UNIT 10:FINANCIAL STATEMENTS OF SOLE TRADERS
Key unit competence: To be able to prepare financial statements of a
Introductory activity
AMANI is a sole trader selling purified mineral water, juice, and milk. He
has invested money in acquiring the assets, including buildings and motor
vehicles, some by cash and others on credit. In his first year of trading,
he has enjoyed an increased number of customers. Though AMANI is not
sure whether he earned profit or loss comparing business expenses and
revenues, he is also not aware of his business’s financial position.
Required: What kind of financial reports to be prepared by AMANI
that provide the information on his business’s performance and financialposition?
10.1. Meaning, objectives and qualitative characteristics of
financial statements
Activity 10.1
CYUSA, a sole trader in Rwamagana, has been requested by Revenue
Authority to report his business financial information, but he is persisting
as why? You are required to help him by answering the following questions.
1. What is the objective of financial statements?2. What are the characteristics of useful financial information?
10.1.1. Meaning of financial statements
Financial statements are a collection of summary level reports about an
organization’s financial performance, financial position, and cash flows. The
main ones are:
– Statement of Profit or Loss (Income statement)
– Statement of financial position (Balance Sheet)
– Statement of Cash flow (Cash flow statement)
10.1.2. Objectives of financial statements
– To provide information about the financial position (Balance sheet)
– To provide information about financial performance (income statement)
– To provide information about changes in financial position of an entity
(cash flow statement)
– To determine whether a business has the capacity to pay back its debts.
– To derive whether financial ratios from the statements can indicate the
condition of the business.
– To use as the basis for an annual report, which is distributed to investors
and the investment community?
10.1.3. Qualitative characteristics of financial statements
The qualitative characteristics of useful financial reporting identify the types of
information are likely to be most useful to users in making decisions about the
reporting entity on the basis of information in its financial report. The qualitative
characteristics apply equally to financial information in general purpose financial
reports as well as to financial information provided in other ways.
Fundamental qualitative characteristics
Relevance and faithful representation are the fundamental qualitative
characteristics of useful financial information.
Relevance
Relevant financial information is capable of making a difference in the decisions
made by users. Financial information is capable of making a difference in
decisions if it has predictive value, confirmatory value, or both. The predictive
value and confirmatory value of financial information are interrelated.
Materiality
Information is material if omitting it or misstating it could influence decisions
that the primary users of general purpose financial reports make on the basis
of those reports, which provide financial information about a specific reporting
entity.
Faithful representation
This fundamental characteristic seeks to maximize the underlying characteristics
of completeness, neutrality and freedom from error.
Enhancing qualitative characteristics
Comparability, verifiability, timeliness and understandability are qualitative
characteristics that enhance the usefulness of information that is relevant andfaithfully represented.
Application activity 10.1
i) Define financial statements
ii) What are the main financial statements?
iii) List the qualitative characteristics of financial statementsiv) What are the main objectives of financial statements?
10.2. Statement of profit or loss/ Income statement
Activity 10.2
The following information relates to the financial year ended 2020 in the
business of Alice, a sole proprietor in Kigali city:
FRW
Sales 100,000
Wages 20,000
Purchases 70,000
Discount received 12,000
Discount allowed 11,000
Alice wants to know the business’s financial performance.
Required:
i) Using the skills got from O level entrepreneurship, which financial
statement to be used in order to get the business financial
performance?ii) Which formula used to get the financial performance of a business?
10.2.1 Meaning of Income Statement
Income statement is a financial statement prepared to provide information about
financial performance of a business. Many businesses try to distinguish between
a gross profit earned on trading, and a net profit. They therefore prepare the
statement of profit or loss in two parts.
In the first part (Trading Account) of the statement revenue from selling goods
and services is compared with direct costs of acquiring, producing or supplying
the goods sold to arrive at a gross profit figure. From this, deductions are made
in the second half of the statement (profit and Loss Account) in respect of
indirect costs (referred to as expenses in financial accounting) to arrive at a net
profit figure.
The statement of profit or loss normally covers a one-year accounting period but
this is not always the case; other accounting periods are permissible in certain
circumstances.
Elements of statement of profit and Loss are incomes and expenses and the
Source of data is a Trial balance.
Heading of income statement is composed by:
– Name of the sole trader
– Name of income statement
– Period of income statement
10.2.2 Format of income statement
There are two formats of preparing the income statement, the Horizontal orT-account format and the Vertical or narrative format
Vertical format
Income statement
NOTES:
1. The list of expenses above is not exhaustive.
2. The net profit is for the period, and it is transferred to the proprietor’s
capital account in the statement of financial position which will be
discussed in the following contents.
