for cash R18 000
on credit R12 000
2 The trade receivables pertain solely to debtors to whom services were rendered on credit
(in other words, the trade debtors).
3 The prepayments comprise the following:
R
Interest expense 625
Wages 500
1 525
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4 The trade and other payables comprise the following:
31 July 20.2 31 July 20.1

R R
Creditors control (iro the purchases of inventory*) 18 000 23 000
Accrued (in arrears) telephone expenses 300 Ð
18 300 23 000
* Cat Services does not sell any merchandise. The purchased inventory pertains to consumable inventory.
5 The depreciation recorded in respect of vehicles amounted to R800, and in respect of

machinery, R700.
6 The addition to property, plant and equipment was paid in full. No property, plant and
equipment were sold during the financial year ended 31 July 20.2.
7 The carrying amounts in respect of vehicles and machinery are as follows:
31 July 20.2 31 July 20.1

R R
Vehicles 39 200 40 000
Machinery 59 300 50 000
Total 98 500 90 000
8 The drawings and the additional capital contribution made by the owner were in cash.
9 The long-term borrowings pertain to a long-term loan. The interest on the loan is not
capitalised.
10 The inventories (consumable material) was disclosed at cost.
REQUIRED
Prepare the statement of cash flows of Cat Services for the year ended 31 July 20.2 to
comply with those requirements of GAAP which are appropriate to the business of the sole
trader. The cash generated from/(used in) operations must be disclosed according to the
direct method. Comparative figures and notes are not required.
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Solution 7.1
CAT SERVICES
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 JULY 20.2
R R
Cash receipts from customers 1 25 000
Cash paid to suppliers and employees
2 (21 900)
Cash generated from operations 3 100

Interest paid 3 (1 250)
Drawings (5 000)
Net cash used in operating activities (3 150)
Investment in property, plant and equipment to expand
operating capacity (10 000)
Addition to machinery 4 (10 000)
Net cash used in investing activities (10 000)
Proceeds from capital contribution 5 5 000
Proceeds from long-term borrowing 6 5 000
Net cash from financing activities 10 000
Net decrease in cash and cash equivalents (3 150)
Cash and cash equivalents at beginning of year 3 625
Cash and cash equivalents at end of year 475
Calculations
Comment
The following calculations are not required by Standard IAS 7 (AC 118), but you must be able
to do them in order to prepare a statement of cash flows. Remember that all calculations must
be shown in your answers to questions in the assignments as well as in the examination. When
showing a calculation, it is not necessary to indicate cash outflows in brackets and cash inflows
without brackets, as is required when cash inflows and cash outflows are disclosed in a
statement of cash flows. You must, however, indicate clearly whether the answer to a
calculation represents a cash inflow or a cash outflow.
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FAC1601/1

1 Cash receipts from customers
The item in the statement of comprehensive income that pertains to cash receipts from
customers is Revenue.
R
Services rendered for cash 18 000
Cash receipts from trade debtors* 7 000
Services rendered on credit 12 000
Add: Debtors control (opening balance) 14 000
Subtract:Debtors control (closing balance) (19 000)
Services rendered for cash and cash receipts from trade debtors 25 000
* Note that a debtor pertaining to an investing activity is not considered to be atradedebtor. Trade debtors are those
debtors to whom a trading entity sells trading inventory (or to whom a service entity renders a specific service) on
credit. Cash receipts from trade debtors are recorded in the cash flows from operating activities section. Transactions
with debtors pertaining to investing activities are disclosed in the cash flows from investing activities section.
Exercise 7.8 in the guide illustrates how the debtors (as presented in the given information) are divided into trade
debtors and a debtor with whom an investing activity has been entered into, and how a non-cash transaction with an
`ìnvesting'' debtor is disclosed as a note to a statement of cash flows.
The cash receipts from the trade debtors can also be calculated by reconstructing the debtors
control account:
Debtors control
Dr (reconstructed for calculation purposes) Cr
20.1 R 20.2 R
Aug 1 Balance b/d 14 000 Jul 31 Bank* 7 000
20.2 Balance c/d 19 000
Jul 31 Services rendered 12 000
26 000 26 000
20.2
Aug 1 Balance b/d 19 000
* Balancing entry
Comment
As the following calculation shows, it is not necessary to distinguish between the services
rendered for cash and the services rendered on credit when the cash receipts from customers
are calculated:
R
Total services rendered R(18 000 + 12 000) 30 000
Add:Debtors control (opening balance) 14 000
Debtors control (closing balance)
Subtract: (19 000)
Services rendered for cash and cash receipts from trade debtors (25 000)
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2 Cash paid to suppliers and employees
The items in the statement of comprehensive income that pertains to cash paid to suppliers
and employees are consumable inventory consumed, rental expenses, wages, water and
electricity, telephone expenses, and insurance expense. The sum of the cash flows from these
items must be calculated.
20.1 20.2 Cash paid to

+Accrued ± Accrued suppliers and
expenses ± expenses + employees
Items in statement of comprehensive income Prepayments Prepayments during 20.2
R R R R
Consumable inventory consumed
(to obtain payments in respect of
the purchases of the inventory) 7 000 ±6 000 + 23 000 +9 000 ± 18 000 = 15 000*
Rental expenses 1 000 Ð Ð = 1 000
Wages 3 100 Ð +500 = 3 600
Water and electricity 1 700 Ð Ð = 1 700
Telephone expenses 300 Ð ± 300 = Ð
Insurance expense 200 Ð + 400 = 600
21 900
* For explanatory purposes, the payments made to trade creditors are calculated in more detail as follows:
Payments made to trade creditors

R
Purchase of consumable inventory 1 * 10 000
Add: Creditors control (opening balance) 23 000
Subtract:Creditors control (closing balance) (18 000)
Payments made to trade creditors* 15 000
* Note that a creditor pertaining to an investing/financing activity is not considered to be a trade creditor. Trade
creditors are those creditors from whom an entity purchases sales merchandise or consumable inventory on credit.
Cash payments to trade creditors are recorded in the cash flows from operating activities section. Transactions with
creditors pertaining to investing activities are disclosed in the cash flows from investing activities section. Exercise 7.4
illustrates how the creditors (as presented in the given information) are divided into trade creditors and creditors with
whom an investing transaction has been entered into, and how a credit transaction with an `ìnvestment'' creditor is
disclosed as a note to a statement of cash flows.
* Purchase of consumable inventory

1
R
Inventory consumed 7 000
Subtract: Inventories (opening balance) (6 000)
Add: Inventories (closing balance) 9 000
Purchase of consumable inventory 10 000
Comment
The amount of inventory consumed, as disclosed in the statement of comprehensive income,

will not necessarily be equal to the inventory purchased or to the payments that were made to
the trade creditors during the financial period. In order to calculate the amount actually paid to
the trade creditors, the amount of inventory purchased must first be determined.
149
FAC1601/1
The payments made to the trade creditors can also be calculated by reconstructing the
consumable inventory and the creditors control accounts:
Consumable inventory
20.1 R 20.2 R
Aug 1 Balance b/d 6 000 Jul 31 Inventory consumed 7 000
20.2
Jul 31 Creditors control* 10 000 Balance c/d 9 000
16 000 16 000
* Balancing entry
Creditors control
20.2 R 20.1 R
Jul 31 Bank* 15 000 Aug 1 Balance b/d 23 000
20.2
Balance c/d 18 000 Jul 31 Consumable inventory 10 000
33 000 33 000
* Balancing entry

3 Interest paid
R
Add: Interest prepaid at end of year (31 July 20.2) 625
Interest paid 1 250

4 Addition to machinery
Step 1: Determine the difference between the opening and closing balances of the
machinery at carrying amount.
(Refer to paragraph 7.6.2 in the prescribed textbook for a discussion of this step, and to
example 7.6, calculation 2, for an illustration and discussion of a similar calculation.)
R
Carrying amount (31 July 20.1) 50 000
Subtract: Depreciation (700)
Carrying amount (31 July 20.2) (59 300)
Increase in (purchase of) machinery (10 000)
Step 2: Determine whether the increase pertains to a cash flow.

Paragraph 6 of the additional information indicates that the addition to the property, plant and
equipment were paid in full and that no property, plant and equipment were sold during the
financial year ended 31 July 20.2. Therefore it can be concluded that the increase in the
machinery pertains to a cash outflow of R10 000.
150
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Comment
If Step 1 had been applied to determine any movements in the vehicles account, the following
results would have been obtained:
R
Carrying amount (31 July 20.1) 40 000
Subtract: Depreciation (800)
Carrying amount (31 July 20.2) (39 200)
Increase/decrease in vehicles Ð
Since no movement took place in respect of vehicles, it was unnecessary to apply Step 2.

5 Proceeds from capital contribution
Since the difference between the opening and closing balances of the capital account of a sole
trader is influenced by the profit (or loss) for the year, any drawings that were made, as well as
any capital contributions that were made, the difference between the opening and closing
balances of the capital account must be analysed to determine what caused the difference. In
this exercise, the statement of changes in equity was given. This statement discloses the
movements in the capital account. The amount given in the statement of changes in equity for
the year ended 31 July 20.2 as a capital contribution was R5 000. The additional information
(refer to paragraph 8 of the additional information) stated that the contribution was made in
cash.

6 Proceeds from long-term borrowing
Step 1: Determine the difference between the opening and closing balances of the long-
term borrowing.
R
Long-term borrowings (Statement of financial position as at 31 July 20.2) 55 000
Subtract:Long-term borrowings (Statement of financial position as at (50 000)
31 July 20.1)
Increase in long-term borrowing 5 000

Since there was an increase in the long-term borrowing to the amount of R5 000, and since the
interest charged on the borrowing was not capitalised (refer to paragraph 9 of the additional
information), the R5 000 must have been received by the business in cash.
Comment
The steps that are indicated in the solutions to exercises 7.1 to 7.4 in respect of the investing
and financing activities are for illustrative purposes only. You do not have to show these steps
in your answers to such questions. As from exercise 7.5, the disclosure of the steps are
omitted.
151
FAC1601/1
Exercise 7.2
Preparation of a statement of cash flows in respect of a close
corporation
Work through the exercise, taking special note of

