financial accounting & reporting fundamentals · financial accounting & reporting...

C A S R I L A N K A C U R R I C U L U M 2 0 1 5

KE1

Financial Accounting &

Reporting Fundamentals

(English)

A d d i t i o n a l S t u d y S u p p o r t M a t e r i a l

This document is designed to use as an additional study support material. The students are

advised to refer the contents presented in the study text and the additional study support

material under each chapter. The students who have already purchased the “Executive

Level KE 1 – Financial Accounting & Reporting Fundamentals” study text are also advised

to refer this study support material.

KE1 – Additional Study Support Material

2 All Rights Reserved

Contents

KE1 Financial Accounting and Reporting Fundamentals

Part A Business Environment and Accounting Framework

1 Accounting and accountability 3

2 Financial statements 11

3 The conceptual framework 16

Part B Accounting Records and Preparing Financial Statements

4 Accounting records 18

5 Double entry bookkeeping and ledger accounting 21

9 Non-current Assets 22

Part C Error Identification and Correction

11 Bank reconciliations 24

Part D Other Types of Entity

15 Partnerships 30

16 Introduction to company accounting 56

Part E Accounting standards

18. Preparation of Financial Statements for Companies 59

27. Interpretation of Financial Statements 80



Additional Content for Chapter 1

Accounting and Accountability

Heading: 5 :Governance (Learning Outcome 1.1.1)

Page No. 18

The section in the Study Text explains only about the Directors and their responsibilities

under the governance structure. The role of Chairman, Chief Executive Officer and other

committees are also a part of the governance structure of a company and are further

explained below.

Chairman and Chief Executive Officer

There are two key tasks at the top of every company. They are conducting business of the

board, and facilitating executive responsibility for management of the company’s

business. While the chairman of a company is responsible for conducting the business of

board, Chief Executive Officer is responsible for day to day management of the company’s

business.

Chairman’s Role

Chairman is responsible for conducting business of the board. As the person responsible

for running the board, the chairman should preserve order and facilitate the effective

discharge of board functions. The chairman should conduct board proceedings in a

proper manner and ensure the following;

The board is in complete control of the company’s affairs and alert all the

stakeholders towards its obligations.

A proper balance of power between executive and non-executive directors should

be maintained.

All directors are encouraged to make an effective contribution within their

respective capabilities.

The effective participation of both executive and non-executive directors are

secured.

Chief Executive Officer’s Role

Chief Executive Officer (CEO) is the most senior role in any company. The CEO is selected

and appointed by the board and reports through the chairman to the board. The CEO is

responsible for the attainment of the company’s mission and business growth,

profitability and service level objectives through leadership that inspires people

efficiently & effectively to execute strategies and plans.



Committees of a Modern Business Organisation

It can be increasingly seen that several committees have been established within the

limited liability companies by the Board of Directors to ensure proper discharge of their

duties to the company. Generally all committees of business organisations are headed by

a member of the board who will be supported by other board/non-board members.

Committees discuss the matters pertaining to the scope of the committee and inform

board about the decisions taken for ratification/information.

The following committees could be commonly seen in most of the business organisations.

Audit committee

Risk management committee

Remuneration committee

Related partly transaction review committee

Duties and responsibilities of some of these committees are explained below.

Audit Committee

Generally the audit committee consists of the non-executive directors of the company.

Chairman of the audit committee should be a member of a professional accountancy body.

Given below are some of the activities of the audit committee.

Reviewing the internal controls and recommending improvements to the internal

control system.

Review and approve internal audit plan

Provide directions to the internal audit team.

Ensure that the financial statements are prepared in compliance with an

applicable financial reporting framework.

Risk Management Committee

Risk Management Committee is a subcommittee of the board whose principal functions

are as follows.

Review and formulate management’s recommendations to the board on risk and

risk management.

Make recommendations to the board on the company’s risk appetite.

Provide direction to management and employees on risk matters.

Maintain oversight of the risk management function and enterprise risk

management.



Remuneration Committee

This consists of independent directors of the company. The following are some of the

activities of the committee.

Decide the remuneration policy especially for the CEO and the other management

team.

Deciding the targets for board of directors & CEO.

Evaluate the achievements of CEO.



Heading: 6 :External environmental factors (Learning Outcome 1.1.3)

Page No. 20

Further explanation of the external environment factors which affect the accounting process

is presented below.

Accounting Environment

This environment can be sub divided into external and internal environment. Internal

environment can be controlled by the management. External environment is beyond the

control of the individual business and the business has to be adjusted accordingly. For an

example, after introducing the Value Added Tax, the business organisations which fall

under liable business organisations had to amend their systems and records to be in line

with the requirements of Value Added Tax law. All the people who are engaged in

accounting must have a proper knowledge about such changes and should be capable of

adjusting to the new requirement. This accounting environment can be discussed under

following headings.



(a) Political and Economic Environment

Changes in economic and political environment have a direct impact on the accounting

process. Therefore, it is essential to know how the changes in economic activities affect

the business as well as the accounting process. If a new tax is imposed by the government,

business organisations should adopt it by doing necessary changes to the accounting

process.

For example, the following may have an impact to the business organisations.

Changes in foreign exchange

International economic depressions

Changes in powerful leaders of countries

Privatisation of corporations

Government tax policy

Change in interest rates

Changes in relationship between salaries, price level, cost of living and savings-

investment

Inflation

(b) Social and Cultural Environment

Business will be affected by the social and cultural values of the country. Some attitudes,

beliefs, behaviours directly or indirectly affect the organisational operations. In some

occasions, religious festivals directly affect the company operations, such as production,

deliveries, marketing etc.

Examples

During the Sinhala-Hindu festive season, there is a high demand for new clothes,

food items, crackers, paintings, etc.

During Vesak festival season, the demand for Vesak cards, oil lamps, coconut oil

will increase.

During the X-mas season, there is a big demand for crackers, cake ingredients,

clothes, gifts, etc.

Change in population structure, social and cultural values also have an impact on the

business.



(c) Technological Environment

Modern technical developments have a major impact on the business. Most of the times,

these technical developments had led the business transactions into a more sophisticated

level.

As an example the accounting activities have become more convenient due to the

development of computer systems. The preparation of financial statements has become

more convenient in a computerised environment when compared with the manual

process.

Because of the technological advancements, the payment methods also have been

improved into more advanced, quick and more secured methods. For example, various

card payment methods (Debit Cards, Credit Cards, MasterCards, etc.) have advanced the

payment methods instead of conventional coin-notes system.

(d) Legal Environment

Business organisations should carry out its activities within the legal framework

applicable to them. Whenever there is a change in legal framework or new law is enforced,

it might affect the accounting process of a business organisation.

For example, when new accounting standards are introduced, business organisations

should prepare financial statements based on the newly introduced accounting

standards.



Heading: 1 : Purpose of Financial Reporting (Learning Outcome 1.1.6)

Five ethical principles are explained below to identify the ethical requirement of the

financial reporting and the consequences of the unethical behaviour.

Five basic ethical principles

There are five basic ethical principles to be followed by the accountants. They are:

(a) Integrity

(b) Objectivity

(c) Professional competence and due care

(d) Confidentiality

(e) Professional behaviour

(a) Integrity

This means that accountant should be straight forward and honest in his/her

professional and business relationships. Integrity also implies dealing fairly with

other people and being truthful. Therefore, an accountant should not be associated

with reports or other communications that,

• he/she believes contain false or misleading information

• omit or obscure information, which makes the communication misleading.

An accountant who always acts with integrity will be trusted by the people who are

regularly dealing with him/her. Integrity of accountants in the business will enhance

the trust of the general public in the profession.

(b) Objectivity

Objectivity is the principle that all professional and business judgments should be

made fairly on the basis of an independent and intellectually honest appraisal

of information. Further it is stated that professional judgement should be:

free from all forms of prejudice and being bias

free from factors which might affect impartiality, such as pressure from a

superior, financial interest in the outcome, a personal or professional

relationship with one of the parties involved, or a conflict of interest.



(c) Professional competence and due care

The principle of professional competence and due care imposes an obligation on

accountants to:

maintain their professional knowledge and skill at the level required to ensure

that their clients or employers receive a competent professional service.

act diligently, in accordance with applicable, technical and professional

standards when providing professional services.

(d) Confidentiality

The principle of confidentiality imposes an obligation on a professional accountant

to refrain from:

Disclosing to anyone outside the firm (or employer organisation) any

confidential information that is acquired as a result of professional and business

relationships, without proper and specific authority. The only exceptions are in

circumstances where the accountant has a legal duty or a professional

right/duty to disclose the information.

Using confidential information to their personal advantage or the advantage of

a third party.

(e) Professional behaviour

The principle of professional behaviour imposes an obligation on members to comply

with relevant laws and regulations and avoid any action that may bring a disrepute to the

profession.

Ethical requirements of financial reporting

Ethics are standards or rules of behaviour and represent a view about how people should

conduct themselves in a better way. Members of the Institute of Chartered Accountants

of Sri Lanka should follow the ethics stipulated by the Institute.

Reasons as to why accountants should behave ethically

The profession requires members to conduct themselves properly and provide

services to the public according to certain standards.

By upholding these standards, the profession's reputation and standing is

protected.

An accountant’s ethical behaviour serves to protect the public interest.

Consequences of unethical behaviour will result in disciplinary action against the

accountant by their employer or professional body.




Financial Statements

Heading: 1 The main elements of financial reports (Learning Outcome 1.2.3 & 1.2.4) Page No. 28

Components of financial statements are explained below with the formats in addition to

contents presented in the Study Text.

Components of Financial Statements

Generally financial statements are prepared for any business annually. As per the periodic

concept, the profits and losses of a business are computed for a period. In practice this

period is one year. In Sri Lanka, most of the business organisation's financial year

commences on April 1 and ends on March 31 of the subsequent year. Government

departments consider the calendar year as the financial year. This calendar year is treated

as the government financial year. Calendar year covers a period commencing from

January 1 to December 31 in each year. Financial statements are really useful for the

parties interested in the business and they are taking economic decisions based on the

information in the financial statements.

Given below are the components of the financial statements.

Statement Objective

1 Statement of Financial Position Shows the financial position as of a given

date.

2 Statement of Profit & Loss and

other comprehensive income Shows the total comprehensive income for a

given period.

3 Cash Flow Statement Disclose the cash receipts and payments in a

given period.

4 Statement of Changes in Equity Describe how the changes happened to the

equity of the company in a given period.