3. Drawings are withdrawals of profit and not expenses. They may be cash
drawings (when cash is drawn) or stock drawings (when stock is drawn).
They must not be included in the statement of profit or Loss. These are
shown as a reduction in the capital account figure on the face of the
statement of financial position and also a reduction of assets.
4. Carriage inwards and carriage outwards are both expenses of
the business. Carriage inwards means transport charges regarding the
goods purchased and it is added to the purchases to increase the cost
of goods sold, while carriage outwards are transport charges regardingthe goods sold and are considered as part of the operating expenses.
5. Returns inwards and Returns outwards
Returns inwards refer to sales returns and are deducted from total sales for the
period to determine net income from sales, also known as turnover. Returns
outwards on the other hand refer to purchases returns, and they are deducted
from total purchases for the period to determine net purchases and cost of
goods sold. The alternative terms used are “returns in” and “returns out”
The statement of Profit or loss shows both the gross profit and the net profit for
the accounting period.10.2.3 Meaning of related terms
– Trading account is an account usually prepared to ascertain the
Gross profit or gross Loss. (This includes all expenses directly incurred
in the trading process) at the end of a trading period.
– Cost of goods sold: is derived by adding purchases to the opening
stock minus closing stock or (cost of goods available for sales- closing
stock) i.e. opening stock +purchases – closing stock)
– Cost of goods available for sale: is opening stock plus the total
purchases for the period. (Opening stock +purchases)
– Gross profit is the difference between the value of revenue (sales)
and the cost of goods sold. It is an excess of selling price of goods
over their cost price. It represents the difference between sales revenue
and purchase price of goods sold
– Gross Loss: If the cost of goods sold exceeds the sales, the difference
will be a gross loss. The main items in the trading account are sales,
purchases, opening stock and closing stock. A trading account or any
other accounts also has a heading which is stated in these forms.
– Net profit is calculated as Gross Profit plus any other income
generated by the business, such as on the sale of non-current assets
and less all other expenses incurred in running the business.
– Net profit may be defined as an excess of gross profit over the expenses
of the business incurred to conduct the business transactions. There
will be a net loss when gross profit is less than the expenses.
– Closing stock: This is the stock at the end of the trading period. This
stock is an asset to the business and is shown as a current asset in the
balance sheet. Closing stock will be shown as additional information onthe trial balance i.e. it will be out of the trial balance items.
10.2.4 Gross profit percentage
Gross profit percentage may be given as percentage of cost price or sale price.
If this percentage is given on the cost price and instead of cost price, the sales
figure is given then this percentage must be changed accordingly and vice
versa. Gross profit as percentage to cost price is known as mark-up and as a
percentage to a sale price ‘margin’.
Example 1
Calculate Mugisha’s Gross profit if the cost of goods sold is FRW 300,000 and
a profit mark-up is 20%.
Solution
Gross Profit = FRW 300,000*20%= FRW 60,000
Example 2
Calculate a Gross profit if the sales are FRW 400,000 and a profit margin is
20%.
Solution
Gross profit = FRW 400,000 * 20% = FRW 80,000
102.5. Forms of financial statement
Single step income statement
A single step income statement is one of two commonly used formats for the
income statement or profit and loss account. The single step format uses only
one subtraction to arrive at net income.
NET INCOME= (REVENUES+GAINS)- (EXPENSES +LOSSES)
An extremely condensed income statement in the single step format would looklike this:
Multiple step income statement
Multi step Income statement segregates the operating revenues from the nonoperating revenues and operating expenses from non-operating expenses,
gains and losses.
The difference between single step income statement and multiple step income
statement is that multiple step reveals the company’s gross profit whereas
single step directly calculates the Net Profit. The format given above on vertical
format is a multiple step income statement.
Example 3
Mr. Samuel has given you the following balances extracted from his books as at
30th September, 2020
Required:
From the above balances, prepare a statement of profit and Loss (or income
statement)ANSWER
Mr Samuel
Statement of profit and Loss for the year ended 30th September 2020
Example 4
On 1st October 2021. Shema Started trading as a snack vendor, selling hot and
cold food from a van which she packs by a road side.
