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COMPANIES GRADE 12 NOTES - ACCOUNTING STUDY GUIDE

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2.1 Concepts relating to companies

Persons in a company:

Concept  Explanation 
Directors People who are appointed by the shareholders to run the company. 
Independent auditor (external)  An auditor who expresses an opinion on the financial statements in an auditor’s report but does not work for the company. 
Internal auditor  An auditor, who supervises the preparation of the financial statements, is responsible for internal control and is employed by the company. 
Shareholders  People who own the company. 
South African Revenue Services (SARS)  The government department to whom the company must pay income tax on the profits and VAT when due.


Documents relating to companies

Concept  Explanation 
Auditor’s report  This is an opinion given by a qualified person on whether the financial statements are reliable or not. 
Qualified auditor’s report  When the auditors find the financial statements acceptable EXCEPT for some aspects that need to be changed, fixed or investigated. 
Unqualified auditor’s report  When the auditors find the financial statements acceptable in ALL respects. 
Disclaimer   When the auditors are not prepared to express an opinion on the financial statements (because they are too unreliable). 
Balance Sheet   This statement reflects the assets, liabilities and net worth (owners’ equity of the company). Another term for this is ‘Statement of Financial Position’. 
Cash Flow  Statement This shows the flow of cash in a company (money coming in and money going out). 
Income Statement  This statement shows the profit or loss made from business operations (income and expenses). Another term for this is ‘Statement of Comprehensive Income’. 
Tax assessment This is issued by SARS to confirm the amount of income tax which the company has to pay based on profits.


Further concepts relating to companies

Concept   Explanation 
Authorised share capital  The maximum number of shares a company can sell. 
Dividends
Interim dividends 
Final dividends		 That portion of the profits (after tax) which has been approved to be shared
amongst the shareholders (total dividends = interim + final). 
Dividends that are paid to the shareholders during the year.
Dividends that are declared (recommended) to the shareholders at the end of the financial year.
Income tax Tax the company pays to SARS on its profits. 
Issued share capital  The number of shares that have actually been sold to shareholders.
Use number of issued shares to calculate dividends. 
Limited liability The liability of the shareholders is limited to their investment in the company (they cannot lose their personal assets). 
No par value   There is no value attached to shares until they are issued. 
Provisional tax  Payments made to SARS during the year based on estimated profits (every 6 months).
Retained income A portion of the profits after tax that are not paid out to the shareholders in dividends but kept (retained) for future growth of the company.
Issue price The price at which shares are issued to the public.
Shareholders earnings Net profit after tax.
Shareholders for dividends The amount still owing to shareholders for dividends declared but not yet paid.
Buy back shares Issued shares that have been repurchased by the company and are retired or cancelled.


Some acronyms (abbreviations) used in companies

AGM  Annual General Meeting 
CA  Chartered Accountant 
CIPRO   Company and Intellectual Property Commission 
GAAP   Generally Accepted Accounting Practice 
IFRS   International Financial Reporting Standards 
JSE   Johannesburg Securities Exchange 
MOI   Memorandum of Incorporation 
SAICA   South African Institute for Chartered Accountants 
SAIPA  South African Institute for Professional Accountants


Gaap concepts

Concept   Explanation 
Business entity rule  The finances of the company are kept separate from that of the shareholders 
Going concern  Financial statements are prepared with the understanding that the company will continue operating in the future 
Historical cost  All assets are recorded at their original cost price e.g. Land and Buildings are recorded at the price that you paid for them 
Matching   Income and expenses must be recorded in the correct financial year e.g. sales and cost of sales 
Materiality  All important items must be shown separately in the financial statements (e.g. directors’ fees) or when decisions must be made (e.g. is it worth having separate accounts for wages and salaries if you have only two employees?) 
Prudence Figures used in financial statements should be realistic (conservative – always record the worst scenario). The aim of this principle is to show the reality “as it is” and not make things prettier than what they are. E.g. you will show ‘net debtors’ in the balance sheet (trade debtors minus provision for bad debts)

2.2 Company General Ledger accounts

  1. Ordinary share capital
  2. sars (income tax)
  3. Shareholders for dividends
  4. Income tax
  5. Dividends on ordinary shares (ordinary share dividends)
  6. Appropriation account

Activity 1: Typical examination questions

Worked example 1
Use the following information to complete the ledger accounts given on the answer sheet for kwik fix ltd for the financial year ended 30 June 2011.   
Information		 To calculate the average share price, use this figure and divide it by the no. of shares issued.
1 000 000 ÷ 500 000 shares = R2 ↓
1 1 July 2010 At the beginning of the year, the company had the following
opening balances:
Ordinary share capital (500 000 shares)
Retained income
SARS (Income tax)
Shareholders for dividends 		 R1 000 000
180 000
(ct) 9 000
130 000 
2 1 July 2010  Issued 50 000 shares to the public at R7,50 per share  
3 23 July 2010  Paid the amounts owing to SARS and the shareholders.  
4 31 December 2010  A first provisional tax payment of R112 500 was made to SARS half-way through the financial year.  
5 31 December 2010  An interim dividend of 15 cents per share was paid to shareholders.  
6 31 March 2011  Bought back 20 000 shares from a disgruntled shareholder. The directors decided to buy back these shares at R8,50 per share.  
7 30 June 2011   A second provisional tax payment of R120 000 was made to SARS at the end of the financial year.  
8 30 June 2011  Final dividends of 30 cents per share were declared at the AGM but have not yet been paid to the shareholders.  
9 30 June 2011  After the completion of the audit, the income tax figure for the year was determined as R240 000. This was calculated on a net profit figure of R800 000.  
10 30 June 2011  Show the closing transfers to the final accounts.  

 

Notes below refer to the information above and to the ledger accounts below ( 1 – 10):  
1 The balances for SARS (Income tax) and Shareholders for dividends are the amounts that were not paid last year and need to be paid this year. 
2 Shares issued to the public at issue price of R7,50 per share 
3 The amounts owing to SARS and the shareholders from last year are now being paid. 
4
7		 The first provisional tax payment is always made half-way (6 months) into the financial year and the second provisional tax payment is made at the end of the financial year. 
5 The interim dividend is paid during the year 
8 The final dividend is declared (not paid) at the end of the financial year. 
6 Shares bought back at R8,50 per share from a shareholder. New average price to be calculated. To calculate average price, find the value of Ordinary Share Capital, R1 375 000 ÷ 55 000 = R2,50). It means that you’re only going to claim R2,50 per share and the rest will be claimed from Retained Income. 
9 The income tax figure for the year is the amount of tax the company owes calculated on the net profit for the year. This needs to be compared to the provisional tax payments made to see whether the company owes SARS more tax (liability) or whether SARS owes the company (asset). The net profit of R800 000 is calculated in the Profit and Loss Account and transferred to the Appropriation Account.
10

The final accounts include the Trading Account, Profit and Loss Account (covered in this example) and the Appropriation Account.

EXAMPLE OF A TRADING ACCOUNT AND PROFIT AND LOSS ACCOUNT (exactly the same as a sole trader or partnership)
TRADING ACCOUNT (F1)

2011
June 		 28  Cost of Sales  GJ  300 000  2011
June 		 28  Sales  GJ 1 470 000
    Profit and loss  GJ  1 170 000          1 470 000
        1 470 000          

PROFIT AND LOSS ACCOUNT (F2) N

2011
June 		 28   Salaries   GJ  130 000  2011
June  		 28  Trading account
(gross profit) 		  GJ  1 170 000
    Directors fees (new)   GJ  160 000      Rent Income   GJ 24 000
    Audit fees (new)    GJ  40 000      Profit on sale of asset    GJ 16 000
    Provision on bad debts adjustment   GJ  1 000         GJ  
    Water and electricity   GJ  29 000           
    Telephone / cell phones   GJ  50 000           
    Appropriation    800 000           
        1 210 000         1 210 000


General Ledger of Kwik Fix Ltd

Shares issued: 500 000 + 50 000 = 550 000 shares issued.

Average price of shares:
R1 000 000 + R375 000 = R1 375 000
R1 375 000 ÷ 550 000 shares = R2,50

                                                                Balance Sheet Section
Dr                                                            Ordinary Share Capital                                                               Cr 
2011
Mar 		 31   Bank 6 (20 000 × R2,50)  CPJ   50 000  2010
July 		 1  Balance   b/d 1 000 000
             31 Bank 2 (50 000 × R7,50)  GJ 375 000
    Balance  c/d  1 325 000           
        1 375 000         1 375 000
          2011
July		 1 Balance b/d 1 325 000

 

                                       Balance Sheet Section
Dr                                    SARS (Income tax)                                      Cr
2010
July 		  23 Bank  CPJ  9 000  2010
July 		 1  Balance  b/d 9 000
2010
Dec  		 31  Bank CPJ 112 500 2011
June 		 30  Income tax GJ 240 000
2011
June 		 30 Bank CPJ 120 000           
    Balance c/d   7 500          249 000
        249 000           
          2011
July		 1 Balance b/d 7 500

The Income Tax assessment was more than the provisional payments. Therefore the balance is on the credit side making it a liability (Trade and Other Payables).

                                           Nominal Accounts Section
Dr                                                INCOME TAX                                                     Cr  
2011
June 		 30  SARS (Income tax)  GJ 240 000   2011
June 		 Appropriation 10   GJ  240 000

   

                                     Balance Sheet Section
Dr                              SHAREHOLDERS FOR DIVIDENDS                        Cr 
2010
July  		 23 Bank  CPJ   130 000  2010
July 		 1 Balance  b/d 130 000
2011
June 		  30 Balance  c/d  159 000  2011
June 		  1 Dividends on
ordinary shares		 GJ 159 000
        289 000          289 000
          2011
July 		  1 Balance b/d 159 000

The R159 000 is the final dividend and is still owing to the shareholders. This is a liability (Trade and Other Payables).

Nominal accounts section
Dr DIVIDENDS ON ORDINARY SHARES Cr        
2010
Dec 		 31 Bank 
(550 000 × 0.15) 		 CPJ  82 500   2011
June 		  30 Appropriation  GJ 241 500
2011
June 		 30 Shareholders for dividends
8 (530 000 × 0.30) 		  GJ 159 000           
        241 500          241 500

There are three different ways of preparing the Appropriation account. Choose the alternative that you have been taught.
Option 1: The Retained Income for the year is transferred from the Appropriation account to the Retained Income account.