5 Accounting Policies and Notes to the

Accounts

Describe and explain the details of the items

shown in the face of the statement of profit

and loss, statement of financial position, and

accounting policies used in the preparation

of financial statements.



1. Statement of Financial Position

Statement of Financial Position explains the financial position of a business

organisation as at a particular date.

Specimen of statement of financial position is given below.

X PLC

Statement of Financial Position as at March 31, 2016

Non-current Assets Rs’000 Rs’000

Property, plant and equipment XXXX

Financial assets XXXX

Intangible assets XXXX XXXX

Current Assets

Stocks XXXX

Other receivables XXXX

Trade receivables XXXX

Financial assets XXXX

Cash & cash equivalent XXXX XXXX

Total Assets XXXX

Equity and Liabilities

Equity

Stated capital XXXX

Revaluation surplus XXXX

Retained profits XXXX XXXX

Non-current Liabilities

Long-term borrowings XXXX

Retirement benefit obligations XXXX XXXX

Current Liabilities

Trade payables XXXX

Short-term borrowings XXXX

Accruals XXXX XXXX

Total Equity and Liabilities XXXX



2. Statement of Profit & Loss and Other comprehensive income

Statement of profit and loss and other comprehensive income account is prepared to

compute the total comprehensive income for the accounting period.

Specimen format of statement of profit & loss and other comprehensive income is given

below.

X Plc

Statement of Profit & Loss & Other Comprehensive Income for the year ended

March 31, 2016

3. Statement of Cash Flow

Statement of Cash flow explains the cash and cash equivalent generated and how it

is distributed within a period. Cash or cash equivalent is the cash, bank balances and

the call deposits. Cash flow explains how the cash was generated by the business within

a period and how it was spent.

Statement of cash flow which provides information that enables users to evaluate the

changes in net assets of an enterprise, its financial structure (including its liquidity

and solvency) and its ability to affect the amounts and timing of cash flows in order to

adopt to changing circumstances and opportunities. Cash flow information is useful in

assessing the ability of the enterprise to generate cash and cash equivalents.

Rs. Rs.

Turnover xxxx

Less: Cost of sales (xxxx)

Gross profit xxxx

Other income xxxx

Less : Expenses

Administration & establishment (xxxx)

Selling & distribution (xxxx)

Finance cost (xxxx)

profit before tax xxxx

Income tax (xxxx)

Profit for the year xxxx

Other comprehensive income

Revaluation surplus xxxx

Gain on remeasurement of AFS Financial assets xxxx xxxx

Total comprehensive income xxxx



Specimen of statement of cash flow is given below.

X Plc

Statement of Cash Flow for the year ended March 31, 2016

Rs. Rs.

Profit before tax xxxx

Add/Deduct- Non-cash items

Depreciation xxxx

Provision for receivables xxxx

xxxx

Working capital changes

(Increase)/Decrease in Inventories xxxx

( Increase)/Decrease in receivables xxxx

Increase /(Decrease) in payables xxxx

xxxx

Income tax paid (xxxx)

Gratuity paid (xxxx)

Cash flows from operating activities xxxx

Investing activities

Acquisition of property, plant & equipment (xxxx)

Proceeds from disposal of property, plant & equipment xxxx

Acquisition of bonds/debentures (xxxx)

Net cash flows from investing activities xxxx

Financing activities

Increase in stated capital xxxx

Long-term loans taken xxxx

Repayment of loans (xxxx)

Net cash flow from financing activities xxxx

Net Increase/(Decrease) in cash & cash equivalents xxxx

Cash & cash equivalents at the beginning of the year xxxx

Cash & cash equivalents at the end of the year xxxxx



4. Statement of Changes in Equity

Equity of a limited liability company is mainly represented by stated capital and retained

earnings. In a given financial year, there may have been some changes occurred in equity.

Statement of changes in equity is prepared for a particular period to identify the

movements in equity occurred and specimen of statement of changes in equity is given

below.

X Plc

Statement of changes in equity for the year ended March 31, 2016

Stat

ed

cap

ital

AF

S

rese

rve

Rev

alu

atio

n

rese

rve

Ret

ain

ed

pro

fit

To

tal

Opening balance xx xx xx xx xx

Changes in accounting policies - - - xx xx

Share issue xx - - - xx

Total comprehensive income - - xx xx xx

Dividend paid - - - (xx) (xx)

Balance at the end of the year xx xx xx xx xx

5. Accounting Policies and Explanatory Notes

Notes to the accounts are the accounting policies and the other disclosures required.

Various accounting policies are applied when preparing the financial statements and it

is required to disclose these accounting policies with the financial statements for getting

the maximum benefit out of the financial statements. In addition to that details of the

items given on the face of the financial statements are further explained by the notes

to the accounts. As an example property plant and equipment are shown as a line item

in the Statement of Financial Position and the details are shown in the notes to the

financial statements. In addition to this, notes are used to disclose the other contingencies

that are not reflected in the financial statements.




The Conceptual Framework

Heading: 1 Background (Learning Outcome 1.2.1)

Page No. 38

The objectives of financial reporting is further explained below in addition to the contents

presented in the Study Text.

1. Conceptual Framework for Financial Reporting

The objective of general purpose financial reporting:

The conceptual framework states that the objective of general purpose financial reporting

is to provide information about the reporting entity that is useful to existing and potential

investors, lenders and other creditors in making decisions about providing resources to

the entity. These users need information about,

The economic resources of the entity

The claims against the entity

Changes in the entity’s economic resources and claims

Information about the entity’s economic resources and the claims against them to help

users to assess the entity’s liquidity and solvency and its likely need for additional

financing. Information about a reporting entity’s financial performance helps users to

understand the return that the entity has produced on its economic resources. This is an

indicator of how efficiently and effectively management has used the resources of the

entity and is helpful in predicting future returns.

Information about a reporting entity’s cash flows during a period, also helps users to

assess the entity’s ability to generate future net cash inflows and gives users a better

understanding of its operations.



2. The Regulatory Framework for Financial Reporting

The regulatory framework of financial reporting refers to regulations applicable to

financial reporting which includes accounting standards, company law, etc.

2.1 GAAP & Sri Lankan GAAP

GAAP refers to a generally accepted accounting practice. It signifies all the rules and

principles that govern accounting.

In Sri Lanka, the mandatory sources of GAAP are the following:

(a) Accounting standards issued by the Institute of Chartered Accountants of

Sri Lanka.

(b) Companies Act

(c) SEC regulations & rulings

2.2 Sri Lanka Accounting & Auditing Standards Act No. 15 of 1995

This legislation empowers CA Sri Lanka to issue accounting and auditing standards.

The Act requires “specified business entities” to prepare and present their financial

statements in compliance with Sri Lanka Accounting Standards.

2.3 Accounting Standards

The IASB develops and publishes new International Financial Reporting Standards

(IFRS). In 2012, the Institute of Chartered Accountants of Sri Lanka made a decision

to converge fully with all pronouncements issued by the IASB and thereafter to adopt

all pronouncements issued by IASB.

2.4 IFRS Foundation The IFRS foundation is the global body responsible for financial reporting. Its objectives are:

(a) To develop in the public interest, a single set of high quality,

understandable enforceable and globally accepted financial reporting

standards based on clearly articulated principles.

(b) To promote the use and rigorous application of those standards.

(c) To promote and facilitate adoption of IFRS.

The International Accounting Standards Board (IASB) which is a body under IFRS

foundation is responsible for the development of new IFRS.




Accounting Records

Heading: 1 The role of source documents (Learning Outcome 2.1.1 & 2.1.2) Page No. 64

A summary of source documents and other records is presented below in addition to contents


Source Documents and Other Records

Transaction Source

document

Preliminary

book

or Journal

Ledger

account

1 Receipt of cash Receipt Cash book Cash book

2 Cash payment Payment voucher Cash book Cash book

3 Purchase goods on credit Purchase invoice Purchase day book

Purchase account

4 Purchase returns Debit note Purchase return day book

Purchase return account

5 Credit sales Sales invoice Sales day book Sales account

6 Sales return Credit note Sales return

day book

Sales return

account

7 Petty expenses

(Small expenses)

Petty cash

voucher

Petty cash

book Petty cash book

8

Purchase of fixed assets

on credit, bad debts,

transferring to reserves

etc….

Journal voucher General

Journal

Respective

ledger

accounts

Usefulness of source documents

1. Being the basic document in support of the transaction

2. As a proof for the occurrence of the transaction

3. As a basis to record the transaction in the books.

4. Ability to minimise errors & omissions.



Payment Voucher

Payment Voucher is the source document raised when making payments. The payment

voucher is one of the source documents used to record the transactions in cash book.

Specimen of Payment Voucher is given below.



Types of Source Documents

Source documents can be divided into two main types based on the use of them in

accounting.

1. Primary source documents

2. Other source documents

Primary source documents

These documents are directly used in recording entries/transactions in journals books of

prime entry. The following are primary source documents:

Payment voucher

Receipt

Invoice

Debit note

Credit note

Petty cash voucher

Journal voucher

Other source documents

These documents are not used to record transaction in the journals. But information in

these documents are used to prepare primary source documents. Examples:

Bank statements

Bank advice

Price quotations

Purchase orders

Remittance advice

Good Received Note (GRN)

Acknowledgement notice

Monthly statements

Management reports

Valuation reports (fixed assets, stocks)




Double Entry Bookkeeping and Ledger Accounting

Heading: 5 The Journal ( Learning Outcome 2.3.2) Page No. 113

Types of transactions to be recorded in journal is explained below.

General Journal

It is essential to record all the transactions in a prime entry book prior to making entries

in the ledger accounts. Any transaction that does not come to the cash book or any other

prime entry book should be first recorded in the General Journal. Entries that are

recorded in the General Journal are as follows:

i. Opening entries

ii. Purchase and sale of fixed assets on credit

iii. Rectification entries

iv. Adjustment entries

v. Other transfer entries

vi. Closing entries

Source document relevant to the General Journal is Journal Voucher. Journal vouchers

are prepared based on invoices, minutes, time sheets and other various documents

Specimen of a general journal is given below.

Date J.V.

No.

Description Ledger

folio

Debit Credit



Additional Content for Chapter 9 Non-current Assets

Methods of depreciation (Learning Outcome 4.2.4)

Page No. 195

Units of production method is a method used under PPE depreciation. This method is

explained below in addition to the other methods described in the Study Text.

