<?page no="1"?> Carsten Berkau Basics of Accounting Accounting <?page no="3"?> Carsten Berkau Basics of Accounting Accounting Edition UVK Verlagsgesellschaft mbH · Konstanz und München <?page no="4"?> Bibliografische Information der Deutschen Bibliothek Die Deutsche Bibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über <http: / / dnb.ddb.de> abrufbar. ISBN 978-3-86764- - Das Werk einschließlich aller seiner Teile ist urheberrechtlich geschützt. Jede Verwertung außerhalb der engen Grenzen des Urheberrechtsgesetzes ist ohne Zustimmung des Verlages unzulässig und strafbar. Das gilt insbesondere für Vervielfältigungen, Übersetzungen, Mikroverfilmungen und die Einspeicherung und Verarbeitung in elektronischen Systemen. © UVK Verlagsgesellschaft mbH, Konstanz und München 201 Einbandgestaltung: Susanne Fuellhaas, Konstanz UVK Verlagsgesellschaft mbH Schützenstr. 24 · 78462 Konstanz Tel. 07531-9053-0 · Fax 07531-9053-98 www.uvk.de <?page no="6"?> Section (A) is an introduction to Accounting. We familiarise you with the subject and to make understood what Accounting is good for. We take a look at Accounting from the company’s point of view and the investor’s one. Section (A) contains the chapters 2 … 5. Section (B) introduces financial statements as purpose of Accounting. We smoothly provide you with a first glance at Bookkeeping. We explain the preparation of financial statements by three simple case studies. We go through the balance sheet and the income statement (major financial statements) and explain every item you find therein. This text book won’t make you a professional Bookkeeper however you quickly understand how Accounting works and what basic postings for academic and practical cases are. We ignore formal aspects and reduce Accounting to what is necessary for managers. Section (B) contains chapters 6 … 15. Section (C) is named Financial Ac-counting and requires some sort of ad-vanced Bookkeeping. Besides the re-cording of business activities, it pro-vides you with further insights of a Bookkeeper’s work when preparing fi-nancial statements. You learn detail problems of Financial Accounting that are paramount for taking a manage-ment position in a company. In many universities section (A) and (B) are taught as preparatory classes or as self-study course. With this book and the online materials from our web-site www.UVK-Luci us.de/ Bilanzen you will be able to learn how to prepare financial statements easily. Section (C) nor mally is allocated to the first Accounting class, often called Financial Accounting. Section (C) contains the chapters 16 … 39. You actually can change the sequence inside of section (C) and learn along your own preferences. <?page no="7"?> From the 5 th edition onwards, we publish our text book Basics of Accounting as two parts: Part (1) is about Bookkeeping and Financial Accounting and part (2) covers Managerial Accounting. The 1 st book Basics of Accounting was published in 2013. It is a preparatory course for Accounting classes in universities and supports the text book Berkau, C.: Bilanzen/ Financial Accounting along IFRSs). Accounting is an instrument for controlling the business. Managers must report by financial statements, too. As a result, they “think Accounting”. Actions taken by managers and the results thereof are scrutinised with regard to effects on profit, financial position and cash flows. Accounting is the language of management. This text book teaches you the basic vocabulary and the grammar of Accounting. In part (1), three sections are covered: (A) Introduction to Accounting (selfstudy) (B) First Steps in Bookkeeping (selfstudy) (C) Financial Accounting This text book is based on an international Accounting syllabus. It covers Accounting from a manager’s point of view. In contrast to many German text books, we do not teach Bookkeeping for the preparation of tax statements nor do we follow formal requirements of Accounting, such as the German Abgabenordnung AO. We only focus on Accounting for commercial financial statements. This is exactly what most international Accounting Schools teach worldwide, too. Basics of Accounting is a text book to learn Accounting from scratch on. We do not expect any knowledge from our readers but a good feeling for and an interest in business. Our approach is teaching based on case studies. We introduce methods of Accounting and explain them basically. Then we show the application by easily understandable cases. As we address international students we teach along an international Accounting syllabus and we write in English. With the separation of our basics, Part (1) now is about Bookkeeping and an introduction to Financial Accounting and Part (2) is about Managerial Accounting. In general, the two parts are taught at universities as two separate subjects, too. We recommend reading our Basics of Accounting in the sequence: Part (1) before part (2). However, part (2) contains a summary of Financial Accounting to make it independent from part (1). After studying this text book, you understand Accounting as an instrument to prepare financial statements. You achieve knowledge of how to run an Accounting system and you understand the steps therein. You can make Bookkeeping entries and develop an idea how to run Accounting software in a company. You gain systemic competences which means you’ll know what data input is required for Accounting and where to retrieve it from, in particular from the Bookkeeping system. You further understand the <?page no="8"?> regulations of Accounting by national law and the International Accounting Standards IFRSs. This books helps you to develop communication skills to discuss the subject in business based on its widely used technical terms. To put it simple: You know how Accounting works and you understand what Accountants say. We teach Accounting as an international subject in English. We primary do not target students who intend to start a career as tax lawyer and/ or auditor or Chartered Accountant and therefor major in Accounting. For those students, statements based on national tax law have a higher importance and in general are taught before commercial financial statements are covered. For those students our book falls under entrance level books in international Accounting. For this reason, we named our book deliberately ‘Basics of Accounting. We are making the attempt to teach Accounting on a sufficient sophisticated Management level but with a moderate and appropriate workload for our readers and students. In our home university we let tutors present sections of this book which are marked self-study. This text book (Part 1) starts on level zero and takes you to the Accounting requirements for managers within less than 550 pages. Bookkeeping is no science but a technique. By practising Accounting you become more and more self-confident and feel safe. Visit our website on www.uvk-lucius.de/ Bilanzen, where you’ll find a whole lot of exercises and examination tasks including detailed solutions. This should help you to prepare your Accounting exam efficiently. The case-based teaching method requires that you study the provided case studies with perseverance, best you take a calculator and recalculate the tables and accounts we provide you with. Even if you attend tutorials, work active and recalculate the cases. Take the time to understand the calculations properly! Only after you applied Accounting yourself you will be able to understand it. We strictly avoid buzz word hopping. We teach all methods that clearly that you can apply them. Later, you must be able to do what you are talking about. In order to make the subject as simple as possible, we apply consistent formats and standards over the whole text book. You will also notice that all exhibits appear similar. As it is internationally common practice, we use accounts for explanations because they show you not only the additions and deductions but the cost flows, too. We are keen to explain every calculation and print results in bold fonts, so you find calculations in the text easily. For your help, we inserted paragraphs titled “How it is done” in order to give you guidance when you go through the steps of calculation. In case your professor gives you an open book exam, these paragraphs can turn out to become pretty helpful as they show Accounting similar to a recipe in a cooking book. <?page no="9"?> We are writing this text book as an international team from Germany and South Africa. Most of the case studies are derived from Carsten’s teaching as an Accounting professor at Hochschule Osnabrück and its partner universities in China, Malaysia, in the Netherlands, South Africa and South Korea. Keabetswe is responsible for the language. As Accountant and native speaker, she edited the text making it proper English and easily understandable. We thank Dr. Jürgen Schechler from UVK-Lucius publisher in Munich, who is our lector. He endorses our book projects and provides us with a very nice and friendly atmosphere for our writing. He manages to make the text book affordable for our students by controlling the printing costs. Enjoy Accounting and become a good Accountant/ Manager! Cape Town, in March 201 Keabetswe and Carsten Berkau <?page no="11"?> In this text book, the below listed conventions apply in order to simplify the cases. These conventions are about legal forms, tax rates, formats, etc. They also apply for examples and exercises you’ll find online on the UVK- Lucius.de-website. At this stage of reading, you won’t understand them all, we just put them at the beginning of the book for you to find them easily and upfront. Note, that they apply for the whole book. They come in alphabetic order below. Account Names: All names of accounts in the text book for Bookkeeping entries are written with capital letters in the text, such as ‘Cash/ Bank account’. We intent you to focus on the accounts for financial statement preparation. However, an account that is not subject to our recordings in the company is written with small letters. Assume there is a bank account with Deutsche Bank and we refer to that account. In that situation, the writing is with small letters: bank account. We do not make Bookkeeping entries therein, but Deutsche Bank AG does. Accounting Periods: Accounting periods always start on 1.01. and end on 31.12. Furthermore, to keep the examples transferable to later classes, we indicate the decade by an X, as in 20X4. X is followed by Y and Z. Alphabetic Order: For all lists, we apply an alphabetic order. Bookkeeping Entries: All Bookkeeping entries are printed in bold and cover the whole page’s width. This way we move them into the centre of the text to give them special attention. Bookkeeping Entries: We write the Bookkeeping entries as debit entries and credit entries. DR stands for debit recorded and CR for credit recorded. All Bookkeeping entries are printed in bold. See, i.e. the Bookkeeping entry for the acquisition of a motor vehicle: DR Motor Vehicle................ 20,000.00 EUR DR VAT.......................... 4,000.00 EUR CR Cash/ Bank.................... 24,000.00 EUR When writing Bookkeeping entries in the text, account names always are written with capital letters, such as Motor Vehicle account. In contrast, writing ‘The item is added to motor vehicles’ indicates we do not refer to the account but to the assets ‘motor vehicles’. The identifier for a Bookkeeping entry always comes in brackets, such as Bookkeeping entry (1). <?page no="12"?> Calculations: In calculations, we only show the units with the results. I.e., 10 + 20.50 = 30.50 EUR. Furthermore, the figures in calculations come without any digits after the decimal point in case they equal to zero. The final result is printed in bold and comes always with two digits after the decimal point and the currency unit. Printing results bold helps you to find figures calculated in the text. All calculations are accurate to the EUR-cent or other currency 1/ 100amounts. Case Studies: The case studies provided by this text book are as easy as possible. Stories are kept simple in order to focus on Accounting. Sometimes you’ll get the impression the examples are too easy or unreal. However, our aim is not storytelling. Accounting cases can become pretty complex easily. Case Study Text Cash Flow Separation: An operating cash flow is a cash flow that does not result from investing nor financing activities. However, interest payments are always regarded as financing cash flow. Companies: For our text book, the legal form of companies does not count very much. Legal forms are country-wise different and are not subject to the Accounting syllabus. However, in contrast to IFRSs we do not refer to companies as “entities”. The IFRS-expression is due to standardisation purpose. Once you take a look at one of the standards and find the word “entity” just remember they are referring to a company. The standards avoid legal aspects of national law with regard to the company’s definition validity. However, we use the technical term “business”, “firm” and “company” interchangeably. Companies mostly are public companies, such as GmbH, AG, Pty Ltd., PLC, Inc. etc. Currency Unit: For all examples, the currency unit will be Euro (EUR). Be aware that all Bookkeeping entries and accounts are in EURs, too. The reporting currency in the statements is EUR. Data format in tables: In tables, negative figures are often disclosed in brackets. (7.50) equals to - 7.50 EUR. In all tables, the currency is EUR, as indicated. Deferred Payment of Income Taxes: In the case studies no deferred payments are made to the revenue service. Taxes are calculated at the year end and are added to short-term liabilities, mostly to Income Tax Liabilities account. <?page no="13"?> Financial Statements for Taxation: It is not intended to deepen your knowledge in tax statements. However, tax statements are relevant to ascertain income taxes liabilities and deferred taxes. To keep examples simple, the total income tax rate always equals to 30 %. Interest payments All payments for interest are made through the Bank account (Cash/ Bank account). No transaction fees apply. Language: This text book is written in South African English. Learning Objectives and Summaries: Every chapter starts by the learning objectives and ends by a summary. Legal Forms of a Business: For this text book we normally use legal forms popular in Germany and South Africa, such as AG, GmbH, Ltd., (Pty) Ltd. In order to make it easily understandable, we apply for most case studies EUR as a currency, even if the company has no legal form along German law. If no indicator for the legal form has been mentioned behind the company’s name assume the company is privately-owned, like SANDPIPER BOOKS for a privatelyowned bookstore. Length of a Month/ Year: 1 month = 21.5 days = 4.3 weeks. 1 year = 12 months = 365 days = 52 weeks. Level of Precision: The level of precision is 2 digits after the decimal point. Results from workings are rounded also. You can use rounded figures for further calculations, i.e. in examinations or case study workings. Sometimes we calculate in MS Excel; in that case the calculation in the background is more precise than the one displayed and visible to you. (Note, rounding is a minor problem for you.) Names: We always use names for companies and write them by capital letters. I.e. SCHULZE-BRAMMELKAMP Ltd. There are no links to actual existing persons or companies intended. In case there are similarities it will be coincidently. In case we refer to actually existing firms we make that clear by the text. You can search for the case studies by the names online in case we refer to it. We only use them once for a case study. Non-existing items: In case something has not been mentioned in a case study you should assume it won’t exist. Sometimes case studies have been cut short in order to get a point made more clearly. Notes: In the text book, we sometimes give you some notes in brackets. They always start by (Note, …) These are some additional hints to better understand <?page no="14"?> our examples or some remarks why we are doing something the way we do. Payment Terms: Payments for all kind of taxes and for dividends are due in the next Accounting period. Furthermore, we ignore any consequence on tax income resulting from profits carried forward nor backwards. Tax payments and dividends are paid in the next following Accounting period without explicit explanation. Presentation of Accounts: Accounts are displayed in the easiest format possible. See the accounts for the car acquisition’s Bookkeeping entry: 20,000.00 4,000.00 24,000.00 Figure 1.1: Accounts In figures, accounts are often displayed with abbreviations due to a better overview. Instead of ‘Property, Plant and Equipment’ we write ‘P, P, E’. Names of accounts only start by a capital letters and then the remaining name is written in small letters. I.e., Motor vehicle as the header of an account displayed. Abbreviations are listed at the end of this text book. Pro-Rata-Temporis Calculation of Depreciation and Interest: Although given as annual rates, depreciation and interest are calculated on a pro rata temporis (PRT) basis and accurate to the month. Pro rata temporis is Latin and means proportional to the time. Monthly depreciation is ascertained as annual depreciation divided by 12. In case the company is in possession of the asset for a shorter period than a full year, all months will count for depreciation if the asset is deployed for the major duration thereof. If the asset is bought on 6.01.20X1 the January will be relevant for depreciation. If the asset is sold on 28.12.20X1 the December counts for depreciation, too. If the asset is sold on 5.12.20X1, the December won’t be considered for depreciation. Interest rates are given on an annual basis with annual compounding only. For loans taken for shorter periods than a year, interest is also calculated on a pro rata temporis basis accurate to the month. The monthly rate of interest is the annual rate divided by 12. The interest is compounded annually and paid at the end of the Accounting period. If a bank loan of 100,000.00 EUR is taken on 4.06.20X4 <?page no="15"?> and the annual rate of interest is 10 %/ a, the interest paid at the end of the year will equal to: 7 × 100,000 × 10%/ 12 = 5,833.33 EUR. In general, pay-off payments take place at the end of the Accounting period. If not, the calculation is to be made in intervals. If there is an extra pay-off payment at the end of each quarter the interest has to be calculated for 4 quarterly periods. Interest is only calculated for debts, such as bank loans, bonds etc. No overdraft of the bank account is considered. In particular, we do not check a bank loan’s balance during the Accounting period for overdrafts and calculate interest thereon. However, an overdrawn bank account leads to a liability recognition. Interest and pay-off are always paid instantly which means the credit entry is in the Cash/ Bank account. Quotation of Law Texts: Law texts are quoted like ‘§ 266 II HGB’ or ‘IAS 1.68’. We use the original law names and no translations thereof. Hence, the HGB is the German Civic Code, called in German: Handelsgesetzbuch (HGB). In this text book, we quote paragraphs mostly without section references and standards mostly without paragraph reference. Note, that IFRS paragraphs are subject to changes frequently. Sequence of Bookkeeping Entries: The sequence of Bookkeeping entries comes along the logical procedure defined by the text reading. Sometimes this differs from the timeline of activities. If there is the acquisition of assets and later these assets are written-off by depreciation, we put these Bookkeeping entries next to each other in the text, although the acquisition might take place on 2.01.20XX and depreciation is recorded on 31.12.20XX. Tax on Capital Returns (Dividend Tax): The tax on capital returns is an income tax. The rate on capital returns is 25 % based on the capital return amount in this text book. Note, the tax on capital returns is not regarded as income tax for the company, although it is owed by the company on behalf of its shareholders. The tax on capital returns is a withholding tax. Total Income Tax: All tasks and exams are based on a total income tax rate of 30 %. Taxation is not part of our Management Accounting syllabus. Transaction Fees: No transaction fees apply. Value Added Tax, Goods and Service Tax: VAT stands for value added tax and GST for Goods and Service Tax. Except of the United Arabic Emirates and some U.S. states such as Delaware, consumers pay VAT once they buy goods or services. We only apply one VAT account. This is different to German Bookkeeping, where input-VAT and output-VAT is recorded in separate accounts: Vorsteuerforderung and Umsatzsteuerschuld. For international <?page no="16"?> Accounting make debit and credit entries in the VAT account. The VAT rate for all case studies and examples equals to 20 %. We ignore any lower/ reduced VAT rates as apply in some countries for food, books etc. Working Definitions: In this text book, we mark some definitions in bold letter writing in the text and copy them to the end of the chapter to make learning Accounting easier for you. We deliberately call them working definitions. The working definitions are to help you to understand the concepts. In contrast, proper academic definitions are more accurate but often more difficult to understand as they must cover all cases and exceptions possible. 10-20-30 Rule: In this text book, the 10-20-30 rule applies. As long as not mentioned otherwise, the interest rate is 10 %/ a, the VAT rate is 20 % and the total income tax rate is 30 %/ a. <?page no="17"?> By the following chapters, we are going to provide an overview about Accounting. We do not want to teach Accounting principles, techniques or instruments yet. However, we’ll give you information in order for you to understand what Bookkeeping and Accounting is like. Recording Bookkeeping entries only starts with section (B). Chapter (2) Cafeteria Example for the Balance Sheet Preparation / Accounting Equation starts with an easy example and intends to introduce into Accounting. We teach you what Accounting is for. For this reason, we refer to a case study of a campus cafeteria and show you all steps of the establishment of the business. We introduce the Accounting equation as basic concept of Accounting. You will prepare your first balance sheet and income statement in that chapter. The case study is as simple as possible in order to focus on the Accounting aspects. The chapter (3) Shareholders’ View on Business: McDonald’s Corporation covers an actually existing company most of you know and probably are customers of. We show you financial statements of McDonald’s Corp. but our focus is not to analyse financial statement. This will be subject to chapter 5 of the text book Bilanzen/ Financial Accounting. In chapter 3, we rather want to draw your attention to the investors’ interest. Assume you want to put your money into a public business the shares thereof are traded at a stock exchange, i.e. New York stock exchange NYSE. The main and almost only information you get from a business comes with their published financial statements. As the money flow to the investors normally is over a long time span, we introduce you to the time value of money concept which you might know already from your Finance class or will learn with us. Seeing McDonald’s Corp. with the eyes of their shareholders allows you to judge whether or not it is a good bargain to buy shares of McDonald’s Corp. Although we can profoundly study the company we cannot predict the company’s share prices and/ or dividend payments. Our Accounting class is not about which shares to buy. You’ll find a lot of business books that promise you to investment advice, our Accounting text book is not one of those. Legal Aspects about Accounting are subject to chapter (4). The very first thing you do when you start your business is to prepare a balance sheet as needed for the memorandum of incorporation MoI, or “the articles”. Hence, even before you start with any business activity, you have to do Accounting work. We explain how to establish a business and the requirements to Accounting resulting therefrom. We do so for companies in Germany. Running a business requires Accounting for Taxation and preparing commercial financial statements. There are <?page no="18"?> national Accounting principles (GAAPs = Generally Accepted Accounting Principles) and International Financial Reporting Standards IFRSs. These laws/ standards provide you with the legal framework of Accounting. We give you in section (A) of the text book an overview and basic knowledge about Accounting regulations without yet studying paragraphs and standards in detail. After reading chapter (4) you’ll feel comfortable with Accounting and know where to look for information if you need it. We named chapter (5) The Excel-Accountant. It is actually no real learning chapter but an instruction how to use the online spreadsheet which comes with this text book and can be downloaded free of charge from the website www.uvk-lucius.de/ Bilanzen. The next upcoming chapters are: (2) Cafeteria Example for the Balance Sheet Preparation (3) Shareholders’ View on Business: McDonald’s Corporation (4) Legal Aspects of Accounting (5) The Excel Accountant <?page no="19"?> Learning Objective: In this chapter, you’ll achieve a basic understanding of Accounting with regard to the financial statements (balance sheet and income statement) and learn about the Accounting equation. We do not yet introduce Bookkeeping entries at this stage. Accountants prepare annual statements in order to disclose whether or not the business is profitable and what the situation is alike the business is in. One of the financial statements is the balance sheet. For understanding the company’s financial position, a balance sheet shows on one side all assets, which are the potentials, and on the other side the financial sources. That way the reader of the balance sheet can see where the financing comes from, mainly from owners’ funds and liabilities. At the beginning of the business, a company prepares a balance sheet which is part of the memorandum of incorporation MoI. The MoI is the contract the attorney sets up when the company is established. Let’s say the company TULBAGH GmbH is established with owners’ capital of 100,000.00 EUR which is deposited in the TULBAGH GmbH’s bank account. The balance sheet discloses then 2 figures: one is the assets which are 100,000.00 EUR in the bank account and the other one is the source of funds which is an owners’ capital of 100,000.00 EUR. The reader of the balance sheet sees that TULBAGH GmbH is established based on 100,000.00 EUR in the bank account which comes from its proprietors. 100,000.00 100,000.00 100,000.00 100,000.00 Figure 2.1: TULBAGH GmbH’s opening balance sheet The balance sheet or along International Financial Reporting Standards <?page no="20"?> IFRSs referred to as the statement of financial position represents the Accounting equation: “The total of the assets is the total of capital and liabilities.” The balance sheet discloses assets and equity and liabilities. Equity is capital contributed by the owners or earned by the company. Liabilities are payment obligations, such as result from short term credits or bank loans. The sums of both sides always have to be the same. (Note, this is the reason for Accountants to call the statement of financial position the balance sheet. This indicates the statement must be in balance.) The equality of assets and equity plus liabilities means, all assets of the business are financed either by owners’ capital of by creditors. A creditor is someone who lends the company money, such as banks, suppliers (who did not receive their money yet), bond holders, revenue service etc. The income statement is the second statement to be introduced now: It compares revenue earned by the business to its expenses. Revenue is received from customers for goods/ services sold. Expenses are paid to suppliers of goods or to service providers. Whether or not a payment occurs is no criterion. There are expenses without payments linked thereto, such as depreciation. Depreciation is the loss in value that happens to an asset when deployed. In case the total revenue exceeds the sum of the expenses, a company earns a profit. Income taxes are to be paid based on the income tax rate - study the national tax law for details. We regularly calculate income taxes as earnings before taxes EBT × income tax rate. Financial statements are prepared at every end of an Accounting period. In this text book, all Accounting periods end on the 31 st December and the total income tax rate equals to 30 %. In this chapter, we do not only provide financial statements as at the end of the Accounting period but for teaching purposes after each and every business activity in order to demonstrate how financial statements work. How it is done (preparing a balance sheet): (1) Prepare a balance sheet in a T-format. (2) Create sections for assets on the left-hand side (debit side) and for capital and liabilities on the right-hand side (credit side). (3) Allocate all assets, capital and liabilities to sections. Thereafter, record changes on assets to the asset section and all changes on capital and on liabilities to the capital section and to the liabilities section. Do so by adding increases and deducting amounts for asset/ capital/ liability decreases. (4) Always check the fulfilment of the Accounting equation. <?page no="21"?> In order to study the Accounting equation (equality of assets and equity/ liabilities) and its impact on financial statements, we observe the case study of a snack shop run by student Ingo Kensington: Capital is the amount of funds assigned to the owners of a business. Here, the money paid in by the founders is their contribution to the business. The investors are the owners of the business. The expression „issued capital” results from companies based on shares. When a company is established by share issue portions of the business are sold to the shareholders, who become owners of a portion of the business and are entitled to receive a portion (share) of the profit the business earns. An asset is any item which is part of the company’s resources. Most of the resources are of physical nature, but they can also be intangibles, such as rights. An example for a right is a production firm manufacturing its goods under license. The license bought or rented from a patent holder falls under such rights and is recognised as an intangible asset. Banks lend you money once you have securities, such as property. For a business bank loan, you have to present a business plan. See the business plan as a kind of application for the bank loan. The business plan explains the business concept and in particular contains a calculation of how the cafeteria earns money and how it is financed. <?page no="22"?> The cafeteria’s situation can be described by the Accounting equation. The Accounting equation is the foundation of Accounting. It states that the total of assets equals to the total of capital and liabilities. The Accounting equation is: n i m j l k k j i Liability Capital Asset (with: i = index for assets, i = 1 … n, j = index for capital, j = 1 …m, k = index for liabilities, k = 1 … l) We formally simplify the equation as below: The Accounting equation can be checked with the balance sheet, too. The total of assets is listed on the lefthand side and capital and liabilities are listed on the right-hand side. We name the left side “debit” and the right one “credit”. The balance sheet contains assets on the debit side indicated by a capital A for assets. It contains items of capital and liabilities on the righthand side, indicated by capital C and capital L - representing capital and liabilities. (Note, do not worry about the grey items, we will explain them later in the text book.) <?page no="23"?> Figure 2.2: KENSINGTON CAFETERIA’s statement of financial position (balance sheet) The Accounting equation is fulfilled as long as the totals of both sides of the balance sheet add up to the same amount. From now onwards, the take the balance sheet for checking the fulfilment of the Accounting equation. We simply compare the total on the lefthand side (asset side) to the total on the right-hand side (capital/ liability side). In Figure 2.2 both sums equal to 1,000.00 EUR which indicates that the Accounting equation is fulfilled. <?page no="24"?> Figure 2.3: KENSINGTON CAFETERIA’s statement of financial position (2) (Note, in order to make the business concept easily understandable, we here call the materials for the sandwich “rolls”. The product sold by the cafeteria is called “sandwich” although it is a buttered roll with chocolate spread.) <?page no="25"?> Figure 2.4: KENSINGTON CAFETERIA’s income statement (Note, we call the income statement the statement of profit and loss and other comprehensive income which is the name based on International Accounting Standards.) <?page no="26"?> Figure 2.5: KENSINGTON CAFETERIA’s statement of financial position (3) <?page no="27"?> Figure 2.6: KENSINGTON CAFETERIA’s statement of financial position (4) <?page no="28"?> Figure 2.7: KENSINGTON CAFETERIA’s statement of financial position (5) The total of equity is seen as book value of a business. The idea is, that in case all assets are sold at their carrying amounts and all liabilities are paid-off at the recognised amounts, the remaining value is owned by the proprietors together. We call the difference between assets and debts the book value of the company, because the values are retrieved from the Bookkeeping records and the balance sheet. This concept of business valuation requires carrying all items at their fair values. There are other approaches to determine the value of a business. The book value calculation is one of them and very common in Accounting. Liquidation means to discontinue all business activities and sell all assets. The company will cease to exist thereafter. As cash is easily exchangeable, Accountants say it is more liquid than other assets - such as machinery, aircrafts, intangible assets etc. In the process of a liquidation, assets are transferred to the most liquid form: cash. In other words, all assets are sold. Furthermore, all debts are retired by paying the amount owing back to the bank or other creditors. Then the remaining amount on both sides of the balance sheet is the equity and is distributed to the owners if positive. <?page no="29"?> The carrying amount of an asset is the amount recorded by Accounting. Based on International Accounting Standards the amount has to reflect the most likely price obtained when sold. We are going to call this the true and fair value concept. Summary: The balance sheet and the income statement indicate the financial situation of the company. The balance sheet gives an overview about assets and the financing of the business. The balance sheet follows the Accounting equation. Assets = Capital + Liabilities. The income statement discloses how the company earns its profit. The financial statements are seen as reporting instrument, which informs the owners and the creditors about the situation of the company. Working definitions: Asset: An asset is any item which is part of the company’s resources. Capital: Capital is the amount of funds assigned to the owners of a business. Liabilities: A liability represents funds coming from other parties than the owners of a business Business plan: The business plan explains the business concept and in particular contains a calculation how the cafeteria is to become a successful company and how it will be financed. Accounting equation: The Accounting equation is the foundation of Accounting. It states that the total of assets equals the total of capital and liabilities. <?page no="30"?> Learning Objective: We show in this chapter the use of Accounting from the investor’s point of view. This should bring Accounting closer to you, because it shows you options to get involved in companies. Do not see Accounting as Bookkeeping. Bookkeeping is only a technique for recording the numbers for preparing the financial statements. Accounting provides a report for investors to make economic decisions and to understand whether and how much profit the business earns. As a business person, Accounting won’t provide you with business ideas. It only measures and discloses how much successful a company is. You need that information to evaluate your business and to make investment decisions. McDonald’s Corp. is an American company based on shares. Very much simplified, the concept of McDonald’s Corp. is similar to KENSINGTON CAFETERIA as explained by the previous chapter. However, McDonald’s Corp. is much bigger. Once you understand KENSINGTON CAFETERIA, you will understand McDonald’s Corp. too. McDonald’s Corp. also is a franchisee. This means, many restaurants you see in the world are actually not owned by McDonald’s Corp. but pay a fee in order to sell food under the name of McDonald’s Corp. in restaurants which appear along the corporate identity policy of Mc Donald’s Corp. The McDonald’s Corp. story starts with its founders who found a restaurant producing burgers very quickly (fast food) and selling them successfully at a low price of $0.15. They bought the restaurant in Illinois and sold the burgers under the name McDonald’s Corp. and in a restaurant with the golden arcs. The yellow arcs which look like an “M” became the brand symbol for McDonald’s Corp.’s restaurants later. Today, McDonald’s Corporation is a company earning a revenue of $24,662 million (= $24.7 billion) in 2016 1 . $9,327 million thereof are earned by franchised revenues. McDonald’s corporation runs 36,899 restaurants worldwide. The total of the balance sheet is $31,023.9 million. McDonald’s Corporation is based on 1,660.6 million common shares. You should check the internet for the last financial statements of McDonald’s Corp. before continuing reading. At the time of printing the text book, the McDonald’s Corp. (MCD) share was traded at $163.06/ share on 24.02.2018. <?page no="31"?> The face value is the nominal value of a share and is reported in the capital section on the balance sheet. In contrast, the value as traded at a stock exchange is the market value of a share. The latter one represents at what price shareholders buy and sell shares among each other. The answer depends very much on the time value of money and the rate of discounting. For long-term decisions, we have to consider that today’s money is worth more than future funds. The discounting rate for the calculation of the time value of money is based on the weighted average cost of capital WACC. The time value of money is a concept of discounting future payments. 100.00 EUR you hold today is better than 100.00 EUR you will receive in 5 years’ time. The reason is that during a period of 5 years you can pay 100.00 EUR into your bank account and can earn an interest thereon. Alternatively, you could invest the 100.00 EUR into a business and earn a return on your investment, such as Joana does as shareholder of McDonald’s Corp. The latter alternative includes the risk that a company does not earn expected profits or even files for bankruptcy. In the latter case the investor loses his/ her shares, which means the share is rated at zero. Investors who take risks want to receive a compensation in return for their risk taking. Accordingly, the return on the investments in shares should exceed interest you earn by saving the money in a bank account. The risk of investing in shares is higher than to deposit money in a bank account. Hence, the return for investors is higher. As the early 100.00 EUR are valued higher than later ones, we discount money received later by a rate of interest that represents the capital income option. We assume, the rate applied for discounting is constant over all five Accounting periods. We further assume the rate of interest called i - equals to 10 %/ a. As at today, the option to receive 100.00 EUR in 5 years’ time is worth: 100 / (1 + 10%) 5 = 62.09 EUR. In order to check this valuation, we assume we invest 62.09 EUR on the capital market for the 1st year. The money later is compounded annually: The money we have at the end of the 1 st period is 62.09 EUR plus the return of 62.09 × 10% = 6.21 EUR. The total as at the end of the first Accounting period equals to: 62.09 + 6.21 = 68.30 EUR. We repeat the investment and leave the full amount of 68.30 EUR in the bank account. This will increase the funds to: 68.30 × (1 + 10%) = 75.13 EUR. In <?page no="32"?> the next year, the funds have increased to: 75.13 × (1 + 10%) = 82.64 EUR. In the next year we have already 90.90 EUR and in the last year we reach 99.99 EUR. (Note, we rounded off after each Accounting period, so it is likely our valuation suffers from a rounding difference.) Accountants do love spreadsheet programs! They use the background formulas linked to cells to compute amounts. We want to analyse our investment of 62.09 EUR by using the MS Excel spreadsheet program. See the design of our Excel sheet for a financial schedule prepared in Figure 3.1. A financial schedule is an annual (column) plan of certain investing and financing activities (lines) in order to determine the final value of the investor’s funds. Here, the final value equals to 100.00 EUR in 20X5. The investments are regular bank savings which earn an annual interest at an interest rate of 10%/ a, compounded annually. All investments have a duration of exactly 1 year. Figure 3.1: Calculation of an investment of 62.09 EUR In Figure 3.1, the discount rate is 10 %/ a, which is the usual classroom rate for Accounting lectures. In real businesses, the applied discount rate is based on the average cost of capital. This rate is the average rate of equity cost and costs for debts and is weighted due to the portions of equity and debt, the investor finances his/ her investments with. <?page no="33"?> (Note, the amount is rounded off.) McD(t) = {-34.90; 1.00; 1.00; 1.00; 1.00; 78.35} <?page no="34"?> Figure 3.2: Financial schedule for Joana’s McDonald’s Corporation share (Note, before you start to invest you should take under consideration that buying shares cost you transaction fees and that the banks charge you for the administration of a securities deposit and administration account.) The example of McDonald’s Corporation shows two ways of how to earn money with shares. Both approaches work together, they do not exclude each other. (1) The first source of earning money is that the shareholder is a partial owner of the company and is entitled to earn a portion of its profit, which is commonly called a dividend. The dividend actually is based on the profit and the available amount of equity for distribution. The available amount for distribution normally is the profit of the period plus profits carried forward from prior Accounting periods. It also can contain funds resulting from dissolving reserves. Note, dividend calculation is subject to national law, in Germany, the company’s act (AktG) applies. (2) The other way to earn money with shares is to buy a share and benefit from the share price increase. This is called capital appreciation. Share prices increases when they are under high demand by potential investors. A company that earns huge profits and pays constantly good dividends is <?page no="35"?> more attractive than a company suffering from losses in a weak economy. Share price appreciation requires an ability to foresee the share prices, which needs to have an insight into the company’s further development and knowledge about the industry/ economy. Potential buyers of shares listen to analysts, who monitor the companies properly. One of the basic sources of information for investors and analysts are the quarterly financial statements companies have to prepare and publish if they participate on the capital market. For non-listed companies, annual financial statements apply. The financial statements disclose how much profit a company earned during the last Accounting period and give an indication about the financial position of the business. The financial position of a company is linked to the assets, which are its potentials to earn profit, and the financing, which indicates how risky the financial structure of the business is and how much can be paid to investors and creditors. Investors often check the non-current assets and derive estimates on how well the company will perform in the future based on past investment returns or by other companies, such as competitors. The cash flow statement provides further information about the potential of future investments and, for example, whether or not a company is able to finance a due bond redemption. Auditors check financial statements. Thus, readers of financial statements can rely on the correctness of the financial statements. Auditing is required by national law and by the stock exchange regulations, such as the Security Exchange Commission SEC in the USA, which applies for McDonald’s Corp. Summary: Companies such as McDonald’s Corp. are based on huge amounts of shares which allow the financing of the business and to invest in business opportunities. Buying shares of companies offers investors to participate in the profit of the company by earning a dividend, which is a share of the company’s profit, and to benefit from share price increases when selling the shares. However, no loss participations are required from investors which means an imbalanced risk distribution in the favour of investors. In business management, payments in different Accounting periods are compared based on the time value of money concept. The discount rate refers to the weighted average cost of capital WACC. Investors make decisions based on financial statements provided by companies. They try to foresee a company’s economical value. Do not gamble with shares! Working Definition: Face Value: The face value is the nominal value of a share and will be reported on in the capital section of the balance sheet as issued capital. Market Value: The value as traded at a stock exchange is the market value of a share. <?page no="36"?> Time Value of Money: The time value of money is a concept of discounting future payments. Available Amount for Distribution: The available amount for distribution normally is the profit of the period plus profits carried forward from prior Accounting periods. <?page no="37"?> Learning Objectives: We’ll introduce legal aspects of Accounting in this chapter. The chapter helps you to achieve knowledge with regard to regulations about Accounting along the International Financial Reporting Standards IFRSs and German GAAPs (Handelsgesetzbuch). Furthermore, we refer to the Company’s Act, such as Aktiengesetz AktG in Germany. We begin with a short introduction of how to establish a company in Germany and of how to fulfil German tax requirements. After studying this chapter, you know where to find relevant paragraphs for most of the Accounting problems you might face in the future of your Management career. As long as the owner runs a business as a sole proprietor, his/ her business is no one else’s business. The owner is reliable to him-/ herself, but has to prepare personal tax statements. A privately-owned business is no legal entity. It belongs to his/ her owner. Increases of the business value are increases of the owner’s fortune and fall under taxable profit. For that reason, no company statements are required and the owner records his/ her business for the profit calculation he/ she has to disclose for purpose of tax calculation. Very often, the owner calculates profit by a comparison of income and expenses. The German tax law provides a simplified tax calculation based on §4 III EStG. The situation changes once the company falls under trading business. A dealership has to prepare financial statements based on § 242 I HGB (balance sheet) and on § 242 II HGB (income statement). The financial statements are based on Bookkeeping records which are required to keep along § 238 I HGB. Small sole traders in the sense of § 241a HGB are exempted. Caution: This paragraph only applies for trading business - not for public companies, see below. A public company, such as an AG or a Ltd., is not in private ownership. There is no owner to be held reliable for the company with his/ her personal assets. We explain how to establish a public company in Germany shortly. All public companies, such as those based on shares, require commercial reports, called financial statements. In Germany, public companies are required to prepare financial statements in accordance with § 264 I HGB. For public companies, the set of financial statement also comprises an appendix which contains information about the company, its management, the owners etc. Public companies that participate on the capital market - meaning the shares or bonds issued by the company are traded publicly at a stock exchange - are required to prepare a cash flow statement, too. In general, preparing financial statements gives helpful information about a company’s situation and about the way of how the company earns profit. Public companies can belong to numerous owners who in general are not involved in the daily business. E.g., a shareholder of an AG owns a portion <?page no="38"?> of the company but is not involved in the operating business. Owners have a strong interest in understanding how their company is performing and are keen to know whether or not they can expect an appropriate return on their investments. In case you buy shares of a company, you want to know how your business is growing. In case you hold shares of different companies you must to be able to predict, whether your total mix of investments in companies or other securities - called your portfolio is strong or weak. We’ll call the mix of investments you are holding your portfolio. However, an owner such as a shareholder of a company cannot drop by at the company’s headquarters and check on the business operations or even interfere therewith. Thus, Joana cannot fly to Illinois and knock at the gate of McDonald’s Corporation in order to suggest a change of its product mix of German McDonald’s restaurants. She only can attend the annual meetings and exercise her voting rights. The main source of information for the owners of a public company (as well as for anyone else interested in the company, such as, banks, business partners, employees, applicants etc.) are the financial statements. (Note, if you apply for a job at a public company, you should study the financial statements in order to find out, whether or not you should work there. You do not invest your money but your career! ) The international regulations about preparing financial statements are called the International Accounting Standards IAS and International Financial Reporting standards IFRS. Both together are referred to as IFRSs. Along IFRSs, a set of financial statements contains a statement of financial position (the balance sheet), a statement of profit and loss and other comprehensive income (income statement), a statement of cash flows and a statement of changes in equity. Furthermore, notes are required. The information provided by financial statements results from the Bookkeeping records companies have to keep by law. All transactions in a business that effect its financial position and/ or its profit/ loss are recorded. IFRSs apply in Europe for group statements and thus for single entity financial statements that are prepared to set up group statements. Furthermore, international businesses prepare more and more voluntarily additional financial statements along IFRSs in order to cooperate with international business partners. We go backward a little bit and study how to establish a public company in Germany. You mostly can transfer this knowledge to other countries but are required to study the national law of the company’s base and/ or consult an attorney for the conveyance of the business. The German law offers two different limited companies, a Gesellschaft mit beschränkter Haftung GmbH (it includes a Unternehmergesellschaft (haftungsbeschränkt) UG) and an AG. The first one(s) follow the GmbHG the latter one applies the German AktG. We refer to a public company if the shares are available to the public which applies for the AG and the Ltd. In contrast, a GmbH and a (Pty) Ltd. <?page no="39"?> company are owned by their proprietor without shares being available to public. In case you intend to establish a company you first have to think about its appropriate legal form. A privatelyowned business does not require the obligation of preparing financial statements as long as you do not trade. All information about the business stays with you - and between you and your German revenue service (Deutsche Finanzbehörde). The risk of privatelyowned businesses is that the owner(s) are held responsible with all their private assets. With regard to the taxation of profits you should consult your tax attorney as the profit of the business is taxable based on the personal income tax rate of the owner which can become quite high for a successful business. In contrast, a public company is subject to taxation itself and pays company taxes, in Germany the Körperschaftsteuer. Owners pay a tax on capital returns for the dividend received, too. Public companies prepare financial statements twice: one for the tax calculation which is to be submitted electronically at the revenue service and another one for commercial financial statements which is published through the German Bundesanzeiger. The advantage that comes with public companies is that in case of a failure of the business, in particular in the case of bankruptcy, no one can go after the private assets of the owners. Think about a company as McDonald’s corporation closing down: Joana won’t pay its creditors, she only loses her share. This is what we call one-sided risk structure and you will learn that it is one of the main reasons why public companies have to prepare financial statements. Now, we assume Joseph Haris made a decision to establish a company in Germany as a public company in the legal form of an Unternehmergesellschaft (haftungsbeschränkt), UG. The company is a Marketing Consultancy. The UG is the small cousin of a GmbH by law and applies GmbHG. It requires from Joseph to contribute the owner’s capital which is at least 1.00 EUR (not recommended). Joseph contributes 10,000.00 EUR which he pays in a bank account at Sparkasse Osnabrück. The bank sells him a special account which can later be converted into a business account. Joseph takes his documents and pays his attorney, Dr. FRESENBURG, a visit in order to establish the company. The attorney prepares a contract between Joseph and his UG, called JOSEPH HARIS MARKETING CONSULTANCY HMC UG (haftungsbeschränkt). The contract is called the memorandum of incorporation and states the ownership of the company, the location, its purpose, the date of commencement of activities (1.01.20X1) etc. At this stage Joseph has to hand in his first balance sheet which is the opening balance sheet. Note, even as Joseph is a man of Marketing, his first business activity is in Accounting! Take a closer look at Figure 4.1or Figure 4.2. As the company is based in Germany (Osnabrück) and prepares financial statements along the German HGB it has to hand in the balance sheet in German language and in EUR based on § 244 HGB. However, we provide a translation in Figure 4.2. <?page no="40"?> Figure 4.1: HMC UG’s opening balance sheet along German HGB 10,000.00 10,000.00 10,000.00 10,000.00 Figure 4.2: HMC UG’s balance sheet in English <?page no="41"?> By the next step, the attorney Dr. FRESENBURG prepares the memorandum of incorporation for the HMC UG (haftungsbeschränkt) and submits the documents at the local district court in Osnabrück. A short time later, Joseph receives a confirmation that his company has been added to the commercial register in Osnabrück under the HRB 48496 number. The chief executive officer (CEO) of the company is Joseph Haris. He furthermore receives a registration confirmation of the German revenue service in Osnabrück, which assigns his company a tax payer’s number. The German revenue service give notice that the company HMC UG (haftungsbeschränkt) is VAT registered, too. With the registrations, Joseph now got two obligations. (1) Fulfilment of tax requirements (2) Obligation to prepare commercial financial statements along HGB. Ad (1): Financial Statements for Taxation In order to fulfil the tax requirements Joseph must prepare financial statements as his company is a public company. However, other businesses, such as a doctor’s clinic, law firms, artists, engineers, consultants etc., do not prepare financial statements but nevertheless have to provide information about their profit for reasons of tax calculations. Tax statements are financial statements, such as balance sheet and income statement prepared for tax calculation. In Germany, a business that falls under § 18 EStG (freelancer paragraph) can prepare a simplified tax declaration following § 4 III EStG. EStG is the German tax law, called Einkommensteuergesetz. The simplified tax declaration is referred to as 4-3-Gewinnermittlung. In Germany, companies that determine the profit based on financial statements have to submit financial statements for taxation in the form of an electronic balance sheet. Joseph actually cannot make that without a Bookkeeping software program and/ or with the support of a tax attorney. Many tax attorneys apply a special chart of accounts, e.g. in the DATEV format, which he can choose in his Bookkeeping software, too. He might hire a Bookkeeper or asks the tax attorney to record his business activities. Ad (2) Commercial Financial Statements As we mentioned earlier already, the HGB requires JOSEPH HARIS MARKETING CONSULTANCY UG (haftungsbeschränkt) to keep Bookkeeping entries and to prepare financial statements. Hence, Joseph takes his first balance sheet as opening balance sheet and transmits it to the German Bundesanzeiger for publication. The Bundesanzeiger offers a website where Joseph registers his company and gets access with his username and a password. For a fee of 25.00 EUR, Joseph now can submit his financial statement to the district court in Osnabrück and publish his first balance sheet online. He has to do so after the next accounting period again. He repeats the district court submission and publication of the financial statements after each and every fiscal year. This text book is about the commercial financial statements only! <?page no="42"?> We do not deepen the knowledge in financial statements for taxation even as it is closely linked to Accounting. The German law, that requires the disclosure of information about the business as financial statements, is the Handelsgesetzbuch (HGB). It applies together with the companies’ act, in Germany the GmbHG or AktG. We shortly repeat: The Handelsgesetzbuch applies for all trading and/ or public companies. According to the German Handelsgesetzbuch, a company is required to provide a complete list of all assets, of all liabilities and of all equity at the time of commencement of a company’s transactions as well as later at least after every Accounting period, which normally is one year. (Note, the German Handelsgesetzbuch refers to Kaufmann. We translate the German word Kaufmann or Handelsunternehmen by dealer, dealership, trading business, etc. When it comes to the German law, it is not recommended to translate technical terms to English. Thus, if you plan to run a German company, check the definition for Kaufmann and don’t make decisions based on translations thereof. However, the German law sees someone as a trader who sells goods. A photographer who sells frames or cameras will be seen as a dealer, too. However, as long as the photographer does not trade, he/ she will be regarded as a freelancer (Freiberufler) with regard to § 18 EStG.) § 240 HGB requires that every salesman has to prepare a proper register of his land, his receivables and payables, his money and all further assets and to provide exact information about their values as at the beginning of the business. He/ she further has to prepare such a register after the end of each and every Accounting period. § 241a Handelsgesetzbuch allows dealers who run their business under the legal form of a sole dealership and who runs a small company with regard to revenue and profit figures, to not keep Bookkeeping records and to not prepare financial statements. This exemption from keeping Bookkeeping records and preparing financial statements does not apply for small limited companies. There are special regulations for limited companies, further. These regulations are about the form of financial statements, e.g. §§ 266 and 275 HGB apply, which prescribe the structure and item naming of statements. The German Handelsgesetzbuch is strict with regard to formal aspects. You might ask yourself whether there is a kind of supervision for financial statements. Yes, there is. Financial statements are checked by auditors/ auditing firms. § 315 Handelsgesetzbuch requires financial statements must be audited for mediumsized and big public companies. Auditing means that a qualified and authorised Accounting expert checks Bookkeeping records and the financial statements for correctness. Correct financial statements means, they have been prepared based on commonly agreed Bookkeeping standards and they are consistent to the commercial law/ IFRSs. The statements must provide a correct view on assets values, the financial position of the company and its profit and loss situation. E.g., a <?page no="43"?> violation of Accounting rules in favour of the company would mean to overstate assets or understate liabilities. Auditors cannot check the financial statements completely (which means every Bookkeeping entry) but will draw samples from the Bookkeeping records and check the financial statements and the process of the preparation thereof. They deliver a report/ statement about their findings in auditing. They are not supposed to judge or evaluate the business. Without financial statements being audited no approval of the financial statements is possible. The approval is required for the appropriation of profits, such as for the declaration of dividends. Preparing faulty financial statements is less a regulatory offense, but results in withholding dividends from the shareholders which obviously is not very much appreciated by them and can cause legal actions! All companies in Germany have to provide the financial statements along the requirements of the Handelsgesetzbuch unless they are exempted by § 241a Handelsgesetzbuch. IFRSs contain Accounting rules also but on an international basis. The regulations are partly similar and partly different to the ones of the German Handelsgesetzbuch. International Accounting is relevant for companies that are involved in international business or belong to a group. The regulations for international Accounting are set by the International Accounting Standards Board IASB based in London, Cannon Street. We call the IASB the standard setter. For more information about the IASB and the procedure of standard releases, visit their website: www.ifrs.org. The IASB issues standards to particular Accounting problems - such as statement of cash flows, revenue recognition, financial instruments etc., which contain paragraphs. The standards released are the result of an international cooperative designand negotiation process. The standards can be downloaded from the IASB website. The standards have numbers and are either called IAS or IFRS. In order to refer to both sets we say IFRSs. The structure of the IFRSs is subject to chapter 3 in the text book Bilanzen/ Financial Accounting. At the time of writing, following standards are released: IAS 1 - Presentation of Financial Statements IAS 2 - Inventories IAS 7 - Statements of Cash Flow IAS 8 - Accounting Policies, Changes in Accounting Estimates and Errors IAS 10 - Events after the Reporting Period IAS 12 - Income Taxes IAS 16 - Property, Plant and Equipment IAS 19 - Employee Benefits IAS 20 - Accounting for Government Grants and Disclosure of Government Assistance IAS 21 - The Effects of Changes in Foreign Exchange Rates <?page no="44"?