Accounting and Finance For Managers

1
2
[[
STUDY PACK
ON
[[
ACCOUNTS AND FINANCE FOR MANAGERS
2017
VOLUME I
3
STUDY PACK ON
ACCOUNTING AND FINANCE FOR MANAGERS

INTERMEDIATE I
@CIPM 2018
THIRD EDITION
CHARTERED INSTITUTE OF PERSONNEL
MANAGEMENT OF NIGERIA
CIPM House, 1 CIPM Avenue, Off Obafemi Awolowo Way,

Opposite Lagos State Secretariat, Alausa, Ikeja, Lagos.
P.O.Box 5412, Marina, Lagos.Tel: 08105588421
E-mail: info@cipmnigeria.org
Website: www.cipmnigeria.org
www.twitter.com/CIPMNIGERIA
www.youtube.com/cipmnigeria
All rights reserved, no part of this publication may be reproduced,stored in retrieval system, or
transmitted in any form or by any means, electronically, mechanical, photocoping or otherwise
without permission of CIPM NIGERIA.
4
FOREWORD
This third edition of our study pack has been made available for the use of our professional students
to assist them in effectively accomplishing their HR professional goal as dictated by the Institute from
time to time.
The text is meant not only for Chartered Institute of Personnel Management of Nigeria (CIPM)
students, but also for researchers, HR practitioners and organisations embarking on the promotion of
human capital development in its entirety. It has therefore been written not only in a manner that
users can pass CIPM professional examinations without tears, but also to provide HR professional
practitioners further education, learning and development references.
Each chapter in the text has been logically arranged to sufficiently cover all the various sections of this
subject in the CIPM examination syllabus in order to enhance systematic learning and understanding
of the students. The document, a product of in-depth study and research is both practical and original.
We have ensured that topics and sub-topics are based on the syllabus and on contemporary HR best
practices.
Although concerted effort has been made to ensure that the text is up to date in matters relating to
theories and practice of contemporary issues in HR, we still advise and encourage students to
complement the study text with other relevant literature materials because of the elastic scope and
dynamics of the HR profession.
Thank you and have a productive preparation as you navigate through the process of becoming a
professional in Human Resources Management.
Ajibola Ponnle.
REGISTRAR/CEO
5
ACKNOWLEDGEMENT
On behalf of the President and the entire membership of the Chartered Institute of Personnel
Management of Nigeria (CIPM), we acknowledge the intellectual prowess of Dr. John A Oyetade, FCA
in writing this well researched text for Accounting and Finance for Managers. The meticulous work of
our reviewer, Mr. Olayiwole L. Raheed has not gone unnoticed and is hereby acknowledged for the
thorough review of this publication.
We also commend and appreciate the efforts of members of the Education Committee of the Institute
for their unflinching support.
Finally, we appreciate the contributions of the National Secretariat staff competently led by the
Registrar/CEO, Mrs. Ajibola Ponnle and the project team, Dr. Charles Ugwu (MCIPM), Mrs. Nkiru
Ikwuegbuenyi, (MCIPM), Miss Charity Nwaigbo, ACIPM and Livina Nwagbara.
6
TABLE OF CONTENTS
CHAPTER ONE: INTRODUCTION TO ACCOUNTING 17

1.0 LEARNING OBJECTIVES 17
1.1 INTRODUCTION 17
1.2 THE HISTORICAL DEVELOPMENT OF ACCOUNTING 17
1.3 REGULATORY FRAMEWORK 18
1.4 THE PURPOSE OF ACCOUNTING 18
1.5 BOOKKEEPING AND ACCOUNTING 18
1.6 IMPORTANCE OF BOOK KEEPING 19
1.7 ACCOUNTING DEFINED 19
1.8 SCOPE OF ACCOUNTING 19
1.9 THE NEED FOR ACCOUNTING INFORMATION 19
1.10 QUALITIES OF GOOD ACCOUNTING INFORMATION 20
1.11 USERS AND THEIR INFORMATION NEEDS 21
1.12 THE WORK OF AN ACCOUNTANT 21
1.12.1 MEMBERS IN PUBLIC PRACTICE 21
1.12.2 MEMBERS NOT IN PUBLIC PRACTICE 22
SUMMARY 23
REVIEW QUESTIONS 24
REFERENCES 25
CHAPTER TWO: STATUTORY AND REGULATORY FRAMEWORK

OF FINANCIAL REPORTING STANDARDS 26
2.1 INTRODUCTION 26
2.2 STATUTORY FRAMEWORK 26
2.3 REGULATORY FRAMEWORK 26
2.4 ACCOUNTING STANDARDS 27
2.5 HISTORY OF INTERNATIONAL ACCOUNTING STANDARDS
BOARD 27
2.6 STRUCTURE OF THE FOUNDATION 28
2.7 THE IFRS INTERPRETATIONS COMMITTEE (IIC) 29
2.8 LIST OF IASS ISSUED BY THE IASC AND ADOPTED BY IASB 30
2.9 FINANCIAL REPORTING COUNCIL (FRC) 34
7
2.10 COMPOSITION OF BOARD OF FRC 36
2.11 STRUCTURE OF FRC 36
2.12 PROCESS LEADING TO ISSUE OF SAS 39
2.13 LIST OF SAS ISSUED TO DATE 40
2.14 WHY ARE ACCOUNTING STANDARDS NECESSARY 41
2.15 STATEMENTS OF ACCOUNTING STANDARDS 42
2.16 APPLICATION OF IFRS AND SAS IN NIGERIA 43
2.17 SUMMARY 44
2.18 REVIEW QUESTIONS 45
REFERENCES 46
CHAPTER THREE: FINANCIAL REPORTING AND

FRAMEWORK OF ACCOUNTING 47
3.0 LEARNING OBJECTIVE 47
3.1 INTRODUCTION 47
3.2 ACCOUNTING METHOD 54
3.3 ACCOUNTING BASES 54
3.4 ACCOUNTING POLICIES 55
3.5 SUMMARY 56
REFERENCES 58
CHAPTER FOUR: CAPITAL AND REVENUE ITEMS 59

4.1 CAPITAL EXPENDITURE 59
4.2 REVENUE EXPENDITURE 59
4.3 ITEMS IN THE STATEMENT OF FINANCIAL POSITION 60
4.3.1 NON-CURRENT ASSETS 60
4.32 CURRENT ASSETS 60
4.3.3 TANGIBLE ASSETS 60
4.3.4 INTANGIBLE ASSETS 61
4.3.5 FICTITIOUS ASSETS 61
4.3.6 WASTING ASSETS 61
4.3.7 LIQUID ASSETS 61
4.3.8 LIABILITIES 61
4.3.9 NON-CURRENT LIABILITIES 62
4.3.10 CURRENT LIABILITIES (OR SHORT-TERM LIABILITIES) 62
4.3.11 PROVISIONS 62
4.3.12 CONTINGENT LIABILITIES 63
4.3.13 CAPITAL 64
4.3.14 EQUITY 65
8
4.4 CAPITAL INCOME 65
4.5 REVENUE INCOME 65
4.6 SUMMARY 66
REFERENCES 68
CHAPTER FIVE: SOURCE DOCUMENTS AND SUBSIDIARY BOOKS 69

5.1 INTRODUCTION 69
5.2 THE SUBSIDIARY BOOKS 69
5.2.1 SALES DAY BOOK 70
5.2.2 PURCHASES DAY BOOK 70
5.2.3 RETURNS INWARD DAY BOOK 70
5.2.4 RETURNS OUTWARD DAY BOOK 71
5.2.5 JOURNAL PROPER 71
5.2.6 CASH BOOK 73
5.2.7 ANALYTICAL PETTY CASH BOOK 83
5.3 THE IMPREST SYSTEM 83
5.4 SUMMARY 92
REFERENCES 95
CHAPTER SIX: ACCOUNTING EQUATION 96

6.0 LEARNING OBJECTIVES: 96
6.1 INTRODUCTION 96
6.2 ITEMS USED IN ACCOUNTING EQUATION/ BALANCE
SHEET EQUATION 96
6.3 STATEMENT OF FINANCIAL POSITIONS ITEMS 97
6.3.1 ASSETS 97
6.3.2 NON CURRENT ASSETS 97
6.3.3 CURRENT ASSETS 97
6.4 LIABILITIES 97
6.4.1 CURRENT LIABILITIES 97
6.4.2 LONG TERM LIABILITIES 97
6.5 SUMMARY 101
6.6 PRACTICE QUESTIONS 102
REFERENCES 104
9
CHAPTER SEVEN: DOUBLE ENTRY SYSTEM 105
7.1 INTRODUCTION 105
7.2 CLASSIFICATION OF ACCOUNTS 106
7.2.1 PERSONAL ACCOUNTS 106
7.2.2 IMPERSONAL ACCOUNTS 106
7.2.3 REVENUE ACCOUNTS 106
7.2.4 EXPENSES ACCOUNTS 106
7.2.5 INTANGIBLE ASSETS ACCOUNTS 107
7.3 SUMMARY 114
REFERENCES 117
CHAPTER EIGHT: LEDGER BALANCING AND EXTRACTION

OF TRIAL BALANCE 118
8.2 RULES FOR THE IDENTIFICATION OF BALANCES 118
8.3 PURPOSE OF TRIAL BALANCE 118
8.4 PROCEDURES FOR BALANCING THE LEDGERS AND TRIAL
BALANCE 119
8.5 NATURE OF TRIAL BALANCE 119
8.6 TRIAL BALANCE (SAMPLE) 119
8.7 EXTENDED TRIAL BALANCE 121
8.8 SUMMARY 127
REFERENCES 135
CHAPTER NINE: ERRORS, CORRECTION OF ERRORS AND

SUSPENCE ACCOUNT 136
9.2 CLASSIFICATION OF ERRORS 136
9.3 ERRORS NOT AFFECTING THE TRIAL BALANCE 136
9.3.1 ERROR OF OMISSION 136
9.3.2 ERROR OF COMMISSION 137
9.3.3 ERROR OF ORIGINAL ENTRY 137
9.3.4 ERROR OF PRINCIPLE 137
9.3.5 ERROR OF COMPLETE REVERSAL OF ENTRY 137
10
9.3.6 ERROR OF TRANSPOSITION 137
9.3.7 ERROR OF DUPLICATION 137
9.3.8 COMPENSATING ERROR 137
9.4 PROCEDURES TO BE FOLLOWED WHEN CORRECTING ERRORS 137
9.5 ERRORS AFFECTING THE TRIAL BALANCE 144
9.5.1 CASTING ERROR 144
9.5.2 PARTIAL REVERSAL OF ENTRY 144
9.5.3 ERROR OF TRANSPOSITION 144
9.5.4 OVER/UNDER- STATEMENT OF OPENING OR CLOSING
BALANCES 144
9.6 SUMMARY 147
REFERENCES 150
CHAPTER TEN: PROVISIONS FOR BAD AND DOUBTFUL DEBTS,

ACCRUALS, PREPAYMENTS AND DISCOUNTS 151
10.2 REASONS FOR MAKING PROVISIONS 151
10.3 CHARACTERISTICS OF PROVISIONS 152
10.4 TYPES OF PROVISIONS 152
10.5 PROVISION FOR DISCOUNT RECEIVED 153
10.6 PROVISIONS MADE TO ENSURE CONSERVATIVE PROFIT 153
10.6.1 PROVISION FOR BAD DEBT 153
10.6.2 PROVISION FOR DOUBTFUL DEBT 153
10.6.3 PROVISION FOR BAD AND DOUBTFUL DEBT 154
10.6.4 PROVISION FOR DISCOUNT ALLOWED 154
10.6.5 PROVISION FOR UNREALIZED PROFIT 154
10.6.6 PROVISIONS AGAINST FUTURE LIABILITIES 154
10.6.7 PROVISION FOR USAGE OF NON-CURRENT TANGIBLE ASSETS 154
10.6.8 PROVISIONS FOR BAD DEBTS, DOUBTFUL DEBTS
DISCOUNT ALLOWED 154
10.7 ACCOUNTING POLICIES 155
10.8 BOOK-KEEPING 157
10.9 PREPAID EXPENSES/PREPAYMENTS 165
10.10 ACCRUED EXPENSES/ACCRUALS 165
10.11 SUMMARY 166
REFERENCES 171
11
CHAPTER ELEVEN: BANK RECONCILIATION 172
11.1 BANK RECONCILIATION STATEMENT 172
11.2 STEPS INVOLVED IN CARRYING OUT BANK RECONCILIATION 173
11.3 FORMAT OF BANK RECONCILIATION STATEMENT 173
11.4 SUMMARY 177
REFERENCES 182
CHAPTER TWELVE: PROPERTY, PLANT & EQUIPMENT,

DEPRECIATION AND PROVISION FOR
DEPRECIATION AND DISPOSAL 183
12.2 DEPRECIATION DEFINED 183
12.3 BASIC TERMINOLOGIES 183
12.4 CAUSES OF DEPRECIATION 184
12.5 REASONS FOR DEPRECIATING ASSETS 185
12.6 METHODS OF COMPUTING DEPRECIATION 185
12.6.1 THE STRAIGHT LINE METHOD 185
12.6.2 THE REDUCING BALANCE METHOD 186
12.6.3 REVALUATION METHOD 186
12.6.4 SUM OF YEARS DIGIT METHOD 187
12.6.5 REDUCING BALANCE METHOD 189
12.6.6 SUM OF YEARS DIGIT METHOD 190
12.7 SUMMARY 194
REFERENCES 196
CHAPTER THIRTEEN: CONTROL ACCOUNTS 197

13.2 THE NATURE AND FUNCTIONS OF CONTROL ACCOUNTS 197
13.3 SOURCES OF INFORMATION FOR CONTROL ACCOUNTS 198
13.4 ACCOUNT RECEIVABLES OR SALES LEDGER ACCOUNT 198
13.5 ACCOUNT PAYABLES OR PURCHASES LEDGER CONTROL
ACCOUNT 199
13.6 SUMMARY 202
12
REFERENCES 205
13
CHAPTER FOURTEEN: SINGLE ENTRY AND INCOMPLETE
RECORDS 206
14.2 SUMMARY 212
REFERENCES 217
CHAPTER FIFTEEN: ACCOUNTS FOR NOT FOR PROFIT MAKING

ORGANISATION 218
15.2 FEATURES OF NOT FOR PROFIT ORGANISATION 218
15.3 RECEIPT AND PAYMENT ACCOUNT 218
15.4 INCOME AND EXPENDITURE ACCOUNT 218
15.5 SOURCES OF INCOME 219
15.6 SUMMARY 227
REFERENCES 231
CHAPTER SIXTEEN: FINANCIAL STATEMENT 232

16.2 TYPES OF COMPANIES 232
16.3 PECULIAR FEATURES OF A COMPANY’S FINANCIAL
STATEMENTS 233
16.4 COMPANY VERSUS OTHER BUSINESS FORMS 237
16.5 FINANCIAL STATEMENTS FOR INTERNAL USE 238
16.6 CONTENTS OF FINANCIAL STATEMENTS OF A COMPANY 238
16.7 SUMMARY 247
REFERENCES 254
CHAPTER SEVENTEEN: MANUFACTURING ACCOUNT 255

