3Syllabus A The context and purpose of financial reporting B The qualitative characteristics of financial informationC The use of double entry and accounting systemsD Recording transactions and eventsE Preparing a trial balanceF Preparing basic financial statementsG Preparing simple consolidated financial statementsH Interpretation of financial statements
4Exam format Exam format 35 questions for 2 marks each 70 TotalTwo hour exam – all questions are compulsory.
5Tackling multiple choice questions 1 The MCQs in your exam contain four possible answers, you have to choose the option that best answers the question.The three incorrect options are called distractors, these are included to test your understanding of the syllabus.The following slides detail how best to avoid the common pitfalls that most students fall into.
6Tackling multiple choice questions 2 Steps to follow when attempting MCQs:Step 1: Skim read all MCQs and identify what appear to be the easier questions.Step 2: Attempt each question:Start with the easier questionsRead the question thoroughlyTry to work out the answer before looking at the options OR you may prefer to look at the options at the beginning
7Tackling multiple choice questions 3 Step 3: Read the four options and see if one matches your own answer.Be careful with numerical questions as the distractors are designed to match answers that incorporate common errors.Check your calculation is correct.Have you followed the requirement exactly?Have you included every stage calculation?
8Tackling multiple choice questions 4 Step 4: What to do if your answer does not match the options?Re-read the question to ensure that you understand it and are answering the requirementEliminate any obviously wrong answersConsider which of the remaining answers is the most likely to be correct and select the option
9Tackling multiple choice questions 5 Step 5: If you are still unsure make a note and continue to the next questionStep 6: Revisit unanswered questions. When you come back to a question after a break you often find you are able to answer it correctly straight away.If you are still unsure have a guess. You are not penalised for incorrect answers, so never leave a question unanswered!
10Tackling multiple choice questions 6 After extensive question practice and revision of MCQs you may find that you recognise a question when you sit the exam.Be aware that the detail and/or requirement may be different. If the question seems familiar read the requirement and options carefully – do not assume that it is identical.
11Chapter 8 Inventory Cost of goods sold Accounting for opening and closing inventoriesCounting inventoriesValuing inventoriesIAS 2
12Syllabus learning outcomes 1 Recognise the need for adjustments for inventory in preparing financial statements.Record opening and closing inventory.
13Syllabus learning outcomes 2 Identify the alternative methods of valuing inventory.Understand and apply the IASB requirements for valuing inventories.Recognise which costs should be included in valuing inventories.
14Syllabus learning outcomes 3 Calculate the value of closing inventory using 'first in, first out' and 'average cost'.Understand the use of continuous and period end inventory records.
15Syllabus learning outcomes 4 Understand the impact of accounting concepts on the valuation of inventory.Identify the impact of inventory valuation methods on profit and on assets.
16Overview Accounting adjustments Inventory Valuation Effects on profit CostNet realisable valueMethods of estimating costFIFOAVCO
17Cost of goods sold 1 Formula for the cost of goods sold $ Opening inventory value XAdd: purchases (or production costs) XXLess: closing inventory value (X)Cost of goods sold X
18Cost of goods sold 2 Carriage inwards Cost paid by purchaser of having goods transported to his businessAdded to cost of purchases
19Cost of goods sold 3 Carriage outwards Cost to the seller, paid by the seller, of having goods transported to customerIs a selling and distribution expense
20Accounting for opening and closing inventories 1 Entries during the yearDuring the year, purchases are recorded by the following entry.DEBIT Purchases $ amount boughtCREDIT Cash or payables $ amount boughtThe inventory account is not touched at all.
21Accounting for opening and closing inventories 2 Entries at year-endThe first thing to do is to transfer the purchases account balance to the statement of profit or loss:DEBIT Statement of profit or loss $ total purchasesCREDIT Purchases $ total purchases
22Accounting for opening and closing inventories 3 The balance on the inventory account is still the opening inventory balance. This must also be transferred to the statement of profit or loss:DEBIT Statement of profit or loss $ opening inventoryCREDIT Inventory $ opening inventory
23Accounting for opening and closing inventories 4 The exact reverse entry is made for the closing inventory (which will be next year’s opening inventory):DEBIT Inventory $ closing inventoryCREDIT Statement of profit or loss $ closing inventory
24Counting inventories 1 Counting inventories In order to make the entry for the closing inventory, we need to know what is held at the year-end. We find this out not from the accounting records, but by going into the warehouse and actually counting the boxes on the shelves.