> IAS 23 - Borrowing Costs IAS 24 - Related Party Disclosures IAS 26 - Accounting and Reporting by Retirement Benefit Plans IAS 27 - Separate Financial Statements IAS 28 - Investments in Associates and Joint Ventures IAS 29 - Financial Reporting in Hyperinflationary Economies IAS 32 - Financial Instruments: Presentation IAS 33 - Earnings per Share IAS 34 - Interim Financial Reporting IAS 36 - Impairment of Assets IAS 37 - Provisions, Contingent Liabilities and Contingent Assets IAS 38 - Intangible Assets IAS 39 - Financial Instruments: Recognition and Measurement IAS 40 - Investment Property IAS 41 - Agriculture Standards issued after 2002 are called International Financial Reporting Standards IFRS: IFRS 1 - First-Time Adoption of International Financial Reporting Standards IFRS 2 - Share-Based Payment IFRS 3 - Business Combinations IFRS 4 - Insurance Contracts IFRS 5 - Non-Current Assets Held for Sale and Discontinued Operations IFRS 6 - Exploration for and Evaluation of Mineral Resources IFRS 7 - Financial Instruments: Disclosures IFRS 8 - Operating Segments IFRS 9 - Financial Instruments IFRS 10 - Consolidated Financial Statements IFRS 11 - Joint Arrangements IFRS 12 - Disclosure of Interests in Other Entities IFRS 13 - Fair Value Measurement IFRS 14 - Regulatory Deferral Accounts IFRS 15 - Revenue from Contracts with Customers IFRS 16 - Leases There further is a framework that describes the principles of international Accounting. Some countries nowadays apply the international Accounting standards IFRSs completely other ones only partly. South Africa, e.g., does not follow national regulations for Accounting anymore and applies the international Accounting standards. The international standards are combined with the companies act in South Africa and the corporate governance King III report. <?page no="45"?> Germany decided not to follow the IFRSs for single-entity financial statements. However, the Germans made adjustments to the Handelsgesetzbuch, the GmbHG and the AktG, etc., known as BilMoG (BilanzModernisierungsGesetz). Companies preparing group statements and based in Europe have to apply IFRSs in case they participate in the capital market. A group consists of at least 2 companies which have a parent-subsidiary-relationship. Parentsubsidiary-relationships are ruled by the company’s act in Germany. The criterion for a group is that one company (parent) controls the other one (subsidiary). Often, the majority (more than 50%) of the voting rights is regarded as indicator for controlling a business. Participation in the financial market is fulfilled, once the companies or at least one of the group members are listed publicly with equity or liability instruments. It does not matter whether the parent or the subsidiary is listed. E.g., if one company of the group issues shares listed at a stock exchange, the whole group will qualify for IFRSs application. The same applies for bonds. Groups have to prepare financial statements similar to a single company that shows the figures for the entire group. Group statements contain a set of financial statements for the whole group that is prepared under the assumption of the group being a single company. Group members then are regarded as departments of the group therein. Group statements do not exempt the group members from the preparation of single-entity financial statements. E.g., a group containing a parent in Germany and a Dutch subsidiary, with the German parent listed at Frankfurt stock exchange, has to prepare single-entity financial statements along Handelsgesetzbuch and the Dutch Woertbook van Koophandel for the two companies and group statements along IFRSs. Group Accounting adds up all items of the German and the Dutch company. Assume the German company owns items of property, plant and equipment to the extent of 1,000,000.00 EUR and the Dutch one of 700,000.00 EUR. In the group statements the item of property, plant and equipment discloses: 1,000,000 + 700,000 = 1,700,000.00 EUR. Group internal profits, receivables/ payables and proprietor relationships have to be adjusted/ cancelled out - referred to as consolidation. Group Accounting is covered by chapter 8 of the text book Bilanzen/ Financial Accounting. Before financial statements can be compared or summarized for the preparation of group statements, they must be transferred to the same law/ Accounting standard. Companies, which are group members, therefore transform their single-entity financial statements to IFRSs in case the group statements have to be prepared along international Accounting standards. The international version of the single-entity financial statements prepared in accordance to IFRSs is called financial statements number 2 (Handelsbilanz 2). We compare the preparation of group statements to adding fractions: if you add 1/ 3 and 1/ 4, you first have to <?page no="46"?> transform the single summands to the same denominator (here: 12). Then you add 4/ 12 + 3/ 12 = 7/ 12. Group statements require to transform singleentity financial statements to IFRSs as their common “denominator” in the same way. GAAPs are generally accepted Accounting principles which apply for preparing financial statements and keeping Bookkeeping records. National GAAPs in Germany are national laws for Accounting in particular the Handelsgesetzbuch. Other GAAPs are UK-GAAPs, US-GAAPs, etc. In general, you might think the application of different laws won’t make a big difference but actually, it does! Often the regulations along the national GAAPs and the IFRSs are very similar so that 95 % of the regulations do not differ much. However, if regulations are different (in 5 % of the cases) the picture can totally change with regard to the values disclosed on financial statements. E.g., the German GAAPs do not allow the recognition of development expenses but IFRSs require their disclosure. Assume a production firm like a car manufacturer say Volkswagen AG, spends a lot of money on the design of a new product, a car: Recognizing the development expenses or not will change the total of the balance sheet significantly. Hence, there is a mismatch of the amount of regulations and their potential to change financial statements which you should keep in mind. Once you understand on GAAP you do not have to study the other one completely, only the differences. This makes the leaning of Accounting convenient. However, the application of a special GAAP will change the financial statements. The GAAPs mentioned so far follow different purposes. The German Handelsgesetzbuch intends to protect creditors. In accordance to this principle, financial statements are required being prepared with the objective to understate assets and profits, because a low profit leads to low dividends, which is in favour of the creditors, because it prevents the company from bankruptcy. Maintaining equity on high level, such as by requesting legal reserve recognition, makes it less likely that the company becomes debtsoverloaded. Excessive indebtedness leads to bankruptcy by national law. In contrast to the public and the creditors, shareholders are less interested in creditors’ protection and might see the legal reserve as means to cut dividends short which results in a reduction of their returns. Consider before you form your own opinion the risk structure of the stakeholders in the business. In contrast to the German Handelsgesetzbuch, the international Accounting standards follow strictly the true and fair view principle. The reporting purpose is to recognise assets and liabilities at the amount they actually have got. Check the example below to understand: A company takes a bank loan of 100,000.00 EUR and has to pay-off the amount in 20 years completely in one lump-payment. It must recognise the bank loan on the credit side of the statement of financial position because it is a liability. In case the rate of interest on the capital market is 10 %, the bank loan’s actual value as at today will be: 100,000 × (1 + 10%) -20 <?page no="47"?> = 14,864.36 EUR. Someone, who takes the latter amount and puts it into a bank account which earns interest of 10 %/ a, annually compounded, will come up with 100,000.00 EUR at the end of 20 years. The IFRSs therefore require discounting liabilities and recognise them at 14,864.36 EUR. In contrast, the German Handelsgesetzbuch requires the loan recognition at 100,000.00 EUR, which is the most likely settlement value. This artificial increase of a liability understates the company’s financial position. Hence, the Handelsgesetzbuch discloses the business’ situation worse than it actually is due to reasons of creditor protection. Summary: Financial statements have to be prepared along the national law. German companies have to prepare the financial statements along the German Handelsgesetzbuch. Other countries apply national GAAPS or international Accounting standards IFRSs for the single-entity financial statements. European groups that participate in the capital market have to prepare their group statements along IFRSs. Hence, all group members have to transform their financial statements to IFRSs in preparation of the set-up of the group statements. National GAAPs and IFRSs result in different figures on the financial statements. The German HGB understates the company’s financial position in order to protect creditors. IFRSs recognition follows the true and fair view principle. Working Definitions: GAAPs: GAAPs are generally accepted Accounting principles which apply for preparing financial statements and keeping Bookkeeping records. Tax Statements: Tax statements are financial statements, such as a balance sheet and an income statement prepared for tax calculation. Group: A group consists of at least 2 companies which have a parent-subsidiary-relationship. Group Statements: Group statements contain a set of financial statements for the whole group that is prepared under the assumption of the group being a single company. <?page no="48"?> Learning Objectives: In this chapter, you do not learn Accounting but about a file for download on the UVK-Lucius website that helps you editing your Bookkeeping entries for the use in the university. This chapter also contains some hints for the use in later chapters of the book. Do not get confused if you find aspects mentioned here that will be covered farther down in the text book. The aim is to provide you a MS-Excel spreadsheet for most of the calculations in the entire text book and the text book Bilanzen/ Financial Accounting. In a real company, the Bookkeepers apply Accounting software. The set of parameters in the Accounting software according to the needs of the company and its adjusting is called customising. There are a lot of parameters which have to be set before the software works. The market leader of software for enterprise resource planning systems (ERP-systems) is SAP AG in Germany. The software is based on transactions. E.g., transaction FB50 makes a Bookkeeping entry. Before you can post anything, the company code, the Accounting area, the Bookkeeping type, the chart of accounts, etc. must be customised. In the university and at home you will mostly make Bookkeeping entries on MS Excel, because in the university, you do not face mass data problems, such as in a real company. Thus, MS Excel will do it for the first steps. We regard MS Excel as a valuable tool for Accounting learners. In more advanced classes, for example in Managerial Accounting and on master’s level classes, SAP customising is part of the syllabus, for example at Hochschule Osnabrück. On the UVK-Lucius.de/ Bilanzenwebsite you’ll be provided with a file called AccountsAndStandards- FORMAT.xls. This file is in use for the preparation of all financial statements and all accounts in this text book and for exam tasks. We recommend applying it also for your first steps in Accounting. We offer this file as an additional service for free download to all our readers. The spreadsheets have been prepared on an English MS-Excel 2016 system. According to the setting therein, figures appear in the format of the text book. You can adjust your MS-Excel to the English data format, but consider this is no file setting but a system setting. This means once you change it to the German format all files you open will appear in the German figure format. See Figure 5.1 for the adjustment window. <?page no="49"?> Figure 5.1: Excel options for the adjustment of the data format Another format is the style data appear in the tables. We use the format 1,000.00 EUR for a positive amount and (1,000.00 EUR) for a negative one. In university venues, the brackets are easier to be seen from the back rows than a minus sign. You can make these changes with the font menu yourself. (Note, in order to make figures appear in columns properly you should leave a blank after the positive amount at the place where closing brackets for negative amounts stand. Furthermore, take always non-proportional fonts for figures, such as Courier.) <?page no="50"?> Figure 5.2: Format adjustment (fonts) We recommend you adjusting your menu in MS Excel that way that you can insert lines easily. There is a function line insert you should add to the function bar. It will help you a lot! The file AccountAndStatement- FORMAT.xls provides you with tabs with templates for Accounting. They are: - Acc (accounts) - JL (journal) - TB (trial balance) - BS (statement of financial position) - German BS - IS (statement of comprehensive income) - German IS - CFS (statement of cash flows) - SCE (statement of changes in equity) - RoA (register of non-current assets) - Int&PayOff (schedule for interest and pay-off scheduling) - PCB (petty cash book) - CB (cash book) - Bank (bank statement) - BP (business plan) <?page no="51"?> Ad (Acc): Account: The accounts are prepared as T-accounts. At the beginning, T-accounts are quite helpful as they indicate the side of the balance sheet. However, use any account format you feel comfortable with. The accounts do not contain any formulas as the accounts’ length varies. According to this text book, the column width is: 1-4-16-0.08-4-16-1. The accounts come with a header which is centred and pre-set to bold letters. On the left-hand side, there is a D indicating the debit side and on the right-hand side a C, standing for credit side. No currency is mentioned, because all Bookkeeping entries for this text book and the text book Bilanzen/ Financial Accounting are made in EUR. The line in the middle is a very narrow cell filled black. Its width is only 0.08. The cells appear as a thin vertical line which separates the debit side from the credit side. This way, you can copy Bookkeeping entries from the debit to the credit side without copying the cell format. It helps you when you record the entry in the contra account by the copy-paste-commands. The style in the data cells is bold courier new. Thus, the figures all have the same distance from each other and can be added easily when you see them in the accounts. If you add the accounts figures, apply the sum function. See the account tab in Figure 5.3. Figure 5.3: Account tab <?page no="52"?> It appears pretty often that you have to balance-off an account. Along the international way of Bookkeeping the balancing figure is inserted as a balance carried down (c/ d) on the “shorter side” of the account above the sum. The balancing figure is copied to the opposite side and marked balance brought down, indicated by b/ d. The Figure 5.4 shows the account “Account 1” before (left-hand side) and after balancing-off. 100,000.00 50,000.00 100,000.00 50,000.00 200,000.00 200,000.00 250,000.00 300,000.00 300,000.00 250,000.00 Figure 5.4: Balancing-off an account In order to balance-off an account in MS Excel calculate the sum on both sides by the sum function. To indicate the sum one accounting side, use one line at the top border and a double line at the bottom border. You can actually calculate one side only, set the format and then copy the cell to the position on the opposite side. In the case of Figure 5.4 you get 300,000.00 EUR on the debit side and 50,000.00 EUR on the credit side. Now, you add a “c/ d” on the credit side and write in MS Excel “=300,000 - 50,000” which gives you the 250,000.00 EUR balancing figure. You can be sure to not calculate in a loop this way. After that, you go under the sum-line on the debit side of the account and use the MS-Excel command “=”. This is not only less work it avoids copying mistakes, too. Be aware there are special mistakes that you only make by application of MS Excel and that won’t happen in an exam written on paper. However, when you practice Accounting you quite often have to look for Bookkeeping errors and the way we suggest is one that avoids mistakes and once they occurred it makes it comfortable to adjust your Bookkeeping records. Ad (JL): Journal A journal is a list of Bookkeeping entries. You actually can make Bookkeeping entries without keeping a journal but it helps you a lot once you have one. The journal contains a description of the bookkeeping entries in the sequence they occur. You’ll see the narrative that gives you further information about the Bookkeeping entries and the accounts in use. We consider a company the owners of which put 100,000.00 EUR into the company’s bank account another one for the acquisition of machinery on cash to the extent of 34,000.00 EUR. Bookkeeping entry (1): debit entry Cash/ Bank 100,000.00 EUR - credit entry Issued Capital 100,000.00 EUR. Bookkeeping entry (2): debit entry Property, Plant, Equipment 34,000.00 EUR - credit entry Cash/ Bank 34,000.00 EUR. <?page no="53"?> Figure 5.5: Journal tab If you apply the journal you can copypaste the Nrand Amount-cells into the account tab. See Figure 5.6. (Note, the advices given are not only for your convenience but to make your Bookkeeping exercise most safe.) Figure 5.6: Accounts linked to the journal Ad (TB): Trial Balance: The trial balance will be introduced in chapter (29) Preparing the Trial Balance. The trial balance is a list of all accounts and the balance brought down therein. <?page no="54"?> It applies to check the double entry system and will help you to detect faulty Bookkeeping entries. In order to prepare a trial balance, transfer the names of your accounts into the list provided and enter the balances brought down of every account into the list. The balances are to be entered on the debit side of the trial balance, if the account is debit balanced and on the credit side for credit balanced accounts. The total of the two columns of the trial balance is calculated and should be the same on the debit as on the credit side. See Figure 5.7 for the trial balance tab. When you prepare the adjusted trial balance, we recommend copying the non-adjusted one for a start. An adjusted trial balance is prepared after the adjustments at the end of the Accounting period have been completed. These comprise depreciation, profit calculation, appropriation of profits, stock taking etc. After adjustments all nominal accounts have been closedoff to the Trading account or to the Profit and Loss account. Their balancing figure will be zero by then. After copying the unadjusted trial balance, strike through all closed-off accounts and change their values to zero. Insert additional lines at the bottom for new accounts required, such as the Retained Earnings account, Income Tax Liability account or the Reserves account. Again, the total on the debit side should be equal to the total of the credit side in order to fulfil the Accounting equation. Check chapter (29) for the details. Figure 5.7: Trial balance tab <?page no="55"?> Ad (BS): Statement of Financial Position: The statement of financial position tab contains a template for a simple balance sheet. It reads Statement of Financial Position such as requested by IAS 1. The total is calculated at the bottom. All items can be adjusted by you and you can add further lines by the insert line function. You have to adjust the statement of financial position depending on the legal form of the business. E.g., a sole dealership won’t disclose an item for issued capital, but for owner’s equity. See the statement of financial position tab Figure 5.8. It contains a balance sheet for a public company on the left-hand side and one for a privately-owned company on the right-hand side. The balance sheet template provided is different to the one we apply in chapter 5 and 6 of the text book Bilanzen/ Financial Accounting because we. prefer to work with T-Accounts for teaching the basics. As you can see in Figure 5.8, the total on the debit side and on the credit side are compared in the statement of financial position tab to indicate inconsistencies with the Accounting equation. On the statement in Figure 5.8, there is only one entry in the Property, Plant and Equipment account and the difference is 300,000.00 EUR therefore. The financial statements require to enter the name of the reporting company and its legal form. Furthermore, the date, at which the balance sheet is prepared is to be mentioned in the header. Adjust the date once you prepare the balance sheet. Figure 5.8: Statement of financial position tab <?page no="56"?> Ad (Ger BS): German Balance Sheet With the new edition of the text book we provide you with a balance sheet along the German HGB. It is for use in German classes when studying the national Accounting rules. In order to offer you the same service for English classed the balance sheet template is available in English too. However, consider the German company has to submit the balance sheet in German. You note, the balance sheet provided is for small companies: a short balance sheet according to § 266 I HGB. The balance sheet on the left-hand side contains a more detailed liability section than required by HGB. Figure 5.9: German balance sheet tab (IS) Statement of Comprehensive Income: The template for the income statement is provided along the nature of expense method. You easily can adjust it to the cost of sales format if required. In the header, you see STATEMENT of PROFIT and LOSS and OTHER COMPREHENSIVE INCOME, which is the name required in accordance with the revised IAS 1. For data input, pls., key in all figures on the credit side as positive amounts and negative figures for expenses. The formulas provided together with the statement will deduct expenses from revenues and calculate the correct taxes based on the conventions laid out in chapter (1). In Figure 5.10 the revenue of 10,000.00 EUR is deducted by expenses of 100.00 EUR; 200.00 EUR; etc. In order to change the income statement to the cost of sales format overwrite “Materials” by “Cost of Sales COS” and change further items as required. For consistency reasons, we recommend to not write the values in the cells but use the MS-Excel functions to copy them from your Profit and Loss <?page no="57"?> account and if applicable from the Trading account. In case the earnings before taxes are negative or zero, the income taxes become zero, too. There is an if-function provided in the income tax cell. See below the statement of comprehensive income tab in Figure 5.10: Figure 5.10: Income statement tab Ad (Ger-IS): German Income Statement We provide you with an income statement along the German HGB, too. See Figure 5.11. <?page no="58"?> Figure 5.11: German income statement tab (CFS) Statement of Cash Flows: The statement of cash flows tab contains a template filled with some examples for cash flows. Feel free to change the items of cash flows in the MS Excel sheet. The formulas linked to the cells add up the cash flow from operating, investing and financing activities to the right side and calculate the total cash flow also. Key in cash inflows as positive amounts and cash outflows as negative figures. The statement of cash flows is introduced by chapter (32) Introduction to Statements of Cash Flows. In that chapter, you will learn different methods of how to prepare a statement of cash flows. The format provided in the MS Excel file is based on the reconciliation of profits with operating cash flows on the left-hand side and along the direct method on the right-hand side. Along that methods, you will prepare the cash flow statement along standard procedures. We provide that formats, because it is for all companies the same one. However, feel free to change the operating cash flow items by making adjustments to your convenience. After preparing the statement of cash flows, we recommend checking the total cash flow with the difference between the opening and closing amount in the Cash/ Bank account. The cash flow calculated in the statement must equal to the difference between the opening and closing balancing figures of the Cash/ Bank account(s). <?page no="59"?> Figure 5.12: Statement of cash flows tab Ad (SCE): Statement of Changes in Equity: The statement of changes in equity is covered by chapter Tax Calculation, Profit Appropriation and Statement of Changes in Equity. The statement shows how the equity, which represents the book value of a company, changes by share issues, addition to reserves and by earning profit and its appropriation. The statement of changes in equity contains columns for the items on the balance sheet and lines for changes thereof. In each line the total of equity is the sum of the equity items, such as issued capital, reserves and retained earnings. Furthermore, the lines are added top down, because the first line discloses the opening amount and the lined thereafter changes in equity. In order to determine the equity as at the end of the Accounting period the total of the lines must be calculated. The statement of changes in equity requires that figures are added up in direction left-right and top-down. The formulas have been linked to the cells already. In Figure 5.13 some figures have been entered into the form for illustration purpose. You have to make the right entries for the profit appropriation: If there is a profit transferred to reserves it is required to make a negative entry in the retained earnings column which represents a debit entry and a positive one for reserves, which indicates a credit entry. The format in the statement of changes in equity is (DR)CR, which means, debit entries are negative, as they reduce equity. This is because equity is recorded on the credit side of the balance sheet. A profit paid to shareholders reduces equity too. It requires one negative figure entered in retained earnings column. Equity will decrease by declaring a dividend, because the Shareholder for Dividend account does not belong to equity. Be aware, the equity reduction is recorded on the statement by only one entry as <?page no="60"?> the contra entry is in the liability section - in the Shareholder for Dividend account. Figure 5.13: Statement of changes in equity tab Ad (RoA): Register of non-current Assets: The register of non-current assets is required along IFRSs and belongs to the notes. The register of non-current assets is covered by chapter Depreciation and chapter (7) of the text book Bilanzen/ Financial Accounting. You find a short introduction to depreciation in chapter (17) of this text book, too. The register of non-current assets is prepared on group level along IFRSs. However, in classroom examples or in exam tasks there are only few assets and it is required to disclose them by single entries. Every asset is recorded by a line which contains the cost of acquisition, the accumulated depreciation and the accumulated impairment loss. The column at the right border shows the carrying amount which is calculated by the formula linked to the cells. You have to enter the amounts for accumulated depreciation and for accumulated impairment losses as negative amounts in order to obtain the correct formula result. Observe some fantasy figures entered into the form in Figure 5.9. In case of a revaluation, you have to adjust the column cost/ revaluation and enter the amount the asset is revalued to. <?page no="61"?> Figure 5.14: Register of non-current assets tab Ad (Int&Pay-off): Interest and Pay-off Schedule: In Accounting it often is required to determine the amount of interest and of pay-off for a bank loan. The interest and pay-off schedule provided calculates liabilities per Accounting period. Our recommendation for the procedure to calculate, e.g., an annuity is as follows: (a) Enter the amount for the annual payment directly. (b) Write the rate of interest somewhere above the column interest. (c) Determine the amount of interest by multiplying the actual amount of the debts by the rate of interest. In the formula, you should fix the rate of interest by the F4-key. (d) Determine the amount for pay-off by deducting interest from the annuity. (e) Go to the next line and add the formula for the actual amount which is previous amount less pay-off. (f) Now you can determine all amounts by just copying cells downwards! (g) Adjust the last pay-off payment manually. See the interest and pay-off tab in Figure 5.15. See the interest calculation in the formula bar: “= C3 * $D$1”. Feel free to extend the template for the calculation of discounted liabilities. Discounting of liabilities is covered in chapter 14 of the text book Bilanzen/ Financial Accounting. <?page no="62"?> Figure 5.15: Interest and pay-off tab Ad (PCB): Petty Cash Book: The petty cash book can be set up easily by the tab PCB. You have to make the entries for the balancing-off manually. The petty cash book is covered by chapter Petty Cash Book of this text book. Figure 5.16: Petty cash book tab Ad (CB): Cash Book: The cash book tab is similar to the one for the petty cash book. You have to add the figures for balancing-off also. In contrast to the other tabs the header has been kept very simple to intentionally give the cash book the look of a <?page no="63"?> normal account. The cash book is subject to chapter (37) Cash Book, Reconciliation with the Bank Statement of this text book. See Figure 5.17. Figure 5.17: Cash book tab Ad (BankST): Bank statement: The statements prepared by the banks come in a different layout and normally the Accountant does not have to write a bank statement. However, we provide you with a simple template for a bank statement you can use for practicing bank reconciliations. Bank statement reconciliation is subject to chapter (37) Cash Book: Reconciliation with the Bank Statement in this text book. <?page no="64"?> Figure 5.18: Bank statement tab Ad (Cons): Consolidation For the purpose of preparing group statements we provide you with a consolidation spreadsheet. It contains columns for particular consolidations which you should copy to the right in order to cover all consolidations required. The tab is linked to a full consolidation which means all subsidiaries are considered by their full amounts as required for Group Accounting. You must adjust formulas in case you want to apply the tab for joint venture Accounting as then proportional consolidation applies. Figure 5.19: Consolidation tab <?page no="65"?> Ad (BP): Business Plan In part (2) of the text book Basics of Accounting you have to prepare business plans. We provide you with a basic template for this task. Figure 5.20: Business plan tab Summary: We provide you online with a spreadsheet you can use to practice Accounting. However, this file is no attempt to design Bookkeeping software but a simple editor used for this text book and for many of the sample solutions you’ll find online on www.uvk-lucius.de/ Bilanzen. It is intended to make Bookkeeping more convenient and efficient for you. Pls., do not forget that your university will make you to write exams on paper which means you should calculate more time for exam tasks than it takes on your computer/ tablet. <?page no="66"?> Now, let’s get started! In section (B), we familiarise you with the basics in Bookkeeping so you can prepare your first financial statements already. In most universities, the first steps in Bookkeeping are not included in the Accounting syllabus but form a prerequisite. The writing of section (B): First Steps in Accounting is verbose as we consider that no instructor will teach you. We are offering you further materials for self-studying online at www.UVK-Lucius.de/ Bilanzen. When introducing Bookkeeping as a language for Accounting, we refer as less as possible to national laws or international Accounting standards IFRSs in order to keep Accounting on an easy level. Furthermore, we ignore tax law and the German Abgabenordnung AO for financial statements for taxation. Hence, we don’t apply charts of Accounts either. We really reduce Bookkeeping to its very basics! In this section (B): First Steps in Accounting, we intentionally do not cram Bookkeeping entries because we want to focus on the main purpose of Accounting which lays in the preparation of financial statements. For that reason we set up easy financial statements at first and only thereafter introduce accounts as a means to record business activities and then we start write down Bookkeeping entries. In contrast to other text books we do not make you learn Bookkeeping entries. You’ll see that they repeat themselves and you are going to get used to them. The chapter (6) Introduction to the Balance Sheet and the Income Statement provides you with knowledge about the main financial statements. They are the balance sheet and the income statement. In more official technical terms (applying IFRSs language), the statement of financial position is the balance sheet and the statement of profit and loss and other comprehensive income is the income statement. The next chapters (7): Activities on the Asset Side, (8): Activities on both Sides of the Statement of Financial Position and (9): Profit and Loss Activities contain business activities that change at first only the asset side of the balance sheet, then the whole statement and thereafter the income statement, too. We use simple case studies ROHRBACH Ltd., FLASSKAMP AG and PELZERHAGEN (Pty) Ltd. to discuss financial statements step-by-step. As a set-up of financial statements after every business activity becomes very demanding we give you an (10) Introduction to T-Accounts and demonstrate how to apply them for the preparation of financial statements. We’ll make entries and teach you how to balance-off accounts and show all accounts for ROHRBACH Ltd. and FLASSKAMP AG. The chapter (11) is about T-Accounts for Profit and Loss and is used for the case study PELZERHAGEN (Pty) Ltd. <?page no="67"?> We introduce the Profit and Loss account and show how to calculate the profit. The chapter (12) Introduction to Bookkeeping Entries will show you how to write Bookkeeping entries in a DR- CR-format. We explain all Bookkeeping entries used for the case studies ROHRBACH Ltd., FLASSKAMP AG and PELZERHAGEN (Pty) Ltd. Chapter (12) also introduces the journal which is a list of Bookkeeping entries according their timeline sequence. By the next chapters (13) Special Asset Accounts, (14) Special Equity Accounts and (15) Special Liability Accounts we go through the main sections of the statement of financial position and explain examples of activities. This way we provide you with a deeper knowledge about the items on the statement of financial position and practise Bookkeeping entries. You will gain a better understanding of Accounting because we cover further aspects of Acccounting besides of the previous case studies. We provide you with examples for all items on the financial statements. After studying all chapters of section (B), you can prepare financial statements along international Bookkeeping standards. You feel familiar with the items thereon and gained a sound knowledge about Bookkeeping as a means for the preparation of financial statements. The upcoming chapters are: (6) Introduction to the Balance Sheet and the Income Statement (7) Activities on the Asset Side (8) Activities on both Sides of the Statement of Financial Position (9) Profit and Loss Activities (10) Introduction to T-Accounts for Real Accounts (11) T-Accounts for Profit and Loss (12) Introduction to Bookkeeping Entries (13) Special Asset Accounts (14) Special Equity Accounts (15) Special Liability Accounts - Payables, Bank Loans and Provisions <?page no="68"?> Learning Objectives: In this chapter, we take a look at the statement of financial position (= balance sheet) and the statement of profit and loss and other comprehensive income (= income statement) in order to explain the items therein. It is intended to present the financial statements as a valuable reporting instrument for owners, creditors and other parties, who have an interest in the financial position of the company. After studying this chapter, you understand the meaning of the statements and have developed an understanding what is disclosed by them. In this chapter, we do not record activities yet, we only show how the statements look like and discuss the meaning of the items thereon. In this text book, we at first introduce Accounting free of formal requirements. We start by a simplified format for the balance sheet. However, this format would be acceptable for financial statements along the IFRSs because it has been taken from the IFRSs’ appendix. In contrast, for German companies, the structure of financial statements provided by this text book, won’t fit. Instead, §§ 266 II, III and 275 II, III HGB apply. These paragraphs prescribe the items, their names and the sequence of appearance thereof on the balance sheet and the income statement. You are supposed to study chapter (2) of the text book Bilanzen/ Financial Accounting for financial statements along the German Handelsgesetzbuch HGB. However, the basics of Accounting do not depend on formal regulations. This is why we do not make you learn them for this course. Just keep in mind that for preparing the financial statements in Germany you have to consider special formal requirements as required by the German Handelsgesetzbuch. For financial statements along IFRSs, formal requirements are less. The statement of financial position as it applies in this text book looks as below. Some Accountants still call it the balance sheet B/ S, so do we in the text, too. <?page no="69"?> Figure 6.1: Statement of financial position The statement of financial position has 2 sides: (1) Asset side and (2) Capital/ liability side. The asset side is the left-hand side of the statement of financial position. It discloses the potentials of the company, such as machinery, inventories, cash on hand etc. Accountants also call the asset side “debit side of the balance sheet”. The capital/ liability side is the right-hand side of the statement of financial position. It displays where the company’s funds come from: they originate from the owners’ contribution and/ or from receiving funds by the creditors. Accountants call it “credit side” or “claims side of the balance sheet”. We now take a closer look at the balance sheet, item by item. Ad (1): Asset Side of the Statement of Financial Position The asset side contains all assets of the business. In general, assets are distinguished based on how long they are kept in the company, e.g. a plane stays longer in an airline company than a bottle of wine served during a flight. Non-current assets are assets that will be longer than one Accounting period in use. The former expression “fixed assets” implied, assets cannot be changed, and therefore is old fashioned. Assets deployed for less than a year, are called current assets. In contrast to current assets most of non-current assets will be written-off during the time in use by depreciation. Depreciation reflects the decrease of an asset’s value by an expense linked to the time or the extent of deployment. Assets that do not deplete, are not subject to depreciation, such as land. The first non-current asset item on the balance sheet is property, plant and <?page no="70"?> equipment (P, P, E). This item contains buildings, land, machinery and equipment. The expression P, P, E originates from the header of IAS 16: Property, Plant and Equipment. Assets are to carried at their actual value. The actual value is referred to as its carrying amount. In case a value of an asset decreases by depreciation, the amount of the P, P, E item is to be disclosed at the cost of acquisition less any depreciation and any impairment loss. An impairment loss is an extraordinary depreciation. An impairment loss can be caused by an accident or a sudden decrease in value of any other kind. Along IFRSs, increases in value of non-current assets are recognised when the assets’ fair value increases. The upgrading of assets is called revaluation in Accounting language. IFRSs require companies to carry all their assets at their fair value. In cases an asset’s fair value exceeds the current value, IAS 16 states, the company has to revalue the asset. (Note, revaluations will be covered by chapter (7) of the text book Bilanzen/ Financial Accounting.) Besides of property, plant and equipment, a balance sheet contains intangible assets too. Intangibles are assets that have no physical nature. Frequently, intangibles are rights, patents, etc. Financial assets are intangible also. However, they mostly are linked to financial instruments and contain assets such as shares, bonds or debentures the company is holding. Current assets are assets that stay for shorter periods of time (less than a year) in the business. The first item of current assets on the balance sheet is called inventories. Inventories are raw materials, work in process WIP and finished goods. A production firm that buys materials will disclose them as raw materials inventory. Once production starts, materials in the factory that are assigned to job orders are recognised as work in process. Goods which have been manufactured but not yet been sold are disclosed as finished goods. In general, companies distinguish three kinds of inventory items on the face of the balance sheet or recognise one total item and describe the single amounts by the notes in detail. The notes are explanations of Accounting required by IFRSs. Further items of non-current assets are receivables (A/ R). The accounts receivables (A/ R) result from payments expected from customers or other business partners. (Note, the name A/ R indicates the receivables are recorded in individualised accounts, such as A/ R-LAMPENSCHULTE. This account A/ R-LAMPEN- SCHULTE would contain receivables the <?page no="71"?> company is entitled to get from their business partner LAMPENSCHULTE.) Prepaid expenses are assets that result from payments made in advance. A company that pays rent for the next Accounting period during the current one, will recognise that payment as prepaid expense in accordance with IFRSs. (Note, Germans disclose prepayments as accruals (Aktiver Rechnungsabgrenzungsposten), which is not seen as an asset. The reason is, that prepaid expenses will become difficult to claim in particular events, such as bankruptcy.) The item cash/ bank represents all cash on hand and at bank accounts. In case a company runs several accounts at different banks, the item cash/ bank will add up all accounts and the cash. Ad (2): Capital and Liability Side of the Statement of Financial Position: The capital and liabilities are often referred to as claims. They contain the owners’ equity (paid in contributions, profit earned by the company) and the debts provided by the creditors of the business. The equity section of the balance sheet starts with issued capital. Issued capital is the funds contributed by the owners when the company is established. If a company is privatelyowned, the equity section of the balance sheet will be called owner’s capital and there won’t be any further items in the equity section, such as reserves or retained earnings. Public companies disclose issued capital, reserves and retained earnings (R/ E). The item reserves contains amounts that belong to the owners of the business. Reserves can result from earnings, from capital issues or from revaluations. Earnings reserves increase as a result of earned profit that is kept in the company. Capital reserves result from share issues with an issue price is paid by the shareholders that exceeds the nominal share value. Liabilities are funds the company owes someone, such as bank loans, open bills from supplies and tax liabilities. A company is obliged to pay-off its liabilities. In the liability section of the statement of financial position a company discloses all amounts owing its creditors. A bank loan is recognised as interest bearing liability. Bonds and debentures are long-term debts also <?page no="72"?> and require interest payments. In contrast, short-term liabilities are shown as payables (A/ P). Payables are due within the next Accounting period. Output-VAT is recorded as A/ P, as it is short-term too. (Note, VAT is no income tax! ) Provisions are liabilities, which are uncertain to a particular extent. E.g.: pensions fund payments, provisions for court cases, etc. Liabilities for income taxes are to be recognised along IAS 12 separately. (Note, the German Handelsgesetzbuch requires the disclosure of a provision for income taxes.) Statement of Profit and Loss and Other Comprehensive Income: The format for the statement of comprehensive income is given by figure 6.2: Figure 6.2: Income statement The statement of profit and loss and other comprehensive income compares the revenue earned by the company to its expenses. The bottom line shows the profit earned during the Accounting period, called earnings after taxes. Another name for the statement of profit and loss and other comprehensive income is income statement I/ S. The amounts on the face of the income statement always are net amounts. Revenue or also called sales is the money or the equivalent thereof, the company receives for selling goods or rendering services. Some companies earn other income resulting from extraordinary activities, such as a production firm when selling property. Expenses represent the consumption of business resources. They contain materials, labour etc. Depreciation is an expense, too, that reflects <?page no="73"?> the reduction of a non-current assets’ value by deployment or depletion. Other expenses are expenses other than materials, labour and depreciation. For example, rent, fees, insurance rates etc. If the profit is calculated before interest has been deducted, it will be called earnings before interest and taxes (EBIT). After interest is deducted from EBIT, the remaining profit is earnings before taxes. Some Accountants call the pretax profit “net profit” (NP). After taxes are deducted from EBT, the profit for the period is called earnings after taxes (EAT) or annual surplus A/ S. Summary: Companies prepare financial statements based on Bookkeeping records in order to provide their owners, creditors, employees, the government and anyone else, who has an interest on the company with information. The main financial statements are the statement of financial position and the statement of comprehensive income. Before the revision of IAS 1, these statements were called balance sheet and income statement. These expressions are still widely in use, in particular in Accounting classes. The statement of financial position discloses all assets on one side and the total of capital and liabilities on the other one. The statement of profit and loss and other comprehensive income shows how the business earns profit by deducting all expenses from the revenue. Working Definitions: Asset side: The asset side is the lefthand side of the statement of financial position. It displays the use of the funds by the business. Capital/ liability side: The capital/ liability side is the right-hand side of the statement of financial position. It displays where the funds come from: from the owners and/ or the creditors of the business. Non-current Assets: Non-current assets are assets that will be longer than one Accounting period in use. Depreciation: Depreciation reflects the decrease of an asset’s carrying amount by an expense linked to the time or the extent of deployment. Impairment loss: An impairment loss is an extraordinary depreciation. Intangible assets: Intangibles are assets that have no physical nature. Notes: The notes are explanations of Accounting required by IFRSs. Current Assets: Current assets are assets that stay for shorter periods of time (less than a year) in the business. Intangibles: Intangibles are assets that have no physical structure. Prepaid Expenses: Prepaid expenses are assets that result from payments in advance. Cash/ Bank: The item cash/ bank represents all cash and bank accounts. Issued Capital: Issued capital is the funds contributed by the owners when the company is established. <?page no="74"?> Liabilities: Liabilities are funds the company owes someone. Provisions: Provisions are liabilities which are uncertain to a particular extent. Statement of Profit and Loss and Other Comprehensive Income: The statement of profit and loss and other comprehensive income compares the revenue earned by the company to its expenses. Revenue: Revenue or also called sales is the money or the equivalent thereof, the company receives for selling goods or rendering services. Expenses: Expenses represent the consumption of business resources. <?page no="75"?> Learning Objectives: In this chapter, we’ll study activities that cause changes on the asset side of the statement of financial position only. You will learn how to record those activities on the balance sheet. It is not intended to introduce Bookkeeping entries yet. You will understand how changes of assets are recorded on the balance sheet. Activities changing the asset side of the balance sheet increase one asset and decrease another one. This results from the Accounting equation. They can be seen as asset swops. As for now, only the asset side will be relevant, hence, we ignore the credit side of the statement of financial position. For that reason, the capital and liability items are greyed out for this chapter. As the operations only effect the asset side, always one asset increases and another one will decrease. The changes in values will cancel out each other. (Note, the money is either cash on hand or it is in the bank account. We do not distinguish cash and bank at this stage.) Figure 7.1: ROHRBACH Ltd.’s statement of financial position (asset side) <?page no="76"?> Activity 1: Figure 7.2: ROHRBACH Ltd.’s statement of financial position (asset side) Activity 2: <?page no="77"?> Figure 7.3: ROHRBACH Ltd.’s statement of financial position (asset side) Activity 3: Figure 7.4: ROHRBACH Ltd.’s statement of financial position (asset side) <?page no="78"?> Activity 4: Figure 7.5: ROHRBACH Ltd.’s statement of financial position (asset side) Summary: Activities that effect the asset side only, increase one asset and decrease another one at the same time. <?page no="79"?> Learning Objectives: In this chapter, we introduce activities that effect both sides of the statement of financial position. You will enhance your knowledge about the balance sheet by studying this chapter. Activities that will cause entries on both sides of the balance sheet, are mainly purchases and sales of assets on credit or payments linked to receivables or loans. We are going to record all activities separately and show the balance sheet after each and every business activity. We study the company FLASSKAMP AG, which is a German company based on shares. Activity 1: Issuing shares par value means the issue price is the same as the face value per share. In other words, no share premium applies. <?page no="80"?> Figure 8.1: FLASSKAMP AG’s statement of financial position Activity 2: Recognition means to put something on the balance sheet. This can be an asset or capital or a liability. <?page no="81"?> Figure 8.2: FLASSKAMP AG’s balance sheet Activity 3: <?page no="82"?> Figure 8.3: FLASSKAMP AG’s statement of financial position Activity 4: Acquisition is buying an asset that is recognised as a non-current one. In contrast, any buying of current assets like inventory is referred to as purchase. <?page no="83"?> Figure 8.4: FLASSKAMP AG’s statement of financial position Activity 5: Figure 8.5: FLASSKAMP AG’s statement of financial position <?page no="84"?> Activity 6: (Note, there is no profit margin considered at this stage of the text book in order to keep the example as simple as possible, in particular it means to keep the case study free of profit and loss which will be covered in the next chapter.) Figure 8.6: FLASSKAMP AG’s statement of financial position Activity 7: <?page no="85"?> Figure 8.7: FLASSKAMP AG’s statement of financial position Activity 8: Figure 8.8: FLASSKAMP AG’s statement of financial position <?page no="86"?> The following rule applies: If the activities effect items on the same side of the balance sheet, one item will increase and the other one decreases. The total of the changes will be zero. If the activities effect items on both sides of the balance sheet, both items will decrease or both items will increase at the same time. This will change the total of the balance sheet. Summary: Activities that change assets and capital/ liabilities, effect both sides of the balance sheet. Increases of an asset are combined to an increase of capital/ liability or a decrease of another asset and vice versa. Working Definitions: Par value issue: Issuing shares par value means the issue price is the same as the face value per share. Recognition: Recognition means to put something on the face of the balance sheet. Acquisition: Acquisition is buying an asset that is recognised as a non-current one. <?page no="87"?> Learning Objectives: This chapter introduces activities that effect assets, capital, liabilities and profit and loss, too. It explains how activities change the equity section of the balance sheet. You will learn about the link between the balance sheet and the income statement. Only simple revenue and expense activities are covered in order to prepare the income statement (= statement of profit and loss and other comprehensive income). An income statement ascertains the company’s profit by deducting all expenses from the revenue earned. Revenue contributes to the increase of equity and increases resources of the company as compensation for the goods sold or services rendered, such as cash on hand. Revenue can be linked to payments or to receivables. E.g., a company that rents out an office block, will receive money from its tenant which is classified as rental income. For revenue that is created from customers by selling goods the expression sales or sales revenue is widely common among Accountants. This applies in particular if the company is trading, such as a car dealer, a supermarket, a wholesaler etc. We use in this text book the term revenue and the abbreviation Rev in the accounts. Expenses are resources consumed by the company’s activities. This can be materials used in the production process, labour, fees paid to other companies, depreciation on machinery, interest paid for bank loans, insurances etc. Not all payments result in expenses. In the previous chapter (7), we observed ROHRBACH Ltd. buying equipment. This acquisition does not count as an expense. Only once ROHRBACH Ltd. writes-off its phone shelves, depreciation applies and this will be recorded as an expense. An expense requires the deployment of resources or the loss in value thereof. A company that uses raw materials inventory for production, will record this as an expense. However, land cannot be written-off, because it keeps its value. There is no depletion. We now go through activities that are linked to revenue and to expenses and we explain their effects on profit calculation. We further transfer the profit to the equity section of the statement of financial position. This will demonstrate how profit increases the owners’ equity. Profit is transferred to retained earnings therefore. Retained earnings is the name of an item on the balance sheet that contains the current profit plus profits from previous Accounting periods. The retained earnings item is the link between the balance sheet and the income statement. In contrast to the German law, there is no extra account for profit/ loss carried forward, but the amounts are recorded in the Retained Earnings account. In case a company makes a loss, the retained earnings will decrease and can become negative. We study the business activities of the hairdresser salon PELZERHAGEN (Pty.) Ltd.: <?page no="88"?> Figure 9.1: PELZERHAGEN (Pty) Ltd.’s statement of financial position Activity 1: <?page no="89"?> Figure 9.2: PELZERHAGEN (Pty) Ltd.’s income statement <?page no="90"?> Figure 9.3: PELZERHAGEN (Pty) Ltd.’s statement of financial position (Note, in general, negative amounts are not to be recognised on the face of the balance sheet. Only retained earnings and liabilities/ assets resulting from deferred taxes can become negative.) Activity 2: (Note, in order to keep the example simple, we assume the amount is paid in the middle of the year.) <?page no="91"?> Figure 9.4: PELZERHAGEN (Pty) Ltd.’s income statement Figure 9.5: PELZERHAGEN (Pty) Ltd.’s statement of financial position <?page no="92"?> Activity 3: Figure 9.6: PELZERHAGEN (Pty) Ltd.’s income statement <?page no="93"?> Figure 9.7: PELZERHAGEN (Pty) Ltd.’s statement of financial position Activity 4: <?page no="94"?> Figure 9.8: PELZERHAGEN (Pty) Ltd.’s income statement <?page no="95"?> Figure 9.9: PELZERHAGEN (Pty) Ltd.’s statement of financial position Summary: Activities that effect profit/ loss of a business are shown on the statement of profit and loss and other comprehensive income. The difference between revenue and expenses is the profit. A negative profit is called a loss. Income taxes are based on the pre-tax profit and are calculated in this text book with a constant income tax rate of 30 %, no tax progression is considered to keep the case study simple. Losses do not cause income taxes nor refunds. The earnings after taxes (EAT) are transferred to retained earnings and increase the owners’ equity on the balance sheet if positive. The equity of the balance sheet represents the book value of the business. Working Definition: Retained Earnings: Retained earnings is the name of an item on the balance sheet that contains the profit and profits from previous Accounting periods. <?page no="96"?> Learning Objectives: In this chapter we introduce T-accounts as instrument for preparing financial statements. After studying this chapter, you will be able to understand the concept accounts, you can distinguish real and nominal accounts and you can record easy business activities therein. You will learn how to make Bookkeeping entries and to balanceoff accounts. The business activities discussed in the previous chapters all effect items on the balance sheet and/ or income statement. It would be possible to record business activity directly on financial statements. Then you had to prepare new financial statements after each and every Bookkeeping entry. However, this means a lot of work in Accounting. In order to simplify the recording procedure, companies post business activities in accounts. The accounts are linked to items on the balance sheet (real accounts) or to items on the income statement (nominal accounts). All accounts and the entries therein are called the Bookkeeping records. All changes caused by business activities will be recorded by making entries in at least two accounts. At the end of every year/ Accounting period, the value of the accounts will be calculated and copied to the financial statements. E.g., the value of the Cash/ Bank account is disclosed on the balance sheet as the cash/ bank item. This way, accounts are linked to items on the financial statements. Recording business activities means, keeping a list of how business activities change items on financial statements. Entries are made like adding lines to a list. The account is a list with two columns, one side is for increases and the other one is for decreases. We introduce T-accounts right now. Like the balance sheet, T-accounts come with two sides. They are called debit side (left) and credit side (right). One of the sides will show the opening value and all increases in the account, whereas the opposite side shows the decreases. Which side contains the opening value and the increases and which one the decreases, depends on the item, the account represents. E.g., an account representing and item of property, plant and equipment: increases thereof will be seen as additions to the value of the item and losses in value as decreases thereof. The Property, Plant, Equipment account is an asset account. Asset accounts show opening amounts and increases on the debit side. An asset reduction, such as caused by depreciation or sale of items, leads to an entry on the credit side of the asset account. We introduce a Cash account. Cash represents cash on hand and is a current asset recognised on the asset side of the balance sheet. Cash accounts disclose the opening amount on the debit side if positive. Our account shows an opening value of 100.00 EUR. It is entered on the debit side. The account looks as below in Figure 10.1. <?page no="97"?> 100.00 Figure 10.1: T-Account “Cash“ Every account has a name shown on the top of the “T”. The name is linked to an ID number. All names and IDs for accounts are listed in the chart of accounts. The list of all accounts in use is referred to as the chart of accounts. A chart of accounts is necessary in order to use the same account names in different companies. Companies that belong to a group, will apply the same chart of accounts. Another reason for chart of accounts is that in particular small companies do not keep their own Bookkeeping records but ask their tax attorney to make bookkeeping entries. The tax attorney later will prepare the financial statements for taxation and submits the electronic balance sheet to the German revenue service. Tax attorneys use Bookkeeping software which allow making Bookkeeping entries for more than one company (clients). The tax attorney and the revenue service have an interest to use standard names and IDnumbers for the accounts. In Germany the chart of accounts by DATEV (= abbreviation for the German word data processing, it is the name of a software design company) became a standard for financial statements for taxation. We do not apply standard chart of accounts in this text book to keep Accounting simple. We assume each item on the balance sheet and each item on the income statement is an account. That will become our simplified training-chart of accounts. There is a P, P, E account, an Intangible Asset account, a Financial Instrument account, an Inventory account etc. The account’s name in Figure 10.1 is Cash. Hence, it belongs to the item cash/ bank on the balance sheet. As we will learn in chapter (16) of this text books, there can be more than one account linked to an item on the financial statements. E.g., a company can run different bank accounts, e.g. with Sparkasse Osnabrück, Commerzbank etc. As a result, all accounts balancing figures will be added to give the value of the item Cash/ Bank on the balance sheet. For now, we assume a 1: 1 relationship between item and account, meaning one account gives the value for an item on the financial statements. In the header of the account, we have to mention the name, the currency unit and the level of rounding that applies for the account. In this text book, the currency for all accounts is EUR and amounts are displayed accurate to two digits after the decimal point. In case <?page no="98"?> of the Cash account in figure 10.1 the opening value (OV) amounts to 100.00 EUR. As the conventions determine already the account display, it is not required to write it on every account. From the previous chapters, we know already that cash is an asset and accordingly, the account belongs to an item on the asset side of the balance sheet. An asset account is an account which records the value of an asset item on the balance sheet. As a result, the opening amount of asset accounts is always shown on the debit side, if positive. The Accountant will enter all increases on the debit side and all decreases on the credit side. We now observe a few changes of the Cash account. The numbers represent the Bookkeeping-IDs. (1) Input of 200.00 EUR. (2) Another input of 400.00 EUR. (3) Output of 130.00 EUR. (4) Another output of 40.00 EUR. (5) Another output of 125.00 EUR. 100.00 130.00 200.00 40.00 400.00 125.00 Figure 10.2: T-account format for the Cash account The account now contains a few debit entries and a few credit entries. The entries come with narrative information. The narrative information given in the account is only the reference number of the entries (1) ... (5), which refers to the text. We farther down in the text book show you how to record the narrative in the journal (see below). We want to ascertain how much money is in the Cash account. We say we want to know the account’s balance or the balancing figure of the Cash account after entries (1) ... (5) have been made. It is the opening amount plus all increases less all decreases. The balancing figure of the Cash account equals to: 100 + 200 + 400 - 130 - 40 - 125 = 405.00 EUR. To balance-off an account means to ascertain the balancing figure of an account. The process of balancingoff an account, doesn’t change the value in the account. A balancing-off is neutral to the figures. An account can be balanced-off at any time and as often as necessary. The process of balancing-off only enters a debit entry and a corresponding credit entry in the same account with the same value. Once we balance-off an account, the balancing figure (here: 405.00 EUR) is entered into the account under the reference “balance carried down“ or “Bal <?page no="99"?