Balance Sheet Section
Dr RETAINED ACCOUNT Cr        
2011
Mar 		 31 Bank (20 000 × R6)   GJ  120 000  2011
June 		 30 Balance  b/d 180 000
June  30 Balance  c/d  378 500      Appropriation  GJ 318 500
                   
        498 500          498 500
          July 1 Balance   378 500

 

Final accounts section
Dr APPROPRIATION ACCOUNT Cr        
2011
June  		  30 Income tax   GJ 240 000  2011
June 		  30 Profit & loss  GJ 800 000
    Dividends on ordinary
shares  		  GJ 241 500           
    Retained income   GJ 318 500           
        800 000         800 000

Option 2: The Retained Income at the beginning of the year less the buy-back of shares adjustment is transferred to the Appropriation account. The Retained Income (after the share buy-back adjustment) at the end of the year is transferred from the Appropriation account to the Retained Income account

Balance sheet section
Dr RETAINED ACCOUNT Cr        
2011
Mar 		  31 Bank (20 000 × R6)  GJ 120 000  2010
July 		 1 Balance b/d 180 000
June   30 Appropriation   GJ 60 000          180 000
          2011
June		 Appropriation    GJ 378 500

 

Final accounts section
Dr APPROPRIATION ACCOUNT Cr        
2011
June 		  30 Income tax  GJ  240 000  2011
June 		 Profit & loss  GJ  800 000
    Dividends on ordinary
shares 		 GJ 241 500    Retained Income
(180 000 – 120 000) 		   60 000
    Retained income  GJ 378 500         
        860 000        860 000

Option 3: The Retained Income at the beginning of the year is transferred to the Appropriation account.
The Retained Income (before the share buy-back adjustment) at the end of the year is transferred from the Appropriation account to the Retained Income account

Balance sheet section
Dr RETAINED ACCOUNT Cr        
2011
Ma 		  31 Bank (20 000 × R6)   GJ 120 000  2011
July 		 1  Balance  b/d 180 000
June   30 Appropriation   GJ 180 000  2011
June 		  30 Appropriation  GJ 498 500
    Balance  c/d   378 500           
        678 500         678 500
          2011
July		 1 Balance b/d 378 500

 

Final accounts section
Dr APPROPRIATION ACCOUNT Cr        
2011
June 		  30 Income tax   GJ 240 000  2011
June 		 30 Profit & loss  GJ  800 000
    Dividends on ordinary
shares		  GJ 241 500      Retained Income    180 000
    Retained income   GJ 498 500           
        980 000         980 000


Practice task 1
General ledger of kwik fix ltd
Balance sheet section

Dr Ordinary Share Capital Cr 
               
               
               
               
               

 

Dr Retained Income Cr 
               
               
               
               
               

 

Dr sars (Income tax) Cr 
               
               
               
               
               

 

Dr Shareholders for Dividends Cr
               
               
               
               
               

 

Nominal section

Dr Income Tax Cr
               
               
               
               
               

 

Dr Dividends on Ordinary Shares Cr
               
               
               
               
               
               

 

Dr Dividends on Ordinary Shares Cr
               
               
               
               
               
               


Final accounts section

Dr Appropriation Account Cr
               
               
               
               
               
               

2.3 Preparation of Financial Statements for companies

Income statement
Use the following steps to prepare an income statement from a pre-adjustment trial balance:

  1. Enter the pre-adjustment trial balance figures from the nominal section onto the answer sheet next to the detail.
    (Remember a pre-adjustment trial balance refers to a trial balance that is NOT final and requires adjustments (entries) to be made to finalise the figures to be used in the preparation of the annual Financial Statements.
  2. Read each adjustment:
    1. If necessary calculate the adjustment amount
    2. Decide on which account is to be debited and which account is to be credited.
    3. On your answer sheet reflect a (+) or a (–) in respect of each adjustment next to the already entered pre-adjustment figure.
      • Outstanding/accrued amounts will be added (+) and prepaid/received in advance amounts will be subtracted (–)
  3. When all the adjustments have been done, calculate your final figures and write them in the column.

Summary of the year end adjustments
Ensure that you know all possible yearend adjustments before attempting the given activities.
Make use of the Pre-adjustment Trial balance of Carl Stores to complete the Income Statement for the year ended 30 June 2014 and the Balance Sheet on 30 June 2014.

PRE-ADJUSTMENT TRIAL BALANCE ON 30 JUNE 2014   
BALANCE SHEET ACCOUNTS SECTION DEBIT  CREDIT 
Ordinary Share capital    351 000
Retained Income    9 100
Loan from Lowveld Bank    50 000 
Land and buildings   270 000   
Equipment (at cost)   75 000   
Vehicle   100 000   
Accumulated depreciation on vehicles   30 000
Accumulated depreciation on equipment    30 500
Fixed Deposit  10 000  
Trading stock  74 000  
Debtors control  16 100  
Provision for bad debts   600
Deposit on water and electricity  1 000  
Bank  15 900  
Cash float  800  
Petty cash  300  
Creditors control   9 500
South African Revenue Services: (PAYE)    
Creditors for salaries    
Pension fund    
Medical aid fund    
NOMINAL ACCOUNTS SECTION
Sales   550 000
Debtors allowances 10 000  
Cost of sales 320 000  
Salaries 95 000  
Wages  30 000  
Water and electricity  7 000  
Pension Fund contribution  4 000  
Medical Fund contribution  2 700  
Bad debts 1 000  
Rent income   13 000
Commission income    8 700
Packing materials  1 200  
Insurance  600  
Bank charges  5 300  
Discount allowed  1 000  
Telephone  12 500  
Interest on fixed deposit    800
Interest on debtors    200
  1 053 400 1 053 400 


Make use of the following adjustments to revise on the adjustments learnt previously

  1. Prepaid expenses: Insurance prepaid, R200
  2. Accrued expenses: Water and electricity still due, R2 000.
  3. Income received in advance: Rent income received in advance, R1 000
  4. Accrued income: Interest on fixed deposit still due, R400 (not capitalized)
  5. Bank charges, R700, interest on overdraft, R200 on late bank statement to be brought into account.
  6. Bank Statement also showed a RD cheque, R1 000 (receive from debtor B. Bam in settlement of his account of R1 100)
  7. Interest capitalized. Loan b/d R55 000 (1 July 2011). Total payments R15 000. Closing balance of loan R50 000.
  8. Depreciation: Depreciate vehicles at 10% p.a. at cost price and Equipment at 10 % p.a. at carrying value
  9. Bad debts: J Jon’s debt written off as bad debt, R200
  10. INCREASE: 2014 Provision for bad debts at 5 % of debtors. (17 000 × 5% = )
  11. Insurance claim of e.g. stock stolen: e.g. Stock stolen valued @ R5 000. The Insurance Company is prepared to pay out R4 000 on the claim put forward
  12. Trading stock deficit: Trading stock according to stock taking, R67 000.
  13. Consumable stores on hand: Closing stock: Packing material, R300
  14. Salary of an employee omitted in error: e.g. Gross salary of Joe
    Soap omitted of R10 000. SARS (PAYE), R1 600 Pension fund
    R500 and Medical fund R900. The owner contributed to the medical fund and pension fund Rand for Rand basis.

Ensure that you know how to interpret the adjustments, how to complete the general journal entry and how it affects the ledger accounts and the financial statements