25Counting inventories 2Some businesses keep detailed records of inventory coming in and going out, so as not to have to count everything on the last day of the year. These records are not part of the double entry system.
26Valuing inventories 1 Valuation Inventories must be valued at the lower of:CostNet realisable value (NRV)
27Valuing inventories 2 Cost Can use per IAS 2: FIFO (First In Last Out) Average costLIFO (Last In First Out) is not permitted
28Valuing inventories 3 NRV Expected selling price X Less: costs to get items ready for sale (X)selling costs (X)X
29Valuing inventories 4Inventory forms a major part of the assets of some companies.So the value placed on the inventory can make a big difference to the profit or loss reported.
30Valuing inventories in China In the 3rd quarter of 2012, the Youngor Group Co had inventory valued at CNY 24 billion.
31IAS 2IAS 2Inventories should be measured at the lower of cost and net realisable value – the comparison between the two should ideally be made separately for each itemCost is the cost incurred in the normal course of business in bringing the product to its present location and condition, including production overheads and costs of conversion
32IAS 2 (cont’d)IAS 2Inventory can include raw materials, work in progress, finished goods, goods purchased for resaleFIFO and average cost are allowedLIFO is not allowed
33IAS 2 (cont’d) Inventories are assets: Held for sale in the ordinary course of businessIn the process of production for such sale; orIn the form of materials or supplies to be consumed in the production process or in the rendering of services
34IAS 2 (cont’d) Net realisable value is the estimated selling price: In the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale
35Tackling the examUnderstanding IAS 2 is a very important and you will be expected to apply it in the exam.
36Lecture example 1According to IAS 2: Inventories, which of the following should not be included in determining the cost of the inventories of an entity?(1) Labour costs(2) Transport costs to deliver goods to customers(3) Administrative overheads(4) Depreciation on factory machine
37Lecture example 1 (cont’d) A All four itemsB 1 onlyC 2 and 3 onlyD 2, 3, and 4 only
38Answer to lecture example 1 Transport costs to deliver goods to customers are an example of carriage outwards and should not be included. Administrative overheads do not relate to production and cannot therefore be included.The depreciation of the factory machine is a production overhead and should be included.
39Lecture example 2Jessie is trying to value her inventory. She has the following information available:$Selling priceCosts incurred to dateCost of work to complete itemSelling costs per itemRequiredWhat is the net realisable value of Jessie's inventory?
40Answer to lecture example 2 Net realisable value is:$Estimated selling price35Less: costs of completion(12)Less: selling costs(1)22
41Lecture example 3On 1 January 20X7 a company held 200 units of finished goods valued at $10 each. During January the following transactions took place:DateUnits purchasedCost per unit10 January300$10.8520 January350$11.5025 January250$13.00
42Lecture example 3 (cont’d) Sales during January were as follows:DateUnits purchasedCost per unit14 January280$18.0021 January40028 January80
43Lecture example 3 (cont’d) RequiredDetermine the valuation of closing inventories and cost of sales using:(a) FIFO(b) Weighted average cost
44Answer to lecture example 3 (a) Closing inventories (FIFO)PurchasesOpeninginventories10 Jan20 Jan25 Jan200300350250Sales14 Jan21 Jan26 Jan(200)Nil(80)(220)(180)90@ $11.50= $1,035@ $13.00= $3,250$4,285
45Answer to lecture example 3 (cont’d) Cost of sales (FIFO)$Opening inventories (200 × $10)2,000Purchases10,53012,530Less: closing inventories(4,285)8,245
46Answer to lecture example 3 (cont’d) (b) Closing inventories and cost of sales (AVCO)UnitsCost$AverageUnit CostTotalCost ofSales1.1.X2b/f20010.002,00010.1.X2Purchase30050010.85(W1)3,2555,25514.1.X2(280)22010.51(2,943)2,3122,94320.1.X235057011.50(W2)4,0256,33721.1.X2(400)17011.12(4,448)1,8894,44825.1.X225042013.00(W3)3,2505,13928.1.X2Sale(80)34012.24(979)4,1609798,370
48Chapter summary 1 1 Introduction Inventories can be a significant figure in an entity’s accounts and will impact both the profit figure and the net asset position. It is important therefore that it is recorded correctly.