Depreciation methods

There are different methods available to be used for deprecation. They are:

i. Straight line method

ii. Diminishing balance method (reducing balance method)

iii. Units of production method

Units of Production Method

Under this method, depreciation is charged based on the number of units produced in a

given financial year. The following formula could be used for this purpose.

Depreciation = Depreciable value of the asset x Number of units produced within the period

Total output expected

Example: Value of a plant owned by Big PLC is Rs. 450,000. If the capacity of the plant is

3,000,000 units and Big PLC expects to produce only 300,000 units for the first year,

600,000 units for the second year etc. the relevant depreciation is given below.

Year Annual production units Annual depreciation Rs.

1 300,000 450,000 x 300,000

3,000,000 45,000

2 600,000 450,000 x 600,000

3,000,000 90,000

3 700,000

450,000 x 700,000 3,000,000

105,000

4 800,000 450,000 x 800,000

3,000,000 120,000

5 600,000 450,000 x 600,000

3,000,000 90,000

3,000,000 450,000



Review of Useful Life

As per LKAS 16, useful life time of the property, plant and equipment should be reviewed

at the end of each reporting period. Accordingly if there is an increase or reduction in

future life span the deprecation for the current period and the future periods are to be

computed based on the revised useful life time.

Review of Depreciation Method

Not only the life time of the asset but also the depreciation method should also be

reviewed from time to time. It is allowed to change the depreciation method if there

is a necessity.

Example

X PLC bought a plant for Rs. 200,000 and depreciated it by using the diminishing

balance method at 10% per annum. After two years it was decided to apply straight

line method for the future period.

Computation is as follows.

Impairment

To determine whether an item of property, plant and equipment is impaired, an entity

applies LKAS 41. This standard explains how an entity reviews the carrying amount of

its assets, how it determines the recoverable amount of an asset and when it recognises

or reverses impairment losses.

Rs. Rs.

Cost of the plant 200,000

Depreciation in the year 1 200,000 x 10% = 20,000

Depreciation in the year 2 180,000 x 10% = 18,000 (38,000)

Balance depreciable value 162,000

Annual depreciation for the next eight years 162,000

8

Future annual depreciation 20,250




Bank Reconciliations

Heading: 2 The bank reconciliation (Learning Outcome 2.7.1 & 2.7.2)

Page No. 247

Further content related to bank reconciliations are detailed below in addition to contents


Reasons/advantages in preparing a bank reconciliation statement

To confirm the accuracy of the bank transactions recorded in the Cash Book.

As a controlling technique of preventing the frauds and errors of the

transactions made with the Bank.

To find the value and the details of unrealised deposits.

To find the value and the details of unpresented cheques.

Why previous month's bank reconciliation statement is needed for preparing the current

month Bank Reconciliation Statement?

To know whether the unrealised deposits in the previous month have been

realised in the current month.

To know whether the unpresented cheques in the previous month have been

presented in the current month.

Methods of preparation of bank reconciliation statement

i. Preparation of bank reconciliation statement without adjusting the cash book

ii. Preparation of bank reconciliation statement after adjusting the cash book.

Preparation of bank reconciliation statement without adjusting the cash book

According to the above method the original cash book balance will be used to prepare

the statement of bank reconciliation. I.e. no adjustment will be made to the cash book

balance. Thereby all the causes of difference will be adjusted in the statement of bank

reconciliation.



Format - statement of bank reconciliation

(a) Balance (positive balance/credit balance) as per bank statement/ negative balance as

per cash book

Particulars Rs Rs

Balance (positive balance/Credit Balance) as per the bank statement

xxxx

Add:

(a) Cheques deposited but not yet realised xxxx (b) Standing Order payments xx

(c) Bank charges xx

(d) Any charges other than charges deducted by the

bank not recorded in the cash book xxxx

(e) Errors-excess debit in cash book or excess credit

in bank statement xx xxxx

xxxx

Less:

(f) Cheques issued but not presented for payment xxx

(g) Direct collections on behalf of customers xxx

(h) Returned Cheques xx

(i) Errors-excess credit in cash book or Excess debt in bank statement xx xxxx

Balance (Positive balance) as per cash book xxxx



(b). Balance (Positive balance) as per cash book/Overdraft (Negative balance/ Debit

Balance) as per bank statement.

Preparation of Bank Reconciliation after Adjusting the Cash Book

According to this method the bank reconciliation statement will be prepared by using

the adjusted cash book balance. Thus, the adjusted cash book balance is determined by

adjusting all the causes which are required to be in the cash book. Those can be

summarised as follows.

Bank charges

Direct collection on behalf of the customers (direct credit to the bank)

Standing order payments

Returned cheques

Cash book errors

Particulars Rs Rs

Balance (positive balance) as per the cash book xxxx

Add:

(a) Cheques issued but not presented for payment xxxx (b) Direct collections on behalf of customers xxx

(c) Returns cheques xxx

(d) Errors-excess credit in cash book or excess debit in

bank statement xxxx xxxx

xxxx

Less:

(e) Cheques sent for collection (realization) but not yet collected (realized) xxxx

(f) Standing order payments xxx

(g) Bank charges xxx

(h) Any charges other than bank charges deducted by the bank not recorded in the cash book xx

(i) Errors-excess debit in cash book or excess credit in bank statement xx xxxx

Balance (positive balance/Credit Balance) as per the bank statement

xxxx



Questions

1) Bank balance shown in Saliya’s book as at March 31, 2016 was Rs. 25,000. This

did not agree with bank statement balance as at that date. The following are the

reasons for the disagreement:

- Unrealised deposit value: Rs. 2,500

- Unpresented cheques value: Rs. 1,000

- Payment of insurance premium made on standing orders but not recorded in the

Cash Book: Rs. 1,500

- Bank charges not recorded in the Cash Book: Rs. 500

Required: Compute the balance appeared in the bank statement as at March

31, 2016.

2) Bank balance shown in Janadaree’s book as at March 31, 2016 was different from

the balance shown in the bank statement. Balance shown in the bank statement

was Rs. 30 Mn. The following are the reasons for the disagreement:

- Unrealised deposit value was Rs. 500 Mn.

- Unpresented cheques value was Rs. 200 Mn.

- A direct deposit of Rs. 30 Mn made by a debtor was not recorded in the cash book.

- Bank charges not recorded in the cash book was Rs. 1 Mn.

- Cheque deposited with bank was dishonoured and was not recorded in the cash

book. The value of the cheque was Rs. 15 Mn.

Required: Compute the balance appeared in the cash book as at March 31, 2016.

3) Bank OD balance shown in Asanga’s book as at March 31, 2016 was Rs. 80 Mn.

This did not agree with bank statement balance as at that date. The following are

the reasons for the disagreements:

- Unrealized deposit value was Rs. 25 Mn.

- Value of the cheques issued but not presented yet for payment was Rs. 38 Mn.

- An amount of Rs. 3 Mn that should have been debited to the cash column

of cash book was inadvertently debited to the bank column of the cash book.

- Dividends directly collected by the bank on behalf of Asanga but not updated

in the cash book was Rs. 10 Mn.

- Total value of bank charges not recorded in the cash book was Rs. 2 Mn.

Required: Compute the balance appeared in the bank statement as at March 31,

2016.



4) Information - Danapala PLC as at March 31, 2016

- Bank OD as per the Bank Statement was Rs 18,560.

- Three cheques issued to the creditors for the values of Rs. 3,700, Rs. 6,500

and Rs. 370 at the last week of the December month were not presented to

the bank for payment.

- Receipt of few cheques for the value of Rs 7,500 was recorded in the debit

side of the bank column but not credited to the bank in the month of

December.

- A bank charge of Rs 70 and the interest of Rs 1,800 charged by the bank

were not recorded in the Cash Book.

- Collection of dividends amounting to Rs 2,850 directly collected by the

Bank was not recorded in the Cash book.

- Deposits made for the value of Rs 90 in the month of December was

appeared in the bank statement but not recorded in the cash book.

- Deposits of Rs 2,400 and Rs 2,100 made on December 27 were realised

only on April 10, 2016.

Required: Prepare the bank reconciliation statement of Danapala PLC as at March

31, 2016 by using the above information.

5) Given below is the cash book, bank statement for the month of January 2016 and

the bank reconciliation statement as at December 31, 2015 of Sirimal PLC.

Bank reconciliation statement as at December 31, 2015

Rs. Rs.

Bank balance as per the cash book 21,000

Add

Unpresented cheques - 081

083

6,000

4,000 10,000

31,000

Less

Unrealised deposits - cheque deposit

cheque deposit 8,100

1,700 (9,800)

21,200



Bank column of cash book of January 2016

Bank statement for the month of January 2016

Date Details Debit Credit Balance

Jan 01 B/F

2,00

0

8,10

0

21,200

Jan 05 Cheques 085 2,000 19,200

Jan 06 Cheque deposit 8,100 27,300

Jan 10 Cheque 081 6,000 21,300

Jan 10 Cash deposit 8,000 29,300

Jan 16 Electricity expenses 1,300 28,000

Jan 20 Cheque deposit 5,000 33,000

Jan 28 Dividend income 3,300 36,300

Jan 30 Bank charges 200 36,100

Required: Prepare the cash book for the month of January 2016 and the bank

reconciliation statement as at January 31, 2016.

Rs Rs

Jan 01 B/F 21,000 Jan 03 Cheque 085 2,000

Jan 10 Cash deposit 8,000 Jan 12 Cheque 086 4,000

Jan 14 Cheque deposit 6,000 Jan 16 Cheque 088 3,000

Jan 18 Cheque deposit 5,000 Jan 21 Cheque 089 5,000

Jan 23 cheque deposit 4,000 Jan 31 Cheque 090 1,000

C/D 29,000

44,000 44,000




Partnerships

Heading: 1 Partnership accounts (Learning Outcome 3.3.1 & 3.3.2)

Dissolution of partnership is discussed below in addition to contents presented in the

Study Text.

Dissolution of Partnership

A partnership may dissolve after the time period which had been originally decided by

the partners or after achieving their objectives or any other reason specified in the

partnership agreement. On dissolution, partners of a partnership would take necessary

steps to sell all the assets of the partnership and settle all the liabilities of the

partnership. After doing so the partners may distribute any excess amount among the

partners on their profit sharing ratio. This process is known as dissolution of a

partnership.

The procedures of dissolution of partnership are explained in sections 32, 33, 34 and 35

of the Partnership Act.