Adjustments at the end of the Financial year

ILLUSTRATION OF THE PROGRESSION OF 14 POSSIBLE YEAR-END ADJUSTMENTS FROM ADJUSTMENT TO INCOME STATEMENT AND TO BALANCE SHEET      
1. Prepaid expenses Insurance prepaid, R200
GENRAL LEDGER INCOME STATEMENT BALANCE SHEET  
Prepaid expenses(CA) B   Insurance (600 – 200)     400     NOTE 5: TRADE AND OTHER RECEIVABLES
Prepaid Expense 200           
Insurance 2600  
Insurance (e) N 
Total b/d 600
600		 Prepaid expenses 200
Profit and loss 400
600 
2. Accrued expenses: Electricity still due, R2 000.    
Accrued expenses (CL) B Water and electricity
(7 000 + 2 000)		 9 000 NOTE 9: TRADE AND OTHER PAYABLES
Accrued Expenses 2 000        
  Water and electricity
2 000
Water and Electricity(e) N
Total b/d 7 000
Accrued expenses 2 000
9 000		 Profit and loss 9 000
9 000
3. Income received in advance Rent income received in advance, R1 000
Income received advance (CL) B Rent Income
(13 000 – 1 000)		 12 000 NOTE 9: TRADE AND OTHER PAYABLES
Income received in advance 1 000        
  Rent income 1 000
Rent income(I) N
Income received in
advance 1 000
Profit and loss 12 000
13 000		 Total 13 000
_____
13 000
4. Accrued income: Interest on fixed deposit still due, R400 (not capitalized)
Accrued income(CA) B Plus Interest income
(800 + 400)		 1 200 NOTE 5:TRADE AND OTHER RECEIVABLES
Accrued Income 400        
Interest on fixed deposit
400		  
Interest on fixed deposit (I) N
Profit and loss 1200
_____
1 200		 Total 800
Accrued income 400
1200
5. Bank charges The bank statement was received after the pre- adjustment trial balance was drawn up.
Bank(CA) B Bank charges
(6 300 +700)
Interest on overdraft
(200)		 7 000
200		 NOTE 6: CASH AND OTHER CASH EQUIVALENTS
Bank (15 900 – 700 – 200) 15 000
Balance b/d 15 900
______
15 900
Balance b/d 15 000		 Bank charges 700
Interest on over draft 200
Balance c/d 15 000
15 900
Bank charges(e)N
Total b/d 6 300
Bank 700
7 000		 Profit on Loss 7 000
_____
7 000
Interest on overdraft (e)N
Bank 200 Profit on Loss 200
6. RD cheques and discount allowed The bank statement was received after the pre- adjustment trial balance was drawn up. The following must be taken into account; RD cheque of R1000 received from a debtor, B Bam, in settlement of his account of R1100
Bank (CA) B   Discount allowed
(1 100 – 100)		 1 000 NOTE 5: TRADE AND OTHER RECEIVABLES
Trade Debtors 17 000
(16 100 + 1 000 + 100)
NOTE 6: CASH AND OTHER CASH EQUIVALENTS
Bank (15 900 – 700 – 200 – 1 000)
14 000
Balance b/d 15 900
______
15 900
Balance b/d 14 000		 Bank charges 700
Interest on over draft 200
B Bam (RD) 1 000
Balance c/d 14 000
15 900
Debtors Control account (CA)B  
2011
Balance b/d 16 100
Bank (RD) 1 000
Journal debits 100
17 100		  
Discount allowed account  
Total b/d 1 100
_____
1 100		 Debtors control 100
Profit and Loss 1 000
1 100
7. Interest capitalized. Loan b/d 55 000 (1 Jan 2009) Total payments R15 000 Closing balance of loan R50 000
Loan: Crazy Bank (CA) B   Interest on loan
(55 000 – 15000 –
50 000)		 10 000 NON-CURRENT LIABILITIES
Loan: Crazy Bank
(50 000 – 5 000)
CURRENT LIABILITIES
Short term loan		 45 000
5 000    
Bank (10 000+5 000)
15 000
Balance c/d 50 000
65 000		 Balance b/d 55 000
Interest on loan 10 000
65 000
Balance b/d 50 000
Interest on loan (I) N
Loan: Crazy Bank 10 000 Profit and loss 10 000
8. Depreciation
Vehicles: R100 000
Accumulated depreciation:R30 000
Depreciation at cost price: 100 000 × 10/100 = 10 000   		 Equipment: R75 000
Accumulated. Depreciation: R30 500
Depreciation at carrying value
75 000 – 30 500 = 44 500 × 10/100 = 4 450 
Depreciation (e) N Depreciation
(10 000 + 4 450)		 14 450 NOTE 3: FIXED ASSETS
Cost price
Accumulated depre.
Carrying value
Movements:
Depreciation
Carrying value
Cost price
Accumulated depre		 75 000
(30 500)
44 500
(4 450)
39 050
75 000
(35 950		 100 000
(30 000)
70 000
(10 000)
60 000
100 000
(40 000)
Accumulated
depreciation on Vehicle
10 000
Accumulated
Depreciation on
equipment 4 450
14 450		 Profit on Loss 14 450
_______
14 450
Accumulated Depreciation on Vehicles (–A) B
  Balance b/d 30 000
Depreciation 10 000
40 000
Accumulated Depreciation on Equipment (–A) B
  Balance b/d 30 500
Depreciation 4 450
34 950
 9. Bad debts J Jon’s debt written off as bad debt, R200      
 Debtors Control (CA) B   Bad Debts (1 000 + 200)     1 200    NOTE 5: TRADE AND OTHER RECEIVABLES
Trade Debtors 17 000
(15 100 +1 000+100 – 200)           
Balance b/d 16 100
Bank (RD) 1 000
Journal debits 100
17 200
Balance b/d 17 000		 Bad debts GJ 200
(journal credits)
Balance c/d 17 000
17 200
 Bad debts (e) N 
 Total b/d 1 000
Debtors control 200
1200		 Profit and loss 1 200
_____
1 200 
10. INCREASE:
INCREASE: Provision for bad debts at 5 % of debtors. (17 000 × 5% = 850)      
 Provision for bad debts (–A) B  Less operating expenses
Provision for bad
debts adjustment
(850 – 600)    		 250     NOTE 5: TRADE AND OTHER RECEIVABLES
Trade debtors 17 000
Less Provision for bad debts (850)
Net Debtors 16 150              
  2014
Balance b/d 600
Provision for bad debts
adjustment 250
850
Debtors control(CA) B 
2014
Balance b/d 17 000		  
Provision for bad debts adjustment (e) N 
Provision for bad
debts 250		 Profit and loss 250
See the calculations when Provision for bad debts are created or increases or decreases at the end of a financial year.
10.1 Provision for bad debts
CREATE: 2012: provision for bad debts at 5% of debtors
Debtors control (CA) B   Less operating expenses
Provision for bad debts
adjustment		 50 NOTE 5: TRADE AND OTHER RECEIVABLES
Trade debtors 1 000
Less Provision for bad debts (50)
Net Debtors 950
2012
Balance b/d 1000		  
Provision for bad debts (–A) B
  2012
Provision for bad debts
adjustment 50
Provision for bad debts adjustment (e) N
Provision for bad debts 50 Profit and loss 50
10.2 INCREASE: 2013
Provision for bad debts from R50 to R70. (1400 × 5%=70)
Provision for bad debts(-A) B Less operating
expenses
Provision for bad debts
adjustment (70 – 50 )		 20 NOTE 5: TRADE AND OTHER RECEIVABLES
Trade debtors 1 400
Less Provision for bad debts (70)
Net Debtors 1 330
  2013
Balance b/d 50
Provision for bad debts
adjustment 20
                   70
Debtors control (CA) B
2013
Balance b/d 1400		  
Provision for bad debts adjustment (e) N
Provision for bad debts 20 Profit and loss 20
10.3 DECREASE: 2014
Provision for bad debts from R70 to R60.
Provision for bad debts (–A) B Plus other operating
income
Provision for bad debts
adjustment (70 – 60)		 10 NOTE 5: TRADE AND OTHER RECEIVABLES
Trade debtors 1 200
Less Provision for bad debts
( 60)
Net Debtors 1 140
Provision for bad debts
adjustment 10
Balance c/d 60
                    70		 2014
Balance b/d 70
                    __
                    70
Balance b/d 60
Debtors control(CA) B
2014
Balance b/d 1200		  
Provision for bad debts adjustment (i) N
Profit and loss 10 Provision for bad debts 10
11. Insurance claim of e.g. stock stolen. E.g. Stock stolen valued @ R5 000.
Insurance is prepared to pay out R4000.      
 Trading Stock (CA) B  Loss on stolen stock
(5 000 – 4 000)  		 1 000   NOTE 4: INVENTORY
Trading stock
(74 000 – 5000) 69 000
NOTE 6: TRADE AND OTHER
RECEIVABLES
Insurance Claim
(5 000 – 4 000) 1 000        
Balance b/d 74 000
______
74 000
Balance b/d 69 000 		 Loss to stolen stock 5 000
Balance c/d 69 000
74 000
Insurance claim (CA) B 
Loss to stolen
stock 4 000		  
Loss to stolen stock (e) N
Trading Stock 5 000
_____
5 000		 Insurance claim 4 000
Profit and Loss 1 000
5 000
12. Trading stock deficit Balance of the Trading stock account is R69 000. Trading stock according to stock taking, R67 000.
Trading stock(CA) B Trading stock deficit
(69 000 – 67 000)		 2 000 NOTE 4: INVENTORY
Trading stock
(69 000 –2000) 67 000
Balance b/d 74 000
______
74 000
Balance b/d 67 000		 Loss to stolen stock 5 000
Trading stock deficit 2 000
Balance c/d 67 000
74 000
Trading stock deficit (e) N
Trading stock 2 000 Profit and loss 2 000
13. Consumable stores on hand; Closing stock: Packing material, R300
Consumable stores on hand (CA) B Packing material
(1 200 – 300)		 900 NOTE 4: INVENTORY
Consumable stores on hand 300
Packing material 300  
Packing material (e N)
Total 1 200
_____
1 200		 Consumable Stores on hand 300
Profit and Loss 900
1 200
Be careful. Does the wording of the adjustment read? After stock taking the packing material USED Is R900 or after stock taking the STOCK on hand, R300.
14. Salary of an employee omitted in error: e.g. Gross salary of Joe Soap omitted of R10 000.
SARS (PAYE), R1600 Pension fund R500 and Medical fund R900.
The owner contributed to the medical fund and pension fund on a Rand for Rand basis.
(10 000 – 1 600 – 500 – 900 = 7 000)
Creditors for salaries (CL) B Salaries (95 000 +10 000)
Pension fund contribution
(4 000 + 500)
Medical fund contribution
(2 700 + 900)		 105 000
4 500
3 600		 NOTE 9: TRADE AND OTHER PAYABLES
SARS (PAYE) 1 600
Pension fund (500 + 500) 1 000
Medical fund (900 + 900) 1 800
Creditors for salaries 7 000
(10 000 – 1 600 – 500 –900)
  Salaries GJ 7 000
SARS (PAYE) (CL) B
  Salaries GJ 1 600
Pension Fund (CL)B
  Salaries GJ 500
Pension Fund contribution
500
1 000
Medical Fund (CL) B
  Salaries GJ 900
Medical Fund
contribution 900
1 800
Salaries (e) N
Total b/d 95 000
Gross salaries GJ 10 000
105 000		 Profit and Loss 105 000
_______
105 000
Pension Fund contribution (e) N
Total b/d 4 000
Pension Fund 500
4 500		 Profit and loss 4 500
_____
4 500
Medical Fund contribution (e)
Total b/d 2 700
Medical Fund contribution
900
3 600		 Profit and loss 3 600
_____
3 600

Do the following calculation to find the figure for CREDITORS FOR SALARIES while completing Note 9 in the following order: use the gross salary of R10 000 and subtract the
– 1 600 SARS (PAY E)
– 500 Pension fund
– 900 Medical fund
= 7 000 Creditors for salaries

Calculations:
Ensure that you are able to do the following CALCULATIONS when attempting the year-end ADJUSTMENTS.
Let’s use Rent Income to illustrate the different calculations for calculating the Rent for the year and to find the amount received in advance or that is still accrued.
The end of the financial year is on 28 February.