> c/ d“ or just “c/ d“. The balance carried down is inserted that way, so that the sum on both sides equal one another. Without balancing off the Cash account, the total on the debit side is: 100 + 200 + 400 = 700.00 EUR. The total on the credit side equals to: 130 + 40 + 125 = 295.00 EUR. In order to indicate that the amount on the credit side is lower than on the debit side, we say the credit side is shorter. By the next step, we add the balancing figure on the shorter side of the account which is the credit side. Now, the sums on both sides are the same: 100 + 200 + 400 = 700.00 EUR as well as: 130 + 40 + 125 + 405 = 700.00 EUR. By entering the balance carried down on the credit side, we changed the value of the bookkeeping entries. This will lead to a breach with the Accounting equation if no further action is taken. What we actually do is we enter the same amount of 405.00 EUR on the opposite side which is the debit side for the Cash account. This entry is indicated “balance brought down” of “Bal b/ d” of just “b/ d”. We actually write the balancing figure as opening amount for the next Accounting period to the opposite side of where the entry for the balance carried down has been made. Observe the balancing-off of the Cash account in Figure 10.3. 100.00 130.00 200.00 40.00 400.00 125.00 405.00 700.00 700.00 405.00 Figure 10.3: T-Account “Cash“ The Cash account’s balance brought down is on the debit side. This means there is cash on hand as at the time of balancing-off the account. We could say the balancing figure is positive. Accountants call accounts with the balancing figure on the debit side debitbalanced and accounts with the balance brought down on the credit side credit balanced. In general, you can expect accounts that represent an item on the balance sheet’s debit side to be debit-balanced and accounts for capital and liabilities to be credit-balanced. In case that happens, the amounts will be positive. Similar rules apply for the nominal accounts. Revenue accounts should be credit-balanced and expense accounts debit-balanced. This is only a common rule, an A/ R accounts can be credit balanced if the company gives the debtor a voucher, for example. Be aware that the balance sheet only shows positive amounts, the items retained earnings and deferred tax liabilities exempted. Let’s assume the Bank account is credit balanced. In that case the company is owing and the amount has to be disclosed as a short-term liability, <?page no="100"?> assumed the negative value results from a short-term bank overdraft. On the balance sheet the bank item shows a zero and the A/ P item will show the short-term liability’s amount. In case we transfer the balancing figure of the Cash account to the face of the balance sheet we make a copy of the value of the balance brought down and paste it on the balance sheet. This is no Bookkeeping entry and does not count as an entry along the double entry system! All figures from real accounts will be copied to the balance sheet, however, some thereof will be aggregated beforehand. The transfer of cash from the Cash account to the balance sheet looks as below in Figure 10.4: Figure 10.4: Cash amount displayed on the balance sheet. All accounts linked to balance sheet’s items on the asset side got the same structure as the Cash account. They show a positive amount on the debit side, they increase on the debit side and they decrease on the credit side. Accounts linked to items on the balance sheet’s credit side, such as equity or liabilities, are inverted. This means they will show the opening amount on the credit side and increases there also. Decreases are made by debit entries. This applies for the Issued Capital account, for the Reserves accounts etc. All accounts which are linked to the balance sheet are called real accounts. Accounts linked to the income statement are called nominal accounts. They can be seen as subordinated accounts to the Retained Earnings account. Remember, the Retained Earnings (R/ E) account is on the credit side. Increases of retained earnings mean the company earns a profit that increases the book value of the business. <?page no="101"?> In order to start with Accounting, we assign one account to each item of the balance sheet and to each item of the income statement. Accordingly, our chart of accounts for training purposes will look alike as listed below: (1) Property, plant and equipment (2) Intangibles (3) Financial assets (4) Inventory (5) Accounts receivables (6) Prepaid expenses (7) Cash/ bank (8) Issued capital (9) Reserves (10) Retained earnings (11) Interest bearing liabilities (12) Accounts payables (13) Provisions (14) Tax liabilities (15) Revenue (16) Other income (17) Materials (18) Labour (19) Depreciation (20) Other expenses (21) Interest (22) Income tax expenses (23) Deferred taxes (Note, the numbers in the list above are not ID-numbers! ) Our chart of the accounts is very simple and we stick to it for the whole text book. That way, we make Accounting very simple for you. Later, we might assign more accounts to one item on the financial statements, which gives us a structure of superior and subordinated accounts. This means for the Cash/ Bank account, on the lower level, there can be an account with Commerzbank, another one with Deutsche Bank, another one with Sparkasse Osnabrück etc. The superior account is called the reconciliation account and is the Cash/ Bank account. All accounts based on the chart of accounts form the general ledger. A general ledger contains the basic accounts without any subordinated accounts. We now make the entries for the cell phone dealer ROHRBACH Ltd. as introduced in chapter (6) Introduction to Statements of Financial Position and Statement of Comprehensive Income: 250,000.00 Figure 10.5: ROHRBACH Ltd.‘s accounts <?page no="102"?> 4,700.00 2,350.00 2,350.00 4,700.00 4,700.00 2,350.00 150,000.00 10,050.00 139,950.00 150,000.00 150,000.00 139,950.00 250,000.00 150,000.00 10,050.00 4,700.00 2,350.00 107,700.00 262,400.00 262,400.00 107,700.00 Figure 10.6: ROHRBACH Ltd.’s accounts <?page no="103"?> 150,000.00 4,700.00 10,050.00 2,350.00 Figure 10.7: ROHRBACH Ltd.’s journal 4,700.00 2,350.00 150,000.00 10,050.00 2,350.00 139,950.00 4,700.00 4,700.00 150,000.00 150,000.00 2,350.00 139,950.00 250,000.00 150,000.00 10,050.00 4,700.00 2,350.00 107,700.00 262,400.00 262,400.00 107,700.00 Figure 10.8: ROHRBACH Ltd.’s accounts The format in Figure 10.8 is easy to prepare and offers you a quick way of making Bookkeeping entries. This simplified account display might suit you, in particular for your exams, as Accounting becomes very quick. There is not much information in the account that can disturb you from recording activities. (Note, there is no law prescribing regulations about how to make Bookkeeping entries.) <?page no="104"?> Figure 10.9: ROHRBACH Ltd.’s statement of financial position (asset side) We apply the knowledge about accounts for the second case study FLASSKAMP AG, too. In contrast to the previous example, FLASSKAMP AG runs accounts that are linked to the capital/ liability side of the statement of financial position. We stick to our account display as introduced above by Figure 10.8 and keep on preparing a journal. For the case study, we introduce capital/ liability accounts. Capital/ liability accounts are linked to capital or to liabilities and will show the opening values on the credit side. Capital/ liabilities accounts are real accounts. They show increases on the credit side and decreases by entries made on the debit side. Before studying the FLASSKAMP AG case study, we learn how the Liability account for a bank loan increases and decreases. We assume someone took a bank loan of 100,000.00 EUR and pays-off an amount of 5,000.00 EUR every period. This allows us to show an account that is continued over more than one Accounting period. The bank loan is recorded as a credit entry in the Interest Bearing Liabilities (IBL) account. This account is linked to the capital/ liability side of the statement of financial position. Observe the account in Figure 10.10: <?page no="105"?> 5,000.00 100,000.00 95,000.00 100,000.00 100,000.00 5,000.00 95,000.00 90,000.00 95,000.00 95,000.00 90,000.00 Figure 10.10: Liability account In this case, taking the bank loan gives an opening value of 100,000.00 EUR which is disclosed as opening value OV on the credit side. The account for interest bearing liabilities is linked to the interest bearing liability item on the credit side of the statement of financial position. The pay-off Bookkeeping entries in every Accounting period reduce the payment obligation of the debtor and are made on the debit side. Every year’s pay-off amount equals to 5,000.00 EUR in this example. Observe the first 2 years of the bank account to understand the way accounts work when they belong to the capital/ liability side and study their difference to asset accounts. Here, the balances brought down are recorded on the credit side always. This means there is still a liability left. Payments that reduce the liabilities are made by debiting the amounts to the Interest Bearing Liabilities account, see Bookkeeping entry (1) and (2). After the first Accounting period the balance of the IBL account is 95,000.00 EUR. After 2 years, it is 90,000.00 EUR. After 2 years, the bank loan is worth 90,000.00 EUR. That is the amount to be disclosed on the balance sheet. The sum of the debit and credit entries is shown below a line and is underlined twice. Every account that has a balancing figure that does not equal zero will disclose it as balance brought down underneath of the sum line. If an account is “empty” in the meaning of balanced to zero, there won’t be a balancing figure. The sum will appear on the bottom line then. How it is done (balancing-off an account): (1) Check whether your account is a (a) real or (b) nominal account. (2a) If the account is a real account, that belongs to the debit side of the balance sheet, make Bookkeeping entries for increases on the debit side and Bookkeeping entries for decreases on the credit side. If the account is a real account, that belongs to the credit side of the balance sheet, make Bookkeeping entries for increases on the credit side and Bookkeeping entries for decreases on the debit side. <?page no="106"?> (2b) If the account is a nominal account, make Bookkeeping entries for revenues on the credit side and Bookkeeping entries for expenses on the debit side. (3) Add up both sides of the account. (4) Insert a figure on the “shorter” side in order to make the sums on the debit side and on the credit side equal. (5) Name the inserted figure balance carried down and indicate this in the account by “Bal c/ d” or only “c/ d”. (6) Write under the figures of the Bookkeeping entries and the balance carried down the sums. Double underline the totals. (7) Transfer the amount of the balance carried down to the opposite side. If the balance carried down is on the debit side, make an entry underneath the sum on the credit side. If the balance carried down is on the credit side, make an entry underneath the sum on the debit side. (8) Name the entry of step (7) balance brought down and indicate the figure by “Bal b/ d” or “b/ d”. After learning how capital/ liability accounts work, we’ll apply this knowledge for the FLASSKAMP AG case study. <?page no="107"?> 500,000.00 92,000.00 200,000.00 600,000.00 600,000.00 23,000.00 23,000.00 92,000.00 Figure 10.11: FLASSKAMP AG’s journal 600,000.00 600,000.00 500,000.00 500,000.00 600,000.00 500,000.00 92,000.00 23,000.00 200,000.00 200,000.00 69,000.00 200,000.00 92,000.00 92,000.00 69,000.00 Figure 10.12: FLASSKAMP AG’s accounts <?page no="108"?> 23,000.00 23,000.00 600,000.00 92,000.00 92,000.00 600,000.00 692,000.00 692,000.00 500,000.00 600,000.00 200,000.00 92,000.00 23,000.00 31,000.00 723,000.00 723,000.00 31,000.00 Figure 10.12: FLASSKAMP AG’s accounts (continued) (Note, in general, we place the accounts along the order they appear in the text.) Figure 10.13: FLASSKAMP AG’s statement of financial position Summary: Accounts are used to record business activities. They contain a debit and a credit side. Entries for increases of assets will be made on the debit side. Reductions of the assets lead to credit entries in the asset accounts. Entries for increases of capital or of liabilities will be made on the credit side. Reductions <?page no="109"?> of capital and liabilities lead to debit entries in the capital/ liability accounts. All accounts linked to the balance sheet are called real accounts. The balancing figure of the real accounts is disclosed as balance brought down and is copied onto the statement of financial position. Accounts for profit calculation are linked to retained earnings. They are referred to as nominal accounts. Increases are credited and decreases debited to nominal accounts. Working Definitions: Real Account: Accounts which are linked to the balance sheet are called real accounts. Nominal Account: Accounts linked to the income statement are called nominal accounts. Asset Account: An asset account is an account which records an asset item on the balance sheet. Capital/ Liability Account: Capital/ liability accounts are linked to capital or to liabilities will show the opening values on the credit side. Balancing-off an Account: To balance-off an account means to ascertain the balancing figure of an account. Chart of Accounts: The list of all accounts in use is referred to as the chart of accounts. <?page no="110"?> Learning Objectives: In this chapter, we deal with nominal accounts which represent revenue and expenses. The outcome of this chapter is to learn how to make Bookkeeping entries for profit relevant activities and how to apply the Profit and Loss account. After studying this chapter, you can calculate profit using T-accounts. In the previous chapter, we only made entries in real accounts. As a result, no profit and loss calculation applied based on the Bookkeeping records made. The previous case studies ROHRBACH Ltd. and FLASSKAMP AG were free of profit which means, the companies sold goods at the same price as they have purchased them for. In a real business world, activities are made with the intention to earn a profit. We record revenue and expense now. Revenue increases the profit of the business expenses decrease it. Later, the resulting profit is transferred into the Retained Earnings account in the equity section of the statement of financial position. Hence, profit increases the book value of the business - and a loss reduces it. Revenue entries are recorded on the credit side of nominal accounts, namely the Revenue account is credited. Bookkeeping entries for expenses are debit entries in nominal accounts, such as Labour account, Depreciation account etc. In contrast to the real accounts, nominal accounts are not transferred to the balance sheet. Nominal accounts are closed-off to the Profit and Loss account. Only the Profit and Loss account is closed-off to the Retained Earnings account on the balance sheet. Hence, a profit increases equity a loss decreases it. Closing-off an account to another account means to transfer the balancing figure of the source account into the target account. By closingoff an account, its balancing figure becomes zero; the account is deleted that way. The previous balancing figure will appear as an entry in the target account. Closing-off an account is regarded as a Bookkeeping entry along the double entry system of Accounting. How it is done (closing-off an account to another one) (1) Determine which source account should be closed-off to which target account should take the balancing figure. (2) Balance-off the source account. (3) In the source account, make an entry opposite to the balance brought down to the same amount as the balance brought down. (4) Make the contra entry in the target account. (5) You might cross out the source account after step (4) as it does not have a value any more. <?page no="111"?> The PELZERHAGEN (Pty) Ltd. case study is about profit and loss calculation. Hence, nominal accounts apply. After recording revenues and expenses, we close-off all nominal accounts to the Profit and Loss account, which means, we transfer all revenues and expenses to profit and loss at the end of the Accounting period. The balancing figure of the P&L account is the profit for the period and is transferred into the Retained Earnings account on the balance sheet. Figure 11.1: PELZERHAGEN (Pty) Ltd.’s statement of financial position <?page no="112"?> In cases one B/ S item is linked to more than one account, the opening amounts cannot be copied from the statement of financial position. In that situation, the amounts are to be taken from the accounts. For instance, the balance sheet item cash/ bank does not tell how much is the balancing figure in the Commerzbank, Deutsche Bank and Sparkasse Osnabrück account and how much cash is on hand. However, this problem is a class room problem only, as in general, accounts will be continued from the previous Accounting periods. Thus, there is no need to read the figures from the financial statements. Compare the opening values in PELZERHAGEN (Pty) Ltd.’s accounts in Figure 11.2. to the balance sheet as shown in Figure 11.1. 100,000.00 3,400.00 100,000.00 100,000.00 130,000.00 48,000.00 100,000.00 178,600.00 230,000.00 230,000.00 178,600.00 50,000.00 10,000.00 3,400.00 3,400.00 40,000.00 3,400.00 3,400.00 50,000.00 50,000.00 40,000.00 48,000.00 48,000.00 50,000.00 50,000.00 48,000.00 48,000.00 50,000.00 Figure 11.2: PELZERHAGEN (Pty) Ltd.’s accounts <?page no="113"?> 130,000.00 130,000.00 48,000.00 130,000.00 130,000.00 130,000.00 10,000.00 3,400.00 68,600.00 130,000.00 130,000.00 20,580.00 68,600.00 48,020.00 68,600.00 68,600.00 48,020.00 48,020.00 20,580.00 20,580.00 48,020.00 20,580.00 10,000.00 10,000.00 10,000.00 10,000.00 Figure 11.2: PELZERHAGEN (Pty) Ltd.’s accounts (continued) 3,400.00 48,000.00 50,000.00 10,000.00 2,350.00 Figure 11.3: PELZERHAGEN (Pty) Ltd.’s journal <?page no="115"?> Figure 11.4: PELZERHAGEN (Pty) Ltd.’s income statement For tax calculations, we take a look at the statement of comprehensive income, before we study the accounts. The income tax is deducted from the earnings before taxes (= pre-tax profit). Along the conventions for this text book the total income tax rate is 30 % based on the pre-tax profit. We simplify the tax calculation and, e.g. ignore income tax progression: 30 % × 68,600 = 20,580.00 EUR. In the income statement the amount for taxes is deducted from earnings before taxes. The result is the annual surplus also known as earnings after taxes EAT. <?page no="116"?> Figure 11.5: PELZERHAGEN (Pty) Ltd.’s statement of financial position How it is done (profit calculation with the Profit and Loss account) (1) Make debit entries for expenses in the relevant nominal accounts. (2) Make credit entries for revenues in the relevant nominal accounts. (3) Close-off all nominal accounts to the Profit and Loss account. (4) Determine the balancing figure of the Profit and Loss account which is EBT. The balancing figure c/ d can be (a) on the debit side or (b) on the credit side. (5a) If the balancing figure c/ d of the Profit and Loss account is on the debit side, the business earns a profit. Determine income taxes by multiplying the total income tax rate by EBT. Determine earnings after taxes by reducing EBT by the income taxes. Make credit entries in the Income Tax Liability account and in the Retained Earnings account. (5b) If the balancing figure c/ d of the Profit and Loss account is on the credit side, the business makes a loss. Close-off the Profit and Loss account to the Retained Earnings account by making a debit entry in the Retained Earnings account and a credit entry in the Profit and Loss account. Income taxes do not apply in this situation. <?page no="117"?> Summary: Accounts support the preparation of financial statements. The accounts are linked to items on the balance sheet and to items on the income statement. The income statement is prepared by the Profit and Loss account. All accounts linked to revenues are credited - all accounts for expenses are debited. After profit calculation, the amount for earnings after taxes is transferred to the Retained Earnings account. Income tax expenses are credited to the Income Tax Liability account on the statement of financial position. Working Definition: Closing-off: Closing-off an account to another account means to put the balancing figure of the source account into the target account. <?page no="118"?> Learning Objectives: This chapter introduces Bookkeeping entries. Talking in Bookkeeping entries will become your language as Accountant and manager. The Bookkeeping entry tells in which accounts entries are made. It further gives the amount. We explain the double entry system as the underlying concept of making Bookkeeping entries. After studying this chapter, you will understand how to record the business activities. In the previous chapters, we made entries with regard to items on the statement of financial position and on the statement of comprehensive income. Later, we made entries for the adjustments in accounts. So far, we only made the entries but we did not write them down. We only did by keeping a list of entries which we refer to as the journal. We now start writing and memorizing complete Bookkeeping entries from this chapter onwards. Furthermore, we’ll acknowledge that a lot of similar activities exists leading to the same kind of Bookkeeping entries. Recording business activities will become a standard procedure for you quickly. A Bookkeeping entry is the recording of a business activity. It contains a debit entry and a credit entry. Bookkeeping entries contain information which account is changed, on which side an entry is made (debit or credit side), which amount is recorded and when the recording is made (date). Ad (1): Account’s name: The account name is written into the Bookkeeping entry. In case we apply a chart of accounts which contains numbers for the identification of accounts, the ID number is mentioned as well. E.g., “3100 Bank account”. Ad (2): Recording on the debit or credit side: We indicate by writing debit entry or credit entry which side of the account is increased. Bookkeeping entries are always added to accounts. No deductions or deletions in accounts are allowed. A debit entry is marked by “DR” for debit recorded, a credit entry is marked by “CR” for credit recorded. Ad (3): Amount recorded: The amount added to an account is written down correctly and in full. No rounding or whatsoever is allowed! Bookkeeping entries always are at the exact amount which contains the full EUR amount plus two digits for the EUR-cents. Ad (4): Date: The date of the Bookkeeping entry is mentioned next to the Bookkeeping entry. The date is exact to the day. No timely information is required for recording. If you apply Bookkeeping software on a computer system, the software will put a time stamp at your Bookkeeping entry, which will help <?page no="119"?> you to distinguish Bookkeeping entries made on the same day. (Note, in this text book we only mention the date in the text and in the journal.) Recording a business activity leads to at least one debit and one credit entry. This is for fulfilling the Accounting equation. A compound Bookkeeping entry is one that contains more than one debit entry and/ or more than one credit entry. The sum of debit entries equals to the total of credit entries in a compound Bookkeeping entry. Along common regulations, a Bookkeeping entry never can be changed. This comes from the old days, when Bookkeeping entries were made on paper. In order to guarantee the correctness of recording, it is not allowed to delete or manipulate entries. The entries had to be written with indelible ink. Once the entry has been recorded, it stays. This rule applies with software solutions too. You are not able to delete or change entries after they have been recorded. (However, with MS Excel you can, which is the reason why MS Excel is no acceptable Bookkeeping software.) Remember: The Bookkeeping entries will determine the values on the financial statements. In order to ensure the data disclosed thereon are correct, Bookkeeping regulations are very strict. In case, something is to be changed, you have to make a follow-up Bookkeeping entry to cancel/ neutralise the faulty one, and both entries will stay on the system. This makes Accounting transparent and prevents from fraud. Today’s software solutions make sure you don’t make wrong Bookkeeping entries. They computer systems precheck every entry before posting. However, in the university you’ll make entries on paper and/ or maybe on MS Excel, which means you make Bookkeeping entries without any prechecks, and you can change them later. For Bookkeeping the double entry system applies. It is closely linked to the Accounting equation we introduced in chapter (2): Cafeteria Example for the Balance Sheet Preparation with regard to the KENSINGTON CAFETERIA case study. The Accounting equation states that always the total of assets equals to the total of capital and liabilities. This leads to bookkeeping entries with debit and credit entries with the sum thereof being zero. Check all entries we made so far in the previous chapters you will see that we always made for each and every activity one entry in an account on the debit side and a contra entry in another account on the credit side. If you follow this rule strictly, the sums on the debit side and the credit side of the balance sheet equal each other. This concept of making debit entries and credit entries together, is referred to as the double entry system. (Note, in order to avoid faulty Bookkeeping, make your entries always in one step and completely. Don’t get interrupted when recording Bookkeeping entries.) In order to state Bookkeeping entries, it is common Accounting practice to name the debit entry at first. The debit entry is followed by the credit entry. In <?page no="120"?> case of compound Bookkeeping entries, all debit entries are mentioned at first followed by the credit entries. Among the debit entries and among the credit entries, the sequence does not matter. In this text book, we display Bookkeeping entries always in bold font style to highlight them within the text. We further use non-proportional font types in order to place the figures straight and at the same position (a 111 has the same width as a 999). This will help you to add debit and credit when you see them on paper. However, due to the format of this text book, we don’t indent credit entries, such as below: DR Inventory 150,000.00 EUR CR Cash/ Bank 150,000.00 EUR All entries made with regard to activities are identified by an ID-number, such as (1), (2), (3) etc. The Bookkeeping description in the text or in the journal always contains the date of recording. Sometimes, the Bookkeeping description is just a narrative and grammatically not a full sentence, such as “Recording depreciation on 31.12.20X8”. The date for adjustments always is the 31.12.20XX. Adjustments are about depreciation, accruals, balancingand closing-off accounts, income tax calculation etc. Bookkeeping entries made when preparing financial statements and which are not linked to ordinary business activities, are referred to as adjustments. They do not have an ID number in this text book. In the accounts the contra account will be shown for reference. We observed this already, when the Depreciation account was closed-off to the Profit and Loss account in Figure 11.2. The reference was “Dpr” in the Profit and Loss account and “P&L” in the Depreciation account. We study below the Bookkeeping entries for the case studies ROHRBACH Ltd., FLASSKAMP AG and PELZERHAGEN (Pty) Ltd.: DR Inventory.................... 150,000.00 EUR CR Cash/ Bank.................... 150,000.00 EUR DR P, P, E Account.............. 4,700.00 EUR CR Cash/ Bank.................... 4,700.00 EUR <?page no="121"?> DR Cash/ Bank.................... 10,050.00 EUR CR Inventory.................... 10,050.00 EUR DR Cash/ Bank.................... 2,350.00 EUR CR Property, Plant, Equipment... 2,350.00 EUR 150,000.00 4,700.00 10,050.00 2,350.00 Figure 12.1: ROHRBACH Ltd.’s journal <?page no="122"?> DR Cash/ Bank.................... 500,000.00 EUR CR Issued Capital............... 500,000.00 EUR DR Inventory.................... 92,000.00 EUR CR Accounts Payables............ 92,000.00 EUR DR Cash/ Bank.................... 200,000.00 EUR CR Interest Bearing Liabilities. 200,000.00 EUR DR P, P, E Account.............. 600,000.00 EUR CR Account Payables............. 600,000.00 EUR <?page no="123"?> DR Accounts Payables............ 600,000.00 EUR CR Cash/ Bank.................... 600,000.00 EUR The expression „on credit“-sale for a sale which is not on cash, sounds wrong as there is a debit entry to be made in the Accounts Receivables account. However, “on credit” is a widely used Accounting term. DR Accounts Receivables......... 23,000.00 EUR CR Inventory.................... 23,000.00 EUR DR Cash/ Bank.................... 23,000.00 EUR CR Accounts Receivables......... 23,000.00 EUR <?page no="124"?> DR Accounts Payables............ 92,000.00 EUR CR Cash/ Bank.................... 92,000.00 EUR 500,000.00 92,000.00 200,000.00 600,000.00 600,000.00 23,000.00 23,000.00 92,000.00 Figure 12.2: FLASSKAMP AG’s journal From here onwards, we trust in the correctness of our Bookkeeping entries along the double entry system. This means we stop checking the fulfilment of the Accounting equation for the following case studies! We trust that all Bookkeeping entries are correct and introduce in chapter (29) Preparing the Trial Balance a concept to check the fulfilment of the Accounting equation more efficiently. As long as we make Bookkeeping entries that are <?page no="125"?> conform to the double entry system, it is likely we make them correct. DR Rent......................... 3,400.00 EUR CR Cash/ Bank.................... 3,400.00 EUR DR Salaries..................... 48,000.00 EUR CR Cash/ Bank.................... 48,000.00 EUR DR P, P, E Account.............. 50,000.00 EUR CR Accounts Payables............ 50,000.00 EUR <?page no="126"?> DR Depreciation................. 10,000.00 EUR CR P, P, E Account.............. 10,000.00 EUR DR Cash/ Bank.................... 130,000.00 EUR CR Revenue...................... 130,000.00 EUR 3,400.00 48,000.00 50,000.00 10,000.00 2,350.00 Figure 12.3: PELZERHAGEN (Pty) Ltd.’s journal <?page no="127"?> DR P&L-ACCOUNT .................. 3,400.00 EUR CR Rent......................... 3,400.00 EUR DR P&L-Account.................. 48,000.00 EUR CR Salaries..................... 48,000.00 EUR DR P&L-Account.................. 10,000.00 EUR CR Depreciation ................. 10,000.00 EUR DR Revenue...................... 130,000.00 EUR CR P&L-Account.................. 130,000.00 EUR DR P&L-Account.................. 20,580.00 EUR CR Income Tax Liabilities....... 20,580.00 EUR DR P&L-Account.................. 48,020.00 EUR CR Retained Earnings............ 48,020.00 EUR Summary: Bookkeeping entries contain debit entries and credit entries. Bookkeeping <?page no="128"?> follows the double entry system in order to fulfil the Accounting equation. A Bookkeeping entry is noted by DR/ CR, the account name, the amount and the date of recording. There is at least one debit entry and one credit entry. Compound Bookkeeping entries can have more than one debit entry or more than one credit entry. The total value of debit entries must equal to total value of credit entries within one Bookkeeping entry. In Accounting, there are real accounts and nominal accounts. All real accounts are linked to the statement of financial position and represent assets, equity or liabilities. All nominal accounts are closed-off to the Profit and Loss account. The profit after taxes is transferred to the equity section of the statement of financial position. It increases the item retained earnings if positive otherwise will reduce it. Working Definitions: Bookkeeping Entry: A Bookkeeping entry is the recording of a business activity. It contains a debit entry and a credit entry. Compound Bookkeeping Entry: A compound Bookkeeping is one entry that contains more than one debit entry and/ or more than one credit entry Adjustment: Bookkeeping entries made when preparing financial statements and which are not linked to ordinary business activities, are referred to as adjustments. <?page no="129"?> Learning Objectives: In the previous chapters, we taught you the basics of Bookkeeping. In this chapter, we now introduce more cases about asset accounts in order to widen your Accounting knowledge. It is intended to familiarise you with more asset examples and Bookkeeping entries related thereto. We follow the asset structure of the balance sheet for our explanations. After studying this chapter, you have gained more experience in terms of making Bookkeeping entries for asset recognition. You further learn about special assets and their requirements with regard to special recordings. To put an asset on the balance sheet requires that the object meets the asset definition and fulfils all recognition criteria. Assets are resources from which a future economic benefit is expected to flow to the company. A future economic benefit can result from the asset’s deployment, its renting out or its sale. The recognition criteria further require that the costs of the asset can be determined reliably. Along IFRSs, all assets are disclosed on the statement of financial position. Note, no single recognition is required on the balance sheet but in the asset accounts. Only the total value of asset groups as shown on the balance sheet structure, such as P, P, E or financial assets, is disclosed on the statement of financial position. A company that has two motor vehicles at a value of 30,000.00 EUR each will disclose under P, P, E an amount of: 2 × 30,000 = 60,000.00 EUR. It probably runs two single motor vehicle accounts for the cars. Assets are to be classified as either non-current or current assets. According to that recognition requirements, there are accounts for non-current assets and current assets. Non-current assets often are written-off by use whereas current assets stay less than one year in the business and will be consumed, such as materials. Some non-current assets, such as land won’t be depreciated, because they do not deplete. Examples for current assets are materials, receivables, securities, prepaid expenses and cash/ bank. For some assets recognition is prohibited. For example, self-generated goodwill cannot be disclosed on the balance sheet. If someone opens a hairdresser salon and achieves a good reputation, the reputation is regarded as self-generated goodwill and must not be recognised on financial statements. When assets are acquired, they are recognised instantly which means the asset account is to be debited. Next, we study: (1) non-current asset and (2) current asset recognition Ad (1): Non-current Assets When a company buys tangible assets, such as land, machinery, interior, tools etc., a debit entry is recorded in the Property, Plant and Equipment account. There is an intention to deploy these assets for running business activities in company. <?page no="130"?> DR P, P, E Account.............. 89,000.00 EUR CR Cash/ Bank.................... 89,000.00 EUR (Note, the consideration of VAT comes in chapter (21) Trading Business: Purchases and Returns with VAT.) There might be circumstances when property counts as investment property along IAS 40. Investment property is land and/ or buildings that are for renting out or held in order to earn a profit by capital appreciation. You must not recognise investment property as P, P, E. They have to be assigned to an extra account called Investment Property account. Only once a company intends to deploy the property item itself, it becomes an item of property, plant and equipment from that time onwards. There are special regulations how an asset is turned from investment property to property, plant and equipment along IFRSs. Study IAS 40 for the details. DR Investment Property.......... 1,000,000.00 EUR CR Cash/ Bank.................... 1,000,000.00 EUR DR P, P, E Account.............. 25,000.00 EUR CR Cash/ Bank.................... 25,000.00 EUR DR P, P, E Account.............. 13,500.00 EUR CR Accounts Payables............ 13,500.00 EUR When a company uses rights in order to produce a product under license, they buy those rights and have to recognise them as intangible assets. The <?page no="131"?> asset’s use can be limited for a certain period of time according to the agreement. An intangible asset is an asset without physical nature. Examples for intangible assets are licenses, warranties, patents, software, franchise agreements etc. Special intangibles cannot be recognised as they are legally prohibited from recognition. E.g. customer lists, patients’ data, etc. cannot be an asset. Only those items can be recognised, the company gains control over. This is the reason, why customer lists, soccer players, sun light for a solar energy provider, nice view for a hotel, etc. are exempted from recognition. DR Intangible Assets............ 10,000.00 EUR CR Cash/ Bank.................... 10,000.00 EUR The next item on the asset list is financial assets. Actually, the definition for financial instruments sounds complicated: Financial instruments are contracts which lead to an asset at one party and to an equity or liability item at the other one. When a company issues shares, the new shareholder will disclose them as a financial asset (one party) and the issuer will recognise an item of issued capital (the other party). DR Financial Instruments........ 144,000.00 EUR CR Cash/ Bank.................... 144,000.00 EUR When a company sells assets the relevant asset account is to be credited. The amount of money or its equivalent received will be added to the Cash/ Bank account on the debit side as it is a cash input. <?page no="132"?> DR Cash/ Bank.................... 67,000.00 EUR CR P, P, E Account.............. 67,000.00 EUR In case a company buys an asset and receives a discount, the discount is to be deducted from the buying price. Learn about discounts allowed later in chapter (36): Discounts of this text book. DR P, P, E ACCOUNT.............. 95.00 EUR CR Cash/ Bank.................... 95.00 EUR Ad (2): Current Assets Current assets are inventories, receivables, securities, prepaid expenses and cash/ bank. Here, we apply certain accounts for different kind of inventory, for receivables, for securities, for prepaid expenses and for cash/ bank. When a business buys inventory the costs are referred to as the purchase costs. We later, in chapter (21) Trading Business), introduce a special Purchase account for the purchases of inventory. In contrast, the technical term for buying items of non-current assets is acquisition. DR Inventory (Materials)........ 15,000.00 EUR CR Cash/ Bank.................... 15,000.00 EUR DR Cash/ Bank.................... 35,000.00 EUR CR Inventory (Finished Goods)... 35,000.00 EUR How it is done (asset recognition): (1) Distinguish between current and non-current assets. (2) Choose the correct asset account that applies. (3) Determine the cost of acquisition or cost of purchase by deducting discounts and input-VAT. <?page no="133"?> (4) Debit the cost of acquisition or cost of purchase to the relevant asset account. (5) Credit the payment or the payables to the Cash/ Bank account or add the amount to the Accounts Payables (A/ P) account if the buy was on credit. When companies make payments for a service received from 3 rd parties in advance - so called prepayments and the time the service paid for is after the balance sheet’s day, the Accountant has to add them to the Prepaid Expenses account. Examples for prepaid expenses are rent, labour, insurances, etc., paid for the next Accounting period. We learn about this concept in detail in chapter (18) Further Expenses and Accruals in this text book. DR Magazine Expenses............ 120.00 EUR CR Cash/ Bank.................... 120.00 EUR DR Prepaid Expenses............. 60.00 EUR CR Magazine Expenses............ 60.00 EUR Frequently, companies have more than one business account. In order to ascertain the total of cash at bank, we only have to add the cash of these different bank accounts. However, the companies want to compare the internal Bookkeeping records with the bank statements received from the banks. For that reason, companies run an account for each and every account they have with a bank. It is important for us to distinguish the accounts properly. we call an account at the bank a bank account, written in small letters. In contrast an account which belongs to the company’s Bookkeeping records is called a Bank account - written with capital letter. When a company distinguishes different bank accounts and/ or runs one or more cash accounts the Cash/ Bank account on the balance sheet will be split into subordinated accounts. The sum of the balances of all accounts is disclosed on the statement of financial position. <?page no="134"?> DR Deutsche Bank account........ 6,000.00 EUR CR Accounts Receivables......... 6,000.00 EUR DR Cash......................... 500.00 EUR CR Deutsche Bank account........ 500.00 EUR 54,000.00 500.00 4,000.00 4,000.00 6,000.00 59,500.00 4,000.00 60,000.00 60,000.00 59,500.00 300.00 6,000.00 6,000.00 500.00 800.00 800.00 800.00 800.00 Figure 13.1: SCHOENMAKERSKOP Ltd.‘s accounts Summary: Asset accounts are for non-current and current assets. Asset accounts increase by debit entries and decrease by credit entries. Particular accounts are Property, Plant and Equipment (P, P, E), Investment Property, Intangible Assets, Financial Assets, Inventory, Accounts Receivables, Prepaid Expenses and Cash/ Bank. <?page no="135"?> Working Definitions: Asset: Assets are resources from which a future economic benefit is expected to flow to the company. Investment Property: Investment property is land and/ or buildings that are for renting out or hold to make a profit by capital appreciation. Intangible Assets: An intangible asset is an asset without physical nature. <?page no="136"?> Learning Objectives: After we studies particular assets, we now do the same with regard to equity. In this chapter, some special equity accounts are introduced in order to widen your Accounting experience. We provide you with an overview on issued capital and reserves. Additionally, the application of the Retained Earnings account is explained in detail. After studying this chapter, you will understand how equity is brought into the business and how profit and loss change it. You learn how to ascertain the book value of the business. The owners’ equity is divided in three major accounts: - Issued Capital account, - Reserves account and - Retained Earnings account. The issued capital is the value of shares at their face value. This is the amount the company at least is held responsible for. It reflects the owners’ contribution to the company. The face value of a share is also called its nominal value. At the time of the share issue, the amount is credited to the Issued Capital account. Reserves are parts of the company’s equity that result from earnings, share issues and revaluations. Reserves increase/ decrease the total amount of equity and as a result the book value of the company. The Retained Earnings account receives all earnings after taxes from the Profit and Loss account and contains all profits/ losses carried forward from prior Accounting periods. Reductions occur when dividends are declared and additions are made to the Earnings Reserves accounts. When a business is established the proprietors contribute funds to the business. The amount might be prescribed by national laws like the company’s act, such as 50,000.00 EUR for the establishment of a German company on shares based on § 7 AktG. The funds paid into the business is the minimum amount by which the company is held responsible. A public company only is held accountable based on its equity. Once the equity becomes negative, the owners have to declare bankruptcy. The issued capital cannot be changed, further share issues or share redemptions exempted. The issued capital is always recognised at its face value and for German companies in EUR. The nominal amount is disclosed by the Issued Share account. Any share issues at an issue price higher than the face value require to post the difference between the issue price and the face value to share premiums or straight to capital reserves. <?page no="137"?> DR Cash/ Bank.................... 50,000.00 EUR CR Issued Capital............... 50,000.00 EUR DR Cash/ Bank.................... 100,000.00 US$ CR Issued Capital............... 100,000.00 US$ DR Cash/ Bank.................... 134,000.00 GBP CR Issued Capital............... 100,000.00 GBP CR Share Premium ................ 34,000.00 GBP The use of share premiums depends on national law. In most countries the amount is transferred into the Capital Reserves account. Capital reserves belong to equity such as issued capital. No mingling of capital reserves with the issued capital is allowed. DR Share Premium ................ 34,000.00 GBP CR Capital Reserves............. 34,000.00 GBP The amount for issued capital does not depend on earnings. Even in case the company earns a loss, the amount is recognized at the face value. In particular, the share market price such as traded at a stock exchange (market price) does not change the issued capital value. <?page no="138"?> DR Cash/ Bank.................... 85,000.00 EUR CR Issued Capital............... 72,500.00 EUR CR Share Premium................ 12,500.00 EUR DR Share Premium................ 12,500.00 EUR CR Capital Reserves............. 12,500.00 EUR The financial statements of the shares issuing company do not depend on the market price of shares as traded at a stock exchange. The company only suffers from a low share price by other investors’ option of an unfriendly taking over, because it then becomes easy (cheap) to buy shares and achieve voting rights. Mergers and Acquisitions are covered in: Basics of Accounting, Part (2), chapter (11): Accounting for Mergers and Acquisitions. A business that earns profits during the years will increase its equity. The Retained Earnings account is credited for every profit after taxes earned. If the company decides to reinvest the funds, it will turn retained earnings into reserves. As a result, an increase is recorded in the Earnings Reserves account and a debit entry is made in the Retained Earnings account. The transfer is neutral to the book value of the business. In general, the appropriation is either putting earnings into the Reserves account, paying a dividend to the shareholders or carrying forward the profit. In case the company does not do anything with regard to the appropriation of profits, the profit stays in the Retained Earnings account and is carried forward to the next Accounting period. The same applies for a loss. DR P&L-Account.................. 300,000.00 EUR CR Retained Earnings............ 300,000.00 EUR DR Retained Earnings............ 300,000.00 EUR CR Earnings Reserves............ 300,000.00 EUR (In Germany, the company’s act (AktG) limits the amount to be put into Earnings Reserves by § 58 AktG to 50 % for that reason, the appropriation for companies in the legal form of an AG frequently follows a 50: 50-ratio.) <?page no="139"?> A company that declares a dividend to its shareholders decreases its equity. Declaring a dividend means to pay the profit to shareholders or to recognise a liability for doing so later. The payables account that applies for dividend payments is called Shareholder for Dividend account. Declaring a dividend means to transfer the profit from equity to liabilities, in other words: equity is reduced. DR P&L-Account.................. 100,000.00 EUR CR Retained Earnings............ 100,000.00 EUR DR Retained Earnings............ 100,000.00 EUR CR A/ P (ShD).................... 100,000.00 EUR A company also can keep the profit earned in the Retained Earnings account. This means to carry profits forward to the next Accounting period. A company can carry forward the profit and can make a decision about the appropriation thereof in later Accounting periods. It can even carry forward the profit for more than one Accounting period. This results in kind of depriving the shareholders of their dividend. DR P&L-ACCOUNT .................. 30,000.00 EUR CR Retained Earnings............ 30,000.00 EUR In case a company earns a loss, equity decreases. <?page no="140"?> DR Retained Earnings............ 45,000.00 EUR CR P&L-Account.................. 45,000.00 EUR A debit entry in the Retained Earnings account decreases the equity of the business. 100,000.00 100,000.00 200,000.00 200,000.00 100,000.00 200,000.00 45,000.00 100,000.00 100,000.00 200,000.00 55,000.00 55,000.00 100,000.00 100,000.00 90,000.00 45,000.00 55,000.00 245,000.00 245,000.00 45,000.00 45,000.00 Figure 14.1: RENSBURG Ltd.‘s accounts (Note, companies applying the German Handelsgesetzbuch (HGB) use the Annual Surplus account in a different way. See § 266 III HGB for the structure of the balance sheet and rules for equity recognition with regard to reserves and their increase and decrease laid out by § 272 HGB. The aspects of retained earnings are linked to the Annual Surplus account and the Bilanzgewinn (R/ E) account along § 268 I HGB.) How it is done (appropriation of profits) (1) If positive, credit the profit for the period to the Retained Earnings account. If negative, make a debit entry in the Retained Earnings account. (2) Decide about the appropriation of profit or parts thereof: (a) carrying forward, (b) putting into reserves and/ or (c) declaring a dividend. <?page no="141"?> (3a) Nothing needs to be done. Leave the amount in the Retained Earnings account. (3b) Take the amount for reserves out of the Retained Earnings account by a debit entry and credit the amount to the Earnings Reserves account. (3c) Take the amount to be declared as a dividend out of the Retained Earnings account and credit the amount to the Shareholder for Dividend account. Close-off the Shareholder for Dividend account to the Accounts Payables account. (4) You might face partial appropriations of profit by combining (a), (b) and (c). Furthermore, check the national law with regard to the amounts. Summary: Equity contains issued capital, reserves and retained earnings. Issued capital is the amount received from share issues. Profits and losses change the total value of a company’s equity. They are added to/ reduced from retained earnings. A company that intends to reinvest the profit, will transfer it to the earnings reserves. A declaration of a dividend reduces the retained earnings and adds the profits to the Shareholder for Dividend account which is part of the short-term liabilities. Definitions: Face value: The face value of a share is its nominal amount. Issued Capital: The issued capital is the value shares at their face value. Reserves: Reserves are parts of the company’s equity that result from earnings, share issues and revaluations. Retained Earnings: The Retained Earnings account receives all earnings after taxes from the Profit and Loss account and contains all profits/ losses carried forward from prior Accounting periods. <?page no="142"?> Learning Objectives: In this chapter, we introduce particular liability accounts and give examples for Bookkeeping entries linked thereto. The aim is to widen your Accounting knowledge with further examples and to familiarise you with the liability section of the statement of financial position. We also give you examples about bank loans and the calculation of interest and pay-off amounts. You need that knowledge once it comes to financing of the business by bank loans. More information about the disclosure of bank loans and other long-term liabilities is given in the text book Bilanzen/ Financial Accounting in chapter (14). A liability is an obligation to pay an amount of money or its equivalent or to deliver goods/ services. It is important to mention, that this obligation has to exist at the time of recording. An expected outflow of money does not qualify for a liability. Hence, a liability exists once you take the bank loan from a bank. The IFRSs and many national GAAPs require to keep long-term and short-term liabilities separate. The reason is that long-term liabilities are to be discounted based on a fair value presentation. Discounting means the value is rated down as more as the payment’s settlement date is in the future. In Germany, § 253 I HGB only requires the disclosure of debts at the most likely settlement amount. Discounting a liability leads to a recognition of long-term debts at present values. (Note, we introduced the time value of money concept that calculates the present value by discounting already in chapter (3): Shareholders’ View on Business.) A payment obligation of 100,000.00 EUR that is completely due in 20 years’ time provided the rate of interest is 10 % is worth today: 100,000 × (1 + 10%) -20 = 14,864.36 EUR. A debtor who has to pay 100,000.00 EUR in 20 years’ time could just deposit the amount of 14,864.36 EUR in a bank account and wait for 20 years in order to obtain the 100,000.00 EUR. In contrast, ignoring the recognition at present value for liabilities means to overrate liabilities which makes the financial position look worse than it actually is. The German Handelsgesetzbuch (HGB) follows creditors’ protection. This is the reason for disclosing loans at their settlement amounts. A settlement amount is the amount of money that actually has to be paid in order to pay-off the loan. The settlement amount for the above-mentioned bank loan equals to 100,000.00 EUR. For now, we do not discount liabilities to keep Accounting simple. Discounting is covered in chapter (14) of the text book Bilanzen/ Financial Accounting. For this reason, we here ignore discounting of liabilities and recognize them at their settlement amount. Although we do not discount longterm debts, we record liabilities separate, in the meaning of long-term and <?page no="143"?> short-term liabilities are not mixed. As a result, we apply one account for long-term liabilities and another one for short-term liabilities. As far as we apply the simplified structure of the statement of financial position as introduced in the previous chapters, the account for long-term liabilities is called Interest Bearing Liabilities account and the one for short-term liabilities is the Accounts Payables account. A company buying goods on credit will disclose the liability as short-term payables in the Accounts Payables A/ P account. DR P, P, E ACCOUNT .............. 60,000.00 EUR CR Accounts Payables............ 60,000.00 EUR DR Accounts Payables............ 60,000.00 EUR CR Cash/ Bank.................... 60,000.00 EUR Liabilities that require the payment of interest normally are long-term liabilities. Those liabilities are bank loans for example. The amount due in later Accounting periods is classified as a longterm liability. Accordingly, the longterm liability is added to the Interest Bearing Liabilities account. DR Cash/ Bank.................... 100,000.00 EUR CR Interest Bearing Liabilities. 100,000.00 EUR Interest is calculated pro rata and accurate to the month (Check with chapter <?page no="144"?> (1): Conventions.). For interest calculation, we need to know the monthly rate of interest. It is the annual interest rate divided by 12. No compound interest calculation applies within an Accounting period! In other words, interest compounds in Accounting on an annual basis. DR Interest..................... 3,000.00 EUR CR Cash/ Bank.................... 3,000.00 EUR A bank loan coming with a constant payment for interest and payoff (together) is called an annuity. With an annuity, the debtor agrees on the amount to be paid which contains interest as well as pay-off and on how long the payments last. If the rate of interest is constant, the absolute amount for interest shrinks by the course of time as the debtor pays-off the loan every year. Hence, the owed amount by the debtor decreases. Interest is always calculated based on the annual rate and the amount owed. For an annuity the periodic development of absolute interest payments and payoff amounts is contrarily to one another: The pay-off increases and the interest decreases. In any case of a bank loan that requires a pay-off in the next Accounting period, the upcoming paid-off is considered a short-term liability. As a result, it has to be transferred from the Interest Bearing Liabilities account into the Accounts Payables A/ P account as required by IAS 1. This has nothing to do with the fact that interest applies for the pay-off amount. (Note, you could assume that the transfer from the IBL account into the A/ P account frees you from paying interest but that is not true.) DR Cash/ Bank.................... 25,000.00 EUR CR Interest Bearing Liabilities. 25,000.00 EUR <?page no="145"?> Figure 15.1: CHATTY Ltd.‘s annuity payment schedule DR Interest..................... 1,125.00 EUR DR Interest Bearing Liability... 1,375.00 EUR CR Cash/ Bank.................... 2,500.00 EUR (Note, the exact amounts are 1,063.125 EUR and 1,436.875 EUR. In Figure 15.1, both amounts are displayed at an accuracy of 2 digits after the decimal point, which means they are rounded to the next EURcent. However, the MS Excel spreadsheet program adds the amounts correctly ignoring the display thereof. As a result, the amount paid equals to: 1,063.13 + 1,436.88 = 2,500.00 EUR not to 2,500.01 EUR.) <?page no="146"?> DR Interest Bearing Liabilities. 1,436.88 EUR CR Accounts Payables............ 1,436.88 EUR 25,000.00 2,500.00 1,125.00 1,125.00 22,500.00 25,000.00 25,000.00 22,500.00 1,375.00 25,000.00 1,436.88 1,436.88 1,436.88 1,436.88 22,188.12 25,000.00 25,000.00 22,188.12 Figure 15.2: CHATTY Ltd.‘s accounts How it is done (liability recognition) (1) Determine the amount of the liability. This amount normally is the most likely settlement amount for the liability. (2) Distinguish between (a) short-term liabilities and (b) long-term liabilities and (c) liabilities that contain portions being long-term and other ones being short-term. (3a) If the liability is a short-term liability, credit the amount to the relevant short-term liability account. You may take the Accounts Payables A/ P account. (3b) If the liability is a long-term liability, credit the amount to the relevant long-term liability account. You may take the Interest Bearing Liabilities account or a Bond/ Debenture account. Discount long-term liabilities (based on chapter (14) text book Bilanzen/ Financial Accounting if required in exam. (3c) If the liability contains long-term liability portions and short-term liability ones, you may set up a <?page no="147"?> liability schedule for calculating the short-term liabilities at first. Transfer the whole liability into the relevant long-term liability account and make a debit entry for the short-term portion and credit that amount to the relevant short-term liability account. Then, discount long-term liabilities. (See above) Record the difference in the Retained Earnings R/ E account. In case the bank loan comes with a constant pay-off amount the calculation becomes easier. Additionally, we want to cover what happens if extra pay-off amounts are offered by the bank which makes the calculation of interest slightly more complicated. We observe the FOLCROFT (Pty) Ltd. bank loan example. <?page no="148"?> Figure 15.3: FOLCROFT (Pty) Ltd.’s bank loan schedule DR Cash/ Bank.................... 75,000.00 EUR CR Interest Bearing Liabilities. 75,000.00 EUR <?page no="149"?> DR Interest..................... 1,743.75 EUR DR Interest Bearing Liabilities. 2,000.00 EUR CR Cash/ Bank.................... 3,743.75 EUR DR Interest Bearing Liabilities. 2,000.00 EUR CR Accounts Payables ........... 2,000.00 EUR DR Interest..................... 62.00 EUR DR Accounts Payables............ 2,000.00 EUR CR Cash/ Bank.................... 2,062.00 EUR We now study some short-term liabilities: In some cases, a business takes a down-payment from a customer to secure a deal. Down-payments do not fall under proceeds, but they are good for the coverage of future payment obligations. Proceeds is a technical term in Accounting for received cash or its <?page no="150"?> equivalent or for receivables the company receives in return for a revenue earned. Not counting as proceeds for the down-payment means, the deal has not been closed yet and, as a consequence, there is no revenue recognition required. Once revenue is recorded the transaction of sales or service rendering has been processed and the Bookkeeping entry becomes tax relevant for income taxes (through the Profit and Loss account) and for output-VAT. Hence, we have to distinguish downpayments from partial payments (proceeds) made in advance properly. The Bookkeeping entries differ as well as legal and tax obligations. A partial payment legally causes the signification of the deal. If someone pays an amount as part of the settlement of the deal, the deal is closed with the payment - no matter how big the portion of that payment is. The payment signifies the deal and requires the revenue recognition and to credit output-VAT. We take a look at the car dealership KAMPUNG Ltd. - our next case study in order to understand the difference between down-payment and partial payments. DR Cash/ Bank.................... 1,000.00 EUR DR Accounts Receivables......... 32,000.00 EUR CR Revenue...................... 33,000.00 EUR DR Cash/ Bank.................... 32,000.00 EUR CR Accounts Receivables......... 32,000.00 EUR <?page no="151"?> DR Cash/ Bank.................... 100.00 EUR CR Deferred Income.............. 100.00 EUR DR Cash/ Bank.................... 41,900.00 EUR DR Deferred Income.............. 100.00 EUR CR Revenue...................... 42,000.00 EUR The down-payment does not cause any revenue recognition, because the sale was not closed at the time when the down-payment is received. In contrast, a partial payment is seen as fulfilment of one party’s obligation of the agreed duties that result from the agreement and signifies the sale. In the event of Mr Burrows cancels the deal, the deferred income will be added to revenue. In case a business has a payment obligation that is uncertain, it has to recognise a provision. A provision is an uncertain liability. It can be uncertain with regard to the amount, to the date of payment(s) or even uncertain to happen. Examples for provisions are payments that result from pending court cases which are not certain with regard to the amount or the sentence of the law case. Pensions are also subject to provisions as the length of the payment to the beneficiary is unknown and/ or the pension duration is uncertain. For further examples, check IAS 37! We study below the case study ALBANS Ltd. The company is drawn to court: <?page no="152"?> DR Other Expenses............... 100,000.00 EUR CR Provision.................... 100,000.00 EUR DR Provision.................... 100,000.00 EUR DR Other Expenses............... 100,000.00 EUR CR Cash/ Bank.................... 200,000.00 EUR (Note, in Germany provisions are to be recognised for outstanding income taxes too. In contrast, along IFRSs a tax liability is to be disclosed. We follow IFRSs here and recognise income tax liabilities as certain liabilities.) (Note, no VAT is to record in this account, because VAT does not fall under income taxes! ) DR P&L-ACCOUNT.................. 135,000.00 EUR CR Income Tax Liabilities....... 135,000.00 EUR DR Income Tax Liabilities....... 135,000.00 EUR CR Cash/ Bank.................... 135,000.00 EUR Summary: Liabilities can be short-term and longterm. They are kept in different accounts. In case a liability is uncertain, a provision is recognised. Dissolving or reducing liabilities means to make a debit entry in the liability account. Long-term liabilities are discounted along IFRSs in order to recognize them at their fair value. Working Definitions: Liability: A liability is an obligation to pay an amount of money or to deliver goods/ services. <?page no="153"?> Settlement amount: A settlement amount is the amount of money that actually has to be paid in order to payoff the loan. Annuity: A bank loan coming with a constant payment for interest and payoff (together) is called an annuity. Provision: A provision is an uncertain liability. It can be uncertain with regard to the amount, to the due date or even uncertain to occur. <?page no="154"?