. how to disclose an investment in property, plant and equipment to maintain operating
capacity
. how to calculate the cash receipts from the sale of machinery
. the non-cash entry pertaining to the revaluation of the financial assets at fair value through
profit or loss: Held for trading: Listed investment (listed shares)
Given information
The following information pertains to Cash CC:
CASH CC
R
Revenue 490 000
Purchases 301 500
332 500
Other income 28 000
Dividend income: Financial assets at fair value through profit or loss:
Gain on financial assets at fair value through profit or loss:
235 500
Depreciation 19 000
Salaries to members 24 000
Wages 36 000
Interest on long-term loan 14 000
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CASH CC
Members'
contribu- Retained
tions earnings Total
R R R
Balances at 1 January 20.8 355 000 8 000 363 000
Members' contributions 20 000 20 000
Balances at 31 December 20.8 375 000 47 000 422 000
CASH CC
Note* 20.8 20.7
R R
ASSETS
Property, plant and equipment 1 448 500 394 000
Inventories 50 000 31 000
Prepayments 2 000 Ð
Other financial assets 50 000 35 000
Cash and cash equivalents 14 000 7 000
Total assets 599 500 497 000
Total equity 422 000 363 000
Retained earnings 47 000 8 000
Distribution to members payable 37 500 15 000
Current tax payable 9 000 11 000
* With the exception of the note pertaining to property, plant and equipment, all notes are excluded.
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CASH CC
NOTE FOR THE YEAR ENDED 31 DECEMBER 20.8
Machinery
Land and and
buildings equipment Total
R R R
Carrying amount at 1 January 20.8 260 000 134 000 394 000
Cost 260 000 177 000 437 000
Additions Ð 77 500 77 500
Disposals Ð (4 000) (4 000)
Depreciation for the year Ð (19 000) (19 000)
Carrying amount at 31 December 20.8 260 000 188 500 448 500
Cost 260 000 237 500 497 500
1 During the year machinery with a cost price of R17 000 was sold for cash at the carrying
amount thereof and replaced with new machinery. Depreciation to the amount of R13 000
was recorded in respect of the sold machinery, as from the date of purchase to the date of
sale thereof.
2 An additional machine was purchased for R40 000 to expand the operating capacity of the
business.
3 All machinery was purchased for cash.
4 No equipment was purchased or sold during the financial year ended 31 December 20.8.
5 The other financial assets pertain to financial assets at fair value through profit or loss: Held
for trading: Listed investments (shares were purchased on the JSE Securities Exchange).
No shares were sold during the current year ended 31 December 20.8.
6 All inventories are purchased and sold on credit.
7 Inventory is recorded at cost.
8 Trade and other payables include:
20.8 20.7
R R
Creditors control (trade creditors) 25 000 33 000
Accrued wages 6 000 5 000
9 The close corporation will be renting additional premises as from 1 January 20.9.
10 The trade receivables pertain to the trade debtors to whom trading inventory was sold on
credit.
11 The prepayments were in respect of a rental expense.
capitalised.
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FAC1601/1
REQUIRED
Prepare the statement of cash flows of Cash CC for the year ended 31 December 20.8 to
comply with those requirements of GAAP which are appropriate to the business of the
close corporation. The cash generated from/(used in) operations must be disclosed
according to the direct method. Comparative figures and notes are not required.
Solution 7.2
CASH CC
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20.8
R R
CASH FLOWS FROM OPERATING ACTIVITIES*
Cash paid to suppliers and employees 2 (390 500)
Dividends received 3 13 000
Income tax paid 5 (38 000)
Distribution to members paid
6 (25 000)
Net cash from operating activities 30 500
Investment in property, plant and equipment to maintain
Replacement of machinery 7 (37 500)
Addition to machinery 7 (40 000)
Proceeds from sale of machinery 8 4 000
Proceeds from members' contributions 9 20 000
Net increase in cash and cash equivalents 7 000
Cash and cash equivalents at end of year 14 000
* The difference of R15 000 (R50 000 ± R35 000) in the other financial assets pertains to the revaluation of the assets
(see statement of comprehensive income). The increase in the statement of financial position is thus due to a non-
cash entry.
155
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Calculations

R
Revenue (sales) 490 000
Subtract: Debtors control (closing balance) (35 000)
Cash receipts from customers 485 000

expenses ± expenses + employees dur-
Items Prepayments Prepayments ing 20.8
R R R R
Statement of comprehensive income
Purchases (for payments made to

trade creditors) 301 500 +33 000 ±25 000 = 309 500
Salaries to members 24 000 Ð Ð = 24 000
Administrative expenses 20 000 Ð Ð = 20 000
Wages 36 000 +5 000 ± 6 000 = 35 000
Statements of financial position
Rental expense Ð Ð + 2 000 = 2 000
390 500

3 Dividends received
No dividends are indicated as receivable at the beginning or at end of the financial year
under review. Therefore it can be concluded that the dividend income for the year ended
31 December 20.8, namely R13 000, was received in cash during the financial year
ended 31 December 20.8.

4 Interest paid
No accrued or prepaid amounts were indicated in respect of an interest expense. Therefore it
can be concluded that the interest as disclosed in the statement of comprehensive income for
the year ended 31 December 20.8, namely R14 000, was paid during the financial year ended
31 December 20.8.

5 Income tax paid
R
Income tax expense 36 000
Add: Current tax payable (opening balance) 11 000
Subtract:Current tax payable (closing balance) (9 000)
Income tax paid 38 000
156
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6 Distribution to members paid
R
Distribution to members 47 500
Add: Distribution to members payable (opening balance) 15 000
Subtract: Distribution to members payable (closing balance) (37 500)
Distribution to members paid 25 000

7 Replacement of and addition to machinery
machinery and equipment at cost account.
The note in respect of property, plant and equipment shows that there were additions to the
amount of R77 500, therefore it is unnecessary to calculate any differences. In the additional
information, paragraph 2, it was mentioned that additional machinery to the amount of R40 000
was purchased to expand the operating capacity of the business. The total amount of additions
was given as R77 500, therefore it can be concluded that machinery to the amount of R37 500
was purchased to replace the machinery that had been sold.
Step 2: Determine whether the additions pertain to a cash flow.

Paragraph 3 of the additional information states that the purchases of machinery were paid for
in cash.

8 Proceeds from the sale of machinery
Cost price ± Accumulated depreciation = Carrying amount
R17 000 ± R13 000 = R4 000
Paragraph 1 of the additional information states that machinery was sold for cash at the
carrying amount thereof, therefore the carrying amount is equal to the selling price of the
machinery.

9 Proceeds from members' contributions
members' contributions account.
R
Members' contributions (Statement of financial position as at
31 December 20.8) 375 000
Members' contributions (Statement of financial position as at
Subtract:
31 December 20.7) (355 000)

Increase in members' contributions* 20 000
* Also refer to the statement of changes in net investment of members for the year ended 31 December 20.8. The
members' contributions of R20 000 is disclosed therein.

No further information was given in respect of members' contributions. It can therefore be
concluded that the increase in the members' contributions was due to a cash contribution.
157
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term borrowing.
R
Long-term borrowings (Statement of financial position as at
31 December 20.8) 100 000
Subtract:Long-term borrowings (Statement of financial position as at
31 December 20.7) (70 000)
Increase in long-term borrowings 30 000

Since there was an increase in the long-term borrowing to the amount of R30 000, and the
interest charged on the borrowing is not capitalised, the R30 000 must have been received by
the business in cash.
Exercise 7.3
corporation
Work through the exercise, taking special note of how to calculate the profit before tax and how
to disclose the adjustments thereto in order to determine the cash generated from operations.
Given information
The following information pertains to Greengrow CC:
Statement of financial position information as at 31 December
20.9 20.8
R R
Long-term loan (Cr) 70 000 100 000
Land and buildings at cost 260 000 260 000
Machinery and equipment at cost 177 000 220 500
Accumulated depreciation 43 000 49 000
Fixed deposits 35 000 50 000
Inventory 31 000 50 000
Debtors control (trade debtors) 30 000 35 000
Bank (Dr) 47 000 Ð
Prepaid rental expense Ð 3 000
Bank overdraft Ð 2 000
SARS (Income tax) (Cr) 11 000 9 000
Interest payable 5 000 6 000
158
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Extract of items disclosed in the statement of comprehensive income for the year ended
31 December 20.9:
R
Interest income: Loans and receivables: Fixed deposits 13 000
Depreciation 19 000
Loss on sale of machinery and equipment 500
Information from the statement of changes in net investment of members for the year ended
31 December 20.9:
R
1 No machinery and equipment were purchased during the financial year. Machinery and
equipment were sold for cash.
2 Inventory is disclosed at cost.
3 A fixed deposit was realised during the financial year.
4 The interest on the long-term loan is not capitalised.
REQUIRED
Prepare the statement of cash flows of Greengrow CC for the year ended 31 December
20.9 to comply with those requirements of GAAP which are appropriate to the business of
the close corporation. The cash generated from/(used in) operations must be disclosed
according to the indirect method. Comparative figures and notes are not required.
159
FAC1601/1
Solution 7.3
GREENGROW CC
R R
CASH FLOW FROM OPERATING ACTIVITIES
Profit before tax 1 113 500
Adjustments for:
Loss on sale of machinery and equipment 500
Depreciation 19 000
Interest income: Loans and receivables: Fixed deposit (13 000)
134 000
Decrease in inventories R(50 000 ± 31 000) 19 000
Decrease in debtors control R(35 000 ± 30 000) 5 000
Decrease in prepaid rent R(3 000 ± Nil) 3 000
Decrease in creditors control R(25 000 ± 13 000) (12 000)
Interest received 2 13 000

Distribution to members paid
5 (60 000)
Proceeds from the sale of machinery and equipment
6 18 000
Proceeds from the maturity of loans and receivables:
Fixed deposit 7 15 000
Net cash from investing activities 33 000
Repayment of long-term borrowing
8 (30 000)
Net cash used in financing activities (30 000)
Cash and cash equivalents at beginning of year (2 000)
Calculations

1 Profit before tax R
Add: Income tax expense 43 000
113 500

2 Interest received
No interest is indicated as receivable at the beginning or at the end of the financial year under
review. Therefore it can be concluded that the interest earned for the year ended
31 December 20.9, namely R13 000, was received during the financial year ended
31 December 20.9.
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3 Interest paid
R
Add: Interest payable (opening balance) 6 000
Subtract: Interest payable (closing balance) (5 000)
Interest paid 15 000

4 Income tax paid
R
Add: [SARS (income tax) opening balance] 9 000
Subtract:[SARS (income tax) closing balance] (11 000)

R
Subtract: Distribution to members payable (closing balance) (15 000)

6 Proceeds from the sale of machinery and equipment
machinery and equipment at cost account.
R
Machinery and equipment at cost (31 December 20.8) 220 500
Machinery and equipment at cost (31 December 20.9)
Subtract: (177 000)
Decrease in machinery and equipment at cost 43 500
Step 2: Determine whether the decrease pertains to a cash flow.

Paragraph 1 of the additional information states that no machinery and equipment were
purchased during the year, therefore the difference pertains solely to the sale of machinery and
equipment. Paragraph 1 also states that machinery and equipment were sold for cash.
Therefore, the decrease in the machinery and equipment was caused by a cash sale of
machinery and equipment with a cost price of R43 500.
In this case the relevant cash flow pertains to the proceeds that were received in respect of the
sales transaction. The selling price (proceeds) can be calculated as follows:
Carrying amount of machinery and equipment sold ± Loss on sale of machinery and equipment
= Selling price
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FAC1601/1
Therefore:
Carrying amount of machinery and equipment sold (unknown) ± R500 = Selling price
(unknown)
The carrying amount is calculated as follows:

Cost price of the machinery and equipment sold ± Accumulated depreciation of the machinery
and equipment sold = Carrying amount of the machinery and equipment sold
R43 500 ± Accumulated depreciation of the machinery and equipment sold (unknown) =
Carrying amount of the machinery and equipment sold (unknown)
The calculation of the accumulated depreciation is best illustrated by the reconstruction of the
accumulated depreciation account:
Accumulated depreciation
20.9 R 20.9 R
Dec 31 Realisation account* 25 000 Jan 1 Balance (given) b/d 49 000
Balance (given) c/d 43 000 Dec 31 Depreciation (given) 19 000
68 000 68 000
* Balancing entry (This figure pertains to the accumulated depreciation in respect of the sold machinery and
equipment.)
The carrying amount can now be calculated:

Cost price of the machinery and equipment sold ± Accumulated depreciation of the machinery
and equipment sold = Carrying amount of the machinery and equipment sold
R43 500 ± R25 000 = R18 500
And now the selling price can be calculated:
Carrying amount of machinery and equipment sold ± Loss on sale of machinery and equipment
= Selling price
R18 500 ± R500 = R18 000
The relevant cash flow in this regard pertains to the cash that was received on the sale of the
machinery and equipment, namely R18 000.

7 Proceeds from the maturity of loans and receivables: Fixed deposit
investments.
R
Fixed deposits (31 December 20.8) 50 000
Subtract:Fixed deposits (31 December 20.9) (35 000)
Realisation of fixed deposit 15 000
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FAC1601/1
Paragraph 3 of the additional information mentioned that a fixed deposit was realised during
the financial year. Cash was thus received.