Section 32

1. With the consent of partners

2. By expiration of agreed time period

3. After the achievement of the objectives

Section 33

1. If the partners become bankrupt

2. Death of the partners

Section 34

Becoming the partnership business illegal

Section 35

1. Mental disorder of the partners

2. Incurring continuous losses in the partnership business

3. Misconduct of a partner

4. By an order of the court



Due to one or more reasons given above there is a possibility of dissolving a

partnership business. Further due to one of the below mentioned reasons a partner can

make a request from the court for the dissolution of the partnership business.

1. Becoming a partner to mental disorder

2. Failure of adhering to the partnership agreement

3. Behaviour of any partner in a way of damaging the goodwill of the partnership

4. Violation of conditions in the partnership business by one of the partners

5. Incurring continuous losses in the partnership business

6. Any reason that the courts decide is just an equitable

Section 44 of the Partnership Act explains the preferential order of releasing the

liabilities from the money received from realisation of assets.

1. Payment of realisation expenses

2. Settlement of external liabilities as per the preferential order

3. Settlement of any loan or an advance given by a partner in addition to the capital

4. Settlement of the capital provided by the partners

5. Distribution at Profit Sharing Ratio (PSR) if there is a balance after settling the

above.

Accounting for dissolution of partnership

Accounting for dissolution of a partnership is done using either of the following

two accounts.

i. Using a realisation account

ii. Using a realisation profit and loss account

1. Realisation Account Method

Realisation account is prepared for computing the profit and loss of the dissolution

of partnership business.

Just as the sale of every property, plant and equipment is recorded in an appropriate

disposal account, for determining the profit or loss on such disposal, the disposal of

all the assets and liabilities of a partnership for the purpose of dissolution of the firm

itself, is recorded in an account which is usually called a realisation account because it

shows the conversion into cash (realisation) of all the assets. The realisation account

which is also referred to as dissolution account is in similar form to the disposal

account of a property, plant and equipment. In that, it compares the cost of the assets

to the extent not already written off, with the sale proceeds thereof, and determines the

profit or loss on the realisation.



The following entries are relevant for this.

1. All the assets other than cash on the date of dissolution;

Realisation account Debit

Relevant asset account Credit

2. Provision accounts of the assets that were transferred to the realisation account;

Relevant provision account Debit

Realisation account Credit

3. Liabilities of the partnership do not transfer into the realisation account. Instead,

the individual ledger accounts are prepared for each liability account.

4. Cash received by realisation of the assets that have been transferred to the

realisation account;

Cash / bank account Debit


5. If a partner acquires an asset of the partnership business; (undertaken value of

such an asset) (who takes over the assets)

Partner's account Debit


6. If a partner had guaranteed a particular asset, the partner has to undertake the

responsibility of realising such asset. As an example if the recovery of a

particular debtor is guaranteed by a partner, it is the responsibility of the partner

to ensure the full realisation of the asset. If there is a deficit, the partner has to

bare it.

Partner’s (decided by the guarantee) account Debit


7. If a partner undertakes a particular liability,

Relevant liability account Debit

Partner’s account Credit

8. Paid cash for releasing the liabilities;

Relevant liability account Debit

Cash account Credit



9. If there is a profit or loss in releasing the liabilities, it has to be transferred to

the realisation account.

10. When making the realisation expenses,


Cash account Credit

11. If the contingent liabilities are crystallised in the dissolution, those have to be

settled.


Cash book Credit

12. After recording the above transactions the realisation account has to be

balanced.

If there is a profit;


Partner's account Credit

If there is a Loss;

Partner's account Debit


13. Finally the partner’s accounts have to be closed down. There are two methods

to do this.

If there is a debit balance in partner's account,

That means the partner has to bring money to the business. The following are

relevant for this.

a) Whether the partner is bankrupt or not.

When a partner is unable to make the debit balance looks good because he has

become insolvent, the Garner vs. Murray decision applies. This legal decision

rules that the deficiency must be borne by the solvent partners in their last agreed

capital ratio and not in the profit sharing ratio which should be used only for

appropriation of profits and losses arising to the business, whereas the capital

deficiency of a partner must be treated as belonging personally to the remaining

partner and must be borne by them in the ratio of their ownership.



The phrase, last agreed capital ratio means the ratio in which partners last agreed

to hold their capital balance, ignoring the current balances, the loan account

balances and the impact of the profit or loss on realisation on the capital account

balances for this purpose.

b) Whether the partner is a limited partner;

If there is a bankrupt partner at the time of dissolution of partnership business,

the court decision given in Garner Vs Murray is applicable. Accordingly the debit

balance of the bankrupt partner's account has to be borne by the remaining

partners at the ratio of final capital balance.

c) When a partner is a limited partner

If a particular partner’s liability is limited up to the amount of capital, he is known

as a limited partner. In this instance, if the partner’s account has a debit balance, it

is not required for him to bring cash in. Therefore this debit balance has to be

borne by the remaining partners at the PSR.

Other than the above mentioned cash bought by the partners, everything else has to

be recorded as follows.

Cash Book Debit

Relevant partner’s account Credit

If there is a credit balance in partner's account;

Meaning of this is that the partner should get money from the partnership

business as the settlement.

The following double entries are relevant for this.

Relevant partner’s account Debit

Cash book Credit



2. Realisation profit and loss account method

Where the sale of each asset and discharge of every liability is recorded in individual

account, for separately determining the profit or loss on each such activity and where

the profits and losses are thereafter transferred to a common account for determining the

combined effect of all these activities, this common account is known as Realisation

Profit and Loss account.

In this method, only the profits or losses are recorded. Here the profits or losses of

realisation of assets are computed separately and transferred to this account. This

transfer can be made only for the profits or losses in revenue nature. Profits or losses

in capital nature have to be transferred to the capital account of the partners.



Example

Ruwan, Sandun and Thushara were sharing their profit at the ratio of 3:2:1 of their

Partnership. Balance sheet as at March 31, 2016 was as follows.

Ruwan, Sandun and Thushara’s Partnership Statement of Financial Position as

at March 31, 2016

Rs ‘000’ Rs ‘000’

Assets

Non-current Assets

Land at Revaluation 250

Building at Revaluation 320

Provision for Depreciation on Building (140 ) 180

Other Property, Plant and Equipment 640

Provision for Depreciation on other Assets (230) 410

Investments 190

Life Insurance Policy 300

Fixed Deposits 210

Good will 180

1,720

Current Assets

Inventories 635

Receivable Accounts 840

Loan – Thushara 300

Prepayments 140

Cash and Cash Equivalents 155 2,070

2,070Total Assets 3,790

Equity and Liabilities Capital Accounts

Ruwan 900

Sandun 400

Thushara 350 1,650

Current Accounts

Ruwan 462

Sandun (109 )

Thushara (139 ) 214

1,864



The following additional information is given.

(1) The partners have realised that the activities carried out by the partnership

are not profitable and therefore they decided to dissolve the partnership at the

earliest.

(2) 3 years ago, partnership has given a personal loan to Thushara, at an interest rate

of 12% per annum. However Thushara has not been able to pay the loan interest

and, as such the loan interest has not been accounted for during the previous 3

year period. At the dissolution, the partners decided to transfer the balance of

loan account to his capital account. Further they have agreed to compute the

loan interest for the past 3 years and make relevant entries in the books of

accounts through the partners’ current accounts.

(3) Mortgage loan has been taken from a finance company against the Land and

Buildings of the partnership. At the time of the dissolution the partnership had

to transfer the title of Land and Buildings to the lending finance company with an

additional payment of Rs. 55,000/- to settle total capital outstanding of the

Mortgage Loan Account.

(4) An investment which costs Rs. 80,000/- was acquired by Ruwan for the value of

Rs.90,000/-

Life Insurance Policy 300

Total Equity 2,164

Non - current Liabilities

Bank Loan 890

Mortgage Loan 460 1,350

Current - Liabilities

Payable Accounts 210

Accrued Expenses 66 276

Total Equity and Liabilities 3,790



(5) Other assets of the company have been realised at the amount given below.

Rs.

Other Property, Plant and Equipment 360,000

Other Investments 65,000

Fixed Deposits 240,000

Inventories 530,000

Cash Collected from Debtors 635,000

Cash collected from Prepayment balances 86,000

(6) When the bank loan was settled the partnership had to pay an additional

interest amounting to Rs. 24,000/- which has not been provided in the books of

accounts as at March 31, 2016. Creditors have settled fully after deducting 10%

discount. It was revealed that Rs. 26,000/- of accrued expenses were merely an

over provision in the books of accounts.

(7) Rs. 210,000/- received from the life assurance policy.

(8) At the dissolution partnership paid Rs. 96,000/- as compensation to the

employees. Further Rs. 23,000/- was paid as realisation expenses.

(9) It has been revealed that no personal assets are owned by Thushara to meet any

deficit arising on dissolution.

Required:

Prepare,

(i) Relevant accounts which are needed to dissolve the partnership

(ii) Partners’ Equity Accounts and Current Accounts

(iii) Cash Book of the Partnership.