He borrowed FRW 2,000,000 from her bank, and the interest cost of the loan
was FRW 50,000 per month.
a) He rented the van at a cost of FRW 800,000 for 3 months. Running
expenses for the van averaged FRW 150,000 per month.
b) He hired a part time helper at a cost of FRW 120,000 per month.
c) His main business was to sell food to customers who stop their cars
by his van, but he also did some special catering arrangements for
business customers, supplying food for office parties. Sales to these
customers were usually on credit.
d) For the three months to 31st December 2021, his total sales were:
i) Cash sales FRW 6,000,000
ii) Credit sales FRW 2,000 (all paid by 31st December 2021)
e) He purchased food from a local food wholesaler, Best Stores. The
cost of purchases in the three months to 31st December 2021 was
FRW 4,250,000, and at 31st December she had sold all of it. He still
owed FRW 850,000 to Best Stores for unpaid purchases on credit.
f) He used his own home for his office work. Telephone and postage
expenses for the three months to 31 December were FRW 100,000.
g) During the period he paid himself FRW 250,000 per month.
Required: Prepare a statement of Profit or Loss for the three months 1October-31 December 2021.
Application activity 10.2
1. Which of the following statements relating to the statement of profit
or loss is false?
i) It shows in detail how the profit or loss of a period has been
made
ii) It shows the value of sales less total expenses as net profit
iii) It represents the financial position at a point in timeiv) It is one of the key accounting statements of any business
10.3 Effect of errors on the calculation of the profit
Activity 10.3
Examine the following errors and show their effects on net profit:
Furniture purchased for FRW 2,000 had been debited to the purchases
account
Goods purchased from Rwanda Group of companies for FRW 2,500 were
credited to the account of Rwanda and company
An invoice from Kanimba firm for FRW 7,800 was omitted
Goods sold to Umutoni for FRW 1,750 were entered in the sales daybook
or sales book as FRW 1,570.
i) The salaries and wages account was over added by FRW 350 and
the rent received account had been over added by FRW 350.
As you have seen in unit 6, some types of errors will cause an imbalance in the
trial balance. The bookkeeper will then know that an error has been made and
will look for it and correct it. In this case, the trial balance will balance but the
statement of profit or loss may be incorrect. You may be asked to consider how
errors, and correction of errors, affect the statement of profit or Loss.
Examination questions frequently require a net profit figure to be corrected. To
arrive at the correct net profit figure, the errors are corrected first and then the
effect of these corrections on net is determined. These adjustments are added
or subtracted from the net profit figure given in the question to find out theadjusted net profit. For this purpose, the following format may be adopted.
NDAMAGE Enterprise makes up its annual accounts to 31st December. Her
trial balance at 31st December 2012 showed the shortage on the debit side of
FRW 1,050. This difference was posted to a Suspense account.
The following errors were then discovered.
i) The purchases journal had been under cast by FRW56,300
ii) The sale of office equipment had been posted to the sales account,
FRW13,205
iii) Received from Kwizera Florien FRW 66,700, a debtor, was correctly
entered in the Cash Book, but had been wrongly posted to the Debtors
Ledger as FRW6,600.
iv) Discount allowed of FRW1,500 had been entered in the cash book, but
was not posted in the customer’s account.
v) Machinery was purchased on credit from Ruvubu Factory for FRW250,000
but no entry had been made in the Enterprise’s books.
Required:
1. For each error state how the net profit will be affected when the errors
are corrected
2. Calculate the corrected net profit if the reported profit was FRW 87,000.
Answer
1. (I) decrease on net profit, (ii) decrease, (iii) no effect, (iv) no effect, (v) noeffec
Example 2
The accountant KAZUNGU prepared a trial balance for his business for the
month of December 2017 but it failed to balance. The total on the debit side
was more than the total on credit side by FRW 33,000. He opened a suspense
account for the difference and proceeded to prepare final accounts. He reported
a net profit of FRW 1,400,000.