8 Repayment of long-term borrowing
long-term borrowing.
R
31 December 20.8) 100 000
31 December 20.9) (70 000)
Decrease in long-term borrowings 30 000

Since there was a decrease in the long-term borrowing to the amount of R30 000, and the
interest charged on the borrowing is not capitalised, a capital amount of R30 000 must have
been repaid by the business.
Exercise 7.4
Preparation of a statement of cash flows in respect of a sole trader
Work through the exercise, taking special note of

. the calculation of a decrease in the trade creditors when only a creditors' figure is given
. the disclosure of the purchase of equipment on credit, in respect of which no payment was
made
163
FAC1601/1
Given information
The following information pertains to L Leyds, a general dealer:
Statement of financial position information as at
28 Feb 20.2 28 Feb 20.1

R R
Equipment at cost 72 000 60 000
Inventory at cost 20 000 16 000
Bank (Dr) 2 000 Ð
Creditors control 19 000 20 000
Bank (overdraft) Ð 6 000
Capital Ð L Leyds 84 200 58 400
Long-term loan (Cr) 80 000 75 000
Accumulated depreciation (equipment) 12 000 9 800
1 The total comprehensive income for the year amounted to R26 000, and has already
been closed off against the capital account of L Leyds. (There were no items pertaining to
other comprehensive income.)
2 No property, plant or equipment was sold or scrapped during the year ended
28 February 20.2. Equipment with a cost price of R7 000 was purchased on credit
during the year. This amount is included in the creditors control figure. By the end of the
year, no payments in respect of the equipment were made. (The amount of this purchase
is significant.) All of the other additions to property, plant and equipment were obtained
from third parties and paid for.
3 The interest expense on the long-term loan during the year amounted to R12 000. The
interest is not capitalised.
4 The creditors in respect of 28 February 20.2 pertain to trade creditors and the creditor
referred to in paragraph 2.
5 Cash withdrawals (closed off against the capital account) by L Leyds during the year
ended 28 February 20.2 amounted to R10 200.
6 L Leyds makes all capital contributions in cash.
REQUIRED
Prepare the statement of cash flows of L Leyds for the year ended 28 February 20.2 to
comply with those requirements of GAAP which are appropriate to the business of the sole
trader. Comparative figures are not required. The cash generated from/(used in)
operations must be disclosed according to the indirect method.
Disclose only the note in respect of the non-cash transaction pertaining to the investing
activity.
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Solution 7.4
L LEYDS
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 28 FEBRUARY 20.2
Note R R
Adjustments for:
Depreciation R(12 000 ± 9 800) 2 200
40 200
Increase in inventories R(20 000 ± 16 000) (4 000)
Decrease in debtors control
R(19 000 ± 17 000) 2 000
Decrease in creditors control (iro trade
creditors)
R[20 000 ± (19 000 ± 7 000*)] (8 000)
Interest paid (12 000)
Drawings (10 200)
Investment in property, plant and equipment
to expand operating capacity (15 000)
Additions to land and buildings 1 (10 000)
Additions to equipment 2 1 (5 000)
Proceeds from capital contribution 3 10 000
* Refer to the discussion under step 2 of calculation 2 for an explanation of the deduction of the R7 000.
165
FAC1601/1
L LEYDS
1. Non-cash transaction pertaining to the investing activity
Equipment with a cost price of R7 000 was purchased on credit during the year. No payments
were made in this regard.
Comment
Since the above credit purchase is regarded as significant (refer to paragraph 2 of the
additional information), the transaction is disclosed in a note to the statement of cash flows.
Calculations

1 Additions to land and buildings
Step 1: Determine the difference between the opening and closing balances of the land and
buildings at cost account.
R
Land and buildings at cost (note to statement of financial position as at
28 February 20.2) 100 000
Subtract:Land and buildings at cost (note to statement of financial position
as at 28 February 20.1) (90 000)
Increase in (purchase of) land and buildings 10 000

Paragraph 2 of the additional information states that all property, plant and equipment, with the
exception of the purchase of equipment from a creditor, was purchased from third parties and
paid for. Therefore we know that the additions to the land and buildings were paid for.

2 Additions to equipment
equipment at cost account.
R
Equipment at cost (note to statement of financial position as at
28 February 20.2) 72 000
Equipment at cost (note to statement of financial position as at
Subtract:
28 February 20.1) (60 000)

Increase in (purchase of) equipment 12 000

Paragraph 2 of the additional information states that all property, plant and equipment, with the
exception of the purchase of equipment with a cost price of R7 000 from a creditor, was paid
for. Therefore, for calculation purposes, the accounting entry that pertains to this transaction
must be ``reversed'' (added back). (That is, the creditors' account is ``debited'' and the
equipment at cost account is ``credited''. In other words, the closing balances of these accounts
must each be reduced by this amount. Note that this ``reversal'' is not an actual accounting
entry. It pertains solely to a calculation to prepare the statement of cash flows.) The effect of
such a ``reversal'' is that the increase in the equipment reduces to R5 000 (R12 000 ± R7 000),
which pertains to the cash purchases of equipment.
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FAC1601/1

3 Proceeds from capital contribution
Step 1: Determine the difference between the opening and closing balances of the capital
account.
R
Capital (Statement of financial position as at 28 February 20.2) 84 200
Add: Drawings 10 200
Subtract: Capital (Statement of financial position as at 28 February 20.1) (58 400)
Total comprehensive income for the year (26 000)
Increase in capital 10 000
The above calculation could also have been made by reconstructing the capital account of
Leyds:
Capital: L Leyds
20.2 R 20.1 R
Feb 28 Drawings 10 200 Mar 1 Balance b/d 58 400
Balance c/d 84 200 Profit or loss account 26 000
Bank* 10 000
94 400 94 400
20.2
Mar 1 Balance b/d 84 200
* Balancing entry

Paragraph 6 of the additional information indicates that all capital contributions by Leyds are
made in cash.

term borrowings.
R
28 February 20.2) 80 000
28 February 20.1) (75 000)
Increase in long-term borrowings 5 000

Since there was an increase in long-term borrowings to the amount of R5 000, and the interest
expense on the borrowing is not capitalised, the R5 000 must have been received by the
business in cash.
167
FAC1601/1
Exercise 7.5
corporation
Work through the exercise, taking special note of how to calculate the cash receipts from
customers when credit losses were recorded during the financial year. Also take note that the
difference between the listed investments (financial assets at fair value through profit or loss:
Held for trading) was due to a revaluation, and that the recording thereof is a non-cash entry.
Given information
The following information pertains to City Traders CC:
BALANCES AT
28 Feb 20.3 28 Feb 20.2
R R
Long-term loan 33 600 80 000
Bank 1 300 (Cr) 800 (Cr)
Machinery at cost 60 000 60 000
Furniture and equipment at cost 4 000 3 000
Listed investments (at fair value) 18 700 19 500
Inventory (merchandise) 9 000 8 000
SARS (income tax) (Cr) 16 000 13 000
Allowance for credit losses 234 Ð
Accumulated depreciation (machinery) 12 000 6 000
Accumulated depreciation (furniture and equipment) 800 400
168
FAC1601/1
ACCOUNT BALANCES WHICH PERTAIN TO THE STATEMENT OF COMPREHENSIVE
INCOME FOR THE YEAR ENDED 28 FEBRUARY 20.3
R
Sales 142000
Purchases 82500
Administrative expenses 10000
Dividends earned 2500
Credit losses 494
Depreciation (machinery) 6 000
Depreciation (furniture and equipment) 400
Loss on financial assets at fair value through profit or loss: Held for trading:
Listed investments 800
1 The interest on the long-term loan is not capitalised.

2 On 28 February 20.3 a distribution to memers for the amount of R6 000 was provided for.
3 Inventory is recorded at cost.
4 The listed investments (financial assets at fair value through profit or loss: Held for
trading) pertain to shares that were purchased on the JSE Securities Exchange. No
shares were purchased or sold during the financial year.
5 All members' contributions were made in cash.
REQUIRED
Prepare the statement of cash flows of City Traders CC for the year ended
28 February 20.3 to comply with the requirements of GAAP which are appropriate to
the business of the close corporation. The cash generated from/(used in) operations
must be disclosed according to the direct method. Comparative figures and notes are not
required.
169
FAC1601/1
Solution 7.5
CITY TRADERS CC
R R
CASH FLOWS FROM OPERATING ACTIVITIES*
Dividends received 3 2 500
Distribution to members paid 6 (3 000)
Additions to furniture and equipment R(4 000 ± 3 000) (1 000)
Proceeds from members' contributions 22 000
R(154 000 ± 132 000)
Repayment of long-term borrowing R(80 000 ± 33 600) (46 400)
Net cash used in financing activities (24 400)
Net decrease in cash and cash equivalents (500)
Cash and cash equivalents at beginning of year (800)
Cash and cash equivalents at end of year (1 300)
*Since no listed shares were purchased or sold during the financial year, it can be concluded that the difference of R800
(R19 500 ± R18 700) pertains to a non-cash entry due to a revaluation of the shares.
Calculations

R
Sales 142 000
Debtors control (closing balance)
Subtract: (2 340)
Credit losses (260)
Cash receipts from customers 142 200
Comment
The given information shows that the following were recorded in the credit losses account:
. The creation of an allowance for credit losses account to the amount of R234. (See list of
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FAC1601/1
balances in the given information.) The accounting entry for the creation of such an
allowance is recorded by debiting the credit losses account and crediting the allowance for
credit losses account with the amount provided for. Note that the debtors control account is
not influenced by this entry.
. The amount of credit losses as shown in the statement of
The recording of credit losses.
comprehensive income is R494. (See extract of balances in the given information.) This
amount is R260 greater than R234. (R494 ± R234 = R260. The R234 pertains to the
creation of the allowance for credit losses.) In other words, during the financial year the
credit losses account was debited with a further amount of R260. With no further information
available, it can be concluded that the R260 pertains to credit losses that were recorded.
(To account for credit losses, the credit losses account is debited and the debtors control
account is credited.) Since this accounting entry influences the debtors control account, the
amount of credit losses that were recorded must be taken into account when the cash
receipts from customers are calculated.
The cash receipts from customers can also be calculated by reconstructing the debtors control
account:
Debtors control
R R
Balance b/d 2 800 Credit losses 260
Sales 142 000 Bank* 142 200
Balance c/d 2 340
144 800 144 800
Balance b/d 2 340
* Balancing entry

R R R R
Purchases 82 500 + 2 300 ± 3 000 = 81 800
Administrative expenses 10 000 Ð Ð = 10 000
91 800
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3 Dividends received
No dividends are indicated as receivable at the beginning or at end of the financial year under
review. Therefore it can be concluded that the dividends earned as disclosed in the information
pertaining to the statement of comprehensive income for the year ended 28 February 20.3,
namely R2 500, were received during the financial year ended 28 February 20.3.

4 Interest paid
No accrued or prepaid amounts were indicated in respect of interest paid. Therefore it can be
concluded that the interest as disclosed in the information pertaining to the statement of
comprehensive income for the year ended 28 February 20.3, namely R12 000, was paid during
the financial year ended 28 February 20.3.