> In this part of the text book, we cover aspects of Financial Accounting and of Cost Accounting which are not ruled by national GAAPs or IFRSs. E.g., liquidations or discounts. For that reason, they are not covered by the text book Bilanzen/ Financial Accounting. The aspects presented in section (C) are not be seen as first steps in Accounting either, but they belong to advanced Accounting as taught in international Accounting classes at a university. The chapter (16): Reconciliation Accounts introduces into the concept of hierarchical account structures. The chapter prepares for the asset management introduced by the next chapter (17): Depreciation. Depreciation is linked to property, plant and equipment and will be the first nominal account to discuss. Further Expenses and Accruals in chapter (18) follow and chapter (19) explains Accounting for Labour. In order to learn about concepts of profit calculation we start by trading businesses. Dealerships are easier to explain as there is no production process to consider. First-off, only purchases will be covered. We’ll use the case studies APPLEDENE (Pty) Ltd. and KLIPFONTAIN Ltd. Chapter (20): Trading Business: Purchases and Returns shows how these companies buy goods and record the purchases. It also covers returns thereof to the supplier which applies in case goods are faulty or do not meet the requirements of the buyer in any other way. In Chapter (21) Trading Business: Purchases and VAT we repeat the previous case studies but now, we consider input-VAT. The following chapters are structured likewise. We add sales activities in chapter (22) Trading Business: Sales. The chapter uses the case studies CORNFLOWER (Pty) Ltd. and DURANT (Pty) Ltd. in order to show revenue recognition and profit calculation. In chapter (23) Trading Business: Sales and VAT the same case studies are discussed under consideration of output-VAT. The chapter (24): Privately-owned Businesses: Drawings describes the appropriation of profits in privately-owned business. We show which Bookkeeping entries are to be made when the owner withdraws assets from the company and what tax considerations are required by that. In chapter (25): Production Firms we introduce and the Bookkeeping entries required for manufacturing firms. In addition to trading business, production firms have to consider material flows and product calculation. The chapter (26): Inventory Systems introduces to the recording of material flows based on the perpetual system and chapter (27): Cost Formulas shows how to deal items of the same kind which are recorded all together. The chapter (28): Income Statement along the Cost of Sales Format compares the two formats for the income statement and shows the benefit of the cost of sales format for a profitability analysis. In order to demonstrate the effect, the <?page no="155"?> case study ASHTON Ltd. that produces with different products is used. The chapter also contains the case study MONTAGU (Pty) Ltd. which summarises the last 4 chapters’ contents. By the chapter (29): Preparing the Trial Balance we cover adjustments as made at the end of every Accounting period. They contain the closing-off of accounts and the profit calculation in preparation for the financial statements. We introduce the trial balance as an instrument to check Bookkeeping entries with regard to the double entry system. The trial balance then applies in the next following chapters consequently. The following chapter (30): Tax Calculation, Profit Appropriation and Statement Changes in Equity is about profit calculation and how profit changes the book value of the company by increasing/ decreasing equity. Remember, the book value of the business is disclosed as the total of equity. In order to understand how to continue the financial records of the previous Accounting period, the chapter (31): Multi Period Bookkeeping shows how to transfer real accounts from the previous Accounting period to the next one. Chapter (32): Introduction to Statements of Cash Flows covers how to calculate and to separate cash flows. We explain by the case studies MANSELL Ltd. and PARKLANDSMAIN how to prepare a statement of cash flows by direct method and by direct method with reconciliation of operating cash flows with earnings before taxation. In chapter (33): Establishment of a Business and Legal Form Changes we introduce to aspects of the incorporation of a business and accompany the company SALDAHNA through its changes in terms of the legal form. Chapter (34): Liquidations is about dissolving a business. We introduce to the Liquidation account for structured postings. The case study MOSSEL SPORTS is about a fitness centre which is liquidated as its owner wants to relocate. Closely linked to liquidations is chapter (35): Disposals, that covers sales and discards of non-current assets. The next chapter (36): Discounts deals with immediate and deferred discounts and shows how to record them under consideration of VAT. Chapter (38): Cash Book - Reconciliation to the Bank Statement deals with the link between the Cash/ Bank account and the bank statement provided by the bank. We introduce the reconciliation process by the case study KRAGGA CONSULTANTS Ltd. and cover the most common differences between cash book and bank statement. This means we compare our Bookkeeping entries to the ones made by the bank. The chapter (38): Petty Cash Book covers the reimbursement system demonstrated by the case study SWARTKLIP Ltd. The simplifications of the Bookkeeping system by books of original entry is explained in chapter (39): Books of Original Entry. We use the CD store MUIRFIELD (Pty) Ltd. to introduce the purchase journal, cash book and explain how to operate an <?page no="156"?> open item Bookkeeping with books of original entry. After studying section (C) of the text book you expanded your knowledge about Accounting and can prepare financial statements on an advanced level. For this text book, we close Financial Accounting and continue by aspects of international Accounting along IFRSs by the text book Bilanzen/ Financial Accounting. You can continue with other text books for studying German law, too. The upcoming chapters are: (16) Reconciliation Accounts (17) Depreciation (18) Further Expenses and Accruals (19) Accounting for Labour (20) Trading Business: Purchases and Returns (21) Trading Business: Purchases and Returns plus VAT (22) Trading Business: Sales (23) Trading Business: Sales plus VAT (24) Privately-owned Business: Drawings (25) Production Firms (26) Inventory Systems (27) Cost Formulas (28) Income Statement along the Cost of Sales Format (29) Preparing the Trial Balance (30) Tax Calculation (31) Multi-Period Bookkeeping (32) Introduction to Statements of Cash Flows (33) Establishment of a Business and Legal Form Changes (34) Liquidations (35) Disposals (36) Discounts (37) Cash Book: Reconciliation with the Bank Statement (38) Petty Cash Book (39) Books of Original Entry <?page no="157"?> Learning Objectives: In this chapter, we deepen our knowledge in Bookkeeping. We introduce reconciliation accounts. The aim is to study the concept of a 1 : n-relationship between accounts and items of the statement of financial position. After studying this chapter, you will understand hierarchical account structures and can apply subsidiary ledgers. For purposes of day-to-day Accounting, it helps to divide one account into subordinated accounts. This will result in a subsidiary ledger. The total of subordinated accounts linked to an item on the financial statements is its subsidiary ledger. It helps in situations, if several items are recorded together but information is needed on a detailed level. So far, we only applied accounts directly linked to an item on the statement of financial position or the statement of comprehensive income. All these accounts fall under the general ledger. The general ledger is a set of accounts with any subordinated accounts exempted. A balance sheet item frequently split up is property, plant and equipment. It allows to maintain a special account for each item of property, plant and equipment in order to determine its particular value, e.g. in order to prepare a register of non-current assets. In case a company dedicates single accounts to every item of property, plant and equipment, we call this Asset Management. Asset management is a subsidiary ledger where instead of making Bookkeeping entries in one P, P, E account every item of property, plant and equipment is represented by its own subordinated account. In order to determine the total value for all items of P, P, E, a summary account is maintained. This account is referred to as the reconciliation account. A reconciliation account is a summary account for a subsidiary ledger. It shows the amount of all items together. The reconciliation account for Asset Management is the Property, Plant and Equipment account. The balance of the reconciliation account is disclosed on the balance sheet as P, P, E. Other items that should be recorded in subsidiary ledgers are receivables, cash/ bank, payables, payroll and reserves. How it is done (running a subsidiary ledger) (1) Set up subordinated accounts for objects and create a reconciliation account at the same time. (2) Make Bookkeeping entries within subordinated accounts. (3) At the year end, determine the balancing figure of all subordinated accounts. (4a) Close-off subordinated accounts to the reconciliation account. <?page no="158"?> Here, we recommend an alternative approach because as a student you make most of your Bookkeeping entries on paper or on a spreadsheet. Hence, the closing-off of accounts deletes all information linked to the single items. Consider, the subsidiary ledger is maintained to keep that information in separate accounts and to continue the accounts over the Accounting periods. For that reason, it is better to regard the reconciliation account as a copy alongside of the double entry system. As a result, we modify our “how-it-is-done-advice” as below: … Avoid step (4a) and continue by (4b)! (4b) Leave the subordinated accounts untouched. (5) In order to determine the total of the subordinated accounts, add the balancing figures thereof. (6) If the accounts are real accounts continue the subordinated accounts. We explain Asset Management with the case study DAGBREEK Ltd. with regard to their motor vehicle accounts. DAGBREEK Ltd. applies subordinated accounts for each of its cars. DR P, P, E - OS-B 4095.......... 53,000.00 EUR CR Cash/ Bank.................... 53,000.00 EUR <?page no="159"?> 12,000.00 53,000.00 ... 53,000.00 12,000.00 53,000.00 Figure 16.1: DAGBREEK Ltd.‘s accounts as at 1.02.20X7 (Note, the accounts are not to be balanced-off at this stage because no depreciation has been considered yet.) The reconciliation account represents the amounts of all items of property, plant and equipment. Often Accountants tend to close-off the subordinate accounts to the reconciliation account. This is common for German Bookkeeping, as real accounts are not continued. We do not do that here, because the reason for the subordinated accounts is to keep them and to benefit from the detailed information stored therein. We only see the reconciliation account as an instrument to determine the sum as to be displayed on the balance sheet’s item. We strongly recommend to maintain the singular accounts of the subsidiary ledger. Hence, DAGBREEK Ltd. keeps the P, P, E - OS 2344 account and the P, P, E - OS 4095 account alive and only sums the balances for recognition on the balance sheet. See the next example RETIEF (Pty) Ltd. below for further consideration: <?page no="160"?> DR P, P, E - Truck (E).......... 230,000.00 EUR CR Cash/ Bank.................... 230,000.00 EUR DR Cash/ Bank.................... 120,000.00 EUR CR P, P, E - Truck (A).......... 120,000.00 EUR 120,000.00 120,000.00 120,000.00 120,000.00 120,000.00 480,000.00 120,000.00 ... 230,000.00 230,000.00 590,000.00 120,000.00 710,000.00 710,000.00 590,000.00 230,000.00 Figure 16.2: RETIEF (Pty) Ltd.‘s accounts (Note, the accounts are not balanced-off yet as depreciation is not yet recorded.) (Note, in some examples we do not provide full account information in order to keep the examples simple. An amount not specified appears as “…”, see the Cash/ Bank account’s opening value.) <?page no="161"?> The reconciliation account can be seen as a parallel account to the subordinated ones, which discloses the total of the balancing figures in the subsidiary ledger. In order to indicate, that the account is void along the double entry system, the Bookkeeping entries made therein are greyed out in this text book. Based on this concept, today’s computer software works too. When asset recognition is recorded, the Accounting software makes redundant debit entries. One is in the subordinated account and the other one for the reconciliation account. For this reason, you have to define the reconciliation account once you create a subsidiary ledger by customizing Accounting software. The same concept of subsidiary ledgers applies for receivables and payables. The name of the item on the face of the balance sheet for receivables and payables indicates already that these accounts are reconciliation accounts because they are named “Accounts Receivables (A/ R)” and “Accounts Payables (A/ P)”. E.g., the Accounts Receivables account is the reconciliation account for all debtors’ accounts. The singular accounts for receivables are linked to the name or ID of the business partners and are therefore referred to as individualised accounts. Consider any hierarchical structure of accounts can be realised with subordinated accounts. There is no restriction even to set up a multi-level hierarchy of accounts. We study the sales ledger of DESPATCH Ltd. next: DR A/ R - HEUWEL ................. 2,600.00 EUR CR Inventory.................... 2,600.00 EUR DR A/ R - CAMPHER ................ 255.00 EUR CR Inventory.................... 255.00 EUR <?page no="162"?> DR A/ R - BORUS ................. 1,656.00 EUR CR Inventory.................... 1,656.00 EUR 100,000.00 2,600.00 2,600.00 2,600.00 255.00 2,600.00 1,656.00 95,489.00 100,000.00 100,000.00 95,489.00 255.00 255.00 1,656.00 1,656.00 255.00 1,656.00 2,600.00 255.00 1,656.00 4,511.00 4,511.00 4,511.00 4,511.00 Figure 16.3: DESPATCH (Pty) Ltd.’s accounts The sales ledger is a subsidiary ledger to the Accounts Receivables account. DR Cash/ Bank.................... 2,600.00 EUR CR A/ R - HEUWEL................. 2,600.00 EUR DR Cash/ Bank.................... 255.00 EUR CR A/ R - CAMPHER................ 255.00 EUR <?page no="163"?> DR Cash/ Bank ................... 1,656.00 EUR CR A/ R - BORUS .................. 1,656.00 EUR (Note, that the identifiers for the next year’s Bookkeeping entries are (A), (B) and (C) in 20X3 in order to distinguish Bookkeeping entries from different Accounting periods.) 100,000.00 2,600.00 2,600.00 2,600.00 255.00 2,600.00 2,600.00 1,656.00 95,489.00 100,000.00 100,000.00 95,489.00 255.00 255.00 1,656.00 1,656.00 255.00 255.00 1,656.00 1,656.00 2,600.00 ... 255.00 2,600.00 1,656.00 4,511.00 255.00 4,511.00 4,511.00 1,656.00 4,511.00 2,600.00 255.00 1,656.00 4,511.00 4,511.00 Figure 16.4: DESPATCH (Pty) Ltd.’s accounts The concept described works for the purchase ledger the same way. Its reconciliation account is the Accounts Payables (A/ P) account. The purchase ledger is a subsidiary ledger to the Accounts Payables account. <?page no="164"?> DR P, P, E Account.............. 7,000.00 EUR CR A/ P - VALLEISIG.............. 7,000.00 EUR DR Inventory.................... 50,000.00 EUR CR A/ P - DeMIST................. 25,000.00 EUR CR Cash/ Bank.................... 25,000.00 EUR DR A/ P - KRUIS ................. 63,000.00 EUR CR Cash/ Bank.................... 63,000.00 EUR 63,000.00 63,000.00 63,000.00 63,000.00 7,000.00 32,000.00 25,000.00 95,000.00 95,000.00 32,000.00 7,000.00 7,000.00 50,000.00 50,000.00 7,000.00 50,000.00 7,000.00 7,000.00 25,000.00 25,000.00 7,000.00 25,000.00 ... 25,000.00 63,000.00 Figure 16.5: SCHECKTER Ltd.‘s accounts <?page no="165"?> A company holding accounts with different banks will use the Cash/ Bank account as reconciliation account, too. Recall the example SCHOENMAKERSKOP Ltd. in chapter (13) Special Asset Accounts of this text book. Summary: Reconciliation accounts are summary accounts. They are used parallel to the double entry system. A subsidiary ledger keeps information about single items, such as assets, bank accounts, debtors, creditors and employees. Working Definitions: Subsidiary Ledger: The total of subordinated accounts that belongs to an item on the financial statements is a subsidiary ledger. General Ledger: The general ledger is a set of accounts with any subordinated accounts exempted. Asset Management: Asset management is a subsidiary ledger where instead of making Bookkeeping entries in one P, P, E account every item of property, plant and equipment is represented by its own account. Reconciliation Account: A reconciliation account is a summary account for a subsidiary ledger. Sales Ledger: The sales ledger is a subsidiary ledger to the Accounts Receivables account. Purchase Ledger: The purchase ledger is a subsidiary ledger to the Accounts Payables account. <?page no="166"?> Learning Objectives: In this chapter, we deal with a special expense: depreciation. We deepen your knowledge in expenses and describe how to record depreciation. In contrast to the previous chapters, we introduce the Accumulated Depreciation account as the contra account for the Depreciation account. We also introduce impairment losses which are posted similar to depreciations. With regard to the financial statements we introduce the register of non-current assets which is disclosed in the notes. It shows the carrying amounts of a company’s assets and their calculation. After studying this chapter, you will be familiar with the basics of depreciation Bookkeeping entries, you understand the methods of depreciation and you can set up a register of non-current assets that shows cost of acquisition, accumulated depreciation and accumulated impairment losses for the items therein. The only thing you cannot handle are revaluations which are subject to chapter (7) of the text book Bilanzen/ Financial Accounting. Depreciation is a technical term in Accounting for an expense that reflects a non-current asset’s loss in value due to its age or deployment. Most of the assets lose their value by use. Some companies even measure their assets deployment, such as airlines the total airframe time and total engine time of their aircrafts. Most companies measure the usage based on the age. Depreciation is then recorded proportional to the age as percentage of the useful life. A company that runs a business car with a useful life of 6 years will depreciate the car to an extent of 1/ 6 = 16.67% of the depreciable amount per year. This means, the car loses its value just by the time elapsed. Park your car for 1 year in the garage without driving it and you’ll see that its value decreases during that period. Just be aware there are even damages expected that come from not using your car! In contrast, there are some assets that are not depreciated at all. E.g., there is no depreciation on land, as it does not deplete by use/ deployment. (Pls., read the conventions about depreciation at the beginning of this text book before you start recording depreciation! ) For now, we only want to apply one single depreciation method, which is straight-line method. This method is very simple and leads to depreciation that is proportional to the time, in other words: every year’s depreciation is to the same amount. Straight-line method makes the curve of the asset’s carrying amount over its time appear as a straight-line. As the slope of the carrying amount curve is constant, depreciation over the useful life is too. The useful life is the time an asset can be used. The useful life of common assets is published for tax calculations as Afa-Tabelle (= list of useful life) issued by the finance minister in Germany. Note, the Afa-Tabelle is not binding for commercial financial statements following IFRSs but gives a strong indicator about the useful life to apply. <?page no="167"?> Calculation of depreciation per period along straight-line method is as follows: We take the amount of the cost of acquisition and divide it by the number of periods the asset will be deployed according to the estimated useful life. In case the asset is used for partial periods, depreciation is calculated pro rata (PRT). See further considerations about depreciation methods in chapter (7) of the text book Bilanzen/ Financial Accounting. In contrast to the PELZERHAGEN (Pty) Ltd. case study from chapter (9, 11, 12), we modify the Bookkeeping entries for depreciation from here onwards: From here on, we apply the Accumulated Depreciation account. The Accumulated Depreciation account is the contra account for depreciation. The Accumulated Depreciation account records all depreciation expenses over the useful life. The value a company carries the asset at, is calculated by deducting any (accumulated) depreciation and any impairment losses from the cost of acquisition. Impairment losses will be discussed further below, for now we see them as extraordinary once-off depreciation. The calculation of the carrying amount is the difference of the cost of acquisition as recognised by the Property, Plant and Equipment account less the balancing figure of the Accumulated Depreciation and Accumulated Impairment Loss account. Companies applying Asset Management keep an Accumulated Depreciation account for every asset they record. You will learn this concept by the following case studies in detail. Note, there is no legal requirement for Asset Management but it applies in almost every company. The next case studies will familiarise you with straight-line method and declining method for depreciation and with impairment losses. You also learn about the register of non-current assets which is required by IAS 1. DR P, P, E - Saw Machine........ 120,000.00 EUR CR Cash/ Bank.................... 120,000.00 EUR <?page no="168"?> DR Depreciation................. 22,000.00 EUR CR Acc. Depr. - Saw Machine..... 22,000.00 EUR The Accumulated Depreciation account supports the preparation of the register of non-current assets. The register of non-current assets is a list of all items of P, P, E that discloses every item’s cost of acquisition, its date of acquisition, its accumulated depreciation, its accumulated impairment losses and its carrying amount as at the time indicated. The statement is required on group level for all depreciable non-current assets along IAS 1. DR Depreciation................. 24,000.00 EUR CR Acc. Depr. - Saw Machine..... 24,000.00 EUR 120,000.00 120,000.00 22,000.00 22,000.00 120,000.00 22,000.00 46,000.00 24,000.00 46,000.00 46,000.00 46,000.00 22,000.00 22,000.00 24,000.00 24,000.00 ... 120,000.00 Figure 17.1: DODD Ltd.’s accounts as at 31.12.20X5 <?page no="169"?> Companies have to prepare the register of non-current assets as part of the notes. In the right column of the register of non-current assets, the carrying amount is disclosed. The carrying amount is the amount the asset is to be recognized at on the balance sheet. Figure 17.2: DODD Ltd.’s register of non-current assets Other reasons for the decrease of an asset’s value are impairment losses. An impairment loss is a reduction of the carrying amount that is caused by extraordinary and unscheduled events, such as accidents or price drops. Under consideration of impairment losses, the carrying amount is calculated as the cost of acquisition less any accumulated depreciation and less any accumulated impairment losses. In the textbook Bilanzen/ Financial Accounting, chapter (7), we’ll learn about fair value recognition that lead to revaluations as it is required by IAS 16. A revaluation is an increase of an asset’s carrying amount. One could say, the revaluation is the opposite of an impairment loss, however, its Bookkeeping entries are different because an impairment loss is recorded in the income statement whereas a revaluation changes equity and deferred tax liabilities. Bookkeeping entries for depreciation are made at the end of the Accounting period as adjustments. Even if an asset is disposed before the year end, a PRTdepreciation expense is recorded. Observe the FAIRBRIDGE Ltd. case study below: <?page no="170"?> Figure 17.3: FAIRBRIDGE Ltd.’s register of non-current assets as at 31.12.20X3 DR Depreciation................. 1,125.00 EUR CR Acc. Depr. OS-FB 222......... 1,125.00 EUR DR Cash/ Bank.................... 1,125.00 EUR DR Acc. Depr. OS-FB 222......... 16,875.00 EUR CR P, P, E - OS-FB 222.......... 18,000.00 EUR <?page no="171"?> DR P, P, E - OS-FB 444.......... 20,000.00 EUR CR Cash/ Bank.................... 20,000.00 EUR DR Depreciation ................. 3,750.00 EUR CR Acc. Depr. - OS-FB 444 ....... 3,750.00 EUR DR Depreciation ................. 4,500.00 EUR CR Acc. Depr. - OS-FB 333 ....... 4,500.00 EUR 18,000.00 18,000.00 16,875.00 15,750.00 1,125.00 16,875.00 16,875.00 18,000.00 18,000.00 9,000.00 18,000.00 13,500.00 4,500.00 13,500.00 13,500.00 13,500.00 20,000.00 20,000.00 3,750.00 3,750.00 20,000.00 3,750.00 1,125.00 9,375.00 ... 20,000.00 3,750.00 1,125.00 4,500.00 9,375.00 9,375.00 Figure 17.4: FAIRBRIDGE Ltd.’s accounts <?page no="172"?> 36,000.00 18,000.00 16,875.00 24,750.00 20,000.00 38,000.00 1,125.00 56,000.00 56,000.00 3,750.00 38,000.00 17,250.00 4,500.00 34,125.00 34,125.00 17,250.00 Figure 17.4: FAIRBRIDGE Ltd.’s accounts (continued) Figure 17.5: FAIRBRIDGE Ltd.’s register of non-current assets as at 31.12.20X3 An alternative method to straight-line method is the declining method. It always applies in cases when the depletion is higher at the commencement than at the end of the useful life. Along a declining method, depreciation is based on a percentage of the carrying amount at the beginning of the Accounting period, e.g. 20 %/ a. Assume a company buys an asset at a cost of acquisition of 25,000.00 EUR. Depreciation in the first year would be: 25,000 × 20% = 5,000.00 EUR/ a. In the second Accounting period, depreciation would be lower as the carrying amount decreased by the first year’s depreciation. In the second Accounting period, depreciation equals to: (25,000 - 5,000) × 20% = 4,000.00 EUR/ a. If depreciation rate is constant the formula for the carrying amount CA calculated based on declining method is: <?page no="173"?> CA T = CA 0 × (1 - depr) T (with: CA = carrying amount at the time t, depr = depreciation per period, t = 0 … T, 0 indicates the initial period, T the last one.) If declining method applies, there is a difference between monthly depreciation and annual depreciation divided by 12. This matters once we have to depreciate an asset for a shorter period than a full Accounting period. We then depreciate the asset pro rata (PRT). We normally provide you with a monthly depreciation rate due to our conventions laid out in chapter (1): Conventions. We assume that an asset bought at 25,000.00 EUR (see above) is depreciated based on a 2 %/ m rate. The depreciation for the first Accounting period (1 year) equals to: 25,000 - 25,000 × (1 - 2%) 12 = 5,382.08 EUR/ a. The amount is significantly below: 12 × 2% × 25,000 = 6,000.00 EUR which would be the result if we calculate on a monthly-rate-equal-to-annual-rate-divided-by-12-rule. In the next Accounting period, depreciation based on a monthly rate of 2 %/ m will be: 19,617.92 - 19,617.92 × (1 - 2%) 12 = 4,223.41 EUR/ a and so on. In this text book and for all website cases, monthly depreciation applies. In case declining method applies, the monthly rate must be given or be calculated. Another aspect to be considered together with depreciation is an impairment loss. Along IAS 36, an impairment loss occurs once the carrying amount is overrating the asset. The reason can be price changes, accidents, unscheduled depletion etc. An impairment loss is recorded similar to deprecation. The Bookkeeping entry is: DR Impairment Loss account - CR Accumulated Impairment Loss account. After an impairment loss occurred, depreciation does not come to a stop. However, there will be an adjustment with regard to depreciation because the depreciable amount will be lower then. The new depreciable amount (after recording an impairment loss) is the asset’s value over its (remaining) useful life. Adjustments after an impairment loss apply for straight-line method as well as for declining method. In order to study depreciation, we take a look at the case study KROLLER Ltd. below: <?page no="174"?> DR P, P, E ACCOUNT.............. 180,000.00 EUR CR Cash/ Bank.................... 180,000.00 EUR 180,000.00 180,000.00 200,000.00 180,000.00 180,000.00 20,000.00 220,000.00 180,000.00 20,000.00 36,677.61 36,677.61 36,677.61 36,677.61 36,677.61 36,677.61 Figure 17.6: KROLLER Ltd.’s accounts 20X0 DR Depreciation................. 17,041.65 EUR CR Acc. Depr.................... 17,041.65 EUR DR Depreciation................. 16,617.35 EUR CR Acc. Depr.................... 16,617.35 EUR <?page no="175"?> DR Repair....................... 4,500.00 EUR CR Cash/ Bank.................... 4,500.00 EUR DR Impairment Loss.............. 15,256.15 EUR CR Acc. Impairment Loss......... 15,256.15 EUR DR Cash/ Bank.................... 10,000.00 EUR DR Acc. Depr. .................. 10,743.85 EUR DR Acc. Impairment Loss......... 15,256.15 EUR CR P, P, E ...................... 36,000.00 EUR DR P, P, E (new)................ 38,000.00 EUR CR Cash/ Bank.................... 38,000.00 EUR <?page no="176"?> DR Depreciation................. 6,171.52 EUR CR Acc. Depr. (new)............. 6,171.52 EUR 180,000.00 180,000.00 200,000.00 180,000.00 180,000.00 36,000.00 20,000.00 144,000.00 220,000.00 180,000.00 180,000.00 180,000.00 10,000.00 20,000.00 144,000.00 48,000.00 38,000.00 58,000.00 58,000.00 48,000.00 36,677.61 36,677.61 17,041.65 10,743.85 36,677.61 16,407.24 17,041.65 6,171.52 39,620.41 59,382.65 16,407.24 39,620.41 39,620.41 70,126.50 70,126.50 39,620.41 59,382.65 4,500.00 4,500.00 15,256.15 15,256.15 4,500.00 15,256.15 15,256.15 15,256.15 38,000.00 38,000.00 15,256.16 15,256.15 38,000.00 6,171.52 6,171.52 6,171.52 Figure 17.7: KROLLER Ltd.’s accounts in 20X1 <?page no="177"?> Figure 17.8: KROLLER Ltd.’s register of non-current assets Summary: Depreciation is an expense that reflects the reduction of a non-current asset’s value due to its use. Most of non-current assets lose their value by use or by elapsed time. The contra account for depreciation is the Accumulated Depreciation account. An overview of a company’s carrying amounts is provided by the register of non-current assets for all depreciable non-current assets. The register of non-current assets is required by IFRSs on group level. A loss in value that occurs accidently or irregularly is referred to as an impairment loss. The contra account for impairment losses is the Accumulated Impairment Loss account. Working Definitions: Depreciation: Depreciation is a technical term in Accounting for an expense that reflects a non-current asset’s loss in value due to its age or its deployment. The useful life of an asset: The useful life of an asset is the time the asset can be used. Accumulated Depreciation account: The Accumulated Depreciation account is the contra account for depreciation. Register of non-current Assets: The register of non-current assets is a list of all items of P, P, E that discloses every item’s cost of acquisition, its date of acquisition, its accumulated depreciation, its accumulated impairment losses and its carrying amount as at the date indicated. Carrying amount: The carrying amount is the amount the asset is to be recognized at. Impairment Loss: An impairment loss is a carrying amount deduction that is caused by extraordinary and unscheduled events, such as accidents or price drops. Revaluation: A revaluation is an increase of an asset’s carrying amount. <?page no="178"?> Learning Objectives: In this chapter, we introduce activities in order for you to become more familiar with the statement of comprehensive income and the items therein. In particular, the accrual principle which requires to assign expenses and revenues to the Accounting period they belong to without payment consideration becomes subject to our attention. This means, a today’s payment made for an expense in the next Accounting period will not count yet but for the next year it is for. After studying this chapter, you can record and accrue prepaid expenses along IFRSs. You understand the matching principle along which expenses and revenues are assigned to Accounting periods they belong to - no matter when payments are made or received. Prepaid expenses are expenses paid in one Accounting period but relevant for another (future) Accounting period. Expenses are recorded by debit entries in nominal accounts. All expenses contribute to a profit reduction regardless of whether a payment has been made. Expenses are recognised in accounts, such as labour, rent, depreciation, internet fees, etc. Some expenses are VAT-relevant, e.g. if a service is received from a third party that is registered for VAT reduction. Below, we observe the case study SIMONI Ltd. for studying prepaid expenses. DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR <?page no="179"?> DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR <?page no="180"?> DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Rent......................... 1,500.00 EUR CR Cash/ Bank.................... 1,500.00 EUR 1,500.00 75,000.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 55,500.00 75,000.00 75,000.00 55,500.00 Figure 18.1: SIMONI Ltd.’s accounts <?page no="181"?> DR Prepaid Expenses............. 1,500.00 EUR CR Rent......................... 1,500.00 EUR 1,500.00 1,500.00 75,000.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 18,000.00 1,500.00 19,500.00 19,500.00 55,500.00 18,000.00 18,000.00 75,000.00 75,000.00 55,500.00 18,000.00 18,000.00 1,500.00 1,500.00 18,000.00 18,000.00 1,500.00 18,000.00 18,000.00 75,000.00 75,000.00 18,000.00 75,000.00 Figure 18.2: SIMONI Ltd.’s accounts <?page no="182"?> DR Rent......................... 1,500.00 EUR CR Prepaid Expenses............. 1,500.00 EUR Figure 18.3: SIMONI Ltd.’s statement of financial position as at 31.12.20X4 (Note, the German Handelsgesetzbuch requires a special item called Aktiver Rechnungsabgrenzungsposten (accrual) for prepayments. The special item on the German Bilanz indicates that accruals are not regarded as assets. Germans consider items such as prepaid rent, prepaid insurance or prepaid labour, as uncertain and non-tradable. They are not worth being an asset and will be kept separate therefrom.) <?page no="183"?> Figure 18.4: SIMONI Ltd.’s income statement for 20X4 How it is done (accruals): (1) Make Bookkeeping entries as along business activities including all payments. (2) Check whether or not expense have been recorded, which are linked to a later Accounting period. (3) In case step (2) is positive, transfer expenses already paid and relevant for the next Accounting period(s) into the Prepaid Expenses account. Credit the amount to the relevant expense account in order to reduce expenses. (4) Prepare financial statements. (5) At the beginning of the next Accounting period close-off the Prepaid Expenses account to the relevant expense account. Summary: Expenses, such as rent, insurance, labour, etc. are often paid in advance. In order to assign the correct expenses to the statement of comprehensive income, accruals are recorded. Along the accrual principle, expenses are assigned to the Accounting period they belong to and not to the period of their payment. Working Definitions: Prepaid Expenses: Expenses that are paid in one Accounting period but are relevant for another (future) Accounting period. <?page no="184"?> (Note, along this definition you could consider the P, P, E account as a prepaid expense account, too what is absolutely correct. The acquisition is a prepayment for depreciation.) <?page no="185"?> Learning Objectives: In this chapter, we’ll take a closer look at Accounting for labour. We introduce payroll accounts and how a withdrawal tax for labour works. We explain the recording of overtime, incentives and vacation with regard to payroll Accounting. After studying this chapter, you can record labour, even in special situations that occur in business. Labour is paid regularly in advance. In order to keep the next case study simple, we assume labour to be paid on the 15th of every month for the month it counts for. Hence, a company pays 50 % of labour in advance and the other half after labour has been delivered by its employees. By law, labour payments are combined with payments for social security and with taxes to be paid on labour (payroll tax). The special rules for German companies will be explained in the text book Bilanzen/ Financial Accounting in chapter (4) linked to the SUNNY AG case study. For now, we apply simplified percentages for social securities and payroll tax. See below. Labour expenses are called just “labour”. Labour contains the net salary as well as payroll tax paid on behalf of the employee and social security payments. Latter ones cover insurance for unemployment, pension contributions and health care plan payments. Study the national law for details. Payroll tax is deducted directly from the salary of the employee. This concept is known as withholding tax. The company pays the payroll tax straight to the revenue service. As the company pays the payroll tax on behalf of its employees, payroll tax is no company tax. However, the company owes the payroll tax by law. In most countries, all payments for an employee is based on his/ her gross salary. The gross salary is the net salary plus payroll taxes and - such as in Germany - half of the social security payments. Social security payment is split up at a half : half ratio between the company and the employee. The portion covered by the employee is called employee’s contribution to social security. It is included in the gross salary. The company owes the other half of the social securities. The company’s contribution is not included in the employee’s gross salary but it counts as labour. For this text book, we make assumptions for the amounts as follows: Full in the meaning of both halves of social security is 25 % of the gross salary and payroll tax 20 % thereof. Payroll tax is withdrawn from the employee’s salary (pay as you earn - PAYE). Expenses for labour equal to: 25/ 2 + 100 = 112.5 % of the gross salary, because it includes the company’s contribution to 25 % of social securities. <?page no="186"?> DR Labour....................... 3,500.00 EUR CR A/ P (Payroll Tax)............ 700.00 EUR CR A/ P (Social Security 50%).... 437.50 EUR CR Cash/ Bank.................... 2,362.50 EUR DR Labour....................... 437.50 EUR CR A/ P (Social Security 50%).... 437.50 EUR DR A/ P (Taxes on Labour)........ 700.00 EUR DR A/ P (Social Security 100%)... 875.00 EUR CR Cash/ Bank.................... 1,575.00 EUR 3,500.00 875.00 437.50 437.50 3,937.50 437.50 3,937.50 3,937.50 875.00 875.00 700.00 700.00 ... 2,362.50 1,575.00 Figure 19.1: SUIDERLAND Ltd.’s accounts <?page no="187"?> How it is done (labour payment): (1) Calculate the gross salary. There might be accruals to consider. (2) Debit the gross salary to the Labour account and credit the payroll tax (as withholding tax) and the employee’s contribution to social security to payables and pay the employee his/ her net salary. (Three credit entries! ) (3) Debit the amount for the employer’s contribution to social security to labour and credit the amount to payables, too. (4) Pay social contribution by debiting the employer’s and employee’s contribution to social security to the payables and make a credit entry in the Cash/ Bank account. (5) Pay payroll tax by making a debit entry in the payables account. (Note, never add payroll tax to tax liabilities as they are no company taxes.) The payment for labour and the calculation of the gross salary are different, if the contract for labour is based on an hourly basis or by completion of work. This is called piecework labour. In contrast a working contract means that the parties agree on a service and the payment thereof normally due after the completion of the service. In this case the agent is not on the payroll of the principal and no employment applies. Working contracts are typical in cases, such as writing an expertise or translating an Accounting text book. We explain piecework labour by the case study CLARITON Ltd. below. <?page no="188"?> DR Labour....................... 4,200.00 EUR CR Payroll Tax/ p................ 840.00 EUR CR Social Security/ p............ 525.00 EUR CR Cash/ Bank.................... 2,835.00 EUR DR Payroll Tax/ p................ 840.00 EUR CR Cash/ Bank.................... 840.00 EUR DR Labour....................... 525.00 EUR CR Social Security/ p............ 525.00 EUR DR Social Security/ p............ 1,050.00 EUR CR Cash/ Bank.................... 1,050.00 EUR <?page no="189"?> Figure 19.2: Calendar November 20X8 and December 20X8 DR Labour....................... 2,295.00 EUR CR Payroll Tax / p............... 459.00 EUR CR Social Security / p........... 286.88 EUR CR Cash/ Bank.................... 1,549.12 EUR DR Payroll Tax/ p................ 459.00 EUR CR Cash/ Bank.................... 459.00 EUR DR Labour....................... 286.87 EUR CR Social Security/ p ............ 286.87 EUR DR Social Security/ p ............ 573.75 EUR CR Cash/ Bank.................... 573.75 EUR <?page no="190"?> DR Labour....................... 75.60 EUR CR Vacation GÜNTER.............. 75.60 EUR DR Vacation Account............. 900.00 EUR DR Labour....................... 1,125.00 EUR CR Payroll Tax/ p................ 405.00 EUR CR Social Security/ p............ 253.13 EUR CR Cash/ Bank.................... 1,366.87 EUR DR Payroll Tax/ p................ 405.00 EUR CR Cash/ Bank.................... 405.00 EUR DR Labour....................... 253.12 EUR CR Social Security/ p............ 253.12 EUR DR Social Security/ p............ 506.25 EUR CR Cash/ Bank.................... 506.25 EUR <?page no="191"?> DR Labour....................... 39.60 EUR CR Vacation WERNER .............. 39.60 EUR DR Labour....................... 2,730.00 EUR CR Payroll Tax/ p................ 546.00 EUR CR Social Security/ p ............ 341.25 EUR CR Cash/ Bank.................... 1,842.75 EUR DR Payroll Tax/ p................ 546.00 EUR CR Cash/ Bank.................... 546.00 EUR DR Labour....................... 341.25 EUR CR Social Security/ p ............ 341.25 EUR DR Social Security/ p ............ 682.50 EUR CR Cash/ Bank.................... 682.50 EUR DR Labour....................... 75.60 EUR CR Vacation Account............. 75.60 EUR <?page no="192"?> DR Incentive.................... 210.00 EUR CR Labour....................... 210.00 EUR DR Labour....................... 360.00 EUR CR Salary GÜNTER/ p.............. 360.00 EUR DR Labour....................... 360.00 EUR CR Salary WERNER/ p.............. 360.00 EUR <?page no="193"?> DR Labour....................... 520.00 EUR CR Salary MARGRET/ p............. 520.00 EUR DR Incentives................... 40.00 EUR CR Labour....................... 40.00 EUR DR Salary GÜNTER/ p.............. 270.00 EUR CR Labour....................... 270.00 EUR DR Salary WERNER/ p.............. 270.00 EUR CR Labour....................... 270.00 EUR DR Salary MARGRET/ p............. 390.00 EUR CR Labour....................... 390.00 EUR (Note, this is a reverse calculation only. We assume the year has exactly 52 weeks with 5 working days. We avoid making all labour Bookkeeping entries for the entire Accounting period 20X8 here.) <?page no="194"?> 4,200.00 840.00 840.00 525.00 4,725.00 459.00 459.00 4,725.00 4,725.00 405.00 405.00 4,725.00 546.00 546.00 2,250.00 2,250.00 1,050.00 525.00 2,835.00 573.75 525.00 840.00 506.25 286.88 1,050.00 682.50 286.87 1,549.12 253.13 459.00 253.12 573.75 341.25 1,366.87 341.25 405.00 2,812.50 2,812.50 506.25 1,842.75 546.00 682.50 75.60 75.60 900.00 860.40 39.60 900.00 900.00 75.60 75.60 210.00 250.00 40.00 250.00 250.00 250.00 270.00 270.00 270.00 270.00 360.00 360.00 360.00 360.00 630.00 630.00 630.00 630.00 360.00 360.00 Figure 19.3: CLARITON Ltd.’s accounts <?page no="195"?> 390.00 390.00 930.00 270.00 520.00 520.00 2,295.00 270.00 910.00 910.00 286.87 390.00 520.00 75.60 210.00 360.00 40.00 1,125.00 253.12 39.60 360.00 2,730.00 341.25 75.60 520.00 8,212.04 9,392.04 9,392.04 8,212.04 Figure 19.3: CLARITON Ltd.’s accounts (continued) Summary: Some expenses are paid in advance. In Accounting this leads to entries in the Prepaid Expenses account. In cases an employee works after payday, the accrual principle of Accounting requires the recording of a liability to the extent of his/ her salary earned during the rest of the month (after payday). The Labour account contains Bookkeeping entries for payroll tax and for social security. These amounts are added to payables at first, if not paid at the same time as the net salary. The payables are dissolved once they become due. In Accounting for labour special accounts, such as Vacation account or Incentive account, apply next to the labour accounts. <?page no="196"?> Learning Objectives: In the next following chapters, we study activities for traders. Trading business is easier to understand than production firms as no manufacturing and calculation is relevant. This chapter only considers purchases and returns. We introduce the Purchase account and the Returns Outwards account. We ignore VAT for all activities. We repeat the entire chapter as chapter (21): Trading Business: Purchases and Returns plus VAT. We then apply the same cases APPLEDEEN (Pty) Ltd. and KLIPFONTEIN Ltd. and study VAT. In this text book, we split trading business in two sections. Purchases and Sales. Purchases are studied at first, sales will be discussed in the next following chapters (22): Trading Business: Sales and Returns and chapter (23): Trading Business: Sales and Returns plus VAT. After you studied these four chapters, you are familiar with the most important Bookkeeping entries in a trading businesses. All dealerships record normal activities such as rent, insurance, labour, depreciation as covered by the previous chapters already. We now focus on inventory movements. They are linked to the goods a company trades with. The core activities of a trading business are to buy goods from its suppliers and to sell them to its customers. Sometimes the customers are companies, too. In that case, we call the dealership a B2B-dealer: Business - to - Business dealer. A business that buys goods in order to sell them to its customers or that use them as materials in production, makes debit entries in a Purchase account. All goods bought will be debited to the Purchase account at first. The Purchase account is an intermediate account for goods bought as inventory. As part of the adjustments, the Purchase account will be closed-off to the Trading account at the yearend. However, the application of the Purchase account depends on the inventory system. There is a periodic system or a perpetual inventory system in use. In scenario (a), the company runs a periodic inventory system. Material expenses are calculated by the opening amount of inventory increased by purchases and reduced by the closing stock. The company must take stock at every Accounting periods’ end in order to ascertain closing stock of inventory. In scenario (b), the company runs a perpetual inventory system. Materials are transferred from the Purchase account into the Material Inventory account. (You can also record material inputs as debit entry in the Material Inventory account.) Any release from stock results in a credit entry in the Material Inventory account and a debit entry in the Material Expenses account. The Material Expense account is later closed-off to the Profit and Loss account. For now, we will introduce a periodic inventory system only. (Note, chapter (26): Perpetual Inventory System will cover the inventory movements based on the perpetual inventory system and shoes differences to a periodic inventory movement systems.) <?page no="197"?> The application of the periodic inventory system requires the company to make Bookkeeping entries only for purchases. No postings for releases from stock are recorded. At the end of the Accounting period, the business takes stock in order to determine how many goods are left. The difference between the opening amount plus purchases less closing stock is disclosed as material expenses on the statement of profit and loss and other comprehensive income. As the periodic system is easy to record, it normally will be taught first. All purchases will be entered into the Purchase account. The Bookkeeping entry for purchases on cash or per bank transfer always is: DR Purchase..................... EUR CR Cash/ Bank.................... EUR In case the purchase is on credit, the Bookkeeping entry is: DR Purchase..................... EUR CR Accounts Payables............ EUR We next study inventory movements for a grocery dealer: DR Cash/ Bank.................... 80,000.00 EUR CR Issued Capital............... 80,000.00 EUR DR Rent......................... 24,000.00 EUR CR Cash/ Bank.................... 24,000.00 EUR <?page no="198"?> DR Purchase..................... 250.00 EUR CR Cash/ Bank.................... 250.00 EUR DR Purchase..................... 400.00 EUR CR Cash/ Bank.................... 400.00 EUR DR Purchase..................... 100.00 EUR CR Accounts Payables............ 100.00 EUR DR Accounts Payables............ 700.00 EUR CR Cash/ Bank.................... 700.00 EUR <?page no="199"?> 80,000.00 24,000.00 80,000.00 80,000.00 13,000.00 80,000.00 20,800.00 14,200.00 36,400.00 94,200.00 94,200.00 14,200.00 24,000.00 24,000.00 13,000.00 70,300.00 24,000.00 24,000.00 20,800.00 36,500.00 70,300.00 70,300.00 36,400.00 36,500.00 70,300.00 250.00 100.00 24,000.00 1,400.00 36,500.00 36,500.00 ... 100.00 250.00 1,400.00 1,650.00 1,650.00 1,650.00 1,650.00 Figure 20.1: APPLEDENE (Pty) Ltd.’s accounts (Note, as far we didn’t consider any sales. As a result, we do not balanced-off the Profit and Loss account yet.) Sometimes, a buyer sends back goods previously bought. Then, it records an entry in the Returns Outwards account. A Returns Outwards account is like a negative Purchase account and applies when goods are sent back to suppliers. The Returns Outwards account will be closed-off to the Trading account in a periodic inventory system. The contra entry for a return is in the Cash/ Bank account if the buyer is refunded instantly. However, more often, the seller sends a voucher or reduces <?page no="200"?> the amount owed by its customer. Then, the buyer will either debit the amount to the Accounts Receivables account for the voucher or makes a debit entry in the Accounts Payables account for a bill reduction. How it is done (returns outwards): (1) Make Bookkeeping entries for purchases. (2) In case a good is faulty or does not meet the requirements, send it back to the supplier. (3) Credit the amount for goods sent back to the Returns Outwards account and make a debit entry in the Cash/ Bank account, if received money, or in the Accounts Payables, if the bill is reduced by the supplier or in the Accounts Receivables for a voucher. (4) When a periodic inventory system applies close-off the Returns Outwards account to the Trading account. Below, we observe the next example KLIPFONTEIN Ltd. DR Cash/ Bank.................... 100,000.00 EUR CR Issued Capital............... 100,000.00 EUR DR Purchase..................... 2,990.00 EUR CR Cash/ Bank.................... 2,990.00 EUR DR Cash/ Bank.................... 1,495.00 EUR CR Returns Outwards............. 1,495.00 EUR <?page no="201"?> DR Purchase..................... 6,200.00 EUR CR Accounts Payables............ 6,200.00 EUR DR Accounts Payables............ 186.00 EUR CR Returns Outwards............. 186.00 EUR DR Accounts Payables............ 6,014.00 EUR CR Cash/ Bank.................... 6,014.00 EUR DR Purchase..................... 9,750.00 EUR CR Cash/ Bank.................... 9,750.00 EUR DR Accounts Receivables......... 9,750.00 EUR CR Returns Outwards............. 9,750.00 EUR <?page no="202"?> DR Purchase..................... 4,320.00 EUR CR Accounts Receivables......... 4,320.00 EUR DR Purchase..................... 11,250.00 EUR CR Accounts Receivables......... 5,430.00 EUR CR Cash/ Bank.................... 5,820.00 EUR 100,000.00 2,990.00 100,000.00 100,000.00 1,495.00 6,014.00 100,000.00 9,750.00 5,820.00 76,921.00 101,495.00 101,495.00 76,921.00 2,990.00 1,495.00 6,200.00 186.00 9,750.00 11,431.00 9,750.00 4,320.00 11,431.00 11,431.00 11,250.00 34,510.00 11,431.00 34,510.00 34,510.00 34,510.00 Figure 20.2: KLIPFONTEIN Ltd.’s accounts in 20X5 <?page no="203"?> 186.00 6,200.00 9,750.00 4,320.00 6,014.00 5,430.00 6,200.00 6,200.00 9,750.00 9,750.00 Figure 20.2: KLIPFONTEIN Ltd.’s accounts in 20X5 (continued) Summary: A trading business that buys goods, makes debit entries in the Purchase account. Goods sent back are considered by credit entries in the Returns Outwards account. The total amount of the goods bought is the difference between the balancing figure in the Purchase account and the Returns Outwards account. The Purchase account and the Returns Outwards account are closed-off to the Trading account. Working Definitions: Purchase Account: The Purchase account is an intermediate account for goods bought as inventory. Returns Outwards Account: A Returns Outwards account is like a negative Purchase account used to record goods sent back to suppliers. <?page no="204"?> Learning Objectives: In this chapter, we introduce input value added tax (input-VAT). In order to keep the chapter simple, the same case studies as in the previous chapter (20): Trading Business: Purchases and Returns Outwards apply: APPLEDENE (Pty) Ltd. and KLIPFONTEIN Ltd. The costs of purchases remain unchanged. As a result, input-VAT is added to the net amounts for the gross amount calculation. After studying this chapter, you understand the concept of value added tax VAT and you can record purchases and returns under consideration of input-VAT. In most countries, the government charges you a consumer tax. There are some exceptions, such as the United Arabic Emirates and some US states, e.g. Alaska and Delaware. The consumer tax is levied on all purchases and is called value added tax VAT. The name comes from the calculation of the tax. It is based on the value of the goods/ services purchased and will be added to the price. A consumer tax based on the net amount of purchased goods/ services is a value added tax (input-VAT). Some countries call VAT a goods&service tax GST. We stick to the term value added tax. VAT is paid by every consumer, no matter whether the person got citizenship or is a foreigner. VAT is the same for all consumers, it does not matter whether you are rich and buy a Rolex watch or you are poor and buy some furniture. However, many countries have a reduced VAT rate on special goods, such as on groceries or on books. (Note, this is the reason, why the cashier in a McDonald’s restaurant asks our whether you want to sit in or take away. If you take away your burger, you are buying groceries and a reduced VAT rate applies than if you sit in.) The way how the VAT is collected is pretty simple. You pay it at the point of sale. In other words, the company selling the goods charges you the net amount plus VAT. Companies that purchase goods or services cannot be distinguished from consumers. They pay VAT, too. This means, they pay the price of the goods they purchase plus a surcharge for VAT. A buyer who buys a product at 200.00 EUR pays 200 + (VAT rate × 200). In this text book the VAT rate is 20 %. Accordingly, the payment for the product above equals to: 200 + 20% × 200 = 240.00 EUR. In different countries, different VAT rates apply. Germany’s tax rate is 19 %, Malaysia has 17 % and in South Africa an increase of the VAT rate from 14 % to 16 % is under discussion. All buyers pay the amount including VAT because they are seen as consumers. The price tags discloses normally the gross amounts. (Note; caution, an exception is USA. As a result you pay more than you read on the price tag.) The amount excluding VAT is called the net amount. The amount including VAT is called the gross amount. The VAT tax you pay when you buy goods is called input-VAT. Companies do not fall under consumers. When companies purchase goods, <?page no="205"?> they buy input resources, such as materials or supplies for goods production or service rendering. As companies don’t buy for consumption, they are exempted from paying input-VAT and as a result they get refunded by the revenue service. Technically, companies keep a record of paid input-VAT and claim back the amount at the end of the Accounting period. The VAT account applies for recording VAT. On the other side, companies collect VAT from their customers on behalf of the revenue service. The VAT tax a company collects when the customer buys products/ services is called output-VAT. As the seller collects the VAT on behalf of the revenue service, companies receive output-VAT based on their sales from customers and pay input- VAT to their suppliers. At the end of the Accounting period, companies declare the VAT received and the VAT paid and are refunded to the extent of the difference, in case input-VAT exceeds output-VAT. Otherwise, a company must pay the difference to the revenue service. The reduction of VAT for companies makes sense: Imagine a good is produced in several production steps each of them in a different company. Without input-VAT reduction, the first company sells the semi-finished good to the next one and receives the amount including VAT. The second one sells the good at the gross price too. If there is no refunding, goods get more expensive as more companies are involved just due to VAT payments. This would even generate a kind of compound VAT. For that reason, companies are refunded for input- VAT but must pay the output-VAT collected from customers. In order to claim input-VAT, a companies has to register for VAT reduction. Otherwise it will be regarded as consumer. A VAT registered company is refunded for input-VAT paid and collects output-VAT on behalf of the revenue service. German public companies that exceed an amount of 15,000.00 EUR in proceeds (= revenue × (1 + VAT rate), are registered for VAT reduction automatically. VAT payment transfers between companies and the revenue service take place monthly. (Note, based on the conventions in this text book, no Accounting periods other than years apply. As a result, VAT payments between companies and revenue service only are made annually.) A company must disclose the output- VAT amount on its bills. Hence, VAT registered companies appear to the customer more expensive than a nonregistered company if they earn the same revenue: If you register for VAT reduction and sell a product at 80.00 EUR net selling price, the price for your customer equals to: 80 × (1 + 20%) = 96.00 EUR. Without VAT registration, your customer pays only 80.00 EUR. A customer who is not VAT registered, will rather make business with your non-VAT-registered competitor for 80.00 EUR. In case your customer is VAT registered too, the VAT surplus on the price does not bother, as you disclose the VAT amount on your bill and your customer is entitled to refund. In terms of Bookkeeping the following procedure applies: Whenever there is a Bookkeeping entry for purchases or acquisitions, the amount for VAT is debited to the VAT account. <?page no="206"?> Along IFRSs, there are some regulations/ technical terms with regard to costs we mention next: The cost of purchase and the cost of acquisition are always net amounts. This comes from standards IAS 2 and IAS 16. VAT is regarded as a refundable purchase tax. Furthermore, VAT refunds and claims do not depend on payment terms. In case someone buys a product on credit, he/ she will be entitled to claim input-VAT - even in cases he/ she has not paid the price in full. Hence, Accountants never split VAT! VAT counts with the purchase or revenue recognition! How it is done (input-VAT) (1) Determine net amount by dividing the gross amount by 120 %. (2) Determine gross amount by multiplying the net amount by 120 %. (3) Calculate VAT by multiplying the net amount by 20 %. (4) For purchases make a debit entry in the Purchase account with regard to the net amount. (5) Make a debit entry for input-VAT in the VAT account. (6) Credit the gross amount to the Cash/ Bank account and/ or Accounts Payables. There might be partial payments. DR Cash/ Bank.................... 80,000.00 EUR CR Issued Capital............... 80,000.00 EUR Rent between companies becomes subject of VAT, if and only if both parties are registered for VAT reduction. <?page no="207"?> DR Rent......................... 24,000.00 EUR CR Cash/ Bank.................... 24,000.00 EUR DR Purchase..................... 250.00 EUR DR VAT.......................... 50.00 EUR CR Cash/ Bank.................... 300.00 EUR 80,000.00 24,000.00 80,000.00 300.00 300.00 ... 300.00 24,000.00 250.00 250.00 ... 250.00 50.00 50.00 ... 50.00 Figure 21.1: APPLEDENE (Pty) Ltd.’s accounts after 54 Bookkeeping entries <?page no="208"?> DR Purchase..................... 400.00 EUR DR VAT.......................... 80.00 EUR CR Cash/ Bank.................... 480.00 EUR DR Purchase..................... 100.00 EUR DR VAT.......................... 20.00 EUR CR Accounts Payables............ 120.00 EUR DR Accounts Payables............ 840.00 EUR CR Cash/ Bank.................... 840.00 EUR (Note, we assume that the first day is on a Monday. This gives us 365 meat deliveries and 52 payments. Accordingly, there is an amount of: 100 × 120% = 120.00 EUR outstanding. Observe the A/ P Account.) <?page no="209"?> 80,000.00 24,000.00 80,000.00 80,000.00 15,600.00 80,000.00 24,960.00 28,240.00 43,680.00 108,240.00 108,240.00 28,240.00 24,000.00 24,000.00 13,000.00 70,300.00 24,000.00 24,000.00 20,800.00 36,500.00 70,300.00 70,300.00 43,680.00 43,800.00 70,300.00 250.00 120.00 24,000.00 1,400.00 43,800.00 43,800.00 ... 120.00 250.00 2,600.00 1,400.00 1,650.00 4,160.00 1,650.00 1,650.00 7,300.00 14,060.00 1,650.00 14,060.00 14,060.00 14,060.00 Figure 21.2: APPLEDENE (Pty) Ltd.’s accounts (aggregated) When companies return goods to their supplier (returns outwards) an adjustment is to be made in the VAT account, too. This is required for correct VAT calculation with regard to refunds from the revenue service. Returns outwards are treated the same as negative purchases. See for further details the repetition of the KLIPFONTEIN Ltd. case study from chapter (20): Trading Business: Purchases and Returns Outwards: How it is done (returns outwards with VAT consideration): (1) Determine the net amount and the gross amount of goods to return. (2) Check whether (a) or not (b) your company applies a Returns Outwards account. <?page no="210"?> (3) Make a debit entry for the gross amount in the Accounts Payables, if the purchase has not been paid yet. Make a debit entry for the gross amount in the Accounts Receivables, if the seller sends you a voucher. Make a debit entry for the gross amount in the Cash/ Bank account, if the money is transferred back. Consider combinations for partial payments. (4) Adjust the input-VAT claim by making a credit entry in the VAT account for the input-VAT linked to the returned product. (5a) Make a credit entry in the Returns Outwards account for the net amount of the good returned. (6a) Close-off the Purchase account and the Returns Outwards account to the Trading Account. (5b) Make a credit entry in the Purchase account for the net amount of the good returned. (6b) Close-off the Purchase account to the Trading Account. (Note, in case a company applies a perpetual inventory system, you must reduce stock for the returns instead of the purchase account.) DR Cash/ Bank.................... 100,000.00 EUR CR Issued Capital............... 100,000.00 EUR DR Purchase..................... 2,990.00 EUR DR VAT.......................... 598.00 EUR CR Cash/ Bank.................... 3,588.00 EUR <?page no="211"?> DR Cash/ Bank.................... 1,794.00 EUR CR VAT.......................... 299.00 EUR CR Returns Outwards............. 1,495.00 EUR DR Purchase..................... 6,200.00 EUR DR VAT.......................... 1,240.00 EUR CR Accounts Payables............ 7,440.00 EUR DR Accounts Payables............ 223.20 EUR CR VAT.......................... 37.20 EUR CR Returns Outwards............. 186.00 EUR DR Accounts Payables............ 7,216.80 EUR CR Cash/ Bank.................... 7,216.80 EUR <?page no="212"?> DR Purchase..................... 9,750.00 EUR DR VAT.......................... 1,950.00 EUR CR Cash/ Bank.................... 11,700.00 EUR DR Accounts Receivables......... 11,700.00 EUR CR VAT.......................... 1,950.00 EUR CR Returns Outwards............. 