17.2 SUMMARY 265
REFERENCES 270
14
CHAPTER EIGHTEEN: PARTNERSHIP ACCOUNT 271
18.1 PARTNERSHIP DEFINED. 271
18.2 PARTNERSHIP AGREEMENT 271
18.3 PARTNERSHIP’S FINAL ACCOUNTS 272
18.4 METHODS OF ACCOUNTING FOR PARTNER'S EQUITY/
INTEREST 272
18.4.1 FLUCTUATING CAPITAL METHOD 272
18.4.2 FIXED CAPITAL METHOD 273
18.5 WHY ARE PARTNERS’ SALARIES CHARGED IN THE
APPROPRIATION ACCOUNT WHILE EMPLOYEES’ SALARIES
ARE CHARGED IN THE STATEMENT OF PROFIT OR LOSS 275
18.6 WHAT IS THE AMOUNT OF PARTNERS’ SALARIES TO BE
DEBITED TO THE APPROPRIATION ACCOUNT AND CREDITED
TO THE PARTNERS’ CAPITAL OR CURRENT ACCOUNT? 275
18.7 GOODWILL 280
18.8 FACTORS CREATING OR CONTRIBUTING TO GOODWILL 280
18.9 TYPES OF GOODWILL 280
18.9.1 PURCHASED GOODWILL 280
18.9.2 INHERENT GOODWILL 281
18.10 NATURE OF GOODWILL IN THE BOOKS OF A PARTNERSHIP 281
18.11 METHODS OF CALCULATING THE VALUE OF INHERENT
GOODWILL 282
18.11.1 PURCHASE OF AVERAGE PROFIT 282
18.12 REVALUATION OF ASSETS 286
18.13 ADMISSION OF A PARTNER 287
18.14 ADMISSION OF A PARTNER DURING THE YEAR 296
18.15 GUARANTEE OF PROFITS TO A PARTNER 303
18.16 RETIREMENT/DEATH OF A PARTNER DURING THE YEAR 304
18.17 MEASURES TO ENSURE AVAILABILITY OF CASH TO PAY OFF
EX-PARTNER(S) 316
18.18 INVESTMENT 316
18.19 LIFE INSURANCE POLICY 316
18.20 RETIREMENT/DEATH OF A PARTNER DURING THE YEAR
LLUSTRATION 319
18.21 SUMMARY 325
REFERENCES 331
15
CHAPTER NINETEEN: ISSUE OF SHARES 332
19.2 TYPES OF SHARES 332
19.2.1 ORDINARY SHARES 332
19.2.2 PREFERENCE SHARES 332
19.2.3 DEFERRED OR FOUNDERS’ SHARES 333
19.3 TYPES OF ISSUES 333
19.3.1 PUBLIC ISSUE 333
19.3.2 PRIVATE PLACEMENT 334
19.3.3 BONUS ISSUE 334
19.3.4 RIGHT ISSUE 334
19.3.5 CONVERSION ISSUE 335
19.4 DEFINITION OF SOME TERMS 335
19.4.1 ISSUE PRICE 335
19.4.2 PAR VALUE (OR NOMINAL VALUE) 335
19.4.3 RIGHTS PRICE 335
19.4.4 CONVERSION PRICE 335
19.4.5 SHARE PREMIUM. 335
19.4.6 DISCOUNT ON SHARES 336
19.4.7 FORFEITURE OF SHARES 336
19.5 REJECTION OF APPLICATIONS 349
19.6 SUMMARY 350
REFERENCES 353
CHAPTER TWENTY: INTERNAL CONTROL SYSTEM 354

20.2 FIVE ELEMENTS OF AN EFFECTIVE CONTROL SYSTEM 354
20.3 CONDITIONS FOR EFFECTIVE OR FUNCTIONAL
INTERNAL CONTROL SYSTEM 355
20.4 CONTROL ACTIVITIES (TYPES OF INTERNAL CONTROL) 355
20.5 AUDIT OF INTERNAL CONTROL 357
20.6 DOCUMENTATION OF INTERNAL CONTROL 357
20.7 AUDIT RISK 358
20.8 REPORTING TO MANAGEMENT 359
20.9 CARRY-OVER-FRAUD OR TEEMING AND LANDING 359
20.10 INTERNAL CONTROL ON CARRY-OVER-FRAUD 359
20.11 LIMITATION OF INTERNAL CONTROL SYSTEM 360
20.12 SUMMARY 361
REFERENCES 363
16
PART B
CHAPTER TWENTY ONE: INTRODUCTION TO FINANCIAL
MANAGEMENT 364
21.1.1 FINANCIAL ACCOUNTING 364
21.1.2 MANAGEMENT ACCOUNTING 365
21.1.3 LAWS 365
21.1.4 ECONOMICS 365
21.1.5 BEHAVIOURAL SCIENCE 365
21.1.6 QUANTITATIVE METHODS 365
21.2 BASIC OBJECTIVE OF FINANCIAL MANAGEMENT 365
21.2.1 PROFIT MAXIMIZATION AS A PRIMARY OBJECTIVE 366
21.2.2 PROFIT MAXIMIZATION AS A PRIMARY OBJECTIVE 366
21.2.3 THE OBJECTIVE ALSO SUFFERS FROM THE FOLLOWING
LIMITATIONS 266
21.3 WEALTH MAXIMIZATION AS A PRIMARY OBJECTIVE 367
21.4 THE STAKEHOLDERS’ THEORY 367
21.5 NON-FINANCIAL OBJECTIVES 368
21.6 JUSTIFICATION FOR SHAREHOLDERS’ WEALTH
MAXIMIZATION AS A COMPANY’S PRIMARY OBJECTIVE 368
21.7 AGENCY THEORY 369
21.8 THE THREE CORE DECISION AREAS IN FINANCIAL
MANAGEMENT 369
21.8.1 INVESTMENT DECISION 369
21.8.2 FINANCING DECISION 369
21.8.3 DIVIDEND DECISION 370
21.9 THE FINANCE MANAGER 370
21.10 THE MAIN FUNCTIONS OF THE FINANCE MANAGER 370
21.10.1 ENVIRONMENTAL FACTORS OF THE FINANCE MANAGER 371
21.10.1.1 FINANCIAL ENVIRONMENT 371
21.10.1.2 ECONOMICS ENVIRONMENT 371
21.10.1.3 BUSINESS ENVIRONMENT 371
21.10.2 PRINCIPAL FUNCTIONS OF THE FINANCE MANAGER 372
21.10.2.1 DEVELOPMENT OF FINANCIAL STRATEGY 372
21.10.2.2 TREASURY MANAGEMENT 372
21.10.2.3 LONG-TERM PLANNING 372
21.10.3 STRUCTURE OF THE FINANCE FUNCTION 372
21.11 THE JOB DESCRIPTION OF THE FINANCE CONTROLLER,
17
TREASURER AND INTERNAL AUDITOR 373
21.11.1 FUNCTIONS OF THE FINANCE CONTROLLER 373
21.11.2 FUNCTIONS OF THE TREASURER 373
21.11.3 FUNCTIONS OF THE INTERNAL AUDITORS 374
21.12 SUMMARY 375
REFERENCES 377
CHAPTER TWENTY TWO: CAPITAL BUDGETING DECISIONS 378

22.2 CHARACTERISTICS OF CAPITAL BUDGETING 379
22.3 METHODS OF APPRAISAL 379
22.3.1 THE TRADITIONAL/CONVENTIONAL METHOD 379
22.3.1.1 ACCOUNTING RATE OF RETURN ARR 379
22.3.1.2 PAY BACK PERIOD 382
22.3.1.3 PBP RECIPROCAL 385
22.3.1.4 PBP WITH BAIL OUT FACTOR 385
22.3.2 THE MODERN/DISCOUNTED CASH FLOW METHOD 385
22.3.2.1 NET PRESENT VALUE 387
22.3.2.2 INTERNAL RATE OF RETURN 390
22.4 SPECIAL ITEMS - DCF COMPUTATION (NPV & IRR) 392
22.5 SUMMARY 394
REFERENCES 396
CHAPTER TWENTY THREE: SOURCES OF FINANCE 397

23.2 SOURCES OF SHORT-TERM FUNDS 397
23.2.1 BANK CREDIT (BANK OVERDRAFT) 398
23.2.2 COMMERCIAL PAPER 398
23.2.3 TRADE CREDITS 399
23.2.4 FACTORING 399
23.2.5 INVOICE DISCOUNTING 401
23.2.6 BILLS DISCOUNTING 401
23.2.7 ACCRUALS 402
23.2.8 ACCEPTANCE CREDIT/BANKERS ACCEPTANCE 402
23.2.9 FRANCHISING 402
18
23.3 MEDIUM TERM SOURCES 403
23.3.1 BANK TERM LOAN 403
23.3.2 VENTURE CAPITAL 403
23.3.3 PROJECT FINANCE 404
23.3.4 EQUIPMENT LEASING 404
23.3.4.1 FINANCE LEASE 404
23.3.4.2 OPERATING LEASE 404
23.3.5 SALE AND LEASEBACK 404
23.3.6 HIRE PURCHASE (VENDOR CREDIT) 404
23.3.7 MORTGAGE 405
23.4 LONG-TERM SOURCES 405
23.4.1 EQUITY CAPITAL/ORDINARY SHARE CAPITAL 405
23.4.2 RAISING OF EQUITY CAPITAL 406
23.4.3 DEBENTURE STOCK 408
23.4.4 PREFERENCE SHARE 409
23.5 FACTORS AFFECTING A COMPANY’S CHOICE OF FINANCE 410
23.6 STOCK DIVIDEND/SCRIP DIVIDEND 411
23.7 SCRIP ISSUE 411
23.8 STOCK SPLIT 412
23.9 REVERSE STOCK SPLIT 412
23.10 SUMMARY 413
REFERENCES 415
CHAPTER TWENTY FOUR: WORKING CAPITAL MANAGEMENT 416

24.2 OPERATING/CASH OR WORKING CAPITAL CYCLE 417
24.2.1 THE OPERATING CYCLE 417
24.2.2 THE CASH CYCLE 417
24.3 OVER CAPITALISATION (UNDER TRADING) 418
24.4 UNDER CAPITALISATION (OVERTRADING) 420
24.4.1 SYMPTOMS OF OVERTRADING 420
24.5 MANAGEMENT DECISION ON WORKING CAPITAL 421
24.6 OVERTRADING – EFFECTS 421
24.7 FACTORS AFFECTING THE AMOUNT OF INVESTMENT IN
WORKING CAPITAL 426
24.8 SOURCES OF WORKING CAPITAL FINANCE 426
24.9 SUMMARY 427
REFERENCES 429
19
CHAPTER TWENTY FIVE: RISK AND COST OF CAPITAL 430
25.2 TYPES OF RISK 430
25.2.1 UNSYSTEMATIC RISK 430
25.2.2 FORMS OF UNSYSTEMATIC RISK 430
25.2.3 SYSTEMATIC RISK 430
25.2.4 FORMS OF SYSTEMATIC RISK 431
25.2.5 MEASUREMENT OF RISK 431
25.2.6 MEASUREMENT OF RISK USING CERTAINTY EQUIVALENT
METHOD 431
25.3 MEASUREMENT OF RISK USING CAPITAL ASSET PRICING
METHOD (CAPM) 432
25.4 DIVERSIFICATION OF RISK 435
25.5 COST OF CAPITAL 435
25.6 APPRAISAL OF THE FINANCIAL PERFORMANCE OF TOP MGMT 436
25.7 THE CONCEPT OF THE COST OF CAPITAL IN DECISION MAKING 436
25.8 TYPES OF COST CAPITAL 438
25.8.1 COST OF EQUITY CAPITAL (Ke) 438
25.8.2 COST OF PREFERENCE SHARE CAPITAL (Kp) 440
25.8.3 COST OF EQUITY DEBENTURE CAPITAL (Kd) 441
25.8.4 WEIGHT COST OF CAPITAL (WACC) 442
25.9 SUMMARY 443
REFERENCES 445
CHAPTER TWENTY SIX: CAPITAL STRUCTURE AND LEVERAGE 446

26.1.1 The traditional view 446
26.1.2 The Net Operating Income Approach 446
26.2 Business Risk: 448
26.2.1 DETERMINANTS OF BUSINESS RISK. 448
26.3 Financial Risk 448
26.4 Gearing 448
26.4.1 OPERATING GEARING 449
26.4.2 FINANCIAL GEARING 449
26.4.3 FORMS OF GEARING 449
26.5 SUMMARY 453
REFERENCES 455
20
CHAPTER TWENTY SEVEN: INTERPRETATION OF FINANCIAL
STATEMENT AND INVESTMENT
ANALYSIS 456
27.2 USERS OF FINANCIAL STATEMENT 456
27.3 DECISIONS MADE BY USERS OF FINANCIAL STATEMENT 456
27.4 TOOLS USED FOR ANALYZING AND INTERPRETATION OF
FINANCIAL STATEMENT 457
27.5 FINANCIAL STATEMENT ANALYSIS 457
27.6 SUMMARY 470
REFERENCES 472
CHAPTER TWENTY EIGHT: THE NIGERIAN FINANCIAL MARKET

28.2 KEY DISTINGUISHING FEATURES OF FINANCIAL MARKETS 473
28.3 CAPITAL MARKETS IN NIGERIA 475
28.4 MAJOR FORMS OF CAPITAL 476
28.5 BASIC DOCUMENT OF A UNIT TRUST SCHEME 478
28.6 PRINCIPAL PARTICIPANTS 478
28.7 ALLOTMENT OF SHARES 481
28.8 PROCEDURE FOR ALLOTMENT OF SHARES 481
28.9 THE SHARE CERTIFICATE 482
28.10 THE CENTRAL SECURITIES CLEARING SYSTEM (CSCS) 482
28.11 FUNCTIONS OF CSCS LIMITED 482
28.12 COMPONENT OF CSCS 482
28.13 HOW THE CSCS WORKS (FLOW OF ACTIVITIES) 483
28.14 BENEFITS DERIVABLE FROM THE CSCS 486
28.15 INTERNATIONAL STOCK EXCHANGE OPERATIONS. 487
28.16 FUNCTION OF MEMBERS 488
28.17 THE STOCK EXCHANGE AUTOMATED QUOTATIONSYSTEM
(SEAQ) 488
28.18 STOCK CLASSIFICATION 489
28.19 THE DEALING AND TRANSFER SYSTEM 489
28.20 CONTRACT NOTE 490
28.21 A PURCHASE OR SALE? 490
28.22 BEARER/UNREGISTERED SECURITIES 490
21
28.23 STOCK EXCHANGE SETTLEMENT AND TRANFER PROCEDURE 491
28.24 BULLS AND BEARS 491
28.25 CONTANGO 491
28.26 SUMMARY 492
REFERENCES 494
22
CHAPTER ONE
INTRODUCTION TO ACCOUNTING
1.0 LEARNING OBJECTIVES
At the end of this chapter, candidates are expected to know and understand:
 The meaning and importance of accounting,
 The meaning of book keeping
 The importance of book keeping
 The needs for accounting,
 The various users of accounting information.
 The qualities of good accounting information.
 The regulatory framework of accounting
 The Service rendered by accountants in practice and not in practice.
1.1 INTRODUCTION
Accounting is concerned basically with ‘accountability’. The underlying purpose of
accounting is to provide financial information about an economic entity. The
information is provided, periodically, to shareholders and others connected with the
organization to enable them decide the extent to which they want to continue to
associate with the organization. The need for accounting is more pronounced in a
business where a lot of finance, risk, and energy have been involved. Financial
information is needed to plan and control the finance and operation of a business.
1.2 THE HISTORICAL DEVELOPMENT OF ACCOUNTING