5 Income tax paid
R
Add: SARS (income tax) Ð opening balance 13 000
Subtract:SARS (income tax) Ð closing balance (16 000)

R
Subtract: Distribution to members payable (closing balance Ð after
adjustment) (6 000)
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Exercise 7.6
corporation
Work through the exercise, taking special note of how to calculate

. payments made to trade creditors when the purchase figure was not given
. the movement in a long-term borrowing when a portion thereof is disclosed as a current
liability
Given information
The following information pertains to Mango CC:
MANGO CC
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE 20.4
Note* 20.4 20.3
R R
Revenue 110 000 90 000
Cost of sales (60 000) (55 000)
Gross profit 50 000 35 000
Other income 3 600 3 900
Rental income Ð 300
Interest income: Loans and receivables: Fixed
deposit 3 600 3 600
53 600 38 900
Distribution, administrative and other expenses (19 100) (19 100)
Salaries and wages 16 000 15 000
Insurance 600 500
Other administrative expenses 1 500 2 600
Finance costs (2 500) (1 800)
Interest on long-term loan 2 500 1 800
Profit before tax 32 000 18 000
Income tax expense (10 000) (8 000)
Profit for the year 22 000 10 000
Other comprehensive income for the year Ð Ð
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MANGO CC
ENDED 30 JUNE 20.4
Members'
contribu- Retained
tions earnings Total
R R R
Balances at 1 July 20.3 60 000 Ð 60 000
Balances at 30 June 20.4 80 000 10 000 90 000
MANGO CC
STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20.4
Note* 20.4 20.3
R R
ASSETS
Financial assets 33 000 22 000
Total assets 105 200 87 000
Total equity 90 000 60 000
Retained earnings 10 000 Ð
Current portion of long-term borrowings 1 000 Ð
Other financial liabilities 4 200 5 000
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1 All purchases were made on credit, whereas all other expenses were paid for in cash.
3 Property, plant and equipment consist of:
20.4 20.3
R R
Machinery at carrying amount 6 000 7 000
Total 46 000 39 000
4 The increase in the land and buildings was paid in full. No machinery was purchased or
sold during the period.
5 The financial assets pertain to loans and receivables: Fixed deposits. Another fixed deposit
was made on 30 June 20.4.
6 The trade receivables include the following:
20.4 20.3
R R
Accrued income (rent) Ð 300
7 400 6 000
7 All members' contributions were made in cash.

capitalised.
9 Trade and other payables represent trade creditors only.
10 The other financial liabilities pertain to a bank overdraft.
REQUIRED
Prepare the statement of cash flows of Mango CC for the year ended 30 June 20.4 to
comply with the requirements of GAAP which are appropriate to the business of the close
corporation. The cash generated from/(used in) operations must be disclosed according to
the direct method. Comparative figures and notes are not required.
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Solution 7.6
MANGO CC
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 30 JUNE 20.4
R R

Interest received 3 3 600
Additions to land and buildings R(40 000 ± 32 000) (8 000)
Acquisition of loans and receivables: Fixed deposit
R(33 000 ± 22 000) (11 000)
Proceeds from members' contributions 20 000
Repayment of long-term borrowing
R[(12 000 ± (4 000 + 1 000*)] (7 000)
Net increase in cash and cash equivalents 800
Cash and cash equivalents at end of year (4 200)
* The current portion of the long-term borrowing (R1 000) must be added to the outstanding amount of the long-term
borrowing (R4 000) in order to calculate the total amount due on 30 June 20.4 (R5 000).
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Calculations

20.3 20.4
+Accrued ± Accrued Cash receipts
income ± In- income + In- from
come received come received customers
Items in advance in advance during 20.4
R R R R
Statement of comprehensive income
Revenue 110 000 + 5 700 ± 7 400 = 108 300
Statement of financial position
Rental income Ð +300 Ð = 300
108 600

Items Prepayments Prepayments during 20.4
R R R R
Cost of sales 60 000 ± 20 000 + 10 000 + 18 800 ± 6 000 = 62 800
Salaries and wages 16 000 Ð Ð = 16 000
Insurance 600 Ð Ð = 600
Other administrative expenses 1 500 Ð Ð = 1 500
80 900
For explanatory purposes, the calculation of the payments to trade creditors are further
clarified:
Payments made to trade creditors
R
Purchases of inventory 1 * 58 800
Add: Creditors control (opening balance) 10 000
Subtract:Creditors control (closing balance) (6 000)
Payments made to trade creditors 62 800
*1 Purchases of inventory
R
Cost of sales 60 000
Subtract: Inventories (opening balance) (20 000)
Add: Inventories (closing balance) 18 800
Purchases of inventory 58 800
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3 Interest received
No interest is indicated as receivable at the beginning or at end of the financial year under
review. Therefore it can be concluded that the interest income as disclosed in the statement of
comprehensive income for the year ended 30 June 20.4, namely R3 600, were received during
the financial year ended 30 June 20.4.

4 Interest, income tax and distribution to members paid
No accrued or prepaid amounts in respect of these items are indicated, therefore it can be
concluded that the interest and income tax expenses as indicated in the statement of
comprehensive income for the year ended 30 June 20.4, and the distribution to members as
indicated in the statement of changes in net investment of members for the year ended
30 June 20.4, were paid during the financial year ended 30 June 20.4.
Exercise 7.7
corporation
Work through the exercise, taking special note of how to disclose the net cash used in
operating activities.
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Given information
The following information pertains to Joho Close Corporation:

JOHO CLOSE CORPORATION
Note 20.6 20.5
R R
Revenue 360 000 300 000
Cost of sales (270 000) (225 000)
Inventory (1 January 20.6) 45 000 30 000
Purchases 285 000 240 000
330 000 270 000
Inventory (31 December 20.6) (60 000) (45 000)
Administrative expenses 26 000 21 000
Finance costs (1 000) (1 000)
Interest on loan from member 1 000 1 000

Asset
Members' replace-
contribu- Retained ment Loan from
tions earnings reserve member Total
R R R R R
Balances at 1 January 20.6 150 000 10 000 30 000 6 000 196 000
Total comprehensive
income for the year 33 000 33 000
Transfer to asset replace-
ment reserve (3 000) 3 000
Loan from member 1 000 1 000
Balances at 31 December 20.6 170 000 20 000 33 000 7 000 230 000
Current liability Ð
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STATEMENT OF FINANCIAL POSITION ACCOUNTS AS AT 31 DECEMBER
20.6 20.5
R R
Asset replacement reserve 33 000 30 000
Loan from member 7 000 6 000
SARS (income tax) 2 000 3 000
257 000 229 000
Accumulated depreciation (furniture and equipment) (21 000) (12 000)
Inventory 60 000 45 000
Bank 7 000 32 000
257 000 229 000
1 No furniture or equipment was sold or scrapped during the financial year ended
31 December 20.6.
2 All purchases of inventory were made on credit and all other purchases and expenses
(except income tax) were paid for in full.
4 The interest on the loan from the member is not capitalised.
REQUIRED
Prepare the statement of cash flows of Joho Close Corporation for the year ended
31 December 20.6 to comply with the requirements of GAAP which are appropriate to the
business of the close corporation. The cash generated from/(used in) operations must be
disclosed according to the indirect method. Comparative figures and notes are not
required.
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Solution 7.7

R R
Adjustments for:
Interest on loan from member 1 000
Depreciation 9 000
64 000
Increase in inventories R(60 000 ± 45 000) (15 000)
Increase in debtors control R(116 000 ± 90 000) (26 000)
Decrease in creditors control R(30 000 ± 25 000) (5 000)

Net cash used in operating activities (25 000)
Additions to furniture and equipment R(95 000 ± 74 000) (21 000)
Proceeds from members' contributions
R(170 000 ± 150 000) 20 000
Proceeds from borrowing [loan from member
R(7 000 ± 6 000)] 1 000
Net decrease in cash and cash equivalents (25 000)
Calculations

1 Interest and distribution to members paid
No accrued or prepaid amounts in respect of these items are indicated, therefore it can be
concluded that the interest expense and the distribution to members as indicated in the
statement of comprehensive income and the statement of changes in net investment of
members for the year ended 31 December 20.6 respectively, were paid during the financial
year ended 31 December 20.6.
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2 Income tax paid
R
Add: SARS (income tax) Ð opening balance 3 000
Subtract:SARS (income tax) Ð closing balance (2 000)
As an additional explanation, the SARS (income tax) ledger account is given:
SARS (income tax)*

20.6 R 20.6 R
Bank** 22 000 Jan 1 Balance b/d 3 000
Dec 31 Balance c/d 2 000 Dec 31 Income tax expense 21 000
24 000 24 000
20.7
Jan 1 Balance b/d 2 000
** Revise paragraph 5.12 of the prescribed textbook.

A credit balance of the SARS (income tax) account is disclosed as ``Current tax payable'' in the statement of financial
position at the year-end, whereas a debit balance is disclosed as ``Current tax receivable'' in the statement of
financial position at the year-end.
** Balancing entry
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Exercise 7.8
Preparation of a statement of cash flows in respect of a partnership
Work through the exercise, taking note of how to calculate and disclose a non-cash transaction
in respect of an investing activity.
Given information
The following information pertains to the partnership, Bluemax:

BLUEMAX
Note* R
Revenue 500 600
Inventory (1 March 20.5) 100 400
Purchases 191 960
292 360
Inventory (28 February 20.6) (96 000)
Other income 14 800
Profit on sale of non-current asset (land and buildings) 10 000
Rental income 4 800
319 040
Administrative expenses (wages included) 70 000
Depreciation 1 200
* Notes excluded
BLUEMAX
Capital Current accounts Appro- Total
B Blue M Max B Blue M Max priation equity
R R R R R R
Balances at 1 March 20.5 193 800 193 800 50 400 (400) Ð 437 600
Capital contribution 26 200 26 200 52 400
the year 247 840 247 840
Interest on capital 13 200 13 200 (26 400)
Interest on current accounts 5 040 (40) (5 000)
Interest on drawings (13 440) (11 720) 25 160
hensive income 120 800 120 800 (241 600)
Drawings (134 400) (117 200) (251 600)
Balances at 28 February 20.6 220 000 220 000 41 600 4 640 Ð 486 240
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STATEMENT OF FINANCIAL POSITION INFORMATION AS AT 28 FEBRUARY
20.6 20.5
R R
Capital: B Blue 220 000 193 800
Capital: M Max 220 000 193 800
Current account: B Blue 41 600 (Cr) 50 400 (Cr)
Current account: M Max 4 640 (Cr) 400 (Dr)
Accumulated depreciation (furniture and equipment) 3 200 2 000
Inventory 96 000 100 400
Bank 67 240 (Dr) 10 000 (Cr)
Accrued income (rent receivable) 400 800
Accrued expenses (wages) 1 200 400
Fixed deposit 40 000 Ð
1 The fixed deposit was made on 28 February 20.6.

2 No land and buildings were purchased during the year. Fifty percent of the selling price of
the land and buildings was received in cash, whereas the outstanding amount was given
on credit. This amount will be received during the 20.7 financial year.
3 No furniture or equipment was sold or scrapped during the year. All purchases were paid
for in cash.
4 All purchases of inventory were on credit. All of the other expenses, except the accrued
expenses, were paid in full.
5 The drawings of the partners were made in cash.
7 There were only trade debtors at 28 February 20.5. The debtors at 28 February 20.6
pertain to trade debtors and the debtor in respect of the sale of land and buildings.
8 All capital contributions were made in cash.
REQUIRED
Prepare the statement of cash flows of Bluemax for the year ended 28 February 20.6 to
comply with the requirements of GAAP which are appropriate to the business of the
partnership. The cash generated from/(used in) operations must be disclosed according to
the direct method. Comparative figures are not required.
Disclose only the note in respect of the non-cash transaction pertaining to the investing
activity.
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Solution 7.8
BLUEMAX
Note R R
Cash paid to suppliers and employees
2 (245 960)
Drawings R(134 400 + 117 200) (251 600)
Net cash from operating activities 640
Investment in property, plant and equipment to
expand operating capacity (800)
Additions to furniture and equipment
R(12 800 ± 12 000) (800)
Proceeds from the sale of land and buildings 1 65 000
Acquisition of loans and receivables: Fixed
deposit R(40 000 ± Nil) (40 000)
Net cash from investing activities 24 200
Proceeds from capital contributions
[R(220 000 ± 193 800) 6 2] 52 400
BLUEMAX
1. Non-cash transaction pertaining to the investing activity
Land and buildings with a cost price of R120 000 were sold for R130 000. An amount of
R65 000 is receivable in the next financial year.
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Calculations

20.5 20.6
+Accrued ± Accrued Cash received
income ± In- income + In- from custo-
come received come received mers during
Items in statement of comprehensive income in advance in advance 20.6
R R R R
Revenue 500 600 + 74 000 ± 81 600 1* = 493 000
Rental income 4 800 + 800 ± 400 = 5 200
498 200
*1 Trade debtors (closing balance)

A debtor included in the amount of R146 600 does not pertain to trade debtors, but to a debtor
who purchased land and buildings from the entity (refer to additional information, paragraph 7).
The closing balance of this debtor's account must be excluded from R146 600. The closing
balance is calculated as follows:
. The selling price of the sold land and buildings:
Carrying amount + Profit on sale
R(360 000 ± 240 000) + R10 000
= R130 000
. According to paragraph 2 of the additional information, 50% of R130 000 is still outstanding
at the end of 20.6:
; R130 000/2 = R65 000 = closing balance.