1  Adjustment (low level)  E.g. the total rent income received is R26 000. Take into account that one month’s rent was received in advance  
  Calculation  26 000 ÷ 13 = R2 000 per month
2 000 × 12 = 24 000
Therefore R2 000 was received in advance. 
  Effect on the financial statements Income statement Balance sheet 
    Rent Income R24 000
(26 000 ÷ 13 × 12)		 Note 9:
Income received in advance R2 000

 

2  Adjustment (medium level)  E.g. the tenant paid his rent one month in advance. Take into account that the rent of R2 000 increased by 10 % from 1 October 2013. Total Rent received, R27 200.  
  Calculation Draw a TIME LINE to find the rent for the year and the rent that was received in advance
Financial year         prepaid
1 Mar  Apr   May   June  July  Aug  Sept   1 Oct  Nov Dec Jan Feb Mar
 2000  2000  2000  2000  2000  2000  2000  2200 2200 2200 2200 2200 2200
R2000 × 7 = 14 000 2 000 + 10%) + R2 200 × 5 = 11 000 + R2 200 = R27 200
  Effect on the financial statements Income statement Balance sheet
    Rent Income R25 000
(14 000 + 11 000)		 Note 9:
Income received in advance R2 200

Number 2 and 3 are almost the same however in no. 3 the Rent per month was not given as in no.2. By using the following method the amounts can still be calculated.

 3 Adjustment(high level)  E.g. The total amount received during the year, R27 200. Take into account that rent increased by 10% on 1 October 2013 and the tenant paid the rent for March during February 2014.  
  Calculation  Draw a TIME LINE to find the rent for the year and the rent that was received in advance
Financial year         prepaid 
1 Mar  Apr  May  June July  Aug  Sept  1 Oct Nov  Dec Jan Feb
 100%  100%  100%  100%  100% 100%   100% 110% 110% 110% 110%  110%
CALCULATION: (100% × 7) + (110% × 5) + (110% × 1) = 27 200
700% + 550% + 110% = 27 200
1360% (known) = 27 200 (known)
MAKE USE OF THE FORMULA:
Unknown %          UNKNOWN is the amount prepaid and KNOWN is the total rent received
Known %
 110% × 27 200 = R2 200 received in advance
1360%       1
Or 27 200 – 2 200 = R25 000 rent income for the year. 
  Effect on the financial statements  Income statement Balance sheet 
    Rent Income R25 000
(27 200 – 2 200)		 Note 9:
Income received in advance R2 200

 

4 Adjustment (high level)  E.g. The total mount received during the year, R22 800. Take into account that the rent increased by 10% on 1 October 2013 and the tenant hasn’t yet paid the rent for February 2014  
Calculation  Draw a TIME LINE to find the rent for the year and the accrued rent.
Financial year         accrued
 1 Mar  Apr  May  June  July  Aug  Sept  1 Oct  Nov Dec Jan Feb Mar
 100%  100%  100%  100%  100%  100%  100%  110% 110% 110% 110% 110% 110%
CALCULATION: (100% × 7) + (110% × 4) = 22 800
700% + 440% = 22 800
1140% = 22 800
MAKE USE OF THE FORMULA: UNKNOWN is the amount accrued and KNOWN is the total rent
received
Unknown %
  Known %
  110% × 22 800 = R2 200 accrued income
  1140%      1
Or 22 800 + 2 200 = R25 000 rent income for the year.  
Effect on the financial statements  Income statement Balance sheet 
  Rent Income R25 000
(22 800+ 2 200)		 Note 5:
Accrued income R2 200

 

5 Adjustment (high level)  E.g. The total mount received during the year, R22 800. Take into account that the rent DECREASED BY 10% on 1 October 2013 and the tenant hasn’t yet paid the rent for February 2014
Calculation  Draw a TIME LINE to find the rent for the year and the rent that was received in advance
Financial year             accrued
 1 Mar  Apr  May  June  July  Aug  Sept  1 Oct  Nov Dec Jan Feb
 100%  100%  100%  100%  100%  100%  100% 90% 90% 90% 90% 90%
CALCULATION: (100% × 7) + (90% × 4) = 22 800
700% + 360% = 27 200
1060% = 27 200
MAKE USE OF THE FORMULA:
Unknown % UNKNOWN is the (%) amount accrued and KNOWN is the total rent received (%)
  Known %
   90%   × 22 800 = R2 200 accrued income
 1360%        1
Or 22 800 – 2 200 = R25 000 rent income for the year.
Effect on the financial statements  Income statement Balance sheet 
  Rent Income R25 000
(22 800+ 2 200)		 Note 5:
Accrued income R2 200


Example adapted from November 2011 ncs Exam paper
Worked Example 2
Prepare the Income statement for the year ended 30 June 2011.
Information
1. ANEESA LTD 
PRE-ADJUSTMENT TRIAL BALANCE AS AT 30 JUNE 2011

  DEBIT  CREDIT 
Balance Sheet Accounts Section  R R
Ordinary share capital    2 820 000 
Retained income    684 460 
Mortgage loan: Joy Bank     804 500 
Land and buildings  2 097 000  
Vehicles   814 000  
Equipment   616 000   
Accumulated depreciation on vehicles    294 800
Accumulated depreciation on equipment    341 000
Trading stock  955 000  
Consumable stores on hand  15 000  
Bank  313 100  
Petty cash  3 300  
Debtors' control 396 000  
Creditors' control    487 300
SARS (Income tax)(This amount is the provisional tax payment.) 261 800  
Provision for bad debts    18 000
Fixed deposit: Broad Bank (8% p.a.)  495 000  

 

Nominal Accounts Section     
Sales    10 500 000 
Debtors’ allowances  (Remember to subtract debtors’ allowances from sales.) 145 200   
Cost of sales   7 487 000   
Rent income     176 880 
Interest income (on fixed deposit)     26 630 
Bad debts recovered     2 300 
Directors' fees   840 000   
Audit fees  73 800  
Salaries and wages  660 000  
Packing material  23 100  
Marketing expenses  480 000  
Sundry expenses  63 770  
Bad debts  12 000  
Ordinary share dividends (This is the interim dividend. DO NOT include on the Income Statement!) 404 800  
  16 155 870 16 155 870


2. ADJUSTMENTS

  1. A physical stock-taking on 30 June 2011 revealed the following inventories on hand:
    Trading stock R902 150
    Packing material R4 260
  2. Directors' fees of R22 500 are outstanding at the end of the financial period.
  3. Make provision for outstanding interest on a fixed deposit. This investment has been in existence for the entire year. Interest is not capitalised.
  4. A debtor who owes us R32 000 has been declared insolvent. His estate paid 40 cents in every rand and this has been correctly recorded. The remaining balance must be written off as irrecoverable.
  5. Provision for bad debts must be adjusted to 5% of debtors.
  6. The rent included R14 520 for July 2011. Adjust accordingly.
  7. Make provision for depreciation as follows:
  8. Vehicles at 15% p.a. on cost price
  9. Equipment at 10% p.a. on the diminishing balance method.
  10. New equipment to the value of R48 000 was purchased on 1 September 2010. This has been correctly recorded.
  11. The loan statement received from Joy Bank on 30 June 2011 reflected the following:
      R 

     

     

    (The total interest forms part of the repayment during the year.
    Capitalised means the interest is added onto the loan. You need to calculate this figure.)
    Balance at the beginning of the financial year  1 125 000 
    Repayments during the year  458 000
    Interest capitalised   ?
    Balance at the end of the financial year 804 500
  12. Income tax for the year, R150 285. 


Answer to worked example 2
1. Aneesa ltd : income statement for the year ended 30 june 2011

  Sales (10 500 000 – 145 200)  10 354 800 
  Cost of sales (7 487 000) (7 487 000)
  Gross profit   2 867 800 
  Other operating income  164 660
 F Rent income (176 880 – 14 5203) 162 360
  Bad debt recovered (2 300) 3 2 300
  Gross operating income 3 032 460 
  Operating expenses  (2 392 600) (This is the total of the operating expenses. REMEMBER to subtract this from gross operating income.)
B Directors fees (840 000 + 22 500) 862 500
  Audit fees (73 800) 73 800
  Salaries and wages (660 000) 660 000
  A Packing material (23 1003 – 4 2603) 18 840
  Marketing expenses (480 000) 480 000
  Sundry expenses (63 770) 63 770
D Bad debts (12 0003 +19 20033) 31 200
E Provision for bad debts adjustment (18 840 3– 18 000) 840
G Depreciation
V: 122 100 3
E: 4 0003 + 22 700		 148 800
A Trading stock deficit 52 850
  Operating profit 639 860
C Interest income(26 630 + 12 970) 39 600
  Profit before interest expenses/finance cost 679 460
H Interest expenses/finance cost 
(458 000 + 804 500 – 1 125 000) or
(1 125 000 – 458 000 – 804 500)		 (137 500)
  Profit before tax 541 960
I Income tax (150 285)
  Net profit after tax 391 675

[52]

↑The letters in this column refer to the explanations on the next page.

2. Explanations of each adjustment

  1. Trading stock:
    The physical stocktaking of R902 150 is less than the amount in the preadjustment trial balance of R955 000. This means that there is a trading stock deficit of R52 850 (R955 000 – R902 150).
    Trading stock deficit = expense item on Income Statement
    Packing material:
    The amount on hand is subtracted from the pre-adjustment trial balance amount.
  2. Directors’ fees are outstanding and therefore get added to pre-adjustment figure.
  3. Interest on fixed deposit = R495 000 × 8% = R39 600 for the year.
    The difference must be added to pre-adjustment trial balance figure.
  4. Calculation of bad debts:
    The estate paid 40 cents therefore 60 cents in every rand must be written off. R32 000 × 0,6 = R19 200. This must be added to the pre-adjustment figure.
  5. Provision for bad debts adjustments calculation.
    Calculate final debtors amount taking adjustment D into account:
    R396 000 – R19 200 = R376 800
    5% of R376 800 = R18 840
    Provision for bad debts must be adjusted to R18 840. It is currently R18 000. The amount of R840 by which it must be adjusted must be shown in the income statement as an expense.
  6. Rent was received in advance and therefore must be subtracted from the pre-adjustment figure.
  7. Depreciation on vehicles: 814 000 × 15% = R122 100
    Depreciation on equipment:
    New equipment
    Bought on 1 September. The cost of the new equipment must be subtracted from the equipment balance
    R616 000 – R48 000 = R568 000
    10% of R48 000 × 10 ÷ 12 = R4 000
    Old equipment
    Using the diminishing balance method, subtract the accumulated depreciation from the cost price (excluding the new equipment) to determine carrying value
    R568 000 – R341 000 = R227 000
    10% of R227 000 = R22 700
    Depreciation is recorded as an expense in the income statement:
    R122 100 + R22 700 + R4 000 = R148 800
  8. To calculate the interest on loan on the Loan Statement:
      Loan: Joy bank  
    R1 125 000 – R458 000
    – R804 500
    = R137 500
    Interest on loan =
    137 500     		 Bank CPJ 458 000
    Balance c/d 804 500
    1 262 500    		 Balance b/d 1 125 000
    Int. on loan GJ 137 500
                       1 262 000
    Balance b/d 804 500
  9. Income tax for the year is subtracted from the net profit before tax 

PLEASE NOTE:
Depreciation is normally an involved calculation affecting both vehicles and equipment. For this reason many marks are awarded for the depreciation figure. Show all your workings so that even if one or two of your figures are wrong, you can still get some marks for calculating correctly.