Rudimentary form of accounting started with bookkeeping by Lucia Pacioli an
Italian monk. In his book titled "Summa de Arithmetical Geometrica, proportion et
proportionslita" published in. 1494 on Arithmetic, Geometry and Proportion, he
devoted a chapter to expound the principles of the double entry system. It became
necessary for managers to report to the owners of their business activities during the
period under review. Such report would include mainly the following:
 How the financial resources of the business have been invested during the
period
 The profit earned or loss incurred during the period
The assets, liabilities and the owner's equity at the end of the period under review. After
this initial development, a lot of changes have been witnessed in accounting. These
changes were informed by sophistication and complexity of businesses and industrial
and political environments which placed more responsibilities on management of
business to disclose more information to owners and other interested parties. For
instance 'a lot of Generally Accepted Accounting Principles (GAAPs) have been
developed to be followed in the preparation of financial statements. Also, accounts
23
have to be 'audited' and reported on as presenting a 'true and fair' position. Accounting
has also gone beyond mere reporting for managerial decisions, to include tax
management, government accounting and social responsibility accounting. The GAAPs
are developed from time to time to keep pace with changes in the economic and
political environment. The GAAPs are also codified into what is known as Accounting
Standards. Therefore, accounting is not a fixed set of rules but a constantly evolving
body of knowledge.
Most countries have their own Local Accounting Standards Board but the body
responsible for developing and issuing International Accounting Standards is the
International Accounting Standards Board (lASB) based in the United Kingdom. In
Nigeria, the Nigerian Accounting Standards Board (NASB) is charged with the
responsibility of developing and issuing local' accounting standards for use by all
preparers arid users of financial statements in Nigeria. Accounting has also changed
from manual records alone; it now also makes use of computer and video displays.
1.3 REGULATORY FRAMEWORK

Due to tile increasing changes in the economic and political environment, statutory and
other regulations have been put in place to ensure the reliability, relevance and
comprehensiveness of financial information, and to narrow areas of differences:
The main statutory document for the regulation of business in Nigeria is the Companies
and Allied Matters Act 1990 (as amended in 2004). Tile company laws are enforceable
in the court of law.
Other legislations relate directly to specific industry such as:
Banks and Other Financial Institutions Act of 1991 (BOFIA 1991)
Insurance Act 2003, Investment Act 2007.
Other regulations consist of accounting standards which include:
Statements of Accounting Standards (SAS) issued by NASB from time to time
International Accounting Standards (IAS) and International Financial
Reporting Standards (IFRS) issued by IASB from time to time.
1.4 THE PURPOSE OF ACCOUNTING

Accounting is the act of recording classifying, summarizing and analyzing financial
transactions of a business.
1.5 BOOKKEEPING AND ACCOUNTING

Bookkeeping is the recording phase of accounting. It is the classification and
recording of business transactions in the books of account. The recording of the
transactions is a routine task, therefore it tends to be repetitive. Accounting on the other
24
hand includes not only the keeping of accounting 'records, but also the design of
efficient accounting systems, the interpretation of accounts and the development of
forecast.
The processes involved in bookkeeping are as follows:
(a) The classification of business transactions using source documents;
(b) Recording of classified transactions in appropriate subsidiary books or books of
prime entry,
(c) Posting of entries from subsidiary books to the ledger; and
(d) Extraction of the trial balance.
1.6 IMPORTANCE OF BOOK KEEPING:

 It helps to determine the costs and value of purchases and sales of goods and
services
 It helps to record and control all expenses and incomes
 It helps to obtain information about cash in hand and bank
 It helps to ascertain debtors’ and creditors’ balances and positions.
 It helps to ascertain the profit or loss made during a particular period.
 It records the value and movement of non-current assets including property owned
by the enterprise.
 It helps to ascertain the financial position of the organization on any given day.
 It helps the business to comply with all relevant government regulations.
 It ensures that accurate financial data are passed into the annual report which is
published.
 It helps to reduce the loss of source documents.
1.7 ACCOUNTING DEFINED

Broadly speaking accounting is the art of recording, classifying and summarizing in an
orderly manner and in monetary terms, transactions and events which are of financial
character and subsequently interpreting the ensuing quantitative information for
business decision purposes.
1.8 SCOPE OF ACCOUNTING
The starting point in the study of accounting is financial accounting; others are cost
accounting, management accounting, auditing, government accounting, and tax
management.
1.9 THE NEED FOR ACCOUNTING INFORMATION

The need for accounting information can be summarized as follows:
 It provides information useful for making economic decisions.
 It provides information to users for predicting, comparing and evaluating the
25
earnings power and financial strength of a business.
 It is used to judge the ability of management to utilize the entity's resources
effectively in achieving the goal of the entity.
 It provides information to creditors for predicting and evaluating the cash flows
of the entity.
 It provides management with detailed accounting data for use in planning and
controll.ing the daily operations of the business.
 It provides information to government for determining the tax payable on the
profit and/or other incomes of an individual or company and for formulating
fiscal policies.
 It forms the basis of reporting on the activities of an enterprise as they affect
the society.
 It serves as the basic instruments by which investors decide the securities in
which to invest.
1.10 QUALITIES OF GOOD ACCOUNTING INFORMATION

Accounting information should possess the following qualities before users can rely on
it.
i. Relevance
ii. Reliability
iii. Comparability
iv. Timeliness
v. Objectivity
vi. Comprehensiveness
vii. Simplicity
viii. Clarity
ix. Conciseness
1.11 USERS AND THEIR INFORMATION NEEDS

Users of accounting information consist of investors, employees, lenders, suppliers and
other trade creditors, customers, government and their agencies and the public. Their
needs are as follows:
(a) Investors are the providers of risk capital
(i) Information is required to help make a decision about buying or selling
shares, taking up a rights issue and voting.
(ii) Investors must have information about the level of dividend, past,
present and future and any changes in share price.
26
(iii) Investors will also need to know whether the management has been
running the company efficiently..
(iv) As well as the position indicated by the financial statements and
earnings per share (EPS), investors will want to know about the liquidity
position of the company, the company's future prospects, and how the
company's shares compare with those of its competitors.
(b) Employees need information about the security of employment and future
prospects for jobs in the company, and to help with collective pay bargaining.
(c) Lenders need information to help them decide whether to lend to a company.
They will also need to check that; the value of any security remains adequate,
that the interest repayments are secure, the cash is available for redemption at the
appropriate time and any financial restrictions (such as maximum debt/equity
ratios) have not been breached.
(d) Suppliers need to know whether the company will be a good customer and pay
its debts.
(e) Customers need to know whether the company will be able to continue
producing and supplying goods.
(f) Government's interest in a company may be one of creditor or customer, as well
as being specifically concerned with compliance with tax and company law,
ability to pay tax and the general contribution of the company to the economy.
(g) The public at large would wish to have information for all the reasons mentioned
above, but it could be suggested that it would be impossible to provide general
purpose accounting information which was specifically designed for the needs of
the public.
1.12 The Work of an Accountant

A professional accountant performs various types of work for an organization either as an
employee of the organisation or as a consultant to the organization. For instance,
members of the Institute of Chartered Accountants of Nigeria (ICAN) are classified into
two broad categories; members in public practice and members not in public practice.
1.12.1 Members in Public Practice

These are accountants working in accounting firms which offer a variety of services
to their clients. Their principal functions are:
(i) Auditing:
(ii) Tax Services
(iii) Management advisory services
(iv) Insolvency Services
(v) Investigation Services
27
1.12.2 Members not in Public Practice
These are accountants in the employment of government ministries and parastatals or
private business concerns. Their main functions include the following:
(i) They prepare the financial statements and the annual reports of the
organisation on behalf of management.
(ii) They provide relevant management accounting information to management
for decision making.
(iii) They set up and run an efficient system of accounting and internal control.
(iv) They act as treasury managers.
28
1.13 SUMMARY
This chapter has laid the foundation for the appreciation of the nature and development of
accounting. The purpose of accounting as a provider of timely, accurate and relevant
information for economic units has been highlighted.
29
1.14 REVIEW QUESTIONS
1. Define Accounting, and critically examine its importance
2. Differentiate between Book keeping and Accounting?
3. In broad terms, what is the purpose of Accounting?
4. Identify the users of accounting information and their importance
5. The knowledge of Accounting is useful in any organization, even in the church.
Explain this statement.
30
References
Ajileye J. O. and Adetifa O. Get Your Financial Accounting Right Book 1 & 2. Lagos: De
Hadey Publishers.
Akeju J.B (2011) Financial Accounting for Beginners. First Edition, Lagos: JAB Associated
Limited.
Akeju J.B. (2012). Financial Accounting for Intermediates. Lagos: JAB Associated Limited.
Fakunle Adeleke O. Modern Business Accounting. Book One. Lagos: Ilasanmi Press and Sons
Nig. Ltd.
Frank, W., & Alan, S. (2008). Business Accounting 1 (IFRS Edition). Harlow: Pearson
Education Limited.
ICAN STUDY PACK (2014). Basic Accounting & Processing System. Emile Wolf
Jennings, A. R . (2006). Financial Accounting. London: Thomson Publisher.
Longe, O. A., & Kazeem, R. A. (2012). Essential Financial Accounting. Ogun: Tonad
Publishers Limited.
Remi, Aborode (2006). A practical approach to advanced Financial Accounting, Master
Stroke consulting.
Robert O. I. (2016) Financial Accounting Made Simple 4th Ed. Lagos: ROI Publishers.
Odo Kalu (2011). Financial Reporting and Ethics Manual. Lagos: Kalmax Associates, Nigeria
Olanrewaju, O. O. (2012). IFRS PAL – Handy Approach. Lagos: Dimkem Publications
Limited.
WYSE (2011). IFRS and IAS. Ikeja, Lagos: WYSE Publishing, Ikeja Lagos.
31
CHAPTER TWO
STATUTORY AND REGULATORY FRAMEWORK OF FINANCIAL
REPORTING STANDARDS
 The Changes in global accounting standards
 The regulatory rules guiding accounting globally
 How to prepare simple financial statement.
2.1 INTRODUCTION
Like any other profession, the accounting profession is practiced within a framework of
statutory and regulatory pronouncements. This is necessary to ensure orderliness,
consistency and uniformity in the practice of the profession.
2.2 STATUTORY FRAMEWORK

The statutory framework comprises the statutes enacted by government to govern the
conduct of economic activities, the main one of which is the Comprises and Allied
Matters Act (C.A.M.A) 1990. This statute stipulates the requirements for the
formation/registration of companies, how companies are to conduct their affairs, the
type of accounting records and financial statements required of companies, how the life
of companies may be brought to an end and so on.
In addition to the C.A.M.A. 1990, other statutes have been enacted by government to
govern economic activities in specialised areas of the Nigerian economy. These include
the following:
(i) Enabling statutes establishing government parastatals like Nigerian Ports Plc,
National Electric Power Authority, Nigeria Airways and so on.
(ii) Statutes regulating the banking/financial sector. These statutes are:
 Banks and Other Financial Institutions Act (BOFIA) 1991
 Central Bank of Nigeria Act 1991
 Nigeria Deposit Insurance Corporation Act 1988
 Money Laundering Act 1995
(iii) Statute regulating the insurance sector: Insurance Act 1997
2.3 REGULATORY FRAMEWORK

This consists of the non-statutory statements, circulars and pronouncements which are
expected to be complied with in the conduct and recording of economic activities. They
include accounting standards and Central Bank of Nigeria (CBN) Monetary Policy
Circulars.
32
2.4 ACCOUNTING STANDARDS
An accounting standard is a statement issued by the appropriate standard-setting body
locally or internationally on a specific area or topic in financial accounting/reporting,
the acceptance/application of which is mandatory for preparers and users of financial
statements.
Accounting standards are issued at the international level by the International
Accounting Standards Board (IASB) - formerly International Accounting
Standards Committee (IASC) - while they were issued in Nigeria by the Nigerian
Accounting Standards Board (NASB) which later transformed into Financial
Reporting Council (FRC). The standards issued by the IASB are known as
International Financial Reporting Standards (IFRS). Those issued by the defunct
IASC were known as International Accounting Standards (IAS) but all of the IASs that
were still valid as at the date the new IASB took off in 2001 were adopted by the new
body. The standards issued by the then NASB were known as Statements of
Accounting Standards (SAS).
2.5 HISTORY OF INTERNATIONAL ACCOUNTING STANDARDS BOARD

The IASC, the precursor of the IASB, was established in 1973, the IASB was
established as an independent, and private sector body lo set acceptable and applicable
standards for the preparers and users of financial statements around the world.
During the period from 1997 – 1999, a restructuring program was implemented which
resulted in the cessation of the operations of the old IASC on 31st March 2001 and its
replacement by a new body. IASC foundation (now known as IFRS Foundation)
based in the USA and hereinafter referred to as The Foundation, with effect from 1st
April 2001. A separate organ, the International Accounting Standards Board
(IASB), supervised and governed by The Foundation, was established and saddled with
the responsibility of developing and issuing IFRS.
The objectives of The Foundation, quoting from its revised constitution approved in
January 2013, are:
 to develop, in the public interest, a single set of high quality, understandable,
enforceable and globally accepted financial reporting standards based upon
clearly articulated principles. These standards should require high quality,
transparent and comparable information in financial statements and other
financial reporting lo help investors, other participants in the world's capital
markets and other users of financial information make economic decisions,
 to promote the use and rigorous application of those standards;
33
 to take account of, as appropriate, the needs of a range of sizes and types of
entities in diverse economic settings;
 to promote and facilitate the adoption of International Financial Reporting
Standards (IFRSs), being the standards and interpretations issued by the IASB,
through the convergence of national accounting standards and IFRSs.
From inception, the IASB decided to adopt all the standards previously issued by its
predecessor, which form part of IFRSs but would continue lo be known as International
Accounting Standards (IAS). These standards-and, indeed, all other IFRSs
subsequently issued by the IASB — could be reviewed, revised, reformatted,
withdrawn or replaced as and when the need arises.
2.6 STRUCTURE OF THE FOUNDATION

The activities of The Foundation and, by implication, the IASB are overseen and
directed by The Trustees who, according to website of The Foundation, are also
responsible for safeguarding the independence of the IASB band ensuring the financing
of the organisation.
The Trustees
Currently numbering 22, The Trustees are appointed for a renewable term of 3 years.
The pioneer chairman of The Trustees was Paul A. Volcker, a former chairman of the
US Federal Reserve Board and the current chairman is Michel Prada, from France
and, among others, a former chairman of the Executive and Technical Committees of
the International Organizations of Securities Commissions (IOSCO).
The distribution of the membership of The Trustees is as follows:
Asia/Oceania : 6 members
Europe : 6 members
North America : 6 members
Africa : 1 member
South America : 1 member
Rest of the World : 2 members
Total : 22 members
The specific responsibilities of The Trustee include, but are not limited to:
 appointing members of the board of IASB;
 appointing members of the IFRS Interpretations Committee (IIC);
 appointing members of the IFRS Advisory Council (IAC);
 establishing and amending the operating procedures, consultative arrangements
and due process of IASB, IIC and IAC;
 review the strategy of the IASB annually;
 ensuring the financing of The Foundation and approving its annual budget..
34
The IASB
As already slated, the responsibility for developing and issuing IFRSs is vested in the
IASB, based in the UK. The pioneer chairman of the IASB was Sir David Tweedie. the
former chairman of the UK Accounting Standards Board and its current chairman is
Hans Hoogervorst from the Netherlands and, among others, the former Minister of
Finance of his country. The following paragraph, in italic text, is lifted from the website
of The Foundation:
The IASB is the independent standard-setting body of the IFRS Foundation. Its
members (currently 16 full-time members) are responsible for the development and
publication of IFRSs including the IFRS for SMEs and for approving Interpretations
of IFRSs as developed by the IFRS Interpretations Committee (formerly called the
IFRIC). All meetings of the IASB are held in public and webcast. In fulfilling its
standard-setting duties the IASB follows a thorough, open and transparent due process
of which the publication of consultative documents, such as discussion papers and
exposure drafts, for public comment is an important component. The IASB engages
closely with stakeholders around the world, including investors, analysts, regulators,
business leaders, accounting standard-setters and the accountancy profession.
Other important organs of The Foundation are the IFRS Interpretations Committee and
the IFRS Advisory Council.
2.7 THE IFRS INTERPRETATIONS COMMITTEE (IIC)