49Chapter summary 2 2 Accounting adjustment As seen in chapter 6 the statement of profit or loss matches the sales revenue earned in a period with the cost of sales incurred to generate that revenue. There are therefore two inventory adjustments: the opening inventory adjustment and the closing inventory adjustment.
50Chapter summary 3 3 Valuation Inventories should be valued at the lower of cost and net realisable value.
51Chapter summary 44 CostThe cost of inventory includes the cost of purchase, costs of conversion and any other costs necessary to bring the inventory to its present location and condition.
52Chapter summary 5 5 Net realisable value (NRV) Net realisable value is the estimated selling price less the costs to completion and any selling and distribution costs.
53Chapter summary 6 6 Theoretical methods of estimating cost Methods available to estimate the cost of inventories are first in, first out (FIFO) and average cost. Under FIFO the inventories held at the year end are the most recent purchases but under average cost the cost of all inventories purchased during the year is weighted to produce an average figure.
54Chapter summary 7 7 Valuation effects on profit In times of rising prices, using FIFO will mean the financial statements show higher inventory values and higher profits.
55Chapter 9 Tangible non current assets Capital and revenue expenditureIAS 16DepreciationNon-current asset disposalsRevaluationsDisclosure
56Syllabus learning outcomes 1 Define non-current assets and recognise the difference between current and non-current assets.Explain the difference between capital and revenue items and classify expenditure accordingly.
57Syllabus learning outcomes 2 Prepare ledger entries to record the acquisition, disposal, depreciation and accumulated depreciation of noncurrent assets.Calculate and record profits or losses on disposal of non- current assets in the statement of profit or loss.
58Syllabus learning outcomes 3 Record the revaluation of a non-current asset and calculate its subsequent depreciation and profit or loss on disposal.
59Syllabus learning outcomes 4 Illustrate how non-current asset balances and movements are disclosed in company financial statements.
60Syllabus learning outcomes 5 Explain the purpose and function of an asset register.
61Syllabus learning outcomes 6 Understand and explain the purpose of depreciation.Calculate the charge for depreciation using the straight line and reducing methods, identifying when each is appropriate.Calculate the adjustments to depreciation necessary if changes are made in the estimated useful life and/or residual value of a non-current asset.Record depreciation in the statement of profit or loss and statement of financial position.
62Capital versus revenue OverviewCapital versus revenueexpenditureCostTangible non-currentassetsRevaluationsDepreciationDisposalsStraight linemethodReducing balancemethod
63Capital and revenue expenditure 1 What is capital expenditure?Capital expenditure results in the acquisition of non- current assets, or an increase in their earning capacity.
64Capital and revenue expenditure 2 What is revenue expenditure?Revenue expenditure is incurred for the purpose of trade or to maintain the existing earning capacity of the non- current assets.
65Tackling the examIt is highly likely that some questions in your exam will focus on the distinction between capital and revenue expenditure.
66IAS 16 IAS 16 Initial measurement – at cost Components of cost — Purchase price (incl import duties, excl trade discount, recoverable sales tax)— Initial estimate of dismantling and restoration costs— Directly attributable costs, eg site preparation, delivery and handling costs installation, assembly costs, testing and professional fees
67Tackling the exam Exam focus point: Only staff costs arising directly from the construction or acquisition of the asset can be capitalised as part of the cost of the asset.The costs of training staff to use a new asset cannot be capitalised because it is not probable that economic benefits will be generated from training the staff as we can’t guarantee that those staff will stay and use the asset. The costs of training staff should be expensed.Watch out for this in your exam!