Answer

Ruwan, Sandun and Thushara’s Partnership

Realised Account

Other property plant &

equipment

640 Other property , plant & equipment

Provision for depreciation

230

Investments 190 Transferred investments

for Ruwan’s Equity A/C

90

Fixed deposits 210

Cash- other PPE 360 Good will 180

Inventory 635 Other investments 65

Receivable accounts 840 Inventories 530

Prepayments 140 Receivable A/C 635

Mortgage loan Interest 25 Prepayments 86

Employees compensation 96 Fixed deposits 240

Extra Bank loan Interest 24 Discounts received 21

Realisation expenses 23 Over provisions of accrued expenses 26

Loss on realisation - capital a/c

- Ruwan 360

- Sandun 240

- Thushara 120 720

3,003 3,003



Partner’s Capital (Rs. 000)

Date Description Ruwan Sadun Thushara

2016/03/31 Capital balance 900 400 350

Thushara’s loan account - - (300)

Investments account (90) - -

Life Insurance fund 105 70 35

Loss on realisation (360) (240) (120)

Transferred from Current A/C 516 (73) (229)

Thushara's deficit (182.76) (81.24) 264

(According to Garner Vs Murray

rule) cash - balance paid

(888.24) (75.76) -

- - -

Cash A/C

(Rs 000) (Rs 000)

2015/04/01 Balance 155 Mortgage loan 55

Realised A/C Bank loan (890 + 24) 914

Other P.P.E. 360 Creditors(210 - 21) 189

Other investments 65 Accrued expenses 40

Fixed deposits 240 Employees compensation 96

Inventories 530 Realised expenses 23

Receivable A/C 635 Equity A/C

Pre - payments 86 Ruwan 888.24

Cash from Life Insurance policy 210 Sandun 75.76

2,281 2,281



Partner’s Current A/C (Rs. 000)


2016/03/31 Current account balance 462 (109 ) (139)

Thushara’s loan interest - for three years - - (108)

Profit adjustment on Thushara’s loan interest 54 36 18

Transferred to capital A/C (516) 73 229

- - -

Land and Building A/C (Rs. 000)

Land 250 Building depreciation provision 140

Building 320 Transferred of land and building

for Mortgage loan

430

570 570

Mortgage Loan ( Rs 000)

Transferred of land and building 430 Balance 460

Cash payments 55 Extra interest to realisation

account

25

485 485

Life Insurance Policy ( Rs. 000)

Balance 300 Cash 210

Life Insurance Fund A/C 90

300 300



Life Insurance Fund ( Rs. 000)

Life Insurance Policy A/C 90 Balance 300

Capital A/C - Ruwan 105

Sandun 70

Thushara 35 210

300 300

Creditors / Payables (Rs. 000)

Cash 189 Balance 210

Discount Received 21

210 210

(Rs. 000)

Thushara’s Deficit 264

Ruwan’s and Sandun’s capital ratio 9:4

According to Garner Vs Murray the amount to be borne by Ruwan 264 x 9

13

182.76

According to Garner Vs Murray the amount to be borne by Sandun 264 x 4

13

81.24



The above answer is given below under Realisation Profit and Loss Account method.

Ruwan, Sandun and Thushara’s Partnership

Realisation profit and loss A/C

(Rs. 000) (Rs.000)

Other P.P.E. Loss 50 Profit from transfer of

investments to Ruwan 10

Loss on other investments 45 Profit from fixed Deposits 30

Discounts from creditors 21

Good will 180 Over provision of Accruals 26

loss on Inventories 105 Loss on Realisation - capital A/C

Receivable A/C - Loss 205 - Ruwan 360

Prepayment A/C - 54 - Sandun 240

loss 25 - Thushara 120 720

Extra Interest for mortgage 24

loan Extra bank loan Interest 96

Employees Compensation 23

Realisation expenses 807 807



Partner’s Capital A/C (Rs. 000)


2016/03/31 Balance 900 400 350

Transfer of Thushara’s - - (300)

loan Investments (90) - -

Life Insurance 105 70 35

Fund Loss on Realisation (360) (240) (120)

Transfer from Current 516 (73) (229)

A/C Thushara’s Deficit

(According to Garner Vs Murray rule)

(182.76) (81.24) 264

-

(888.24) (75.76) -

Cash A/C (Rs. 000)

2016/04/01 Balance 155 Interest on Mortgage Loan 55

Bank loan (890+24) 914

Other P.P.E 360 Creditors (210 - 21) 189

Other Investments 65 Accrued Expenses(66 - 26) 40

Fixed Deposits 240 Employees Compensation 96

Inventories 530 Realisation expenses 23

Receivable A/C 635 Capital A/C

Prepayments 86 Ruwan 888.24

Life Insurance 210 Sandun 75.76

2,281 2,281



Partner’s Current A/C (Rs. 000)


2016/03/31 Balance 462 (109) (139)

Loan Interest of Thushara’s - - (108)

Profit based on Thushara’s loan Interest

to

54 36 18

Capital A/C (516) 73 229

Land and Building A/C (Rs 000)

Land 250 Building 140

Building 320 Transfer of building & land to

settle the Mortgage loan

430

570 570

Mortgage Loan (Rs 000)

Acquisition of buildings & land 430 Balance 460

Cash paid 55 Extra Interest to Realisation

A/C

25

485 485

Life Insurance fund (Rs 000)

Life Insurance policy A/C 90 Balance 300

Capital A/C - Ruwan 105

- Sandun 70

- Thushara 35 210

300 300



Creditors A/C (Rs 000)

Cash 189 Balance 210

Discount Received 21

210 210

Other Property, Plant & Equipment (Rs 000)

Balance – Cost 640 Balance – Accumulated Dep 230

Cash 360

Realisation P/L A/C 50

640 640

Investment A/C (Rs 000)

Balance 190 Acquired by Ruwan 90

To Realisation Profit & Loss Account 10 Cash 65

Realisation Profit & Loss A/C 45

200 200

Rs (000)

Deficit of Thushara’s 264

Capital Ratio of Ruwan’s and Sandun’s 9:4

According to Garney VS Murray rule amount borne by Ruwan 264 x 9

13

182.76

According to Garney Vs Murray rule amount borne by Sandun 264 x 4

13

81.24



Examples for final accounts in partnership

1. Aruna and Bandara were in partnership business without having a written agreement

for a long period in buying and selling goods. Their financial year ends on March 31

of each year.

October 1, 2015 Chamil was admitted to the partnership business, subject to the

following conditions.

a. Goodwill is valued for 60% of average profit of the last 3 years ended as of the

date on which the goodwill valuation is done. Goodwill is not shown in the

Statement of Financial Positions as an intangible asset.

b. Salary for Aruna Rs.2.000/- per month. Interest will be paid for capital is 6% p.a.

Profit Sharing Ratio, Aruna: Bandara: Chamil =3: 2: 1. 4% interest will be charged

for drawings.

c. It is required to transfer the balances in current account of Bandara and Chamil

into their capital account at the end of each year and the carried down balances of

the capital accounts should be arranged according to the ratio of PSR. For this

exercise capital account of Aruna is considered as the basis. Chamil brought

Rs.250,000/- in cash on October 1, 2015 when he entered into the Partnership

Business.



Following balances were extracted from the trial balance as at March 31, 2016

Debt (Rs.) Credit (Rs.)

Land at cost 920,000

-Receivables and payables 212,500 139,000

Stock as at 01/04/2015 173,000 -

Salaries 123,500 -

Rent 27,500 -

Bank OD - 38,000

Sales - 970,500

Provision for doubtful debt - 6,125

Motor vehicle at cost 260,000 -

Provision for depreciation of motor vehicle - 120,000

Purchases 562,000 -

Stationary 7,000 -

Advertising 18,000 -

Partners drawings 111,000 -

Capital - Aruna - 750,000

- Bandara - 300,000

- Chamil - 250,000

General expenses 16,500 -

Loan of Aruna - 150,000 Cash in hand 292,625 -

2,723,625 2,723,625



The following additional information is also given.

1. Advertising material of Rs.3000/= is included in the stock value of Rs.237,500/-

physically counted on March 31, 2016.

2. Salaries taken by Aruna is also included in the salaries account. Furthermore,

drawings of Aruna and Bandara in each month were Rs. 5,000/- and Rs. 3,000/-

respectively. Chamil has drawn Rs. 2,500 on the 15th of each month starting

October 15, 2015.

3. Rent for the premises Rs. 2500/- per month

4. Motor vehicles are to be depreciated at 20% on reducing balance method

5. Provision for bad debt as at March 31, 2016 should be 5% from the debtors

6. No entries were made for the goods taken by Aruna for the value of Rs. 20,000/-

on January 1,2016 and the goods taken by Chamil on February 1, 2016 for the

value of Rs. 30,000/- as a gift for Bandara’s wedding.

7. Profits in more recent 3 years are as follows

Year ended 31.03.2013 Rs.220, 000/-

Year ended 31.03.2014 Rs.336, 000/-

Profit in 31.03. 2015 Rs.304, 000/-

8 . Interest amounting to Rs.7,500 is payable for the loan taken from Aruna for the

year ended March 31, 2016.

No adjustments have been done in the books required for the admission of Chamil.

Required: Prepare the following:

a. Trading Account and Statement of Comprehensive Income of Aruna,Bandara and

Chamil partnership for the year ended March 31, 2016.

b. Current and capital accounts of partners.

c. The Statement of Financial Positions as at March 31, 2016.



Answer

Trading Account and Statement of Comprehensive Income of Aruna,Bandara

and Chamil partnership for the year ended March 31, 2016

Description Rs Rs Rs

Sales 970,500

970,500Cost of Sales

Stock as at 01.04.2015 173,000

Purchases 562,000

735,000

Drawings in goods [20,000 + 30,000] (50,000)

685,000

Stock as at 31.03.2016 [237,500 – 3,000] (234,500) (450,500)

Gross Profit 520,000

Administration and Establishment

expenseRent 30,000

Salaries (123,500 – 12,000) 111,500

Stationeries 7,000

General expenses 16,500 165,000

Selling and distribution expense

Advertising (18,000 – 3,000) 15,000

Depreciation of Motor Vehicle 28,000

Provision for Doubtful debts 4,500 47,500

Finance expenses

Interest for Aruna’s Loan 7,500 7,500 (220,000)

Profit for the year 300,000

01.04.2015 to

30.09.2015

01.10.2015 to

31.03.2015

Net Profit in the year 150,000 150,000

Add : Interest on drawing

Aruna 683



Bandara 150

Chamil 217

Less: Interest on Capital

Aruna (22,500)

Bandara (9,900)

Chamil (6,600)

Salaries

Aruna (12,000)

Profits

Aruna (50,025)

Bandara (75,000) (33,350)

Chamil (75,000) (16,675)



Aruna, Bandara and Chamil Partnership

Statement of Financial Position as at March 31, 2016

Rs Rs Rs

Assets

Non-current assets Cost Depreciation Net

Property plan and equipment

Free hold land 920,000 - 920,000

Motor vehicle 260,000 148,000 112,000

1,180,000 148,000 1,032,000

Current Assets

Trading stocks 234,500

Advertising material stocks 3,000

Receivable 212,500

Provision for bad doubtful debts (10,625) 201,875

Cash and cash equivalent 292,625 732,000

Total assets 1,764,000

Equity and liabilities

Capital accounts Aruna 750,000

Bandara 500,000

Chamil 250,000 1,500,000

Current Accounts Aruna 54,342

Bandara (87,900)

) Chamil (31,942) (65,500)

1,434,500

Non-current liabilities

38,000

Loan taken from Aruna 150,000

Current Liabilities

Bank OD 38,000

Creditors 139,000

Rent payable 2,500 179,500

Total equity and liabilities 1,764,000



Adjusting the Capital as per PSR

Aruna Bandara Chamil

Capital balance as at 01.10.2015 750,000 300,000 250,000

PSR 3 2 1

Capital by considering Aruna as the basis 750,000 500,000 250,000

Amount to be transferred from current account

- 200,000 -

Advertising

Balance 18,000 Stock 3,000

P and L 15,000

18,000 18,000

Salaries

Balance 123,500 Aruna’s salary 12,000

P and L 111,500

123,500 123,500

Rent

Balance 27,500 P and L 30,000

C/D 2,500

30,000 30000

Drawings

Cash Goods

Aruna 60,000 20,000

Bandara 36,000 --

Chamil 15,000 30,000

111,000 50,000



Current account of partners

Computation of Goodwill


Drawings in cash (60,000) (36,000) (15,000)

Drawings in goods (40,000) - (10,000) Interest on drawings (683) (150) (217) Profits shares in 1st 6 months 75,000 75,000 -

Loan interest of Aruna 7,500 - - Interest on Capital 22,500 9,900 6,600 Profit share in last 6 months 50,025 33,350 16,675 Transfer to Capital Accounts - (170,000) (30,000)

Balance as at 31.03.2016 54,342 (87900)

((87,900)

(31,942)

Computation of interest on drawings Rs.