9,750.00 EUR DR Purchase..................... 4,320.00 EUR DR VAT.......................... 864.00 EUR CR Accounts Receivables......... 5,184.00 EUR DR Purchase..................... 11,250.00 EUR DR VAT.......................... 2,250.00 EUR CR Accounts Receivables......... 6,516.00 EUR CR Cash/ Bank.................... 6,984.00 EUR <?page no="213"?> 100,000.00 3,588.00 100,000.00 100,000.00 1,794.00 7,216.80 100,000.00 11,700.00 6,984.00 72,305.20 101,794.00 101,794.00 72,305.20 2,990.00 1,495.00 6,200.00 186.00 9,750.00 11,431.00 9,750.00 4,320.00 11,431.00 11,431.00 11,250.00 34,510.00 11,431.00 34,510.00 34,510.00 34,510.00 223.20 7,440.00 11,700.00 5,184.00 7,216.80 6,516.00 7,440.00 7,440.00 11,700.00 11,700.00 598.00 299.00 1,240.00 37.20 1,950.00 1,950.00 864.00 2,250.00 4,615.80 6,902.00 6,902.00 4,615.80 Figure 21.3: KLIPFONTEIN Ltd.’s accounts Summary: VAT is a tax based on the cost of purchase of goods bought. VAT registered companies claim back input- <?page no="214"?> VAT at the end of an Accounting period. When buying goods companies debit input-VAT to the VAT account. When returning goods to suppliers, companies have to adjust the VAT claim by making credit entries in the VAT account for input-VAT compensation due to the goods returned. Working Definitions: Value Added Tax: A consumer tax based on the net amount of purchased goods/ services is a value added tax (input-VAT). Input-VAT: Input-VAT is the VAT tax you pay when you buy goods. Output-VAT: The VAT tax the company collects when the customer buys products/ services, is called output- VAT. <?page no="215"?> Learning Objectives: In this chapter, the most common Bookkeeping entries for sales and returns are discussed. All transactions are based on a periodic inventory system. The Trading account applies for the gross profit calculation. This chapter does not cover VAT. We repeat case studies in the next chapter (23): Trading Business: Sales and Returns plus VAT and then consider input-VAT as well as output-VAT. After studying the next two chapters, you will be familiarised with recording sales and returns inwards in a trading business. You also learn how to calculate gross profit in the Trading Account T/ A. A trading company buys goods and sells them to its customers. The previous chapters only covered purchases and returns outwards, because we keep the case studies simple and explain trading businesses side by side. Now, we add the second perspective: sales and returns inwards. A return inwards is a return by the customer who sends back bought goods to the seller. This chapter completes your view on trading businesses. When we record sales, we make Bookkeeping entries on the debit side for cash received and/ or receivables obtained and on the credit side for revenue recognition. However, we won’t record any cost of sales yet as we only apply the periodic inventory system. The perpetual inventory system is introduced in chapter (26): Inventory Systems. With the application of a periodic inventory system, we calculate the cost of sales based on closing stocks at the end of the Accounting period which are deducted from opening inventory and purchases. Hence, cost of sales equals to the opening value of goods, plus purchases and less closing stock. Returns might also apply and cause adjustments to the cost of sales calculation. For all sales, we credit the Sales account. The name revenue or sales revenue is common for this account too. For us, no distinction is made between those technical terms. However, for dealerships, the expression sales is more common. Due to our 3 letter abbreviation policy, we write “Rev” in the accounts to indicate the account. We avoid “Sal” as it can be confused with salary. (Note, at the same time, we use “Lab” for salary.) The debit entry for sales is either recorded in the Cash/ Bank account or in receivables depending on payment terms. Be aware, there might be partial payments, too, which lead to debit entries in both accounts and give you a compound Bookkeeping entry. In order to determine the profit earned during the Accounting period, we compare purchases and sales. However, purchases will be increased by opening amounts in the Inventory account and reduced by closing stock and returns outwards if there are any. Similar to returns outwards, returns inwards may apply which are recorded once customers send back goods. Further down in the Profit and Loss account, more expenses, such as rent, labour, administration etc. are to be considered for net profit calculation. <?page no="216"?> For trading businesses, the gross profit is an important figure. The gross profit is the difference between sales less returns inwards and less material expenses. A negative gross profit is a gross loss. For gross profit calculating the Trading account applies. How it is done (calculating gross profit): (1) Calculate sales (net amount) (2) If there are any returns inwards deduct them from sales. (3) Deduct purchases and opening values of stock. (4) Add closing stock and returns outwards if there are any. (5) The result is the gross profit to be transferred to the credit side of the Profit and Loss account if positive. A negative amount is called gross loss and is transferred to the debit side of the Profit and Loss account. The following example is about a car dealer. DR Cash/ Bank.................... 100,000.00 EUR CR Issued Capital............... 100,000.00 EUR DR Rent......................... 36,000.00 EUR CR Cash/ Bank.................... 36,000.00 EUR <?page no="217"?> DR Purchase..................... 48,000.00 EUR CR Cash/ Bank.................... 48,000.00 EUR DR Cash/ Bank.................... 17,500.00 EUR CR Sales........................ 17,500.00 EUR DR Purchase..................... 20,000.00 EUR CR Accounts Payables............ 20,000.00 EUR DR Accounts Payables............ 20,000.00 EUR CR Cash/ Bank.................... 20,000.00 EUR DR Cash/ Bank.................... 5,000.00 EUR DR Accounts Receivables......... 17,000.00 EUR CR Sales........................ 22,000.00 EUR DR Cash/ Bank.................... 17,000.00 EUR CR Accounts Receivables......... 17,000.00 EUR <?page no="218"?> 100,000.00 36,000.00 100,000.00 100,000.00 17,500.00 48,000.00 100,000.00 5,000.00 20,000.00 17,000.00 35,500.00 139,500.00 139,500.00 35,500.00 36,000.00 48,000.00 20,000.00 17,500.00 20,000.00 20,000.00 22,000.00 17,000.00 17,000.00 Figure 22.1: CORNFLOWER (Pty) Ltd.’s accounts For the gross profit calculation, we apply the Trading account (T/ A). The Trading account is an account that displays on the debit side the opening value of inventory, all purchases and all returns inwards. On the credit side, there is sales, closing stock and all returns outwards. The <?page no="219"?> balancing figure of the Trading account is the gross profit. In case the Trading account is credit balanced the company earns a gross profit. If the balancing figure (balance b/ d) of the Trading account is on the debit side the company makes a gross loss. How it is done (gross profit calculation): (1) Make Bookkeeping entries for all purchases and revenue recognition. (2) Transfer the opening value of inventories to the debit side of the Trading account by closing-off the Inventory account to the Trading account. (3) Close-off the Purchase account to the Trading account. (4) Close-off the Sales/ Revenue account to the Trading account. (5) Take stock. Make a debit entry for closing stock in the Inventory account and credit the amount to the Trading account. (6) Close-off the Returns Inwards account to the Trading account. (7) Close-off the Returns Outwards account to the Trading account. (8) Balance-off the Trading account in order to calculate the gross profit or gross loss. A gross profit results from a credit balanced Trading account. A gross loss results from a debit balanced Trading account. (9) Close-off the Trading account to the Profit and Loss account. <?page no="220"?> DR Inventory.................... 32,000.00 EUR CR Trading Account.............. 32,000.00 EUR 100,000.00 36,000.00 100,000.00 100,000.00 17,500.00 48,000.00 100,000.00 5,000.00 20,000.00 17,000.00 35,500.00 139,500.00 139,500.00 35,500.00 36,000.00 36,000.00 48,000.00 36,000.00 36,000.00 20,000.00 68,000.00 68,000.00 68,000.00 68,000.00 68,000.00 17,500.00 20,000.00 20,000.00 39,500.00 22,000.00 39,500.00 39,500.00 39,500.00 39,500.00 17,000.00 17,000.00 68,000.00 39,500.00 3,500.00 32,000.00 71,500.00 71,500.00 3,500.00 3,500.00 32,000.00 32,000.00 36,000.00 3,500.00 32,000.00 32,500.00 36,000.00 36,000.00 32,500.00 32,500.00 32,500.00 32,500.00 32,500.00 Figure 22.2: CORNFLOWER (Pty) Ltd.’s accounts <?page no="221"?> DR Sales........................ 39,500.00 EUR CR Trading Account.............. 39,500.00 EUR DR Trading Account.............. 68,000.00 EUR CR Purchase..................... 68,000.00 EUR DR Trading Account.............. 3,500.00 EUR CR Profit and Loss.............. 3,500.00 EUR DR Profit and Loss.............. 36,000.00 EUR CR Rent......................... 36,000.00 EUR Net loss is the technical term for a negative profit. Our simplified tax model does not consider any tax deferrals, hence, the net loss is the net loss after taxes. In contrast, a net profit stands for a positive amount. A net profit is the sales less all expenses (income tax expenses exempted) that occurred during the Accounting period. A net profit is the same as earnings before taxes. DR Retained Earnings............ 32,500.00 EUR CR Profit and Loss.............. 32,500.00 EUR <?page no="222"?> Observe the financial statements for CORNFLOWER (Pty) Ltd. in Figure 22.3. Figure 22.3: CORNFLOWER (Pty) Ltd.’s income statement for 20X9 Figure 22.4: CORNFLOWER (Pty) Ltd.’s statement of financial position as at 31.12.20X9 <?page no="223"?> With regard to the valuation of goods on stock, IAS 2 and § 255 HGB apply: The valuation is always at cost of purchase (net amount). No additions are allowed. How it is done (calculation of net profit): (1) Determine gross profit in the Trading account. (2) Close-off the Trading account to the Profit and Loss account. (3) Make debit entries for all further expenses, including interest. (4) Balance-off the Profit and Loss account. (5) At this stage, the balancing figure in the Profit and Loss account represents the net profit. We name it earnings before taxes (= EBT). A debit balanced Profit and Loss account indicates a net loss. We discuss another case study below, where the amounts are not that easy to oversee, which occurs in most trading companies. Think about a grocery shop like Lidl, Aldi, Checker’s, Tesco, Woolworth etc. Furthermore, we now consider returns. There will be returns inwards and returns outwards. Again, we make the Bookkeeping entries at first and then apply the Trading account in order to calculate the gross profit. Figure 22.5: DURANT (Pty) Ltd.’s statement of financial position <?page no="224"?> 100,000.00 20,000.00 59,000.00 61,000.00 100,000.00 35,000.00 50,000.00 15,000.00 Figure 22.6: DURANT (Pty) Ltd.’s accounts <?page no="225"?> DR Income Tax Liabilities....... 15,000.00 EUR CR Cash/ Bank.................... 15,000.00 EUR DR Accounts Payables............ 34,840.00 EUR CR Cash/ Bank.................... 34,840.00 EUR DR Cash/ Bank.................... 8,400.00 EUR CR Sales........................ 8,400.00 EUR DR Accounts Receivables......... 1,020.00 EUR CR Sales........................ 1,020.00 EUR DR Cash/ Bank.................... 1,020.00 EUR CR Accounts Receivables......... 1,020.00 EUR DR Returns Inwards.............. 30.00 EUR CR Accounts Payables............ 30.00 EUR <?page no="226"?> DR Purchase..................... 13,400.00 EUR CR Accounts Payables............ 13,400.00 EUR DR Cash/ Bank.................... 7,040.00 EUR CR Sales........................ 7,040.00 EUR DR Accounts Payables............ 134.00 EUR CR Returns Outwards............. 134.00 EUR DR Accounts Payables............ 13,266.00 EUR CR Cash/ Bank.................... 13,266.00 EUR DR Depreciation................. 2,000.00 EUR CR Accumulated Depreciation..... 2,000.00 EUR 100,000.00 100,000.00 20,000.00 100,000.00 22,000.00 2,000.00 22,000.00 22,000.00 22,000.00 Figure 22.7: DURANT (Pty) Ltd.’s accounts <?page no="227"?> 59,000.00 61,000.00 15,000.00 8,400.00 34,840.00 1,020.00 13,266.00 7,040.00 14,354.00 77,460.00 77,460.00 14,354.00 100,000.00 100,000.00 35,000.00 100,000.00 34,840.00 50,000.00 15,000.00 15,000.00 134.00 30.00 13,266.00 13,400.00 15,190.00 63,430.00 63,430.00 15,190.00 8,400.00 1,020.00 1,020.00 1,020.00 16,460.00 7,040.00 16,460.00 16,460.00 16,460.00 30.00 30.00 13,400.00 13,400.00 30.00 13,400.00 134.00 134.00 2,000.00 2,000.00 134.00 2,000.00 Figure 22.7: DURANT (Pty) Ltd.’s accounts (continued) <?page no="228"?> 100,000.00 100,000.00 20,000.00 100,000.00 22,000.00 2,000.00 22,000.00 22,000.00 22,000.00 59,000.00 59,000.00 61,000.00 15,000.00 59,600.00 59,600.00 8,400.00 34,840.00 118,600.00 118,600.00 1,020.00 13,266.00 59,600.00 7,040.00 14,354.00 77,460.00 77,460.00 14,354.00 100,000.00 100,000.00 35,000.00 100,000.00 36,234.80 1,234.80 36,234.80 36,234.80 36,234.80 34,840.00 50,000.00 15,000.00 15,000.00 134.00 30.00 529.20 529.20 13,266.00 13,400.00 15,529.20 15,529.20 15,190.00 529.20 63,430.00 63,430.00 15,190.00 8,400.00 1,020.00 1,020.00 1,020.00 16,460.00 7,040.00 16,460.00 16,460.00 16,460.00 16,460.00 Figure 22.8: DURANT (Pty) Ltd.’s accounts <?page no="229"?> 30.00 30.00 13,400.00 13,400.00 30.00 30.00 13,400.00 13,400.00 134.00 134.00 2,000.00 2,000.00 134.00 134.00 2,000.00 2,000.00 59,000.00 16,460.00 2,000.00 3,764.00 13,400.00 59,600.00 1,764.00 30.00 134.00 3,764.00 3,764.00 3,764.00 1,234.80 1,764.00 76,194.00 76,194.00 529.20 3,764.00 3,764.00 1,764.00 1,764.00 Figure 22.8: DURANT (Pty) Ltd.’s accounts (continued) Figure 22.9: DURANT (Pty) Ltd.’s statement of financial position <?page no="230"?> Figure 22.10: DURANT (Pty) Ltd. income statement Summary: In a trading business, the gross profit is calculated by the Trading account. The net profit is calculated in the Profit and Loss account. <?page no="231"?> Working Definitions: Gross Profit: The gross profit is the difference between sales less returns inwards and less material expenses. Trading Account: The Trading account is an account that displays on the debit side the opening value of inventory, all purchases and all returns inwards. On the credit side there is sales, closing stock and all returns outwards. The balancing figure of the Trading account is the gross profit. Net Profit: A net profit is the sales less all expenses (income tax expenses exempted) that occurred during the Accounting period. <?page no="232"?> Learning Objectives: We study again the cases of CORNFLOWER (Pty) Ltd. and DURANT (Pty) Ltd. from the previous chapter and consider VAT for purchases and sales now. We are going to understand that VAT does not effect a business’s profit, but it changes payments and payables (or receivables) on the balance sheet. After studying this chapter, you will be able to record activities of a trading business including inputand output-VAT. You know also the amount to be paid to or get refunded from the revenue service for VAT. For the case studies, all costs, expenses and net selling prices remain unchanged with regard to the previous chapter (22) Trading Business: Sales and Returns. We start our extended case study repetition by CORNFLOWER (Pty) Ltd., the car dealer: DR Cash/ Bank.................... 100,000.00 EUR CR Issued Capital............... 100,000.00 EUR DR Rent......................... 36,000.00 EUR DR VAT.......................... 7,200.00 EUR CR Cash/ Bank.................... 43,200.00 EUR (Note, it is required that the sellers disclose VAT on the bill. In case CORNFLOWER (Pty) Ltd. bought the cars from a private owner, no VAT would be disclosed on the bill and CORNFLOWER (Pty) Ltd. would pay 16,000.00 EUR/ p. No input-VAT claim would be accepted in that case.) <?page no="233"?> DR Purchase..................... 48,000.00 EUR DR VAT.......................... 9,600.00 EUR CR Cash/ Bank.................... 57,600.00 EUR (Note, even if the buyer is a private person, he/ she pays the gross amount.) DR Cash/ Bank.................... 21,000.00 EUR CR VAT.......................... 3,500.00 EUR CR Sales........................ 17,500.00 EUR DR Purchase..................... 20,000.00 EUR DR VAT.......................... 4,000.00 EUR CR Accounts Payables............ 24,000.00 EUR DR Accounts Payables............ 24,000.00 EUR CR Cash/ Bank.................... 24,000.00 EUR <?page no="234"?> DR Cash/ Bank.................... 5,000.00 EUR DR Accounts Receivables......... 21,400.00 EUR CR VAT.......................... 4,400.00 EUR CR Sales........................ 22,000.00 EUR DR Cash/ Bank.................... 21,400.00 EUR CR Accounts Receivables......... 21,400.00 EUR 100,000.00 43,200.00 100,000.00 100,000.00 21,000.00 57,600.00 100,000.00 5,000.00 24,000.00 21,400.00 22,600.00 147,400.00 147,400.00 22,600.00 36,000.00 48,000.00 20,000.00 17,500.00 24,000.00 24,000.00 22,000.00 21,400.00 21,400.00 7,200.00 3,500.00 9,600.00 4,400.00 4,000.00 12,900.00 20,800.00 20,800.00 12,900.00 Figure 23.1: CORNFLOWER (Pty) Ltd.’s accounts <?page no="235"?> DR Sales........................ 39,500.00 EUR CR Trading Account.............. 39,500.00 EUR DR Trading Account.............. 68,000.00 EUR CR Purchase..................... 68,000.00 EUR DR Inventory.................... 32,000.00 EUR CR Trading Account.............. 32,000.00 EUR DR Trading Account.............. 3,500.00 EUR CR Profit and Loss.............. 3,500.00 EUR DR Profit and Loss.............. 36,000.00 EUR CR Rent......................... 36,000.00 EUR DR Retained Earnings............ 32,500.00 EUR CR Profit and Loss.............. 32,500.00 EUR <?page no="236"?> 100,000.00 43,200.00 100,000.00 100,000.00 21,000.00 57,600.00 100,000.00 5,000.00 24,000.00 21,400.00 22,600.00 147,400.00 147,400.00 22,600.00 36,000.00 36,000.00 48,000.00 36,000.00 36,000.00 20,000.00 68,000.00 68,000.00 68,000.00 68,000.00 68,000.00 17,500.00 24,000.00 24,000.00 39,500.00 22,000.00 39,500.00 39,500.00 39,500.00 39,500.00 21,400.00 21,400.00 7,200.00 3,500.00 9,600.00 4,400.00 4,000.00 12,900.00 20,800.00 20,800.00 12,900.00 68,000.00 39,500.00 36,000.00 3,500.00 3,500.00 32,000.00 32,500.00 71,500.00 71,500.00 36,000.00 36,000.00 3,500.00 3,500.00 32,500.00 32,500.00 32,500.00 32,500.00 32,000.00 32,000.00 32,500.00 32,000.00 Figure 23.2: CORNFLOWER (Pty) Ltd.’s accounts <?page no="237"?> Figure 23.3: CORNFLOWER (Pty) Ltd.’s income statement for 20X9 <?page no="238"?> Figure 23.4: CORNFLOWER (Pty) Ltd.’s statement of financial position as at 31.12.20X9 DR Cash/ Bank.................... 12,900.00 EUR CR VAT.......................... 12,900.00 EUR We now study again the DURANT (Pty) Ltd. case with consideration of VAT. This example contains returns which require to make adjustments for VAT, too. <?page no="239"?> Figure 23.5: DURANT (Pty) Ltd.’s statement of financial position 100,000.00 20,000.00 59,000.00 61,000.00 100,000.00 35,000.00 50,000.00 15,000.00 Figure 23.6: DURANT (Pty) Ltd.’s accounts <?page no="240"?> DR Income Tax Liabilities....... 15,000.00 EUR CR Cash/ Bank.................... 15,000.00 EUR DR Accounts Payables............ 41,808.00 EUR CR Cash/ Bank.................... 41,808.00 EUR DR Cash/ Bank.................... 10,080.00 EUR CR VAT.......................... 1,680.00 EUR CR Sales........................ 8,400.00 EUR DR Accounts Receivables......... 1,224.00 EUR CR VAT.......................... 204.00 EUR CR Sales........................ 1,020.00 EUR DR Cash/ Bank.................... 1,224.00 EUR CR Accounts Receivables......... 1,224.00 EUR <?page no="241"?> DR Returns Inwards.............. 30.00 EUR DR VAT.......................... 6.00 EUR CR Accounts Payables............ 36.00 EUR DR Purchase..................... 13,400.00 EUR DR VAT.......................... 2,680.00 EUR CR Accounts Payables............ 16,080.00 EUR DR Cash/ Bank.................... 8,448.00 EUR CR VAT.......................... 1,408.00 EUR CR Sales........................ 7,040.00 EUR DR Accounts Payables............ 160.80 EUR CR VAT.......................... 26.80 EUR CR Returns Outwards............. 134.00 EUR <?page no="242"?> DR Accounts Payables............ 15,919.20 EUR CR Cash/ Bank.................... 15,919.20 EUR DR Depreciation................. 2,000.00 EUR CR Accumulated Depreciation..... 2,000.00 EUR 100,000.00 100,000.00 20,000.00 100,000.00 22,000.00 2,000.00 22,000.00 22,000.00 22,000.00 100,000.00 100,000.00 59,000.00 100,000.00 41,808.00 50,000.00 15,000.00 15,000.00 160.80 36.00 15,919.20 16,080.00 8,228.00 66,116.00 66,116.00 8,228.00 134.00 134.00 2,000.00 2,000.00 134.00 2,000.00 35,000.00 Figure 23.7: DURANT (Pty) Ltd.’s accounts <?page no="243"?> 100,000.00 100,000.00 20,000.00 100,000.00 22,000.00 2,000.00 22,000.00 22,000.00 22,000.00 6.00 1,680.00 61,000.00 15,000.00 2,680.00 204.00 10,080.00 41,808.00 1,408.00 1,224.00 15,919.20 632.80 26.80 8,448.00 8,024.80 3,318.80 3,318.80 80,752.00 80,752.00 632.80 8,024.80 100,000.00 100,000.00 59,000.00 59,000.00 100,000.00 59,600.00 59,600.00 118,600.00 118,600.00 59,600.00 34,840.00 50,000.00 15,000.00 15,000.00 160.80 36.00 529.20 529.20 15,919.20 16,080.00 15,529.20 15,529.20 15,196.00 529.20 66,116.00 66,116.00 15,196.00 8,400.00 1,224.00 1,224.00 1,020.00 16,460.00 7,040.00 16,460.00 16,460.00 16,460.00 16,460.00 Figure 23.8: DURANT (Pty) Ltd.’s accounts <?page no="244"?> 30.00 30.00 13,400.00 13,400.00 30.00 30.00 13,400.00 13,400.00 134.00 134.00 2,000.00 2,000.00 134.00 134.00 2,000.00 2,000.00 35,000.00 59,000.00 16,460.00 36,234.80 1,234.80 13,400.00 59,600.00 36,234.80 36,234.80 30.00 134.00 36,234.80 3,764.00 76,194.00 76,194.00 3,764.00 3,764.00 2,000.00 3,764.00 1,764.00 3,764.00 3,764.00 1,234.80 1,764.00 529.20 1,764.00 1,764.00 Figure 23.8: DURANT (Pty) Ltd.’s accounts (continued) <?page no="245"?> Figure 23.9: DURANT (Pty) Ltd.’s statement of financial position Figure 23.10: DURANT (Pty) Ltd. income statement <?page no="246"?> DR VAT.......................... 632.80 EUR CR Cash/ Bank.................... 632.80 EUR How it is done (posting output-VAT): (1) Determine the gross and the net amount of the sales or revenue. (2) Make a debit entry for the gross amount in the Cash/ Bank account or Accounts Receivables. Consider partial payments accordingly. (3) Credit output-VAT to the VAT account. (4) Credit the net amount to the Sales/ Revenue account. How it is done (VAT claim): (1) Make all entries in the VAT account for input-VAT and output-VAT. (2) Balance-off the VAT account. (3) Prepare a VAT statement and send it to the revenue service. (4) If output-VAT exceeds input-VAT transfer the difference into the revenue service’s account once it is due. If input-VAT exceeds output-VAT, you expect the authorities to refund you the difference. Summary: VAT registered companies have to credit output-VAT to the VAT account at the time of revenue recognition. The output-VAT is collected by the company on behalf of the revenue service. Returns outwards are similar to a sale activity and require crediting the VAT account. Crediting the VAT account results in a payment obligation for VAT in the next Accounting period according to the conventions that apply for this text book. This obligation is not effected by any payment received from customers. The consideration of VAT effects the Cash/ Bank account, receivables and payables. The statement of comprehensive income is not effectuated by VAT, as long as the net selling prices equal to the no-VAT values. <?page no="247"?> Learning Objectives: After studying how to earn profit, we show in this chapter, how a private owner of a company receives an income from his/ her business by withdrawing money or goods. The appropriation of profits for limited companies is covered by the chapter (30): Tax Calculation, Profit Appropriation and Statement of Changes in Equity. Here, we explain also that using company assets privately or taking out goods is regarded as an owner’s benefit and counts as a drawing. Companies based on shares and earning a profit either distribute their profit to shareholders or they keep it in the business for reinvestments. Privatelyowned companies do not declare dividends but the owners make drawings in order to participate from the profit their business earns. A drawing is taking out assets (e.g. materials or cash) of a business or using business assets privately. Making a drawing decreases the business’ equity. Therefore, the Bookkeeping entry for drawings has to be on the debit side of the equity account. For privately-owned businesses we apply the Drawings account. It belongs to the equity section. In contrast to limited companies, the equity section for privately-owned businesses is simpler. In general, there is only one item, named owners’ equity. The Drawing account reduces owners’ capital. Find below in Figure 24.1 the form for a privately owned business which applies in case the company even has to prepare a statement of financial position. Figure 24.1: Structure of the balance sheet for privately-owned companies <?page no="248"?> It is important to understand that never a drawing becomes relevant for profit calculation. It cannot not change the profitability of the business. Drawings and private deployments of business resources must not go through the Profit and Loss account! Hence, drawings do not fall under expenses of the business. On the other side - better: the contra entry to be considered on the debit side - a drawing reduces assets as they are withdrawn from the business. It also becomes necessary making adjustments in the VAT account for drawings linked to assets that were subject to input-VAT recording. Private deployment of assets is not eligible for VAT reduction, as it is not linked to business operations. Hence, an owner taking assets is regarded as a consumer and must not claim input- VAT for assets used privately. We further explain this aspect by the discussion of a theft case: Think of a company owner who is registered for VAT reduction and buys himself a new car and pays 84,000.00 EUR for it. The car is bought in the name of the company. Hence, the company claims the input-VAT from the revenue service. Although the car’s owner is the company and it is supposed to be ridden on business only, the car is frequently used privately. We assume the car was never used for business purpose. At the end of the Accounting period, the owner claims the input-VAT of: 20% × (84,000/ 120%) = 14,000.00 EUR which makes him buy a private car “free of VAT”. This case is an example for tax evasion and is punishable by national VAT law. Only the company can deduct input- VAT - a private person cannot because it is a consumer. How it is done (cash drawing): (1) When taking the money out of the Cash/ Bank account for private purpose, record this as a drawing. It gives a debit entry in the Drawings account and a credit entry in the Cash/ Bank account. (2) At the end of the Accounting period close-off the Drawings account to the Owners’ Capital account. How it is done (drawing based on withdrawal of goods or using company resources): (1) Determine the net amount and the gross amount of the goods withdrawn or calculate the value of the privately deployed resources. (Can be complicated! ) (2) When taking out the goods or using the company resources, make a debit entry in the Drawings account to the extent of the gross value of the goods/ service taken. (3) Adjust the VAT account: Credit the input-VAT recorded beforehand to the VAT account. This cancels out the input-VAT claim. <?page no="249"?> (4a) For withdrawn goods, credit the net amount to the related Inventory account or Purchase account. If the asset is a non-current asset, make the credit entry in the relevant account, such as the P, P, E account for instance. (4b) When using company resources privately, make a credit entry in the related expense account. You might have to consider adjustments for VAT also. (5) Close-off the Drawings account to the Owners’ Capital account. We apply the how-it-is-done instructions for the business car example above. When buying the car, the owner of the business adds the car to the P, P, E account: DR P, P, E ACCOUNT .............. 70,000.00 EUR DR VAT.......................... 14,000.00 EUR CR Cash/ Bank.................... 84,000.00 EUR When taking the car out of the company completely, the owner must record a drawing and record an adjustment for the input-VAT: DR Drawings..................... 84,000.00 EUR CR VAT.......................... 14,000.00 EUR CR P, P, E ...................... 70,000.00 EUR Later, the owner closes-off the Drawings account to the Owners’ Capital account: DR Owner’s Capital.............. 84,000.00 EUR CR Drawings..................... 84,000.00 EUR Now the situation is cleared: The owner has ceteris paribus no VAT claim resulting from the car acquisition. Furthermore, the car does no longer fall under company assets. The owner paid 84,000.00 EUR for the acquisition, received a refund of 14,000.00 EUR and paid 14,000.00 EUR output-VAT once conveying the car to his private assets. We modify the situation slightly and discuss a situation, in case the owner only uses the car partly (50 %) for private and half on business purpose. The car now stays in the Bookkeeping records of the company as its item of property, plant and equipment. We ignore further motor vehicle costs, such as insurance and petrol to keep the case as simple as possible. The <?page no="250"?> Bookkeeping entry for the car’s acquisition is the same as above. As the car stays in the business, it becomes subject to depreciation. Assume the car is written-off along straight-line method and the useful life is 5 years. Depreciation on the car for a full year yields: 70,000 / 5 = 14,000.00 EUR. DR Depreciation................. 14,000.00 EUR CR Acc. Depr.................... 14,000.00 EUR The expenses for a one year car deployment at a half : half ratio are: 14,000.00 / 2 = 7,000.00 EUR. This is the equivalent value for using the car for half of a year privately. The owner makes the Bookkeeping entry below. It is recorded as drawing. DR Drawings .................... 7,000.00 EUR CR Depreciation................. 7,000.00 EUR The drawing is high enough in order to adjust input-VAT, too. If the car is permanently in private use to the extent of 50 %, we accept that 7,000.00 EUR of the input-VAT paid at the time of acquisition is to be adjusted. Spreading the amount for drawings over 5 years, gives a further drawing for input-VAT to the extent of: 7,000 / 5 = 1,400.00 EUR. We record the drawing as below and close-off the Drawings account to the Owner’s Capital account: DR Drawings..................... 1,400.00 EUR CR VAT.......................... 1,400.00 EUR DR Owner’s Capital.............. 8,400.00 EUR CR Drawings..................... 8,400.00 EUR After the latter Bookkeeping entry, the input-VAT claim is reduced based on the drawing and the expense account is reduced by 50 %. According to the drawing, the owner’s equity is now 8,400.00 EUR lower which is the equivalent to the (gross) car deployment for half of a year. <?page no="251"?> 56,000.00 (15,400.00) 0.00 12,600.00 (84,000.00) (15,400.00) (15,400.00) Figure 24.2: Balance sheet of a company when using a car 50 % privately Next, we observe a private owned company and drawings by the case study VANGUARD: As a trading company, VANGUARD has to prepare financial statements by national law, even as it is no limited company. <?page no="252"?> Figure 24.3: VANGUARD’s statement of financial position (Note, the distinction in capital and retained earnings is for teaching purpose. The company can just disclose an owner’s equity to the extent of 100,000.00 EUR.) 90,000.00 36,000.00 10,000.00 36,000.00 60,000.00 40,000.00 Figure 24.4: VANGUARD’s accounts <?page no="253"?> DR Rent......................... 30,000.00 EUR DR VAT.......................... 6,000.00 EUR CR Cash/ Bank.................... 36,000.00 EUR DR Purchase..................... 55,200.00 EUR DR VAT.......................... 11,040.00 EUR CR Cash/ Bank.................... 66,240.00 EUR DR Labour....................... 28,800.00 EUR CR Cash/ Bank.................... 28,800.00 EUR <?page no="254"?> DR Cash/ Bank.................... 205,632.00 EUR CR VAT.......................... 34,272.00 EUR CR Sales........................ 171,360.00 EUR DR Drawings..................... 30,000.00 EUR CR Cash/ Bank.................... 30,000.00 EUR DR Depreciation................. 9,000.00 EUR CR Accumulated Depreciation..... 9,000.00 EUR <?page no="255"?> DR Drawings..................... 2,496.00 EUR CR VAT.......................... 416.00 EUR CR Depreciation ................. 187.20 EUR CR Materials.................... 1,268.80 EUR CR Rent......................... 624.00 EUR DR Drawings..................... 30,000.00 EUR CR Cash/ Bank.................... 30,000.00 EUR 90,000.00 90,000.00 36,000.00 90,000.00 45,000.00 9,000.00 45,000.00 45,000.00 45,000.00 10,000.00 36,000.00 12,000.00 205,632.00 36,000.00 66,240.00 28,800.00 30,000.00 30,000.00 38,592.00 241,632.00 241,632.00 38,592.00 Figure 24.5: VANGUARD’s accounts <?page no="256"?> 60,000.00 60,000.00 40,000.00 60,000.00 1,268.80 30,000.00 624.00 29,376.00 30,000.00 30,000.00 29,376.00 6,000.00 34,272.00 55,200.00 55,200.00 11,040.00 416.00 55,200.00 17,648.00 34,688.00 34,688.00 17,648.00 28,800.00 28,800.00 171,360.00 171,360.00 28,800.00 171,360.00 30,000.00 9,000.00 187.20 2,496.00 8,812.80 30,000.00 62,496.00 9,000.00 9,000.00 62,496.00 62,496.00 8,812.80 62,496.00 Figure 24.5: VANGUARD’s accounts (continued) <?page no="257"?> 90,000.00 90,000.00 36,000.00 90,000.00 45,000.00 9,000.00 45,000.00 45,000.00 45,000.00 10,000.00 10,000.00 36,000.00 36,000.00 4,200.00 4,200.00 205,632.00 66,240.00 14,200.00 14,200.00 28,800.00 4,200.00 30,000.00 30,000.00 50,592.00 241,632.00 241,632.00 50,592.00 60,000.00 60,000.00 40,000.00 60,000.00 84,640.00 44,640.00 84,640.00 84,640.00 84,640.00 55,200.00 55,200.00 30,000.00 624.00 55,200.00 55,200.00 29,376.00 30,000.00 30,000.00 29,376.00 29,376.00 6,000.00 34,272.00 1,268.80 1,268.80 11,040.00 416.00 17,648.00 34,688.00 34,688.00 17,648.00 Figure 24.6: VANGUARD’s accounts <?page no="258"?> 28,800.00 28,800.00 171,360.00 171,360.00 28,800.00 28,800.00 171,360.00 171,360.00 30,000.00 9,000.00 187.20 2,496.00 8,812.80 30,000.00 62,496.00 9,000.00 9,000.00 62,496.00 62,496.00 8,812.80 8,812.80 62,496.00 10,000.00 171,360.00 8,812.80 111,628.80 55,200.00 4,200.00 28,800.00 111,628.80 1,268.80 29,376.00 176,828.80 176,828.80 44,640.00 111,628.80 111,628.80 111,628.80 111,628.80 44,640.00 44,640.00 44,640.00 44,640.00 Figure 24.6: VANGUARD’s accounts (continued) Figure 24.7: VANGUARD’s income statement <?page no="259"?> Figure 24.8: VANGUARD’s statement of financial position For the understanding of how the owners earn money from a privatelyowned business, we discuss another case study which is about a partnership. The company is a law firm and the partners are attorneys who work for their own company. Besides the partners, there are other attorneys who are employed by the law firm. DR Cash/ Bank.................... 1,000,000.00 EUR CR Owners’ capital.............. 1,000,000.00 EUR <?page no="260"?> DR Labour....................... 480,000.00 EUR CR Cash/ Bank.................... 480,000.00 EUR DR Rent......................... 156,000.00 EUR CR Cash/ Bank.................... 156,000.00 EUR DR Prepaid Expenses............. 12,000.00 EUR CR Rent......................... 12,000.00 EUR DR Office Materials............. 20,000.00 EUR DR VAT.......................... 4,000.00 EUR CR Cash/ Bank.................... 24,000.00 EUR <?page no="261"?> DR Cash/ Bank.................... 2,160,000.00 EUR DR Accounts Receivables......... 240,000.00 EUR CR VAT.......................... 400,000.00 EUR CR Revenue...................... 2,000,000.00 EUR DR Drawings..................... 900,000.00 EUR CR Cash/ Bank.................... 900,000.00 EUR DR Cash/ Bank.................... 250,000.00 EUR CR Owners’ Equity............... 250,000.00 EUR <?page no="262"?> 1,000,000.00 480,000.00 900,000.00 1,000,000.00 2,160,000.00 156,000.00 250,000.00 250,000.00 24,000.00 1,706,000.00 1,356,000.00 900,000.00 2,606,000.00 2,606,000.00 1,850,000.00 1,706,000.00 3,410,000.00 3,410,000.00 1,850,000.00 480,000.00 480,000.00 156,000.00 12,000.00 144,000.00 156,000.00 156,000.00 12,000.00 12,000.00 2,000,000.00 2,000,000.00 12,000.00 240,000.00 240,000.00 4,000.00 400,000.00 240,000.00 396,000.00 400,000.00 400,000.00 396,000.00 20,000.00 20,000.00 900,000.00 900,000.00 480,000.00 2,000,000.00 144,000.00 20,000.00 1,356,000.00 2,000,000.00 2,000,000.00 1,356,000.00 1,356,000.00 Figure 24.9: PAROW HOUTBANK’s accounts <?page no="263"?> Figure 24.10: PAROW HOUTBANK’s statement of financial position <?page no="264"?> Figure 24.11: PAROW HOUTBANK’s statement of comprehensive income The income tax calculation in most countries is based on progressive tax rates. This means a person earning a high profit pays more taxes than lowlevel income tax payers. See below the outcome of the tax progression system for PAROW HOUTBANK’s partners: Summary: To withdraw assets from a business is called drawing. Drawings are to be separated from expenses recorded in the Profit and Loss account. Drawings do not change the profit of the business. In the event of assets other than cash are taken out, input-VAT is to be adjusted to the extent of goods/ services withdrawn. The Drawings account is to be closedoff to the Owners’ Capital account. <?page no="265"?> Working Definition: Drawing: A drawing is taking out assets (e.g. materials or cash) of a business or to use business assets privately. . <?page no="266"?> Learning Objectives: A production firm’s Accounting system is more difficult than a trading business’s one’s, because movements of materials/ goods inside of the factory must be recorded. Furthermore, overhead allocations take place in order to calculate the cost of goods manufactured. At the end of the Accounting period, the production firm has to recognise the value of finished goods and work in process on the balance sheet. The inventory of finished goods is to be valued at its costs of manufacturing. In this chapter, we’ll introduce Manufacturing Accounting as a means of ascertaining unit costs. After studying this chapter, you can calculate unit costs of products manufactured and those, which still are under production. You learn the cost flow in production firms and can prepare balance sheets with correct inventory valuations. Any non-current asset bought is recognised at its cost of acquisition less accumulated depreciation and accumulated impairment losses. In some cases, revaluations might apply. The costs of an asset produced in a factory are to be disclosed at its cost of manufacturing. The costs of manufacturing contain direct costs, such as materials and labour, and portions of overheads for resources deployed in the manufacturing process. All costs linked to production, such as materials, labour, depreciation on production facilities, supervisor’s salary etc., count as costs of manufacturing. In contrast, costs not linked to production (called non-manufacturing overheads), such as administration costs and cost for distribution and advertising, never do. We refer to chapter 9 of the text book Bilanzen/ Financial Accounting for further consideration of Manufacturing Accounting. In production firms, at least 3 kinds of stock accounts apply. There are inventory accounts for raw materials, for work in process and for finished goods. Some companies even store semi-finished goods and apply a Semi- Finished Goods Inventory account. We only stick to the basic 3 categories of Inventory accounts. Hence, the material flow is: raw materials work in process finished goods. Material bought is debited to the Raw Material Inventory account. Once materials are released from stock, because they go into a product, the Accountant adds them to the relevant job order. A job order is an internal order in a factory. It gathers all costs that occur during the production process. The reconciliation account for all job orders is the Work in Process WIP account - it represents the value of all products under production. (Note, in order to not confuse you with too many account names, we call the account for job order 90684: “WIP-90684”. The reconciliation account is named just “WIP account”. In the text below, we refer to WIP because a company is not obliged to apply subordinated job order accounts. However, they frequently do for Management Accounting purpose.) The WIP account is debited for direct costs and applied overheads. Once <?page no="267"?> production is finished, the goods are put on stock. The Accountant then makes a debit entry in the Finished Goods Inventory account and credits the amount to the WIP account. Once a company sells finished goods, they are released from stock (finished goods inventory) and put on the income statement as an expense. The expense account for finished goods released from stock is the Cost of Sales COS account. (also called Cost of Goods Sold COS account) Once goods are sold, the Accountant makes a debit entry in the Cost of Sales account and debits the amount to the Finished Goods Inventory account. The costs of sales (= cost of goods sold) are the costs of manufacturing for goods that have been sold during the Accounting period. Why do Accountants in production firms have to know about product calculation? It is for inventory valuation (raw materials + WIP + finished goods) on the balance sheet. The inventory valuation urges companies to calculate their goods on stock and those still in the factory. Furthermore, the detailed calculation of goods is required by Management Accounting. It is covered in part II of this text book. How it is done (expensing finished goods): (1) After the purchase of materials assign them to an Inventory account. Best is to apply a Raw Materials Inventory account as a subordinated account to the Inventory account. (2) When a job order requests a release from stock assign the materials to that particular job order. Make a debit entry in the Job Order account and credit the amount to the Raw Materials Inventory account. Call the Job Order XXX account WIP-XXX. (3) Assign further expenses to the job order. Do that either directly or by cost allocation. Other expenses can be direct labour, depreciation, material overheads etc. (4) Once a job order is finished, add the goods manufactured to the finished goods inventory. Close-off the Job Order account to the Inventory (finished goods) account. Best, apply a Finished Goods Inventory account. (5) Consider a sale of finished goods as expense. Debit the amount to the Cost of Sales (COS) account. (6) Close-off the Cost of Sales account to the Profit and Loss account for profit calculation. We explain the basic Bookkeeping entries in this chapter by a case study about the bicycle manufacturer REGENT BIKE (Pty) Ltd. <?page no="268"?> DR Cash/ Bank.................... 50,000.00 EUR CR Issued Capital............... 50,000.00 EUR DR Rent......................... 12,000.00 EUR CR Cash/ Bank.................... 12,000.00 EUR DR Purchase..................... 2,520,000.00 EUR DR VAT.......................... 504,000.00 EUR CR Cash/ Bank.................... 3,024,000.00 EUR DR Raw Materials Inventory...... 2,520,000.00 EUR CR Purchase..................... 2,520,000.00 EUR <?page no="269"?> DR Labour....................... 96,000.00 EUR CR Cash/ Bank.................... 96,000.00 EUR DR WIP .......................... 2,068,000.00 EUR CR Raw Materials................ 1,960,000.00 EUR CR Labour....................... 96,000.00 EUR CR Rent......................... 12,000.00 EUR DR Finished Goods Inventory..... 2,068,000.00 EUR CR WIP .......................... 2,068,000.00 EUR The lot size is the amount of goods manufactured by one job order. DR Cash/ Bank.................... 4,200,000.00 EUR CR VAT.......................... 700,000.00 EUR CR Sales........................ 3,500,000.00 EUR <?page no="270"?> DR Cost of Goods Sold (COS)..... 1,809,500.00 EUR CR Finished Goods Inventory..... 1,809,500.00 EUR DR Distribution................. 10,000.00 EUR CR Cash/ Bank.................... 10,000.00 EUR DR Administration............... 30,000.00 EUR CR Cash/ Bank.................... 30,000.00 EUR 50,000.00 12,000.00 50,000.00 50,000.00 4,200,000.00 3,024,000.00 50,000.00 96,000.00 10,000.00 30,000.00 1,078,000.00 4,250,000.00 4,250,000.00 1,078,000.00 12,000.00 12,000.00 2,520,000.00 2,520,000.00 Figure 25.1: REGENT BIKE (Pty) Ltd.’s accounts <?page no="271"?> 504,000.00 700,000.00 2,520,000.00 1,960,000.00 196,000.00 560,000.00 700,000.00 700,000.00 2,520,000.00 2,520,000.00 196,000.00 560,000.00 96,000.00 96,000.00 2,068,000.00 2,068,000.00 2,068,000.00 1,809,500.00 3,500,000.00 258,500.00 2,068,000.00 2,068,000.00 258,500.00 10,000.00 30,000.00 1,809,500.00 50,000.00 12,000.00 50,000.00 50,000.00 4,200,000.00 3,024,000.00 50,000.00 96,000.00 10,000.00 30,000.00 1,078,000.00 4,250,000.00 4,250,000.00 1,078,000.00 12,000.00 12,000.00 2,520,000.00 2,520,000.00 Figure 25.1: REGENT BIKE (Pty) Ltd.’s accounts (continued) <?page no="272"?> 12,000.00 12,000.00 2,520,000.00 2,520,000.00 504,000.00 700,000.00 2,520,000.00 1,960,000.00 196,000.00 560,000.00 700,000.00 700,000.00 2,520,000.00 2,520,000.00 196,000.00 560,000.00 96,000.00 96,000.00 2,068,000.00 2,068,000.00 2,068,000.00 1,809,500.00 3,500,000.00 3,500,000.00 258,500.00 2,068,000.00 2,068,000.00 258,500.00 10,000.00 10,000.00 30,000.00 30,000.00 10,000.00 10,000.00 30,000.00 30,000.00 Figure 25.2: REGENT BIKES (Pty) Ltd.’s accounts <?page no="273"?> 1,809,500.00 1,809,500.00 1,809,500.00 3,500,000.00 1,690,500.00 3,500,000.00 3,500,000.00 10,000.00 1,690,500.00 30,000.00 1,650,500.00 1,690,500.00 1,690,500.00 1,155,350.00 1,650,500.00 495,150.00 1,650,500.00 1,650,500.00 1,155,350.00 1,155,350.00 495,150.00 495,150.00 1,155,350.00 495,150.00 Figure 25.2: REGENT BIKE (Pty) Ltd.’s accounts (continued) Figure 25.3: REGENT BIKE (Pty) Ltd.’s income statement <?page no="274"?> Figure 25.4: REGENT BIKES (Pty) Ltd.’s statement of financial position Summary: Production firms apply three special Inventory accounts. There is a Raw Materials Inventory account, a Work in Process account and a Finished Goods Inventory account. Cost for the goods still in the manufacturing process are represented by the WIP account until the production process is completed. Once production is completed, the costs are added to the Finished Goods Inventory account. Finished goods are expensed, once they are sold. For expensing finished goods the Cost of Goods Sold (COS) account is debited and Finished Goods Inventory account is credited. Working Definitions: Cost of Manufacturing: The costs of manufacturing contain direct costs, such as materials and labour, and portions of overheads for resources deployed in the manufacturing process. Job Order: A job order is an internal order in a factory. WIP account: The reconciliation account for all job orders is the Work in Process WIP account - it represents the value of all products under production. Cost of Sales/ Cost of Goods Sold: The expense account for finished goods released from stock is called the Cost of Sales account. Lot Size: The lot size is the amount of goods manufactured by one job order. <?page no="275"?> Learning Objectives: In this chapter, we introduce a more sophisticated inventory system that discloses stock levels all the time. Before, we applied a periodic inventory system which only records inputs and requires stock taking at the end of the Accounting period. We now explain how inventory movements can be recorded whenever goods are added and released from stock. Applying a perpetual inventory system, real-time information about stock levels becomes available at any time. After studying this chapter, you are qualified to discuss and decide about appropriate inventory movement systems and you can apply the periodic and the perpetual system. We start by a recall of Accounting for inventories: when we calculated profit for traders, we applied the Purchase account and closed it off to the Trading account at the end of the Accounting period. We computed the material expenses as opening amount of the inventories plus all purchases less closing stock and less any returns inwards. In order to ascertain the closing stock, we had to take stock. As stock was only taken at the end of the Accounting period, our inventory system was referred to as the periodic inventory system. A periodic inventory system records inventory movements based on input postings and stock taking at the end of the Accounting period. How it is done (periodic inventory system): (1) Prepare Inventory accounts for particular kind of stock like materials, work in process and finished goods. Split up accounts for different kind of inventory, for different materials e.g. (2) The opening amount of inventory is transferred to the debit side of the Inventory account. (3) Add purchases to the debit side of the Trading account. Credit the Purchases account accordingly. (4) When you release goods (materials, finished goods) from stock, do not make Bookkeeping entries. (5) When you prepare the financial statements on the balance sheet date, take stock. Credit the closing stock to the Trading account and make a corresponding debit entry in the Inventory account. Calculate material expenses as opening value plus purchases less closing stock. Consider returns, if there are any. (6) Consider special situations that might occur, such as disposals, impairment losses, value adjustments, discounts etc. <?page no="276"?> Many companies need to know the current level of their goods/ parts on stock at real-time. E.g., a wine trading company wants to know the amount of South African Pinotage still on stock in order to decide when to re-order further bottles. If you shop in a department store, you can see that scanners are used at the cash points. The scanners make the cashiers’ lives more comfortable because he/ she does not have to key in the prices anymore. However, the main reason for the scanner application is that the barcode information contains the good identification number, which is captured in order to deduct the sold goods from stock. Hence, the scan triggers a Bookkeeping entry such as: DR Cost of Sales account - CR Inventory account. A company that records releases from stock applies a perpetual inventory system. A perpetual inventory system records inventory movements in realtime, based on inputs and outputs. No stock taking is necessary if a perpetual system applies. Most of companies nowadays run a perpetual inventory system at least for their important goods/ parts. Only less important material movements such as the stock of office materials (pencils) might still be calculated based on a periodic inventory system. How it is done (perpetual inventory system): (1) Prepare Inventory accounts for particular kind of stock, such as materials, work in process and finished goods. Split-up accounts for different kind of inventory, for different materials e.g. (2) The opening amount of inventory is disclosed on the debit side of the Inventory account. (3) Add purchases to the debit side of the Inventory account. Credit the Purchases account accordingly. (4) When you release goods (materials, finished goods) from stock, make a debit entry in the Material Expense account or in the Cost of Goods Sold (COS) account and credit the amount to the relevant Inventory account. (5) Once you want to know the level of stock of a particular item, balance-off the Inventory account. (6) When you prepare the financial statements on the balance sheet date, balance-off the accounts and add stock levels of different goods to the inventory item on the balance sheet. (7) Consider special situations that might occur, such as disposals, impairment losses, value adjustments, discounts etc. In order to explain a perpetual inventory system, we’ll study an example of the furniture dealer WITSAND (Pty) Ltd. We first discuss the periodic system and later present the same example <?page no="277"?> again but then applying the perpetual inventory system. This way, you can see the differences between the inventory movement systems clearly. Periodic Inventory System: Figure 26.1: WITSAND (Pty) Ltd.’s statement of financial position 25,000.00 2,700.00 Figure 26.2: WITSAND (Pty) Ltd.’s accounts <?page no="278"?> 22,300.00 50,000.00 Figure 26.2: WITSAND (Pty) Ltd.’s accounts (continued) DR Purchase..................... 3,000.00 EUR DR VAT.......................... 600.00 EUR CR Cash/ Bank.................... 3,600.00 EUR DR Purchase..................... 3,800.00 EUR DR VAT.......................... 760.00 EUR CR Cash/ Bank.................... 4,560.00 EUR DR Purchase..................... 5,400.00 EUR DR VAT.......................... 1,080.00 EUR CR Cash/ Bank.................... 6,480.00 EUR DR Purchase..................... 3,750.00 EUR DR VAT.......................... 750.00 EUR CR Cash/ Bank.................... 4,500.00 EUR <?page no="279"?> DR Cash/ Bank.................... 5,040.00 EUR CR VAT.......................... 840.00 EUR CR Sales........................ 4,200.00 EUR DR Cash/ Bank.................... 10,380.00 EUR CR VAT.......................... 1,730.00 EUR CR Sales........................ 8,650.00 EUR DR Purchase..................... 4,000.00 EUR DR VAT.......................... 800.00 EUR CR Cash/ Bank.................... 4,800.00 EUR DR Cash/ Bank.................... 21,420.00 EUR DR VAT.......................... 3,570.00 EUR CR Sales........................ 17,850.00 EUR <?page no="280"?> DR Rent......................... 2,000.00 EUR CR Cash/ Bank.................... 2,000.00 EUR 25,000.00 25,000.00 2,700.00 2,700.00 25,000.00 2,700.00 22,300.00 3,600.00 50,000.00 50,000.00 5,040.00 4,560.00 50,000.00 10,380.00 6,480.00 21,420.00 4,500.00 4,800.00 2,000.00 33,200.00 59,140.00 59,140.00 33,200.00 600.00 840.00 3,000.00 760.00 1,730.00 3,800.00 1,080.00 3,570.00 5,400.00 750.00 3,750.00 800.00 4,000.00 19,950.00 2,150.00 19,950.00 19,950.00 6,140.00 6,140.00 19,950.00 2,150.00 4,200.00 2,000.00 2,000.00 8,650.00 2,000.00 30,700.00 17,850.00 30,700.00 30,700.00 30,700.00 Figure 26.3: WITSAND (Pty) Ltd.’s accounts <?page no="281"?> DR T/ A .......................... 2,700.00 EUR CR Inventory.................... 2,700.00 EUR DR T/ A .......................... 19,950.00 EUR CR Purchase..................... 19,950.00 EUR DR Inventory.................... 2,600.00 EUR CR T/ A .......................... 2,600.00 EUR DR Sales........................ 30,700.00 EUR CR T/ A .......................... 30,700.00 EUR DR T/ A .......................... 10,650.00 EUR CR Profit and Loss.............. 10,650.00 EUR <?page no="282"?> DR Profit and Loss.............. 2,000.00 EUR CR Rent......................... 2,000.00 EUR DR P&L-ACCOUNT.................. 2,595.00 EUR CR Income Tax Liabilities....... 2,595.00 EUR DR P&L-ACCOUNT.................. 6,055.00 EUR CR Retained Earnings............ 6,055.00 EUR 25,000.00 25,000.00 2,700.00 2,700.00 25,000.00 2,700.00 2,700.00 2,600.00 2,600.00 5,300.00 5,300.00 2,600.00 22,300.00 3,600.00 50,000.00 50,000.00 5,040.00 4,560.00 50,000.00 10,380.00 6,480.00 21,420.00 4,500.00 4,800.00 2,000.00 33,200.00 59,140.00 59,140.00 33,200.00 Figure 26.4: WITSAND (Pty) Ltd.’s accounts <?page no="283"?> 4,200.00 2,000.00 2,000.00 8,650.00 2,000.00 2,000.00 30,700.00 17,850.00 30,700.00 30,700.00 30,700.00 30,700.00 2,700.00 30,700.00 2,000.00 10,650.00 19,950.00 2,600.00 8,650.00 10,650.00 10,650.00 10,650.00 33,300.00 33,300.00 2,595.00 8,650.00 10,650.00 10,650.00 6,055.00 8,650.00 8,650.00 2,595.00 2,595.00 6,055.00 6,055.00 2,595.00 6,055.00 Figure 26.4: WITSAND (Pty) Ltd.’s accounts (continued) 600.00 840.00 3,000.00 760.00 1,730.00 3,800.00 1,080.00 3,570.00 5,400.00 750.00 3,750.00 800.00 4,000.00 19,950.00 2,150.00 19,950.00 19,950.00 6,140.00 6,140.00 19,950.00 19,950.00 2,150.00 <?page no="284"?> Figure 26.5: WITSAND (Pty) Ltd.’s statement of financial position Figure 26.6: WITSAND (Pty) Ltd.’s income statement <?page no="285"?> Perpetual Inventory System: With a perpetual inventory system, Bookkeeping entries for material inputs are the same. In contrast to an periodic inventory system, Bookkeeping entries for goods/ parts releases from stock are made. This gives the advantage of reading stock levels from the Inventory account’s balancing figure at any time. The number of the Bookkeeping entries increase for this case study WITSAND (Pty) Ltd, once we apply the perpetual inventory system. Think about a big supermarket with a lot of sale transactions. The Bookkeeping entries made applying the perpetual inventory system will be much more than for a periodic inventory system. Every customer buying goods triggers a Bookkeeping entry for every single item bought. In a supermarket you purchase in big amounts but you sell in small ones. Hence, the application of the perpetual inventory system increases the amount of Bookkeeping entries by far more than to double it. In order to not confuse you with previous postings, the example linked to the perpetual inventory system identifies Bookkeeping entries now by letters, such as (a), (b), (c) etc. 25,000.00 600.00 0.00 0.00 2,100.00 22,300.00 Figure 26.7: WITSAND (Pty) Ltd.’s accounts <?page no="286"?> 50,000.00 Figure 27.6: WITSAND (Pty) Ltd.’s accounts (continued) When inventory movements are recorded with a perpetual inventory system, the amounts are debited/ credited to the Inventory accounts. This gives two Bookkeeping entries per movement. Observe the case study WITSAND (Pty) Ltd. again, now under considering the application of a perpetual inventory system: DR Purchase..................... 3,000.00 EUR DR VAT.......................... 600.00 EUR CR Cash/ Bank.................... 3,600.00 EUR DR Inventory - Double Bed....... 3,000.00 EUR CR Purchase..................... 3,000.00 EUR DR Purchase..................... 3,800.00 EUR DR VAT.......................... 760.00 EUR CR Cash/ Bank.................... 4,560.00 EUR DR Inventory - Queen Size....... 3,800.00 EUR CR Purchase..................... 3,800.00 EUR <?page no="287"?> DR Purchase..................... 5,400.00 EUR DR VAT.......................... 1,080.00 EUR CR Cash/ Bank.................... 6,480.00 EUR DR Inventory - Single Bed ....... 5,400.00 EUR CR Purchase..................... 5,400.00 EUR DR Purchase..................... 3,750.00 EUR DR VAT.......................... 750.00 EUR CR Cash/ Bank.................... 4,500.00 EUR DR Inventory - Cots............. 3,750.00 EUR CR Purchase..................... 3,750.00 EUR DR Cash/ Bank.................... 840.00 EUR CR VAT.......................... 140.00 EUR CR Sales........................ 700.00 EUR DR Cost of Goods Sold........... 400.00 EUR CR Inventory - Double Bed ....... 400.00 EUR <?page no="288"?> DR Cash/ Bank.................... 1,800.00 EUR CR VAT.......................... 300.00 EUR CR Sales........................ 1,500.00 EUR DR Cost of Goods Sold........... 950.00 EUR CR Inventory - Queen Size....... 950.00 EUR DR Cash/ Bank.................... 2,400.00 EUR CR VAT.......................... 400.00 EUR CR Sales........................ 2,000.00 EUR DR Cost of Goods Sold........... 1,500.00 EUR CR Inventory - Cots............. 1,500.00 EUR DR Cash/ Bank.................... 3,360.00 EUR CR VAT.......................... 560.00 EUR CR Sales........................ 2,800.00 EUR DR Cost of Goods Sold........... 1,600.00 EUR CR Inventory - Double Bed....... 1,600.00 EUR DR Cash/ Bank.................... 2,520.00 EUR CR VAT.......................... 420.00 EUR CR Sales........................ 2,100.00 EUR DR Cost of Goods Sold........... 1,330.00 EUR CR Inventory - Queen Size....... 1,330.00 EUR <?page no="289"?> DR Cash/ Bank.................... 4,500.00 EUR CR VAT.......................... 750.00 EUR CR Sales........................ 3,750.00 EUR DR Cost of Goods Sold........... 2,700.00 EUR CR Inventory - Single Bed ....... 2,700.00 EUR 25,000.00 25,000.00 600.00 400.00 25,000.00 3,000.00 1,600.00 1,600.00 3,600.00 3,600.00 1,600.00 0.00 950.00 0.00 2,700.00 3,800.00 1,330.00 5,400.00 2,700.00 1,520.00 5,400.00 5,400.00 3,800.00 3,800.00 2,700.00 1,520.00 0.00 950.00 0.00 2,700.00 3,800.00 1,330.00 5,400.00 2,700.00 1,520.00 5,400.00 5,400.00 3,800.00 3,800.00 2,700.00 1,520.00 Figure 26.8: WITSAND (Pty) Ltd.’s accounts <?page no="290"?> 2,100.00 1,500.00 22,300.00 3,600.00 3,750.00 4,350.00 840.00 4,560.00 5,850.00 5,850.00 1,800.00 6,480.00 4,350.00 2,400.00 4,500.00 3,360.00 2,520.00 4,500.00 18,580.00 37,720.00 37,720.00 18,580.00 50,000.00 50,000.00 3,000.00 3,000.00 50,000.00 3,800.00 3,800.00 5,400.00 5,400.00 3,750.00 3,750.00 15,950.00 15,950.00 600.00 140.00 700.00 760.00 300.00 1,500.00 1,080.00 400.00 2,000.00 750.00 560.00 2,800.00 420.00 2,100.00 750.00 12,850.00 3,750.00 620.00 12,850.00 12,850.00 3,190.00 3,190.00 12,850.00 620.00 400.00 950.00 1,500.00 1,600.00 1,330.00 2,700.00 8,480.00 8,480.00 8,480.00 8,480.00 Figure 26.8: WITSAND (Pty) Ltd.’s accounts (continued) <?page no="291"?> DR Purchase..................... 4,000.00 EUR DR VAT.......................... 800.00 EUR CR Cash/ Bank.................... 4,800.00 EUR DR Inventory - Double Bed ....... 4,000.00 EUR CR Purchase..................... 4,000.00 EUR DR Cash/ Bank.................... 10,080.00 EUR CR VAT.......................... 1,680.00 EUR CR Sales........................ 8,400.00 EUR DR Cost of Goods Sold........... 4,800.00 EUR CR Inventory - Queen Size ....... 4,800.00 EUR DR Cash/ Bank.................... 2,880.00 EUR CR VAT.......................... 480.00 EUR CR Sales........................ 2,400.00 EUR DR Cost of Goods Sold........... 1,520.00 EUR CR Inventory - Queen Size ....... 1,520.00 EUR <?page no="292"?> (Note, we continue Bookkeeping entry identification by capital letters, as no small letters are left.) DR Cash/ Bank.................... 1,500.00 EUR CR VAT.......................... 250.00 EUR CR Sales........................ 1,250.00 EUR DR Cost of Goods Sold........... 900.00 EUR CR Inventory - Queen Size....... 900.00 EUR DR Cash/ Bank.................... 6,960.00 EUR CR VAT.......................... 1,160.00 EUR CR Sales........................ 5,800.00 EUR DR Cost of Goods Sold........... 4,350.00 EUR CR Inventory - Cots............. 4,350.00 EUR DR Rent......................... 2,000.00 EUR CR Cash/ Bank.................... 2,000.00 EUR <?page no="293"?> 25,000.00 25,000.00 600.00 400.00 25,000.00 3,000.00 1,600.00 1,600.00 3,600.00 3,600.00 1,600.00 4,800.00 4,000.00 800.00 5,600.00 5,600.00 800.00 0.00 950.00 0.00 2,700.00 3,800.00 1,330.00 5,400.00 2,700.00 1,520.00 5,400.00 5,400.00 3,800.00 3,800.00 2,700.00 900.00 1,520.00 1,520.00 1,800.00 2,700.00 2,700.00 1,800.00 2,100.00 1,500.00 22,300.00 3,600.00 3,750.00 4,350.00 840.00 4,560.00 5,850.00 5,850.00 1,800.00 6,480.00 4,350.00 4,350.00 2,400.00 4,500.00 3,360.00 2,520.00 4,500.00 18,580.00 37,720.00 37,720.00 18,580.00 4,800.00 10,080.00 2,000.00 2,880.00 1,500.00 6,960.00 33,200.00 40,000.00 40,000.00 33,200.00 50,000.00 50,000.00 3,000.00 3,000.00 50,000.00 3,800.00 3,800.00 5,400.00 5,400.00 3,750.00 3,750.00 15,950.00 15,950.00 4,000.00 4,000.00 Figure 26.9: WITSAND (Pty) Ltd.’s accounts <?page no="294"?> 600.00 140.00 700.00 760.00 300.00 1,500.00 1,080.00 400.00 2,000.00 750.00 560.00 2,800.00 420.00 2,100.00 750.00 12,850.00 3,750.00 620.00 12,850.00 12,850.00 3,190.00 3,190.00 12,850.00 620.00 1,680.00 8,400.00 800.00 480.00 2,400.00 250.00 1,250.00 2,150.00 1,160.00 30,700.00 5,800.00 3,570.00 3,570.00 30,700.00 30,700.00 2,150.00 30,700.00 400.00 2,000.00 2,000.00 950.00 2,000.00 1,500.00 1,600.00 1,330.00 2,700.00 8,480.00 8,480.00 8,480.00 8,480.00 4,800.00 1,520.00 900.00 4,350.00 20,050.00 20,050.00 20,050.00 20,050.00 Figure 26.9: WITSAND (Pty) Ltd.’s accounts (continued) DR T/ A.......................... 20,050.00 EUR CR Cost of Goods Sold........... 20,050.00 EUR DR Sales........................ 30,700.00 EUR CR T/ A.......................... 30,700.00 EUR <?page no="295"?> DR T/ A .......................... 10,650.00 EUR CR Profit and Loss.............. 10,650.00 EUR DR Profit and Loss.............. 2,000.00 EUR CR Rent......................... 2,000.00 EUR DR P&L-ACCOUNT .................. 2,595.00 EUR CR Income Tax Liabilities....... 2,595.00 EUR DR P&L-ACCOUNT .................. 6,055.00 EUR CR Retained Earnings............ 6,055.00 EUR 25,000.00 25,000.00 600.00 400.00 25,000.00 3,000.00 1,600.00 1,600.00 3,600.00 3,600.00 1,600.00 4,800.00 4,000.00 800.00 5,600.00 5,600.00 800.00 0.00 950.00 0.00 2,700.00 3,800.00 1,330.00 5,400.00 2,700.00 1,520.00 5,400.00 5,400.00 3,800.00 3,800.00 2,700.00 900.00 1,520.00 1,520.00 1,800.00 2,700.00 2,700.00 1,800.00 Figure 26.10: WITSAND (Pty) Ltd.’s accounts <?page no="296"?