This committees review, on a timely basis, accounting issues that are likely to receive
divergent or unacceptable treatment if proper guidelines are not put in place in the form
of an IFRS. It also develops interpretations of standards issued by the IASB. Such
interpretations are published after being approved by the IASB.
Formed in 1997 as Standards Interpretations Committee (SIC) of the defunct IASC, it
has gone through a metamorphosis to its current name. The committee also reviews
emerging issues relating to existing IFRS, which were not considered when the
standards were developed, with a view to developing modifications to the existing
IFRS. The IIC consist of one non-voting chairman - currently. Mr. Wayne Upton, an
International Director with the IASB) 14 voting members.
The IFRS Advisory Council (IAC)

The IAC consists of over 30 members and is currently chaired by Mr. Paul Cherry, a
Canadian consultant. The [AC provides a forum for organisations and individuals with
an interest in international financial reporting to participate in the standard-setting
35
process. The IAC shall be consulted by the IASB on proposed standard-setting projects
and by The Trustees on proposed changes to the IASB constitution. The council is thus
able to make inputs into the development of IFRSs and review of the operations of the
IASB. The website of The Foundation gives the following information regarding the
IFRS Advisory Council - quoted here in four paragraphs of italic text:
The IFRS Advisory Council is the formal advisory body to the IASB and the Trustees of
the IFRS Foundation. It consists of a wide range of representatives from groups that
are affected by and interested in the IASB’s work. These include investors, financial
analysts and other users of financial statements, as well as preparers, academics,
auditors, regulators, professional accounting bodies and standard-setters. Members of
the Advisory Council are appointed by the Trustees.
The Advisory Council also provides advice on single projects with a particular
emphasis on practical application and implementation issues, including matters
relating to existing standards that may warrant consideration by the IFRS
Interpretations Committee.
The Advisor Council serves as a sounding board for the IASB, and can be used to
gather views that supplement the normal consultative process.
If the IASB ultimately takes a position on a particular issue that differs from a polled
expression of the Advisory Council, the IASB gives the Advisory Council its reasons for
coming to a different position.
2.8 LIST OF IASs ISSUED BY THE IASC AND ADOPTED BY IASB

Before it finally ceased operations on 31st March 2001, the IASC had issued the
following standards. Following this list is a second one showing IFRSs issued lo dale
by the IASB
INTERNATIONAL ACCOUNTING STANDARDS
IAS No. Topic Status
1 Presentation of Financial Statements Last revised in May 2012, revised
version effective since 1 Jan, 2013
2 Inventories Last revised in Dee. 2003; revised
3 Consolidated Financial Statements Replaced by IAS 27 & IAS 28
4 Depreciation Accounting Replaced by 1AS 16, 22 & 38
36
5 Information to be disclosed in Financial Replaced by IAS 1
Statements
6 Accounting Responses to Changing Prices Replaced by IAS 15
7 Statement of Cash Flows Last revised in July 2009; revised
version effective since 1 Jan. 2010
8 Accounting, Changes in Accounting Last revised in Dec. 2003; revised
Estimates and version effective since 1 Jan, 2005
Errors
9 Research and Development Costs Superseded by 1AS 38
10 Events after Reporting Period Last revised in Dec. 2003; revised
version effective since 1 Jan. 2005;
retitled Sept. 2007
11 Constructing Contracts Last revised in Dec. 1993; revised
12 Income Taxes Last revised in Dec. 2010; revised
13 Presentation of Current Assets and Current Replaced by IAS 1
Liabilities.
14 Reporting Financial Information by Segment Superseded by IFRS 8 since 1 Jan.
2009
15 Information Reflecting the Effect of Withdrawn effective 1 Jan. 2005
Changing Prices
16 Property, Plant and Equipment Last revised in May 2012; revised
17 Leases Last revised in April 2009; revised
18 Revenue Last revised in Dec. 1998; revised
version effective since 1 Jan, 2001;
Appendix amended April 2009
19 Employee Benefits Last revised in Nov. 2013; revised
version takes effect 1 July. 2014
20 Accounting for Government Grants and Last revised in May 2008; revised
Disclosure of Government Assistance. version effective since 1 Jan, 2009
21 The Effect of Changes in Foreign Exchange Last revised in Jan. 2008; revised
Rates version effective since 1 July. 2009
22 Business Combinations Superseded by IFRS 3 since March
2004.
37
23 Borrowing Costs Last revised May 2008; revised
24 Related Party Disclosures Last revised Nov. 2009: revised
25 Accounting for Investments Withdrawn April 2000
26 Accounting and Reporting by Retirement Last revised Jan. 1987; revised version
Benefit Plans effective since 1 Jan, 1990;
reformatted 1994
27 Separate Financial Statements Revised July 2010; refilled May 201 1
28 Investments in Associates and Joint Ventures Revised and retitled May 2011;
effective since 1 Jan. 2013
29 Financial Reporting in Hyper inflationary Last revised May 2008; revised
Economics version effective since 1 Jan, 2009
30 Disclosures in the Financial Statements of Superseded by IFRS 7 since Aug.
Banks and similar Financial Institutions 2005.
31 Financial Reporting of Interests in Joint Superseded by IFRS 11 and IFRS 12 ,
venture since May 2011
32 Financial Instruments: Disclosure and Revision in Dec. 2011 lakes effect in 1
Presentation Jan. 2014 while revision in May 2012
took effect 1 Jan. 2013
33 Earnings Per Share Last revised Aug. 2008; revised
34 Interim Financial Reporting Last revised May 2012; revised
35 Discontinuing Operations Superseded by IFRS 5 since March
2004.
36 Impairment of Assets Last revised May 2013; revised
version takes effect 1 Jan, 2014
37 Provisions, Contingent Liabilities and Last revised Sept. 1998; revised
Contingent Assets version effective since 1 July 1999;
Currently being revised.
38 Intangible Assets Last revised April 2009; revised
version effective since 1 July 2009
39 Financial Instruments: Recognition and First issued in Dec. 1998 and effective
Measurement since 1 Jan. 2001; has undergone series
of revisions since then and is still
being revised,
40 Investment Property Last revised May 2008; revised
41 Agriculture Last revised May 2008; revised
38
Note: The shaded IASs are no longer applicable because they have either been withdrawn or
superseded.
INTERNATIONAL FINANCIAL REPORTING STANDARDS
IFRS Topic Status
NO.
Conceptual Framework for Financial Reporting Approved by IASB in Sept.
2010
IFRS for SMEs Exposure Draft (ED) issued in
Feb. 2007; approved &
effective since July 2009.; now
due for revision.
1 First-Time Adoption of IFRS Last revised in May 2012;
revised version effective since
1 Jan, 2013
2 Share-Based Payments Last revised in June 2009;
1 Jan, 2010
3 Business Combinations Last revised in May 2010;
1 July 2010
4 Insurance Contracts Last revised Aug. 2005
5 Non-Current Assets Held for Sale and Discontinued Last revised in April 2009;
Operations revised version effective since 1
Jan, 2010;
6 Exploration for and Evaluation of Mineral Resources Issued in Dec. 2004; amended
in June 2005; effective since 1
Jan, 2006;
7 Financial Instruments – Disclosures First issued in Aug. 2005 and
effective since 1 Jan. 2007; has
undergone series of revisions
since then and is still being
revised.
8 Operating Segments Supersedes IAS 14; last revised
in April 2009; revised version
effective since 1 Jan. 2010
9 Financial Instruments Intended to replace IAS 39;
Phase 3 of the project – dealing
39
with Hedge Accounting – was
published in Nov. 2013.
10 Consolidated Financial Statements Last revised in Oct. 2012;
revised version takes effect 1
Jan. 2014
11 Joint Arrangements Last revised in June 2012;
1 Jan, 2013
12 Disclosure of Interest in other Entities Last revised in Oct. 2012;
revised version takes effect 1
Jan. 2014
13 Fair Value Measurement Issued in May 2011; effective
since 1 Jan, 2013.
2.9 FINANCIAL REPORTING COUNCIL (FRC)

The predecessor of the FRC, the Nigerian Accounting Standards Board (NASB) was
established on September 9, 1982 to develop and issue accounting standards for
prepares and users of financial statements in Nigeria. In other words, the NASB was
created to do for Nigeria what the then IASC did - and the IASB does - for the world.
In July, 2010 the Federal Executive Council approved the move towards convergence
of accounting standards in Nigeria with the IFRS. To this end, it directed the NASB to
do whatever was necessary to achieve the convergence objective. On September 3rd
2010 the NASB announced a phased implementation guideline as follows:
 Publicly listed entities to implement IFRS by January 1st, 2012
 Other Public Interest Entities to implement IFRS by January 1st, 2013
 Small and Medium-sized Entities to implement the IFRS for SMEs by January
1st, 2014
 Micro-sized entities may use either IFRS for SMEs or the Small and Medium-
sized Entities Guidelines on Accounting (SMEGA) Level 3 issued by the
United Nations Conference on Trade and Development (UNCTAD).
In July 2011, the Financial Reporting Council of Nigeria Act (2011) was signed into
law creating the new body and repealing the Nigerian Accounting Standards Board Act
(2003). From the information available from the website of FRC (with the direct
quotations from the website being shown in italic text), the benefits of the FRC Act are:
40
 Creation of Enabling Environment
The law would create the enabling environment for Ike implementation of the
IFRS and to guarantee credible financial reporting regime in both public and
private sector entities in Nigeria.
 Wealth Creation
It is expected that the FRC Act would enhance wealth creation and economic
transformation thus facilitating the transformation agenda of the Federal
government of Nigeria.
 Increase in Foreign Direct Investment and assurance of easier access to
external capital.
The law would provide the platform for economic integration, harmonization
and internationalization are legal reforms that are capable of re-assuring the
markets and the public at large that corporate reporting and governance
frameworks are sufficiently robust.
 Enhancement of Local and Foreign Investors' confidence in the quality
assurance systems of financial reporting in public and private sector entities in
Nigeria.
 More Meaningful and decision enhancing information can now be arrived at
from financial statements issued in Nigeria because Accounting, Actuarial,
Valuation and Auditing Standards, used in the preparation of these statements,
shall be issued and regulated by this Financial Reporting Council.
 The FRC is a unified independent regulatory body for Accounting, Auditing,
Actuarial, Valuation and Corporate Governance. As such, compliance
monitoring in these areas will hence be addressed from the platform of
professionalism and legislation.
 Job creation; as graduates of accounting and related fields, from Nigeria '
tertiary institutions shall become internationally acceptable and employable.
 The Public Sector Financial management reform shall be enhanced with the
application of Public Sector Accounting Standards which shall be issued by the
Financial Reporting Council.
41
2.10 COMPOSITION OF BOARD OF FRC
According to the FRC Act, the Board of FRC comprise 22 members as follows:
(i) A chairman who shall be an experienced professional accountant
(ii) Two representatives from Institute of Chartered Accountants of Nigeria (ICAN)
(iii) Two representatives from Association of National Accountants of Nigeria
(ANAN)
One representative from each of the following
(iv) Chartered Institute of Stockbrokers (CIS)
(v) Federal Ministry of Commerce (FMC)
(vi) Federal Ministry of Finance (FMF)
(vii) Central Bank of Nigeria (CBN)
(viii) Corporate Affairs Commission (CAC)
(ix) Federal Inland Revenue Service (FIRS)
(x) Nigeria Deposit Insurance Corporation (NDIC)
(xi) Securities and Exchange Commission (SEC)
(xii) Nigeria Stock Exchange (NSE)
(xiii) The Office of the Auditor-General for the Federation
(xiv) The Office of the Accountant-General of the Federation
(xv) Chartered Institute of Taxation of Nigeria (CITN)
(xvi) Nigeria Accounting Association (NAA)
(xvii) Nigerian Association of Chambers of Commerce, Industry, Mines and
Agriculture (NACCIMA)
(xviii) Nigerian Institute of Estate Surveyors and Valuers;
(xix) National Pension Commission
(xx) Executive Secretary of the Council
2.11 STRUCTURE OF FRC

At the top of the structure of the FRC is the Board headed by the chairman. The FRC
Act established the following 7 Directorates – each, of course, headed by a director – to
assist the board in discharging its functions:
(i) Directorate of Accounting Standards – Public Sector
(ii) Directorate of Accounting Standards – Private Sector
(iii) Directorate of Auditing Practices Standards;
(iv) Directorate of Actuarial Standards;
(v) Directorate of Inspections and Monitoring;
(vi) Directorate of Valuation Standards; and
(vii) Directorate of Corporate Governance
42
The FRC Act also created the following three Standing Committees to, among others,
consider, advise and make recommendations to the Council on key issues:
(i) Technical and Oversight Committee
(ii) Finance and General Purpose Committee
(iii) Audit Committee (non-executives)
Objectives of FRC
The objects of the FRC, according to section 11 of the FRC Act, are to:
(a) protect investors and other stakeholders interest;
(b) give guidance on issues relating to financial reporting and corporate governance
to ICAN, ANAN, CIS, FMC and all other bodies represented in the Council;
(c) ensure good corporate governance practices in the public and private sectors of
the Nigerian economy;
(d) ensure accuracy and reliability of financial reports and corporate disclosures,
pursuant to the various laws and regulations currently in existences; and
(e) harmonize activities of relevant professional and regulatory bodies as relating to
Corporate Governance and Financial Reporting.
Functions of FRC
The functions of FRC are set out in Section 8 (1) of the FRC Act. They are to:
(a) develop and publish accounting and financial reporting standards to be observed
in the preparation of financial statement of public interest entities;
(b) review, promote and enforce compliance with the accounting and financial
reporting standards adopted by the Council;
(c) receive notices of non-compliance with approved standards from preparers,
users, other third parties or auditors of financial statements;
(d) receive copies of annual reports and financial statements of public interest
entities from preparers within 60 days of the approval of the Board;
(e) advise the Federal Government on matters relating to accounting and financial
reporting standards;
(f) maintain a register of professional accountants arid other professionals engaged
in the financial reporting process;
(g) monitor compliance with the reporting requirements specified in the adopted
code of corporate governance;
(h) promote compliance with the adopted standards issued by the International
Federation of Accountants and International Accounting Standards Board;
(i) monitor and promote education, research and training in the fields of
accounting, auditing, financial reporting and corporate governance;
(j) conduct practice reviews of registered professionals;
43
(k) review financial statements and reports of public interest entities;
(l) enforce compliance with the Act and the rules of the Council on registered
professionals and the affected public interest entities;
(m) establish such systems, schemes or engage in any relevant activity, either alone
or in conjunction with any other organization or agency, whether local or
international, for the discharge of its functions;
(n) receive copies of all qualified reports together with detailed explanations for
such qualifications from auditors of the financial statements within a period of
30 days from the date of such qualification and such reports shall not be
announced to the public until all accounting issues relating to the reports are
resolved by the Council;
(o) adopt and keep up-to-date accounting and financial reporting standards, and
ensure consistency between standards issued and the International Financial
Reporting Standards;
(p) specify, in the accounting and financial reporting standards, the minimum
requirements for recognition, measurement, presentation and disclosure in
annual financial statements, group annual financial statements or other financial
reports which every public interest entity shall comply with, in the preparation
of financial statements and reports;
(q) develop or adopt and keep up-to-date auditing standards issued by relevant
professional bodies and ensure consistency between the standards issued and the
auditing standards and pronouncements of the International Auditing and
Assurance Standards Board; and
(r) perform such other functions which in the opinion of the Board are necessary or
expedient to ensure the efficient performance of the functions of the Council.
The FRC is also empowered under section 8(2) to issue rules and guidelines for the
purpose of implementing auditing and accounting standards.
Functions of the Board of FRC