Practice task 2
Use this blank income statement to practice doing the task again on your own. Once you have completed the task, compare your answer to the worked example on the previous pages.

Aneesa ltd: Income Statement for the year ended 30 June 2011

Sales   
Cost of sales   
Gross profit   
Other operating income   
   
Gross operating income   
Operating expenses   
   
   
   
Operating profit  
   
   
   
Profit before tax  
   
Net profit after tax  

[52]

Worked example 3
Balance Sheet and notes
Use the following steps to prepare a balance sheet from the given information:

  1. Enter the figures from the information given onto the answer sheet next to the details.
  2. Read the additional information:
    1. If necessary calculate the adjustment amount.
    2. Decide on which account is to be debited and which account is to be credited.
    3. On your answer sheet reflect a (+) or a (–) in respect of each item next to the already entered pre-adjustment figure.
  3. When all the additional information has been considered, calculate the final figures and write them in the column.

Example adapted from November 2009 NCS exam paper
Practice task 3
You are provided with information relating to Qwando Limited for the financial year ended 30 June 2011.
Prepare the Retained income note. (18)
Prepare the Balance Sheet on 30 June 2011. (36)
Information

  1. The following figures were taken from the financial records of the financial year ended 30 June 2011.
       R
    Ordinary share capital (see information 2 below)  2 400 000 
    Retained income (on 1 July 2010)  738 000
    Shareholders for dividends (see information 4 below)   60 000
    Fixed deposit at Supa Bank (see information 5 below)  ?
    Mortgage Bond from Supa Bank (see information 7 below)  3 881 000
    Fixed/tangible assets  ?
    Debtors’ control  45 000
    Creditors’ control 85 200
    Creditors for salaries 12 300
    Provision for bad debts (see Information 6 below) ?
    SARS (Income tax – provisional tax payments) 400 000
    SARS (PAYE) 6 650
    Expenses payable (accrued) 7 200
    Income receivable (accrued) 7 950
    Bank (favourable balance) 168 450
    Trading stock 129 600
    Consumable stores on hand 5 600
  2. Shares:
    • There were 700 000 ordinary shares in issue at the beginning of the financial year.
    • On 1 January 2011, 100 000 ordinary shares were issued to the public at R3,80 cents per share. This has been correctly recorded and is included in the figures above.
    • On 1 June 2011, 40 000 were repurchased from a shareholder at R4,50 per share. A direct transfer was put through from the Bank account but no entry has been made in the books.
  3. The net profit before tax for the year ended 30 June 2011 was calculated as R1 250 000. No entry for income tax calculated at a rate of 30% of the net profit has been made.
  4. Dividends were as follows:
    • Interim dividends of 20 cents per share were paid on 31 December 2010.
    • Final dividends of 35 cents per share were declared on 30 June 2011. All shareholders at this date qualify for dividends.
  5. One third of the total fixed deposits mature on 31 August 2011.
  6. Provision for bad debts must be adjusted to 5% of debtors.
  7. The loan statement from Supa Bank on 30 June 2011 reflects the following:
    SUPA BANK  
    LOAN STATEMENT ON 30 JUNE 2011 
    Balance on 1 July 2010  R384 000 
    Interest charged  57 600 
    Monthly instalments in terms of the loan agreement (12 × R8 800)
    (These monthly instalments include interest on the capital repayments of the loan)
    (The monthly capital repayments on the loan will remain constant until the loan has been paid in full on 30 June 2019.     		 105 600 
    Balance on 30 June 2011  R336 000 

Answers to practice task 3

  RETAINED INCOME   R
  Balance on the last day of the previous year  738 000 
3 Net profit after tax for the period(1 250 000 – 30%)  875 000 
2 Retained income on 40 000 shares repurchased
(40 000 × R1,50) 		 (60 000) 
(Total dividends (interim and final) are shown here.)→  Ordinary share dividends  (406 000) 
4 Paid (interim)
(700 000 shares × 20c) 		 140 000 
2 & 4 Recommended (final)
(760 000 shares × 35c) 		 266 000 
  Balance on the last day of the current year  1 147 000 

[16]

Qwando Limited
Balance Sheet on 30 June 2011

  ASSETS   
  NON CURRENT ASSETS   3 921 000 
  Fixed / tangible assets (4 021 000)  3 881 000 
(Fixed assets are always shown at book value on the Balance Sheet.)
  Financial assets   
5   Fixed deposit: Supra Bank
(60 000 – 20 000)		 40 000 
  CURRENT ASSETS  219 350 
  Inventories
(129 6003 + 5 600) 		 135 200 
6 Trade and other receivables
(45 0003 + 7 9503 – 2 2503 + 25 000)
(Amount owed by SARS to the business. This implies the business overpaid its taxes to SARS.)		 75 700 
5 Cash and cash equivalents
(168 450 + 20 000 – 120 000- 60 000)		 8 450
  TOTAL ASSETS 4 140 350
  EQUITY AND LIABILITIES  
  CAPITAL AND RESERVES 3 427 000
2 Ordinary share capital (2 400 000 – 120 000) 2 280 000
2 Retained income (see note on previous page) 1 147 000
  NON-CURRENT LIABILITIES 288 000
  Mortgage loan: Supa Bank
(336 000 – 48 000)		 288 000
  CURRENT LIABILITIES 425 350
  Trade and other payables
(85 200 + 12 300 + 6 650 + 7 200)		 111 350
  Shareholders for dividends 266 000
(This is the final dividend declared at the end of the year).
  Current portion of loan 48 000
  TOTAL EQUITY AND LIABILITIES 4 140 350

[38]
The numbers in this column refer to the explanations on the next page.

Explanations of each adjustment

2. Shares:
The new issue of shares have been properly recorded. The repurchase of 40 000 shares at R4,50. The ordinary share capital account must be reduced by the average share price (2 400 000 ÷ 800 000 shares = R3)
The retained income account will be reduced by the difference between the buyback price and average price ( R4,50 – R3 = R1,50 × 40 000 shares)

3. Net profit after tax must be calculated by subtracting income tax from net profit before tax. This must be entered in the retained income note.
Tax calculation = (R1 250 000 × 30% = R375 000).
Net profit after tax = R1 250 000 – R375 000 = R875 000).

4. Dividends:
Calculation of interim/paid dividends = 700 000 × 20 cents = R140 000
Calculation of final/declared dividends = 700 000 + 100 000 (issued) – 40 000 (repurchased) = 760 000 shares
760 000 × 35 cents = R266 000
Total dividends = R140 000 + R266 000 = R406 000

5.Calculation of short term portion of fixed deposit:
The portion of the fixed deposit that will be received within the next 12 months must be subtracted from financial assets and shown under cash and cash equivalents under current assets on the balance sheet.
(1/3 of R60 000 = R20 000)

6. Provision for bad debts is calculated at 5% of debtors control: 5% of R45 000 = R2 250.
Provision for bad debts must be subtracted from trade and other receivables.

7. Repayments of the capital amount of the loan that will be made in the next 12 months must be subtracted from the non-current liabilities and shown under current liabilities as a ‘current portion of loan’.
R105 600 (total repayments) – R57 600 (interest) = R48 000 (capital portion of repayments for the year. 

Practice task 3 (continued)

RETAINED INCOME   R
Balance on the last day of the previous year   
   
   
Balance on the last day of the current year  
   
   
QWANDO LIMITED BALANCE SHEET ON 30 JUNE 2011 
ASSETS  
NON CURRENT ASSETS  
Fixed/tangible assets  
Financial assets  
Fixed deposit: Supra Bank  
   
CURRENT ASSETS  
   
   
TOTAL ASSETS  
   
EQUITY AND LIABILITIES  
CAPITAL AND RESERVES  
   
   
NON-CURRENT LIABILITIES  
Mortgage loan: Supa Bank  
   
CURRENT LIABILITIES  
   
   
TOTAL EQUITY AND LIABILITIES  

[38]

Some important notes to the financial statements

TANGIBLE/FIXED ASSETS  Land & Buildings  Vehicles  Total 
Carrying value at beginning of year

 C C C
(A – B = C)
Cost  A A A
Accumulated depreciation  (B) = 0  (B)  (B)
       
Movements       
Additions  D D D
Disposals at carrying value  (E) (E) (E)
Depreciation
(LAND AND BUILDINGS ARE
NOT DEPRECIATED. A zero
will always be shown in
these blocks.)		 (F) = 0 (F) (F)
       
Carrying value at end of year J J J
Cost H H H
Accumulated depreciation (I) = 0 (I) (I)

C + D – E – F = J OR H – I = J
The total carrying value gets transferred to the Balance Sheet.

TRADE & OTHER RECEIVABLES   
Net trade debtors  M (K – L = M) 
Trade debtors  K
Provision for bad debts  (L)
SARS (income tax)  N(Amount overpaid to SARS.)
Expenses prepaid  O
Income accrued (receivable)  P
  Q

M + N + O + P = Q
Transfer Q to the current assets section in the Balance Sheet.