Therefore, R65 000 must be excluded from R146 600:
R(146 600 ± 65 000) = R81 600 = closing balance of trade debtors.

R R R R
Purchases 191 960 + 97 200 ± 112 400 = 176 760
Administrative expenses 70 000 + 400 ±1 200 = 69 200
245 960
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SELF-ASSESSMENT
Yes No
. briefly discuss the purpose and importance of a statement of cash
flows?
. briefly explain the relationship between a statement of cash flows
and the other financial statements that were prepared on the accrual
basis of accounting, and to describe how this relationship impacts
on the preparation of a statement of cash flows?
. prepare a statement of cash flows and the note in respect of non-
cash transactions pertaining to investing and financing activities
according to the requirements of Standard IAS 7 (AC 118) by
utilising information which is mainly obtained from the other financial
statements and any relevant notes thereto, for each of the following
business entities?
Ð sole proprietor
Ð partnership
Ð close corporation
If you answered ``no'' to any of these questions, it would be in your best interest to
revise the relevant section(s) of the study material thoroughly.
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8
STUDY UNIT
Analysis and interpretation of financial

statements
CONTENTS

Key concepts 189
8.2 The nature and scope of financial statement analysis 190
8.3 The objective of financial statement analysis 190
8.4 The application of financial statement analysis 190
8.5 The limitations of financial statement analysis 191
8.6 Exercise and solution 191
Self-assessment 197
Learning outcomes
& discuss the nature, scope and objectives of financial statement analysis
& explain the need for financial statement analysis
& define, calculate and interpret the following ratios:
Ð return on equity
Ð return on total assets
Ð gross profit percentage
Ð profit margin
Ð financial leverage and leverage effect
Ð current ratio
Ð acid test ratio
Ð trade receivables collection period
Ð trade payables settlement period
Ð inventory turnover rate
Ð inventory holding period
Ð debt-equity ratio
Ð times interest earned ratio
& discuss the limitations of financial statement analysis
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Key concepts
& Financial statement analysis
& Ratio analysis
& Profitability ratios
& Liquidity ratios
& Solvency ratios
& Limitations of financial statement analysis
189
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8.1 Introduction
Financial statements summarise the financial performance and financial position of an entity for
a period in the past. For the information to be useful to the various users of the statements,
various formulas are used to analyse and interpret it.
Read through paragraph 8.1 in the prescribed textbook to familiarise yourself with the
background on financial statement analysis.
8.2 The nature and scope of financial statement analysis
Read through paragraph 8.2 in the prescribed textbook about the nature and scope of financial
statement analysis.
8.3 The objective of financial statement analysis
The main objective of financial statement analysis is to assess the entity's performance and
financial position in relation to risk. The information gathered from the analysis of the financial
statements can be used to pinpoint areas that require further investigation and to plan for the
future.
Read through paragraph 8.3 of the prescribed textbook about the objective of financial
statement analysis.
8.4 The application of financial statement analysis
Ratios are classified according to the information they provide. The following ratios are dealt
with in this module:
. Profitability ratios
. Liquidity ratios, and
. Solvency ratios
provide several different measures of the success of an entity in generating

Profitability ratios
comprehensive income. In this course, the following ratios are used to measure the profitability
of an entity:
. The return on equity measures how profitable the investment of capital is for the owners of
the entity.
. The return on total assetsis a measure of how effectively an entity's assets are being used
to generate comprehensive income.
. The gross profit percentage is a measure of the gross profit earned on sales. The gross
profit margin considers the entity's cost of goods sold, but does not include any selling
costs.
. The profit margin measures how much comprehensive income an entity makes for every
Rand it generates in revenue.
. The financial leverageand leverage effect are measures of the extent to which an entity
benefits from of the use of debt in contrast to equity.
Study paragraph 8.4.1 in the prescribed textbook and pay particular attention to the definition of
the different types of profitability ratios and the way in which they are calculated and
interpretated.
Liquidity ratios provide information about the entity's ability to meet its short-term (current)
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financial obligations with its current assets as they become due. These ratios are of particular
interest to those extending short-term credit to an entity. In this course the following ratios are
used to measure the liquidity position of an entity:
. The current ratio contrasts current assets with current liabilities in order to assess the extent
to which current liabilities are covered by current assets.
. The acid ratio has the same objective as the current ratio but the ratio excludes
test
inventories.
. The trade receivables period measures the time period for which accounts
collection
receivable are outstanding.

. The trade payables settlement period measures how long it takes an entity to settle its
creditors.
. The aim of the is to assess whether an entity is investing too much in
inventory turnover rate
inventories.
. The inventory holding period measures the number of days it takes an entity to convert
invertory into sales.
Study paragraph 8.4.2 in the prescribed textbook and pay particular attention to the definitions
of the different types of liquidity ratios and the way in which they are calculated and
interpretated.
Solvency ratios measure the extent to which an entity is able to meet its long term obligations
and remain solvent. An entity's financing is obtained from equity and the borrowing of money.
The greater the proportion of the loans (debt) in relation to the equity, the greater the risk will be
for the entity and the financier.
In this course, we use the following ratios to measure the solvency of an entity:
. The debt-equity measures the proportion of equity and debt used by the entity to
ratio
finance its assets.

. The measures the ability of the entity to generate comprehensive
times interest earned ratio
income to cover the interest obligations on outstanding debt. This ratio is also known as the
interest coverage ratio.
Study paragraph 8.4.3 in the prescribed textbook. Focus on the definitions of the different types
of solvency ratios and the way in which they are calculated and interpretated.
8.5 The limitations of financial statement analysis
It is important to take note of the limitations of financial statement analysis when the information
is used for decision making purposes.
Study paragraph 8.5 in the prescribed textbook. Can you think of any other limitations of
financial statement analysis and why it should be used with caution when making predictions?
Work through example 8.1. Note how the different ratios are calculated and interpreted. In
conclusion, read the summary in paragraph 8.6 of the prescribed textbook.
8.6 Exercise and solution
Exercise 8.1
Analysis and interpretation of financial statements
Work through the exercise, noting how the different ratios are calculated and the very basic
interpretation of the ratios when comparing them with those for the previous year.
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Given information
The following information pertains to Golden Arrow CC:
GOLDEN ARROW CC
20.1 20.0
R R
Revenue 360 000 307 500
Cost of sales (270 000) (225 000)
Inventory (1 March 20.0) 66 000 58 000
Purchases 273 000 233 000
339 000 291 000
Inventory (28 February 20.1) (69 000) (66 000)
Other income 1 000 1 000
Interest income: Loans and receivables: Fixed deposit 1 000 1 000
91 000 83 500
Administration expenses 45 000 43 000
Remuneration: Accounting officer 15 000 10 000
Finance costs (15 000) (10 000)
Interest on long-term loan 15 000 10 000
GOLDEN ARROW CC
ENDED 28 FEBRUARY 20.1
Members' Retained
contributions earnings Total
R R R
Balances as at 1 March 20.0 100 000 19 000 119 000
Balances as at 28 February 20.1 123 000 24 000 147 000
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GOLDEN ARROW CC
20.1 20.0
R R
ASSETS
Financial assets (Loans and receivables) 8 000 8 000
Trade receivables (Trade debtors) 68 000 57 000
Total assets 252 000 223 000
Total equity 147 000 119 000
Members' contribution 123 000 100 000
Trade and other payables (Trade creditors) 41 000 36 000
Other financial liabilities (Bank overdraft) 14 000 18 000
1 R270 000 of the 20.0 and R330 000 of the 20.1 sales were on credit.
2 All the purchases for both years were on credit.
3 The financial asset consists of a fixed deposit at the Second National Bank at 12,5%
interest per annum. The money was invested on 1 March 19.9 for a five-year period.
4 Trade debtors amounted to R55 000 in 19.9 and trade creditors to R34 000 in 19.9.
5 The closing balance of the inventory account amounted to R63 000 in 19.9.
REQUIRED
As a potential investor determine the profitability, liquidity and solvency position of
Golden Arrow CC.
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Solution 8.1
1 Profitability
Return on equity:
20.1 20.0
Profit before tax R7 000 x 100 R12 500 x 100
x 100 =
Total equity R147 000 R119 000
= 4,76% 10,50%
There is a remarkable deterioration in the return on equity in 20.1 of 5,74% (10,5 ± 4,76%).
Return on total assets:
Profit before interest and tax

x 100 =
R22 000 1 x 100 R22 500 1 x 100
Total assets R252 000 R223 000
= 8,73% 10,09%
Profit before interest

1
R R
Interest expense 15 000 10 000
22 000 22 500
There was a deterioration in the return on assets of 1,36% (10,09% ± 8,73%) in 20.1.
Gross profit percentage:
Gross profit = R90 000 x 100 R82 500 x 100

x 100
Sales R360 000 R307 500
= 25,00% 26,83%
The gross profit margin deteriorated by 1,83% (26,83% ± 25,00%) in 20.1 which is one of
the reasons why the other profitability ratios deteriorated.
Profit margin:
Profit before tax = R7 000 x 100 R12 500 x 100
x 100
Sales R360 000 R307 500
= 1,94% 4,07%
The profit margin deteriorated by 2,13% (4,07 ± 1,94%) which can be attributed to an
increase in expenses and the decrease in the gross profit percentage.
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Financial leverage:
20.1 20.0
Return on equity: Return on assets 4,76 : 8,73 10,50 : 10,09
0,54 : 1 1,04 : 1
[OR] [OR]
Return on equity 4,76% 10,50%

Return on assets 8,73% 10,09%
= 0,55 1,04
The financial leverage declined to a very low level in 20.1, which is an indication of
inefficient use of borrowed funds during the year.
Leverage effect:
20.1 20.0
Return on equity (4,76%) 10,50%
Less: Return on assets (8,73)% (10,09)%
(3,97)% 0,41%)
The members of the corporation received a negative return of 3,97% on their investment in
20.1 indicating that the borrowed money was not effectively used. The situation was better
in 20.0 because a positive return of 0,41% was received.
2 Liquidity
Current ratio: 20.1 20.0
Current assets = R137 000 R123 000
Current liabilities R 55 000 R 54 000
= 2,49 : 1 2,27 : 1
The current ratio of Golden Arrow CC indicates a healthy liquidity position. However, it is
increasing and is higher than the standard of 2:1, thus indicating a larger than necessary
investment in current assets.
20.1 20.0
Acid test ratio:
Current assets less inventory = R(137 000 ± 69 000) R(123 000 ± 66 000)
Current liabilities R55 000 R54 000
= 1,24 : 1 1,06 : 1
The acid test ratio of Golden Arrow CC is good although it is higher than the standard of
1:1, which indicates that the CC's investment in current assets is higher than necessary.
Trade receivables collection period: 20.1 20.0