Aruna 30,000 x 4/100 X 3 ½ /12 + 20,000 X 4/100 X 3/12+

20,000 X 4/100 X 2/12

683

Bandara 18,000 x 4/100 X 2 ½ /12 150

Chamil 15,000 x 4/100 X 3/12 + 10,000 X 4/100 X 2/12 217

1,050

Goodwill on the date Chamil's admission

Year Net profit

2012/2013 (6 Months) 110,000

2013/2014 336,000 2014/2015 304,000

2015/2016 (6 Months) 150,000

900,000 x 60%

3

180,000



Capital account of Partners


Capital balances 750,000 300,000 250,000

Goodwill adjustment 90,000 90,000 -

Eliminating the Goodwill (90,000) (60,000) (30,000)

Transfer from Current A/C on 31.03.2016 - 170,000 30,000

Balance as at 31.03. 2016 750,000 500,000 250,000




Introduction to Company Accounting

Accounting for issue of shares

The double entries to record raising of finance by issue of shares are provided below.

Consideration received on application (issue price x no. of shares applied for).

Bank Account Debit

Application and Allotment Account Credit

When shares are allotted (Issue price x No. of shares allotted)

Application and Allotment Account Debit

Stated Capital Account Credit

There may be a situation of oversubscription of a share issue. Then, the excess money

received should be returned to the applicants when shares are allotted. The double entry

to record this return of excess money is;

Application and Allotment Account Debit

Bank Account Credit

Example 1

Big Plc issues 10Mn shares at a price of Rs.25.00 each. Applications have been received

for Rs. 10Mn shares and they have been allocated accordingly. Prepare the book-keeping

entries to record this share issue.

Answer

Receipts of consideration on application ( for 10Mn shares x Rs.25 each = 250Mn)

Bank Account Debit Rs. 250Mn

Application and Allotment Account Credit Rs.250Mn

Allotment of Shares (10Mn shares x Rs.25 each = 250Mn)

Application and Allotment Account Debit Rs. 250Mn

Stated Capital Account Credit Rs. 250Mn



Application Allotment Account

Stated Capital Account 250Mn Bank Account 250Mn

250Mn 250Mn

Stated Capital Account

Balance C/F 250Mn Application and

Allotment Account

250Mn

250Mn 250Mn

Balance B/F 250Mn

Example 2

Big Plc issues 20Mn shares at a price of Rs. 25 each. Applications had been received for

30Mn shares and the excess application money was rejected when allotting shares.

Prepare the book-keeping entries to record this share issue.

Answer

Receipts of consideration on application ( for 30Mn shares x Rs.25 each = 750Mn)

Bank Account Debit Rs. 750Mn

Application and Allotment Account Credit Rs.750Mn

Allotment of Shares (10Mn shares x Rs.25 each = 250Mn)

Application and Allotment Account Debit Rs. 250Mn

Stated Capital Account Credit Rs. 250Mn

Application Allotment Account

Bank Account 250Mn Bank Account 750Mn

Stated Capital Account 500Mn

750Mn 750Mn



Stated Capital Account

Sometimes, shares may not be paid in full upon issue. The consideration for a share may

be called in number of steps such as on application, on allotment and on series of calls.

Balance C/F 500Mn Application and

Allotment Account

500Mn

500Mn 500Mn

Balance B/F 500Mn




Preparation of Financial Statements for Companies

Learning Outcome 4.1.2/4.1.3

Format to be used in preparing the financial statements for internal use is given below with two

examples.

Specimen statement of Profit & Loss Account for Internal Management purpose.



XYZ Plc

Statement of profit & Loss Account for the year ended March 31, 2016

Rs. Rs.

Revenue xxxx

Less: cost of sales

Stocks as at April 1, 2015 xxxx

Add: Purchases xxxx

Carriage inwards xxxx

xxxx

Less: closing stock (xxxx)

Stocks lost (xxxx)

Cost of Sales (xxxx)

Gross profit xxxx

Add: Other income xxxx

Less : expenses

Administration expenses

Building rent (xxxx)

Staff wages (xxxx)

Insurance (xxxx) (xxxx)

Selling & distribution expenses (xxxx)

Commissions (xxxx)

Advertising cost (xxxx)

Salaries and wages – sales and delivery staff (xxxx)

Finance cost (xxxx)

Interest paid on loan (xxxx)

xxxx

Profit before tax xxxx

Less: income tax (xxxx)

Profit for the year xxxx



Example 1

Hiruka (Pvt) Ltd has been carrying on a business of importing, local buying, whole sale and

retail selling of motor vehicle spare parts. Following trial balance was extracted from the

books of Hiruka (Pvt) Ltd as at March 31, 2012.

Trial balance as at March 31, 2012 (Rs. ‘000)

Particulars Debit

(Rs. ‘000)

Credit

(Rs. ‘000)

Stated capital 50,000 Retained profit 18,240 Land 10,500 Buildings 20,500 Motor vehicles 27,700

Equipment, tools and computers 18,500 Sales 275,120 Cash in hand 275 Salaries and wages – sales and delivery

Office

12,750 - Office staff 4,500

Stock as at April 1, 2011 77,400 Provisions for depreciation as at April 1, 2011

- Buildings 6,800

- Motor Vehicles 11,400 - Equipment, tools and computers 13,500

Purchases - Imports 124,350 - Local purchases 15,530

Income tax 1,750

Overtime - sales staff 2,750 Import duty and clearance 2,450 Fixed deposit (12%) 25,000 Trade debtors 28,500 Insurance- Building 500

Motor Vehicles 750 Equipment and computers 200

Sales promotion 12,850 Business promotion expenses 2,550 Bank overdraft 1,650 Creditors control account 37,250 EPF & ETF - sales and delivery

- office

1,830 - Office 640



Electricity 2,670

Water 550 Security charges 2,440 Stationery 1,230 Building maintenance 122 Fuel expenses 7,430 Vehicle maintenance 5,350 Donation 500 Audit fees 250 Provision for bad debts 2,250 Discounts 600 VAT payable 1,290 Carriage inwards 320 Overdraft Interest 280 Bad debts written off 2,210 Sales returns 120 Telephone 198 Other administration expenses 1,455

417,500 417,500

The following information is also available for your consideration.

(1) Value of physical stocks as at March 31, 2012 was Rs. 71,550,000.

Spare parts stocks costing Rs.2, 500,000 (sold for Rs. 5,000,000 to a wholesale

customer) awaiting collection by the wholesale customer was included in the above

closing stock of the business as at March 31, 2012.

(2) Annual insurance premium of Rs. 300,000 was paid for building insurance for the

period December 1, 2011 to November 30, 2012, and this amount has been debited

to the building insurance account.

(3)

(4)

New oil filters used for three wheelers costing Rs. 50,000 were distributed during

the year as free samples. However no entries have been recorded in the financial

statements in this regard.

A motor lorry that had a cost of Rs. 8 Mn and accumulated depreciation of Rs. 3.2

Mn as at April 1, 2011 was given in part exchange for a new motor lorry costing Rs.

10 Mn on October 1, 2011, and an invoice for the net amount payable of Rs. 4 Mn was

paid by a cheque. The accountant has debited the motor vehicle maintenance account

with Rs. 4 Mn and credited the bank account with Rs.4 Mn and no other entries

have been recorded in the books of account.



(5) Depreciation should be provided at the following rates per annum on straight line

basis.

Buildings - 2% Equipment, tools and computers - 20% Motor vehicles - 20%

(6) The following expenses need to be accrued as at March 31,2012.

Rs.

Electricity 550,000

Security 120,000

Water 20,000

(7) Bank balance shown in the trial balance was extracted prior to the preparation of bank

reconciliation statement for the month of March 2012. Upon preparing the bank

reconciliation the followings were noted.

A cheque received from a debtor amounting to Rs. 500,000 was deposited in

the bank on March 25, 2012. This cheque has been dishonoured by the bank on

March 28, 2012 and a bank charge of Rs. 3,000 has been charged as a fee.

However none of the above actions have been recorded in the books of the

business.

Overdraft interest amounting to Rs. 25,000 has been charged by the bank for

the month of March 2012. This has not been recorded in the books of the

business.

A cheque payment made to a supplier amounting to Rs. 250,000 has been

debited to the Hiruka’s business bank account as Rs. 520,000 by the bank.

(8) Trade debtors shown in the trial balance include debts outstanding for more than one

year amounting to Rs. 2.7 Mn. It was identified that Rs. 1.7 Mn of the above is not

recoverable and needs to be written off. Further it was decided to provide a specific

bad and doubtful debt provision of 50% for a customer whose outstanding balance as

at March 31, 2012 was of Rs.1Mn.

General provision for debts should be made for the total debtors outstanding except

above Rs. 2.7 Mn at 10%.



(9) The trade creditors control account balance included in the trial balance does not agree

with the totals of the creditor’s ledger. The followings were noted during the review of

creditors control account and the creditor’s ledger.

A batch total of local credit purchases of spare parts amounting to Rs. 875,000 have

been entered in the double entry system as Rs. 785,000. However, individual ledger

account entries were done correctly in the creditor’s account.

Interest charged by the suppliers for delay in payments amounting to Rs. 50,000 has

not been recorded in the control account. However, this transaction has been correctly

recorded in the creditor’s ledger.