TRADE & OTHER PAYABLES  
Trade creditors   R
Expenses accrued (payable)   S
Income received in advance   T
Shareholders for dividends   U(Dividend declared but not yet paid (final dividend).
SARS (income tax)   V(Amount still owing to SARS.)
Creditors for salaries   W(Gross salaries less deductions.)
Unemployment insurance fund   X Deductions + contributions.
Pension fund  Y
Medical aid fund  Z
  AA
(AA: Total transferred to current liabilities section of the Balance)

2.4 Cash Flow Statements

Purpose of a Cash Flow Statement

The Income Statement shows the result of business’ operations (net profit).
The Balance Sheet shows the financial position of the business on a specific day (ie how much the business is worth).
Neither of them shows where the business gets its funds from or how the funds are used. The emphasis is on the cash aspects/components.
The Cash Flow Statement is prepared for this purpose and shows where the funds come from and how they are used. 


Basic concepts and terminology
Hint : Cash Flow Statements focus on all aspects of CASH surrounding a business. Remember CASH IS KING for Cash Flow Statements.

Concept   Definition 
Cash inflow  Money coming into the business. This amount does NOT have brackets. (e.g. sale of shares) 
Cash outflow   Money going out of the business. This amount HAS brackets. (e.g. bought a fixed asset for cash) 

All the information needed for a cash flow statement and notes can be found on the income statement, balance sheet and notes.

Worked example 4
Preparation of the cash flow statement
Practice task 4
Prepare the cash flow statement (all relevant notes have been done for you). (15)
Additional information
Extract from balance sheet

  2012  2011   Flow of cash 
(Remember we are looking for the flow of cash. This
means you will need to calculate the difference
between this year’s and last year’s figures, to
determine the figures to place on the Cash Flow
Statement.)
Ordinary share capital  R471 600  R410 000  **see note below 
Retained income  R10 400  R9 000  This has no effect on a cash flow statement. 
Fixed deposit  R28 000  R23 000  (R5 000)  (Outflow)
Loan from Beta Bank (interest is not capitalised)  R74 000  R80 000  (R6 000)  (Outflow)
Bank   R35 300  R10 040   R25 260  Inflow
Cash float  R2 000  R2 000  R0  No change

** During the year the following transactions took place regarding share capital:

  • 8 000 Shares were issued and the company received R79 600 from shareholders.
  • Repurchased 3 000 shares at 820 cents per share

Notes to the cash flow statement
Note 1: Reconciliation between profit before tax and cash generated from operations:

   R  
Profit before tax  30 000  Make sure you use the profit before tax from the Income Statement. If profit after tax is given, remember to add back the tax.
Adjustments i.r.o. (in respect of):  21 200   
Depreciation   12 000   
Interest expense 9 200   
Operating profit before changes in working capital  51 200   
Changes in working capital  5 000   
(Increase)/Decrease in inventory  (3 000)  Difference between last year’s and this year’s figures.Remember to
exclude amounts owed to shareholders, accrued interest and amounts owed to
or by SARS for income tax.
(Increase)/Decrease in debtors 5 600
Increase/(Decrease) in creditors 2 400
Cash generated from operations 56 200 Transfer these figures to the Cash Flow Statement (net change in cash and cash equivalents).


Note 2: Cash and cash equivalents

  Net change
(Net change is calculated as the difference between last year’s and this year’s figures.) 		 ATTENTION: Watch your dates! Make sure you are using the figures from the correct year.  
2012  2011   
Bank   25 260  35 300   10 040  These amounts come DIRECTLY from
cash and cash equivalents on the
Balance Sheet.
Cash float   0 2 000  2 000 
  25 260   37 300  12 040   
  Transfer this figure to the Cash Flow Statement (cash flow from operating activities).  


Note 3: Dividends paid

Total dividends for the year (interim + final)  (R10 000) 
This figure is always shown in brackets.
Amount due at the beginning of the year [dr (cr)]  (R4 500) 
Last year’s shareholders’ for dividends amount. This figure is shown in brackets because it was paid during the year.
Amount due at the end of the year (final) [(dr) cr]   R6 000 
This year’s shareholders for dividends amount. This figure is NOT shown in brackets because it is still not paid.
Dividends paid  (R8 500) 
This is the total amount paid out for dividends this year. This figure is shown in brackets on the Cash Flow Statement (cash flow from operating activities)

Before you attempt a Cash Flow Statement question, ensure that you can identify the information that is given to you to determine if you have to complete notes or simply show all your working calculations.

Note 4: Taxation paid

Total tax for the year   (R13 500)
The income tax figure from the Income Statement. This figure is shown in brackets. 
Balance due at the beginning of the year [dr (cr)]  (R1 600) 
Last year’s SARS income tax balance. If the figure is under trade and other payables it will have brackets. If the figure is under trade and other receivables it will not have brackets. [dr (cr)]
Balance due at the end of the year [(dr) cr]   R1 200 
This year’s SARS income tax balance. If the figure is under trade and other payables it will not have brackets. If the figure is under trade and other receivables it will have brackets. [(dr) cr]
Tax paid  (R13 900)


Cash Flow Statement for the year ended …

  NOTES R     
Cash flow from operating activities    24 960  A  Operating activities:
The most common source
of cash for a company. It
not only involves the buying
and selling of stock, but also
includes paying creditors,
receiving money from debtors
and paying expenses.
Cash generated from operations  1 56 200 B  
Interest paid    (8 840)  C  
Dividends paid  3 (8 500)   D   
Income tax paid  4 (13 900)     
Cash flow from investing activities   (48 700)  E Investing activities:
The activities that focus on
the buying and selling of fixed
assets and the increasing and
decreasing of investments
(e.g. fixed deposits).
Purchase of fixed assets   (48 500)    
Proceeds from sale of fixed assets   4 800    
Increase of investment   (5 000) F  
Decrease of investment   -    
Cash flow from financing activities   49 000 G Financing activities:
How a company is funded
through loans and capital:
• The issuing of shares
• The repurchase of shares
• The obtaining of a loan
• The repayment of a loan
Proceeds from shares issued   79 600 H  
Repurchase of shares   (24 600) I  
Proceeds from long-term loans   -    
Payment of long-term loans   (6 000) J  
Net change in cash and cash equivalents   25 260 K To check your answer, see
K, L + M:
• If both balances are
favourable you subtract,
eg. 37 300 – 12 040 =
25 260.
• If one of the balances is
an overdraft, then you
add, eg. M + (L).
• An overdraft is shown in
brackets ( ). Memorise the
following to determine if K
is in brackets or not:
 K
 L
 M
OR
 K
 (L)
 M
Cash and cash equivalents at the beginning of the year   12 040 L
Cash and cash equivalents at the end of the year   37 300 M

[15]

Explanations of A to L

  1. Cash generated from operations – interest paid – dividends paid – income tax paid = A
    R56 200 – R8 840 – R8 500 – R12 900 = R24 960
    Inflow (Outflow) (Outflow) (Outflow) Inflow
  2. Cash generated from operations transferred from Note 1 (under Notes to the Cash Flow Statement).
  3. Dividends paid transferred from Note 3 (under Notes to the Cash Flow Statement).
  4. Income tax paid transferred from Note 4 (under Notes to the Cash Flow Statement).
  5. Purchase of fixed assets – proceeds from sale of fixed assets – increase in investment = E
    – R48 500 + R4 800 – R5 000 = – R48 700
    (Outflow) Inflow (Outflow) (Outflow)
  6. This figure comes from the Extract from the Balance Sheet and is calculated by finding the difference
    between this year’s and last year’s figures:
    R25 000 – R20 000 = R5 000
    (Outflow)
    Increasing the fixed deposit is an outflow as money is moving out of the bank account and into the
    fixed deposit account.
  7. Proceeds from shares issued – repurchase of shares - payment of long-term loans = G
    R79 600 – R24 600 – R6 000 = R49 000
    Inflow (Outflow) – (Outflow)
  8. Issue of new shares: The amount of R79 000 was given (inflow)
  9. Repurchase of shares: 3 000 × R8,20 = R24 600 (outflow)
  10. This figure comes from the Extract from the Balance Sheet and is calculated by finding the difference
    between this year’s and last year’s figures:
    R74 000 – R80000 = –R6 000 (Outflow)
  11. A – E + G = K (R24 960 – R48 700 + R49 000 = R25 260)
    To verify this figure check the Net Change Total in Note 2 (Cash and Cash Equivalents)
    under Notes to the Cash Flow Statement
  12. This figure comes from the extract from the Balance Sheet, calculated by adding the Bank figure and
    Cash Float figure from last year i.e. 2011.
    To verify this figure check the total of the Bank and Cash Float figure for 2011 in Note 2 (Cash and
    Cash Equivalents) under Notes to the Cash Flow Statement.
  13. This figure comes from the extract from the Balance Sheet, calculated by adding the Bank figure and
    Cash Float figure from this year i.e. 2012.
    To verify this figure check the total of the Bank and Cash Float figures for 2012 in Note 2 (Cash and
    Cash Equivalents) under Notes to the Cash Flow Statement. 

 

Cash Flow Statement for the year ended …

  NOTES R 
Cash flow from operating activities     
Cash generated from operations  1  
Interest paid    (8 840) 
Dividends paid  3 ( 
Income tax paid  4  
Cash flow from investing activities    
Purchase of fixed assets   (48 500)
Proceeds from sale of fixed assets    
Increase of investment    
Decrease of investment   -
Cash flow from financing activities    
Proceeds from shares issued    
Repurchase of shares    
Proceeds from long-term loans   -
Payment of long-term loans    
Net change in cash and cash equivalents  2  
Cash and cash equivalents at the beginning of the year  2  
Cash and cash equivalents at the end of the year  2  

[15]

2.5 Analysis and interpretation of Financial Statements

Area of analysis  Description Related financial indicators 
Profitability  How efficient the company
is in its normal operating
activities		 % Gross profit on sales
% Net profit on sales
% Operating expenses on
sales
% Operating profit on sales
% Gross profit on cost of
sales (mark-up) 
Liquidity  The ability of a company
to pay off its immediate
(short-term) debts 		 Current ratio
Acid test ratio
Net current assets (net
working capital)
Turnover rate of stock
Debtors’ collection period
Creditors’ payment period
Average period of stock on
hand
Solvency  The ability of a company to
pay off all its debts 		 Solvency ratio
Net assets
Return  Are the shareholders
earning a fair amount on
their investment? 		 % Return on average
shareholders’ equity
Earnings per share
Dividends per share
Net asset value
Financial risk
Gearing		 To what extent is the
company financed by
loans (borrowed money)
compared to its own capital		 Debt / equity ratio
% Return on total capital
employed

Follow these steps when commenting on the financial indicators:

  1. Consider what the question is asking you to analyse (e.g. Liquidity).
    Decide on the relevant financial indicator(s).
  2. Name the financial indicator(s) giving figures or ratios or percentages.
  3. Compare the current year’s indicator(s) with that of the previous year.
    Say whether it has increased or decreased.
  4. If possible provide a general comment.