68IAS 16 (cont’d) Subsequent expenditure — added to carrying amount if improves condition beyond previous performanceRepairs and maintenance costs are expensed.
71Depreciation 1 Depreciation – accruals concept Is a process of spreading the original cost of a non-current asset over the accounting periods in which its benefit will be felt
72Depreciation 2 Two methods Straight line dep’n = Reducing balance dep’n = cost × RB%
73Depreciation 3 The double entry for depreciation is as follows: DEBIT Depreciation expense (SPL)CREDIT Accumulated depreciation (SOFP)
74Depreciation 4 Change in expected life If after a period of an asset’s life it is realised that the original useful life has been changed, then the depreciation charge needs to be adjusted.The revised charge from that date becomes:CV at revised dateRemaining useful life
75Tackling the exam Exam focus point: If an exam question gives you the purchase date of a non- current asset which is part way through an accounting period, you should generally assume that depreciation should be calculated in this way as a ‘part year’ amount, unless the question states otherwise.
76Non-current asset disposals 1 On disposal of an asset a profit or loss will arise depending on whether disposal proceeds are greater or less than the carrying value of the asset.If proceeds > CV = profitIf proceeds < CV = loss
77Non-current asset disposals 2 Double entry for a disposalEliminate costDEBIT DisposalsCREDIT Non-current assetsEliminate accumulated depreciationDEBIT Provision for depreciationCREDIT Disposals
78Non-current asset disposals 3 Account for sales proceedsDEBIT CashCREDIT Disposalsor if part exchange dealDEBIT Non-current assetswith part exchange valueTransfer balance on disposals account to the statement of profit or loss
79Revaluations 1 IAS 16 allows a choice between Keeping asset at cost Revaluing to fair valueFair value may give fairer view on business.
80Revaluations 2 Accounting for a revaluation A revaluation is recorded as follows:DEBIT Non-current asset(revalued amount less original cost)DEBIT Accumulated depreciation(total depreciation to date)CREDIT Revaluation surplus(revalued amount less carrying value)
81Disclosure Disclosure With regard to disclosure, a proforma non-current asset note is shown here.TotalLand and buildingsPlan and equipment$ 000Cost or valuationAt January 20X716010060Revaluation surplus20-Additions in year5030Disposals in year(45)(15)(30)At 31 December 20X7185135DepreciationAt 1 January 20X710Charge for year752Eliminated on disposals(3)34259Carrying value1511104113080
82Tackling the exam 1 Exam focus point: There was a question on revaluations in the December exam. This asked for the depreciation charge and balance on the revaluation reserve at the end of the financial year, following a revaluation at the beginning of the year.The examiner commented that this was one of the questions with the lowest pass rates that session. Students correctly calculated the balance on the revaluation reserve but failed to identify the correct depreciation charge for the year.
83Tackling the exam 2As the revaluation took place at the beginning of the year, a whole year’s depreciation had to be calculated using the revalued amount over the remaining useful economic life.The remaining useful life needed to be calculated by working out the original depreciation charge and comparing this to the accumulated depreciation brought forward to find out how long the asset had been held.Students who answered the question wrongly had used the original useful economic life rather than the remaining useful economic life figure.
84Lecture example 1 Required What examples of tangible non-current assets can you identify?
85Answer to lecture example 1 Examples include:(a) Land and buildings(b) Plant and equipment(c) Motor vehicles(d) Furniture and fittings, computers
86Lecture example 2 On 10 December 20X7 an entity bought a machine. The breakdown on the invoice showed:$Cost of machine ,000Delivery costsOne-year maintenance contract21,100Further installation costs of $500 were also incurred.
87Lecture example 2 (cont’d) RequiredAt what amount should the machine be capitalised in the entity's records?A $20,000B $20,700C $20,200D $21,600
88Answer to lecture example 2 BThe cost capitalised should include the purchase price ($20,000) plus all directly attributable costs (delivery and installation).The cost of the maintenance contract should be shown as an expense in the statement of profit or loss.