Under section 10 of FRC Act, the functions of the board of GRC are to:
(a) determine broad strategies and priorities;
(b) set out budget, secure the necessary funding and monitor expenditure;
(c) appoint the Directors and other senior management staff;
(d) oversee the delivery by each directorate of their functions, through regular
reports from the directorates’ coordinating directors;
(e) oversee the performance of the executive through regular reports from the Chief
Executive Officer;
(f) ensure that the Council and its directorates achieve high levels of accountability
and transparency;
44
(g) undertake annual assessment of the risks to the success of the operations of the
Council and oversee the necessary risk mitigation plan; and
(h) undertake annual evaluation of its own performance, and that of its committees
and operating bodies, against its objectives, including a review of the schedule
of matters reserved to the Board.
2.12 PROCESS LEADING TO ISSUE OF SAS

The development of a Statement of Accounting Standard (SAS) involves a long process
usually referred to as due process. The due process ensures that all interested parties
get the chance to make inputs into the proposed standard.
The process begins with the selection of a topic to be standardised. To be selected for
standardisation, an accounting problem must be sufficiently significant in terms of its
effect on financial statements; otherwise the cost of the due process may not be
justifiable. Any individual or entity having interest in financial reporting, such as the
business community and member-organisations of the FRC - can write to the council to
suggest a topic for standardisation.
The next stage in the process is the selection of a steering committee (SC) consisting
of, at least, six experts and leading authorities in the area to be standardised drawn from
the public, private and professional sectors.. The members of the committee usually
include an accountant in public practice, a representative of the Board of Inland
Revenue, an academic, and at least one person representing the business community
who may be affected by the proposed standard. The idea is to ensure that the
composition of the SC is as broadly based as possible, comprising professionals in the
private and public sector of the economy.
The SC carries out extensive deliberations on the area of accounting to be standardised
with a view to developing an Exposure Draft (ED) for the approval of the council. The
ED is a document designed to "expose" the contents of the proposed SAS for comments
from interested parties. To facilitate the SC's work, the secretariat of the FRC conducts
research into the accounting, legal and other ramifications of the proposed standard and
issues a document known as Points Outline Paper (POP) detailing, in broad terms, the
aspects to be covered by the proposed standard. The POP, after being approved by the
Council, then forms the basis of the work of the SC on the proposed standard. The work
of the SC includes, among others, the detailed study of the existing local laws,
regulations, current practices and accounting standards issued in other countries. When
a satisfactory draft ED is developed and approved by the SC — after about six meetings
- it is recommended to the Council for consideration and approval as an ED.
45
To consider the draft ED, the council meets, at a technical session which lasts about
three working days usually held outside Lagos. Every word, sentence and paragraph of
the draft ED is examined and re-examined. When a satisfactory draft is finally
produced, council members arc requested to vote in favour of or against its exposure. If
two-thirds of council members present at the technical session vote in favour of its
exposure as an ED, the document is then printed and distributed to trade associations,
governments and their parastalals, practising accounting firms and some individuals as
may be directed by the council.
Each ED is exposed for about three months during which comments in writing arc
expected Horn recipients of the document. Comments that are received are carefully
analysed and pertinent ones incorporated into the document to improve its contents. An
amended ED must be approved by three-quarters of council members present at the
meeting before it becomes an SAS. If the comments received are radically different
from the basic thrust of the ED, the Council may decide to hold a public hearing - for
the respondents to present, clarify and defend their positions. Ideas and issues generated
from the public hearing may be- incorporated into the document to further improve it.
So far, three such public hearings have been held on:
(i) Accounting by Banks and Non-Bank Financial Institutions.
(ii) Leases
(iii) Accounting in the Petroleum Industry
The final document approved by the Council is then issued as an SAS. The printing and
distribution of the SAS are of course, the administrative responsibilities of the
secretariat.
2.13 LIST OF SAS ISSUED TO DATE

SAS No. Topic Equivalent IFRS
1 Disclosure of Accounting Policies IAS 1
2 Information to be Disclosed in Financial Statements IAS 1
3 Accounting for Property, Plant & Equipment IAS 16
4 Inventory IAS 2
5 Construction contracts IAS 11
6 Extra – Ordinary Items and Prior Year Adjustments IAS 8
7 Foreign Currency Conversions and Translations IAS 21
8 Accounting for Employees’ Retirement Benefits IAS 19 & IAS 26
9 Accounting for Depreciation IAS 16
10 Accounting by Banks and Non – Bank Financial IFRS 7
Institutions (Part 1)
46
11 Leases IAS 17
12 Accounting for Deferred Taxes IAS 12
13 Accounting for Investments IAS 32, 39; IFRS 7,
9
14 Accounting in the Petroleum Industry: Upstream Activities IFRS 6
15 Accounting by Banks and Non – Bank Financial IFRS 7
Institutions (Part II)
16 Accounting for Insurance Business IFRS 4
17 Accounting in the Petroleum Industry: Downstream IFRS 6
Activities
18 Statement of Cash Flows IAS 7
19 Accounting for Taxes IAS 12
20 Abridged Financial Statements
21 Earnings Per Share IAS 33
22 Research and Development Costs IAS 38
23 Provisions, Contingent Liabilities and Contingent Assets IAS 37
24 Segment Reporting IFRS 8
25 Telecommunications Activities
26 Business Combinations IFRS 3
27 Consolidated and Separate Financial Statements IFRS 10 and IAS 27
28 Investments in Associates IAS 28
29 Interests in Joint Ventures IFRS 11
30 Interim Financial Reporting IAS 34
31 Intangible Assets IAS 38
2.14 WHY ARE ACCOUNTING STANDARDS NECESSARY?

International Financial Reporting Standards
The principles underlying financial statements prepared the world over in the pre-IFRS
period vary from one country to another. This did not enhance the comparability of the
financial statements, as there is usually due to the sometimes wide divergence in the
domestic accounting standards adopted in different countries. Things are already
changing as approximately 120 nations and reporting jurisdictions already permit or
require IFRS for domestic listed companies. Out of these, approximately 90 countries
have already fully conformed with IFRS and include a statement acknowledging such
conformity in audit reports.
The following are some- of the arguments in favour of IFRS.
47
(1) IFRS are of particular benefit to multinational companies, as the cost of drawing
up their financial statements around the world would be substantially reduced if
IFRS are adopted in all the countries in which they operate.
(2) Global investors and investment analysts are often confused by the different
standards in use from one country to another. This makes their task of
interpreting financial statements ever more difficult. This constitutes a
drawback to cross - border financing transactions, securities trading and
foreign investment. It is therefore necessary to have a single set of rules by
which assets, liabilities and incomes are measured all over the world. The IFRS
meet this need.
(3) The financial distress that occurred in Asia in a decade-and-half ago and the
global financial meltdown a half-decade ago brought to the fore the need for
transparent financial reporting governed by principles and procedures which
enjoy global acceptance and application. The development, issuance and
adoption of IFRS greatly enhance the transparency of financial reporting.
(4) IFRS are useful for developing country or countries that do not have standard -
setting bodies. It should be noted that the cost of establishing standard -- setting
apparatus could be substantial. This is quite apart from the fact that the process
of developing and issuing standard is time - consuming. 'I here fore, countries
that lack the requisite resources can avoid this cost by simply adopting IFRS.
2.15 STATEMENTS OF ACCOUNTING STANDARDS

While the adopt ion of IAS and IFRS brings about uniformity in global financial
accounting & reporting, it must be emphasized that the economic environment can vary
widely from country to country. For example, there are some economic activities that
are peculiar to a few countries. IFRS can, therefore, not meet the financial reporting
needs in all countries. Statement of Accounting Standards are indigenous to Nigeria and
they are issued only after giving due consideration for Nigerian laws, customs, business
culture and level of economic development. The following are some of the benefits of
SAS.
(1) Nigerians receive their accounting education and training from different countries of
the world where they have been exposed to a wide variety of accounting principles,
procedures and business culture. It is therefore essential that local standards be set in
Nigeria to harmonize financial reporting procedures.
48
(2) The existence of SAS guide international companies operating in Nigeria in their
financial reporting in Nigeria. This does not detract from the well-known need for
uniformity in global reporting. However, the need for global uniformity must be
balanced against the need to have financial statements of companies operating in
Nigeria reflect the peculiarities of the Nigerian economic environment.
(3) SAS serve as text of reference and study materials for students and lecturers in
accounting in higher institutions of learning in Nigeria.
2.16 APPLICATION OF IFRS AND SAS IN NIGERIA

Both IFRS and SAS are applicable in Nigeria except that if an IFRS is inconsistent with
an SAS, the IFRS would be inapplicable to the extent of the inconsistency. This implies
that on any matter on which an IFRS and an SAS make conflicting pronouncements,
the SAS shall supersede the IFRS in Nigeria.
From the foregoing, the following points can be made with respect to the application of
IFRS and SAS in Nigeria.
(i) The SAS is always applicable in Nigeria as required by law.
(ii) The IFRS is applicable in Nigeria subject to the following rules.
(a) An IFRS is applicable in Nigeria if it makes pronouncements on tropic(s) not
yet covered by SAS. For example IAS 20, IAS 23 and IFRS 11 will be applied
in Nigeria in reporting Government Grants, Borrowing Costs and Joint
Arrangements respectively because there are no SAS on these topics.
(b) An IFRS is applicable in Nigeria if it deals with a topic already covered by an
SAS but, within that topic, covers a matter not addressed by the SAS. For
example both IAS 16 and SAS 3 arc on Property, Plant and Equipment but
IAS 16 deals with "Review of Useful Life" a matter not addressed by SAS 3.
For this reason, IAS 16 applies in Nigeria on the matter of review of the
usefulness of a non-current asset.
49
2.17 SUMMARY
This chapter has discussed a number of fundamental topics as it relates to various standards
and regulatory framework in basic accounting such as;
- The changes in global accounting standards.
- The regulatory rules guiding accounting globally
- How to prepare simple financial statement.
50
1. Trace the evolution of international accounting standard.
2. List the composition and functions of board of financial reporting council
3. Why are accounting standards necessary in Nigeria?
4. List 10 statement of accounting standards issued to date.
51
References
Hadey Publishers.
Limited.
Nig. Ltd.
Education Limited.
Publishers Limited.
Stroke consulting.
Limited.
52
CHAPTER THREE
FINANCIAL REPORTING AND FRAMEWORK OF ACCOUNTING
3.0 LEARNING OBJECTIVE

 The meaning of Accounting concepts and conventions
 Accounting Bases
 Accounting policies
3.1 INTRODUCTION
Financial accounting is not an end in itself. It provides information to the various users
of financial statements. Many of these users have conflicting information needs. Over
the centuries during which the financial accounting profession has developed, a body of
principles has evolved to regulate the practice of the profession so that the preparation
of Financial Statements is guided by consistent and acceptable principles.
These principles, known as concepts, are so fundamental that their application can not
be taken for granted. They have been accepted, and issued in the form of accounting
standards, by such bodies as the IASB and FRC (formerly NASB).
We will now consider each of these concepts. The text in bold italic arc quotations from
SAS 1 while the boxed texts in plain italic are quotations from The Framework or IAS
1.
i. Entity
Every economic unit, regardless of its legal form of existence, is treated as a separate
entity (in accounting) from parties having proprietary or economic interest in it.
A strict application of this concept ensures that only the expenses incurred by/for the
business, incomes earned by the business, assets acquired for the business and liabilities
owed by the business are respectively recorded as expenses, incomes, assets and
liabilities in the books of the business.
For instance, if the owner withdraws money from the bank account of the business to
pay the rent of his residential accommodation, the amount would not be debited to the
rent account in the books of the business. Rather, the owner's drawings account would
be debited.
53
ii. Going Concern
The assumption is that the business unit will operate in perpetuity; that is the
business is not expected to be liquidated in the foreseeable future. A business is
considered a going concern if it is capable of earning a reasonable net income and
there is no intention or threat from any source to curtail significantly its line of
business in the foreseeable future.
The financial statements are normally prepared on the assumption that an entity is a
going concern and will continue in operation for the foreseeable future. Hence, it is
assumed that the entity has neither the intention nor the need to liquidate or curtail
materially the scale of its operations; if such an intention or need exists, the financial
statements may have to be prepared on a different basis and, if so, the basis used is
disclosed - The Framework
Without this assumption, application of the historical cost concept (to be considered
later) would not make sense at all. For example, if there is evidence suggesting that the
entity is about to be liquidated, the assets would no longer be carried at cost. Rather, the
assets would be restated to their realizable values.
iii. Periodicity
Although the results of a business unit cannot be determined with precision until its
final liquidation, the business community and users of financial statements require that
the business be divided into accounting periods (usually one year) and that changes in
position be measured over these periods.
IAS 1 deals with this topic under the title Frequency of Reporting: An entity shall
present a complete set of financial statements (including comparative information) at
least annually. When an entity changes the end of its reporting period and presents
financial statements for a period longer or shorter than one year, an entity shall
disclose, in addition to the period covered by the financial statement:
(a) the reason for using a longer or shorter period, and
(b) the fact that amounts presented in the financial statements are not entirely
comparable.
In compliance with this concept, statement of profit or loss and other comprehensive
income of a business entity is usually prepared for "the year ended ....", i.e. every 12
months, except in the following instances:-
 the first final accounts after commencement of business,
 the last final accounts up to cessation of business; and
 when there is a change to a new accounting period.
54
Also, the statement of financial position is usually prepared to show the financial
position of (the firm at the end of every year.
iv. Realisation
The concept establishes the rule for the periodic recognition of revenue as soon as (a)
it is capable of objective measurement and (b) the value of assets received or
receivable in exchange is reasonably certain. It is possible to recognise revenue at a
variety of points e.g. when goods are produced, when goods are delivered or when the
transaction is completed. Choice in most cases is an Industrial norm; and depends on
which of the points is the critical event. Only when this event is passed can revenue
be legitimately recognized.
The Framework and IAS 18 stipulate the same thing in different words. They both
require a reporting entity to recognise revenue — that is, deem revenue to be realised
and therefore incorporate it in statement of profit or loss — when:
• it is probable that any future economic benefit associated with the item of
revenue will flow to the entity; and
• the amount of revenue can be measured with reliability.
Revenue should be recognised at the point when the sale is deemed to have been made.
This point is sometimes referred to as the "critical event". It should be "noted that this
point differs for different transactions.
For most transactions involving sale of goods, the sale can be deemed to have been
made when the customer signs the sales invoice (thereby accepting liability to pay for
the goods) whether the goods have been delivered to the customer or not. For cash-on-
delivery (C.O.D) transactions, the sale is not made until the goods are delivered to the
customer. For goods sent out on sale-or-ret urn, the sale is not made until the customer
has indicated his intention to buy the goods.
v. Matching
The concept holds that for any accounting period, the earned revenue and all the
incurred costs that generated that revenue must be matched and reported for the
period. If revenue is carried over from a prior period or deferred to a future period, all
elements of costs and expenses relating to that revenue are usually carried over or
deferred as the case may be.
Accrual Basis of Accounting.
The matching concept is known in IAS 1 as Accrual Basis of Accounting. IAS 1
stipulates as follows concerning this concept: An entity shall prepare its financial
55
statements, except for cash flow information, using the accrual basis of accounting.
When the accrual basis of accounting is used, an entity recognises items as assets,
liabilities, equity, income and expenses (the elements of financial statements) when they
satisfy the definitions and recognition criteria for those elements in The Framework.
It is in compliance with this concept that the adjustments referred to in chapter two are
carried o. before preparing the final accounts.
vi. Consistency
Usually there is more than one way in which an item may be treated in the accounts
without violating accounting principles. The concept of consistency holds that when a
company selects a method, it should continue (unless conditions warrant a change) to
use that method in subsequent periods so that a comparison of accounting figures over
time is meaningful. The concept ensures that the accounting treatment of tike items is
inconsistent taking one accounting period with another.
IAS 1 deals with this topic under the title Consistency of Presentation: An entity shall
retain the presentation and Classification of items in the financial statements from one
period to the next unless;
(a) It is apparent, fallowing a significant change in the nature of the entity's
operations or a review of its, financial statements, that another presentation or
classification would be more appropriate having regard to the criteria for the
selection and application of accounting policies in IAS 8; or
(b) an IFRS requires a change in presentation.
The application of this concept requires that if, for example, the firm chooses to
depreciate its motor vehicles on straight line basis, it should continue to do so in
subsequent periods. It would not be proper to use straight line method in one period,
then reducing balance method in the next period, and sum-of-the-digits method in the
period after that. Such frequent changes do not allow valid and meaningful comparisons
of accounting figures to be made over time.
Another aspect of consistency is that, having chosen to depreciate motor vehicles on