Worked example 5: Comment on the liquidity position of the company

Financial indicator   2010  2011 
Current ratio  1,3 : 1 2,1 : 1 
Acid test ratio  0,6 : 1  1,4 : 1 
  • Current ratio 3 has improved from 1,3 : 1 to 2,1 : 1(It means that the company has current assets of R2,10 for every R1 debt.)
  • Acid test ratio 3 has also improved from 0,6 : 1 to 1,4 : 1 
  • This company is in a good liquidity position and should be able to pay its short-term debt easily.  [5]

Worked example 6: Comment on the earnings per share (EPS) and dividends per share (DPS) of the company
Earnings per share is the ‘if’; if all the profit after tax was declared as dividends, the earnings would have been 35c per share. However what “really happened” is that dividends were declared of only 25c per share. The difference is the profit that the company kept called ‘retained income’.

Financial indicator  2010  2011 
Earnings per share (EPS)   35c per share  15c per share 
Dividends per share (DPS)  25c per share  20c per share
  • EPS has declined from 35c to 15c per share. 
  • DPS has declined from 25c to 20c per share. 
  • In 2010 their EPS was 35c while the DPS was only 25c per share. This means that the company retained 10c per share for future growth. 
  • In 2011 they only earned 15c per share but gave the shareholders 20c per share meaning that none of this year’s profits were retained.
    (It’s the ‘if’! If all the profit after tax was declared a dividend, they would have earned 15c per share. However, the shareholders received more, being 20c per share. That means that some of the retained income of the previous year was used to finance the difference.)
    [6]

Worked example 7: Comment on the debt/equity ratio of the company

Financial indicator  2010  2011 
Debt/equity ratio  0.6:1  0,4:1 
  • Debt/equity ratio decreased3 by 0,2 from 0,6 : 1 to 0,4 : 1. 
  • By repaying the loan the company has a lower financial risk. [3]

Worked example 8: Comment on the percentage return on shareholders’ equity (ROSHE) of the company

Financial indicator  2010  2011 
% return on shareholders’ equity (ROSHE)  18 %   24 % 
  • ROSHE improved3 by 6 % from 18 % to 24 %.
  • The shareholders should be pleased as a return of 24 % is higher than an alternative investment (e.g. fixed deposit).  [3]

Formulae: Financial indicators

Financial indicator  How it is calculated - formula  Answer shown as/in 
1. Gross profit on cost of sales (mark-up)  Gross profit  × 100
Cost of sales     1 		  %
2. Gross profit on sales  Gross profit × 100
  Sales              1 		  %
3. Operating expenses on sales  Operating expenses × 100
          Sales                   1 		  %
4. Operating profit on sales  Operating profit × 100
      Sales                1 		  %
5. Net profit after tax on sales  Net profit after tax × 100
      Sales                    1 		  %
6 .Solvency ratio  Total assets : Total liabilities  Ratio (ℵ : 1) 
7. Net assets (shareholders’ equity)  Total assets − Total liabilities  Rands 
8. Current ratio Current assets : Current liabilities Ratio (ℵ : 1) 
9. Acid-test ratio (Receivables + cash) : Current liabilities
OR
(Current assets – inventories) : Current liabilities		 Ratio (ℵ : 1) 
10. Turnover rate of stock Cost of sales
Average stock		 Times per year
11. Period for which enough stock is on hand/period of
stock on hand (stock holding period)		 Average stock ×  365
Cost of sales         1		 Number of days
12. Debtors average collection period Average debtors × 365
   Credit sales           1		 Number of days
13. Creditors average payment period Average creditors × 365
    Credit sales           1		 Number of days
14. Debt/equity ratio Non-current liabilities : Shareholders’ equity Ratio (ℵ : 1) 
15. Return on equity (shareholders’ equity)         Net profit after tax           × 100
Average shareholders’ equity      1		 %
16. Return on total capital employed        Net profit before tax + interest on loans    × 100
Average shareholders’ equity + average loans    1		 %
17. Earnings per share (‘if’)        Net profit after tax      × 100
Number of issued shares      1		 Cents
18. Dividends per share (what really happened)    Interim & final dividends    × 100
Number of issued shares          1 		 Cents
19. Net asset value per share (this is the real value of the share)      Shareholders’ equity     × 100
Number of issued shares        1		 Cents

OTHER IMPORTANT FORMULAE:
To calculate the selling price (SP): Shareholders’ equity =  Ordinary share capital + Retained income
SP = CP × 100 + mark-up
                          100 
To calculate the cost price (CP):
CP = SP ×       100        
                100 + mark-up

Worked example 9
(This question shows some of the basic financial indicators that will help you earn easy marks)
You are provided with information relating to Glebo Limited for the year ended 30 June 2011.
Practice task 5
Use the given information to calculate the following financial indicators for 2011. (31)

  1. % Gross profit on cost of sales (mark-up)
  2. % Net profit on sales
  3. % Operating profit on sales
  4. Current ratio
  5. Acid test ratio
  6. Debt/equity ratio
  7. Solvency ratio
  8.  Net asset value per share
  9.  Earnings per share

Information
Glebo Limited
Extrac t from income statement for the year ended 30 june 2011

  2011 
Sales  9 000 000 
Cost of sales 5 625 000 
Operating profit   1 423 200 
Income tax  426 000 
Net profit after tax 904 000 


Glebo limited
Balance sheet as at 30 june 2011

  2011 
ASSETS  
Non-current assets 4 626 000
Fixed assets 4 326 000
Financial assets  300 000
Current assets  2 557 000
Inventories (all trading stock)  1 640 000 
Trade and other receivables (all trade debtors)  810 000 
SARS (Income tax) 0
Cash and cash equivalents 107 000
TOTAL ASSETS 7 183 000
EQUITY AND LIABILITIES
Ordinary shareholders’ equity 4 123 000
Ordinary share capital (1 100 000 shares ) 2 910 000
Retained income 1 213 000
Non-current liabilities 1 980 000
Mortgage loan: Jozi Bank (13% p.a.) 1 980 000
Current liabilities 1 080 000
Trade and other payables (all trade creditors) 705 000
SARS (Income tax) 32 000
Shareholders for dividends 275 000
Bank overdraft 0
Current portion of loan 68 000
TOTAL EQUITY AND LIABILITIES 7 183 000


Answer to practice task 5

1  Calculate % gross profit on cost of sales (mark-up) [4]
(Sales – cost of sales) × 100 = 9 000 000 – 5 625 000 × 100
      Cost of sales                               5 625 000
= 3 375 000  × 100
   5 625 000
= 60% 
 2 Calculate % net profit on sales [3]
Net profit after tax × 100 = 904 000 × 100
       Sales                               9000 000
= 10%
 3 Calculate % operating profit on sales [3]
Operating profit × 100 = 1 423 000 × 100
       Sales                            9 000 000
= 15,8%
 4 Calculate current ratio [3]
Current assets ÷ current liabilities
= 2 557 000 ÷ 1 080 000
= 2,4 : 1 
 5 Calculate acid-test ratio [4]
(Current assets – stock) ÷ current liabilities
= (2 557 000 – 1 640 000) ÷ 1 080 000
= 917 000 ÷ 1 080 000
= 0,85 : 1
 6 Calculate debt/equity ratio [3]
Non-current liabilities ÷ ordinary shareholders’ equity
= 1 980 000 ÷ 4 123 000
= 0,48 : 1 
 7 Calculate solvency ratio [4]
Total assets ÷ total liabilities
= 7 183 000 ÷ (1 980 000 + 1 080 000)
= 7 183 000 ÷ 3 060 000
= 2,3: 1
 8 Calculate net asset value per share [4]
Ordinary shareholders’ equity × 100 = 4 123 000 × 100
   Number of shares issued          1      1 100 000      1
= 374,8 cents per share
(Ordinary share capital ÷ par value of shares)
 9 Calculate earnings per share [3]
      Net profit after tax        × 100 =   904 000    × 100
Number of shares issued        1      1 100 000        1
= 82,2 cents per share

Multiply by 100 in order to get the answer in cents per share.

2.6 Comments on an audit report

The need for financial statements: there are several groups of people who will be interested in the financial statements of a business.

Several groups of people who will be interested  Reasons why they are interested in the financial results 
The owners of the business (shareholders) owners are interested in the overall health of the business.
A potential owner. may be interested in investing money in the business.
The management of the business (board of directors). use the report for planning purposes, to maintain certain good practices and to improve on areas of weakness.
Banks who have lent money to the business. Banks are interested in whether there are enough assets in the business to cover their loans. These assets can be sold to repay the loans.
The employees of the business and trade unions They are interested in whether the business is profitable and in negotiating wage increases.
SARS, because the company is a legal person and has to pay tax. SARS is interested in the profit or loss made and the tax that is paid on this.
The auditor who has to report to the shareholders
by giving his opinion on whether he thinks the
financial statements are a fair reflection of the
business during the financial year.		  

 
Function of the independent auditor

  • The auditor must sign an Auditors Report which serves as an assurance to the shareholders that the financial statements are reliable.
  • The auditor is not required to check every transaction or to check for fraud. Her function is to give the shareholders her opinion on whether or not the financial records are a true and fair representation of the company’s operations for that year at a specific date at the end of that financial year.
  • The shareholders use the true and fair financial statements to make their decisions.
  • If the auditor becomes aware of fraud, then he has a duty to report this to the shareholders.
  • Auditors are bound by very high ethical standards and can face disciplinary proceedings if they are found to have been negligent in their work.