During the month of January 2018 he discovered the following mistakes which
had been made in December 2017:
1. The purchases account had been under cast by FRW 2,000
2. Payment of FRW 555,000 by cheque for insurance was properly recorded
in the cash book but was posted to insurance account by mistake as
FRW 515,000
3. A sales invoice of FRW 300,000 was not recorded in the sales day book
and therefore not posted to the ledger
4. The credit side of the sales account was under added by FRW 4,000
5. Motor vehicle repairs costing FRW 50,000was debited to Motor Vehicle
account
6. Payment of FRW 680,000 cash to John a creditor was properly recorded
in John’s account but was wrongly recorded in cash book as FRW
670,000
7. The bookkeeper had made a mistake by debiting ledger fee of FRW
15,000 to the cash book but properly recorded in the ledger fee account
8. Sale of goods for FRW 600,000 on credit to Mbabazi was properly
recorded in the sales account but was wrongly recorded in Uwimbabazi
account
9. The bank column of the cash book credit side was over added by FRW
1,000
10. A credit note issued for FRW 800,000 was properly recorded in the
customer’s account but was wrongly recorded in the other account
necessary for completion of double entry as FRW 820,000
11. Discount received of FRW 6,000 was debited to discount allowedaccoun
Required: Statement of corrected net profit
Application activity 10.3
An accountant of MUYANGO extracts a trial balance which fails to agree
by a figure of FRW 2,400,000. He places the difference in Suspense
account and then proceeds to prepare draft Trading and Profit and Loss
Account for the year ended 31st May 2018 which results in a net profit of
FRW 64,000,000. Later he attempts to find the errors which had causedhis trial balance to disagree. The following errors are found:
10.4 Statement of financial position/ Balance sheet
Activity 10.4
A balance sheet is a financial statement which shows the financial position of an
organization at a particular date with regards to its assets, liabilities and owner’s
equity. When a balance sheet balances, it means that the accounting equation
has been satisfied.
Heading of balance sheets:
• Name of the sole trader
• Name of balance sheets
• End period of balance sheets
Format of balance sheets:
• Horizontal format
• Vertical format
Elements of balance sheets
- Assets: Assets represent the resources owned by the business. These
are resources controlled by the entity as a result of past events. Assets are
classified into current and non-current assets.
• Current assets: Current assets are the assets acquired by a firm and
stay in the firm for a short period of time, usually less than one year. The
current assets are:
- Cash and cash equivalent (bank, petty cash)
- Marketable securities/short term securities
- Account receivables
- Bills receivable
- Inventory (stock of goods, stock of raw materials and supplies,
stock of work in progress, stock of finished goods and semifinished goods)
- Prepaid expenses
- Accrued income
• Fixed assets/ Non-current assets
- Investment
- Tangible assets: They are those assets which have physical
existence and which are in use in an enterprise for a period of
one year and above. They are mainly: premises, land, buildings,
plant and machinery, equipment, furniture, fixture and fittings,
motor vehicle, long term securities in portfolio etc
- Intangible assets: intangible fixed assets are assets which do
not have physical existence. They are mainly: leasehold, patent,
Goodwill, Trade mark, organization cost at creation of the
company, copyright and license.
- Liabilities: Present obligations of an entity as a result of past event.
Liabilities are classified into current and non-current liabilities.
• Current liability: These are obligations of payments maturing in less
than one financial year. They are:
- Note payable
- Creditors
- Overdraft
- Tax payable
- Unearned revenues
- Prepaid income
- Accrued expenses
• Non-current liability: they are obligations of payments maturing in
more than one financial year. They are: long term bank loans, bonds
(debenture) loans.
• Equity
Equity is the net amount of funds invested in a business by its owners, plus any
retained earnings (Net profit):
Owner’s equity = capital plus net profit minus drawings
Accounting equation:
Assets = Liabilities + Owner’s Equity
OR
Owner’s equity= capital +Net profit - Drawings.
Importance of a balance
a) The balance sheet helps to know the three origins of economic
resources used by a firm:
• Contribution of shareholders or owners
• Long, medium and short term liabilities
• Internal financing (retained earnings and reserves)
Sources of capital used by a business are:
- Personal resources
- Borrowing from friends or banks
- Trade credits
- Bank overdraft
b) The balance sheet helps to know the use of economic resources
The uses are:
• Fixed assets (Fixed capital)
• Current assets (stocks, receivables, cash)
Structural equilibrium of the enterprise
The structural equilibrium is based on the following general principles:
1. Owner’s equity should be greater than liabilities.
2. Capital employed (owner’s equity plus long term liabilities) should cover
the fixed assets and part of current liabilities.
3. Current liabilities should be invested only into current assets and basicallyin cash and receivables so to be easily reimbursed.
FORMAT
Balance sheet as at……
Example 1
Mr. Samuel has given you the following balances extracted from his books as at
30th September,2020
You are required to prepare the statement of financial position as at 30th
September 2020
Solution
Mr SamuelStatement of financial position as at 30th September 2020
Mr Samuel
Statement of financial position as at 30th September 2020
EXAMPLE 2
The following monthly Trial balance was extracted from the books of Ben on 31st
May,2019:
Required:
a) Statement of Profit and Loss for the period ended 31st May 2019
b) Statement of financial position as at 31st May 2019
ANSWER
Ben
Statement of profit and loss for the period ended31st May 2019
Application activity 10.4
1) Which of the following statements relating to how a five-year bank
loan is shown in the statement of financial position is true:
i) It should be shown as a non-current asset
ii) It should be shown as a non-current liability
iii) It should be split into a current liability and non-current liability
iv) It should be shown as a current liability
2) Which of the following statements correctly describes the contents
of the statement of financial position?
i) A list of ledger balances shown in debit and credit columns
ii) A list of all the assets owned and all the liabilities owed by a
business
iii) A record of income generated and expenditure incurred over a
given period
iv) A record of the amount of cash generated and used by a company
in a given period.