Average trade receivables x 365 = R62 500 1 x 365 R56 000 2 x 365
Credit sales R330 000 R270 000
= 69,13 days 75,70 days
Average trade receivables 20.1 R(68 000 + 57 000) = R125 000 7 2 = R62 500.
1
Average trade receivables 20.0 R(57 000 + 55 000) = R112 000 7 2 = R56 000.
2
The collection period improved from 75,70 days in 20.0 to 69,13 days in 20.1. Debtors paid
their accounts 6,57 days earlier in 20.1 compared with 20.0.
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Trade payables payment period: 20.1 20.0
Average trade payables x 365 = R38 500 1 x 365 R35 000 2 x 365
Credit purchases R273 000 R233 000
= 51,47 days 54,83 days
Average trade payables 20.1 R(41 000 + 36 000) = R77 000 7 2 = R38 500.
1
Average trade payables 20.0 R(36 000 + 34 000) = R70 000 7 2 = R35 000.
2
Golden Arrow CC settled the accounts of creditors in 51,47 days in 20.1 and in 54,83 days in
20.0. This is 3,36 days earlier in 20.1. Comparing this information with the trade receivables
collection period, the CC settled the creditors accounts before they received payment from the
debtors. This could have a negative effect on an entity's cash flow and is one of the reasons
why the acid test ratio revealed a higher than necessary investment in current assets.
Inventory turnover rate: 20.1 20.0

Cost of sales = R270 000 R225 000
Average inventory R67 500 1 R64 500 2
= 4 times 3.49 times
Average inventory 20.1 R(69 000 + 66 000) = R135 000 7 2 = R67 500.
1
Average inventory 20.0 R(66 000 + 63 000) = R129 000 7 2 = R64 500.
2
Golden Arrow CC improved the inventory turnover rate from 20.0 to 20.1. Improvement in the
inventory turnover rate is generally associated with good management of inventory which
usually leads to the saving of cost associated with keeping inventory for longer periods.
Inventory holding period: 20.1 20.0
Average inventory x 365 = R67 500 x 365
1
R64 500 x 365
2
Cost of sales R270 000 R225 000

= 91,25 days 104,63 days
and Refer previous calculations.

1 2
The inventory holding period indicates the number of days that inventory is on hand Ð in
other words, how long it takes an entity to sell inventory purchased. Golden Arrow CC
recorded a decrease in the number of days it keeps its inventory. This can be interpreted
as an improvement in the management of inventory by the entity.
3 Solvency
Debt-equity ratio:
20.1 20.0
Total debt x 100 = R105 000 x 100 R104 000 x 100
Total equity R147 000 R119 000
= 71,43% 87,39%
The level of debt in the entity's financial structure decreased from 87,39% in 20.0 to
71,43% in 20.1. A high level of debt-equity ratio generally means that an entity has been
aggressive in financing its growth with debt.
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Times interest earned ratio: 20.1 20.0
Profit before interest and tax = R22 000 R22 500
Finance costs R15 000 R10 000
= 1,47 times 2,25 times
The number of times profit generated was able to cover the interest payment on its debt,
decreased from 2,25 times in 20.0 to 1,47 times in 20.1, which confirms the CC's poor
profitability during the year.
Taking this basic analysis into account would you invest in Golden Arrow CC?
SELF-ASSESSMENT
After having worked through this study unit
Yes No
. are you able to discuss the nature, scope and objectives of financial
statement analysis?
. do you understand the need for financial statement analysis?
. are you able to define, calculate and interpret the following ratios?
Ð return on equity
Ð return on total assets
Ð gross profit percentage
Ð profit margin
Ð financial leverage and leverage effect
Ð current ratio
Ð acid test ratio
Ð trade receivables collection period
Ð trade payables settlement period
Ð inventory turnover rate
Ð inventory holding period
Ð debt-equity ratio
Ð times interest earned ratio
. are you able to discuss the limitations of financial statement

analysis?
If you answered ``yes'' to all the above assessment criteria, you have completed your
studies on the analysis and interpretation of financial statements. If your answer was
``no'' revise that section before proceeding to the next study unit.
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9
STUDY UNIT
Branches
CONTENTS

Key concepts 199
9.2 Accounting for dependent branches 200
9.3 Recording of transactions where inventory sent to the branch is invoiced
by the head office at cost price 200
9.4 Recording of transactions where inventory sent to the branch is invoiced
by the head office at selling price 200
Self-assessment 220
Learning outcomes
& explain the concept of branches
& briefly explain the difference between dependent and independent branches
& identify the information to be included in the reports submitted by a dependent branch to
the head office
& record the transactions between a head office and a dependent branch in the books of the
head office where inventory sent to the branch is invoiced at cost price
& record the transactions between a head office and a dependent branch in the books of the
head office where inventory sent to the branch is invoiced at selling price
& record the transactions of a dependent branch pertaining to the following where inventory is
invoiced at cost price or at selling price:
Ð purchases of inventory by the branch
Ð sales of inventory by the branch
Ð inventory damaged or stolen at the branch
Ð inventory sold by the branch at a discount
Ð inter-branch inventory transactions
Ð settlement discount granted to debtors of the branch
Ð donations made by the branch
Ð cash embezzled at the branch
Ð inventory in transit between the branch and the head office
& identify and record a shortage or surplus in the inventory of a branch where inventory is
invoiced by the head office at selling price
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Key concepts
& Head office
& Dependent branches
& Branch inventory
& Inventory to branch
& Branch adjustments
& Branch gross profit (or loss)
& Branch profit (or loss)
& Inventory transactions
& Other branch transactions
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9.1 Introduction
A business entity can establish a branch (or branches) which is geographically separated from
the central (main) enterprise, but which still forms part of the business entity. One of the
reasons why business entities establish branches is to broaden their markets. Thereby
increasing their potential revenues so as, ultimately, to maximise their profitability. Branches
can be managed as dependent or independent entities, each with its own distinct accounting
requirements. In this module only dependent branches are addressed.
Read through paragraph 9.1 in the prescribed textbook for an introductory discussion on branches.
9.2 Accounting for dependent branches
The head office of a dependent branch is responsible for supplying inventory to the branch,
and for recording all of the accounting transactions of the branch in its books (that is, the books
of the head office). The head office can invoice inventory to the branch at either cost or selling
price. Each method of invoicing requires a different accounting recording procedure. A branch
may also purchase inventory from other suppliers. Usually, the head office of a dependent
branch is responsible for the payment of the major expenses of the branch. The head office
may also decide to provide the branch with petty cash for the payment of minor expenses that
are incurred by the branch.
Since the activities of a dependent branch are recorded in the books of its head office, a
dependent branch is usually required to submit a report to the head office in respect of the
transactions that have occurred at the branch over a given financial period.
Study paragraph 9.2 in the prescribed textbook.
9.3 Recording of transactions where inventory sent to the
branch is invoiced by the head office at cost price
When this method of bookkeeping is followed, two accounts must be opened in the books of
the head office, namely:
. a branch inventory account, and
. an inventory to branch account
These accounts are concerned specifically with the recording of transactions that pertain to the
inventory of the branch. The other business activities of a branch are recorded in other
accounts in the books of the head office, for example, a branch debtors control account, a
branch asset account or a branch expenses account.
Paragraph 9.3 of the prescribed textbook discusses the recording of transactions where
inventory was invoiced at cost price in detail. Study this paragraph, and make sure that you
understand each of the examples included therein.
9.4 Recording of transactions where inventory sent to the
branch is invoiced by the head office at selling price
When inventory is invoiced to the branch at selling price, the branch inventory account will not
reflect the gross profit of the branch, as was the case when the inventory was invoiced to the
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branch at cost price. An additional account, namely a ``branch adjustment account'', is required
to reflect the gross profit. The branch inventory account (at selling price) functions as an
inventory control account.
The recording of all inventory transactions in the branch inventory account (at selling price) is
done at selling price. Each selling price is divided into two amounts, namely the cost price and
the profit mark-up of the inventory. These two amounts are disclosed separately in the branch
inventory account (at selling price), and must add up to the selling price. The reason for this
separate disclosure in the branch inventory account is that the entries pertaining to the cost
price and the entries pertaining to the profit mark-up have different contra accounts. For
example, when inventory that is sent to the branch is recorded (assume a cost of R100 and a
mark-up of R50), the branch inventory account is debited (separately) with the cost price
(R100) and the profit mark-up thereof (R50) against different contra accounts, namely the
inventory to branch account (R100) and the branch adjustment account (R50), respectively.
The inventory to branch account is credited with the cost price (R100), and the branch
adjustment account is credited with the profit mark-up (R50). The branch inventory account
was debited with R150 (in total).
Study paragraph 9.4.1 of the prescribed textbook.
The calculation of the profit mark-up in branch inventory is discussed in paragraph 9.4.2 of the
prescribed textbook. Study this paragraph and ensure that you can calculate the profit mark-up
and the selling price when given the cost price, and that you can calculate the profit mark-up
and the cost price when given the selling price.
Paragraphs 9.4.3 to 9.4.13 of the prescribed textbook discuss the recording of transactions
where inventory was invoiced at selling price. Study these paragraphs, and make sure that you
understand each of the examples included therein.
Exercise 9.1
Preparation of general ledger accounts in the books of head office
in respect of a branch where inventory is invoiced to the branch at
cost price
Work through the exercise. Take note that the gross profit is the balancing figure in the branch
inventory account (at cost).
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Given information
The following information pertains to the head office and branch of Boom CC:
Transactions during the year ended 31 December 20.1 R
Inventory sent to branch 4 800
Inventory returned to head office by the branch 80
Sales by branch for the year: cash 2 000
credit 3 290
Cash received from branch debtors and paid into the head office
bank account 2 890
Sundry expenses paid by head office 600
1 The branch began trading on 2 January 20.1 and inventory is invoiced to the branch at
cost price.
2 An amount of R50 must be written off as a credit loss.
3 Discount on selling prices granted to clients in respect of cash sales amounted to R30.
4 Inventory at 31 December 20.1 amounted to R480.
REQUIRED
Prepare the following accounts properly balanced/closed off, in the general ledger of the
head office for the year ended 31 December 20.1:
(a) Branch inventory account
(b) Inventory to branch account
(c) Branch debtors control account
(d) Branch expenses account
(e) Bank account (partly)
Solution 9.1
BOOM CC (HEAD OFFICE)

GENERAL LEDGER
(a)
Dr Branch inventory (at cost price) Cr
20.1 R 20.1 R
Dec 31 Inventory to branch Dec 31 Inventory to branch

(Deliveries at cost) 4 800 (Returns at cost) 80
Branch expenses Bank (Cash sales) 2 000
(Branch gross profit for Branch debtors control
the year*) 1 050 (Credit sales) 3 290
Balance c/d
(Closing inventory) 480
5 850 5 850
20.2
Jan 1 Balance b/d
(Opening inventory) 480
* Balancing entry
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(b)
Dr Inventory to branch (at cost price) Cr
20.1 R 20.1 R
Dec 31 Branch inventory Dec 31 Branch inventory

(Returns at cost) 80 (Deliveries at cost) 4 800
Head office: Trading
account* 4 720
4 800 4 800
* Balancing entry
(c)
Dr Branch debtors control Cr
20.1 R 20.1 R
Dec 31 Branch inventory Dec 31 Bank (Collections depos-

(Credit sales) 3 290 ited by branch) 2 890
Branch expenses
(Credit losses) 50
Balance c/d 350
3 290 3 290
20.2
Jan 1 Balance b/d 350
(d)
Dr Branch expenses Cr
20.1 R 20.1 R
Dec 31 Bank Dec 31 Branch inventory