straight line basis, ail motor vehicles owned by the firm - the Mercedes "S" Class used
by the chairman; the delivery van used by the sales staff; motorcycles used by dispatch
clerks etc. - should be depreciated on that basis.
vii. Historical Cost

The historical cost concept holds that cost is the appropriate hash for initial accounting
recognition of all assets acquisitions, services rendered/received, expenses incurred,
56
'creditors' and 'owners' interests; and, it also holds that subsequent to acquisition, cost
values are retained throughout the accounting process.
In The Framework, the IASB notes that Financial statements are most commonly
prepared in accordance with an accounting model based on recoverable historical cost
and the nominal financial capital maintenance concept. Other models and concepts
may be more appropriate in order to meet the objective of providing information that is
useful for making economic decisions although there is at present no consensus for
change. This Conceptual Framework has been developed so that it if applicable to a
range of accounting models and concepts of capital and capital maintenance.
In financial accounting, there is a variety of values that can be ascribed to any item.
These include cost, market value and net realisable value. Provided the going concern
concept still applies to the firm, the historical cost concept holds that cost is the most
reliable and verifiable value at which an item should be initially recognised and
subsequently carried in the books.
The reason for the preference for cost is that, of all the possible values, cost is the only
one that is supported with verifiable documentary evidence in the nature of the receipt
or invoice obtained when the asset or service was purchased.
In the choice and application of appropriate accounting policies, some of the
fundamental concepts enumerated above contradict one another.
In order to resolve such contradictions, the following principles known as conventions
are applied:-
viii. Substance Over Form

Although business transactions are usually governed by legal principles, they are
nevertheless accounted for and presented in accordance with their substance and
financial reality and not merely with their legal form.
On the same topic, IAS 18 has this to say: The recognition criteria in this Standard are
usually applied separately to each transaction. However, in certain circumstances, it is
necessary to apply the recognition criteria to the separately identifiable components of
a single transaction in order to reflect the substance of the transaction. For example,
when the selling price of a product includes an identifiable amount for subsequent
servicing, that amount is deferred and recognised as revenue over the period during
which the service is performed. Conversely, the recognition criteria are applied to two
or more transactions together when they are linked in such a way that the commercial
effect cannot be understood without reference to the series of transactions as a whole.
For example, an entity may sell goods and, at the same time, enter into a separate
agreement to repurchase the goods at a later date, thus negating the substantive effect
of the transaction; in such a case, the two transactions are dealt with together.
57
The aim of this convention is to prevent entities from distorting their results by
dogmatically following the letters of the law instead of showing the substance of the
entities' transactions.
An example of the application of this convention is in accounting for hire purchase

transactions in the books of the buyer. Under the law, the buyer does not acquire title to
the item until he has paid all installments provided for under the terms of the contract.
Going strictly by the law therefore, a hire-purchased asset should not be carried in the
buyer's statement of financial position until all installments have been paid and the title
in the asset legally passes to the buyer. In spite of this fact, the buyer, at the inception
of the transaction, brings the item into his books as a non-current asset and carries it in
his statement of financial position.
The reasons for this treatment are:-

a. Since all incomes earned will be reported in the statement of profit or loss, it is
necessary to report, on the statement of financial position, all the assets
(including the one acquired on hire purchase terms) employed to generate the
incomes.
b. Firms that acquire assets on hire purchase terms invariably intend to honour all
obligations and acquire title at the conclusion of the transaction. Such firms only
choose the hire purchase option as a means of financing the purchase of the
non-current asset because they cannot afford to purchase the assets outright.
ix. Objectivity
This principle connotes independence of judgment on the part of the accountant
preparing the financial statements. Objectivity requires support by verifiable evidence
in contrast to subjectivity or dependence on the unverifiable opinion of the
accountant preparing the financial statements.
x. Fairness
This is an extension of the objectivity principle. In view of the fact that there are
many users of accounting information, all having differing needs, the fairness
principle requires that accounting reports should be prepared not to favour any
group or segment of society.
The objectivity and fairness conventions arc obviously intertwined. To be fair and
objective, the accountant must prepare the financial statements in line with generally
accepted accounting principles (GAAP) as represented by the accounting standards
58
issued by the IASB and FRC. This ensures that the same set of financial statements will
be available to the various users of accounting information.
xi. Materiality
The principle holds that only items of material values are accorded their strict
accounting treatment.
IAS 1 has the following to say regarding this concept which it names Materiality and
Aggregation: An entity shall present separately each material class of similar items.
An entity shall present separately items of a dissimilar nature or function unless they
are immaterial. If a line item is not individually material, it is aggregated with other
items either in those statements or in the notes. An entity need not provide a specific
disclosure required by an IFRS if the information is not material.
Also, The Framework, lists materiality as one of the three fundamental qualitative
characteristics of financial information, the other two being relevance and faithful
representation. It has this to say concerning materiality: Information is material if
omitting it or misstating it could influence decisions that users make on the basis of
financial information about a specific reporting entity, in other words, materiality is an
entity-specific aspect of relevance based on the nature or magnitude, or both, of the
items to which the information relates in the context of an individual entity’s financial
report. Consequently, the Hoard cannot specify a uniform quantitative threshold for
materiality or predetermine what could be material in a particular situation.
An item will be considered material if its omission or misstatement could distort the
financial statement such that it influences the economic decisions of users taken on the
basis of the financial statements.
Where an item is not material and the cost of according it the strict accounting
treatment outweighs the benefits, an alternative treatment that would involve less cost
and effort should be given the item. An example of the application of this convention is
in the decision as to whether to capitalise or expense an item in the year that it is
acquired/Incurred.
For example, a ruler (probably purchased for N500) that is well made will meet all the
criteria for depreciable assets (see chapter 4) as listed below:-
i. Useful life of more than one year.
ii. Acquired for use in the business
iii. Limited useful life.
iv. Not intended for sale in the ordinary course of business.
59
Clearly, it would be absurd to capitalise the cost of the ruler and begin to charge
depreciation on it every year because it meets the above criteria. The cost and effort
involved in doing that would be far out of proportion with the benefits. It would
therefore not be inappropriate if the cost of the ruler, because of its immateriality, is
expensed lo the statement of profit or loss in the year of its purchase.
xii. Prudence
This principle demands exercising great care in the recognition of profit whilst all
known losses adequately provided for. This is however not a justification for the
creation of secret or hidden reserves.
Revenues should not be recognised until they are realised (see Realisation concept) On
the other hand, all foreseeable losses should be provided for by charging them to the
current period's statement of profit or loss. It is in compliance with this convention that
such provisions as provision for bad/doubtful debt and provision for unrealised profit
are made. A strict application of prudence convention would ensure that profits and
assets of the firm are not overstated.
Distinction between Accounting Method, Accounting Bases and Accounting Policies
3.2 ACCOUNTING METHOD

An accounting method is the medium through which the foregoing fundamental
accounting concepts are applied to financial transactions and the preparation of
financial statements. It is also the method adopted in recognising, measuring and
valuing an item of revenue, expense, gain, loss or any asset or liability.
In view of the wide variety and complexity of types of enterprises and business
transactions, it would be unrealistic to have only one method to be applied in all
transactions. This is the justification for the existence, for example, of different
methods of calculating deprecation on non-current assets (i.e. straight-line, reducing
balance, sum-of-the-digits and so on) and valuing Inventory (i.e. First In First Out, Last
In First Out, Weighted Average Price and so on).
3.3 ACCOUNTING BASES

These are the totality of methods adopted by an enterprise for applying fundamental
accounting concepts to its financial transactions. The two recognised accounting
bases are:
60
(i) Accrual Basis
Under this basis, incomes/revenues are recognised when they are earned not
necessarily when they are received and expenses are recognised when they are
incurred not necessarily when they are paid. In other words, revenues and expenses
are recognised in the accounting period to which they relate irrespective of the
period in which they are actually received and paid. This basis is used by the profit-
oriented entities in the non -government sector.
(ii) Cash Basis
Under this basis, incomes/revenues and expenses are recognized in the accounting
period in which they are actually received and paid. Thus, under this basis, Receivables'
balances (receivables) and Payables' balances (payables) are not carried on the
statement of financial position. This basis is used in the public (government) sector.
3.4 ACCOUNTING POLICIES

These are those bases, rules, principles, conventions and procedure adopted in
preparing and presenting financial statements. Differing accounting policies exist
and the reporting entity is required by SAS 1 to disclose it's accounting policies to
enable users have a better appreciation and understanding of the financial statements.
The following are some of the areas in which divergent accounting policies may exist:
 Consolidation policy;
 Construction Contracts;
 Taxation;
 Receivables;
 Inventory;
 Depreciable assets;
 Payables;
 Liabilities and provisions;
 Pension costs, and
 Intangible assets.
61
3.5 SUMMARY
This chapter has discussed various accounting concepts and conventions, and the basic
assumptions applicable in the preparation f financial statements. It also covered accounting
bases and policies that should be adhered to.
62
1. Explain the term “Accounting concepts”
2. State and discuss the accounting applications of four fundamental accounting concepts.
3. Why should business separate the transactions of his business from those of his private
life?
4. Discuss the criteria that make a business a Going Concern
5. Write short notes on the following:

i. Historical concept ii. Going Concern iii. Accrual iv. Business Entity v.
Matching
6. One of the features of non-current assets is that they are used in a business for more
than 12months. The cost/revalued amounts of such items are therefore spread over their
useful life. Put up a convincing argument on the accounting concept this accounting
treatment upholds.
63
References
Hadey Publishers.
Limited.
Nig. Ltd.
Education Limited.
Publishers Limited.
Stroke consulting.
Limited.
64
CHAPTER FOUR
CAPITAL AND REVENUE ITEMS

 The meaning of capital and revenue expenditure
 The difference Capital expenditure
 The Revenue expenditure
 The meaning of Capital and Revenue Income
4.1 CAPITAL EXPENDITURE

This is an expenditure from which the business entity will derive benefits for more than
one year. The item or resource acquired with this expenditure will be held and used by
the organisation for years. Example of capital expenditure includes the cost of acquiring
a motor vehicle (provided it is not acquired for resale) and the cost of acquiring patent
rights.
Since the benefits of a capital expenditure will be enjoyed by the business entity for
more than one year, it shall not be expensed to the statement of profit or loss in the year
that the related item or resource is acquired. Rather, the expenditure is capitalized to
the statement of financial position from where it will be spread on a rational basis over
the number of years for which the items will be economically useful. This is done by
writing off (i.e. charging) to the statement of profit or loss of each of the years of its
useful life, the portion of the original cost estimated to have been used up in the year.
4.2 REVENUE EXPENDITURE

This is an expenditure, the full benefits of which are used up within one year. It is
charged to the statement of profit or loss as an expense in the year that it is incurred.
See definition of expenses on the preceding page and the format of the statement of
profit or loss for a list of typical revenue expenditure.
It should be noted that the cost of some immaterial items which meet the criteria for
capital expenditure (e.g. rulers and stapling machines) are, however, usually treated as
expenses in the year of acquisition because of the relative insignificance of their values.
Some organisations also set materiality limits so that all items costing less than the
limit will be treated as expenses in the year of acquisition even if some of them will be
in use for more than one year.
65
4.3 ITEMS IN THE STATEMENT OF FINANCIAL POSITION
ASSETS
An asset is a resource - tangible or otherwise — owned and used by a business entity
for the purpose of generating income. An asset yields future economic benefits to the
business entity which owns or controls it.
A more complete definition of an asset is given in IASB's Conceptual Framework for

Financial Reporting (hereinafter referred to simply as The Framework), There an asset
is defined as a resource controlled by the entity us a remit of past events and from
which future economic: benefit',- arc expected to flow to the entity. The Framework
states that the future economic benefit embodied in an asset is the potential to
contribute, directly or indirectly, to the flow of cash and cash equivalents to the
entity. The Framework clarifies further that the future economic benefits embodied in
an asset may flow to the entity in a number of ways. For example, an asset may be:
(a) used singly or in combination with other assets in the production of goods or
services to be sold by the entity (e.g. plant and machinery in the factory of a
manufacturing entity);
(b) exchanged for other assets (e.g. trading-in an old asset for a new one);
(c) used to settle a liability (e.g. payment of cash to settle a supplier); or
(d) distributed to the owners of the entity (e.g. the owner takes cash or other assets
of the entity for his private/personal use).
Assets may be non-current assets (new IFRS term for what used to be known as fixed
assets) or current assets.
4.3.1 Non-Current Assets

These are assets whose useful economic lives exceed one year i.e. the business entity
will enjoy the benefits from the ownership and use of the assets for years. Examples
include furniture and motor vehicles, provided they were not acquired for resale. From
the definition of capital expenditure above, it is perhaps needless to add that the cost of
a non-current asset is a capital expenditure.
4.3.2 Current Assets