3) From the following information, prepare a statement of financialposition
10.5 Effect of errors on the balance sheet
Activity 10.5
After extracting the trial balance and financial statements of MUHIRE, an
investigation revealed the following errors:
1. Debtors account over casted by FRW 30,000
2. Rent received debited in discount allowed FRW 40,000
3. Purchases of machinery completely omitted
4. Cash received from a debtor FRW 215,000 recorded in both
accounts as FRW 151,000
REQUIRED: Show the effect of each error on the balance sheet
When correcting errors, you may be asked to consider how errors, and
correction of errors, affect the statement of financial position. Examination
questions frequently require a balance sheet to be corrected. To arrive at the
correct balance sheet, the errors are corrected first and then the effect of these
corrections on balance sheet is determined. These adjustments are used to
correct the balance sheet.
ExampleSet out below is the draft Balance Sheet of KAZUNGU as at 31st March 2020
After correcting the errors that caused the suspense account to take place and
preparing a statement of corrected net profit, the following results was obtained:
Application activity 10.5
Below are particulars regarding Odile’ final accounts:
The net profit per the accounts is found to be FRW 154,000. The Balance
Sheet when drawn up appeared to be as follows:
OdileDraft balance as at 31st/12/2021
The following errors were subsequently detected and corrected:
a) cash sales entry entered in cash book only FRW 6,000
b) Drawings (cash) completely omitted from books FRW 1,000
c) Rent account under cast FRW 2,000
d) Creditor BARASA paid, but entry in his ledger account only FRW 5,000
Required:
Draw up statement of adjusted net profit and revised balance sheet at 31stDecember 2021
10.6 Statement of cash flow
Activity 10.6
10.6.1 The meaning of statement cash flow and related terms
The term cash is used to mean fund or cash on hand and demand deposit.
Cash equivalent are short term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant
risk of changes in value.
Cash flows are inflows and outflows of cash and cash equivalent.
Cash and cash equivalent: These are items which are not held for investment
or other long term purposes, but rather to meet short term cash commitments. An
investment’s maturity date should normally be three months from its acquisition
date.
A cash flow statement is a financial statement that shows us the exact source
(inflows) of the business fund obtained during a period and the use to which the
business funds are applied (outflows)
Statements of cash flows are a useful addition to the financial statements of a
company because accounting profit is not the only indicator of performance.
They concentrate on the sources and uses of cash and are a useful indicator of
a company’s liquidity and solvency.
It has been argued that “profit” does not always give a useful or meaningful
picture of a company’s operations. Readers of a company’s financial statements
might even be missed by a reported profit figure.
Statements of cash flows are frequently given as an additional statement,
supplementing the statement of financial position, statement of profit or loss
and related notes.
Statement of cash flows indicates the changes that took place in the cash
balances between two balance sheet dates. It provides historical information
about cash and cash equivalents, classifying cash flow from operating, investing
and financing activities.
The cash flow statements presented by companies contain information on three
parts:
Cash from operating activities
Cash flow from financing activities
Cash from investing activities
The manner of presentation of cash flows from operating, investing and financing
activities depends on the nature of the enterprise. By classifying cash flows
between different activities in this way, users can see the impact on cash and
cash equivalents of each one, and their relationship with each other.
10.6.2 Benefits statement of cash flow
1. Useful for short term planning: it will enable the business to ensure cash
is available to meet its financial obligations.
2. Helps in efficient cash management: projected cash flow statement will
help on planning and coordinating sources and application of cash.
3. Helps in internal finance management
4. Disclose the movement of cash showing the increase or decrease in
cash and hence explaining the decreases or increases of cash
5. Discloses success or failure of cash planning comparison between the
projected cash flow statement and the actual cash flow statement will
indicate success or failure.
6. Statement of cash flow enhance comparability: as they are not affected
by differing accounting policies used for the same type of transactions
or events.
10.6.3 Distinguish among operating, investing, and financing
activities.
The statement of cash flow is portioned into three segments, namely: cash flow
resulting from operating activities, cash flow resulting from investing activities,
and cash flow resulting from financing activities.