> 2,100.00 1,500.00 22,300.00 3,600.00 3,750.00 4,350.00 840.00 4,560.00 5,850.00 5,850.00 1,800.00 6,480.00 4,350.00 4,350.00 2,400.00 4,500.00 3,360.00 2,520.00 4,500.00 18,580.00 37,720.00 37,720.00 18,580.00 4,800.00 10,080.00 2,000.00 2,880.00 1,500.00 6,960.00 33,200.00 40,000.00 40,000.00 33,200.00 50,000.00 50,000.00 3,000.00 3,000.00 50,000.00 3,800.00 3,800.00 5,400.00 5,400.00 3,750.00 3,750.00 15,950.00 15,950.00 4,000.00 4,000.00 600.00 140.00 700.00 760.00 300.00 1,500.00 1,080.00 400.00 2,000.00 750.00 560.00 2,800.00 420.00 2,100.00 750.00 12,850.00 3,750.00 620.00 12,850.00 12,850.00 3,190.00 3,190.00 12,850.00 620.00 1,680.00 8,400.00 800.00 480.00 2,400.00 250.00 1,250.00 2,150.00 1,160.00 30,700.00 5,800.00 3,570.00 3,570.00 30,700.00 30,700.00 2,150.00 30,700.00 30,700.00 Figure 26.10: WITSAND (Pty) Ltd.’s accounts (continued) <?page no="297"?> 400.00 2,000.00 2,000.00 950.00 2,000.00 1,500.00 1,600.00 1,330.00 2,700.00 8,480.00 8,480.00 8,480.00 8,480.00 4,800.00 1,520.00 900.00 4,350.00 20,050.00 20,050.00 20,050.00 20,050.00 20,050.00 20,050.00 30,700.00 2,000.00 10,650.00 10,650.00 8,650.00 30,700.00 30,700.00 10,650.00 10,650.00 10,650.00 10,650.00 2,595.00 8,650.00 6,055.00 8,650.00 8,650.00 2,595.00 2,595.00 6,055.00 6,055.00 2,595.00 6,055.00 Figure 26.10: WITSAND (Pty) Ltd.’s accounts (continued) <?page no="298"?> Figure 26.11: WITSAND (Pty) Ltd.’s statement of financial position Figure 26.12: WITSAND (Pty) Ltd.’s income statement Summary: Applying different inventory system does not change financial statements. When applying a perpetual inventory system, the company does not count stock. The perpetual inventory system <?page no="299"?> provides information about stock levels at any time. This real-time information is helpful for Logistics. A periodic inventory system often applies for minor important goods/ parts. Accounting classes start in general with the periodic inventory system, because it is easier in terms of making Bookkeeping entries (there are fewer). However, many students find the perpetual inventory system more meaningful, because it shows the closing stock as balancing figure in the inventory accounts before adjustments begin. Working Definitions: Periodic Inventory System: A periodic inventory system records inventory movements based on input postings and stock taking at the end of the Accounting period. Perpetual Inventory System: A perpetual inventory system records inventory movements in real-time, based on inputs and outputs. <?page no="300"?> Learning Objectives: So long, we assumed goods of inventory are released from stock by the same sequence they were added. In this chapter, we introduce different cost formulas by the case study MALGAS (Pty) Ltd. Cost formulas apply, if a company stores similar goods. In particular if goods cannot be identified as they all look the same. The reason can be, that there are too many goods of the same kind, such as screws or some minor office material (paper clips) or that the recorded goods are liquids/ gases. The cost formulas differ with regard to the assumption about the sequence the goods are consumed. We’ll show that the application of different cost formulas leads to different inventory valuations and has an impact on the profit calculation. After studying this chapter, you can apply most common cost formulas and you can discuss their effect on inventory valuation and profit calculation. In general, every asset must be valued individually. However, in case an individual valuation is not feasible or does not make sense from the economic point of view, companies are allowed to value indistinct or similar assets together. As long as goods are added to stock at the same costs, the order of consumption does not matter at all. But if items are bought at different prices, the companies have to assume a particular sequence for stock releases. Think about a box of screws in a workshop department. The screws might have been bought at different purchase prices but they are all the same. Whenever new packages of screws are bought, they are put into the same box. After a while, the screws in the box are mixed and it is no longer possible to determine at which price a particular screw has been purchased. A similar situation applies for tanks fluids are filled in. You do not know which litre of petrol at which price is consumed by your car when you filled up the tank at different prices. We assume you never empty your petrol tank completely. A cost formula is an assumption about the sequence goods are released from stock. The most common cost formulas are weighted average, first-in-firstout and last-in-first-out. A company that applies the first-in-first-out cost formula assumes that the items of inventory are used in the same sequence as they have been added. First-in-firstout FIFO is allowed along IFRSs and Handelsgesetzbuch. Last-in-first-out LIFO applies, if goods are piled up and the goods released from stock will be taken from the top of the stack. Lastin-first-out only applies in cases the real order of consumption follows this sequence. Imagine a company that deals with steal mats which are very heavy. It is completely unlikely, that the steal mats lying at the bottom of the pile are used before all other ones on top have been taken. Weighted average method means, the average costs of the assets on stock are calculated once they are consumed. This applies in particular for liquids and gases. In general, changing cost formulas is not allowed in Accounting. It infringes <?page no="301"?> the principle of consistency which is required for preparing financial statements. If cost formulas are changed, it has to happen for a good reason and it applies for all assets of the similar kind together. Be aware, the change of cost formulas might trigger calculations along IAS 8. This standards states that changes in Accounting policies must apply for the comparative data on financial statements, too. In this text book, we consider a change of cost formulas probably does not happen. We’ll explain the application of different cost formulas by the example MALGAS (Pty) Ltd., which is a fashion store (trading business). As the cost formulas determine profit, we explain the application of the formulas by an example which includes the profit calculation in a Profit and Loss account. We cover the same case study applying the 3 different cost formulas to mark the differences. Figure 27.1: MALGAS (Pty) Ltd.’s statement of financial position <?page no="302"?> DR Purchase..................... 35,500.00 EUR DR VAT.......................... 7,100.00 EUR CR Cash/ Bank.................... 42,600.00 EUR DR Inventory.................... 35,500.00 EUR CR Purchase..................... 35,500.00 EUR DR Cash/ Bank.................... 33,264.00 EUR CR VAT.......................... 5,544.00 EUR CR Sales........................ 27,720.00 EUR DR Purchase..................... 36,000.00 EUR DR VAT.......................... 7,200.00 EUR CR Cash/ Bank.................... 43,200.00 EUR DR Inventory.................... 36,000.00 EUR CR Purchase..................... 36,000.00 EUR <?page no="303"?> DR Cash/ Bank.................... 62,964.00 EUR CR VAT.......................... 10,494.00 EUR CR Sales........................ 52,470.00 EUR Weighted Average (A): The weighted average cost formula values inventory movements at their average cost of purchase. The average is called weighted, as the prices count based on their amounts. How it is done (weighted average cost formula): (1) Determine the average amount of opening stock. (2) When goods are added to stock, calculate the average unit costs by unit cost of opening stock multiplied by opening amount plus stock input as input amount times unit costs of input and divide the total thereof by the total amount of stock. (3) When stock is released, determine the stock reduction by output amount times weighted average unit costs as described above. (4) Continue the procedure based on inputs and releases of stock. DR Cost of Goods Sold........... 19,833.33 EUR CR Inventory.................... 19,833.33 EUR <?page no="304"?> DR Cost of Goods Sold........... 37,918.63 EUR CR Inventory.................... 37,918.63 EUR 100,000.00 100,000.00 7,000.00 19,833.33 100,000.00 35,500.00 37,918.63 36,000.00 20,748.04 78,500.00 78,500.00 20,748.04 43,000.00 42,600.00 100,000.00 100,000.00 33,264.00 43,200.00 100,000.00 62,964.00 53,428.00 139,228.00 139,228.00 53,428.00 50,000.00 50,000.00 35,500.00 35,500.00 50,000.00 36,000.00 36,000.00 71,500.00 71,500.00 7,100.00 5,544.00 27,720.00 7,200.00 10,494.00 80,190.00 52,470.00 1,738.00 80,190.00 80,190.00 16,038.00 16,038.00 80,190.00 80,190.00 1,738.00 Figure 27.2: MALGAS (Pty) Ltd. accounts (A) <?page no="305"?> 19,833.00 57,751.63 80,190.00 37,918.63 57,751.63 22,438.37 57,751.63 57,751.63 80,190.00 80,190.00 57,751.63 6,731.51 22,438.37 15,706.86 22,438.37 22,438.37 6,731.51 6,731.51 15,706.86 15,706.86 6,731.51 15,706.86 Figure 27.2: MALGAS (Pty) Ltd. accounts (A) (continued) Figure 27.3: MALGAS (Pty) Ltd.’s income statement (A) <?page no="306"?> Figure 27.4: MALGAS (Pty) Ltd.’s statement of financial position (A) First-In-First-Out (B): The first-in-first-out cost formula is based on the assumption that items are released from stock by the same sequence they were added to stock before. How it is done (first-in-first-out): (1) Determine the opening amount on stock with regard to all inputs. (2) When material is added to stock, make a Bookkeeping entry and keep in mind the amount of materials and the unit cost of purchase. (3) When materials are released from stock, make inventory postings with regard to the unit costs that way that the opening input has been released at first, followed by the first purchase, the next one etc. Consider the last input coming last. (4) Continue. . . <?page no="307"?> DR Cost of Goods Sold........... 19,780.00 EUR CR Inventory.................... 19,780.00 EUR DR Cost of Goods Sold........... 37,840.00 EUR CR Inventory.................... 37,840.00 EUR 100,000.00 100,000.00 7,000.00 19,780.00 100,000.00 35,500.00 37,840.00 36,000.00 20,880.00 78,500.00 78,500.00 20,880.00 43,000.00 42,600.00 100,000.00 100,000.00 33,264.00 43,200.00 100,000.00 62,964.00 53,428.00 139,228.00 139,228.00 53,428.00 50,000.00 50,000.00 35,500.00 35,500.00 50,000.00 36,000.00 36,000.00 71,500.00 71,500.00 Figure 27.5: MALGAS (Pty) Ltd.’s accounts (B) <?page no="308"?> 7,100.00 5,544.00 27,720.00 7,200.00 10,494.00 80,190.00 52,470.00 1,738.00 80,190.00 80,190.00 16,038.00 16,038.00 80,190.00 80,190.00 1,738.00 19,780.00 57,620.00 80,190.00 37,840.00 57,620.00 22,570.00 57,620.00 57,620.00 80,190.00 80,190.00 57,620.00 6,771.00 22,570.00 15,799.00 22,570.00 22,570.00 6,771.00 6,771.00 15,799.00 15,799.00 6,771.00 15,799.00 Figure 27.5: MALGAS (Pty) Ltd.’s accounts (B) (continued) Figure 27.6: MALGAS (Pty) Ltd.’s income statement (B) <?page no="309"?> Figure 27.7: MALGAS (Pty) Ltd.’s statement of financial position (B) Last-In-First-Out (C): The last-in-first-out formula normally does not apply. It only can be used exceptionally. Here, the sequence the dresses are released from stock, does not request a last-in-first-out formula. However, we show the effect of its application with regard to inventory valuation and profit calculation. The last-in-first-out cost formula records inventory valuations based on the reverse sequence of how they were added to stock before. How it is done (last-in-first-out): (1) Determine the opening amount on stock with regard to all inputs. (2) When material is added to stock, make a Bookkeeping entry and keep in mind the amount of materials and the unit cost of purchase. (3) When materials are released from stock, make inventory postings with regard to the unit costs like the last input has been released at first, then the second last one etc. (4) Continue. . . <?page no="310"?> DR Cost of Goods Sold........... 19,880.00 EUR CR Inventory.................... 19,880.00 EUR DR Cost of Goods Sold........... 19,880.00 EUR CR Inventory.................... 19,880.00 EUR 100,000.00 100,000.00 7,000.00 19,880.00 100,000.00 35,500.00 38,130.00 36,000.00 20,490.00 78,500.00 78,500.00 20,490.00 43,000.00 42,600.00 100,000.00 100,000.00 33,264.00 43,200.00 100,000.00 62,964.00 53,428.00 139,228.00 139,228.00 53,428.00 Figure 27.8: MALGAS (Pty) Ltd.’s accounts (C) <?page no="311"?> 50,000.00 50,000.00 35,500.00 35,500.00 50,000.00 36,000.00 36,000.00 71,500.00 71,500.00 7,100.00 5,544.00 27,720.00 7,200.00 10,494.00 80,190.00 52,470.00 1,738.00 80,190.00 80,190.00 16,038.00 16,038.00 80,190.00 80,190.00 1,738.00 19,880.00 58,010.00 80,190.00 38,130.00 58,010.00 22,180.00 58,010.00 58,010.00 80,190.00 80,190.00 58,010.00 6,654.00 22,180.00 15,526.00 22,180.00 22,180.00 6,654.00 6,654.00 15,526.00 15,526.00 6,654.00 15,526.00 Figure 36.8: MALGAS (Pty) Ltd.’s accounts (C) (continued) <?page no="312"?> Figure 27.9: MALGAS (Pty) Ltd.’s income statement (C) Figure 27.10: MALGAS (Pty) Ltd.’s statement of financial position (C) <?page no="313"?> The cost formula does not depend on the inventory movement system applied. If a company applies a periodic inventory system, the Accountant has to determine the value of the closing stock, as we did above for the balance sheet. Summary: When items of inventory are similar or equal to each other and the effort for tracking the purchase prices is unacceptably high, cost formulas apply for the calculation of inventory movements. The most popular formulas are weighted average method, first-infirst-out and exceptionally applicable: last-in-first-out formula. The different cost formulas lead to different inventory valuations and profit calculation. Working Definitions: Weighted Average Cost Formula: The weighted average cost formula values inventory movements at their average cost of purchase. The average is called weighted, as the prices for the goods count based on their amounts. First-in-First-out Cost Formula: The first-in-first-out cost formula is based on the assumption that items are released from stock by the same sequence they were added to stock before. Last-in-First-out Cost Formula: The last-in-first-out cost formula records inventory valuations based on the reverse sequence of how they were put on stock before. <?page no="314"?> Learning Objectives: In this chapter, we’ll widen your knowledge in profit and loss calculation: we introduce another format for the statement of profit and loss and other comprehensive income. It shows the cost of sales of the products/ services a company produces/ renders and is a helpful reporting instrument for making product/ service mix decisions. We applied the cost of sales format for the income statement in the REGENT BIKE (Pty) Ltd. case study in chapter 25 already but explain the format now in detail. In order to show the differences to the alternative nature of expense format, we discuss one case study and prepare the income statement along both formats. After this chapter, you can prepare the statement of profit and loss and other comprehensive income knowing how to apply the “Nature of Expense (NoE)” and “Cost of Sales (COS)” format. You can discuss the impact of the formats on the profitability analysis in Management Accounting, too. You can distinguish the formats and can discuss advantages and disadvantages thereof. In general, a statement of profit and loss and other comprehensive income compares the revenue with expenses. Companies use the statement of profit and loss and other comprehensive income for reporting about their profitability and to support management decisions, such as a decision about which products and which amounts thereof should be made. Such a decision is called a product-mix decision. The comparison of revenue and expenses shows, how the business earns profit. The difference of revenue and expenses can be distorted by adding finished goods to stock because the goods’ costs of manufacturing contain overheads that are added to inventories and only are released once the products are sold. There are two ways to prepare an income statement (short for statement of profit and loss and other comprehensive income): - NoE: the nature of expense method and - COS: the cost of sales format. Both formats will give you the same net profit and annual surplus. The income statement along the nature of expense format calculates profit starting with the revenue and deducting all costs for the period; it adjusts the revenue for costs of manufacturing for stock increases of finished goods and/ or inventory deductions, both together referred to as changes in inventory. The income statement along the nature of expense format shows all cost categories relevant for profit and loss and helps you to understand and predict how profit changes as a result of variations of costs categories, e.g. what will happen, if labour increases by 3 %. In contrast, the income statement along the cost of sales format starts with the revenue and deducts costs for the goods/ services sold and further down other non-manufacturing expenses. The income statement <?page no="315"?> along the cost of sales format shows you by which products/ services the company earns profit and which products/ services contribute to losses. It is a powerful report to support product/ service mix decisions and can be prepared as a profitability analysis including multiple contribution margin Accounting. Read chapter (20): Multi- Level Contribution Margin Accounting in the second part of this text book. In most cases, the profit calculation requires a product calculation. It becomes relevant once a company produces a different amount of goods/ services than it sells during the Accounting period. In this - most likely - situation, changes in the finished goods’ inventories must be recorded (based on the calculation). As the statement of profit and loss and other comprehensive income compares revenues to expenses, they must be based on the same amounts of goods/ services. In case the company increases or decreases inventories of finished goods and/ or work in process, the comparison between revenue and expenses requires either revenue adjustments or changes in expenses. Otherwise, the profit information is distorted. As mentioned above, the nature of expense method adjusts revenues by changes in inventory of finished goods, whereas the cost of sales format adjusts expenses in order to only consider expenses for the goods sold. The advantage of the statement of profit and loss and other comprehensive income along the cost of sales format is the option to provide particular columns for certain products, certain customer groups, certain regions and/ or certain market segments. An income statement along the cost of sales format can be separated with regard to cost objects in order to provide detailed information about partial profits. It tells the company by which products/ customers/ market segments it earns its profit. We are going to demonstrate this option by the case study ASHTON Ltd. in this chapter. The company is a wine farm and discloses profit assigned to different red wines (Merlot and Pinotage). You can study by which wine ASHTON Ltd. earns more profit. Actually, the contribution margin tells you how much revenue is left to cover fixed costs after proportional costs are deducted: A contribution margin is a product’s revenue less its proportional costs. The contribution margin got its name from the idea that the contribution margins of all products together has to cover all fixed costs of the company in order to earn profit. In other words: the contribution margin is the product’s portion by which its revenue exceeds costs. This difference is seen as its contribution to cover fixed costs. We now explain the difference between the formats for the statement of profit and loss and other comprehensive income with regard to the profit calculation. The case study is about a wine farm ASHTON Ltd. that produces more wines than it sells in the Accounting period 20X4. As a result, ASHTON Ltd. will store wines. We first prepare the statement of profit and loss and other comprehensive income along the nature of expense method as we are already used to do. <?page no="316"?> In the next step further down, we prepare the same statements along the cost of sales format. For efficiency reasons, we start-off making Bookkeeping entries that are identical for both methods. Only at a late step, we split the text and (1) make Bookkeeping entries for the nature of expense method NoE and (2) for the cost of sales format COS separately. DR Cash/ Bank.................... 1,000,000.00 EUR CR Issued Capital............... 1,000,000.00 EUR DR Cash/ Bank.................... 500,000.00 EUR CR Interest Bearing Liabilities. 500,000.00 EUR DR Interest..................... 25,000.00 EUR CR Cash/ Bank.................... 25,000.00 EUR DR Interest Bearing Liabilities. 50,000.00 EUR CR Cash/ Bank.................... 50,000.00 EUR DR Interest Bearing Liabilities. 50,000.00 EUR CR Account Payables............. 50,000.00 EUR <?page no="317"?> DR P, P, E - Land............... 800,000.00 EUR CR Cash/ Bank.................... 800,000.00 EUR DR P, P, E - Pinotage........... 700,000.00 EUR DR VAT.......................... 140,000.00 EUR CR Cash/ Bank.................... 840,000.00 EUR DR P, P, E - Merlot............. 500,000.00 EUR DR VAT ......................... 100,000.00 EUR CR Cash/ Bank.................... 600,000.00 EUR DR Depreciation ................. 70,000.00 EUR CR Acc. Depr. - Pinotage........ 70,000.00 EUR DR Depreciation ................. 50,000.00 EUR CR Acc. Depr. - Merlot.......... 50,000.00 EUR <?page no="318"?> DR P, P, E - Barrels............ 400,000.00 EUR DR VAT.......................... 80,000.00 EUR CR Cash/ Bank.................... 480,000.00 EUR DR Depreciation................. 20,000.00 EUR CR Acc. Depr. - Barrels......... 20,000.00 EUR DR Labour....................... 250,000.00 EUR CR Cash/ Bank.................... 250,000.00 EUR DR Labour....................... 150,000.00 EUR CR Cash/ Bank.................... 150,000.00 EUR DR Purchase..................... 150,000.00 EUR DR VAT.......................... 30,000.00 EUR CR Cash/ Bank.................... 180,000.00 EUR <?page no="319"?> DR Cash/ Bank.................... 1,324,800.00 EUR CR VAT.......................... 220,800.00 EUR CR Sales........................ 1,104,000.00 EUR DR Cash/ Bank.................... 1,101,600.00 EUR CR VAT.......................... 183,600.00 EUR CR Sales........................ 918,000.00 EUR 1,000,000.00 25,000.00 1,000,000.00 500,000.00 50,000.00 1,324,800.00 800,000.00 1,101,600.00 840,000.00 600,000.00 480,000.00 250,000.00 50,000.00 150,000.00 180,000.00 50,000.00 500,000.00 25,000.00 50,000.00 800,000.00 140,000.00 220,800.00 100,000.00 183,600.00 80,000.00 30,000.00 Figure 28.1: ASHTON Ltd.’s accounts <?page no="320"?> 700,000.00 70,000.00 500,000.00 50,000.00 70,000.00 400,000.00 50,000.00 20,000.00 250,000.00 20,000.00 150,000.00 1,104,000.00 150,000.00 918,000.00 Figure 28.1: ASHTON Ltd.’s accounts (continued) We next prepare the statement of comprehensive income along two alternative methods. At first, we make entries and set up the statement along the nature of expense method NoE. Thereafter, we start over (from here) and prepare the entries and the statement along the cost of sales format COS. Nature of Expense Method (NoE): In order to determine the profit for ASHTON Ltd., we apply the Trading account and the Profit and Loss account. Along the nature of expense method, all nominal accounts are closed-off to either the Trading account or to the Profit and Loss account. The Purchase account, the Sales account and the Returns account are closed-off to the Trading account. This includes the closing stock of the Inventory account. All further non-manufacturing expense accounts are closed-off to the Profit-and-Loss account. How it is done (profit and loss along nature of expense format): (1) Make Bookkeeping entries for revenue and expenses. (2) Close-off all Revenue and Expense accounts to the Trading account and/ or the Profit and Loss account. <?page no="321"?> (3) If there is an increase or decrease of stock with regard to finished goods, calculate the products at first. (4) Calculate profit by adding increases of stock of finished goods to revenues and deduct decreases of stock of finished goods and all further expenses. In order to determine material expenses, apply the Trading account. DR Profit and Loss.............. 25,000.00 EUR CR Interest..................... 25,000.00 EUR DR Profit and Loss.............. 140,000.00 EUR CR Depreciation ................. 140,000.00 EUR DR Profit and Loss.............. 400,000.00 EUR CR Labour....................... 400,000.00 EUR DR Sales........................ 2,022,000.00 EUR CR Trading Account.............. 2,022,000.00 EUR DR Trading Account.............. 150,000.00 EUR CR Purchase..................... 150,000.00 EUR <?page no="322"?> DR Inventory.................... 99,400.00 EUR CR Trading Account.............. 99,400.00 EUR DR Inventory.................... 26,800.00 EUR CR Trading Account.............. 26,800.00 EUR DR Trading Account.............. 1,998,200.00 EUR CR Profit and Loss.............. 1,998,200.00 EUR <?page no="323"?> 1,000,000.00 25,000.00 1,000,000.00 1,000,000.00 500,000.00 50,000.00 1,000,000.00 1,324,800.00 800,000.00 1,101,600.00 840,000.00 600,000.00 480,000.00 250,000.00 150,000.00 50,000.00 50,000.00 180,000.00 50,000.00 551,400.00 3,926,400.00 3,926,400.00 551,400.00 50,000.00 500,000.00 25,000.00 25,000.00 50,000.00 25,000.00 25,000.00 400,000.00 500,000.00 500,000.00 400,000.00 800,000.00 800,000.00 140,000.00 220,800.00 800,000.00 100,000.00 183,600.00 80,000.00 30,000.00 54,400.00 404,400.00 404,400.00 54,400.00 700,000.00 700,000.00 70,000.00 70,000.00 700,000.00 70,000.00 500,000.00 500,000.00 50,000.00 50,000.00 500,000.00 50,000.00 Figure 28.2: ASHTON Ltd.’s accounts <?page no="324"?> 70,000.00 400,000.00 400,000.00 50,000.00 400,000.00 20,000.00 140,000.00 140,000.00 140,000.00 140,000.00 140,000.00 250,000.00 20,000.00 20,000.00 150,000.00 400,000.00 20,000.00 400,000.00 400,000.00 400,000.00 400,000.00 1,104,000.00 150,000.00 150,000.00 2,022,000.00 918,000.00 150,000.00 150,000.00 2,022,000.00 2,022,000.00 2,022,000.00 2,022,000.00 150,000.00 2,022,000.00 25,000.00 1,998,200.00 99,400.00 140,000.00 1,998,200.00 26,800.00 400,000.00 2,148,200.00 2,148,200.00 1,433,200.00 1,998,200.00 1,998,200.00 1,998,200.00 1,998,200.00 429,960.00 1,433,200.00 1,003,240.00 1,433,200.00 1,433,200.00 99,400.00 429,960.00 429,960.00 26,800.00 126,200.00 429,960.00 126,200.00 126,200.00 126,200.00 1,003,240.00 1,003,240.00 1,003,240.00 Figure 28.2: ASHTON Ltd.’s accounts (continued) <?page no="325"?> Figure 28.3: ASHTON Ltd.’s income statement (NoE) <?page no="326"?> Figure 28.4: ASHTON Ltd.’s statement of financial position Cost of Sales Format (COS): How it is done (profit calculation along the cost of sales method): (1) Make all Bookkeeping entries for revenue and expenses. (2) Run a Manufacturing Accounting by applying Work in Process accounts for direct costs of products and Manufacturing Overhead accounts for indirect costs. Consider only manufacturing expenses. Apply overheads. This includes the transfer of underor over-applied overheads into the Cost of Goods Sold (COS) account. If particular information is required for different products, dedicate a particular Work in Process account to your product of interest. <?page no="327"?> (3) Once production is finished, close-off the relevant Work in Process account to the Inventory of Finished Goods account. You may apply cost formulas for inventory movements if goods are interchangeable or intermingle, such as liquids or gases. (4) Once products are sold, transfer the expenses into the Cost of Goods Sold (COS) account and credit the amount to the Inventory of Finished Goods account. (5) Calculate profit by deducting cost of goods sold from revenue. Reduce the amount(s) by non-manufacturing expenses later. DR Inventory - Bottles.......... 150,000.00 EUR CR Purchase..................... 150,000.00 EUR DR WIP - Pinotage............... 75,000.00 EUR CR Inventory - Bottles.......... 75,000.00 EUR DR WIP - Merlot................. 75,000.00 EUR CR Inventory - Bottles.......... 75,000.00 EUR DR WIP - Pinotage............... 70,000.00 EUR CR Depreciation ................. 70,000.00 EUR DR WIP - Merlot................. 50,000.00 EUR CR Depreciation ................. 50,000.00 EUR DR Manufacturing Overheads...... 420,000.00 EUR CR Depreciation ................. 20,000.00 EUR CR Labour....................... 400,000.00 EUR <?page no="328"?> DR WIP - Pinotage............... 210,000.00 EUR CR Manufacturing Overheads...... 210,000.00 EUR DR WIP - Merlot................. 210,000.00 EUR CR Manufacturing Overheads...... 210,000.00 EUR In contrast to this basic case study, the application of overheads in most real companies is based on a predetermined overhead allocation basis. We cover overhead applications in Basics of Accounting (part II) in chapter (18): Job Order Costing. DR FG Inventory - Pinotage...... 355,000.00 EUR CR WIP - Pinotage............... 355,000.00 EUR DR FG Inventory - Merlot........ 335,000.00 EUR CR WIP - Merlot................. 335,000.00 EUR DR Cost of Goods Sold........... 255,600.00 EUR CR FG Inventory - Pinotage...... 255,600.00 EUR DR Cost of Goods Sold........... 308,200.00 EUR CR FG Inventory - Merlot........ 308,200.00 EUR <?page no="329"?> DR Sales........................ 2,022,000.00 EUR CR Profit and Loss.............. 2,022,000.00 EUR DR Profit and Loss.............. 563,800.00 EUR CR Cost of Goods Sold........... 563,800.00 EUR DR Profit and Loss.............. 25,000.00 EUR CR Interest..................... 25,000.00 EUR 1,000,000.00 25,000.00 1,000,000.00 1,000,000.00 500,000.00 50,000.00 1,000,000.00 1,324,800.00 960,000.00 1,101,600.00 840,000.00 600,000.00 480,000.00 250,000.00 50,000.00 50,000.00 150,000.00 50,000.00 180,000.00 391,400.00 3,926,400.00 3,926,400.00 391,400.00 50,000.00 500,000.00 25,000.00 25,000.00 50,000.00 25,000.00 25,000.00 400,000.00 500,000.00 500,000.00 400,000.00 Figure 28.5: ASHTON Ltd.’s accounts <?page no="330"?> 800,000.00 800,000.00 160,000.00 220,800.00 800,000.00 140,000.00 183,600.00 100,000.00 80,000.00 30,000.00 105,600.00 510,000.00 510,000.00 105,600.00 700,000.00 700,000.00 70,000.00 70,000.00 700,000.00 70,000.00 500,000.00 500,000.00 50,000.00 50,000.00 500,000.00 50,000.00 70,000.00 400,000.00 400,000.00 50,000.00 400,000.00 20,000.00 140,000.00 140,000.00 140,000.00 140,000.00 70,000.00 50,000.00 20,000.00 140,000.00 140,000.00 20,000.00 20,000.00 250,000.00 20,000.00 20,000.00 150,000.00 400,000.00 20,000.00 400,000.00 400,000.00 400,000.00 400,000.00 Figure 28.5: ASHTON Ltd.’s accounts (continued) <?page no="331"?> 1,104,000.00 150,000.00 150,000.00 2,022,000.00 918,000.00 150,000.00 150,000.00 2,022,000.00 2,022,000.00 2,022,000.00 2,022,000.00 75,000.00 75,000.00 70,000.00 50,000.00 210,000.00 355,000.00 210,000.00 335,000.00 355,000.00 355,000.00 335,000.00 335,000.00 355,000.00 355,000.00 335,000.00 335,000.00 150,000.00 75,000.00 20,000.00 75,000.00 400,000.00 420,000.00 150,000.00 150,000.00 420,000.00 420,000.00 420,000.00 210,000.00 210,000.00 420,000.00 420,000.00 355,000.00 255,600.00 335,000.00 308,200.00 99,400.00 26,800.00 355,000.00 355,000.00 335,000.00 335,000.00 99,400.00 26,800.00 308,200.00 563,800.00 2,022,000.00 255,600.00 563,800.00 25,000.00 563,800.00 563,800.00 1,433,200.00 563,800.00 563,800.00 2,022,000.00 2,022,000.00 429,960.00 1,433,200.00 1,003,240.00 1,433,200.00 1,433,200.00 429,960.00 429,960.00 1,003,240.00 1,003,240.00 429,960.00 1,003,240.00 Figure 28.5: ASHTON Ltd.’s accounts (continued) <?page no="332"?> Figure 28.6: ASHTON Ltd.’s income statement (COS) <?page no="333"?> Figure 28.7: ASHTON Ltd.’s income statement based on Contribution Margin Accounting) In the last three chapters, we covered inventory movements, cost formulas and income statements based on different formats. The next case study MONTAGU (Pty) Ltd. summarises these aspects. In particular, we show how inventory valuations are made outside of the Bookkeeping records. <?page no="334"?> DR Cash/ Bank.................... 10,000.00 EUR CR Share Capital................ 10,000.00 EUR DR Rent......................... 12,000.00 EUR CR Cash/ Bank.................... 12,000.00 EUR DR Labour....................... 36,000.00 EUR CR Cash/ Bank.................... 36,000.00 EUR <?page no="335"?> Figure 28.8: MONTAGU (Pty) Ltd.’s inventory movements for punchers Figure 28.9: MONTAGU (Pty) Ltd.’s inventory movements for staplers <?page no="336"?> Figure 28.10: MONTAGU (Pty) Ltd.’s inventory movements for punchers (Note, the amount is rounded off. Although, in the MS-Excel table disclosed in Figure 28.10 amounts are displayed as rounded, they stay accurate in the system.) <?page no="337"?> (Note, we do not show the fastest approach here, as for a periodic inventory system we only need to know the closing stock of punchers and the value thereof. However, we demonstrate here the calculation as it is made by Accounting.) DR Purchase..................... 2,300.00 EUR DR VAT.......................... 460.00 EUR CR Cash/ Bank.................... 2,760.00 EUR DR Inventory Punchers........... 2,300.00 EUR CR Purchase..................... 2,300.00 EUR <?page no="338"?> DR Cash/ Bank.................... 5,100.00 EUR CR VAT.......................... 850.00 EUR CR Revenue...................... 4,250.00 EUR DR Cost of Sales (COS).......... 1,955.00 EUR CR Inventory Punchers........... 1,955.00 EUR DR Purchase .................... 2,640.00 EUR DR VAT.......................... 528.00 EUR CR Cash/ Bank.................... 3,168.00 EUR DR Inventory Punchers........... 2,640.00 EUR CR Purchase..................... 2,640.00 EUR DR Cash/ Bank.................... 3,600.00 EUR CR VAT.......................... 600.00 EUR CR Revenue...................... 3,000.00 EUR DR Cost of Sales (COS).......... 1,326.67 EUR CR Inventory Punchers........... 1,326.67 EUR <?page no="339"?> DR Purchase .................... 1,250.00 EUR DR VAT.......................... 250.00 EUR CR Cash/ Bank.................... 1,500.00 EUR DR Inventory Punchers........... 1,250.00 EUR CR Purchase..................... 1,250.00 EUR DR Cash/ Bank.................... 4,500.00 EUR CR VAT.......................... 750.00 EUR CR Revenue...................... 3,750.00 EUR DR Cost of Sales (COS).......... 1,745.00 EUR CR Inventory Punchers........... 1,745.00 EUR DR Revenue...................... 50.00 EUR DR VAT.......................... 10.00 EUR CR Cash/ Bank.................... 60.00 EUR <?page no="340"?> DR Inventory Punchers........... 23.27 EUR CR Cost of Sales (COS).......... 23.27 EUR DR Purchase .................... 2,142.00 EUR DR VAT.......................... 428.40 EUR CR Cash/ Bank.................... 2,570.40 EUR DR Inventory Punchers........... 2,142.00 EUR CR Purchase..................... 2,142.00 EUR DR Cash/ Bank.................... 6,000.00 EUR CR VAT.......................... 1,000.00 EUR CR Revenue...................... 5,000.00 EUR DR Cost of Sales (COS).......... 2,360.71 EUR CR Inventory Punchers........... 2,360.71 EUR <?page no="341"?> Figure 28.11: MONTAGU (Pty) Ltd.’s inventory movement for staplers <?page no="342"?> DR Purchase..................... 28,560.00 EUR DR VAT.......................... 5,712.00 EUR CR Cash/ Bank.................... 34,272.00 EUR DR Inventory Staplers........... 28,560.00 EUR CR Purchase..................... 28,560.00 EUR <?page no="343"?> DR Cash/ Bank.................... 48,144.00 EUR CR VAT.......................... 8,024.00 EUR CR Revenue...................... 40,120.00 EUR DR Cost of Sales (COS).......... 20,461.20 EUR CR Inventory Staplers........... 20,461.20 EUR DR Purchase..................... 33,000.00 EUR DR VAT.......................... 6,600.00 EUR CR Cash/ Bank.................... 39,600.00 EUR DR Inventory Staplers........... 33,000.00 EUR CR Purchase..................... 33,000.00 EUR DR Cash/ Bank.................... 84,600.00 EUR CR VAT.......................... 14.100.00 EUR CR Revenue...................... 70,500.00 EUR DR Cost of Sales (COS).......... 38,184.84 EUR CR Inventory Staplers........... 38,184.84 EUR <?page no="344"?> DR Purchase..................... 49,000.00 EUR DR VAT.......................... 9,800.00 EUR CR Cash/ Bank.................... 58,800.00 EUR DR Inventory Staplers........... 49,000.00 EUR CR Purchase..................... 49,000.00 EUR DR Cash/ Bank.................... 105,000.00 EUR CR VAT.......................... 17,500.00 EUR CR Revenue...................... 87,500.00 EUR DR Cost of Sales (COS).......... 43,105.63 EUR CR Inventory Staplers........... 43.105.63 EUR DR Purchase..................... 64,500.00 EUR DR VAT.......................... 12,900.00 EUR CR Cash/ Bank.................... 77,400.00 EUR DR Inventory Staplers........... 64,500.00 EUR CR Purchase..................... 64,500.00 EUR <?page no="345"?> DR Cash/ Bank.................... 5,985.60 EUR CR Discount..................... 5,985.60 EUR DR Discount..................... 5,985.60 EUR CR VAT.......................... 997.60 EUR CR Inventory Staplers........... 4,988.00 EUR DR Cash/ Bank.................... 191,856.00 EUR CR VAT.......................... 31,976.00 EUR CR Revenue...................... 159,880.00 EUR DR Cost of Sales (COS).......... 65,064.65 EUR CR Inventory Staplers........... 65,064.65 EUR <?page no="346"?> 10,000.00 12,000.00 10,000.00 10,000.00 5,100.00 36,000.00 10,000.00 3,600.00 2,760.00 4,500.00 3,168.00 6,000.00 1,500.00 48,144.00 60.00 84,600.00 2,570.40 105,000.00 34,272.00 5,985.60 39,600.00 191,856.00 58,800.00 77,400.00 196,655.20 464,785.60 464,785.60 196,655.20 12,000.00 12,000.00 36,000.00 36,000.00 2,300.00 2,300.00 460.00 850.00 2,640.00 2,640.00 528.00 600.00 1,250.00 1,250.00 250.00 750.00 2,142.00 2,142.00 10.00 1,000.00 28,560.00 28,560.00 428.40 8,024.00 33,000.00 33,000.00 5,712.00 14,100.00 49,000.00 49,000.00 6,600.00 17,500.00 64,500.00 64,500.00 9,800.00 997.60 183,392.00 183,392.00 12,900.00 31,976.00 39,109.20 75,797.60 75,797.60 39,109.20 2,300.00 1,955.00 50.00 4,250.00 2,640.00 1,326.67 3,000.00 1,250.00 1,745.00 3,750.00 23.27 2,360.71 5,000.00 2,142.00 967.89 40,120.00 8,355.27 8,355.27 70,500.00 967.89 87,500.00 373,950.00 159,880.00 374,000.00 374,000.00 Figure 28.12: MONTAGU (Pty) Ltd.’s accounts <?page no="347"?> 1,955.00 23.27 28,560.00 20,461.20 1,326.67 33,000.00 38,184.84 1,745.00 49,000.00 43,105.63 2,360.71 64,500.00 4,988.00 20,461.20 65,064.65 38,184.84 3,255.68 43,105.63 175,060.00 175,060.00 65,064.65 174,180.43 3,255.68 174,203.70 174,203.70 5,985.60 5,985.60 36,000.00 373,950.00 12,000.00 174,180.43 151,769.57 373,950.00 373,950.00 45,530.87 151,769.57 106,238.70 151,769.57 151,769.57 45,530.87 45,530.87 106,238.70 106,238.70 45,530.87 106,238.70 Figure 28.12: MONTAGU (Pty) Ltd.’s accounts (continued) <?page no="348"?> Figure 28.13: MONTAGU (Pty) Ltd.’s statement of comprehensive income Figure 28.14: MONTAGU (Pty) Ltd.’s statement of financial position <?page no="349"?> Figure 28.15: MONTAGU (Pty) Ltd. income statement along the NoE format Summary: Companies can prepare the statement of profit and loss and other comprehensive income along the nature of expense method or the cost of sales format. Both formats provide the same amount of profit. The nature of expense method considers all expenses and makes adjustments to the revenue by changes in inventory. The cost of sales format is based on the revenue less cost for goods sold during the Accounting period. The cost of sales format is often used for Management Accounting purposes as it provides information about the contribution margin of products, customers, marketing segments, etc. IFRSs and Handelsgesetzbuch do not prescribe any method for income statement calculation. <?page no="350"?> Working Definitions: Statement of Comprehensive Income along the Nature of Expense Method: The income statement along the nature of expense format calculates profit starting with the revenue and deducting all costs for the period; it adjusts the revenue for costs of manufacturing for stock increases of finished goods and/ or inventory deductions, both together referred to as changes in inventory. Statement of Comprehensive Income along the Cost of Sales Format: The income statement along the cost of sales format starts with the revenue and deducts costs for the goods/ services sold and further down other nonmanufacturing expenses. Contribution Margin: A contribution margin is a product’s revenue less its proportional costs. <?page no="351"?> Learning Objectives: In this chapter, we learn how to derive financial statements from a trial balance. The concept of the trial balance is to check the Bookkeeping entries with regard to the double entry system. The application of the trial balance helps us to avoid Bookkeeping errors. The trial balance actually is a list of balancing figures of all accounts in use by a reporting company. At any time, the total of debit entries has to equal to the total of credit entries. After studying this chapter, you can check your Bookkeeping records conveniently which can become very helpful in your Accounting exam. However, if you make Bookkeeping entries with a software system, you can skip this chapter. Applying the trial balance assures you already at the beginning of the Accounting procedure that your Bookkeeping entries are correct with regard to the double entry system. If they are faulty, the trial balance will provide you with hints of how to find your mistake. The concept of the trial balance is quite simple: After making Bookkeeping entries, balance-off all your accounts and compare the total of balancing figures (b/ d) on the debit side to the sum on the credit side. If both sums are the same, the Bookkeeping records are likely to be consistent with regard to the double entry system. Actually, the comparison on the trial balance only can indicate mistakes. It does not proof that the Bookkeeping records are correct. However, equal sums indicate a high probability that entries have been made correctly and are consistent with the double entry system. The trial balance and the adjusted trial balance that is prepared after the profit calculation - is introduced by the case study PENTZ Ltd. PENTZ Ltd. is a production firm and dealership at the same time. The PENTZ Ltd. deliberately is more complex than previous case studies in this text book in order to point out the power of the trial balance concept. A trial balance works as follows: How it is done (trial balance): (1) Make Bookkeeping entries for all business activities in the relevant accounts. Balance-off all accounts. (2) Prepare a list with lines for every account therein. Make two columns, one for debit entries and the other one credit entries. Enter the balances brought down for all accounts in the columns debit entry or credit entry according to the side they belong to. A debit balanced account’s balance is entered on the debit side. A credit balanced account’s balance is entered on the credit side. (Focus on the balanced b/ d! ) <?page no="352"?> (3) Compare the total of the columns debit entries and credit entries. If they are the same your Bookkeeping records look good. (4) Make the adjustment postings for the profit calculation, such as for depreciation, accruals etc. Calculate the earnings before taxes and earnings after taxes. Make Bookkeeping entries for income tax liabilities and retained earnings. In case you prepare financial statements after the appropriation of profit calculate and record dividends, additions/ reductions to reserves. Balance-off the Retained Earnings account. In case the company carries forward a profit/ loss there is a balance b/ d to be considered for the Retained Earnings account, too. (5) Transfer the adjustments to the trial balance. We recommend to copy the previous trial balance and make adjustments. Hence, delete the nominal accounts that have been closed-off to the Profit and Loss account. Consider that the Trading account as well as the Profit and Loss account are closed-off. After preparing the adjusted trial balance, compare the total of the balancing figures for all your accounts. (6) Prepare the income statement based on the information you retrieve from the Trading account and the Profit and Loss account. Prepare the balance sheet based on the real accounts listed on the adjusted trial balance. You might combine accounts for the balance sheet preparation, such as P, P, E account and the Accumulated Depreciation account. We shortly start-off with the case study PENTZ Ltd. by making Bookkeeping entries for business activities. Later we prepare the trial balance. We record adjustments and derive the Profit and Loss account. Thereafter, we prepare the adjusted trial balance. Our Bookkeeping procedure follows the steps below: - Step (A): Making Bookkeeping entries. - Step (B): Preparing the trial balance. - Step (C): Checking the trial balance - Step (D): Making adjustments. - Step (E): Preparing the adjusted trial balance. - Step (F): Deriving financial statements. Ad step (A): Making Bookkeeping Entries: <?page no="353"?> DR Cash/ Bank.................... 100,000.00 EUR CR Issued Capital............... 100,000.00 EUR (Note, we strongly recommend making bookkeeping entries for prepaid expenses together with the business activities if not required otherwise in an exam.) DR Rent......................... 5,000.00 EUR CR Cash/ Bank.................... 5,000.00 EUR DR Rent......................... 5,000.00 EUR CR Cash/ Bank.................... 5,000.00 EUR DR Rent......................... 5,000.00 EUR CR Cash/ Bank.................... 5,000.00 EUR DR Rent......................... 5,000.00 EUR CR Cash/ Bank.................... 5,000.00 EUR DR Rent......................... 5,000.00 EUR CR Cash/ Bank.................... 5,000.00 EUR <?page no="354"?> DR P, P, E Account.............. 21,500.00 EUR DR VAT.......................... 4,300.00 EUR CR Cash/ Bank.................... 12,900.00 EUR CR Accounts Payables............ 12,900.00 EUR DR Depreciation................. 5,375.00 EUR CR Acc. Depr.................... 5,375.00 EUR DR Purchase..................... 30,000.00 EUR DR VAT.......................... 6,000.00 EUR CR Cash/ Bank.................... 36,000.00 EUR DR Purchase..................... 1,350.00 EUR DR VAT.......................... 270.00 EUR CR Cash/ Bank.................... 1,620.00 EUR DR Purchase..................... 2,800.00 EUR DR VAT.......................... 560.00 EUR CR Cash/ Bank.................... 3,360.00 EUR <?page no="355"?> DR RM-Bodies.................... 30,000.00 EUR CR Purchase..................... 30,000.00 EUR DR RM-Resin..................... 1,350.00 EUR CR Purchase..................... 1,350.00 EUR DR RM-Paint..................... 2,800.00 EUR CR Purchase..................... 2,800.00 EUR DR Labour....................... 43,750.00 EUR CR Cash/ Bank.................... 43,750.00 EUR DR Work in Process.............. 76,718.75 EUR CR Labour....................... 43,750.00 EUR CR Depreciation ................. 5,375.00 EUR CR RM-Bodies.................... 25,000.00 EUR CR RM-Resin..................... 843.75 EUR CR RM-Paint..................... 1,750.00 EUR <?page no="356"?> DR Finished Goods Inventory..... 76,718.75 EUR CR Work in Process.............. 76,718.75 EUR DR Cash/ Bank.................... 66,000.00 EUR DR Accounts Receivables......... 66,000.00 EUR CR VAT.......................... 22,000.00 EUR CR Sales........................ 110,000.00 EUR DR Cost of Goods Sold (COS)..... 61,375.00 EUR CR Finished Goods Inventory..... 61,375.00 EUR DR Purchase..................... 3,800.00 EUR DR VAT.......................... 760.00 EUR CR Cash/ Bank.................... 4,560.00 EUR <?page no="357"?> DR Merchandise Goods............ 3,800.00 EUR CR Purchase..................... 3,800.00 EUR DR Cash/ Bank.................... 5,520.00 EUR CR VAT.......................... 920.00 EUR CR Sales........................ 4,600.00 EUR DR Labour....................... 90,000.00 EUR CR Cash/ Bank.................... 90,000.00 EUR DR Prepaid Expenses............. 5,000.00 EUR CR Rent......................... 5,000.00 EUR 100,000.00 5,000.00 100,000.00 100,000.00 66,000.00 5,000.00 100,000.00 5,520.00 5,000.00 5,000.00 5,000.00 12,900.00 36,000.00 1,620.00 3,360.00 43,750.00 4,560.00 45,190.00 90,000.00 216,710.00 217,190.00 45,670.00 Figure 29.1: PENTZ Ltd.’s accounts <?page no="358"?> 5,000.00 5,000.00 21,500.00 21,500.00 5,000.00 21,500.00 5,000.00 5,000.00 5,000.00 20,000.00 25,000.00 25,000.00 20,000.00 4,300.00 22,000.00 12,900.00 12,900.00 6,000.00 920.00 12,900.00 270.00 560.00 760.00 11,030.00 22,920.00 22,920.00 11,030.00 5,375.00 5,375.00 5,375.00 5,375.00 5,375.00 30,000.00 30,000.00 30,000.00 25,000.00 1,350.00 1,350.00 5,000.00 2,800.00 2,800.00 30,000.00 30,000.00 3,800.00 3,800.00 5,000.00 37,950.00 37,950.00 1,350.00 843.75 2,800.00 1,750.00 506.25 1,050.00 1,350.00 1,350.00 2,800.00 2,800.00 506.25 1,050.00 43,750.00 43,750.00 76,718.75 76,718.75 Figure 29.1: PENTZ Ltd.’s accounts (continued) <?page no="359"?> 76,718.75 61,375.00 110,000.00 15,343.75 114,600.00 4,600.00 76,718.75 76,718.75 114,600.00 114,600.00 15,343.75 114,600.00 66,000.00 66,000.00 61,375.00 61,375.00 66,000.00 61,375.00 3,800.00 3,800.00 5,000.00 5,000.00 3,800.00 5,000.00 90,000.00 90,000.00 90,000.00 Figure 29.1: PENTZ Ltd.’s accounts (continued) Ad step (B): Preparing the Trial Balance: The Bookkeeping entries and the accounts look complex enough to explain the benefit of the trial balance. At this stage of recording, we might be uncertain, whether or not we made Bookkeeping entry mistakes. In order to check the so far made postings for the consistency with the double entry system, we set up the trial balance. A trial balance is a list of all accounts that shows their balances brought down sorted that way, that debit balanced accounts’ balancing figures are in one column and credit balanced accounts’ balancing figures in another one. At the bottom line of the columns, the total of the balancing figures for the debit side and for the credit side are calculated. Both sums have to equal. Any difference between the debit and credit side, is an indicator for a breach with the double entry system. <?page no="360"?> Figure 29.2: PENTZ Ltd.’s trial balance Ad step (C): Checking the Trial Balance A good condition of the trial balance means the total of the debit entry column and the total of the credit entry column must be the same. Furthermore, we check criteria as indicated by Figure 29.3. <?page no="361"?> Figure 29.3: A good trial balance A good trial balance does not contain any figures that result from faulty balances. Besides the equality of the sums, there are some further checks required - in particular in order to find Bookkeeping entry mistakes when the sums do not equal. Balancing amounts (b/ d) for assets should always be on the debit side. This indicates the accounts are debit balanced. There can be exceptions for Cash/ Bank and for Accounts Receivables. Otherwise, asset accounts linked to objects of physical nature cannot become credit balanced. A credit balanced Accounts Receivables account can result from a return and its compensation. The amount for the balancing figure of the Accumulated Depreciation account always has to be on the credit side. No negative depreciation is possible. The amounts for the accounts on the credit side of the statement of financial position should be on the credit side. This means the accounts are credit balanced. No negative capital is allowed. The only exception is about a negative balanced Retained Earnings account in cases of a loss or losses carried forward. In general, liabilities are credit balanced, too. There can be an exception for the Accounts Payables. A debit balanced Account Payables account indicates the company is expected to receive money from its suppliers. That could happen if the supplier sent a voucher in return, e.g. Only in case the trial balance fulfils these requirements, you should continue the Accounting process. (Note, in case the trial balance does not work out in your exam and you cannot find the mistake, move on to another task. The amount of marks you can earn based on faulty Bookkeeping entries are limited and probably make you fail the exam.) <?page no="362"?> Ad step (D): Making Adjustments: DR Trading Account.............. 3,800.00 EUR CR Merchandise Goods............ 3,800.00 EUR DR Sales........................ 4,600.00 EUR CR Trading Account.............. 4,600.00 EUR DR Merchandise Goods............ 2,280.00 EUR CR Trading Account.............. 2,280.00 EUR DR Trading Account.............. 3,080.00 EUR CR Profit and Loss.............. 3,080.00 EUR <?page no="363"?> DR Sales........................ 110,000.00 EUR CR Profit and Loss.............. 110,000.00 EUR DR Profit and Loss.............. 61,375.00 EUR CR Cost of Goods Sold........... 61,375.00 EUR DR Profit and Loss.............. 90,000.00 EUR CR Labour....................... 90,000.00 EUR DR Profit and Loss.............. 20,000.00 EUR CR Rent......................... 20,000.00 EUR DR Retained Earnings............ 58,295.00 EUR CR Profit and Loss.............. 58,295.00 EUR <?page no="364"?> 100,000.00 5,000.00 100,000.00 100,000.00 66,000.00 5,000.00 100,000.00 5,520.00 5,000.00 5,000.00 5,000.00 12,900.00 36,000.00 1,620.00 3,360.00 43,750.00 4,560.00 45,670.00 90,000.00 217,190.00 217,190.00 45,670.00 5,000.00 5,000.00 21,500.00 21,500.00 5,000.00 21,500.00 5,000.00 5,000.00 5,000.00 20,000.00 25,000.00 25,000.00 20,000.00 20,000.00 4,300.00 22,000.00 12,900.00 12,900.00 6,000.00 920.00 12,900.00 270.00 560.00 760.00 11,030.00 22,920.00 22,920.00 11,030.00 5,375.00 5,375.00 5,375.00 5,375.00 5,375.00 Figure 29.4: PENTZ Ltd.’s accounts <?page no="365"?> 30,000.00 30,000.00 30,000.00 25,000.00 1,350.00 1,350.00 5,000.00 2,800.00 2,800.00 30,000.00 30,000.00 3,800.00 3,800.00 5,000.00 37,950.00 37,950.00 1,350.00 843.75 2,800.00 1,750.00 506.25 1,050.00 1,350.00 1,350.00 2,800.00 2,800.00 506.25 1,050.00 43,750.00 43,750.00 76,718.75 76,718.75 76,718.75 61,375.00 110,000.00 15,343.75 114,600.00 4,600.00 76,718.75 76,718.75 114,600.00 114,600.00 15,343.75 4,600.00 114,600.00 110,000.00 114,600.00 114,600.00 66,000.00 66,000.00 61,375.00 61,375.00 66,000.00 61,375.00 61,375.00 3,800.00 3,800.00 5,000.00 5,000.00 3,800.00 3,800.00 5,000.00 2,280.00 2,280.00 6,080.00 6,080.00 2,280.00 Figure 29.4: PENTZ Ltd.’s accounts (continued) <?page no="366"?> 90,000.00 90,000.00 3,800.00 4,600.00 90,000.00 90,000.00 3,080.00 2,280.00 6,880.00 6,880.00 3,080.00 3,080.00 61,375.00 3,080.00 58,295.00 58,295.00 90,000.00 110,000.00 58,295.00 20,000.00 58,295.00 171,375.00 171,375.00 58,295.00 58,295.00 Figure 29.4: PENTZ Ltd.’s accounts (continued) Ad step (E): Preparing the Adjusted Trial Balance: A trial balance prepared after adjustments have been made is an adjusted trial balance. <?page no="367"?> Figure 29.5: PENTZ Ltd.’s adjusted trial balance Ad step (F): Deriving Financial Statements: In the last step, financial statements are prepared. The adjusted trial balance is very close to the statement of financial position already. It only contains real accounts. Some minor adjustments are to be made for the financial statements, in particular some accounts are combined, such as P, P, E and accumulated depreciation. In academia, case studies normally do not require much calculation for deriving the balance sheet from the adjusted trial balance because case studies are less complex. <?page no="368"?> Figure 29.6: PENTZ Ltd.’s statement of financial position <?page no="369"?> Figure 29.7: PENTZ Ltd.’s statement of comprehensive income Summary: The trial balance is a list of accounts and the comparison of their balancing figures (b/ d). The trial balance applies detect Bookkeeping mistakes with regard to the double entry system. Many companies apply the trial balance in order to provide an overview about the accounts after balancing them off and before financial statements are prepared. It is often in use for the preparation of consolidated financial statements, too. Working Definitions: Trial Balance: A trial balance is a list of all accounts that shows their balances brought down sorted in a way, that debit balanced accounts’ balancing figures are in one column and credit balanced accounts’ balancing figures in another one. Adjusted Trial Balance: A trial balance prepared after adjustments is an adjusted trial balance. <?page no="370"?> Learning Objectives: This chapter covers how much income taxes companies pay, how they appropriate their profits and how they record changes in their equity section of the balance sheet. We apply a simplified income tax calculation whereas the income taxes are: 30% × earnings before taxes. This is the total income tax rate that is in use by the IASB for examples, too. After studying this chapter, you understand the profit and dividend calculation and you can prepare a statement of changes in equity. The owners of a company invest in order to receive a return. The company pays them a portion of its profit according to the share the owners hold of the business. The level of payment depends on national law, the company act applies. We call the allocation of earnings to its owners and/ or keeping earnings in the business for reinvestments the appropriation of profits. The appropriation of profits is its distribution as a dividend declaration, additions to reserves and/ or carrying forward a profit/ loss to the next Accounting period. Investors see the company as an investment object. They compare their input to the returns they receive later as a dividend or as a profit on disposal of their shares. The percentage they receive is their capital appreciation and is measured as the return on investment. Public limited companies do not apply the drawing concept as introduced in chapter (24): Privately-owned Business: Drawings. There are more owners, sometimes a few thousands of shareholders who own the business together. Limited companies declare dividends to pay them a return. A dividend is a share of the profit earned in the last or previous Accounting periods that is paid to the shareholders. When a company shares profit with its owners, the Retained Earnings account is debited and the Cash/ Bank or the Shareholder for Dividend account, the latter one being a subordinated account to the Accounts Payables account, is credited. This reflects that by declaring and paying dividends, the company’s equity decreases. For declaration of a dividend the profit must be ascertained at first. Most of the companies need to get their financial statements checked by professionals which we refer to as auditing. Without auditing, no decision about the appropriation of profits can be made. A decision about the appropriation of profits requires approval from the board and the supervisors or on the annual meeting. The auditing of the financial statements means an independent auditor checks the Bookkeeping records and the financial statements. Unrestricted access to financial records and further documents, such as minutes of annual meetings or board meetings, must be given to the auditors. The auditing of financial statements is required by national law. For example, in Germany § 315 HGB applies. According to that paragraph no financial statements will <?page no="371"?> be approved and therefore no dividend can be paid before the financial statements are audited. The paragraph applies for German limited companies that are not classified based on their size along the criteria stated by § 267 HGB. The criteria refer to the total of the balance sheet, the average amount of employees and to earned revenue. Check other country’s national law with regard to auditing - it is not ruled by IFRSs. We take a closer look to a limited company for the explanation of tax calculation and the appropriation of profits along IFRSs. There is a more detailed description in chapter 12 of the text book Bilanzen/ Financial Accounting about tax calculation. We explain the aspects for this chapter by the case study RAATS Ltd. Figure 30.1: RAATS Ltd.’s statement of financial position In order to focus on taxes and the appropriation of profits, we cut the activities of RAATS Ltd. short: DR Income Tax Liabilities....... 30,000.00 EUR CR Cash/ Bank.................... 30,000.00 EUR <?page no="372"?> DR Cash/ Bank.................... 312,000.00 EUR CR VAT.......................... 52,000.00 EUR CR Sales........................ 260,000.00 EUR DR Other Expenses............... 150,000.00 EUR DR VAT.......................... 30,000.00 EUR CR Cash/ Bank.................... 180,000.00 EUR 158,000.00 158,000.00 22,000.00 22,000.00 158,000.00 22,000.00 90,000.00 30,000.00 150,000.00 150,000.00 312,000.00 180,000.00 150,000.00 192,000.00 402,000.00 402,000.00 192,000.00 20,000.00 70,000.00 Figure 30.2: RAATS Ltd.’s accounts <?page no="373"?> 30,000.00 30,000.00 30,000.00 52,000.00 22,000.00 52,000.00 52,000.00 22,000.00 260,000.00 260,000.00 150,000.00 150,000.00 260,000.00 150,000.00 Figure 30.2: RAATS Ltd.’s accounts (continued) Figure 30.3: RAATS Ltd.’s trial balance In general, the calculation of income taxes follows the national tax law. Special calculation apply for the calculation of taxable profit. We assume RAATS Ltd. is a German company. The German tax law - Einkommensteuergesetz (EStG) requires the payment of income taxes which consist of business tax, corporate tax and a surcharge for the German reunion that based on the corporate tax. The business tax (= Gewerbesteuer) is based <?page no="374"?> on the corporate tax profit and depends on the location where the company is based. In general we can say that as more infrastructure a city offers as higher is the corporate tax rate. For RAATS Ltd. we assume the tax rates to be 14.17 % for the business tax, 15 % for the corporate tax and 5.5 % surcharge on the corporate tax for the German reunion. This tax rates result in a total tax rate of 30 %. Additional to the taxes of the company, the investor pays income taxes himself, if residential in Germany and unlimited tax paying. Dividends are taxable based on a tax on capital returns (= Kapitalertragsteuer). The shareholder’s income resulting from shareholding is the base for the dividend tax calculation. In general, the company does not pay out the gross dividend to German shareholders. The dividend tax is withheld by the company and paid directly into the German revenue service’s account. A withholding tax is payable by the company on behalf of the recipient of the funds, here the dividend tax is paid by the company on behalf of the shareholders. In Germany, the dividend tax is 25 % of the net dividend. Furthermore, a surcharge on the dividend tax applies for the German reunion to the extent of 5.5 %. We go back to income tax calculation: When we prepare the Profit and Loss account we record income taxes on the debit side of the Profit and Loss account. This indicates income taxes are an expense. In order to understand the concept of making this Bookkeeping entry consider the following. We can record income taxes in a special Income Tax Expense account. The contra entry would be in the Income Tax Liabilities account. Then, we close-off the Income Tax Expense account to the Profit and Loss account which gives a debit entry in the Profit and Loss account and a credit entry in the Income Tax Expense account. By this entry, the Income Tax Expense account is balanced-off to zero and can be deleted. In this text book we record income taxes based on a kind of shortcut. We skip the Income Tax Expense account and just make a debit entry in the Profit and Loss account and a credit entry in the Income Tax Liabilities account. The result is the same. <?page no="375"?> 158,000.00 158,000.00 22,000.00 22,000.00 158,000.00 22,000.00 90,000.00 30,000.00 150,000.00 150,000.00 312,000.00 180,000.00 150,000.00 192,000.00 402,000.00 402,000.00 192,000.00 20,000.00 20,000.00 70,000.00 20,000.00 147,000.00 77,000.00 147,000.00 147,000.00 147,000.00 30,000.00 30,000.00 30,000.00 52,000.00 33,000.00 33,000.00 22,000.00 63,000.00 63,000.00 52,000.00 52,000.00 33,000.00 22,000.00 260,000.00 260,000.00 150,000.00 150,000.00 260,000.00 260,000.00 150,000.00 150,000.00 260,000.00 110,000.00 260,000.00 260,000.00 33,000.00 110,000.00 77,000.00 110,000.00 110,000.00 Figure 30.4: RAATS Ltd.’s accounts <?page no="376"?> Figure 30.5: RAATS Ltd. adjusted trial balance The distributable amount is the amount that is available to be paid to the shareholders without further reserves being dissolved and after all deductions that are relevant have been taken out. These reductions can be for preference dividends or special reserves required by the national company’s act. In Germany a legal reserve applies. Keep in mind, the distributable amount calculation is subject to national law, not to IFRS regulations. (Note, we do not divide the gross dividend into net dividend and tax portion, because it remains a liability, no matter to whom the amount is paid later. This is a simplification for the text book and the lectures/ exams. Study Berkau: Bilanzen/ Financial Accounting for further considerations.) Accountants call the account for the payable dividend “Shareholder for <?page no="377"?