These are assets whose useful economic lives do not exceed one year. They exist for
only a short time before they are transformed into other kinds of assets. In other words,
the composition of current assets is constantly changing. Cash at bank or in hand
change to inventory when goods are purchased for resale, which then to receivables
when the goods are sold on credit and which change back to cash at bank or in hand
when the debts arc collected. These transformations take place many times within one
66
accounting year. This is the reason why current assets are sometimes referred to as
circulating assets.
The above classification of assets is according to their permanence. Assets can also be
classified according to their nature as follows:
4.3.3 Tangible Assets

These are assets that can be seen and touched e.g. motor vehicles and Inventory.
4.3.4 Intangible Assets

These are assets that can neither be touched nor seen hut are valuable to the business
e.g. goodwill, patents and trademarks.
4.3.5 Fictitious Assets

These are items that have characteristics resembling those of assets but are not assets in
the true sense of the word because they do not yield future economic benefits to the
entity. They are debit balances that have no realizable value to the organisation. An
example is accumulated loss brought forward. These are carried on the statement of
financial position but arc to be “written off” as soon as there are sufficient profits (or
reserves) to absorb them.
4.3.6 Wasting Assets

These are assets whose values dwindle as a result of being worked or exploited.
Examples are mines and quarries.
4.3.7 Liquid Assets

These are cash in hand or at bank and other non-cash assets (such as marketable short-
term investments) which can be quickly turned into cash.
4.3.8 LIABILITIES
These are amounts owed by the business. Liabilities represent the claim by outsiders
over the assets of a firm, more specifically, both The Framework and IAS 37 -
Provisions, Contingent Liabilities and Contingent Assets define a liability as a
present obligation of the entity arising from post events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic
benefits. Liabilities can be classified according to the time-frame within which they fall
due as follows:
67
4.3.9 Non-Current Liabilities
These are liabilities which fall due after more than one year e.g. debentures -and bank
loans. “Non-current liabilities” is the new IFRS term for what used to be known as
Non-current liabilities.
4.3.10 Current Liabilities (or Short-Term Liabilities)

These are liabilities which fall due within one year. Examples include trade payables,
bank overdraft and accrued expenses.
Other kinds of liabilities normally encountered in financial accounting are provisions
and contingent liabilities.
4.3.11 Provisions
The Framework and IAS 37 define a provision as a liability of uncertain timing of
amount. What is the definition of provisions under Nigerian Generally Accepted
Accounting Practices (a term which is usually shortened in Nigerian GAAP or, even
shorter still, NGAAP)?. The NGAAP definitions of provisions are contained in
paragraph 82. Part V of Schedule 2 to the Companies and Allied Matters Act
(C.A.M.A.), 2004. Although these clauses relate to the published accounts of
companies, they none-the-less equally apply to other business forms. The two types of
provisions defined in that paragraph are:
(i) Provision for depreciation and diminution in value of assets - "any amount
written off by way of providing for depreciation and diminution in value of
assets".
(ii) Provision for liabilities and charges – “any amount retained as reasonably
necessary for the purpose of providing for any liability or loss which is either
likely to be incurred or certain to be incurred but is uncertain as to amount or as
to the date on which it will arise”.
Do these two definitions contradict the NGAAP definitions? The answer is: No. The
words may differ but a closer examination of the definition reveals the uniformity of the
underlying precepts. The key precepts in the IFRS definition are uncertainty of timing
and uncertainty of amount. With respect to definition of ''provision for depreciation and
diminution in value, as assets” as given by CAMA, it is clear that there can be no
certainty (or precision) in the timing and amount of the periodic depreciation charges
because the calculation is based on estimates of both (or one of) the expected useful life
and scrap value of the depreciable asset. With respect to CAMA’s definition of
"provision for liabilities and charges", the lack of certainty (or precision) in the timing
and amount is evident from the inclusion of the following phrases in the definition:
68
 “likely to be incurred” and
 “uncertain as to amount or as to the date on which it will arise”.
Examples of (i) include provision for depreciation, provision for bad and doubtful debt.
and provision for discount on receivables. On the statement of financial position, these
provisions are deducted from the assets to which they relate. Provision for depreciation
is deducted from the cost or revalued amount of non-current assets to obtain the net
book value of the non-current assets while both provision for bad debt and provision for
discount on receivables are deducted from gross value of Receivables to obtain the
realisable value of receivables.
Examples of (ii) include provision for deferred taxation, provision for pension costs,
provision for redundancy costs and provision for repairs and maintenance. These
provisions do not relate to any asset appearing on the statement of financial position.
For this reason, they are not deducted from any asset as is done in the ease of the
provisions mentioned in the preceding paragraph. They are, rather, disclosed separately
as liabilities on the statement of financial position.
Provisions stand in. contrast to accrued expenses (or accruals). The latter are amounts
set aside out of profits to provide for charges, liabilities or losses known to exist at the
statement of financial position date whose amounts can be ascertained with substantial
accuracy e.g. accrued salaries and accrued electricity charges, in other words, accrued
expenses are of certain timing and amount.
4.3.12 Contingent Liabilities

According to IAS 37, a contingent liability is:
 a possible obligation arising from past events and whose existence would only
be confirmed by the occurrence or non-occurrence of some uncertain future
events; or
 a present obligation arising from past events but:
o which is unlikely to result in outflow of resources embodying economic
benefits; or
o the obligation cannot be measured with sufficient reliability.
69
Examples of contingent liabilities include:
(i) damages/costs which may be awarded against the firm if judgments is
eventually entered in a litigation pending as at the statement of financial
position date; and
(ii) discounted bills of exchange (more on bills of exchange in chapter 7).
From the definition and examples given above, it is obvious that with respect to a
contingent liability:
 an obligation does not exist -or has not arisen -as at the reporting date; or
 where an obligation exists as at the reporting date, its amount cannot be
ascertained with any reasonable degree of reliability/accuracy; or
• there is no certainty that an obligation would arise in future.
With all these facts, it is therefore not surprising that IAS 37 stipulates that contingent
liabilities should not be recognised in the statement of financial position the way
provisions and accrued expenses are. Rather, the estimated amount of the contingent
liabilities as well as explanatory information thereon should be disclosed by way of
notes to the statement of financial position.
4.3.13 Capital
From a sole trader's point of view, capital as at the reporting date, is the:
• total value of resources (in cash or kind) with which the proprietor commenced
the business; plus
• value of additional resources (in cash or kind) introduced by the proprietor
during the reporting period; plus
• profits earned by the business during the reporting period; or, minus
• losses incurred by the business during the reporting period; and minus
• value of resources (in cash or kind) of the business withdrawn by the owner for
his private use.
The capital balance, at the reporting date, also known as owner's equity, in fact
represents the proprietors claim over the assets of the business entity at that date.
From the point of view of a limited liability company, capital (more appropriately
described as share capital) is the total funds contributed by the shareholders. This fund
is subsequently increased by the undistributed profits (i.e. reserves) while it is
decreased by the losses of the company. In a company, the sum of (he share capital (in
respect of which shares have voting rights) and reserves is known as equity which is
the claim of the shareholders over the assets of the company.
70
4.3.14 Equity
The explanations given above concerning equity is consistent with The Framework's
definition of equity. It defines equity as the residual interest in the assets of the entity
after deducting all its liabilities.
4.4 CAPITAL INCOME

When an item of capital expenditure (Non-current Asset) is sold, the receipt is called
capital receipt or income. This income derived from sale of non-trading assets including
non-current assets. The profit or loss derived from the sale of non-trading assets is
included in statement of profit or loss and other comprehensive income in the year in
which the sales took place. This particular income is regarded as other comprehensive
income in the financial statement.
4.5 REVENUE INCOME

This is income derived from;
i. Sales of trading assets i.e inventory
ii. Interest received from investments
iii. Revenue income is included in the statement of profit or loss of the period in
which it relates.
71
4.6 SUMMARY
The basis and necessity for capital and revenue as well as features in recognizing the items of
capital and revenue have been covered, also subdivision of expenditure into capital and
revenue expenditure together with treatment of loan interest and distinction between capital
and revenue income was given in this chapter.
72
1. Distinguish between Capital and Revenue Expenditure
2. State whether each of the items below is a Capital or Revenue Expenditure and state
the reasons in each case
- Paid for the erection of signpost N5,600
- Bought various types goods for resale for N60,000
- Paid N600 to the men who unloaded the goods purchased in (ii) above
- Purchase a delivery van for N50,000
- Paid an advertisement cost to cover a product for three years N120,000
- Acquired some fixtures and fittings for N42,000
- Paid one year rent advance N36,000
3. Why should revenue expenditure be distinguished from capital expenditure? Give at

least six examples of transactions in each category.
4. List Ten items, which can be classified as Capital Expenditure and Revenue
Expenditures.
73
References
Abdulrasaq Abdullahi (2009). Financial Management. Lagos: Corporate Publishing.

Hadey Publishers.
Limited.
Fakunle Adeleke O. Modern Business Accounting. Book One. Lagos: Ilesanmi Press and Sons
Nig. Ltd.
Education Limited.
Publishers Limited.
Oye, Akinsulire (2008). Financial Management 5th Ed. Lagos: Ceemol Nigeria Limited.
Stroke consulting.
Limited.
74
CHAPTER FIVE
SOURCE DOCUMENTS AND SUBSIDIARY BOOKS

 The meaning of source and subsidiary books
 The various source documents used in an accounting
 And their uses such as Sales day book, Purchase day book
 Different types of Cash book
 Different types of discounts
5.1 INTRODUCTION
Transactions are not normally posted from the source documents directly to the ledger.
They are normally recorded first in subsidiary books before they are posted into the
ledger. Subsidiary books can be defined as the books into which transactions are
recorded on a daily basis from the source documents and from which transfers are made
at suitable periodic intervals, to the relevant accounts in the ledger. The use of
subsidiary books prevents the ledger from containing too much detail.
In a trading organization, a very large proportion of transactions relates to credit sales,

credit purchases, returns from customers and returns to suppliers. If these are posted
directly to the ledger as they occur, the sales account, purchases account, returns
inwards account and returns outwards account respectively would end up containing
too many entries.
Apart from the four transactions mentioned above, another type of transaction that
occurs in very large number is the receipt and payment of money. Again, to prevent the
ledger from being cluttered up with too much detail, the bank account and cash account
are taken out of the ledger and combined in one subsidiary book known as cash book.
Other transactions outside the ones mentioned above are recorded first in journal proper
before being posted into the ledger.
5.2 THE SUBSIDIARY BOOKS normally used in financial accounting are listed below:-
• Sales Day Book : for recording credit sales.
• Purchases Day Book : for recording credit purchases.
• Returns Inward Day Book : for recording returns from
customers.
• Returns Outward Day Book : for recording returns to suppliers.
• Cash Book : for recording the receipt and
payment of money;
• Journal Proper : for recording other transactions.
75
Other names for subsidiary books are books of original entry and books of prime entry.
Each subsidiary book will now be considered in greater detail.
5.2.1 Sales Day Book

As credit sales occur, the credit sale invoices arc listed in the sales day book which is
ruled up to show, among others, the date of the sale, the customer's name, the invoice
number and the amount. The customer's personal account is debited while the credit
entry to sales account is delayed. At the end of a suitable periodic interval (which may
be weekly, monthly, quarterly or any other convenient period), the total of the sales day
book shall he posted to the credit side of sales account in the general ledger. At this
point, the double entry for the credit sales is now complete. The sales day book is not
an account and therefore docs not from part of the double-entry record; however, the
use of sales day book considerably reduces the number of entries in the sales account.
Another name for the sales day book is sales journal.
5.2.2 Purchases Day Book

The same factors which necessitate the use of sales day book for credit sales also make
it necessary to use purchases day book for credit purchases. Credit purchase invoices
arc listed in the purchases day book on a daily basis as the credit purchases are made,
the suppliers' personal accounts being credited. "The debit entry to purchases account is
delayed until the end of the suitable periodic interval. Then the total of the purchases
day hook is transferred to the debit of the purchases account in the general ledger
thereby completing the double entry for the credit purchases. The purchases day book,
not being an account, is not part of the double-entry records, its use, however, saves the
purchases account from containing too much detail.
The purchases daily book is also known as purchases journal.
5.2.3 Returns Inward Day Book

When customers return goods, credit notes are issued to the customers indicating that
their personal accounts are being credited with the value of goods they returned thereby
reducing the amount being owed by them. In a typical trading business, the volume of
returns from customers is relatively large. In furtherance of the objective of preventing
the ledger from containing unnecessary details, a returns inwards day book is
maintained in which all the credit notes are listed, while the customers' personal
accounts are credited. At the end of the suitable periodic interval, the total of the returns
inwards day book is posted to the debit of the returns inwards account in the general
ledger thereby completing the double entry for the returns from customers. As with the
two day books already considered, the returns inwards day book is outside the double-
76
entry system but its use prevents the returns inwards account [or sales returns account]
from being congested with too many entries.
The returns inwards book is sometimes called returns inward journal or sales returns
day book.
5.2.4 Returns Outward Day Book

When goods are returned to suppliers, debit notes are issued to them to indicate that the
suppliers' personal accounts are being debited - with the value of goods returned to
them - to reduce the debt being owed to them. These debit notes are listed in the returns
outwards day book while the suppliers' personal accounts arc debited. The double entry
shall be completed when, at the end of the suitable periodic interval, the total of the
returns outwards day book is posted to the credit of the returns outwards account in the
general ledger. Of course the returns outwards day book is not part of the double-entry
records but its use saves the returns outwards account [or purchases returns account]
from too much details.
Alternative names for this day book are returns outward journal or purchases
returns day book.
NOTE: The use to which the sales day book and purchases day book are put, as
described earlier, assumes that credit sales and credit purchases are much larger in
volume than cash sales and cash purchases for a typical trading organisation.
It is possible, however, for the reverse to be the case i.e. cash sales and cash purchases
arc much more than credit sales and credit purchases. If this is the case, the objective of
taking unnecessary detail out of the ledger can be achieved by using these day books
for cash sales and purchases instead of credit sales and purchases.
5.2.5 Journal Proper

The journal proper is used to record transactions - such as the following - for which the
other day books are inappropriate, before they are posted to the ledger:-
i. the purchase and sale of non-current assets on credit;
ii. opening entries
iii. correction of errors;
iv. transfer from one account to another;
v. taking of goods by the owner from the business for his private use; and
vi. any other transaction which cannot be recorded in any of the other subsidiary
books.
The following benefits are derivable from the use of the journal proper:
1. The journal book is a kind of diary of transactions which fall outside the ones in
other subsidiary books.
77
2. The journal book gives the explanation for each entry through the narration
attached to each journal entry.
3. The journal book also serves as a book of instruction in that it tells the
bookkeeper which account to debit and which to credit.
NB: In practice, the journal proper can be maintained in either of two ways
namely;
i. in pre-numbered loose sheets known as journal vouchers which are filed
up for future reference; or
ii. in a bound book known as journal book.
Some examples, now follow illustrating the typical transactions which are recorded via
the journal proper:
Illustration 1.7; Purchase of non-current asset on credit

A motor vehicle was purchased by Mr. ROI on credit at a cost of N400,000 from
SCOA Motors on 15th July 20X8.
The journal to record this transaction, in the books of Mr. ROI, will appear as follows:
DR. CR.
N N
Motor Vehicle Account 400,000
SCOA Account 400,000
Being cost of motor vehicle purchased on credit from SCOA on 15th July 20X8.
Illustration 1.8: Correction of errors