Operating activities
Operating activities include the production, sales and delivery of the company’s
product as well as collecting payment from its customers. This could include
purchasing raw materials, building inventory, advertising, and shipping the
product. Cash flows from operating activities are primarily derived from the
principal revenue-producing activities of the entity. Most of these components
will be those items which determine the net profit or loss of the enterprise.
Operating cash flows include (Examples):
• Receipts from the sale of goods or services
• Receipts for the sale of loans, debt or equity instruments in a trading
portfolio
• Interest received on loans
• Dividends received on equity securities
• Payments to suppliers for goods and services
• Payments to employees or on behalf of employees
• Interest payments
Investing activities
The cash flows classified under this heading show the extent of new investment
in assets which will generate future profit and cash flows.
The standard gives the following examples of cash flows arising from investing
activities:
• Purchases or sale of fixed asset (assets can be land, building, equipment,
marketable securities, etc)
• Cash payments to acquire shares or loan notes of other entity
• Cash receipts from sales of shares or loan notes of other entities
• Cash advances and loans made to other parties
• Cash receipts from the payment of advances loans and loans made to
other parties
• Payments related to mergers and acquisitions
Financing activities
Financing activities include the inflow of cash from investors such as banks and
shareholders, as well as the outflow of cash to shareholders as dividends as the
company generates income. This is an indicator of likely future interest and
dividend payments. Other activities which impact the long term liabilities and
equity of the company are also listed in the financing activities section of the
cash flow statement.
The standard gives the following examples of cash flows which might arise
under these headings:
• Proceeds from issuing loans, bonds, mortgages and other short term
or long term borrowings
• Payments of dividends
• Payments to owners to acquire or redeem the entity’s share of company
shares
• Repayment of debt principal, including capital leases
• For non-profit organizations, receipts of donor-restricted cash that is
limited to long term purposes.
• Interest payments can also be considered under this activity if not
considered under operating activities – However, interest payments
of financial institutions should always be classified under operating
activities
Items under the financing activities section include:
• Dividends paid
• Sale or repurchase of the company’s stock
• Net borrowings
• Payment of dividend tax
10.6.4 Net cash position
This is a difference between the cash inflows and cash outflows. That is the
cash at the beginning plus total cash inflows less total cash outflows. When
it is with a positive result it is called a SUPLUS whereas a negative result is a
DEFICIT
How to deal with surplus
Positive cash flow indicates that a company has more money flowing into the
business than out of it over a specified period. This is an ideal situation to be in
because having an excess of cash allows the company to:
• Expand business activities
• Settle debt payments
• Reinvest in itself and its shareholders
• Acquire new fixed assets
• Increase credit sales and decrease cash sales
• Increase cash purchases and decrease credit purchases
Positive cash flow does not necessarily translate to profit, however. Your
business can be profitable without being cash flow-positive, and you can have
positive cash flow without actually making a profit.
How to deal with deficit
• Increase cash sales and decrease credit sales
• Increase credit purchases and decrease cash purchases
Net cash flows
It indicates whether a business has enough cash to cover the expected cash
payment (surplus) it means cash inflows are greater than cash outflows or not,
it means cash outflows are greater than cash inflows.
10.6.5 Components of cash and cash equivalent
Cash and cash equivalents consist of cash on hand and balances with banks,
and investments in money market instruments.
10.6.6 Formats of cash flow statement
The standard offers a choice of method for this part of statement of cash flows.
Direct method: Discloses major classes of gross cash receipts and gross
cash payments.
Indirect method: net profit or loss is adjusted for the effects of transactions
of a non-cash nature, any deferrals or accruals of past or future operating cash
receipts or payments, and items of income or expense associated with investing
or financing activities.
Direct method discloses information not available elsewhere in the financial
statement, which could be of use in estimating future cash flows. However, the
indirect method is simpler, more widely used and more likely to be examined.
Direct method
FORMAT
Cash flow statement as at……
NOTE: This format does not to separate operating cash flow, investing cashflows and financing cash flows.
OR
Cash flow statement as at……
SOLUTION
CASH FLOW STATEMENT (DIRECT METHOD)
Example 2
Mugabo had the following information in 2014:
Application activity 10.6
1. Define cash and cash equivalent.
2. Which of the following headings is not classification of cash flow?
a) Operating
b) Investing
c) Administration
d) Financing
3. Umuhoza had the following transactions during the year.
a) Cash received from customers 32,900
b) Cash paid to suppliers 17,950,000
c) Cash paid to employees 11,250
d) Interest paid 2,100
From the following information, calculate the cash flow from operatingactivities.