Quality of auditors
External Auditors should be registered professionals with professional bodies such as South African Institute of Chartered Accountants (SAICA) and the Independent Regulatory Board for Auditors (IRBA). Advantages of companies engaging registered Auditors:

  • Auditors are guided by a professional code of ethics.
  • Companies are assured of high quality work from qualified Auditors.
  • High professional standards are maintained since auditors are answerable to their affiliate bodies.
  • Disciplinary measures can be taken against Auditors who are negligent in performing their duties.
  • Auditors may be deregistered from professional bodies if they commit any act of misconduct.
  • Auditors can be sued for producing a misleading report.
  • Auditors may lose future contracts due to the production of substandard work.

The independent auditor and the audit report
An auditor is a person who expresses an opinion on financial information and accounting controls. The independent auditor cannot be an employee of the company. She is appointed at the AGM (annual general meeting) by the shareholders, and not by the directors. She charges fees according to the number of hours she expects to spend on the audit.
The opinion of the independent auditor must be based on an assessment of whether the financial statements:

  • Have been prepared in such a way as to give a fair representation of the company’s activity
  • Are understandable and not confusing to the reader
  • Are prepared in accordance with GAAP
  • Are prepared in accordance with the requirements of the Companies Act.

The role of internal auditors
The internal auditors ensure that the internal controls are tested and play an important role in looking for fraud or mistakes in the business. They need to check, for example, debtors, wages or computer entries in every aspect of the business.
The internal auditor will be an employee of the business organisation and will earn a salary from the company.
The independent auditor (external) will consider the checks carried out by an internal auditor.

Audit reports
Auditors will issue a report after they have completed their work to express an opinion on their findings. Such a report is addressed to the shareholders (owners of the company).The report could be:

  • Qualified – a bad report with some irregularities, in which auditors have to state the kind of irregularity noted to the shareholders (qualify their statements).
  • Unqualified – good report with minor irregularities if any.
  • Withheld/Disclaimer – very bad report in which auditors may recommend further investigations on certain outstanding irregularities before issuing a report.

KING CODE: CODE OF GOOD GOVERNANCE: “STARDIF”

S T A R D I F
Social responsibilities  Transparencies  Accountability  Responsible management  Discipline  Independence  Fairness 
Contributing to community in which the business operate  Does things in an open manner (no hidden agenda).  Able to explain your actions when called to as a business  Showing critical consideration for certain aspects for example taking care of the environment  Business must stick to its principles and ethics.  Business must operate without influence from outside  Being considerate to your stakeholders and giving them what they deserve.

The word, “STARDIF” will help you to remember what the Code of good governance stands for!

Worked example 6
EXAMPLE OF AN UNQUALIFIED REPORT
(GOOD REPORT):
You are provided with an extract from the report of the independent auditors:

Audit opinion – To the shareholders:
We have examined the financial statements set out on pages 8 to 20.
In our opinion, the financial statements fairly present, in all material respects, the financial position of the company at 30 June 2009 and the results of their operations and cash flows for the year ended, in accordance with International Financial Reporting Standards (IFRS), and in the manner required by the Companies Act in South Africa.
Barlow & Bokwe
Chartered Accountants (SA)
Registered Accountants and Auditors
Cape Town 6 September 2009 
  • The auditor’s function is to give the shareholders who appointed him at the AGM his opinion.
  • The auditor is not required to check every transaction or to check for fraud.
  • An auditor only expresses an opinion whether or not the financial records are a true and fair representation of the company’s operations for that year at a specific date at the end of that financial year.

The following questions are normally asked in an examination. Make sure that you study the above information before answering the questions.

  1. State whether the shareholders would be satisfied or dissatisfied with this audit report. Give a reason for your answer. [3]
  2. Explain why the auditors found it necessary to stipulate the page numbers (that is 8 to 20) in this report. [2]
  3. Explain why the Companies Act makes it a requirement for public companies to be audited by an independent auditor. [2]
  4. Explain TWO major consequences for Barlow and Bokwe should they be negligent in performing their duties. [4]
  5. What actions would Barlow and Bokwe have to perform to verify the Fixed/Tangible Assets figure in the Balance Sheet? Provide THREE points. [3]
  6. Quinton Qwando, the major shareholder and managing director, has informed the auditors that he intends to buy the unissued shares himself next year without advertising the new issue to the other shareholders or the public. What advice should the auditors give to Quinton? Briefly explain. [4]

Memorandum

  1. State whether the shareholders would be satisfied or dissatisfied
    with this audit report. Give a reason for your answer.
    Satisfied 
    Any valid reason 
    Possible responses
    • The financial statements are fairly presented - this is a positive report
    • This is an unqualified report
    • The auditors did not mention any irregularities
  2. Explain why the auditors found it necessary to stipulate the page numbers (i.e. 8 to 20) in this report.
    They are only responsible for the pages that have been stipulated in the auditors' report 
  3. Explain why the Companies Act makes it a requirement for public companies to be audited by an independent auditor.
    The shareholders of a company need to have confidence in the company’s ability to look after the investment 
  4. Name TWO major consequences for Barlow and Bokwe should they be negligent in performing their duties.
    Any two valid consequences (External Auditors should be registered professionals with professional bodies such as South African Institute of Chartered Accountants (SAICA). This is to protect the shareholders and to ensure that continuous training takes place.)
    Possible responses
    • Can be sued
    • Not be re-appointed as auditors
    • Face disciplinary procedures by the professional body
  5. What actions would Barlow and Bokwe have to perform to verify the Fixed/Tangible Assets figure in the Balance Sheet? Provide THREE points.(Remember that all fixed assets are recorded in an Asset register. Every fixed asset has its own entry in the asset register from the time bought, the yearly depreciation till the date of disposal.)
    Three actions
    Possible responses
    • Examine the financial records of the business – external audit
    • Assess the internal control of the business
    • Assess the accounting principles used by the business
    • Inspect the fixed asset register
  6. Loans 2Quinton Qwando, the major shareholder and managing director, has informed the auditors that he intends to buy the unissued shares himself next year without advertising the new issue to the other shareholders or the public. What advice should the auditors give to Quinton? Briefly explain.
    Advice: This is unethical and the issue of new shares should be advertised to all according to the Memorandum and Articles of Association, as this is a public company. 
    Explanation: The other shareholders will be disadvantaged, as
    Quinton will be increasing his shareholding percentage, which will effectively reduce the returns and dividends that the others are earning. By offering the shares on the open market the company could raise more money than if they sold at an agreed price to one buyer.
    Any valid explanation.
    (It’s a good idea to learn and understand “STARDIF” for this type of question:
  • Transparency
  • Accountability
  • Responsible management
  • Discipline
  • Fairness)

EXAMPLES OF AN UNQUALIFIED AND A QUALIFIED AUDIT REPORT
You are provided with extracts from the independent audit reports of Kwela Ltd and Pomi Ltd.
Extract from audit report of Kwela Ltd:
In our opinion, the financial statements fairly present, in all material respects, the financial position of this company at 28 February 2012 and the results of their operations and cash flows for the year ended in accordance with International Financial Reporting Standards, and in the manner required by the Companies Act of South Africa.
(Unqualified – good report in which there are minor irregularities if any.)
Extract from audit report of Pomi Ltd:
In our opinion, except for the effects of the company’s overvaluation of its fixed assets, the financial statements fairly present the financial position of the company on 29 February 2012 and the results of their operations and cash flows for the year ended in accordance with International Financial Reporting Standards, and in the manner required by the Companies Act of South Africa.
(Qualified – a bad report with some irregularities in which auditors have to state the kind of irregularity noted to the shareholders (qualify their statements).)
REQUIRED:
Consider the audit reports of Kwela Ltd and Pomi Ltd. How would these audit reports influence James in deciding in which company to buy shares? Explain in respect of each company.
Memorandum

  1. How would these audit reports influence James in deciding in which company to buy shares?
    Explanation on the audit report of Kwela Ltd 
    • James will know that he can rely on the figures in the financial statements as the company has received an unqualified audit report
    • James will know that he can rely on the figures in the financial statements as there is fair presentation in all material respects
    • The report is unqualified – it is a good (i.e. reliable) report.

      Explanation on the audit report of Pomi Ltd 
    • James will know that he cannot rely on the figures in the financial statements as the company has received an qualified audit report
    • James will know that he cannot rely on the figures in the financial statements as they drew attention to shortcomings in the financial statements
    • James will be unhappy because the fixed assets had been overvalued in the opinion of the auditors (which means that the true value of his possible investment is not certain as indicated by the net asset value).

EXAMPLE OF A WITHHELD /DISCLAIMER AUDIT REPORT
(Withheld – very bad report in which auditors may recommend further investigations on certain outstanding irregularities before issuing a report.
If the auditor becomes aware of fraud, then he has a duty to report this to the shareholders.
Auditors are bound by very high ethical standards and can face disciplinary proceedings if they are found to have been negligent in their work.)
MAR 2009
Refer to the newspaper article provided.
JSE suspends Woodview Ltd over no annual report
By Ima Snoop, 12 Feb 2009
The trading of shares of furniture company Woodview Ltd were suspended by the JSE Securities Exchange yesterday after the company failed to publish its annual report three months after the end of their financial year-end.
The CEO of Woodview Ltd put out a statement explaining that the auditors had withheld their report and that this was causing a delay.
The company postponed its AGM. The shareholders have not been informed of the reason for the postponement.
Prior to the JSE’s action, the share price of Woodview Ltd dropped 30% to 140 cents per share.
The directors of Bhaga Toys Ltd are worried that a similar problem could occur in their company. Briefly explain why this would be a serious problem for the company. Provide two points
Memorandum
Refer to the newspaper article provided. The directors of Bhaga Toys Ltd are worried that a similar problem could occur in their company.
Briefly explain why this would be a serious problem for the company.
Provide two points.
Any two valid explanations 

  • A delay would cause shareholders to become suspicious
  • Shareholders would not vote for these directors next year
  • New shareholders will avoid the company and share prices could drop
  • The directors would be guilty of a criminal offence. In terms of the Companies Act they have to produce financial statements within three months
  • It will affect the ability to raise capital/loans in future as investors will be suspicious
Last modified on Wednesday, 08 September 2021 12:50
Published in Accounting Study Guide and Notes Grade 12

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