Discount received from the suppliers for prompt payments amounting to Rs. 100,000

has not been recorded in the creditor’s ledger, even though this has been correctly

recorded in the creditor’s control account.

(10) Fixed deposit balance shown in the trial balance was the balance held as at April 1,

2011. Interest on this fixed deposit for the financial year 2011/2012 has not been

recognised in the books of accounts.

Required,

Prepare the followings for the use of internal management of the business.

(a) Statement of profit & loss and other comprehensive income for the year ended

March 31, 2012.

(b) Statement of Financial Position as at March 31, 2012



Example 2

Haymal (Pvt) Ltd has been in the business of manufacturing and selling of components

used in washing machines. The trial balance of his business as at March 31, 2016 is as

follows.

Haymal’s Business (Pvt) Ltd

Trial Balance as at March 31, 2016

Debit

(Rs. '000)

Credit

(Rs. '000)

Stated Capital 150,000

Retained Profit 22,400

Land 57,500 Office building 25,000

Plant & Machinery 62,500

Motor vehicles 18,200

Equipment 5,400 Accumulated Depreciation – April 1, 2016

- Office building

- Plant & Machinery

- Motor vehicles

- Equipment

12,000 34,600 11,800

2,700

Inventories – April 1, 2016

- Raw materials

- Finished goods

- Work in progress

16,400 73,800

4,100

Purchases – raw materials 193,200 Sales 419,600 Provision for bad debts 7,200 Sales returns 12,400 Trade receivables / Trade payables 93,500 47,700 Purchase returns 8,200 Wages 48,400 Administration salaries 6,250 Electricity 37,400

Machinery maintenance 11,380

Insurance 7,800 Security 5,500



Sales promotion 9,200 Discounts 2,630 3,800

Other factory overheads 12,480 VAT payable 18,320 Disallowed input VAT 2,220 Sale of plant 7,500 Long term loan 40,000 Loan interest 6,850 Staff loan 2,800 Rent of factory building 7,200 Other administration expenses 11,500 Other selling expenses 14,600 Wages of maintenance staff 2,860 Import duty & carriage inwards 4,650 Investment in fixed deposit 25,000 Cash & cash equivalents 2,500 Suspense account 2,600

785,820 785,820

The following additional information is also available for your consideration.

1. Value of inventories as at March 31, 2016 was as follows.

Raw materials - Rs. 23.7 Mn

Work in progress - Rs. 2.2 Mn

Finished goods - Rs. 7.5 Mn

1.1 The above raw materials include damaged materials costing Rs.4 Mn. Managing

Director is of the view that these materials could not be used in production. However,

he is confident that he could sell these materials for Rs. 1.5 Mn after incurring a selling

cost of Rs. 100,000.

1.2 A customer returned finished goods sold at a price of Rs. 1.2 Mn on March 30, 2016.

However, this event was not recorded in the books of accounts of the business even

on March 31, 2016. But the value of these goods has been included in the above

finished goods at the above price. Haymal maintains a gross profit of 20% on the cost

of products sold. The above amount is shown under trade receivables as at March

31, 2016 as an amount receivable from the customer.



1.3 Finished goods costing Rs. 2 Mn was set aside in the stores for a special order placed

by one of the customers. Sale transaction relating to the above took place on April 1,

2016, where the business raised an invoice for the customer amounting to Rs. 2.4

Mn. However, the value of this stock has not been included in the balance of

finished goods shown above.

2. Goods costing Rs. 2 Mn was robbed while in transit from factory to stores on

February 20, 2016. Stocks in transit have been insured for Rs. 1.5 Mn. Insurance

company has confirmed that it will pay the sum insured in full. Accounting entries

relating to above events have not been recorded in the books of accounts of the

business.

3. Trial balance of Haymal’s as at March 31, 2016 did not agree, and the difference was

transferred to a suspense account. Subsequently the following errors were identified

in reviewing the accuracy of accounting records.

(i) Electricity bill paid in the month of January 2016 amounting to Rs. 2.8 M n had

been recorded in the electricity account as Rs. 8.2 Mn

(ii) Factory rent paid amounting to Rs. 1.2 Mn had been omitted from factory rent

account.

(iii)Credit purchases amounting to Rs. 5.7 Mn from Saman were recorded in Trade

payables account as Rs. 7.5 Mn. However this transaction has been correctly

recorded in the purchase account.

(iv) Rs.5 Mn received from a debtor of the business has been credited twice to debtors

control account.

4. Trade receivables amounting to Rs. 8 Mn need to be written off as bad debts.

Provision for bad debts should be kept at 5% of the trade receivables (net) outstanding

as at March 31, 2016.

5. A plant which was acquired on April 1, 2016 for Rs. 20 Mn was disposed of Rs. 7.5 Mn

on December 3 1 , 2015. Sale proceeds received have been debited to cash book and

credited to sale of plant account. No other entries have been made in the books of

account of the business in this regard.



6. Property, plant & equipment should be depreciated using straight line method

at following rates.

Office building - 5% per annum

Plant & Machinery - 12.5% per annum

Motor vehicles - 20% per annum

Equipment - 25% per annum

7. The followings need to be accrued as at 31/03/2016.

Electricity - Rs. 2.3 Mn

Security - Rs. 0.8 Mn

Insurance - Rs. 1.2 Mn

8. The following expenses are to be apportioned as follows.

Factory Administration Sales

Electricity 60% 30% 10%

Security 50% 40% 10%

Insurance 40% 30% 30%

Maintenance wages 60% 40% -

9. Investment in fixed deposit was made on January 1, 2016. Bank has offered an

interest at the rate of 16% per annum. However, no interest income has been

recognised in the 2015/2016 financial statements of the business.

You are required to prepare the followings for the use of internal management of the

business.

(a) Manufacturing Account for the year ended on March 31, 2016

(b) Statement of Comprehensive Income for the year ended on March 31, 2016

(c) Statement of Financial Position as at March 31, 2016



Heading: 10 Consolidated financial statement (Learning Outcome 3.2.4) Page No. 466

Further details related to consolidated financial statement is discussed below with

examples.

Consolidated financial statements

Many large business organisations consist of several companies controlled by one central

or administrative company. These companies put together are called a group. The

controlling company is called the parent/holding company and it will own all or some

shares in other companies, called subsidiaries. In Sri Lanka, companies Act No 07 of 2007

requires that the results of a group should be presented as a single economic entity.

There are many reasons for one company to buy shares in another company.

Some of them include;

A company may acquire shares in a supplier to ensure continued supply.

A company may buy shares in a customer to secure a distribution network

Tax or legal reasons

Where one company controls another, there is a parent subsidiary relationship. In most

cases, control is achieved where the parent company owns a majority of the ordinary

shares in the subsidiary. SLFRS 10 requires that the results of a parent company and its

subsidiaries are consolidated and consolidated financial statements to be prepared.

Consolidated financial statements are the financial statements of a group which the

assets, liabilities, equity, income, expenses and cash flows of the parent and its

subsidiaries are presented as those of a single economic entity. When a parent issues

consolidated financial statements, it should consolidate all subsidiaries, both foreign and

domestic.

Process of consolidation

The consolidation process involves adding together the assets, liabilities, equity, income

and expenses of the parent company and subsidiaries on a line by line basis.



Process of preparing consolidated statement of financial position

The statement of financial position of a parent and its subsidiaries are combined on a line

by line basis by adding together the items like assets, liabilities and equity.

The following two procedures are then performed in order to prepare the consolidated

statement of financial position.

(a) Take the individual accounts of the parent company and each subsidiary and

cancel items which appear as an asset in one company and a liability/ equity on

another.

(b) Add together all the uncancelled assets and liabilities throughout the group.

Items requiring cancellation may include the following;

I. The asset “investment in subsidiary companies” which appears in the parent

company’s accounts will be cancelled with the equity “Stated capital” in the

subsidiaries accounts.

II. There may be intra group trading within the group. For example, parent company

may sell goods on credit to subsidiary company. As a result subsidiary company

would be a receivable one in the accounts of the parent company, while the parent

company would be a payable one in the accounts of the subsidiary company.



Example:

The statement of financial position of parent company (P PLC) and subsidiary company

(S PLC) as at March 31, 2015 is given below;

P PLC acquired 100% of equity capital of S PLC from the date of incorporation of S PLC. P

PLC sells goods on credit to S PLC.

Statement of financial position as at March 31, 2015.

P PLC

(Rs 000)

S PLC

(Rs 000)

No current assets

Property plant & equipment 50,000 30,000

Investment in S PLC (3Mn shares @

10% each)

30,000 -

Current assets

Inventories 24,000 6,000

Receivable from S PLC 5,000 -

Other trade receivables 18,000 4,000

Cash and cash equivalents 3,000 5,000

50,000 15,000

Total assets 130,000 45,000

Equity

Stated capital 75,000 30,000

Retained profit 15,000 5,000

90,000 35,000

Current liabilities

Payable to P PLC - 5,000

Other trade payables 40,000 5,000

40,000 10,000

Total equity & liabilities 130,000 45,000



You are required to prepare the consolidated statement of financial position of P PLC as

at March 31, 2015.

Solution

The cancelling items are;

a) P PLC’s asset “investment in shares of S PLC’s” amounting to Rs. 30 Mn should be

cancelled with S PLC’s stated capital of Rs. 30 Mn.

b) P PLC’s assets “recivable from S PLC" amounting to Rs. 5 Mn should be cancelled

with S PLC’s payable to P PLC amounting to Rs. 5 Mn”

The remaining assets and liabilities are added together to produce the following

consolidated statement of financial position.

P PLC,

Consolidated statement of financial position as at March 31, 2015

Rs. 000

Non-current assets

Property plant & equipment 80,000

Current assets

Inventories 30,000

Other trade receivables 22,000

Cash and cash equivalents 8,000

60,000

Total assets 140,000

Equity

Stated equity 75,000

Retained earnings 20,000

95,000

Current liabilities

Other trade payables 45,000

Total equity & liabilities 140,000

Consolidated statement of profit or loss

The statement of profit or loss of a parent company and its subsidiaries are added on a

line by line basis by adding together the items of income and expenditure. Consolidation

adjustment may then be required.



Example 1:

P PLC acquired 100% of the ordinary shares of S PLC on that company’s incorporation on

April 1, 2014. The statement of profit or loss of the two companies for the year ended on

March 31, 2015 is set out below.