4. Use the following data to construct a statement of cash flows usingthe direct method.
During 2000 declared and paid dividends of FRW 2,500
During 2000, ABC paid FRW 46,000 in cash to acquire new fixed assets.
The account payable was used only for inventory. No debt was retiredduring 2000.
10.7 Accounting records for incomplete information
Activity 10.7
Maurice has a small business buying and selling energy drinks. This
business does not write its accounts in double entry form due to lack of
accounting skills. Besides, given the size of his business, it is not mandatory
for him to keep the books of accounts. Maurice records its cash transaction
(not necessarily in a professionally written cash book) and simply lists its
debtors and creditors. Only single records are made, important records for
conformity to double entry are omitted and therefore incomplete. Figures
for credit sales, credit purchases, opening capital etc. are missing.
From the above scenario, answer the following questions:
1. How Maurice ltd records are called?
2. Is this book-keeping suitable? Justify your answer.
10.7.1 Meaning of accounting for incomplete record or single
entry accounting
Single entry accounting may be defined as a system of book keeping in which the
dual aspect of transactions is ignored and in which personal accounts only are
maintained. It means any system which is single entry system. In the questions
based on incomplete records, some information is provided and some missing
information is to be found.
Obviously this book-keeping system is unsuitable. It is impossible to extract any
trial balance. Financial statements cannot therefore be prepared from information
supplied under single entry and incomplete records because some key figures
for financial statements preparation are missing and the trial balance cannot be
prepared. No set of single rules can be given as short cut to the understanding
of the principles involved. These figures are obtained by applying the basic
principles of the double entry.
There are two main kinds of the questions based on incomplete records:
a) Those requiring a computation of profit based on increase in net assets
b) Those requiring the production of the final accounts from a cash book
The following steps are followed when attempting to re-organize and prepare
final accounts/financial statements from single entry and incomplete records.
Step 1
Calculation of the opening capital
In many cases, the sole trader may not know with how much capital he/she
started business. The opening capital can be determined by preparing the
statement of affairs. A statement of affairs is simply an opening balance sheet.
Step 2
Re-writing the cash book
Sometimes it may be necessary to re-write the cash book professionally in a
columnar form applying double entry system. This especially necessary where
the closing cash/bank balances are not provided. Re-writing the cash book may
also reveal ‘hidden’ drawings etc. it is also necessary to complete the double
entry for all items entered into the cash book.
Step 3
Calculating credit sales and credit purchases
Since in single entry, debtors and creditors are simply listed, credit sales and
credit purchases cannot easily be ascertained. There are no purchases or sales
A/Cs maintained in a double entry fashion. These key figures can be determined
by preparing control accounts. Debtors control account for credit sales and
creditors control accounts for credit purchases. In some instances, credit sales
and credit purchases could be computed from accounting ratios (mark up andmargin).
Step 4
Adjusting some expense accounts
Some expense accounts may require to be adjusted. This is because in these
accounts information is scattered and disorganized. It may occur that in the
same case expense account there were prepayments and/ or accruals and
cash payments during the year. This scattered information needs to be brought
together so that the figures to be posted to the profit and loss account aredetermined. This step will require opening T Account
Step 5
Preparation of the trial balance
Previously it was impossible to prepare the trial balance when the entries were
single form and some key figures were missing. Having transformed single entry
records into double entry, all the ledger accounts created for completion of
double entry and cash book are balanced off or closed and together with the
previously missing figures for credit sales, credit purchases, opening capital
etc, a trial balance can be prepared
Step 6
Preparation of financial statements
Once the trial balance has agreed, final accounts/financial statements can be
prepared. The financial statements that are prepared by sole traders are income
statements and balance sheet.
NOTE
In examinations some of the above steps may be omitted especially step V
above.
Computing of profit
The net assets basis uses the principles of fundamental accounting equation
to build up a set of accounts and to calculate the profit figure. The accounting
equation is:
Profit = Increase in assets +drawings – Additional Capital – Increase in other
liabilities.
The net worth of a business means the net value of assets which belongs to the
proprietor. Any increase in capital represents the increase in net value of assets.
If there are no drawings and no additional capital is introduced by the proprietor,
then this increase is due to the net profit earned during particular year.
Drawings reduce the value of assets so there are added into assets to find
actual profit similarly, an additional capital introduced by the proprietor results
in the increase in assets but this has not come about as a part of profit thus it is
deducted to arrive at the figure of true profit. Any increase in outside liabilities
like bank loan is also deducted
Example 4
The records of UWERA provide the following information for the year ending
31st December 2015.