> Dividend ShD account” because it leads to a list of shareholders eligible for receiving dividends. DR Retained Earnings............ 58,800.00 EUR CR Dividends Payables ShD ....... 58,800.00 EUR DR Retained Earnings............ 51,450.00 EUR CR Earnings Reserves............ 51,450.00 EUR 158,000.00 158,000.00 22,000.00 22,000.00 158,000.00 22,000.00 90,000.00 30,000.00 150,000.00 150,000.00 312,000.00 180,000.00 150,000.00 192,000.00 402,000.00 402,000.00 192,000.00 20,000.00 70,000.00 71,450.00 51,450.00 147,000.00 77,000.00 71,450.00 71,450.00 147,000.00 147,000.00 71,450.00 58,800.00 147,000.00 51,450.00 36,750.00 147,000.00 147,000.00 36,750.00 Figure 30.6: RAATS Ltd.’s accounts <?page no="378"?> 30,000.00 30,000.00 30,000.00 52,000.00 33,000.00 33,000.00 22,000.00 63,000.00 63,000.00 52,000.00 52,000.00 33,000.00 22,000.00 260,000.00 260,000.00 150,000.00 150,000.00 260,000.00 260,000.00 150,000.00 150,000.00 260,000.00 58,800.00 58,800.00 110,000.00 58,800.00 260,000.00 260,000.00 33,000.00 110,000.00 77,000.00 110,000.00 110,000.00 Figure 30.6: RAATS Ltd.’s accounts (continued) In general, companies prepare their financial statements under consideration of the appropriation of profits. <?page no="379"?> Figure 30.7: RAATS Ltd.’s prolonged income statement The prolonged statement of profit and loss and other comprehensive income is required by § 158 AktG for German companies based on shares. The lower section of this income statement discloses where the distributable amount goes to. <?page no="380"?> Figure 30.8: RAATS Ltd.’s statement of financial position after appropriation of profit Along international Accounting standards the equity section of the balance sheet needs further explanation about how equity changes what is disclosed by an extra statement called the statement of changes in equity. The statement is prepared in the (DR)CR format - meaning debit entries are displayed as negative figures. RAATS Ltd.’s equity changes as a result from the profit earned and its appropriation. Other changes in equity can be share issues or redemption and revaluations along IAS 16. Dissolving reserves can cause further changes in equity. <?page no="381"?> Figure 30.9: RAATS Ltd.’s statement of changes in equity. Summary: Companies have to pay income taxes based on the pre-tax profit (simplified tax calculation). In Germany, the income tax rate depends on the location of the company due to the business tax portion. The amount for the total income tax rate is close to 30 % for limited companies. In this text book, the income tax rate is always 30 %, as agreed on by the conventions. The appropriation of profits results in paying dividends to shareholders plus paying dividend tax on their behalf to the revenue service, additions to earnings reserves and/ or carrying forward profit to the next Accounting period. Companies prepare the financial statements under consideration of the appropriation of profits. Any appropriation of profits requires the approval of financial statements which needs auditing in most of the cases. The statement of changes in equity discloses increases or decreases of equity during the last two Accounting periods. The shareholder can see how the book value of his/ her company changes because equity measures a company’s value. For income tax calculation and the appropriation of profits, national law applies. Working Definitions: Appropriation of Profit: The appropriation of profits is its distribution as a dividend declaration, additions to reserves and/ or carrying forward a profit/ loss to the next Accounting period. Dividend: A dividend is a share of the profit earned in the last or previous Accounting periods that is paid to the shareholders. Distributable amount: The distributable amount is the amount that is available to be paid to the shareholders without further reserves being dissolved and after all deductions that are relevant have been taken out also. Withholding tax: A withholding tax is payable by the company on behalf of the recipient of the funds, here the dividend tax is paid by the company on behalf of the shareholders. <?page no="382"?> Learning Objectives: In international Accounting, real accounts are continued over several Accounting periods. This is different to the German system where accounts are closed-off to the End-of-Period accounts (= Schlußbilanzkonto) in order to derive the balance sheet. In Germany, the End-of-Period account and the balance sheet belong to the double entry system. This is different to international Accounting. In this chapter, we show how to maintain real accounts over multiple Accounting periods. We study a 2-Accounting-periodexample to illustrate the continuation of real accounts and prepare financial statements as at the end of the 2-Accounting-period time. When introducing T-accounts and their balancing-off, we mentioned already that you can balance-off and continue accounts at any time and as often as you want. That is what international companies do at the end of every Accounting period. Real accounts are balanced-off and are later continued. In contrast, all nominal accounts - which record revenues, gains and all expenses closed-off to the Profit and Loss account as part of the adjustments. After studying this chapter, you can keep Bookkeeping recordings for periods longer than one year. You also know how to prepare intermediate financial statements at any period, mostly quarterly or even monthly. All real accounts must be balanced-off at the end of an Accounting period. The date linked to the balance carried down normally is 31.12.20XX. The balance brought down is regarded as the opening value for the next Accounting period. Hence, the date thereto is 1.01.20XY. Besides of the continuation of real accounts, the preparation of financial statements works the same way as discussed in the previous chapters of this text book. We observe a case study for the business consultancy GOUSBLOM Ltd. to learn about the continuation of accounts. DR Cash/ Bank.................... 500,000.00 EUR CR Issued Capital............... 500,000.00 EUR <?page no="383"?> DR Rent......................... 48,000.00 EUR CR Cash/ Bank.................... 48,000.00 EUR DR Rent......................... 48,000.00 EUR CR Cash/ Bank.................... 48,000.00 EUR DR Prepaid Expenses............. 48,000.00 EUR CR Rent......................... 48,000.00 EUR DR P, P, E Account.............. 144,000.00 EUR DR VAT.......................... 28,800.00 EUR CR Cash/ Bank.................... 172,800.00 EUR DR Depreciation ................. 36,000.00 EUR CR Acc. Depr.................... 36,000.00 EUR <?page no="384"?> DR Labour....................... 1,500,000.00 EUR CR Cash/ Bank.................... 1,500,000.00 EUR DR Cash/ Bank.................... 4,800,000.00 EUR CR VAT.......................... 800,000.00 EUR CR Revenue...................... 4,000,000.00 EUR (Note, we write cd7 (short for: c/ d 31.12.20X7) to indicate the accounts are balanced-off on 31.12.20X7. We write bd8 (short for: b/ d 1.01.20X8) for balance brought down on 1.01.20X8. This only applies for the real accounts, because nominal accounts are not continued but closed-off to profit and loss.) 500,000.00 48,000.00 500,000.00 500,000.00 4,800,000.00 48,000.00 500,000.00 172,800.00 1,500,000.00 3,531,200.00 5,300,000.00 5,300,000.00 3,531,200.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 96,000.00 96,000.00 48,000.00 144,000.00 144,000.00 28,800.00 800,000.00 144,000.00 771,200.00 800,000.00 800,000.00 771,200.00 Figure 31.1: GOUSBLOM Ltd.’s accounts 20X7 <?page no="385"?> 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 1,500,000.00 1,500,000.00 4,000,000.00 4,000,000.00 1,500,000.00 4,000,000.00 Figure 31.1: GOUSBLOM Ltd.’s accounts 20X7 (continued) Figure 31.2: GOUSBLOM Ltd.’s trial balance 20X7 DR Profit and Loss.............. 48,000.00 EUR CR Rent......................... 48,000.00 EUR DR Profit and Loss.............. 36,000.00 EUR CR Depreciation ................. 36,000.00 EUR <?page no="386"?> DR Profit and Loss.............. 1,500,000.00 EUR CR Labour....................... 1,500,000.00 EUR DR Revenue...................... 4,000,000.00 EUR CR Profit and Loss.............. 4,000,000.00 EUR DR Profit and Loss.............. 724,800.00 EUR CR Income Tax Liabilities....... 724,800.00 EUR DR Profit and Loss.............. 1,691,200.00 EUR CR Retained Earnings............ 1,691,200.00 EUR 500,000.00 48,000.00 500,000.00 500,000.00 4,800,000.00 48,000.00 500,000.00 172,800.00 1,500,000.00 3,531,200.00 5,300,000.00 5,300,000.00 3,531,200.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 96,000.00 96,000.00 48,000.00 48,000.00 Figure 31.3: GOUSBLOM Ltd.’s accounts 20X7 <?page no="387"?> 144,000.00 144,000.00 28,800.00 800,000.00 144,000.00 771,200.00 800,000.00 800,000.00 771,200.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 1,500,000.00 1,500,000.00 4,000,000.00 4,000,000.00 1,500,000.00 1,500,000.00 4,000,000.00 4,000,000.00 48,000.00 4,000,000.00 1,691,200.00 1,691,200.00 36,000.00 1,691,200.00 1,500,000.00 2,416,000.00 4,000,000.00 4,000,000.00 724,800.00 2,416,000.00 1,691,200.00 2,416,000.00 2,416,000.00 724,800.00 724,800.00 724,800.00 Figure 31.3: GOUSBLOM Ltd.’s accounts 20X7 (continued) <?page no="388"?> Figure 31.4: GOUSBLOM Ltd.’s adjusted trial balance DR Retained Earnings............ 250,000.00 EUR CR Dividends Payables (A/ P)..... 250,000.00 EUR <?page no="389"?> DR Retained Earnings............ 1,000,000.00 EUR CR Earnings Reserves............ 1,000,000.00 EUR 500,000.00 48,000.00 500,000.00 500,000.00 4,800,000.00 48,000.00 500,000.00 172,800.00 1,500,000.00 3,531,200.00 5,300,000.00 5,300,000.00 3,531,200.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 96,000.00 96,000.00 48,000.00 48,000.00 144,000.00 144,000.00 28,800.00 800,000.00 144,000.00 771,200.00 800,000.00 800,000.00 771,200.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 1,500,000.00 1,500,000.00 4,000,000.00 4,000,000.00 1,500,000.00 1,500,000.00 4,000,000.00 4,000,000.00 48,000.00 4,000,000.00 1,691,200.00 1,691,200.00 36,000.00 250,000.00 1,691,200.00 1,500,000.00 1,000,000.00 2,416,000.00 441,200.00 4,000,000.00 4,000,000.00 1,691,200.00 1,691,200.00 724,800.00 2,416,000.00 441,200.00 1,691,200.00 2,416,000.00 2,416,000.00 Figure 31.5: GOUSBLOM Ltd.’s accounts 20X7 <?page no="390"?> 724,800.00 724,800.00 250,000.00 250,000.00 724,800.00 250,000.00 1,000,000.00 1,000,000.00 1,000,000.00 Figure 31.5: GOUSBLOM Ltd.’s accounts 20X7 (continued) Figure 31.6: GOUSBLOM Ltd.’s statement of financial position <?page no="391"?> Figure 31.7: GOUSBLOM Ltd.’s income statement DR Rent......................... 48,000.00 EUR CR Prepaid Expenses............. 48,000.00 EUR <?page no="392"?> DR Income Tax Liabilities....... 724,800.00 EUR CR Cash/ Bank.................... 724,800.00 EUR DR VAT.......................... 771,200.00 EUR CR Cash/ Bank.................... 771,200.00 EUR DR Dividends Payables (A/ P)..... 250,000.00 EUR CR Cash/ Bank.................... 250,000.00 EUR DR Depreciation................. 36,000.00 EUR CR Accumulated Depreciation..... 36,000.00 EUR DR Labour....................... 1,700,000.00 EUR CR Cash/ Bank.................... 1,700,000.00 EUR <?page no="393"?> DR Cash/ Bank.................... 4,920,000.00 EUR CR VAT.......................... 820,000.00 EUR CR Revenue...................... 4,100,000.00 EUR 500,000.00 48,000.00 500,000.00 500,000.00 4,800,000.00 48,000.00 500,000.00 500,000.00 172,800.00 500,000.00 1,500,000.00 3,531,200.00 5,300,000.00 5,300,000.00 3,531,200.00 724,800.00 4,920,000.00 771,200.00 250,000.00 1,700,000.00 5,005,200.00 8,451,200.00 8,451,200.00 5,005,200.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 144,000.00 144,000.00 28,800.00 800,000.00 144,000.00 144,000.00 771,200.00 800,000.00 800,000.00 771,200.00 771,200.00 820,000.00 820,000.00 1,591,200.00 1,591,200.00 820,000.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 72,000.00 36,000.00 72,000.00 72,000.00 72,000.00 Figure 31.8: GOUSBLOM Ltd.’s accounts 20X8 <?page no="394"?> 1,700,000.00 1,700,000.00 4,100,000.00 4,100,000.00 1,700,000.00 4,100,000.00 250,000.00 250,000.00 1,691,200.00 1,691,200.00 250,000.00 250,000.00 250,000.00 1,691,200.00 1,000,000.00 441,200.00 1,691,200.00 1,691,200.00 441,200.00 724,800.00 724,800.00 1,000,000.00 1,000,000.00 724,800.00 724,800.00 1,000,000.00 Figure 31.8: GOUSBLOM Ltd.’s accounts 20X8 (continued) Figure 31.9: GOUSBLOM Ltd.’s trial balance <?page no="395"?> DR Profit and Loss.............. 48,000.00 EUR CR Rent......................... 48,000.00 EUR DR Profit and Loss.............. 36,000.00 EUR CR Depreciation ................. 36,000.00 EUR DR Profit and Loss.............. 1,700,000.00 EUR CR Labour....................... 1,700,000.00 EUR DR Revenue...................... 4,100,000.00 EUR CR Profit and Loss.............. 4,100,000.00 EUR 500,000.00 48,000.00 500,000.00 500,000.00 4,800,000.00 48,000.00 500,000.00 500,000.00 172,800.00 500,000.00 1,500,000.00 3,531,200.00 5,300,000.00 5,300,000.00 3,531,200.00 724,800.00 4,920,000.00 771,200.00 250,000.00 1,700,000.00 5,005,200.00 8,451,200.00 8,451,200.00 5,005,200.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 48,000.00 Figure 31.10: GOUSBLOM Ltd.’s accounts 20X8 <?page no="396"?> 144,000.00 144,000.00 28,800.00 800,000.00 144,000.00 144,000.00 771,200.00 144,000.00 800,000.00 800,000.00 771,200.00 771,200.00 820,000.00 820,000.00 1,591,200.00 1,591,200.00 820,000.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 36,000.00 72,000.00 36,000.00 72,000.00 72,000.00 72,000.00 1,700,000.00 1,700,000.00 4,100,000.00 4,100,000.00 1,700,000.00 1,700,000.00 4,100,000.00 4,100,000.00 250,000.00 250,000.00 1,691,200.00 1,691,200.00 250,000.00 250,000.00 250,000.00 1,691,200.00 1,000,000.00 441,200.00 1,691,200.00 1,691,200.00 441,200.00 2,062,400.00 1,621,200.00 2,062,400.00 2,062,400.00 2,062,400.00 724,800.00 724,800.00 1,000,000.00 1,000,000.00 724,800.00 724,800.00 1,000,000.00 1,000,000.00 694,800.00 694,800.00 1,000,000.00 1,419,600.00 1,419,600.00 694,800.00 Figure 31.10: GOUSBLOM Ltd.’s accounts 20X8 (continued) <?page no="397"?> 48,000.00 4,100,000.00 36,000.00 1,700,000.00 2,316,000.00 4,100,000.00 4,100,000.00 694,800.00 2,316,000.00 1,621,200.00 2,316,000.00 2,316,000.00 Figure 31.10: GOUSBLOM Ltd.’s accounts 20X8 (continued) Figure 31.11: GOUSBLOM Ltd.’s adjusted trial balance <?page no="398"?> Figure 31.12: GOUSBLOM Ltd.’s statement of financial position Figure 31.13: GOUSBLOM Ltd.’s income statement <?page no="399"?> How it is done (multi-period Bookkeeping records): (1) Make Bookkeeping entries for all business activities in the relevant accounts. (2) Balance-off all accounts. (3) Close-off all nominal accounts to the Trading account and Profit and Loss account. (4) Prepare financial statements. (5) Consider the balances brought down in the real accounts as their opening values for the next Accounting period. (I) Make Bookkeeping entries for all business activities in the relevant accounts. (II) Balance-off all accounts. . . . (Note, you regularly have to make some Bookkeeping entries at the beginning of an Accounting period. These Bookkeeping entries can be the tax payments, dissolving prepaid expenses, payments for dividends etc. In an exam tasks, these Accounting period opening Bookkeeping entries might not explicitly be mentioned. Don’t forget! ) Summary: In contrast to the German system of Bookkeeping entries, real accounts are continued in the next Accounting period for international Accounting. <?page no="400"?> Learning Objectives: In this chapter, we introduce the statement of cash flows. The statement of cash flows forms a part of a full set of financial statements along IAS 1. The cash flow statement shows increases or decreases on cash/ bank. It is structured to show cash flows for operating activities, cash flow from investing activities and cash flow from financing activities separately. We cover how to prepare a cash flow statement based on the direct method and along a reconciliation of profits with the operating cash flows. After studying this chapter, you can read and analyse cash flow statements. Furthermore, you can prepare cash flow statements along the direct method and the reconciliation method. In Germany, a statement of cash flows is not compulsory for single-entity financial statements by national law (Handelsgesetzbuch). A single statement is a set of financial statements prepared for one company only. In contrast, group statements are prepared for groups and contain a consolidation of all single statements therein. The standard case for a German company is, no cash flow statement is provided. The statement of cash flows is required in case a single company participates on the public capital market. See § 264 Handelsgesetzbuch. Furthermore, all group statements contain statement of cash flows. In contrast, a cash flow statement is always prepared along IAS 1. A cash flow statement discloses the total of payment activities sorted by their nature of payment. There are different methods for the preparation of a cash flow statement. Here, we introduce the direct method at first. Later we show how the reconciliation method works. All cash flows are to be classified in: - Cash flows from operating activities, - Cash flows from investing activities and - Cash flows from financing activities. The differentiation of cash flows is required as cash flows can compensate each other. In general, a cash flow from operating activities should be high, whereas a cash flow from investing activities should be negative. Consider a high positive cash flow from investing activities most likely indicates a liquidation! However, the financing cash flow should be positive, too. For the above reason, splitting in three cash flow categories is required and ruled by IAS 7. Along IAS 7 cash flows from operating activities are defined as follows: Cash flows from operating activities are all cash flows that are not linked to financing activities or investing activities. This residual definition is pretty helpful, as the cash flows from investing and financing activities are easy to tell. Cash flows from investing activities result from payments for acquisitions and disposals of non-current assets. Cash flows from financing activities are <?page no="401"?> e.g. linked to contributions of owners, such as shares issued, and to loans, such as bank loans or bonds. Furthermore, all payments linked to equity and liabilities, such as dividends, interest and pay-offs are regarded as cash flows from financing activities. After a while, you won’t have problems to distinguish different cash flows. In the second part of this chapter, we present a more efficient way to calculate cash flows from operating activities by the reconciliation method. This way, only the calculation of the operating cash flow is changed, the other ones remain based on the direct method. In order to understand the differences between the methods, we apply the same case study for both methods. The cash flows from investing and financing activities are calculated based on the direct method always. In general, cash flow statements do not consider VAT. In real companies, VAT is refunded/ paid within a month, except of payments made in December. However, in this text book, all VAT payments to and from the revenue service are due in the next Accounting period per conventions, which is in the next year. For that reason, our cash flow calculations are based on gross amounts. We explain the direct method at first: Along the direct method all activities are recorded and the cash flow statement is derived from a company’s cash and bank accounts. We actually go through each and every entry in the Cash/ Bank account and classify them in operating, investing or financing entries. Direct Method: We show the book store case study MANSELL Ltd. in order to explain the statement of cash flows. We explain the cash flows from all business activities with regard to their classifications. DR Cash/ Bank.................... 100,000.00 EUR CR Issued Capital............... 100,000.00 EUR <?page no="402"?> DR Cash/ Bank.................... 40,000.00 EUR CR Interest Bearing Liabilities. 40,000.00 EUR DR Interest..................... 1,700.00 EUR CR Cash/ Bank.................... 1,700.00 EUR DR Interest Bearing Liabilities. 2,000.00 EUR CR Cash/ Bank.................... 2,000.00 EUR DR Interest Bearing Liabilities. 2,000.00 EUR CR Accounts Payables............ 2,000.00 EUR DR Rent......................... 24,000.00 EUR CR Cash/ Bank.................... 24,000.00 EUR <?page no="403"?> DR P, P, E Account.............. 13,910.00 EUR DR VAT.......................... 2,782.00 EUR CR Cash/ Bank.................... 8,346.00 EUR CR Accounts Payables............ 8,346.00 EUR DR Depreciation ................. 1,391.00 EUR CR Acc. Depr.................... 1,391.00 EUR DR Purchase..................... 27,200.00 EUR DR VAT.......................... 5,440.00 EUR CR Cash/ Bank.................... 32,640.00 EUR <?page no="404"?> DR Cash/ Bank.................... 50,460.00 EUR CR VAT.......................... 8,410.00 EUR CR Sales........................ 42,050.00 EUR 100,000.00 1,700.00 100,000.00 100,000.00 40,000.00 2,000.00 100,000.00 50,460.00 24,000.00 8,346.00 32,640.00 121,774.00 190,460.00 190,460.00 121,774.00 2,000.00 40,000.00 1,700.00 1,700.00 2,000.00 1,700.00 36,000.00 40,000.00 40,000.00 36,000.00 2,000.00 24,000.00 24,000.00 10,346.00 8,346.00 24,000.00 10,346.00 10,346.00 10,346.00 13,910.00 13,910.00 2,782.00 8,410.00 13,910.00 5,440.00 188.00 8,410.00 8,410.00 188.00 Figure 32.1: MANSELL Ltd.’s accounts <?page no="405"?> 1,391.00 1,391.00 1,391.00 1,391.00 1,391.00 1,391.00 27,200.00 27,200.00 42,050.00 42,050.00 27,200.00 42,050.00 Figure 32.1: MANSELL Ltd.’s accounts (continued) Figure 32.2: MANSELL Ltd.’s trial balance <?page no="406"?> 100,000.00 1,700.00 100,000.00 100,000.00 40,000.00 2,000.00 100,000.00 50,460.00 24,000.00 8,346.00 32,640.00 121,774.00 190,460.00 190,460.00 121,774.00 2,000.00 40,000.00 1,700.00 1,700.00 2,000.00 1,700.00 1,700.00 36,000.00 40,000.00 40,000.00 36,000.00 2,000.00 24,000.00 24,000.00 10,346.00 8,346.00 24,000.00 24,000.00 10,346.00 10,346.00 10,346.00 13,910.00 13,910.00 2,782.00 8,410.00 13,910.00 5,440.00 188.00 8,410.00 8,410.00 188.00 1,391.00 1,391.00 1,391.00 1,391.00 1,391.00 1,391.00 1,391.00 Figure 32.3: MANSELL Ltd.’s accounts <?page no="407"?> 27,200.00 27,200.00 42,050.00 42,050.00 27,200.00 27,200.00 42,050.00 42,050.00 27,200.00 42,050.00 7,480.00 7,480.00 22,330.00 7,480.00 7,480.00 49,530.00 49,530.00 22,330.00 22,330.00 1,700.00 22,330.00 4,761.00 4,761.00 24,000.00 4,761.00 1,391.00 4,761.00 27,091.00 27,091.00 4,761.00 4,761.00 Figure 32.3: MANSELL Ltd.’s accounts (continued) <?page no="408"?> Figure 32.4: MANSELL Ltd.’s adjusted trial balance <?page no="409"?> Figure 32.5: MANSELL Ltd.’s income statement Figure 32.6: MANSELL Ltd.’s statement of financial position <?page no="410"?> Figure 32.7: MANSELL Ltd.’s statement of cash flows The cash flow statement does not require Bookkeeping entries. It can be derived directly from the Cash/ Bank account which we refer to as the direct method. The statement of cash flows assigns cash flows to the categories cash flow from operating activities, cash flow from investing activities and cash flow from financing activities. The cash flow statement is not prepared in order to ascertain the total cash flow. That one can easily be read from the Cash/ Bank account values. The statement of cash flows more illustrates where the cash flow results <?page no="411"?> from (which classification). Here, MANSELL Ltd.’s cash flow mostly results from financial cash inputs reduced by a negative cash flow from operating business and investments. We see that MANSELL Ltd. has to change its business in order to not run out of cash. Furthermore the loss situation is not satisfying either. We here refrain from an analysis of its financial statements but study an alternative method for the statement of cash flows. We focus on the calculation of the cash flow from operating activities. The problem with the direct method is, that in order to classify the cash flows in the Cash/ Bank account, a company has to check every entry in the Cash/ Bank account in order to assign them to the relevant cash flow category. Some companies make a few thousands of Bookkeeping entries every day or even every minute, so the direct method cannot be applicable for them. Instead of checking every single cash flow operation, companies often apply the reconciliation of profits with the operating cash flow. It does not require preparing a cash flow statement from the scratch on. It starts with the income statement’ profit. In order to understand the reconciliation method, we acknowledge, that with regard to the operating cash flows a high overlap of entries in the income statement and the cash flow statement exists. However, there are expenses that do not cause an operating cash flow and there are cash flows that do not cause expenses. We name a few of those cases in order to develop a feeling for the differentiation. Expenses, that do not result in operating cash flows are depreciation, increases in provisions, interest etc. On the other hand, cash flows that are no expenses, result from purchases, if the inventories are not consumed. Other examples are changes in receivables and payables, including VAT and income tax payables. The reconciliation method starts with the profit as calculated by the income statements and makes corrections with regard to the above described cases. The cash flow from investing and financing activities cannot be derived from the profit calculation as for the reasons below: No indication is given for investing or financing cash flows by the income statement. Consider taking a bank loan: No evidence for taking a bank loan or paying it off is found on the income statement whatsoever. The same applies for share issues or bond issues. The income statement might recognise dividends or interest, but that information does not tell the amount of shares, bank loans nor of bonds. Hence, the reconciliation only works for operating cash flows. The other cash flows are calculated directly. We do not explain the reconciliation method further, but we apply it for two case studies. PARKLANDSMAIN introduces the very basics. Later, we study again MANSELL Ltd. in order to compare direct method and reconciliation method. <?page no="412"?> Reconciliation Method: (Note, in order to not confuse you by this interim-case study, we use Roman figures for the identification of Bookkeeping entries.) DR Cash/ Bank.................... 5,000.00 EUR CR Owner’s Capital.............. 5,000.00 EUR DR P, P, E ACCOUNT.............. 600.00 EUR CR Cash/ Bank.................... 600.00 EUR DR Inventory ................... 1,000.00 EUR CR Cash/ Bank.................... 1,000.00 EUR DR Labour....................... 400.00 EUR CR Cash/ Bank.................... 400.00 EUR DR Material Expenses............ 250.00 EUR CR Inventory.................... 250.00 EUR <?page no="413"?> DR Cash/ Bank.................... 600.00 EUR DR Accounts Receivables......... 600.00 EUR CR Revenue...................... 1,200.00 EUR DR Depreciation ................. 300.00 EUR CR Acc. Depr.................... 300.00 EUR 5,000.00 600.00 5,000.00 5,000.00 600.00 1,000.00 400.00 3,600.00 5,600.00 5,600.00 3,600.00 600.00 600.00 1,000.00 250.00 600.00 750.00 1,000.00 1,000.00 750.00 400.00 400.00 250.00 250.00 600.00 600.00 1,200.00 1,200.00 600.00 300.00 300.00 300.00 300.00 300.00 Figure 32.8: PARKLANDSMAIN’s accounts <?page no="414"?> 400.00 1,200.00 250.00 250.00 250.00 250.00 300.00 250.00 1,200.00 1,200.00 250.00 250.00 Figure 32.8: PARKLANDSMAIN’s accounts (continued) Figure 32.9: PARKLANDSMAIN’s statement of cash flows <?page no="415"?> Figure 32.10: PARKLANDSMAIN’s income statement <?page no="416"?> Figure 32.11: PARKLANDSMAIN’s reconciliation statement In general, the reconciliation statement starts with the profit for the period. Depreciation is added as depreciation is considered as expense and deducted for profit calculation. As depreciation is neutral to the cash flow, the amount is added. Similar is the procedure for interest. Actually, interest is paid. However, the reconciliation statement determines the cash flow resulting from operating activities only. This means the interest payment is to be cancelled out by adding interest paid to the profit. With regard to the cash flow statement, interest is later considered in the cash flow from financing activities section. By the next step the changes in working capital are discussed. In order to understand the concept of reconciliation, we assume that every change in the working capital is made against the Cash/ Bank account. A company that increases receivables, assumes all added receivables result from lending money to other parties through the Cash/ Bank account. Hence, any increase in receivables results in a negative cash flow. Prepaid expenses are some sort of receivables, <?page no="417"?> too! There is a payment for a service rendered in the future, such as labour, rent, insurance etc. As a result, we treat prepaid expense increases the same way as increases of any other receivables. Any inventory increase is seen as a purchase through the Cash/ Bank account. According to that assumption, increases of stock become negative cash flows. In contrast, a decrease of inventory is a positive cash flow. We assume that inventories, such as finished goods or raw materials, are sold during the Accounting period. All changes in payables mean that someone lent our business money. This results in an obligation to pay the money back and thus a positive cash flow. Changes in VAT will be considered as special receivables, if the VAT account is debit balanced, and like payables, if the VAT account is credit balanced. In case the reconciliation statement starts by the profit after taxes (EAT on the first line) an increase in tax liabilities is likely. This results from the profit calculation: When we calculate profit we disclose the income tax as a portion thereof. Only prepayments of income taxes of tax payments from the last Accounting period can cause a tax liability deduction. Changes of tax liabilities are linked to the operating cash flow. In total, any increase of a liability is regarded as positive cash flow on the reconciliation statement. The major advantage of the reconciliation statement is that it takes the changes in working capital from balance sheet items and not from single activities. Hence, the effort for the operating cash flow calculation is always the same, no matter how many business activities are recorded. How it is done (reconciliation of profit with operating cash flows): (1) Take the profit after taxes from the income statement and put it into the reconciliation statement’s first line. (2) Add depreciation. (3) Add interest paid and deduct interest received. (4) Check the balance sheet for changes in receivables. Deduct the total of increases of receivables or add the total of decreases thereof. Consider prepaid expenses like receivables. (5) Check all inventory accounts. Deduct increases of inventory or add decreases thereof. (6) Check the balance sheet for changes in payables. Add the total of increases of payables or deduct the total of decreases thereof. (7) Check the VAT account if not already included in payables or receivables. Deduct increases of VAT receivables or add decreases of VAT receivables. Or add increases of VAT payables or deduct decreases of VAT. <?page no="418"?> (8) Add increases of income taxes or deduct decreases thereof. (9) Transfer the operating cash flow to the statement of cash flows. (10) Consider adjustments for separating investing cash flow. (Note, a mistake often made in exams is that the working capital itself is considered instead of changes thereof.) Figure 32.12 PARKLANDSMAIN’s statement of cash flows After studying PARKLANDSMAIN, we take our cash flow considerations to the next level and apply it for MANSELL Ltd. Now, we consider VAT. As we prepared already financial statements for MANSELL Ltd., we only apply the reconciliation method on the MANSELL Ltd. example. We want to determine the operating cash flow by reconciliation of its profits from the income statement. From our previous calculations we know the operating cash flow equals to -6,180.00 EUR. We expect to calculate the same amount now: As you can observe below, we only need knowledge about the income statement and the statement of financial position for the cash flow calculation. There is no need for us to analyse single accounts. <?page no="419"?> Figure 32.13: MANSELL Ltd.’s income statement (as above) Figure 32.14: MANSELL Ltd.’s statement of financial position (as above) <?page no="420"?> Changes in working capital Figure 32.15: MANSELL Ltd.’s half of the reconciliation statement <?page no="421"?> Changes in working capital Figure 32.16: MANSELL Ltd.’s (full) reconciliation statement Figure 32.17: MANSELL Ltd.’s statement of cash flows <?page no="422"?> We present another case study about a production firm applying the reconciliation method. We show how to calculate stock of finished goods therein and we have to deal with income taxes because SUNLANDS AG earns a profit. <?page no="423"?> Figure 32.18: SUNLANDS Ltd.’s income statement for 20X3 <?page no="424"?> DR Cash/ Bank.................... 417,500.00 EUR CR Issued Capital .............. 250,000.00 EUR CR Capital Reserves............. 167,500.00 EUR DR Cash/ Bank ................... 100,000.00 EUR CR Interest Bear. Liabilities. . 100,000.00 EUR (Note, along IFRSs the redeemable bonds must be discounted. As the discounting of liabilities is subject to chapter 14 of the text book Bilanzen/ Financial Accounting we suspend the discounting.) DR Interest (Coupon) ........... 2,700.00 EUR CR Cash/ Bank.................... 2,700.00 EUR DR Cash/ Bank.................... 80,000.00 EUR CR Interest Bear. Liabilities. . 80,000.00 EUR DR Interest .................... 3,720.00 EUR DR Interest Bear. Liabilities. . 1,280.00 EUR CR Cash/ Bank.................... 5,000.00 EUR DR P, P, E ACCOUNT.............. 40,000.00 EUR DR VAT.......................... 8,000.00 EUR CR Cash/ Bank ................... 48,000.00 EUR <?page no="425"?> DR Depreciation ................ 6,000.00 EUR CR Acc. Depr.................... 6,000.00 EUR DR Purchase..................... 375,000.00 EUR DR VAT ......................... 75,000.00 EUR CR Accounts Payables A/ P ........ 247,500.00 EUR CR Cash/ Bank ................... 202,500.00 EUR DR Labour....................... 113,000.00 EUR CR Cash/ Bank ................... 113,000.00 EUR DR Cash/ Bank.................... 873,794.40 EUR CR VAT.......................... 145,632.40 EUR CR Revenue...................... 728,162.00 EUR <?page no="426"?> 417,500.00 2,700.00 250,000.00 250,000.00 100,000.00 5,000.00 250,000.00 80,000.00 48,000.00 873,794.40 202,500.00 113,000.00 1,100,094.40 1,471,294.40 1,471,294.40 1,100,094.40 167,500.00 167,500.00 100,000.00 100,000.00 167,500.00 100,000.00 2,700.00 2,700.00 1,280.00 80,000.00 2,700.00 2,700.00 78,720.00 80,000.00 80,000.00 78,720.00 3,720.00 3,720.00 40,000.00 40,000.00 3,720.00 3,720.00 40,000.00 8,000.00 8,000.00 6,000.00 6,000.00 8,000.00 6,000.00 6,000.00 375,000.00 375,000.00 6,000.00 Figure 32.19: SUNLANDS Ltd.’s accounts <?page no="427"?> 75,000.00 145,632.40 247,500.00 247,500.00 70,632.40 247,500.00 145,632.40 145,632.40 70,632.40 113,000.00 113,000.00 728,162.00 728,162.00 728,162.00 728,162.00 375,000.00 494,000.00 113,000.00 119,000.00 119,000.00 6,000.00 494,000.00 494,000.00 119,000.00 119,000.00 375,000.00 375,000.00 494,000.00 418,269.80 75,730.20 494,000.00 494,000.00 75,730.20 418,269.80 418,269.80 418,269.80 728,162.00 2,700.00 3,720.00 303,472.20 728,162.00 728,162.00 91,041.66 303,472.20 212,430.54 303,472.20 303,472.20 212,430.54 212,430.54 91,041.66 91,041.66 212,430.54 91,041.66 Figure 32.19: SUNLANDS Ltd.’s accounts (continued) <?page no="428"?> Figure 32.20: SUNLANDS Ltd.’s income statement Figure 32.21: SUNLANDS Ltd.’s statement of financial position <?page no="430"?> Figure 32.22: SUNLANDS Ltd.’s statement of cash flows <?page no="431"?> Figure 32.23: Reconciliation statement <?page no="432"?> Figure 32.24: SUNLANDS Ltd.’s statement of cash flows Summary: The set of financial statements along IAS 1 contains a statement of cash flows. The cash flow results from changes in the Cash/ Bank account. It can be derived directly from the Cash/ Bank account or by reconciliation of profits with the operating cash flows. Working Definitions: Single Statement: A single statement is a set of financial statements prepared for one company. Statement of Cash Flows: A cash flow statement discloses the total of payment activities sorted by their nature of payment. Cash Flow from Operating Activities: Cash flows from operating activities are all cash flows that are not linked to financing activities or investing activities. Cash Flow from Investing Activities: Cash flows from investing activities result from payments for acquisitions and disposals of non-current assets. <?page no="433"?> Cash Flow from Financing Activities: Cash flows from financing activities are e.g. linked to contributions of owners, such as shares issued, and to loans, such as bank loans or bonds. Furthermore, all payments linked to equity and liabilities, such as dividends, interest and pay-offs are regarded as cash flows from financing activities. <?page no="434"?> Learning Objectives: We introduce the incorporation of a business and changes of legal forms from the point of view of Accounting in this chapter. We give you an overview about the Bookkeeping entries for the establishment of a privatelyowned business, a transfer to a partnership and then to a public limited company. Be aware, we cannot cover all legal forms here. Pls., study national law to gain knowledge about legal forms and the consequences thereof with regard to responsibility, tax regulations and the appropriation of profits. Below, we discuss one case study. Even as its legal form changes, the business concept stays the same. We focus on the company’s profit calculations and how the owner(s) get a share of it in return of the investments. For the discussion of the establishment of a company we use the snack shop case SALDANHA. It starts as a sole trader and later is turned into a partnership. At the end of this chapter, we accompany the business going public. <?page no="435"?> Since BilMoG small companies which are sole traders are exempted from keeping Bookkeeping records, as stated by § 241a HGB (Handelsgesetzbuch). A 4.3 profit-calculation-statement is based on German tax law and determines an Accounting period’s profit by comparison of incoming payments and cash outflows. It refers to § 4 III EStG. Along a 4.3 profit calculation, payments made for the business are seen as expenses. Even in case the payment counts for future Accounting periods, such as next year’s rent, they are assigned to the actual year. This means, for the sake of simplification, the accrual principle is ignored. An exception is the acquisition of assets. The payment itself is no expense but depreciation on the assets is. Non-current assets are to be writtenoff by depreciation although the 4.3 calculation ignores accruals otherwise. We make Stephen Saldanha voluntarily prepare financial statements, such as a statement of financial position and a statement of comprehensive income, along IFRSs. He also can prepare a profit calculation based on a comparison of two balance sheets along German tax law. Here, we only focus on the commercial statements and do not cover financial statements for taxation. DR Cash/ Bank.................... 9,000.00 EUR CR Owner’s Capital.............. 9,000.00 EUR <?page no="436"?> DR P, P, E Account.............. 5,000.00 EUR DR VAT.......................... 1,000.00 EUR CR Cash/ Bank.................... 6,000.00 EUR DR Purchase .................... 2,500.00 EUR DR VAT.......................... 500.00 EUR CR Cash/ Bank.................... 3,000.00 EUR DR Purchase .................... 2,000.00 EUR DR VAT.......................... 400.00 EUR CR Cash/ Bank.................... 2,400.00 EUR DR Rent......................... 1,200.00 EUR CR Cash/ Bank.................... 1,200.00 EUR <?page no="437"?> DR Cash/ Bank.................... 48,000.00 EUR CR VAT.......................... 8,000.00 EUR CR Sales........................ 40,000.00 EUR 5,000.00 5,000.00 9,000.00 9,000.00 5,000.00 9,000.00 9,000.00 6,000.00 1,000.00 8,000.00 48,000.00 3,000.00 500.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 1,200.00 2,100.00 20,400.00 8,000.00 8,000.00 57,000.00 57,000.00 2,100.00 20,400.00 Figure 33.1: SALDANHA’s accounts <?page no="438"?> 2,500.00 40,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 24,500.00 24,500.00 24,500.00 24,500.00 1,200.00 Figure 33.1: Stephen Saldanha’s accounts (continued) Figure 33.2: Stephen Saldanha’s trial balance <?page no="439"?> DR Inventory.................... 500.00 EUR CR Trading Account.............. 500.00 EUR DR Trading Account.............. 24,500.00 EUR CR Purchase..................... 24,500.00 EUR DR Sales........................ 40,000.00 EUR CR Trading Account.............. 40,000.00 EUR DR Trading Account.............. 16,000.00 EUR CR Profit and Loss.............. 16,000.00 EUR <?page no="440"?> DR Depreciation................. 1,000.00 EUR CR Accumulated Depreciation..... 1,000.00 EUR DR Profit and Loss.............. 1,200.00 EUR CR Rent......................... 1,200.00 EUR DR Profit and Loss.............. 1,000.00 EUR CR Depreciation................. 1,000.00 EUR DR Profit and Loss.............. 13,800.00 EUR CR Owner’s Capital.............. 13,800.00 EUR 5,000.00 5,000.00 9,000.00 9,000.00 5,000.00 9,000.00 22,800.00 13,800.00 22,800.00 22,800.00 22,800.00 Figure 33.3: SALDANHA’s accounts <?page no="441"?> 9,000.00 6,000.00 1,000.00 8,000.00 48,000.00 3,000.00 500.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 1,200.00 2,100.00 20,400.00 8,000.00 8,000.00 57,000.00 57,000.00 2,100.00 20,400.00 2,500.00 24,500.00 500.00 2,000.00 16,000.00 40,000.00 2,000.00 40,500.00 40,500.00 2,000.00 16,000.00 16,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 24,500.00 24,500.00 24,500.00 24,500.00 24,500.00 1,200.00 1,200.00 40,000.00 40,000.00 1,200.00 1,200.00 500.00 500.00 1,000.00 1,000.00 500.00 1,000.00 1,000.00 Figure 33.3: SALDANHA’s accounts (continued) <?page no="442"?> 1,000.00 1,000.00 16,000.00 1,200.00 13,800.00 16,000.00 16,000.00 13,800.00 13,800.00 Figure 33.3: SALDANHA’s accounts (continued) Figure 33.4: SALDANHA’s adjusted trial balance DR Drawings..................... 10,000.00 EUR CR Cash/ Bank.................... 10,000.00 EUR <?page no="443"?> 5,000.00 5,000.00 9,000.00 9,000.00 5,000.00 9,000.00 22,800.00 13,800.00 22,800.00 22,800.00 12,100.00 22,800.00 10,700.00 22,800.00 22,800.00 10,700.00 9,000.00 6,000.00 1,000.00 8,000.00 48,000.00 3,000.00 500.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 2,400.00 400.00 1,200.00 2,100.00 20,400.00 8,000.00 8,000.00 57,000.00 57,000.00 2,100.00 20,400.00 10,000.00 2,100.00 8,300.00 20,400.00 20,400.00 8,300.00 Figure 33.5: SALDANHA’s accounts <?page no="444"?> 2,500.00 24,500.00 500.00 2,000.00 16,000.00 40,000.00 2,000.00 40,500.00 40,500.00 2,000.00 16,000.00 16,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 2,000.00 24,500.00 24,500.00 24,500.00 24,500.00 24,500.00 1,200.00 1,200.00 40,000.00 40,000.00 1,200.00 1,200.00 500.00 500.00 1,000.00 1,000.00 500.00 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00 16,000.00 1,000.00 1,200.00 13,800.00 16,000.00 16,000.00 13,800.00 13,800.00 10,000.00 2,100.00 12,100.00 12,100.00 12,100.00 12,100.00 12,100.00 Figure 33.5: Stephen Saldanha’s accounts (continued) <?page no="445"?> (Note, before you establish a partnership take a very close look at your partners! ) <?page no="446"?> Figure 33.6: SNACKY-TICKY-shop’s statement of financial position <?page no="447"?> 4,000.00 38,400.00 500.00 33,900.00 Figure 33.7: SNACKY-TICKY-shop’s accounts DR Cash/ Bank.................... 20,000.00 EUR CR Interest Bearing Liabilities. 20,000.00 EUR DR Interest .................... 1,000.00 EUR CR Cash/ Bank.................... 1,000.00 EUR <?page no="448"?> DR Interest Bearing Liabilities. 2,000.00 EUR CR Cash/ Bank.................... 2,000.00 EUR DR Interest Bearing Liabilities. 2,000.00 EUR CR Short-term Liabilities....... 2,000.00 EUR The recognition of liabilities is covered in the text book Bilanzen/ Financial Accounting’s chapter (14): Liabilities. DR P, P, E Account.............. 27,000.00 EUR DR VAT.......................... 5,400.00 EUR CR Cash/ Bank.................... 32,400.00 EUR DR Depreciation................. 6,400.00 EUR CR Accumulated Depreciation..... 6,400.00 EUR DR Rent......................... 6,000.00 EUR CR Cash/ Bank.................... 6,000.00 EUR <?page no="449"?> DR Purchase..................... 17,000.00 EUR DR VAT.......................... 3,400.00 EUR CR Cash/ Bank.................... 20,400.00 EUR DR Purchase..................... 14,000.00 EUR DR VAT.......................... 2,800.00 EUR CR Cash/ Bank.................... 16,800.00 EUR DR Cash/ Bank.................... 369,600.00 EUR CR VAT.......................... 61,600.00 EUR CR Sales........................ 308,000.00 EUR <?page no="450"?> DR Labour....................... 24,100.00 EUR CR Cash/ Bank.................... 24,100.00 EUR 4,000.00 38,400.00 38,400.00 27,000.00 31,000.00 38,400.00 31,000.00 31,000.00 31,000.00 500.00 500.00 33,900.00 1,000.00 500.00 20,000.00 2,000.00 369,600.00 32,400.00 6,000.00 20,400.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 24,100.00 136,000.00 423,500.00 423,500.00 136,000.00 2,000.00 20,000.00 1,000.00 1,000.00 2,000.00 1,000.00 16,000.00 20,000.00 20,000.00 16,000.00 Figure 33.8: SNACKY-TICKY-shop’s accounts <?page no="451"?> 2,000.00 2,000.00 5,400.00 61,600.00 2,000.00 3,400.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 19,200.00 61,600.00 61,600.00 19,200.00 6,400.00 6,400.00 6,400.00 6,400.00 6,400.00 6,400.00 6,000.00 6,000.00 17,000.00 6,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 185,000.00 185,000.00 185,000.00 185,000.00 308,000.00 308,000.00 24,100.00 24,100.00 308,000.00 24,100.00 Figure 33.8: SNACKY-TICKY-shop’s accounts (continued) <?page no="452"?> Figure 33.9: SNACKY-TICKY-shop’s trial balance DR Trading Account.............. 500.00 EUR CR Inventory.................... 500.00 EUR DR Trading Account.............. 185,000.00 EUR CR Purchase..................... 185,000.00 EUR <?page no="453"?> DR Sales........................ 308,000.00 EUR CR Trading Account.............. 308,000.00 EUR DR Inventory.................... 17,000.00 EUR CR Trading Account.............. 17,000.00 EUR DR Trading Account.............. 128,500.00 EUR CR Profit and Loss.............. 128,500.00 EUR DR Profit and Loss.............. 1,000.00 EUR CR Interest..................... 1,000.00 EUR DR Profit and Loss.............. 6,400.00 EUR CR Depreciation ................. 6,400.00 EUR DR Profit and Loss.............. 6,000.00 EUR CR Rent......................... 6,000.00 EUR DR Profit and Loss.............. 24,100.00 EUR CR Labour....................... 24,100.00 EUR DR P&L-ACCOUNT .................. 102,000.00 EUR CR Partners’ Capital............ 102,000.00 EUR DR Drawings..................... 34,000.00 EUR CR Cash/ Bank.................... 34,000.00 EUR DR Partners’ Capital............ 102,000.00 EUR CR Drawings..................... 102,000.00 EUR <?page no="454"?> 4,000.00 38,400.00 38,400.00 27,000.00 31,000.00 102,000.00 38,400.00 31,000.00 31,000.00 38,400.00 102,000.00 31,000.00 140,400.00 140,400.00 38,400.00 500.00 500.00 33,900.00 1,000.00 500.00 500.00 20,000.00 2,000.00 17,000.00 17,000.00 369,600.00 32,400.00 17,500.00 17,500.00 6,000.00 17,000.00 20,400.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 16,800.00 24,100.00 136,000.00 423,500.00 423,500.00 136,000.00 34,000.00 34,000.00 34,000.00 34,000.00 136,000.00 136,000.00 34,000.00 2,000.00 20,000.00 1,000.00 1,000.00 2,000.00 1,000.00 1,000.00 16,000.00 20,000.00 20,000.00 16,000.00 Figure 33.10: SNACKY-TICKY shop’s accounts <?page no="455"?> 2,000.00 2,000.00 5,400.00 61,600.00 2,000.00 3,400.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 2,800.00 19,200.00 61,600.00 61,600.00 19,200.00 6,400.00 6,400.00 6,400.00 6,400.00 6,400.00 6,400.00 6,400.00 6,000.00 6,000.00 17,000.00 6,000.00 6,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 14,000.00 185,000.00 185,000.00 185,000.00 185,000.00 185,000.00 308,000.00 308,000.00 24,100.00 24,100.00 308,000.00 308,000.00 24,100.00 24,100.00 Figure 33.10: SNACKY-TICKY-shop’s accounts (continued) <?page no="456"?> 500.00 308,000.00 1,000.00 139,500.00 185,000.00 17,000.00 6,400.00 139,500.00 6,000.00 325,000.00 325,000.00 24,100.00 139,500.00 139,500.00 102,000.00 139,500.00 139,500.00 102,000.00 102,000.00 34,000.00 34,000.00 34,000.00 102,000.00 102,000.00 102,000.00 102,000.00 102,000.00 Figure 33.10: SNACKY-TICKY-shop’s accounts (continued) Figure 33.11: SNACKY-TICKY-shop’s adjusted trial balance <?page no="457"?> Figure 33.12: SNACKY-TICKY-shop’s statement of financial position <?page no="458"?> Figure 33.13: SNACKY-TICKY-shop’s income statement <?page no="459"?> (Note, liquidations are subject to the next following chapter. The liquidation is not covered in detail at this stage of the text book. We only divide the book value of the business by 3 partners, which indicates the partnership sold the sales shacks at their carrying amount and returned the snacks to the supplier.) In general, companies can be owned by the state or privately. Privatelyowned companies are e.g. proprietary owned companies ((Pty) Ltd.), public companies (Ltd.) and personal liability companies (Inc.). A private company has restrictions on how to attract new shareholders and on how to sell shares. Shares can be issued through an intermediary e.g., a bank. Furthermore, there is a restricted transferability of shares for privately-owned companies. This means the memorandum of incorporation can state, that shares only can be sold if the sale is approved by the other shareholders and/ or have to be offered to the remaining shareholders at first. However, public companies can raise capital from the general public and the shares are freely transferable. A privately-owned company gives the founders more control but it is more difficult for the shareholders to sell the shares. Hence, shares of a public company are more popular and are traded higher. The memorandum of incorporation is a document that sets out the rights and duties of the shareholders and directors. It is to be signed by the founders of the company. The company must be registered. By the date of incorporation, the company is regarded as a legal entity. The expression limited indicates that the shareholder’s liability is limited to the value of their shares. Shareholders are not liable for any losses exceeding the amount of equity. Equity does not mean the share price, but the book value of the business. Besides of issued <?page no="460"?> capital, this contains all reserves and retained earnings. The memorandum of incorporation signifies the purpose of the company, aspects of dissolving the company, the way how to elect the board of directors, the annual meetings, the power of directors, the shareholders’ rights, the authorization of shares, etc. The memorandum of incorporation must be consistent with national law. DR Cash/ Bank.................... 1,000,000.00 EUR CR Application and Allotment.... 1,000,000.00 EUR Under-subscription of shares occurs if less shares are applied for than offered to the public. Oversubscription is a share issue with more applicants than share offers. In the event of over-subscription, the money paid by applicants who did not receive shares has to be refunded. A par value share issue is a share issue at the nominal amount of the shares. Share issues at an issue price exceeding the nominal value require adding the difference between the issue price and the shares’ face value into a Share Premium account which is to be closed-off to the Capital Reserves account along German AktG, e.g. DR Application and Allotment.... 1,000,000.00 EUR CR Share Capital................ 1,000,000.00 EUR <?page no="461"?> 1,000,000.00 1,000,000.00 1,000,000.00 1,000,000.00 Figure 33.14: SNACKY-TICKY Ltd.‘s accounts How it is done (share issue): (1) When shares are issued the applicants will pay the share’s issue price into the Cash/ Bank account (through a bank for instance). Credit the Application and Allotment account respectively. (2) If there is an oversubscription pay back the amounts to applicants who do not become subscribers. (3) Allot shares to subscribers by debiting the amount of the issue price × amount to the Application and Allotment account. (4) Credit the amount of the face value of shares issued to the Issued Capital account. (5) If the issue price exceeds the face value of shares credit the difference between issue price and face value to the Share Premium account. (6) Close-off the Share Premium account to the Capital Reserves account after consideration of special postings for the share issue procedure along national law might have been made. <?page no="462"?> Figure 33.15: SNACKY-TICKY Ltd.’s statement of financial position DR P, P, E Account.............. 716,800.00 EUR DR VAT.......................... 143,360.00 EUR CR Cash/ Bank.................... 860,160.00 EUR DR Cash/ Bank.................... 50,000.00 EUR CR Short-term Liabilities....... 50,000.00 EUR DR Interest..................... 3,000.00 EUR CR Cash/ Bank.................... 3,000.00 EUR <?page no="463"?> DR Short-term Liabilities....... 50,000.00 EUR CR Cash/ Bank.................... 50,000.00 EUR DR Purchase..................... 140,000.00 EUR DR VAT.......................... 28,000.00 EUR CR Cash/ Bank.................... 168,000.00 EUR DR Purchase..................... 112,000.00 EUR DR VAT.......................... 22,400.00 EUR CR Cash/ Bank.................... 134,400.00 EUR DR Rent......................... 23,520.00 EUR CR Cash/ Bank.................... 23,520.00 EUR <?page no="464"?> DR Cash/ Bank.................... 2,419,200.00 EUR CR VAT.......................... 403,200.00 EUR CR Sales........................ 2,016,000.00 EUR DR Depreciation................. 143,360.00 EUR CR Accumulated Depreciation..... 143,360.00 EUR 1,000,000.00 860,160.00 1,000,000.00 1,000,000.00 50,000.00 3,000.00 2,419,200.00 50,000.00 168,000.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 23,520.00 886,120.00 3,469,200.00 3,469,200.00 886,120.00 Figure 33.16: SNACKY-TICKY Ltd.’s accounts <?page no="465"?> 1,000,000.00 1,000,000.00 716,800.00 716,800.00 1,000,000.00 716,800.00 143,360.00 403,200.00 140,000.00 28,000.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 1,372,000.00 22,400.00 14,560.00 1,372,000.00 1,372,000.00 417,760.00 417,760.00 1,372,000.00 14,560.00 50,000.00 50,000.00 3,000.00 3,000.00 3,000.00 23,520.00 23,520.00 2,016,000.00 2,016,000.00 23,520.00 2,016,000.00 143,360.00 143,360.00 143,360.00 143,360.00 143,360.00 143,360.00 Figure 33.16: SNACKY-TICKY Ltd.’s accounts (continued) <?page no="466"?> Figure 33.17: SNACKY-TICKY Ltd.’s trial balance DR Inventory.................... 28,000.00 EUR CR Trading Account.............. 28,000.00 EUR DR Trading Account.............. 1,372,000.00 EUR CR Purchase..................... 1,372,000.00 EUR DR Sales........................ 2,016,000.00 EUR CR Trading Account.............. 2,016,000.00 EUR DR Trading Account.............. 672,000.00 EUR CR Profit and Loss.............. 672,000.00 EUR <?page no="467"?> DR Profit and Loss.............. 3,000.00 EUR CR Interest..................... 3,000.00 EUR DR Profit and Loss.............. 23,520.00 EUR CR Rent......................... 23,520.00 EUR DR Profit and Loss.............. 143,360.00 EUR CR Depreciation ................. 143,360.00 EUR DR Profit and Loss.............. 150,636.00 EUR CR Income Tax Liabilities....... 150,636.00 EUR DR Profit and Loss.............. 351,484.00 EUR CR R/ E .......................... 351,484.00 EUR DR R/ E .......................... 50,000.00 EUR CR Shareholder for Dividend..... 50,000.00 EUR DR R/ E .......................... 200,000.00 EUR CR Earnings Reserves............ 200,000.00 EUR <?page no="468"?> 1,000,000.00 860,160.00 1,000,000.00 1,000,000.00 50,000.00 3,000.00 2,419,200.00 50,000.00 168,000.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 134,400.00 23,520.00 886,120.00 3,469,200.00 3,469,200.00 886,120.00 1,000,000.00 1,000,000.00 716,800.00 716,800.00 1,000,000.00 716,800.00 143,360.00 403,200.00 140,000.00 28,000.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 22,400.00 112,000.00 1,372,000.00 22,400.00 14,560.00 1,372,000.00 1,372,000.00 417,760.00 417,760.00 1,372,000.00 1,372,000.00 14,560.00 Figure 33.18: SNACKY-TICKY Ltd.’s accounts <?page no="469"?> 50,000.00 50,000.00 3,000.00 3,000.00 3,000.00 3,000.00 23,520.00 23,520.00 2,016,000.00 2,016,000.00 23,520.00 23,520.00 2,016,000.00 2,016,000.00 143,360.00 143,360.00 143,360.00 143,360.00 143,360.00 143,360.00 143,360.00 1,372,000.00 28,000.00 28,000.00 28,000.00 672,000.00 2,016,000.00 28,000.00 2,044,000.00 2,044,000.00 672,000.00 672,000.00 3,000.00 672,000.00 150,636.00 150,636.00 23,520.00 150,636.00 143,360.00 502,120.00 672,000.00 672,000.00 150,636.00 502,120.00 351,484.00 502,120.00 502,120.00 50,000.00 351,484.00 50,000.00 50,000.00 200,000.00 50,000.00 101,484.00 351,484.00 351,484.00 101,484.00 Figure 33.18: SNACKY-TICKY Ltd.’s accounts (continued) <?page no="470"?> 200,000.00 200,000.00 200,000.00 Figure 33.18: SNACKY-TICKY Ltd.’s accounts (continued) Figure 33.19: SNACKY-TICKY Ltd.’s adjusted trial balance (Note, no notes are considered for this case study. For studying notes, read the text book Bilanzen/ Financial Accounting in particular chapter 6.) <?page no="471"?> Figure 33.20: SNACKY-TICKY Ltd.’s statement of financial position (Note, in contrast to the previous statements of financial position, this one now contains the items reserves and retained earnings in the equity section.) <?page no="472"?> Figure 33.21: SNACKY-TICKY Ltd.’s income statement <?page no="473"?> Figure 33.22: SNACKY-TICKY Ltd.’s statement of cash flows Figure 33.23: SNACKY-TICKY Ltd.’s statement of changes in equity Earnings per share is a ratio defined by IAS 33. It is the amount of the earnings distributable to the shareholders divided by the average number of shares outstanding. It indicates how much a 100 % dividend declaration would be worth. The earnings per share are used as the denominator in the price-earnings-ratio. <?page no="474"?> Summary: Companies can operate under different legal forms. The legal form has consequences with regard to the liability of the owners, tax payments and the appropriation of profits. We observed a similar business as a sole trader, a partnership and a public company. The public company is a legal entity and has to pay taxes. Public companies have to prepare a full set of financial statements along IFRSs. Working Definitions: 4.3 Gewinnermittlungs-statement: A 4.3 profit-calculation-statement is based on German tax law and determines an Accounting period’s profit by comparison of incoming payments and cash outflows. Par value share issue: A par value share issue is a share issue at the nominal amount of the shares. Underand over subscription: Under-subscription of shares happens when less shares are applied for than offered. Over-subscription is a share issue with more applicants than share offers. Memorandum of Incorporation: The memorandum of incorporation is a document that sets out the rights and duties of the shareholders and directors. Earnings per share EPS: Earnings per share is the amount of the earnings distributable to the shareholders divided by the average number of shares outstanding. <?page no="475"?> Learning Objectives: We introduce activities to dissolve a company in this chapter. The liquidation is discussed from the Accounting point of view. In particular, we explain the application of the Liquidation account. When a company is closed, debts are to be settled and thereafter remaining assets are shared among owners. After studying this chapter, you know how to record a business liquidation. Liquidations will be required if the business activities are no longer continued. As a result of a liquidation, the company cease to exist. This does not always mean the business files for bankruptcy, it also can happen that, e.g., a partnership is dissolved, because the owner intends to withdraw their funds, maybe because there is a disagreement or in order to invest in another business. Or, as another example, a company can be liquidated, because the owner intends to relocate. In Accounting the technical term liquid means easy to exchange. Cash is more liquid than a digging machine, for example. The liquidation of a business requires that all assets are turned into an easily exchangeable form. Mostly, they are converted into cash. Cash is regarded to be most easily exchangeable between parties. Hence, liquidation means quite often to sell (all) assets. On the other side of the balance sheet, all liabilities are retired. This requires to pay them off. This is often linked to transaction costs, such as fees, which we ignore for this text book. The remaining assets after settlement of all liabilities are shared among owners and are called the profit on liquidation. The memorandum of incorporation might determine how owners split it among each other. How it is done (liquidation): (1) After the decision for liquidation has been made do not continue business operations. (2) Sell all assets preferably on cash. (3) Settle all outstanding liabilities by payments. (4) In case the cash/ bank item then exceeds liabilities, distribute the remaining amount to the owners according to their share of the business. In case cash/ bank item is too short to settle liabilities, you most probably have to file for bankruptcy. (5) If there are preference shareholders, consider them at first with regard to share the remaining assets. You must put them into a position along the pecking order where they enjoy priority over ordinary shareholders. <?page no="476"?> We are going through an example to get across the idea of liquidations. Figure 34.1: MOSSEL SPORTS’ statement of financial position <?page no="477"?> 200,000.00 80,000.00 10,000.00 90,000.00 120,000.00 35,000.00 15,000.00 50,000.00 Figure 34.2: MOSSEL SPORTS’ accounts The Liquidation account is a temporary account that applies to record all liquidation activities. Later all accounts of the business are closedoff to the Liquidation account and, as a result, the company won’t exist any longer. Bad debts are receivables that a business is probably not able to collect. To write-off receivables as bad debts means to add them as an expense to profit and loss. <?page no="478"?> DR Accumulated Depreciation..... 80,000.00 EUR DR Liquidation.................. 120,000.00 EUR CR P, P, E Account.............. 200,000.00 EUR DR Cash/ Bank.................... 105,000.00 EUR DR Loss on Disposal............. 15,000.00 EUR CR Liquidation.................. 120,000.00 EUR DR Liquidation.................. 10,000.00 EUR CR Accounts Receivables......... 10,000.00 EUR DR Cash/ Bank.................... 8,000.00 EUR DR Loss on Settlement........... 2,000.00 EUR CR Liquidation.................. 10,000.00 EUR DR Interest Bearing Liabilities. 15,000.00 EUR CR Cash/ Bank.................... 15,000.00 EUR DR Accounts Payables............ 50,000.00 EUR CR Cash/ Bank.................... 50,000.00 EUR In case the owners want to keep the results of the liquidation process separately, they can apply subordinated accounts for the liquidation of single items and apply the Liquidation account as reconciliation account thereof. <?page no="479"?> 200,000.00 200,000.00 80,000.00 80,000.00 10,000.00 10,000.00 90,000.00 15,000.00 105,000.00 50,000.00 8,000.00 138,000.00 203,000.00 203,000.00 138,000.00 120,000.00 35,000.00 15,000.00 15,000.00 50,000.00 50,000.00 120,000.00 120,000.00 15,000.00 10,000.00 10,000.00 130,000.00 130,000.00 2,000.00 Figure 34.3: MOSSEL SPORTS’ accounts <?page no="480"?> DR Owner’s Capital.............. 120,000.00 EUR DR Retained Earnings............ 35,000.00 EUR CR Loss on Disposal............. 15,000.00 EUR CR Loss on Settlement........... 