89Lecture example 3A business buys a machine for $2,500. It is expected to have a useful life of three years after which time it will have a scrap value of $250.Required(a) Calculate the annual depreciation charge.(b) Calculate the cost, accumulated depreciation and net book value (NBV) for each year of the asset's life. Note: NBV = cost – accumulated depreciation to date.
90Answer to lecture example 3 Straight line method:2,500 ─ 2503 years= $750 per annumDepreciation charge=
91Answer to lecture example 3 (cont’d) YearCostAccumulated depreciationNBV12,5007501,75021,5001,00032,250250
92Answer to lecture example 3 (cont’d) Graphical representation$2,500250YearNBV
93Lecture example 4A business buys a machine costing $6,000. The depreciation rate is 40% on a reducing balance basis.RequiredCalculate depreciation expense, accumulated depreciation and net book value of the asset for the first three years.
94Answer to lecture example 4 YearDep’n rateDep’n expenseAcc’ddep’nNBV140%2,4003,60021,4403,8402,16038644,7041,296
95Answer to lecture example 4 (cont’d) Graphical representation$6,000YearNBV3,6002,1601,296
96Lecture example 5 Required Using the information in Lecture example 3, show:(a) The journal entry which would have been written at the end of the first year.(b) The treatment of depreciation for all years in the relevant ledger accounts.(c) The relevant statement of profit or loss and statement of financial position extracts for each year.
97Answer to lecture example 5 (a) Journal entryDebit Credit$ $Depreciation expenseAccumulated depreciationBeing annual depreciation charged on machine
98Answer to lecture example 5 (cont’d) Accounting for depreciation:Machine (SOFP)$Cash2,500Bal c/dBal b/d
100Answer to lecture example 5 (cont’d) Accumulated depreciation (SOFP)$Bal c/d7501,5002,250Year 1 Depreciation expenseYear 2 Bal b/dDepreciation expenseYear 3 Bal b/d
101Answer to lecture example 5 (cont’d) Statement of profit or loss (extracts):Year Year Year 3$ $ $ExpensesDepreciationStatement of financial position (extracts):Cost Accumulated Net BookDepreciation Value$ $ $(Year 1) Machine , (750) ,750(Year 2) Machine , (1,500) ,000(Year 3) Machine , (2,250)
102Lecture example 6The machine costing $6,000 in Lecture example 4 is sold in year 3 for $3,000. No depreciation is charged in the year of disposal.Required(a) Calculate the profit or loss on disposal of the machine.(b) Complete the ledger accounts to show how the disposal would be accounted for.
103Answer to lecture example 6 $Sales proceeds ,000NBV at end of year (2,160)840
104Answer to lecture example 6 (cont’d) (b)Machine (SOFP)Bal b/d$6,000(a) Disposal accountAccumulated depreciation (SOFP)(b) Disposal account$3,840Bal b/d
105Answer to lecture example 6 (cont’d) Disposal account (SPL)(a) MachineBalance = profiton disposal (SPL)$6,0008406,840(c) Cash(b) Accumulated dep’n3,0003,840
106Lecture example 7Assume in Lecture example 6 that instead of cash proceeds of $3,000, there is a part exchange allowance of $3,000 on a replacement machine costing $10,000.Required(a) Calculate the profit or loss on disposal of the machine.(b) Calculate the amount of cash paid for the new machine.(c) Complete the ledger accounts to show both the disposal and the acquisition.
107Answer to lecture example 7 The profit on disposal is still $840, the only difference is that the proceeds were not received in cash, but in the form of a part exchange allowance.Cash paid for the new machine is $7,000 ($10,000 – $3,000)
108Answer to lecture example 7 (cont’d) Old machine (SOFP)Bal b/d$6,000(a) Disposal accountAccumulated depreciation (SOFP)(b) Disposal account$3,840Bal b/d
109Answer to lecture example 7 (cont’d) New machine (SOFP)(c) Disposal accountCashBal b/d$3,0007,00010,000Bal c/d
110Answer to lecture example 7 (cont’d) Disposal account (SPL)(a) MachineProfit disposal (SPL)$6,0008406,840(c) New machine (part exchange)(b) Accumulated depreciation3,0003,840
111Lecture example 8A building costing $100,000 on which depreciation of $20,000 has been charged is to be revalued to $150,000.Required(a) Show the double entry to record the revaluation and make the postings to the ledger accounts.(b) What would be the depreciation charge for the year if the building has a remaining useful life of 40 years?