Capital January FRW 5,600,000
Capital 31ST December FRW 8,500,000
Drawings FRW 2,500,000
New capital introduced by UWERA FRW 1,500,000
Calculate UWERA’s net profit on the basis of these figures.
Profit= FRW 2,900 + 2,500-1,500= FRW 3,900
Note: Increase in assets is the increase in capital from 1st January to 31st
December 2015.
10.7.2 Final accounts from incomplete records
To prepare the final accounts from incomplete records, the following steps are
taken:
a) Statement of affairs
b) Reconstruction of accounts
Statement of affairs
In order to find out the opening capital, a statement of affairs is prepared.
Total assets and total liabilities are taken into consideration and the difference
between these two is taken as capital at the start of accounting period.
Example 5
CYUBAHIRO does not keep proper records of his business transactions but hegives the following information as at 1st January 2016.
Required: Prepare the statement of affairs to find his capital as at 1st January
2016.
Reconstruction of accounts
From the given information, the missing figures are obtained by reconstructing the
control accounts. These accounts are reconstructed by applying the principles
of double entry to the available information. Normally, creditors’ accounts are
prepared to find out the figures of purchases and sales and those are prepared
in step IV. The cash or bank account is constructed to find out the balance at
bank. Similarly, nominal accounts can be constructed as required.
An important aspect of these accounts is to build up the whole of the answer onsimultaneous basis rather than completing one account at a time.
Illustration 6
James is a sole trader and does not maintain a full set of accounting records
The following information regarding his cash and bank transactions was obtained
for the year ended on 31st/12/2017
The bank loan was obtained on 31/6/2017 and it is at interest rate of 20%p.a.
interest for the period accrued.
Vehicle is to be depreciated by 20%p.a. on cost.
Required:
i) Determine James’ opening capital on 1/1/2017
ii) Write up a cash book
iii) Prepare a set of final accounts that can be prepared from the aboveinformation for the year ended on 31st December 2017.
Answer
James
Statement of Affairs as at 1/1/ 2017
James
Cash book
Application activity 10.7
1. When Ossie completed his extended trial balance the totals were:Statement of profit or Loss columns
What is Ossie’s profit or Loss for the period?
A A loss of FRW 7,209,000
B A loss of FRW 12,318,000
C A profit of FRW 7,209,000
D A profit of FRW 12,318,000
2. In the last 12 months, Joanna’s capital balance increased by FRW
6,798,000. In the year her drawings totaled FRW 14,600,000 and
she introduced additional capital of FRW 2,900,000.
What is Joana’s net profit or loss for the year?
a) FRW 4,902,000 loss
b) FRW 18,498,000 loss
c) FRW 4,902,000 profitd) FRW 18,498,000 profit
Skills Lab
1. Referring to AKEZA ledger accounts (Unit 4.5), prepare a trial
balance and a balance sheet.
End of unit assessment
1. Clement’s trial balance includes balances for: insurance, trade
payables, trade receivables.
Which of the following statement is correct?
a) Insurance is a current asset, trade payables is an expense, trade
receivables is a current liability
b) Insurance is an expense, trade payables is a current liability, trade
receivables is a current asset
c) Insurance is an expense, trade payables is a current asset, trade
receivables is a current liability
d) Insurance is a current liability, trade payable is an expense, trade
receivables is a current asset.
2. At 31st October 2016 Jane owed her suppliers FRW 13,856,000.
During the year to 31ST October 2017 she owed FRW 11,552,000.
What was the value of Jane’s credit purchases for the year to 31 October
2017?
a) FRW 70,478,000
b) FRW 93,582,000
c) FRW 98,190,000
d) FRW 121,294,000
3. At 30 November 2013, John’s bank current account was overdrawn.
He also had a bank loan on which monthly capital repayments were
due to commence in February 2015.
How should these balances be reported on his statement of financialposition at 30 November 2013?
Where should these items ultimately appear in the financial statements?
a) Both items should appear in the statement of profit or loss
b) Item (i) in the statement of financial position and item (ii) in the
statement of profit or Loss
c) Both items should appear in the statement of financial position
d) Item (i) in the statement of profit or loss and item (ii) in the
statement of financial position
5. From the following particulars relating to Silas, a sole trader, you
are required to prepare his statement of profit or Loss for the yearending 30th June, 2020 and a Balance sheet as on that date.
Trial balance as at 30th June 2020
Stock at 30stJune 2020 was valued at FRW 6,000
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