2,000.00 EUR CR Cash/ Bank.................... 138,000.00 EUR 200,000.00 200,000.00 80,000.00 80,000.00 10,000.00 10,000.00 90,000.00 15,000.00 105,000.00 50,000.00 8,000.00 138,000.00 203,000.00 203,000.00 138,000.00 138,000.00 120,000.00 120,000.00 35,000.00 35,000.00 15,000.00 15,000.00 50,000.00 50,000.00 120,000.00 120,000.00 15,000.00 15,000.00 10,000.00 10,000.00 130,000.00 130,000.00 2,000.00 2,000.00 Figure 34.4: MOSSEL SPORTS’ accounts <?page no="481"?> In cases a company sells its assets by earning a profit, income tax becomes relevant and the profit on disposal is to be recorded through the Profit and Loss account. Income tax liabilities are to be settled within the process of liquidation. DR Cash/ Bank.................... 124,000.00 EUR CR Profit on Disposal........... 4,000.00 EUR CR Liquidation .................. 120,000.00 EUR DR Cash/ Bank.................... 7,500.00 EUR DR Loss on Disposal............. 2,500.00 EUR CR Liquidation .................. 10,000.00 EUR 200,000.00 200,000.00 80,000.00 80,000.00 10,000.00 10,000.00 90,000.00 15,000.00 124,000.00 50,000.00 7,500.00 156,500.00 221,500.00 221,500.00 156,500.00 450.00 156,050.00 156,500.00 156,500.00 156,050.00 156,050.00 120,000.00 120,000.00 35,000.00 35,000.00 36,050.00 35,000.00 1,050.00 36,050.00 36,050.00 Figure 34.5: MOSSEL SPORTS accounts in case of profit on asset sale <?page no="482"?> 15,000.00 15,000.00 50,000.00 50,000.00 120,000.00 120,000.00 4,000.00 4,000.00 10,000.00 10,000.00 4,000.00 4,000.00 130,000.00 130,000.00 2,500.00 2,500.00 2,500.00 4,000.00 2,500.00 2,500.00 1,500.00 4,000.00 4,000.00 450.00 1,500.00 1,050.00 1,500.00 1,500.00 450.00 450.00 Figure 34.5: MOSSEL SPORTS accounts in case of profit on asset sale (continued) DR Income Tax Liabilities....... 450.00 EUR CR Cash/ Bank.................... 450.00 EUR DR Owner’s Capital.............. 120,000.00 EUR DR Retained Earnings............ 36,050.00 EUR CR Cash/ Bank.................... 156,050.00 EUR <?page no="483"?> Liquidations of partnerships and of public companies work similar. In contrast to MOSSEL SPORTS, the liquidation of a public company pays an agreed share of the profit (depending on the amount of shares held) to the proprietors/ shareholders based on the regulations signified in the memorandum of corporation. In case a company’s liquidation results in a negative amount for equity (liabilities cannot be settled) national law is considered with regard to the obligation to file for bankruptcy. In this case, the company often won’t be allowed to make the settlement payments on its own anymore, in order to guarantee the same share of liquidation payment to all creditors. In a situation of bankruptcy, shareholders lose their whole interest in the company (the shares are valued at zero), but won’t be held liable for debts. In the events of liquidation losses, managers or in companies based on shares the CEO and CFO (= chief financial officer) can be held liable for losses, resulting from mistakes/ misconducts that can be proved and used against them. Even own shareholders might sue their managers based on civil law, for their losses resulting from losing their shares.) In this text book, we are not keen to discuss many different national law aspects. We only focus on Accounting and how to record liquidations. That is the reason, why the chapter is only illustrated by a case study about a privately-owned business. However, you will find a liquidation example about a public company in the text book Bilanzen/ Financial Accounting in chapter (7). Summary: Liquidation is the process of dissolving a business. All assets are sold and converted into cash or cash equivalents. All debts are paid-off. The remaining amount is paid to owners - if positive. The remaining amount can differ from the previous book value of the company. The reason is that in case of a liquidation assets are sold below carrying amounts. Working Definitions: Liquidation Account: The Liquidation account is a temporary account that applies to record all liquidation activities. Bad Debts: Bad debts are receivables that a business is probably not able to collect. <?page no="484"?> Learning Objectives: Disposals of non-current assets are necessary, once items do not fulfil the recognition requirements any longer. This can occur because they are no longer deployed or when they are sold. We here do not discuss the reasons for disposals but the Bookkeeping entries made. Postings for disposals become also relevant when a non-current asset is completely destroyed. This chapter covers the application of the Realisation account. After this chapter, you can record the disposal of assets and transfer the profit/ loss on disposal into the Profit and Loss account. Along IFRSs, an asset is an item that makes future economic benefits flow to the entity that is deploying it or is its owner. If and only if there is a future economic benefit resulting from the asset and the value measurement thereof can be relied on, it meets the qualification criteria for an asset. An asset that provides no further benefit has to be deleted from the Bookkeeping records. Providing no future economic benefit means, the asset cannot be sold nor used in any viable way possible. Some German companies write-off assets completely and assign a reminding value to the extent of 1.00 EUR thereto. This does not work along IFRSs. Once the asset is written-off completely, either a revaluation to the fair value is recorded or its disposal is in order. Other reasons for disposals are selling or discarding of assets. The Bookkeeping entries for the disposal can be made all together by one Bookkeeping entry. However, it is easier to apply the Realisation account and to split Bookkeeping entries. A Realisation account is a temporary account that records all activities which are linked to the disposal of a non-current asset. The Realisation account splits the process of disposal in single activities, such as receiving cash, recording VAT, removing asset from the Bookkeeping records etc. All activities are recorded separately. The contra entry for all postings is the Realisation account. How it is done (disposal of a non-current asset): (1) Create a Realisation account. (2) Close-off the non-current asset account (Most likely the Property, Plant and Equipment account applies.) to the Realisation account. (3) Close-off the Accumulated Depreciation account dedicated to the relevant non-current asset to the Realisation account, too. If no Asset Management applies, take the relevant amount for the asset out of the general Accumulated Depreciation account. You might consider <?page no="485"?> not yet recorded depreciation for the actual Accounting period at first. Do the same with regard to impairment losses and relevant accounts thereto. (4) When receiving a payment on cash, debit the amount to the Cash/ Bank account and make a credit entry in the Realisation account. When receiving a voucher or any other kind of receivables, debit the amount to the relevant account (most likely the Accounts Receivables accounts applies.) and make a credit entry in the Realisation account. You might consider combinations. (5) In case the sale is relevant for output-VAT, make a debit entry in the Realisation account and credit the amount to the VAT account. (6) Balance-off the Realisation account. A debit balanced Realisation account means a loss on disposal a credit balanced one a profit on disposal. (7) Close-off the Realisation account to the Profit and Loss account. (8) In case you dispose an asset that was subject to revaluation previously, close-off the Deferred Tax Liability account to the Revaluation Reserves account and then the Revaluation Reserves account dedicated to the disposed asset to retained earnings. Note, revaluations apply along IAS 16 only. They are discussed in the text book Bilanzen/ Financial Accounting in chapter (7). We explain the application of the Realisation account by the case study WARDRIF Ltd. <?page no="486"?> Figure 35.1: WARDRIF Ltd.’s register of non-current assets 35,000.00 21,000.00 40,000.00 10,000.00 40,000.00 10,000.00 35,000.00 7,000.00 60,000.00 6,000.00 Figure 35.2: WARDRIF Ltd.’s accounts <?page no="487"?> DR Cash/ Bank.................... 240,000.00 EUR CR VAT.......................... 40,000.00 EUR CR Revenue...................... 200,000.00 EUR DR Other Expenses............... 50,000.00 EUR DR VAT.......................... 10,000.00 EUR CR Cash/ Bank.................... 60,000.00 EUR DR Depreciation ................. 4,000.00 EUR CR Acc depr OS-W 200 ............ 4,000.00 EUR DR Depreciation ................. 4,000.00 EUR CR Acc Depr OS-W 300 ............ 4,000.00 EUR <?page no="488"?> DR Cash/ Bank.................... 31,050.00 EUR CR Realisation.................. 31,050.00 EUR DR Realisation.................. 5,175.00 EUR CR VAT.......................... 5,175.00 EUR DR Depreciation................. 4,000.00 EUR CR Acc Depr OS-W 200............ 4,000.00 EUR DR Realisation.................. 40,000.00 EUR CR P, P, E - “OS-W 200”......... 40,000.00 EUR <?page no="489"?> DR Acc. Depr OS-W 200........... 14,000.00 EUR CR Realisation .................. 14,000.00 EUR DR Realisation “OS-W 200” ....... 125.00 EUR CR Profit and Loss.............. 125.00 EUR DR Cash/ Bank.................... 31,890.00 EUR CR Realisation .................. 31,890.00 EUR DR Realisation .................. 5,315.00 EUR CR VAT.......................... 5,315.00 EUR DR Depreciation ................. 4,000.00 EUR CR Acc. Depr. OS-W 300.......... 4,000.00 EUR DR Realisation .................. 40,000.00 EUR CR P, P, E - “OS-W 300”......... 40,000.00 EUR <?page no="490"?> DR Acc. Depr. OS-W 300.......... 14,000.00 EUR CR Realisation.................. 14,000.00 EUR DR Profit and Loss.............. 575.00 EUR CR Realisation.................. 575.00 EUR DR Depreciation................. 9,000.00 EUR CR Acc. Depr. OS-W 500.......... 9,000.00 EUR (Note, see for revaluations chapter 7 of the text book Bilanzen/ Financial Accounting.) <?page no="491"?> DR Impairment Loss.............. 45,000.00 EUR CR Acc. Impairment Losses....... 45,000.00 EUR DR Cash/ Bank.................... 600.00 EUR CR Realisation .................. 600.00 EUR DR Realisation .................. 100.00 EUR CR VAT.......................... 100.00 EUR DR Realisation .................. 60,000.00 EUR CR P, P, E “OS-W 500”........... 60,000.00 EUR DR Acc. Depr. OS-W 500.......... 15,000.00 EUR CR Realisation .................. 15,000.00 EUR DR Acc. IL OS-W 500............. 45,000.00 EUR CR Realisation .................. 45,000.00 EUR DR Realisation .................. 500.00 EUR CR Profit and Loss.............. 500.00 EUR <?page no="492"?> DR Depreciation................. 7,000.00 EUR CR Acc. Depr. OS-W 100.......... 7,000.00 EUR DR Depreciation................. 7,000.00 EUR CR Acc. Depr. OS-W 400.......... 7,000.00 EUR DR Profit and Loss ............. 31,000.00 EUR CR Depreciation................. 31,000.00 EUR DR Profit and Loss.............. 45,000.00 EUR CR Impairment Loss.............. 45,000.00 EUR DR Profit and Loss.............. 50,000.00 EUR CR Other Expenses............... 50,000.00 EUR DR Revenue...................... 200,000.00 EUR CR Profit and Loss.............. 200,000.00 EUR <?page no="493"?> 35,000.00 35,000.00 21,000.00 35,000.00 28,000.00 7,000.00 28,000.00 28,000.00 28,000.00 40,000.00 40,000.00 14,000.00 10,000.00 4,000.00 14,000.00 14,000.00 40,000.00 40,000.00 14,000.00 10,000.00 4,000.00 14,000.00 14,000.00 35,000.00 35,000.00 7,000.00 35,000.00 14,000.00 7,000.00 14,000.00 14,000.00 14,000.00 60,000.00 60,000.00 15,000.00 6,000.00 9,000.00 15,000.00 15,000.00 0.00 60,000.00 10,000.00 40,000.00 240,000.00 5,175.00 31,050.00 5,315.00 31,890.00 40,590.00 100.00 600.00 243,540.00 50,590.00 50,590.00 303,540.00 303,540.00 40,590.00 243,540.00 Figure 35.3: WARDRIF Ltd.’s accounts <?page no="494"?> 200,000.00 200,000.00 50,000.00 50,000.00 200,000.00 200,000.00 50,000.00 50,000.00 5,175.00 31,050.00 4,000.00 40,000.00 14,000.00 4,000.00 125.00 9,000.00 45,175.00 45,175.00 7,000.00 125.00 125.00 7,000.00 31,000.00 31,000.00 31,000.00 31,000.00 31,000.00 5,315.00 31,890.00 125.00 575.00 40,000.00 14,000.00 31,000.00 500.00 575.00 45,000.00 200,000.00 45,890.00 45,890.00 50,000.00 575.00 575.00 74,950.00 201,075.00 201,075.00 22,485.00 74,950.00 52,465.00 74,950.00 74,950.00 45,000.00 45,000.00 45,000.00 45,000.00 52,465.00 52,465.00 100.00 600.00 52,465.00 60,000.00 15,000.00 500.00 45,000.00 60,600.00 60,600.00 500.00 500.00 22,485.00 22,485.00 22,485.00 Figure 35.3: WARDRIF Ltd.’s accounts (continued) <?page no="495"?> (Note, this is done for text book reasons only.) Figure 35.4: WARDRIF Ltd.’s register of non-current assets Figure 35.5: WARDRIF Ltd.’s income statement <?page no="496"?> Summary: A company that disposes assets applies a Realisation account for each asset disposed. The profit or loss on disposal is disclosed in the statement of profit and loss and other comprehensive income under the item of other income or other expenses. Working Definition: Realisation Account: A realisation account is a temporary account that is used to record all activities linked to the disposal of a non-current asset. <?page no="497"?> Learning Objectives: A discount is a price deduction. It can be linked to a purchase price (discount received), or a price demanded for goods/ services sold (discount allowed). Discounts are calculated as a fixed EUR-amount or as a percentage based on the original price. It does not matter whether the discount is reduced at the time of purchase or later, such as a money-give-back-discount. A discount that is linked to the quantity of goods purchased or its value is widely called a rebate. A Company receiving or allowing discounts has either to adjust the value of goods bough or the revenue received. The same applies for VAT. We introduce the effect of discounts to Accounting and teach you the relevant Bookkeeping entries. Depending on the time when the discount is allowed or received, there are two approaches for its recording: (1) You reduces costs/ sales directly at the point of purchase/ sales, and (2) you record the business activity without discount and consider the discount later what gives you Bookkeeping entries for deferred discounts. The method to apply depends on the way the discount is given/ received. In case a discount is agreed at the time of sale method (1) is appropriate. In case a discount is given/ allowed only after some requirements are fulfilled, such as purchasing a certain amount of goods or buying for a certain value, there is no other way than to apply method (2). An example for a deferred discount is a rebate-card your hairdresser gives you in order to bind you to his salon. After 10 haircuts the 11 th one is for free. After studying this chapter, you understand discounts from the point of view of Accounting and you can make correct Bookkeeping entries for discounts allowed/ received. You further become aware how discounts change amounts your assets are carried at and their depreciation. The valuation of assets bought/ sold at a discounts is ruled by IFRSs. In a case a discount is allowed on a purchase or acquisition, a discount causes a reduction of the initial asset valuation and subsequent valuation, meaning depreciation is effectuated. Regulations about discounts are found in IAS 2 and IAS 16. They both request deducting all discounts for asset valuations and IFRS 15 contains regulations for revenue recognition. The valuation of assets/ revenue always is made ex-discounts. Hence, all inventory movements, cost of sales and revenues are based on net amounts without discounts. Similar regulations apply for subsequent valuations. These applies for depreciation and revaluations, the latter ones recorded based on the gross replacement method. Read further considerations on revaluations in chapter (7) of the text book Bilanzen/ Financial Accounting. We keep always the following rule in mind: discounts can never be disclosed on financial statements. Even if a particular Discount account applies, it must be closed-off, latest on <?page no="498"?> the balance sheet date. If a customer buys on credit and receives a discount, the discount is to be deducted from receivables, too. The same applies for payables to suppliers. We show two methods for discount consideration: (1) Direct Discounts (2) Deferred Discounts Ad (1): Direct Discounts With regard to discounts, direct means immediate. The easiest way to make a Bookkeeping entry for a discount is to reduce the amount instantly. This leads to a Bookkeeping entry that only records the business activity based on the reduced price. If you buy something for 100.00 EUR and you receive a 5%discount, the adjusted amount equals to: 100 × (1 - 5%) = 95.00 EUR. We’ll show this method by a few examples and consider VAT too. DR Purchase..................... 2,400.00 EUR DR VAT.......................... 480.00 EUR CR Cash/ Bank.................... 2,880.00 EUR DR Cash/ Bank.................... 4.56 EUR CR VAT.......................... 0.76 EUR CR Sales........................ 3.80 EUR The consideration of immediate discounts received or allowed is fairly simple. We only change the prices for purchase/ sales and VAT. Once we think about a discount as a price deduction the impact on VAT becomes quite clear. <?page no="499"?> How it is done (immediate discounts): (1) Multiply the purchase price / sales price by the factor (1 - discount [%]). (2) If VAT applies, multiply VAT by the factor (1 - discount [%]), too. (3) Record the purchase/ sale based on the reduced amounts. Ad (2): Deferred Discount If the discount is allowed or received after the time of purchase/ sales, the Bookkeeping entries are more complicated as you have to apply a Discount Allowed/ Received account. Some companies offer a discount after the sale has been recorded already. For instance, they offer a discount once a certain amount of goods has been ordered by the customer (rebate). Or they use a discount to compensate an unsatisfied customer in order to avoid returns. In these situations, a discount must be posted to a Discount account. When a customer receives a discount, the account’s name is Discount Received account. A company that sells goods at a reduced price, applies the Discount Allowed account. A Discount account is a temporary account to record discounts. It has to be closed-off to the Purchases-, Property, Plant and Equipment-, Salesand/ or VAT account. The discount changes the costs of purchase/ acquisition or selling prices. If discounts are allowed/ received after the purchase/ sales date, valuations and subsequent Bookkeeping entries, must be adjusted. A discount received on cost of acquisition changes depreciation, for example. The Discount account cannot be transferred to the statement of financial position. In any case, Discount accounts are to close-off. In company delaying the recording of a received discount, overstates the inventory valuation. As a consequence, expenses resulting from stock releases, such as cost of sales or manufacturing costs, increase (in the sense of not reducing them) expenses and decrease profits. If goods are not consumed, inventory left on stock are over-priced then. For this reasons, a company records a discount, once it receives it. If the company buys on 2.01.20X5 goods and receives a discount thereon half a year later, the discount is to be recorded on 2.07.20X5 as deferred discount. Inventory adjustments are due at the same date. How it is done (deferred discounts): (1) Make Bookkeeping entries for purchase and sale. (2) Once a discount is received, add it immediately to the Discount Received account. Credit the discount to the Discount Received account and make a debit entry in the Cash/ Bank account if paid, or in the Accounts Payables if payment is still awaited. Once a discount is <?page no="500"?> allowed, add it to the Discount Allowed account. Debit the discount to the Discount Allowed account. If you pay the discount directly, make a credit entry in the Cash/ Bank account. If you reduce an open bill or give the buyer/ customer a voucher, record a debit entry in the Accounts Receivables account. (3) Split up the discount in a net amount and a VAT portion. (4) Close-off the Discount Received account to inventory, non-current asset or service expenses and adjust the VAT account. Close-off the Discount Allowed account to the Sales/ Revenue account and VAT account. (5) Special Bookkeeping entries might apply in particular situations. We’ll show the application of Discount accounts and their dissimilation by the example HETKRUIS Ltd., which is a trading business. DR Purchase..................... 10,000.00 EUR DR VAT.......................... 2,000.00 EUR CR Accounts Payables............ 12,000.00 EUR DR Purchase..................... 8,000.00 EUR DR VAT.......................... 1,600.00 EUR CR Accounts Payables............ 9,600.00 EUR <?page no="501"?> DR Purchase..................... 12,000.00 EUR DR VAT.......................... 2,400.00 EUR CR Accounts Payables............ 14,400.00 EUR DR Discount Received ............ 1,800.00 EUR CR Accounts Payables............ 1,800.00 EUR DR Purchase..................... 30,000.00 EUR DR VAT.......................... 6,000.00 EUR CR Accounts Payables............ 36,000.00 EUR DR Accounts Payables............ 34,200.00 EUR CR Cash/ Bank.................... 34,200.00 EUR <?page no="502"?> 10,000.00 2,000.00 8,000.00 1,600.00 12,000.00 2,400.00 1,800.00 12,000.00 1,800.00 9,600.00 34,200.00 14,400.00 36,000.00 36,000.00 34,200.00 34,200.00 ... 34,200.00 Figure 36.1: FIXCARS (Pty) Ltd.’s accounts DR Discount Received............ 500.00 EUR CR Purchase..................... 500.00 EUR DR Discount Received............ 100.00 EUR CR VAT.......................... 100.00 EUR DR Discount Received............ 400.00 EUR CR Purchase..................... 400.00 EUR <?page no="503"?> DR Discount Received ............ 80.00 EUR CR VAT.......................... 80.00 EUR DR Discount Received ............ 600.00 EUR CR Purchase..................... 600.00 EUR DR Discount Received ............ 120.00 EUR CR VAT.......................... 120.00 EUR 10,000.00 500.00 2,000.00 100.00 8,000.00 400.00 1,600.00 80.00 12,000.00 600.00 2,400.00 120.00 28,500.00 5,700.00 30,000.00 30,000.00 6,000.00 6,000.00 28,500.00 5,700.00 1,800.00 12,000.00 500.00 1,800.00 9,600.00 100.00 34,200.00 14,400.00 400.00 36,000.00 36,000.00 80.00 34,200.00 34,200.00 600.00 120.00 1,800.00 1,800.00 ... 34,200.00 Figure 36.2: FIXCARS (Pty) Ltd.’s accounts <?page no="504"?> DR Purchase..................... 28,500.00 EUR DR VAT.......................... 5,700.00 EUR CR Accounts Payables............ 34,200.00 EUR We now check the accounts at HETKRUIS Ltd., who is the seller. In order to make the recording distinguishable to FIXCARS (Pty) Ltd.’s ones, we identify HETKRUIS Ltd.’s Bookkeeping entries by capitals. DR Accounts Receivables......... 12,000.00 EUR CR VAT.......................... 2,000.00 EUR CR Sales........................ 10,000.00 EUR DR Accounts Receivables......... 9,600.00 EUR CR VAT.......................... 1,600.00 EUR CR Sales........................ 8,000.00 EUR DR Accounts Receivables......... 14,400.00 EUR CR VAT.......................... 2,400.00 EUR CR Sales........................ 12,000.00 EUR DR Discount Allowed............. 1,800.00 EUR CR Accounts Receivable.......... 1,800.00 EUR <?page no="505"?> 10,000.00 2,000.00 8,000.00 1,600.00 12,000.00 2,400.00 12,000.00 1,800.00 1,800.00 9,600.00 14,400.00 Figure 36.3: HETKRUIS Ltd.’s accounts DR Cash......................... 34,200.00 EUR CR Accounts Receivables......... 34,000.00 EUR DR Sale......................... 500.00 EUR CR Discount Allowed............. 500.00 EUR DR VAT.......................... 100.00 EUR CR Discount Allowed............. 100.00 EUR DR Sale......................... 400.00 EUR CR Discount Allowed............. 400.00 EUR <?page no="506"?> DR VAT.......................... 80.00 EUR CR Discount Allowed............. 80.00 EUR DR Sales........................ 600.00 EUR CR Discount Allowed............. 600.00 EUR DR VAT.......................... 120.00 EUR CR Discount Allowed............. 120.00 EUR 500.00 10,000.00 100.00 2,000.00 400.00 8,000.00 80.00 1,600.00 600.00 12,000.00 120.00 2,400.00 28,500.00 5,700.00 30,000.00 30,000.00 6,000.00 6,000.00 28,500.00 5,700.00 12,000.00 1,800.00 1,800.00 500.00 9,600.00 34,200.00 100.00 14,400.00 400.00 36,000.00 36,000.00 80.00 600.00 120.00 1,800.00 1,800.00 ... 34,200.00 Figure 36.4: HETKRUIS Ltd.’s accounts <?page no="507"?> In some events, the agreement on the discount takes place after the balance sheet date. Assume in the previous case study, HETKRUIS Ltd. allows a discount, once a customer orders for 50,000.00 EUR within a period of 2 years. If the discount is allowed for purchases in past Accounting periods, an adjustment for inventories only will be made for goods still on stock. In order to dissolve the Discount account, we recommend posting the discount received for prior Accounting period’s purchase to inventories as far as possible and then closing-off the Discount account to other income. In particular, it is not intended to adjust finished goods for discounted parts included therein, purchased before the discount but eligible for it. However, the VAT account needs adjustment (for other income), too. We show a discount received for an acquisition in the next case study BELLICK AG. In that case study, the discount is allowed in the next Accounting period due to a customer’s complaint. DR P, P, E Account.............. 1,260.00 EUR DR VAT.......................... 252.00 EUR CR Cash/ Bank.................... 1,512.00 EUR DR Depreciation ................. 105.00 EUR CR Acc. Depr.................... 105.00 EUR 1,260.00 1,260.00 ... 1,512.00 1,260.00 1,512.00 1,512.00 1,512.00 1,512.00 Figure 36.5: BELLICK AG’s accounts as at 31.12.20X7 <?page no="508"?> 252.00 252.00 105.00 105.00 252.00 105.00 105.00 105.00 105.00 105.00 105.00 105.00 Figure 36.5: BELLICK AG’s accounts as at 31.12.20X7 (continued) DR Cash/ Bank.................... 252.00 EUR CR VAT.......................... 252.00 EUR DR Cash/ Bank.................... 72.00 EUR CR Discount Received............ 72.00 EUR DR Discount Received............ 72.00 EUR CR VAT.......................... 12.00 EUR CR P, P, E Account.............. 60.00 EUR <?page no="509"?> Depreciation.................... 105.00 EUR CR Accumulated Depreciation..... 105.00 EUR Depreciation.................... 297.00 EUR CR Accumulated Depreciation..... 297.00 EUR 1, 2 6 0.0 0 1, 2 6 0.0 0 ... 1 ,5 1 2. 0 0 1, 2 6 0.0 0 6 0.0 0 1, 5 1 2.0 0 1, 2 0 0.0 0 1 ,5 1 2. 0 0 1 ,5 1 2. 0 0 1, 2 6 0.0 0 1, 2 6 0.0 0 2 5 2. 0 0 1 ,5 1 2. 0 0 1, 2 0 0.0 0 7 2 .0 0 1, 1 8 8.0 0 1, 5 1 2.0 0 1 , 5 1 2. 0 0 1 ,1 8 8. 0 0 252.00 252.00 105.00 252.00 252.00 297.00 402.00 12.00 12.00 402.00 402.00 264.00 264.00 402.00 402.00 12.00 105.00 105.00 402.00 402.00 105.00 105.00 507.00 297.00 507.00 507.00 507.00 Figure 36.6: BELLICK AG’s accounts as at 31.12.20X8 <?page no="510"?> 60.00 72.00 12.00 72.00 72.00 Figure 36.6: BELLICK AG’s accounts as at 31.12.20X8 Summary: Discounts can be received or allowed. The consideration of discounts is required along the IFRSs and national GAAPS, e.g., the German Handelsgesetzbuch. They state that the entries in the Purchaseor Property, Plant and Equipment account, in the Sales account and in the VAT account are at ex-discount-values. Discounts are recorded once notice is taken thereof. For discounts known at the time of purchase/ sale, an instant discount is recorded. This leads to a price reduction. In all other cases, when the decision about the discount is made after recording the purchase/ sales, a deferred discount is recorded. Then, the Discount accounts (Discount Received account or Discount Allowed account) apply. Working Definition: Discount Account: A Discount account is a temporary account to record discounts. <?page no="511"?> Learning Objectives: Companies have accounts at banks, such as Commerzbank, FNB etc. The banks keep a record of payments that go into the accounts and payments out of the accounts and can derive the account’s balancing figure. Additionally, a firm’s Accountants represent bank accounts by internal accounts. They are subordinated to the Cash/ Bank account. Hence, the bank and the company record payment movements parallel to each other. (Note, in order to distinguish the accounts, we write the Bank account that is linked to our own Bookkeeping records with capital letters. When we refer to the account recorded by the bank we take small letters. Our Commerzbank Bank account - their Commerzbank bank account.) In this chapter, we point out how to compare Bank accounts with bank statements sent by the bank. Furthermore, we show how to adjust differences between accounts by making extra Bookkeeping entries in (our) Bank accounts. After studying this chapter, you can explain reasons for differences between Bookkeeping records and bank statements and you can reconcile the bank statements with the Bookkeeping records. A bank statement is a summary of all activities with the bank over an Accounting period. Mostly, bank statements are printable on demand (online banking) or your bank sends it to you monthly. An example for a bank statement is depicted by Figure 37.1. In general, bank statements come in a 3-column format and not as a T-account, such as we are used to. In order to understand bank statements, consider the bank statement is always prepared from your bank’s point of view. This means, money you have in the bank account is regarded as payable by the bank. The reason is, the bank has to pay the money in the accounts back to its owner - which is the account holder. Accordingly, bank deposits are printed on the credit side of the bank statement and withdrawals on its debit side. - A deposit is any transaction to put money into a bank account. A deposit can be made by the account holder or by, e.g., a customer thereof. A deposit can be done by visiting the bank and filling a deposit slip. Alternatively, an electronic fund transfer (EFT) can be made by internet banking. Receiving a stop order (see below) can be another way to receive funds. <?page no="512"?> - A stop order is an agreement with the bank to pay regularly money into another account. A stop order can be for monthly payments, for quarterly payments, etc. The order is called stop order as it continues until the account holder will stop it. - A debit order is an order to let someone draw money from an account. It means the party that issues the debit order, allows the bank of the receiving party to withdraw a certain amount of money from the account. Figure 37.1: KRAGGA CONSULTANTS Ltd.’s bank statement - A cheque is an alternative way of payment. One party that issues (draws) a cheque allows the receiving party to withdraw money from its account. If there are sufficient funds the bank transfers the money. Otherwise, the bank returns the cheque marked as R/ D (= Refer to drawer). A returned cheque is called bounced or dishonoured. In case a cheque has not been cleared for more than 6 months, it will expire. The technical term for such a cheque is a stale cheque. Cheques can be cancelled by the issuer, too - e.g., if a customer does not receive ordered goods he/ she will make use of this possibility to cancel the payment. - Service fees are bank fees for running an account. They are levied <?page no="513"?> based on periods (PRT, pro rata) or on the amount of transactions. - A withdrawal is taking cash out of a bank account. This can be done in the bank at the desk or through an automatic teller machine (ATM). - An EFT transfer is a transfer made by internet banking. EFT stands for electronic funds transfer. - EFT charges mean that the bank charges a transfer fee for using internet banking. Some banks charge the customer per transaction. - Interest income is revenue earned by keeping money in an account. The bank calculates the amount by an annual interest rate pro rata temporis, which is based on the time the funds stay in the account. Special terms may apply. (Note, in this text book we calculate interest accurate to the month, however in this chapter, we calculate accurate to the day.) We return to the case study: DR Bank......................... 100,000.00 EUR CR Issued Capital............... 100,000.00 EUR DR Insurance.................... 100.00 EUR CR Bank......................... 100.00 EUR DR Insurance.................... 100.00 EUR CR Bank......................... 100.00 EUR DR Insurance.................... 100.00 EUR CR Bank......................... 100.00 EUR DR Insurance.................... 100.00 EUR CR Bank......................... 100.00 EUR <?page no="514"?> DR P, P, E Account.............. 50,000.00 EUR DR VAT.......................... 10,000.00 EUR CR Bank......................... 60,000.00 EUR DR P, P, E Account.............. 360.00 EUR DR VAT.......................... 60.00 EUR CR Bank......................... 300.00 EUR DR Bank......................... 240,000.00 EUR CR VAT.......................... 40,000.00 EUR CR Revenue...................... 200,000.00 EUR (Note, we’ll introduce the petty cash book in the next chapter (38): Petty Cash Book.) DR Cash......................... 5,000.00 EUR CR Bank......................... 5,000.00 EUR DR Bank......................... 6,000.00 EUR CR VAT.......................... 1,000.00 EUR CR Revenue...................... 5,000.00 EUR <?page no="515"?> DR Rent......................... 6,500.00 EUR CR Bank......................... 6,500.00 EUR DR Bank......................... 54,000.00 EUR CR VAT.......................... 9,000.00 EUR CR Revenue...................... 45,000.00 EUR DR Labour....................... 230,000.00 EUR CR Bank......................... 230,000.00 EUR 100,000.00 100.00 100,000.00 100,000.00 240,000.00 100.00 100,000.00 6,000.00 100.00 54,000.00 100.00 60,000.00 360.00 5,000.00 6,500.00 170,000.00 157,740.00 400,000.00 400,000.00 157,740.00 100.00 50,000.00 100.00 300.00 50,300.00 100.00 50,300.00 50,300.00 100.00 400.00 50,300.00 400.00 400.00 400.00 Figure 37.2: KRAGGA CONSULTANTS Ltd.’s accounts <?page no="516"?> 10,000.00 40,000.00 200,000.00 60.00 1,000.00 5,000.00 39,940.00 9,000.00 250,000.00 45,000.00 50,000.00 50,000.00 250,000.00 250,000.00 39,940.00 250,000.00 5,000.00 5,000.00 6,500.00 6,500.00 5,000.00 6,500.00 170,000.00 170,000.00 170,000.00 Figure 37.2: KRAGGA CONSULTANTS Ltd.’s accounts (continued) For the explanation of the difference and to adjust the Bookkeeping records, we reconcile the bank statement with the Bookkeeping records. The reason for the bank reconciliation is that the reporting company has to ensure that the amount for the cash/ bank item on the statement of financial position is correct. The reconciliation process in particular makes sure, all available information provided by the bank statement is used to determine the correct amount for the cash/ bank item on the face of the statement of financial position. Reconciliation items therefore only appear in the Cash/ Bank account or on the bank statement but never in both at the same time. How it is done (bank statement reconciliation): (1) Compare the Cash/ Bank account to the bank statement provided. (2) Add bank fees withdrawn from the bank account without further notice. (3) Adjust timely differences between the Bank account and the bank statement in the Cash/ Bank account. (4) Calculate interest earned if there is any on a pro rata temporis policy and based on the annual rate of interest. <?page no="517"?> (5) Compare the adjusted Cash/ Bank account to the bank statement for final check. 100,000.00 100.00 240,000.00 100.00 6,000.00 100.00 54,000.00 100.00 60,000.00 360.00 5,000.00 6,500.00 170,000.00 157,740.00 400,000.00 400,000.00 157,740.00 Figure 37.3: KRAGGA CONSULTANTS Ltd.’s Bank account <?page no="518"?> Figure 37.4: KRAGGA CONSULTANTS Ltd.’s bank statement DR Bank Fees.................... 79.50 EUR CR Cash/ Bank.................... 79.50 EUR <?page no="519"?> DR Bank......................... 2,969.85 EUR CR Interest Earned.............. 2,969.85 EUR 100,000.00 100.00 100,000.00 100,000.00 240,000.00 100.00 100,000.00 6,000.00 100.00 54,000.00 100.00 60,000.00 360.00 5,000.00 6,500.00 170,000.00 157,740.00 400,000.00 400,000.00 157,740.00 79.50 2,969.85 160,630.35 160,709.85 160,709.85 160,630.35 Figure 37.5: KRAGGA CONSULTANTS Ltd.’s accounts <?page no="520"?> 100.00 50,000.00 100.00 300.00 50,300.00 100.00 50,300.00 50,300.00 100.00 400.00 50,300.00 400.00 400.00 400.00 10,000.00 40,000.00 200,000.00 60.00 1,000.00 5,000.00 39,940.00 9,000.00 250,000.00 45,000.00 50,000.00 50,000.00 250,000.00 250,000.00 39,940.00 250,000.00 5,000.00 5,000.00 6,500.00 6,500.00 5,000.00 6,500.00 170,000.00 170,000.00 79.50 79.50 170,000.00 79.50 2,969.85 2,969.85 2,969.85 Figure 37.5: KRAGGA CONSULTANTS Ltd.’s accounts (continued) DR Profit and Loss.............. 400.00 EUR CR Insurance.................... 400.00 EUR DR Profit and Loss.............. 6,500.00 EUR CR Rent......................... 6,500.00 EUR <?page no="521"?> DR Profit and Loss.............. 170,000.00 EUR CR Labour....................... 170,000.00 EUR DR Sales........................ 250,000.00 EUR CR Profit and Loss.............. 250,000.00 EUR DR Interest Earned.............. 2,969.85 EUR CR Profit and Loss.............. 2,969.85 EUR 100,000.00 100.00 100,000.00 100,000.00 240,000.00 100.00 100,000.00 6,000.00 100.00 54,000.00 100.00 60,000.00 360.00 5,000.00 6,500.00 170,000.00 157,740.00 400,000.00 400,000.00 157,740.00 79.50 2,969.85 160,630.35 160,709.85 160,709.85 160,630.35 100.00 50,000.00 100.00 300.00 50,300.00 100.00 50,300.00 50,300.00 100.00 400.00 50,300.00 400.00 400.00 400.00 400.00 Figure 37.6: KRAGGA CONSULTANTS Ltd.’s accounts <?page no="522"?> 10,000.00 40,000.00 200,000.00 60.00 1,000.00 5,000.00 39,940.00 9,000.00 250,000.00 45,000.00 50,000.00 50,000.00 250,000.00 250,000.00 39,940.00 250,000.00 250,000.00 5,000.00 5,000.00 6,500.00 6,500.00 5,000.00 6,500.00 6,500.00 170,000.00 170,000.00 79.50 79.50 170,000.00 170,000.00 79.50 79.50 2,969.85 2,969.85 400.00 250,000.00 2,969.85 2,969.85 6,500.00 2,969.85 170,000.00 79.50 75,990.35 252,969.85 252,969.85 22,797.11 75,990.35 53,193.25 75,990.35 75,990.35 22,797.11 22,797.11 53,193.25 53,193.25 22,797.11 53,193.25 Figure 37.6: KRAGGA CONSULTANTS Ltd.’s accounts (continued) <?page no="523"?> Figure 37.7: KRAGGA CONSULTANTS Ltd.’s income statement Figure 37.8: KRAGGA CONSULTANTS Ltd.’s statement of financial position <?page no="524"?> Summary: A bank statement can reveal further information which is not always directly available to the Accountant in the first place. Items can be missing in the bank statements, too, which have been posted in the Accounting records due to timely differences. The reconciliation process compares the Bookkeeping records to the bank statement and requires adjustments to make sure that all actual information for the cash/ bank item on the statement of financial position and for the income statement (such as bank fees) are considered. Working Definitions: Bank Statement: A bank statement is a summary of all activities with the bank over an Accounting period. Deposit: A deposit is any transaction to put money into a bank account. A deposit can be made by yourself or by a customer for example. Stop order: A stop order is an agreement with the bank to pay regularly money into another account. Debit order: A debit order is an order to let someone draw money from an account. Cheque: A cheque is an alternative way of payment. One party that issues (draws) a cheque allows the receiving party to withdraw money from its account. Service Fees: Service fees are bank fees for running an account. Withdrawal: A withdrawal is taking cash out of an account. This can be done in the bank or through an automatic teller machine (ATM). EFT Transfer: An EFT transfer is a transfer made by internet banking. EFT stands for electronic funds transfer. EFT Charges: EFT charges mean that the bank charges a transfer fee for using internet banking. Interest Income: Interest income is revenue earned by keeping money in the account. <?page no="525"?> Learning Objectives: In this chapter, we introduce the first book of original entries, others follow in chapter (39): Books of Original Entries. We explain the concept of the petty cash book (PCB) and how reimbursements work by the case study SWARTKLIP Ltd. After studying this chapter, you can apply the Petty Cash Book. Not all purchases and acquisitions are paid through bank accounts. Some activities are of minor value or importance and are simply bought on cash. E.g., office errands for coffee, paper clips etc. are most likely paid on cash. For keeping Bookkeeping records and for the preparation of a complete income statement, it is necessary to assign even minor expenditures to the appropriate expense accounts. It is common practice to run one or even several Petty Cash Books. The Petty Cash Book is a record for minor purchases bought on cash. At the beginning of the Accounting period, an amount - referred to as petty cash float - is paid to the keeper of the Petty Cash Book. The petty cash float is the initial amount in the petty cash book. After making purchases, all receipts are allocated to the applicable expense category which is later assigned to a specific account, such as the Office Materials-, Decorationsor Business Entertainment account. In general at the end of the month, the Petty Cash Book is filled up again, which means, an amount is added to the Petty Cash Book, so that the petty cash float is reached again. The person responsible for the Petty Cash Book is called the petty cashier. Commonly, companies apply several petty cash books, normally department-wise. We explain the Petty Cash Book by the case study SWARTKLIP Ltd., which covers expenses recorded through the petty cash book. We compare these expense to those that are posted straight to normal expenses. How it is done (Petty Cash Book): (1) Draw an amount of cash from the Cash/ Bank account and add it to the Petty Cash Book. This amount is the petty cash float. (2) Determine rules which kind of expenses are recorded in the petty cash book and which ones are not. (3) When an expense is paid for a Petty Cash Book-relevant activity, credit the gross amount to the petty cash book and make debit entries for input-VAT and particular expense columns in the Petty Cash Book. (4) At the end of the Accounting period or when the petty cash float has been spent, add payments to fill up the Petty Cash Book. <?page no="526"?> (5) Transfer the sum of expenses and the sum of input- VAT into the expense accounts and to the VAT account. (6) Reimburse the petty cashier for the money spent. DR Bank Account................. 50,000.00 EUR CR Issued Capital............... 50,000.00 EUR DR Bank Account................. 100,000.00 EUR CR Interest Bearing Liabilities. 100,000.00 EUR DR Interest..................... 3,500.00 EUR CR Bank Account................. 3,500.00 EUR DR Interest Bearing Liabilities. 5,000.00 EUR CR Bank Account................. 5,000.00 EUR DR Interest Bearing Liabilities. 5,000.00 EUR CR Accounts Payables............ 5,000.00 EUR DR P, P, E Account.............. 70,000.00 EUR DR VAT.......................... 14,000.00 EUR CR Bank Account................. 84,000.00 EUR <?page no="527"?> DR Depreciation ................. 20,000.00 EUR CR Acc. Depr.................... 20,000.00 EUR DR Rent......................... 10,000.00 EUR CR Bank Account................. 10,000.00 EUR DR Cash Account................. 1,000.00 EUR CR Bank Account................. 1,000.00 EUR DR Petty Cash Book.............. 500.00 EUR CR Cash Account................. 500.00 EUR (Note, you find a similar template included in the file on the website www.UVK- Lucius.de/ Bilanzen for download.) <?page no="528"?> Figure 38.1: SWARTKLIP Ltd.‘s Petty Cash Book (1) DR Purchase..................... 100.00 EUR DR VAT.......................... 20.00 EUR CR Accounts Payables............ 120.00 EUR DR Accounts Payables............ 120.00 EUR CR Bank Account................. 120.00 EUR <?page no="529"?> DR Stationary Expenses.......... 100.00 EUR CR Purchase..................... 100.00 EUR Figure 38.2: SWARTKLIP Ltd.’s petty cash book (2) Figure 38.3: SWARTKLIP Ltd.’s petty cash book (3) <?page no="530"?> DR Petty Cash Book.............. 396.00 EUR CR Cash......................... 396.00 EUR Figure 38.4: SWARTKLIP Ltd.’s petty cash book (4) DR VAT.......................... 66.00 EUR CR Petty Cash Book.............. 66.00 EUR <?page no="531"?> DR Stationary Expenses.......... 225.00 EUR CR Petty Cash Book.............. 225.00 EUR DR Catering Expenses............ 25.00 EUR CR Petty Cash Book.............. 25.00 EUR DR Decoration Expenses.......... 22.50 EUR CR Petty Cash Book.............. 22.50 EUR DR Business Car Expenses........ 57.50 EUR CR Petty Cash Book.............. 57.50 EUR DR Bank Account................. 75,000.00 EUR CR VAT.......................... 12,500.00 EUR CR Revenue...................... 62,500.00 EUR DR Labour....................... 50,000.00 EUR CR Bank Account................. 50,000.00 EUR <?page no="532"?> 50,000.00 3,500.00 50,000.00 50,000.00 100,000.00 5,000.00 50,000.00 75,000.00 84,000.00 10,000.00 1,000.00 120.00 50,000.00 71,380.00 225,000.00 225,000.00 71,380.00 5,000.00 100,000.00 3,500.00 3,500.00 5,000.00 3,500.00 90,000.00 10,000.00 100,000.00 90,000.00 70,000.00 70,000.00 14,000.00 12,500.00 70,000.00 20.00 66.00 1,586.00 14,086.00 14,086.00 1,586.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 10,000.00 10,000.00 1,000.00 500.00 10,000.00 396.00 104.00 1,000.00 1,000.00 104.00 Figure 38.5: SWARTKLIP Ltd.’s accounts <?page no="533"?> 500.00 66.00 100.00 100.00 396.00 225.00 25.00 22.50 57.50 500.00 896.00 896.00 50,000.00 50,000.00 500.00 50,000.00 120.00 5,000.00 100.00 5,000.00 120.00 225.00 325.00 5,120.00 5,120.00 325.00 325.00 5,000.00 325.00 25.00 25.00 22.50 22.50 25.00 22.50 57.50 57.50 62,500.00 62,500.00 57.50 62,500.00 Figure 38.5: SWARTKLIP Ltd.’s accounts (continued) DR Profit and Loss.............. 3,500.00 EUR CR Interest..................... 3,500.00 EUR DR Profit and Loss.............. 20,000.00 EUR CR Depreciation ................. 20,000.00 EUR DR Profit and Loss.............. 10,000.00 EUR CR Rent......................... 10,000.00 EUR <?page no="534"?> DR Profit and Loss.............. 325.00 EUR CR Stationary Expenses.......... 325.00 EUR DR Profit and Loss.............. 25.00 EUR CR Catering Expenses............ 25.00 EUR DR Profit and Loss.............. 22.50 EUR CR Decoration Expenses.......... 22.50 EUR DR Profit and Loss.............. 57.50 EUR CR Business Car Expenses........ 57.50 EUR DR Profit and Loss.............. 50,000.00 EUR CR Labour....................... 50,000.00 EUR DR Revenue...................... 62,500.00 EUR CR Profit and Loss.............. 62,500.00 EUR Observe the accounts: 50,000.00 3,500.00 50,000.00 50,000.00 100,000.00 5,000.00 50,000.00 75,000.00 84,000.00 10,000.00 1,000.00 120.00 50,000.00 71,380.00 225,000.00 225,000.00 71,380.00 5,000.00 100,000.00 3,500.00 3,500.00 95,000.00 3,500.00 3,500.00 100,000.00 100,000.00 95,000.00 Figure 38.6: SWARTKLIP Ltd.’s accounts <?page no="535"?> 70,000.00 70,000.00 14,000.00 12,500.00 70,000.00 20.00 66.00 1,586.00 14,086.00 14,086.00 1,586.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 10,000.00 10,000.00 1,000.00 500.00 10,000.00 10,000.00 396.00 104.00 1,000.00 1,000.00 104.00 500.00 66.00 100.00 100.00 396.00 225.00 25.00 22.50 57.50 500.00 896.00 896.00 50,000.00 50,000.00 500.00 50,000.00 50,000.00 120.00 5,000.00 100.00 5,000.00 120.00 225.00 325.00 5,120.00 5,120.00 325.00 325.00 5,000.00 325.00 325.00 Figure 38.6: SWARTKLIP Ltd.’s accounts (continued) <?page no="536"?> 25.00 25.00 22.50 22.50 25.00 25.00 22.50 22.50 57.50 57.50 62,500.00 62,500.00 57.50 57.50 62,500.00 62,500.00 3,500.00 62,500.00 21,430.00 21,430.00 20,000.00 21,430.00 10,000.00 325.00 25.00 22.50 57.50 50,000.00 21,430.00 83,930.00 62,500.00 21,430.00 21,430.00 Figure 38.6: SWARTKLIP Ltd.’s accounts (continued) <?page no="537"?> Figure 38.7: SWARTKLIP Ltd.’s income statement Figure 38.8: SWARTKLIP Ltd.’s statement of financial position <?page no="538"?> Summary: The petty cash book applies for recording minor purchases and expenses paid on cash. The concept guarantees that input-VAT and all expenses are recorded and allocated correctly. Instead of recording each and every purchase or expense, the petty cash book gathers purchases and expenses and allows making Bookkeeping entry for the totals only. Due to this concept, the Petty Cash Book forms a portion of the Bookkeeping records and must be saved. Working Definitions: Petty Cash Book: The petty cash book is a record for minor purchases bought on cash. Petty Cash Float: The petty cash float is the initial amount in the petty cash book. <?page no="539"?> Learning Objectives: To our experience, you can survive as an Accountant without knowledge about books of original entry. Nowadays, the need to apply books of original entries (BOE) is low, because companies record Bookkeeping entries by computer software. As a result, you can make as many Bookkeeping entries as you want. In the old days, the BOE-concept was used to split Accounting work and therefore to reduce the amount of entries made in the Bookkeeping records. We only write this chapter with the intention to make you familiar with the concept of books of original entry in case you see it in a company or taught at the university. Books of original entries are still included in the Accounting syllabus at most universities. Books of original entry are documents to gather purchases or sales, for example. They apply to reduce the amount of Bookkeeping entries. A huge production company might have thousands of Bookkeeping entries for purchases every day. In the old days of Accounting, when the Bookkeeper made all entries on paper, the huge amount of Bookkeeping entries would have filled the records quickly. Consider that Bookkeeping entries were made on paper and did not allow parallel recording. At that time, it made sense to gather Bookkeeping entries in a separate document outside of the Bookkeeping records at first and to make Bookkeeping entries for a few hundred of purchases together later. We experienced this method with regard to the Petty Cash Book in the previous chapter already. In order to understand the concept of books of original entry, think about a small paper block you keep in the glove compartment of your car. Every time when you go to a gas station to fuel-up your car, you write the paid amount on this paper block and you keep the receipt, too. At the end of the month, you have made a few entries on the paper block and you calculate the sum of your petrol purchases. Then, you only make one single Bookkeeping entry for the total of your petrol expenses together. You debit the net amount to the Petrol Expense account and the input-VAT to your VAT account and you make a credit entry in the Bank account - provided you always pay by your credit card at the gas stations. Your paper block would be regarded as a book of original entry. A book of original entry is a list for similar Bookkeeping entries, such as purchases, sales, labour, etc. Only the total of the entries are recorded as Bookkeeping entries. The book of original entry with its single entries therein, must be kept as a Bookkeeping document. Books of original entry are commonly called journals, too. E.g., purchase journal for a book of original entry that contains purchases. Companies apply books of original entry for purchases, for sales, for the cash book, for returns inwards and for returns <?page no="540"?> outwards. In case a company applies books of original entry, the cash book dominates the other ones. Hence, purchases are only recorded in the purchase journal, if they have been made on credit. In contrast, a cash purchase is recorded in the cash book. The cash book differs a little bit from other books of original entries. It actually replaces the Cash/ Bank account. Hence, it falls under real accounts. It contains columns for different banks and a cash column. A company that banks with Commerzbank AG and with Sparkasse Osnabrück would use one column for cash, one for bank “Commerzbank AG” and another one for bank “Sparkasse Osnabrück”, for example. The format for the books of original entries which represent items on the debit side (e.g. Purchase Journal, Cash Book) is DR(CR). This means debit entries are disclosed as positive amounts and credit entries are negative. (Remember, we write negative amounts in brackets.) If you compare the concept to the previous chapter (38): Petty Cash Book, you easily understand, the Petty Cash Book is a book of original entry, too. How it is done (purchase journal): (1) Create a purchase journal as a list document. You can use the MS-Excel file provided through our website www.UTB-Lucius.de/ Bilanzen. (2) When a purchase takes place, check whether or not it is on cash. Cash purchases are not subject to the purchase journal. (3) Record a purchase on credit in the purchase journal. Make an entry for the net amount and for input- VAT. (4) If your company does not apply a Returns Outwards account, record returns outwards without payment-compensation as negative purchases in the purchase journal. (5) At the end of the Accounting period, add-up all purchases recorded. (6) Transfer the total of purchases into the Purchase account and the total of VAT into the VAT account. (7) Make credit entries in the Accounts Payables, or rather in the subordinated business partner related accounts thereof. (Note, we describe the Purchase Journal as an example. Other journals work similarly.) We explain the concept of books of original entries by the case study MUIRFIELD (Pty) Ltd., which is a trading company. <?page no="541"?> DR Cash Book (Bank)............. 50,000.00 EUR CR Issued Capital............... 50,000.00 EUR (Note, the Bookkeeping entry contains the column within the Cash Book in brackets.) Figure 39.1: MUIRFIELD (Pty) Ltd.’s Cash Book <?page no="542"?> DR Rent......................... 12,000.00 EUR CR Cash Book (Bank)............. 12,000.00 EUR DR Purchase..................... 1,600.00 EUR DR VAT.......................... 320.00 EUR CR Cash Book (Bank)............. 1,920.00 EUR <?page no="543"?> Figure 39.2: MUIRFIELD (Pty) Ltd.‘s purchase journal An open item Bookkeeping system is a purchase, sales or human resource ledger as a subsidiary ledger where every supplier, customer or employee has an individualised account. In an open item Bookkeeping system it becomes easy to observe which payment to which supplier, from which customer or to which employee is still outstanding (= open). <?page no="544"?> DR Purchase..................... 40,550.00 EUR DR VAT.......................... 8,110.00 EUR CR A/ P (AFRICAN MUSIC).......... 9,600.00 EUR CR A/ P (MUSIC IMPORT)........... 8,160.00 EUR CR A/ P (AFRICAN MUSIC).......... 4,650.00 EUR CR A/ P (eMUSIC)................. 7,560.00 EUR DR A/ P (MUSIC IMPORT)........... 960.00 EUR CR A/ P (eMUSIC)................. 16,200.00 EUR CR A/ P (RAINBOW)................ 3,450.00 EUR (Note, it would have looked better pulling the 7th entry upwards to the other debit entries. We didn’t do that for the sake of a better overview.) DR Cash Book (Cash)............. 3,180.00 EUR CR VAT.......................... 530.00 EUR CR Sales........................ 2,650.00 EUR DR Cash Book (Cash)............. 2,385.00 EUR CR VAT.......................... 397.50 EUR CR Sales........................ 1,987.50 EUR <?page no="545"?> DR Cash Book (Cash)............. 12,720.00 EUR CR VAT.......................... 2,120.00 EUR CR Sales........................ 10,600.00 EUR DR Cash Book (Bank)............. 10,000.00 EUR CR Cash Book (Cash)............. 10,000.00 EUR DR A/ P (eMUSIC)................. 23,760.00 EUR CR Cash Book (Bank)............. 23,760.00 EUR DR Labour....................... 5,000.00 EUR CR Cash Book (Bank)............. 5,000.00 EUR <?page no="546"?> Figure 39.3: MUIRFIELD (Pty) Ltd.‘s Cash Book 50,000.00 50,000.00 12,000.00 12,000.00 50,000.00 12,000.00 320.00 530.00 1,600.00 8,110.00 397.50 40,550.00 42,150.00 2,120.00 42,150.00 42,150.00 5,382.50 42,150.00 8,430.00 8,430.00 5,382.50 9,600.00 960.00 8,160.00 14,250.00 4,650.00 7,200.00 14,250.00 14,250.00 8,160.00 8,160.00 14,250.00 7,200.00 Figure 39.4: MUIRFIELD (Pty) Ltd.’s accounts (cash book in figure 39.3) <?page no="547"?> 23,760.00 7,560.00 3,450.00 3,450.00 16,200.00 3,450.00 23,760.00 23,760.00 2,650.00 5,000.00 5,000.00 1,987.50 5,000.00 15,237.50 10,600.00 15,237.50 15,237.50 15,237.50 Figure 39.4: MUIRFIELD (Pty) Ltd.’s accounts (continued) (Note, by the calculator-based trial balance application we run a „light“-trial balance. A trial balance is recommended because making Bookkeeping entries in 2 figures (accounts and another one for journals) is likely to end up faulty.) DR Inventory.................... 32,800.00 EUR CR Trading Account.............. 32,800.00 EUR DR Sales ....................... 15,237.50 EUR CR Trading Account.............. 15,237.50 EUR <?page no="548"?> DR Trading Account.............. 42,150.00 EUR CR Purchase..................... 42,150.00 EUR DR Trading Account.............. 5,887.50 EUR CR P&L-Account.................. 5,887.50 EUR DR Profit and Loss.............. 12,000.00 EUR CR Rent......................... 12,000.00 EUR DR Profit and Loss.............. 5,000.00 EUR CR Labour....................... 5,000.00 EUR DR Retained Earnings............ 11,112.50 EUR CR P&L-Account.................. 11,112.50 EUR 50,000.00 50,000.00 12,000.00 12,000.00 50,000.00 12,000.00 12,000.00 320.00 530.00 1,600.00 8,110.00 397.50 40,550.00 42,150.00 2,120.00 42,150.00 42,150.00 5,382.50 42,150.00 42,150.00 8,430.00 8,430.00 5,382.50 Figure 39.5: MUIRFIELD (Pty) Ltd.‘s accounts (cash book in figure 39.3) <?page no="549"?> 9,600.00 960.00 8,160.00 14,250.00 4,650.00 7,200.00 14,250.00 14,250.00 8,160.00 8,160.00 14,250.00 7,200.00 23,760.00 7,560.00 3,450.00 3,450.00 16,200.00 3,450.00 23,760.00 23,760.00 2,650.00 5,000.00 5,000.00 1,987.50 5,000.00 5,000.00 15,237.50 10,600.00 15,237.50 15,237.50 15,237.50 15,237.50 42,150.00 15,237.50 32,800.00 32,800.00 5,887.50 32,800.00 32,800.00 48,037.50 48,037.50 5,887.50 5,887.50 12,000.00 5,887.50 11,112.50 11,112.50 5,000.00 11,112.50 11,112.50 17,000.00 17,000.00 11,112.50 11,112.50 Figure 39.5: MUIRFIELD (Pty) Ltd.‘s accounts (continued) <?page no="550"?> Figure 39.6: MUIRFIELD (Pty) Ltd.‘s statement of financial position Figure 39.7: MUIRFIELD (Pty) Ltd.‘s income statement <?page no="551"?> Summary: Books of original entry are documents to gather items resulting from numerous transactions, such as purchases, sales, returns, etc. The books of original entry allow to make Bookkeeping entries for sums. The only book of original entry that is regarded as a real account is the Cash Book. All the other books of original entry are no genuine accounts in terms of the double entry system. The total of their items must be transferred into accounts, such as the total of purchases of the Purchase Journal into the Purchase account. Working Definitions: Books of Original Entry: A book of original entry is a list for similar Bookkeeping entries, such as purchases, sales, labour, etc. Open Item Bookkeeping System: An open item Bookkeeping system is a purchase, sales or human resource ledger as a subsidiary ledger where every supplier, customer or employee has an individualised account. <?page no="552"?> ABC Activity Based Costing ABM Activity Based Management AC Airport company costs (for check-in) Acc Accounting Acc Accumulated Acc Depr Accumulated Depreciation, in accounts: AcD Acc IL Accumulated Impairment Loss Adj Adjustment alu Aluminium AO Abgabenordnung AP Airport fees A/ P Accounts Payables A/ R Accounts Receivables / a per annum, per year AUD Australian Dollar Bal Balance BCE Business Car Expenses BE Break-even Bhd. Berhad BoE Books of original Entry BOM Bill of materials b/ d Balance brought down B/ S Balance Sheet BV Besloten Vennootschap met Beperkte Aansprakelijkheid C Costs (total) C Credit CaE Catering Costs, Business Entertainment Costs CapRes Capital Reserves CB Cash Book C-BE Cash-Break-even C/ B Cash/ Bank CC Cost Centre CD Cost Driver CEO Chief Executive Officer c/ d Balance carried down c/ f carried forward (Profit) CFO Chief Financial Officer, Accountant CFS Statement of Cash Flows CM Contribution Margin CMA Contribution Margin Accounting CMRatio Contribution Margin Ratio CPA Chartered Professional Accountant COS Cost of Sales, Cost of Goods Sold <?page no="553"?> CR Credit Recorded, Credit Entry CVP Cost Volume Profit CVPA Cost Volume Profit Analysis, CVP-analysis D damage D Debit / d per day DcE Decoration Costs PC Delta Proportional Costs Dep Department Depr, Dpr Depreciation DOL Degree of Operating Leverage DR Debit Recorded, Debit Entry Drw Drawing Dst Distribution e Euler’s number EarnRes Earnings Reserves EAT Earnings After Taxes EBIT Earnings Before Interest and Taxes EBT Earnings Before Taxes EPS Earnings Per Share ERP Enterprise Resource Planning Eur Europe EUR Euro EVA TM Economic Value Added FA Financial Accounting F-BE Financial Break-even FC Fixed Costs fCF Cash Flow from Financing Activities FE FarEast FG Finished Goods FGb Finished Goods, banana FGl Finished Goods, lemmon FGs Finished Goods, strawberry Fin Finance FIM Faculty of Industrial Management fst 90° fastener Fue Fuel costs GP Gross Profit GR Garden Route GST Goods and Service Tax, same as Value Added Tax VAT HGB Handelsgesetzbuch hin Hinge HRC Hengyuan Refining Company Bhd. IAS International Accounting Standards IASB International Accounting Standards Board <?page no="554"?> IBL Interest Bearing Liabilities iCF Cash Flow from Investing Activities ID Identifier, Identification Number IFG Inventory of finished goods IFRS International Financial Reporting Standards IL Impairment Loss Inc. Incorporation (USA) Inv Inventory IRM Inventory of raw materials I/ S Income Statement IT Income Taxes ITL Income Tax Liabilities JO Job Order KB KIRSTENBOSCH (Pty) Ltd. kg Kilogram KL Kuala Lumpur ky kayak, #ky = number of kayaks Lab Labour Liab Liability, Liabilities Lst Loss on settlement Ltd. Limited company LoD Loss on Disposal m Metre MA Management Accounting MASB Malaysian Accounting Standards Board Mat Materials, Material Costs McD McDonals’s Corporation McT Mc Toy GmbH MG Merchandise Goods MHIL Malaysia Hengyuan International Limited MIA Malaysian Institute of Accounting MoF Manufacturing Overheads for the Filling department MOI Memorandum of Incorporation Moh Manufacturing Overheads, also: Manufacturing Overheads account / m per month MoP Manufacturing Overheads for the Production department MoS Margin of Safety, MoS unit is based on units, MoS % is based on sales portions MTF MOBILE TARTE FLAMBEE GmbH Mtn Maintenance MYR Malaysian Ringgit NoE Nature of Expense method NOP Net Operating Profit NOPAT Net Operating Profit After Taxes NP Net Profit <?page no="555"?> NPO Non-Profit Organisation NSP Net Selling Price NYSE New York Stock Exchange oCF Cash Flow from Operating Activities OE Owners Equity OTH Other Costs out Outsourcing P Probability P Profit P out Profit for outsourcing screnario pan Pane P&L Profit and Loss PC Proportional costs PCB Petty Cash Book PE Physical Education P.I. Profitability Index PoD Profit on Disposal P, P, E Property, Plant and Equipment Pch Purchases PLC Public Limited Company (in the UK) PRT Pro Rata Temporis (Pty) Ltd. Proprietary limited company (in Australia, South Africa) PTO Public Tender Offer PV Present Value R South African Rand R/ D Refer to Drawer R/ E Retained Earnings Res Reserves Rev Revenue, Sales RI Residual Income RM Malaysian Ringgit (currency in Malaysia) Rnt Rent RoA Register of non-current Assets RU Reference Unit SAICA South African Institute of Chartered Accountants Sal Salary SCap Share Capital Sch SCHLUCHMAN SCE Statement of Changes in Equity SCF Statement of Cash Flows SCI Statement of Comprehensive Income scr Screw Sdn. Bhd. Sendirian Berhad SHPC Shandong Hengyuan Petrochemical Company Limited SFP Statement of Financial Position <?page no="556"?> ShD Shareholder for Dividend sht Sheet SOH Service Overheads, Service Overheads account SPA Sales and Purchase Agreement SRC Shell Refining Company (Federation of Malaya) Bhd. StB Steuerberater, tax attorney StE Stationary Expenses str Strip T/ A Trading Account Tkt Ticketing TS Tax Statement (used in a case study as reference unit) TT Time Ticket / u per unit UMP Universiti Malaysia Pahang V Value VAT Value Added Tax, same as Goods and Service Tax GST VDI Verein Deutscher Ingenieure / w per week WIP Work in Progress, Work-in-Process WP Wirtschaftsprüfer, auditor Wst Waste ZAR South African Rand Standard deviation Mean <?page no="564"?> Berkau, C. [2013]: Bilanzen, 3. Aufl. Konstanz, München. Berkau, C.; Berkau, K.S. [2018]: Basics of Accounting, Part (II) Managerial Accounting, 5 th Edition. Konstanz, München. Brigham, E.F.; Houston, J.F. 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