(Sundry expenses) 600 (Branch gross profit for
Branch debtors control the year) 1 050
(Credit losses) 50
Head office: Profit or loss
(Branch profit for the
year*) 400
1 050 1 050
* Balancing entry
(e)
Dr Bank (extract) Cr
20.1 R 20.1 R
Dec 31 Branch debtors control Dec 31 Branch expenses

(Collections deposited (Sundry expenses) 600
by branch) 2 890
Branch inventory
(Cash sales) 2 000
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Comment
. The cash discount on sales of R30 will not be recorded, because the cash sales of R2 000
already excludes this amount.
. Only cash transactions with the branch are shown in the bank account. In practice the bank
account will contain the cash transactions of the branch as well as those of the head office.
. In the above solution we see that the branch inventory is brought down as a balance in the
branch inventory account at the end of the financial period. The balances of the branch
debtors control and the branch asset accounts are added to the head office balances and
disclosed as a total amount in the statement of financial position.
Exercises 9.2 to 9.5 pertain to situations where inventory is invoiced at selling price. Take note
that the gross profit of the branch is not calculated as the balancing figure in the branch
inventory account (at selling price). Since the branch inventory account (at selling price)
functions as an inventory control account, the balancing figure in the branch inventory account
(at selling price) reflects either an inventory surplus or a shortage.
Exercise 9.2
selling price
Given information
The following information pertains to the head office and branch of Check CC:
Transactions during the year ended 31 December 20.2 R
Inventory sent to branch (cost price) 4 800
Inventory returned to head office by the branch (cost price) 80
Sales by branch for the year: cash 2 000
credit 3 290
Cash received from branch debtors and paid into the head office
bank account 2 890
Sundry expenses paid by head office 600
1 The branch commenced business on 2 January 20.2 and goods are invoiced to the branch
at selling price, which is cost plus 25%.
2 After consulting the branch manager, it was decided to write off an amount of R50 as
irrecoverable.
3 Discount on selling prices granted to clients in respect of cash sales amounted to R30.
4 Inventory at 31 December 20.2 (cost price) amounted to R480.
REQUIRED
(c) Branch adjustment account
(d) Branch debtors control account
(e) Branch expenses account
(f) Bank account
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Solution 9.2
CHECK CC (HEAD OFFICE)

GENERAL LEDGER
(a)
Dr Branch inventory (at selling price) Cr
20.2 R 20.2 R
Dec 31 Inventory to branch Dec 31 Inventory to branch

(Deliveries at cost) 4 800 (Returns at cost) 80
Branch adjustment Branch adjustment
(Mark-up on deliveries)
1 1 200 (Mark-up on returns) 2 20
Branch adjustment Branch adjustment
(Inventory surplus*) 20 (Discount on cash sales) 30
Bank (Cash sales) 2 000
Branch debtors control
(Credit sales) 3 290
Balance c/d
(Closing inventory) 600
R(480 + 120) 3
6 020 6 020
20.3
Jan 1 Balance b/d
(Opening inventory) 600
* Balancing entry
(b)
Dr Inventory to branch (at cost price) Cr
20.2 R 20.2 R

(Returns at cost) 80 (Deliveries at cost) 4 800
Head office: Trading
account* 4 720
4 800 4 800
* Balancing entry
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(c)
Dr Branch adjustment Cr
20.2 R 20.2 R

(Mark-up on returns) 2 20 (Mark-up on deliveries)
1 1 200
Branch inventory Branch inventory
(Discount on sales) 30 (Inventory surplus) 20
Balance c/d
(Mark-up on closing

inventory) 3 120
Branch expenses
(Branch gross profit
for the year*) 1 050
1 220 1 220
20.3
Jan 1 Balance b/d
(Mark-up on opening
inventory) 120
* Balancing entry
(d)
Dr Branch debtors control Cr
20.2 R 20.2 R
Dec 31 Branch inventory Dec 31 Bank (Collections

(Credit sales) 3 290 deposited by branch) 2 890
Branch expenses
(Credit losses) 50
Balance c/d 350
3 290 3 290
20.3
Jan 1 Balance b/d 350
(e)
20.2 R 20.2 R
Dec 31 Bank: Dec 31 Branch adjustment

(Sundry expenses) 600 (Branch gross profit for
Branch debtors control the year) 1 050
(Credit losses) 50
(Branch profit for the
year*) 400
1 050 1 050
* Balancing entry
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(f)
Dr Bank (extract) Cr
20.2 R 20.2 R
Dec 31 Branch debtors control Dec 31 Branch expenses

(Collections deposited (Sundry expenses) 600
by the branch) 2 890
Branch inventory
(Cash sales) 2 000
Comments
. A cash discount on sales is referred to in the prescribed textbook as amark-down on sales.

Both these words are accepted as correct.
. The inventory surplus is the balancing entry in the branch inventory account.
. The gross profit is calculated in the branch adjustment account, contrary to where inventory
is supplied at cost.
. The inventory to branch account, the branch debtors control account, the branch expenses
account and the bank account remain unchanged. Refer to exercise 9.1 where the same
information was used, except that inventory is supplied to the branch at cost.
. Take note that the same branch gross profit (R1 050) and branch profit (R400) was
calculated, regardless of whether the inventory was supplied at cost or at selling price.
. To convert the inventory of the branch to cost price, the balance of the branch adjustment
account must be deducted from the balance on the branch inventory account (R600 ±
R120). In the statement of financial position the inventory of the branch is added to the
inventory of the head office at cost (R480).
. The closing inventory at 31 December 20.2 is the opening inventory at 1 January 20.3.
Calculations

1 Profit mark-up on inventory sent to branch
%
Cost 100
Profit mark-up 25
Selling price 125
Mark-up on deliveries = R 4 800 x 25¤100 = R1 200.

Comment: Take note that the cost price of the inventory was given.

2 Profit mark-up on returns
R80 x 25¤100 = R20

3 Profit mark-up on closing inventory
R480 x 25¤100 = R120
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Exercise 9.3
selling price
Given information
The following information pertains to the head office and the branch of Pama CC:
Transactions for the year ended 31 December 20.3 R
Inventory sent to branch (selling price) 18 750
Cash sales (deposited in bank) 17 918
Returns to head office (selling price) 186
Sundry expenses paid by head office 4 760
1 All purchases are made by head office and all goods required by the branch are supplied
by head office at selling price, that is cost price plus 50%.
2 A burglary took place during the year and R55 in cash (cash sales) and inventory to the
value of R36 (selling price) were stolen, but no entries were made in the books.
3 The net proceeds of the annual sale amounted to R360. Inventory was sold at selling price
less 10% and no entries were made in the books concerning this price reduction.
4 Inventory invoiced to the branch at R75 (included in the amount of R18 750 above) were
still in transit at 31 December 20.3 and were therefore not included in the branch's
inventory at 31 December 20.3.
5 Inventory at selling price: R
31 December 20.2 1 500
31 December 20.3 1 950
REQUIRED
(c) Branch adjustment account
(d) Branch expenses account
NB: The date columns of the accounts are not required.
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Solution 9.3
PAMA CC (HEAD OFFICE)

GENERAL LEDGER
(a)
Dr Branch inventory Cr
R R
Balance b/d Bank (Sales) 17 918
(Opening inventory) 1 500 Inventory to branch
Inventory to branch
(Returns at cost) 3 124

(Deliveries at cost) 1 12 500 Branch adjustment
Branch adjustment (Mark-up on returns) 4 62
(Mark-up on deliveries) 2 6 250 Branch expenses
Branch adjustment (Cash stolen) 55
(Inventory surplus*) 10 (Inventory stolen at cost) 5 24
Branch adjustment
(Mark-up on inventory stolen)
6 12
Branch adjustment
(Discount on sales) 7 40
Balance c/d
(Inventory in transit) 75
(Closing inventory) 1 950
20 260 20 260
Balance b/d
(Inventory in transit) 75
(Opening inventory) 1 950
* Balancing entry
(b)
Dr Inventory to branch Cr
R R
(Returns at cost) 3 124 (Deliveries at cost)
1 12 500
Head office: Trading account* 12 376
12 500 12 500
* Balancing entry
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(c)
R R
Branch inventory Balance b/d
(Mark-up on returns) 4 62 (Mark-up on opening inven-
Branch inventory
tory) 10 500

(Mark-up on inventory stolen) 6 12 Branch inventory
Branch inventory
(Mark-up on deliveries) 2 6 250
(Discount on sales) 7 40 Branch inventory
Balance c/d (Inventory surplus) 10
(Mark-up on inventory returned) 8 25

(Mark-up on closing inventory) 9 650
Branch expenses
(Branch gross profit for the year*) 5 971
6 760 6 760
Balance b/d
(Mark-up on inventory in

transit) 8 25
(Mark-up on opening inven-

tory) 9 650
* Balancing entry
(d)
R R
Sundry expenses (paid by head Branch adjustment
office) 4 760 (Branch gross profit for the
Branch inventory year) 5 971
(Cash stolen) 55
Branch inventory
(Inventory stolen) 5 24
(Branch profit for the year*) 1 132
5 971 5 971
* Balancing entry
Calculations

1 Cost of inventory sent to branch
%
Cost 100
Profit mark-up 50
Selling price 150
Deliveries at cost = R18 750 x 100¤150 = R12 500.

Comment: Take note that the selling price was given.
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2 Profit mark-up on deliveries
R18 750 x 50¤150 = R6 250

3 Cost of returns to head office
100
R186 x ¤150 = R124

4 Profit mark-up on returns to head office
R186 x 50¤150 = R62

5 Cost of inventory stolen
R36 x 100¤150 = R24

6 Profit mark-up on inventory stolen
R36 x 50¤150 = R12

7 Discount on sale
R360 = 90% of original selling price
R360 100
Original selling price = x
1 90
= R400
Discount = R(400 ± 360) = R40
or
%
Cost price 100
Profit mark-up 50
Original selling price 150
Mark-down (10% x 150) (15)
Sold at 135
Original selling price

R360 x 150¤135 = R400
Mark-down on the original selling price
R(400 ± 360) = R40
or
R400 x 15¤150 = R40

8 Profit mark-up on closing inventory in transit
R75 x 50¤150 = R25

R1 950 x 50¤150 = R650

10 Profit mark-up on opening inventory
R1 500 x 50¤150 = R500
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Exercise 9.4
selling price
Given information
The following information pertains to the head office and the Bloemfontein branch of Hope CC:
Transactions for the year ended 28 February 20.5 R

Settlement discount granted to debtors
Ð Head office 700
Ð Branch 180
Credit losses recovered
Ð Head office 140
Ð Branch 60
Inventory to branch (at selling price) 102 000
Sales (cash)
Ð Head office 215 000
Ð Branch 93 750
Purchases 180 000
Sundry selling and administrative expenses
Ð Head office 51 200
Ð Branch 13 100
Returns from branch (at selling price) 2 000
1 All purchases are made by the head office and supplied to the branch at cost price plus
25%.
2 Inventory at:
Head office Branch
(at cost) (at selling price)
R R
28 February 20.4 20 000 15 000
28 February 20.5 25 000 16 000
3 Inventory returned by the branch to the head office, in transit at 28 February 20.5,
amounted to R4 000 (selling price).
4 R150 cash was embezzled by the cashier at the branch by altering sales invoices. This
figure has not yet been recorded in the books.
5 During the year a burglary took place at the branch and inventory at a cost price of R120
was stolen. Included in the branch sales is an amount of R110 which was received from
an insurance company in full settlement of the company's claim regarding the theft.
6 The branch's annual sale took place in January 20.5 and inventory was sold at selling
price less 10%. The total proceeds of the sale amounted to R9 000, which was included in
the sales amount.
7 All the branch expenses are paid by the head office.
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REQUIRED
head office for the year ended 28 February 20.5:
(b) Branch adjustment account
(c) Branch expenses account
Solution 9.4
HOPE CC (HEAD OFFICE)

