On this page you will find Companies Grade 12 Notes Accounting Study Guide
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
- Ordinary share capital
- sars (income tax)
- Shareholders for dividends
- Income tax
- Dividends on ordinary shares (ordinary share dividends)
- 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)
PROFIT AND LOSS ACCOUNT (F2) N
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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:
- 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. - Read each adjustment:
- If necessary calculate the adjustment amount
- Decide on which account is to be debited and which account is to be credited.
- 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 (–)
- 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
- Prepaid expenses: Insurance prepaid, R200
- Accrued expenses: Water and electricity still due, R2 000.
- Income received in advance: Rent income received in advance, R1 000
- Accrued income: Interest on fixed deposit still due, R400 (not capitalized)
- Bank charges, R700, interest on overdraft, R200 on late bank statement to be brought into account.
- Bank Statement also showed a RD cheque, R1 000 (receive from debtor B. Bam in settlement of his account of R1 100)
- Interest capitalized. Loan b/d R55 000 (1 July 2011). Total payments R15 000. Closing balance of loan R50 000.
- Depreciation: Depreciate vehicles at 10% p.a. at cost price and Equipment at 10 % p.a. at carrying value
- Bad debts: J Jon’s debt written off as bad debt, R200
- INCREASE: 2014 Provision for bad debts at 5 % of debtors. (17 000 × 5% = )
- 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
- Trading stock deficit: Trading stock according to stock taking, R67 000.
- Consumable stores on hand: Closing stock: Packing material, R300
- 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
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
CALCULATION: (100% × 7) + (110% × 5) + (110% × 1) = 27 200 | ||||||||||||||||||||||||||||||||||||||
| 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.
CALCULATION: (100% × 7) + (110% × 4) = 22 800 | ||||||||||||||||||||||||||||||||||||||||
| 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
CALCULATION: (100% × 7) + (90% × 4) = 22 800 | |||||||||||||||||||||||||||||||||||||
| 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
|
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
| ||||||
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:
- Enter the figures from the information given onto the answer sheet next to the details.
- Read the additional information:
- If necessary calculate the adjustment amount.
- Decide on which account is to be debited and which account is to be credited.
- On your answer sheet reflect a (+) or a (–) in respect of each item next to the already entered pre-adjustment figure.
- 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
- 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 - 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.
- 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.
- 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.
- One third of the total fixed deposits mature on 31 August 2011.
- Provision for bad debts must be adjusted to 5% of debtors.
- 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: 5.Calculation of short term portion of fixed deposit: 6. Provision for bad debts is calculated at 5% of debtors control: 5% of R45 000 = R2 250. 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’. |
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:
OR
| |||||||
| 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
|
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:
- Consider what the question is asking you to analyse (e.g. Liquidity).
Decide on the relevant financial indicator(s). - Name the financial indicator(s) giving figures or ratios or percentages.
- Compare the current year’s indicator(s) with that of the previous year.
Say whether it has increased or decreased. - 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)
- % Gross profit on cost of sales (mark-up)
- % Net profit on sales
- % Operating profit on sales
- Current ratio
- Acid test ratio
- Debt/equity ratio
- Solvency ratio
- Net asset value per share
- 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.
- State whether the shareholders would be satisfied or dissatisfied with this audit report. Give a reason for your answer. [3]
- Explain why the auditors found it necessary to stipulate the page numbers (that is 8 to 20) in this report. [2]
- Explain why the Companies Act makes it a requirement for public companies to be audited by an independent auditor. [2]
- Explain TWO major consequences for Barlow and Bokwe should they be negligent in performing their duties. [4]
- What actions would Barlow and Bokwe have to perform to verify the Fixed/Tangible Assets figure in the Balance Sheet? Provide THREE points. [3]
- 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
- 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
- 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 - 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 - 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
- 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
- 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
- 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