P PLC (Rs 000) S PLC (Rs 000)

Revenue 80,000 50,000

Less: Cost of sales (45,000) (28,000)

Gross profit 35,000 22,000

Less: Expenses

Administration expenses (12,000) (8,000)

Selling and distribution

expenses

(8,000) (5,000)

Finance cost (5,000) (1,000)

Profit before tax 10,000 8,000

Income tax (2,000) (1,000)

Profit for the year 8,000 7,000

You are required to prepare the consolidated statement of profit or loss for P PLC group,

for the year ended March 31, 2015.

Answer

P PLC, Consolidated statement of profit or loss for the year ended March 31, 2015

Rs. 000

Revenue 130,000

Less: Cost of sales (73,000)

Gross profit 57,000

Less: Expenses

Administration expenses (20,000)

Selling and distribution expenses (13,000)

Finance cost (6,000)

Profit before tax 18,000

Income tax (3.000)




Consolidation adjustments

1. Non-controlling interest

When the parent company does not own 100% of ordinary shares of a subsidiary, non-

controlling adjustment needs to be done. For example if the parent company owns

80% of ordinary shares of a subsidiary, balance 20% of ordinary shares are owned by

non-controlling shareholders. Therefore 20% of the profit earned by the subsidiary

belongs to non-controlling shareholders. As a result profit belonging to non-

controlling shareholders needs to be shown separately in the consolidated statement

of profit or loss.

2. Intra group trading

The consolidated statement of profit or loss should be dealt with the results of the

group as those of a single entity. When one company of a group of companies sells

goods to another company, the relevant amount is added to the sales revenue of the

first company and to the cost of sales of the second company. However this is a

transaction taking place within the group of companies.

The consolidated figures for sales revenue and cost of sales should represent sales to

the outsiders and purchase from the outsiders. An adjustment is therefore required to

reduce the sales revenue and cost of sales by the value of intra group sales during the

year.

Example:

P PLC acquired 80% of ordinary shares of S PLC on April 1, 2014, the date S PLC was

incorporated as a limited liability company. The statement of profit or loss of the two

companies for the year ended on March 31, 2015 is set out below.

P PLC (Rs 000) S PLC (Rs 000)

Revenue 80,000 50,000

Less: Cost of sales (45,000) (28,000)

Gross profit 35,000 22,000

Less: Expenses

Administration expenses (12,000) (8,000)

Selling and distribution expenses (8,000) (5,000)

Finance cost (5,000) (1,000)

Profit before tax 10,000 8,000

Income tax (2,000) (1,000)

Profit for the year 8,000 7,000



During the year ended on March 31, 2015 P PLC sold goods worth of Rs. 10 Mn to S PLC.

S PLC sold all goods purchased from P PLC, as of March 31, 2015.

Prepare the consolidated statement of profit or loss of P PLC group for the period ended

on March 31, 2015.

Answer

P PLC

Consolidated statement of profit or loss for the year ended on March 31, 2015

Rs’ 000

Revenue 120,000

Less: Cost of sales (63,000)

Gross profit 57,000

Less: Expenses

Administration of expenses (20,000)

Selling & Distribution expenses (13,000)

Finance cost (6,000)

(39,000)

Profit before tax 18,000

Income tax (3,000)


Profit attributable to non-controlling shareholders 1,400

Profit attributable to parent 13,600

15,000

Workings

1. Consolidated Revenue = Revenue of P PLC + Revenue of S PLC –

Inter-company sales

= 80,000 + 50,000 - 10,000

= 120,000

2. Consolidated cost of sales = Cost of sales of P PLC + Cost of sales of S PLC –

Inter group purchases

= 45,000 + 28,000 - 10,000

= 63,000

Profit attributable to non-controlling interest shareholders

Profit of S PLC for the year = 7,000

Non-controlling interest = 20%

Profit attributable to non-controlling interest shareholders = 7,000 x 20%

= 1,400



Heading 8 : LKAS 18 Learning Outcome 4.3.1 Page No.458

Criteria to be satisfied to recognise revenue from, the sale of goods and rendering of sources

are explained. Furthermore, how to recognise interest, dividend and royalties income are

also explained in this document.

Revenue Recognition (LKAS 18)

Identification of transactions

The recognition criteria in this standard are usually applied separately to each

transaction. In certain circumstances, it is necessary to apply the recognition criteria

to the separately identifiable components of a single transaction in order to reflect

the substance of the transaction. For example, when the selling price of a product

includes an identifiable amount for subsequent servicing, that amount is deferred and

recognised as revenue over the period during which the service is performed.

Conversely, the recognition criteria is applied to two or more transactions together

with which they are linked in such a way that commercial effect can not be understood

without reference to the series of transactions as a whole.

For example, an enterprise may sell goods and at the same time enter into a separate

agreement to purchase the goods at a later date, thus negating the substantive effect of

the transaction. In such a case, the two transactions are dealt together.

Sale of goods

Revenue from sale of goods should be recognised when all the following conditions

are satisfied.

a) The enterprise has transferred to the buyer the significant risks and rewards of

ownership of the goods.

b) The enterprise retains neither continuing managerial involvement to the degree

usually associated with ownership nor effective control over the goods sold.

c) The amount of revenue can be measured reliably.

d) It is probable that economic benefits associated with the transaction will flow to the

enterprise.

e) The cost incurred or to be incurred in respect of the transaction can be measured

reliably.



The assessment of when an enterprise has transferred the significant risks and

rewards of ownership to the buyer requires an examination of the circumstances of

the transaction. In most of the cases, the transfer of the risks and rewards of ownership

coincides with the transfer of risk of the legal title or the passing of possession to the

buyer. This is the case for most retail sales. In other cases, the transfer of risks and

rewards of ownership occurs at a different time from the transfer of legal title or the

passing of possession.

If the inflow of economic benefit is confirmed, revenue should be recognised. However,

if the realisation of revenue value included in the revenue is doubtful, the amount that

may not be realised has to be treated as an expense and not permitted to be adjusted

for the already identified revenue.

As an example, the revenue of a transaction of sale of a particular good is recognised

as Rs 100,000 and if it is expected that Rs 75,000 which has not been received as yet

is not receivable even in future, this Rs 75,000 should be treated as an expense and not

be adjusted for the income.

If there are revenue and expenditure to a particular transaction, the identification of

both revenue and expenditure should be made simultaneously. This process is known as

matching the revenue and expense. If it is difficult to identify reliably the expenditure of

a transaction, the corresponding income should not be recognised and if there is any

receipt collected in advance, it should be considered as a liability.

Rendering of Services

When the outcome of a transaction involving the rendering of services can be

estimated reliably, revenue associated with the transaction should be recognised by

reference to the stage of completion of the transaction at the Statement of Financial

Position date. The outcome of a transaction can be estimated reliably when all the

following conditions are satisfied.

a) The amount of revenue can be measured reliably.

b) It is probable that the economic benefits associated with the transaction will flow

to the enterprise.

c) The stage of completion of the transaction at the balance sheet date can be

measured reliably.

d) The cost incurred for the transaction and the cost to complete the transaction can

be measured reliably.



The completed level of a transaction is considered at the Statement of Financial Position

date by using the percentage of completion method. According to this method, revenue

relevant for the period during which the service is rendered is properly identified and

this method is recommended even by LKAS 11. Revenue should be recognised only

when the receipt of economic benefits is confirmed. However, if there is a doubt of

realising the amount of revenue already recognised as revenue, that amount of revenue

should not be adjusted for the revenue already identified and it has to be treated as an

expenditure.

There are so many methods for computing the completion percentage of a transaction

and the most reliable method should be applied by the enterprise to estimate the value

of the services already rendered.

Following are some methods that can be used according to the nature of the

transaction.

a) A certificate issued by some expert regarding the work completed up to now.

b) Considering the already provided service as a percentage of total service to be

rendered.

c) Considering the provided service up to the Statement of Financial Position date as

a percentage of total service to be rendered.

If a particular activity is more important when comparing with the other activities,

revenue recognition is deferred till the completion of that special activity. In a

transaction relating to providing the service and if it is difficult to estimate the

value of final product, only the identified expenses and the probable receipts

can be recognised as the revenue. As an example, the expenses incurred up to

now are only Rs 500,000 of a project of which the final outcome cannot be

identified as yet and if the recoverability of that amount is confirmed, only that

amount [ Rs 500,000] can be recognised as the revenue.



Interest, Dividends and Royalties

This revenue is recognised only,

a) It is probable that the economic benefits associated with the transaction will flow

to the enterprise.

b) The amount of the revenue can be measured reliably.

Revenue should be recognised on the following basis.

a) Interest should be recognised on a time proportion basis that takes into

account the effective yield on the asset.

b) Royalties should be recognised on an accrual basis in accordance with

the substance of the relevant agreement.

c) Dividends should be recognised when the shareholders' right to receive

payment is established.

When unpaid interest is accrued before the acquisition of an interest bearing

investment, the subsequent receipt of interest is allocated between pre acquisition and

post-acquisition periods. Only the post-acquisition portion is recognised as revenue.




Interpretation of Financial Statements

Profitability & Return

Profitability ratios

(a) Gross profit as a percentage of sales

(b) Net profit as a percentage of sales

(c) Asset turnover ratio

Gross profit as a percentage of sales

This measures the gross margin earned on revenue by a company before taking into

account of overhead costs. This can be computed as follows.

Gross profit ratio = Gross profit x 100

Sales

Example

The following data relates to Big PLC for the year ended on 31st March 2016.

Sales / Revenue Rs. 500 Mn

Cost of Sales Rs. 200 Mn

Gross profit Rs. 300 Mn

Compute the gross profit ratio

Gross profit ratio = 300 Mn x 100

500 Mn

= 60%

This means the business earns a gross profit of Rs. 60 from every sale of Rs. 100.

Generally this ratio does not fluctuate from year to year. If there is a charge in gross

profit ratio, the reasons for it should be investigated.



Net profit as a percentage of sales

This ratio shows the relationship between the net profit and sales. It is calculated as

follows.

Net profit ratio = Net profit x 100

Sales

Example: The following data relates to Big PLC

Sales Rs. 500 Mn

Net profit Rs. 100 Mn

Compute the net profit ratio

Net profit ratio = 100 x 100

500

= 20%

This means that the business earns a net profit of Rs. 20 from a sale of 100.

Assets Turnover ratio

This ratio measures the efficiency of generating sales from the assets invested in a

company. It can be calculated as follows.

Asset Turnover ratio = Sales

Average total assets