GENERAL LEDGER
(a)
R R
Balance b/d Bank (cash sales)

3 93 640
(Opening inventory) 15 000 Inventory to branch
Inventory to branch
(Returns at cost) 4 1 600

(Deliveries at cost) 1 81 600 Branch adjustment
Branch adjustment (Mark-up on returns) 5 400
(Mark-up on deliveries)
2 20 400 Branch expenses
(Cash embezzled) 150

(Inventory stolen at cost) 6 120
Branch adjustment
(Mark-up on inventory stolen) 7 30
Branch adjustment
(Discount on sales) 8 1 000
Inventory to branch
(Inventory returned at cost) 9 3 200
Branch adjustment
Branch adjustment
(Inventory shortage*) 60
Balance c/d
117 000 117 000
Balance b/d
* Balancing entry
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(b)
R R

(Mark-up on returns) 5 400 (Mark-up on opening inventory)
10 3 000
(Mark-up on inventory stolen) 7 30 (Mark-up on deliveries) 2 20 400
Branch inventory
(Discount on sales) 8 1 000
Branch inventory
Branch inventory
(Inventory shortage) 60
Settlement discount granted 180
Balance c/d
(Mark-up on closing inventory) 11 3 200
Branch expenses
23 400 23 400
Balance b/d
(Mark-up on opening inventory) 3 200
* Balancing entry
Comment:
Refer to example 9.17, in the prescribed textbook, with regard to the closing off procedure of
the settlement discount granted account.
(c)
R R
Branch inventory Branch adjustment

(Cash embezzled) 150 (Branch gross profit for the year) 17 730
Branch inventory Credit losses recovered 60
(Inventory stolen) 6 120 Bank (proceeds from insurance
Selling and administrative
claim) 6 110
expenses 13 100
17 900 17 900
* Balancing entry
Calculations

%
Cost 100
Profit mark-up 25
Selling price 125
100
R102 000 x ¤125 = R81 600
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2 Profit mark-up on inventory sent to branch
R102 000 x 25¤125 = R20 400
R

3 Cash sales
Sales 93 750
Payment received from insurance company (110)
93 640

4 Cost of returns from branch
R2 000 x 100¤125 = R1 600

5 Profit mark-up on returns from branch
R2 000 x 25¤125 = R400

6 Inventory stolen at cost 120
Proceeds from insurance plan (110)
10

R120 x 25¤100 = R30

8 Discount on sales
Proceeds of R9 000 are equal to 90% of the original selling price, thus
Original selling price =
R9 000 100
1
x
90
(or R9 000 7
0,9)
= R10 000
Discount = R(10 000 ± 9 000)
= R1 000
or
%
Cost price 100
Profit mark-up 25
Original selling price 125
Mark-down (10% 6 125) 12,5
Sold at 112,5
Original selling price R9 000 x 125¤112,5 = R10 000

Mark-down on the original selling price R(10 000 ± 9 000) = R1 000
or
R10 000 x 12,5¤125 = R1 000

9 Markup on inventory returned (in transit)
Cost price = R4 000 x 100¤125 = R3 200
Mark-up = R4 000 x 25¤125 = R800
The inventory in transit from the branch to head office (cost price, R3 200) was debited to
the inventory to branch account and will be disclosed as part of the closing inventory of the
head office.

R15 000 x 25¤125 = R3 000

R16 000 x 25¤125 = R3 200
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Exercise 9.5
Preparation of general ledger accounts is in the books of head
office in respect of a branch where inventory is invoiced to the
branch at selling price
Given information
The following information pertains to the head office and branch of Sucro Confectionary CC:
Transactions during the year ended 28 February 20.2 R
Inventory to branch at selling price 64 500
Inventory returned to head office at selling price 1 800
Cash sales of branch embezzled by cashier 375
Administrative expenses of branch paid by head office 5 000
Discount granted to branch debtors for early settlement 150
Cash sales by branch (after deducting local purchases
Ð cost price R500) 41 500
Credit sales of branch 20 000
Rent of branch paid by head office 1 800
Inventory damaged Ð selling price 300
Credit losses of branch written off 50
1 Inventory was supplied to the branch by head office at selling price, ie at cost price
plus 50%.
2 Inventory at selling price at:
28 February 20.1 Ð R4 500
28 February 20.2 Ð R4 800
3 It is estimated that theft of inventory amounting to R360 (selling price) occurred during the
year. This amount must be taken into account during inventory reconciliations.
4 During the year the branch donated inventory (cost R60) towards a local charity fund-
raising campaign.
5 Inventory purchased locally was also sold at cost price plus 50%.
REQUIRED
head office for the year ended 28 February 20.2:
(b) Branch adjustment account
(c) Branch expenses account
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Solution 9.5
SUCRO CONFECTIONERY CC (HEAD OFFICE)

GENERAL LEDGER
(a)
R R
Balance b/d Inventory to branch
(Returns at cost) 4 1 200
Inventory to branch Branch adjustment

(Deliveries at cost) 1 43 000
(Mark-up on returns) 5 600
Branch adjustment Branch expenses

(Mark-up on deliveries) 2 21 500 (Cash embezzled) 375
Bank (Local purchases) 500
Bank (Cash sales) 6 42 000
Branch adjustment Branch debtors control

(Mark-up on local purchases) 3 250 (Credit sales) 20 000
Branch expenses

(Cost of inventory damaged) 7 200
Branch adjustment
(Mark-up on inventory damaged) 8 100
Branch expenses

(Cost of inventory stolen) 9 240
Branch adjustment

(Mark-up on inventory stolen) 10 120
Branch expenses
(Inventory donated at cost) 60
Branch adjustment

(Mark-up on inventory donated) 11 30
Branch adjustment
(Inventory shortage*) 25
Balance c/d
69 750 69 750
Balance b/d
* Balancing entry
217
FAC1601/1
(b)
R R
(Mark-up on returns) 5 600
(Mark-up on opening inventory) 12 1 500
(Mark-up on inventory damaged) 8 100
(Mark-up on deliveries) 2 21 500
(Mark-up on inventory stolen) 10 120 (Mark-up on local purchases) 3 250
Branch inventory

(Mark-up on inventory donated) 11 30
Settlement discount granted 150
Branch inventory
(Inventory shortage) 25
Balance c/d

(Mark-up on closing inventory) 13 1 600
Branch expenses
23 250 23 250
Balance b/d
(Mark-up on opening inventory) 1 600
* Balancing entry
(c)
R R
Branch inventory Branch adjustment
(Cash sales embezzled) 375 (Branch gross profit for the
Administrative expenses 5 000 year) 20 625
Rent expense 1 800
Branch inventory
(Inventory damaged) 7 200
Credit losses 50
Branch inventory 240

(Inventory stolen) 9
Branch inventory
(Inventory donated) 60
20 625 20 625
* Balancing entry
218
FAC1601/1
Calculations

%
Cost 100
Profit mark-up 50
Selling price 150
100
Deliveries at cost R64 500 x ¤150 = R43 000

2 Profit mark-up of inventory sent to branch
R64 500 x 50¤150 = R21 500

3 Profit mark-up on local purchases
R500 x 50¤100 = R250

4 Cost of returns from branch
R1 800 x 100¤150 = R1 200

5 Profit mark-up on returns from branch
R1 800 x 50¤150 = R600

6 Bank (Cash sales)
R
Cash sales by branch (after deduction of R500) 41 500
Cash used for local purchases 500
Total cash sales 42 000

7 Cost of inventory damaged
100
R300 x ¤150 = R200

8 Profit mark-up on inventory damaged
R300 x 50¤150 = R100

9 Cost of inventory stolen
100
R360 x ¤150 = R240

R360 x 50¤150 = R120

11 Profit mark-up on inventory donated
R60 x 50¤100 = R30

R4 500 x 50¤150 = R1 500

R4 800 x 50¤150 = R1 600
219
FAC1601/1
SELF-ASSESSMENT
Yes No
. briefly discuss the concept of branches?
. briefly explain the differences between dependent and independent
branches?
. briefly discuss the information to be included in the reports
submitted by a dependent branch to a head office?
. record the transactions between a head office and a dependent
branch in the books of the head office where inventory sent to the
branch is invoiced at cost price?
. record the transactions between a head office and a dependent
branch in the books of the head office where inventory sent to the
branch is invoiced at selling price?
. record the transactions of a dependent branch pertaining to the
following where inventory is invoiced at cost price or at selling price?
ÐPurchases of inventory by the branch
ÐSales of inventory by the branch
ÐInventory sold by the branch at a discount
ÐInventory damaged or stolen at the branch
ÐInter-branch inventory transactions
ÐSettlement discount granted to debtors of the branch
ÐDonations made by the branch
ÐCash embezzled at the branch
ÐInventory in transit from the branch to the head office and from
the head office to the branch
. identify and record a shortage or surplus in the inventory of a branch
where inventory is invoiced by the head office at selling price?
If you answered ``yes'' to all the above assessment criteria, you have completed your
studies on branches. If you answered ``no'' to any of the above criteria, you must revise
that section before starting a revision programme in preparation for the examination.
Like many academic journeys, your's started with your acquisition of knowledge and
understanding of accounting. By studying Accounting 1, you have obtained a first
glimpse of the way accountants reflect on the realities of the business world.
If you have worked through all the study units in the study guide, you have completed
your studies for this module. You now need to do as many exercises as possible in
preparation for the examination. Good luck!
220
FAC1601/1

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INTRODUCTION AND OVERVIEW OF THE MODULE (iv)

Introduction to the preparation of financial statements 1

Establishment and financial statements of a partnership 13

Changes in the ownership structure of partnerships 37

The liquidation of a partnership 57

Introduction to companies 110

Statement of cash flows 135

Analysis and interpretation of financial statements 188

``It is difficult to say what is impossible,

for the dream of yesterday is the hope of today

and the reality of tomorrow.''

4 Tutorial Letter 101 and prescribed textbook

5 Learning outcomes and self-assessment

6.1 References to the prescribed textbook

Action word Interpretation

Read Read so as to obtain a broad and basic background knowledge of

Study Learn with a view to gaining the highest level of understanding

Prepare Compile or complete what is required on the basis of previous

6.2 Examples, exercises, self-assessment criteria, assignments

and examination questions

Adjust To adapt to new conditions/environment; to put in order; add;

8 References to cash transactions

Introduction to the preparation of financial

& listset theof financial

1.2 Framework for the preparation and presentation of

1.2.2 Objective of financial statements

1.2.4 Qualitative characteristics of financial statements

Qualitative characteristics refer to those aspects, applicable to all information contained in

1.2.5 Elements of financial statements

that pertain to the financial performance of the entity.

1.2.6 Recognition and disclosure

1.2.7 Measurement of the elements in financial statements

1.3 Generally accepted accounting practice, Statements of

Generally Accepted Accounting Practice and Interna-

tional Accounting Standards

1.4 Presentation of financial statements: IAS 1 (AC 101)

1.4.3 The purpose of financial statements

1.4.4 General features of financial statements

1.4.5 Structure and contents of financial statements

1.4.5.2 Identification of financial statements

1.4.5.3 Statement of financial position

1.4.5.5 Statement of changes in equity

1.4.5.6 Statement of cash flows

1.5 Financial instruments

1.5.1 Introduction and definitions

1.6 Practical applications of IAS 1 (AC 101)

Order of presentation Order of presentation

Study the example in paragraph 1.6 of the prescribed textbook.

1.7 Exercise and solution

(g) Name five measurement bases.

Investment: Shares in Marble Ltd (R25 6 100) 2 500

shares of Marble Ltd at the financial year end

Gain on financial asset at fair value through profit or loss 2 500

Establishment and financial statements of

2.2 Reasons for the formation of partnerships

2.3 The legal position of a partner