112Answer to lecture example 8 (a) The double entry is$ $Dr Non-current asset – building (150 – 100) 50,000Dr Accumulated depreciation – building ,000Cr Revaluation reserve (β) ,000
113Answer to lecture example 8 (cont’d) Building (SOFP)$Bal b/d100,000Revaluation reserve50,000Bal c/d150,000
114Answer to lecture example 8 (cont’d) Accumulated depreciation (SOFP)$Revaluation reserve20,000Bal b/dRevaluation reserve (SOFP)$Building50,000Revaluation reserve70,000Accumulated depreciation20,000Bal b/d
115Answer to lecture example 8 (cont’d) (b) Depreciation charge is$150,000 / 40 years = $3,750
116Lecture example 9 1.1.X1 Asset cost $40,000 Estimated useful life five yearsNo residual value1.1.X3 Total useful life revised to four years.RequiredCalculate the depreciation charge, accumulated depreciation and NBV for each year of the asset's life (year end 31 December).
117Answer to lecture example 9 Review of useful life:YearDepreciationcharge$AccumulateddepreciationNBV20X140,000/5=8,00032,00020X216,00024,00020X324,000/212,00028,00020X440,000
118Lecture example 10 1.1.X1 Asset cost $40,000 Residual value $1,500 Useful life five yearsDepreciation: 25% reducing balance1.1.X3 Change depreciation method to straight lineRequiredCalculate the depreciation charge, accumulated depreciation and NBV for each year of the asset’s life (year ended 31 December).
119Answer to lecture example 10 Change in method of depreciation:Dep’ncharge$AccumulateddepreciationNBV20X140,000 × 25%10,00030,00020X230,000 × 25%7,50017,50022,50020X3(22,500-1,500)/37,00024,50015,50020X431,5008,50020X538,5001,500
120Chapter summary 1 1 Introduction Expenditure on non-current assets is often significant and it is important therefore that it is accounted for appropriately.
121Chapter summary 2 2 Non-current assets Capital expenditure results in a non-current asset being shown on the statement of financial position. Revenue expenditure, such as repairs and maintenance, is shown as an expense in the statement of profit or loss.Tangible non-current assets should initially be recorded at cost. This includes the purchase price of the item plus any directly attributable costs to bring the item to its intended location and ready to use.
122Chapter summary 3 3 Depreciation Depreciation is an expense charged in relation to the asset each year to reflect the using up of the asset. Land usually has an unlimited useful life and so is not depreciated.
123Chapter summary 4 4 Methods of depreciation Depreciation is usually calculated on a straight line or reducing balance basis.
124Chapter summary 5 5 Straight line method This method is suitable for assets which are used up evenly during their life time. The depreciation expense is the same each year.
125Chapter summary 6 6 Reducing balance method This method is suitable for assets which generate more revenue in the earlier years of their life. The depreciation expense is higher in the initial years.
126Chapter summary 7 7 Accounting for depreciation Depreciation is recorded by way of a journal entry. The expense is recorded as a debit entry and reduces profit. The credit is made to the accumulated depreciation account and reduces the carrying value of the asset in the statement of financial position.
127Chapter summary 8 8 Disposal of non-current assets On disposal of a non-current asset the sales proceeds are compared to the net book value of the asset in order to calculate the profit or loss on disposal. Where an asset is given in part exchange for another asset, the part exchange allowance takes the place of the sales proceeds.
128Chapter summary 9 9 Revaluations An entity may choose to revalue its assets rather than hold them at cost – this is a choice of accounting policy. Where an entity revalues, it must revalue all assets in the same class and the depreciation charge is based on the revalued amount.
129Chapter summary 10 10 Depreciation revisited If an entity changes the method of depreciation used from straight line to reducing balance (or vice versa) or revises the useful life of an asset it should write off the asset’s net book value using the revised method or useful life.