Goods worth N100,000 were sold by Mr. ROI on credit to Ade on 1st March 20X7. The
book-keeper, in error, debited this amount to the account of Ada.
In the books of Mr. ROI, the correcting journal entry will be as follows:
DR. CR.
N N
Ade Account 100,000
Ada Account 100,000
Being credit sale to Ade wrongly debited to Ada's account now corrected.
Illustration 1.9: Transfer from one account to another

A Receivable, Ogunkoya, who was owing Mr.1 ROI 50,000 was declared bankrupt on
1/4/X8. He however convinced his friend, Bature, who is also a credit customer of Mr.
78
ROI to pay the debt on his behalf. Thereafter, Bature wrote a letter to Mr. ROI on 7 th
April 20X8 directing that Ogunkoya's debt be transferred to his own account.
The journal entry to effect the transfer, in the books of Mr. ROI, will look as follows:
DR. CR.
N N
Bature Account 50,000
Ogunkoya Account 50,000
Being transfer of the indebtedness of Ogunkoya to the account of Bature per his letter
dated 7 April 20X8.
The following points should be borne in mind regarding journal entries:

i. The account(s) to be debited should be written first before writing the
account(s) to be credited.
ii. A narration should be annexed explaining the journal entry. The narration
should be clear, brief, concise and begin with the word being although in
modern times this word is beginning to fall into disuse.
iii. It used to be the practice that the account(s) to be debited will be preceded by
the word 'To" and the account(s) to be credited preceded by the word "By". It
also used be the practice that the account(s) to be credited will be inset to the
right. In. modern times, however, these practices have been discontinued.
5.2.6 Cash Book
In a business entity, the function of receiving and paying out money (cither in the form
of cash or cheques) requires a considerable number of entries. If these transactions arc
posted directly to the ledger, the bank account and cash account will contain too many
entries. The objective of decongesting the ledger is carried one step further by taking
the bank account and cash account out of the ledger and combining both in one
subsidiary book called cash book.
2 -Column Cash Book

This cash book is so-called because it has two columns, one each for bunk and cash
transactions. The two columns on the debit side record the receipt of money while the
two columns on the credit side record payment of money. The bank column on the
debit side records cheques received and cash paid into bank while the bank column on
the credit side records payments by cheques. The cash column on the debit side records
cash received while the cash column on the credit side records cash paid.
79
Contra Entry
When the double entry for a transaction appears on both sides of the cash book, this is
called a contra entry. Contra entries in the cash book are made when cash is deposited
into the bank account out of the cash in hand or when cash is withdrawn from the bank
account for office use.
Shown below is the format of a typical 2-column cash book.
2 - Column Cash Book
Date Particulars Cash Bank Date Particulars Cash Bank
N N N N
1/1/X7 Balance b/d x x 1/1/x7 Furniture x
2/1/X7 Bank (contra) x 2/1/x7 Cash (contra) x
5/1/X7 Abu x 3/1/x7 Oghene x
11/1/X7 Sales x 6/1/x7 Wages X
24/1/X7 Rasheed x 12/1/x7 Peter x
25/1/X7 Cash (Contra) x 15/1/x7 Rent x
29/1/X7 Sales x 17/1/x7 Drawings X
30/1/X7 Moshood x 25/1/x7 Bank (contra) X
28/1/x7 Kayode X
29/1/x7 Transport Expenses X
30/1/x7 Stationery X
31/1/x7 Balance c/d X x
x x X x
1/2/X7 Balance b/d x x
Illustration 1.10:
On 1s1 April 20X3, Nnamadu, a trader, had N24,375 as cash in hand and a balance of
N468,900 in his bank account. The following arc the transactions of Nnamadu for the
month of April 20X3;
April 3rd: Received the sum of N79,875 from A. Bola.

April 6th: Sum of N15,000 was received in cash from O. Kunle
Settled the account Ponle and Co. N54,000 by cheque after deducting
5% cash discount.
April 7th: Deposited N37,500 into the bank
April 8th: Paid wages of N56,200 by cash.
April 13th: Paid BB Brothers account N16,500 less 21/2 discount.
April 15th: Laraba settled her account of N56,250 less 5% discount.
April 19th: Received a cheque of N64,125 from Biodun after allowing a discount of
N3,375. The cheque was deposited into the bank immediately.
April 20th: Paid tax office the sum of N5,065 by cash.
80
April 21st: Received cash of N49,500 less 21/2 discount from Julius Chizea; paid
wages of N56,250 in cash.
April 26th: Chukwu’s account of N41,250 was settled by cheque after deducting 5%
discount
April 27th: Received from Olu Samonda the sum of N106,875 after allowing a cash
discount of N5,625.
April 28th: Paid wages by cheque N56,250 and withdrew N3,750 by cheque for
private use.
You are required to prepare a 2-column cash books for Nnamadu for the month of April 20X3.
Solution
Cash Book
Date Particular Cash Bank Date Particular Cash Bank
N N N N
1/4/X3 Bal. b/d 24,375 468,900 6/4/x3 Ponle & Co. - 51,300
3/4/X3 A. Bola 79,875 - 7/4/x3 Bank (contra) 37,500 -
6/4/X3 O. Kunle 15,000 - 8/4/x3 Wages 56,200 -
7/4/X3 Cash (Contra) - 37,500 13/4/x3 B.B. Brothers 16,088 -
15/4/X3 Laraba 53,438 - 20/4/x3 Tax 5,065 -
19/3/X3 Biodun - 64,125 21/4/x3 Wages 56,250 -
21/4/X3 Julius Chizea 49,500 - 26/4/x3 Chukwu - 39,188
27/4/X3 Olu Samonda 106,875 - 28/4/x3 Wages - 56,250
28/4/x3 Drawings - 3,750
30/4/x3 Bal. c/d 157,960 450,037
329,063 570,525 329,063 570,525
1/5/X3 Bal. b/d 157,960 420,037
3-Column Cash Book

A three-column cash book has a third column (in addition to the two columns for bank and
cash) for recording the cash discounts allowed to Receivables and cash discounts received from
Payables. A cash discount is the amount allowed off (i.e. deducted from) debts to encourage
settlement of the debts within a specified period of time.
In a typical trading organisation, cash discounts arc fairly common and require a large number
of entries. If these are posted directly to the discount allowed account (when cash discounts are
allowed to Receivables) or discount received account (when cash discounts are received from
Payables), both' accounts will end tip containing too many entries. If this is to be avoided, it is
necessary to modify the recording process so that postings are only made periodically to the
81
discounts accounts in the general ledger. This need is met by adding a third column to the cash
book to record the cash discounts on a memorandum basis before the periodic totals are
transferred to the discounts accounts.
The discount column on the left-hand side of the each book is for discounts allowed to
Receivables while the discount column on the right-hand side records discounts received from
Payables. For example, when a customer is allowed a cash discount, this is listed in the
discount allowed column while the personal account of the customer is credited. At the end of
the suitable periodic interval, the total of the discount allowed column is transferred to the
debit side of discount allowed account in the general ledger. Conversely, when each discount is
received from a Payable, this is listed in the discount received column while the Payable's
personal account is debited. At the end of the suitable periodic interval, the total of discount
received column is transferred to the credit side of the discount received account in the general
ledger.
As already stated, the discounts columns are memoranda i.e. they are not part of the double-
entry system. They arc merely used as convenient means of accumulating the discounts before
the totals are posted to the discounts accounts in the general ledger. Thus, the discount column
of the 3-column cash book does for cash discounts what sales day book, for example, does for
credit sales. The format of a typical 3-column cash book is shown below.-
3 - Column Cash Book
Date Particulars Discount Cash Bank Date Particulars Discount Cash Basic
Allowed Received
N N N N N N
1/1/X7 Balance b/d x x 1/1/x7 Furniture x
2/1/X7 Bank (Contra) x x 2/1/x7 Cash (Contra) x
5/1/X7 Abu x x 3/1/x7 Oghene x x
11/1/X7 Sales x 6/1/x7 Wages x
24/1/X7 Rasheed x x 12/1/x7 Peter x x
25/1/X7 Cash (Contra) x 15/1/x7 Rent x
29/1/X7 Sales x 17/1/x7 Drawings x
30/1/X7 Moshood x 25/1/x7 Bank(Contra) x
28/1/x7 Kayode x x
29/1/x7 Transport x
Exps
30/1/x7 Stationery x
31/1/x7 Balance c/d x x
x x x x x x
1/2/X7 Balance b/d x x
82
Illustration 1.11:
Bolanle started a small business with N80,000 on 2/1/X8 which he paid into a bunk account for
the business on the same date His transactions for the rest of the month were as follows:
5/1/X8: Purchases by cheque N27,300.

6/1/X8: Credit purchases N25,200.
Electricity paid by cheque N500; Rent: N700 by cheque.
7/1/X8: Drew cash for office use N1,200
Sales: by cheque N42,520
by cash N480
on credit N50,000.
8/1/X8: Paid Payables by cheque N15,100 and received discount of N320. 9/1/X8:
Cash sales N17,115; cash wages paid N500.
10/1/X8: Paid into bank the sales made on 9/1/X8. Stationery bought by cash N50. 12/1/X8:
Received from customers cheques for N39,200 and allowed discount of N800. 15/1/X8:
Drew cash from bank for office use N200.
16/1/X8 Servicing and repairs by cash N120.
Purchases: by cash N20,000
by cheques N5,000
on credit N45,000
20/1/X8: Sales: By cash N37,500
By cheques N17,000
22/1/X8: Paid Payables N27,900 by cheque and received discount of N100.
Cash sales N2,000 which was. Immediately lodged it into the bank.
24/1/X8: Payments by cheque:
Rent N1,200
Rates N300
Wages N2,000
28/1/X8: Salaries by cheque N3,600.
30/1/X8: Cash lodged into bank N10,000.
31/1/X8: Drew- cheque for petty cash N200.
Required:
Three- column cash book of Bolanle for the month of January, 20X8.
83
Solution:
Cash Book
Date Particulars Disc. Cash Bank Date Particulars Disc. Cash Bank
All’d Rec’d
N N N N N N
2/1/X8 Capital - - 80,000 5/1/X8 Purchases - - 27,300
7/1/X8 Bank (contra) - 1.200 - 6/1/x8 Electricity - - 500
7/1/X8 Sales - 480 42,520 6/1/x8 Rent - - 700
9/1/X8 Sales - 17,115 - 7/1/x8 Cash (contra) - - 1,200
10/1/X8 Cash (contra) - - 17,115 8/1/x8 Trade 320 - 15,100
Payables
12/1/X8 Trade 800 - 39,200 9/1/x8 Wages - 500 -
Receivables
15/1/X8 Bank (contra) - 200 - 10/1/x8 Bank (contra) - 17,115 -
20/1/X8 Sales - 37,500 17,000 10/1/x8 Stationery - 50 -
22/1/X8 Sales - - 2,000 15/1/x8 Cash (contra) - - 200
30/1/X8 Cash (contra) - - 10,000 16/1/x8 Repairs - 120 -
31/1/X8 Bank (contra) - 200 - 16/1/x8 Purchases - 20,000 5,000
22/1/x8 Trade 100 - 27,900
Payables
24/1/x8 Rent - - 1,200
24/1/x8 Rates - - 300
24/1/x8 Wages - - 2,000
28/1/x8 Salaries - - 3,600
30/1/x8 Bank (contra) - 10,000 -
31/1/x8 Cash (contra) - - 200
31/1/x8 Balance c/d - 8,910 122,635
800 56,695 207,835 420 56,695 207,835
1/2/X8 Balance b/d - 8,910 122,635
NOTE:
i. The records in sales day book, purchases day hook, returns inwards day book, returns
outwards day hook, journal proper and discounts columns of the three-column cash
book are memoranda records. A memorandum record is one which is not a double-
entry record. This is why the double-entry for the transactions recorded therein must he
completed by making transfers at suitable periodic intervals from these records to the
appropriate ledger accounts.
ii. The bank and cash columns of the cash book are accounts and therefore form part of
the double-entry system. This is a unique feature of the cash book. It is the only
subsidiary book which is part of the double-entry system. It is the reason why transfers
are not required to be made from the bank and cash columns to the ledger.
84
Analytical Cash Book
In the two types of cash book so far discussed, the various amounts received and paid are
respectively debited and credited without being analyzed to show the various sources of
incomes or types of expenditure. In practice, analysis columns, with appropriate headings, are
maintained on either side of the cash book for proper analysis of the amounts received or paid.
Shown below is the format of a typical analytical 3-column cash book. The analysis columns -
which are headed with bold italic typeface just to distinguish them – are used to analyse the
various receipts and payments. Of course, the actual number and headings for these columns
depend on the actual transactions. The ones shown in the format below are merely for
illustration’.
Cash Book
RECEIPTS PAYMENTS
Dat Particul Disc Cash Bank Trade Sale Contr Date Partic Disc Cash Bank Trade Electr Rent Cont
e ars . Receiv s a ulars . Payab icity ra
ables les
N N N N N N N N N N N N N
It must be sated that analytical cash book is rarely tested by the examiner. The examiner has
restricted questions on cash book to the non-analytical one previously covered from page 10 to
13. Despite this fact, I am of the opinion that students need to familiarise themselves with
analytical cash book for the following reasons;
 the examiner could at any time decide to examine it;
 it is the type they would most likely encounter in practice unless they work in a
computerised accounting environment; and
 knowledge of it would make it easier for them to understand the next topic, analytical petty
cash book.
The major advantage of using analytical cash book is that receipts and payments of the same
kind can be accumulated in the appropriate column before posting the total to the appropriate
ledger account. This way, instead of making a posting to the ledger account every instance that
type of receipt or payment occurs, only the total of the column would need to be posted to the
ledger account. For example, if payments were made on ten different occasions for "office
expenses" during a particular month, it would not be necessary to make ten postings to office
expenses account during the month. Rather, only one posting — representing the total of the
85
office expenses column - would be made to that account at the end of the month. As can be
inferred from this example, the use of analytical cash book reduces the number of postings to
the ledger thus enhancing the objective of decongesting the ledger.
Illustration 1.12
Using the facts in illustration 1.11, you are required to draw up the analytical cash book of
Bolanle for the month of January 20X8.
86
Solution to Illustration 1.12
Cash Book
RECEIPTS PAYMENTS
Date Particulars Disc Cash Bank Capita Sales Trade Contra Date Particulars Dis Cash Bank Purchases Elect Rent & Trade Sal. & station Repair Contra
l Receiv c ricity Rates Payables Wages ery s
ables
N N N N N N N N N N N N N N N N N N
2/1/X8 Capital 80,000 80,000 5/1/X8 Purchases 27,300 27,300
7/1/X8 Bank 1,200 1,200 6/1/X8 Electricity 500 500
7/1/X8 Sales 480 42,520 43,000 6/1/X8 Rent 700 700
9/1/X8 Sales 17,115 17,115 7/1/X8 Cash 1,200 1,200
10/1/X8 Cash 17,115 17,115 8/1/X8 T. payables 320 15,100 15,100
12/1/X8 T. Receivables 800 39,200 39,200 9/1/X8 Wages 500 500
15/1/X8 Bank 200 200 10/1/X8 Bank 17,115 17,115
20/1/X8 Sales 37,500 17,000 54,500 10/1/X8 Stationery 50 50
22/1/X8 Sales 2,000 2,000 15/1/X8 Cash 200 200
30/1/X8 Cash 10,000 10,000 16/1/X8 Repairs 120 120
31/1/X8 Bank 200 200 16/1/X8 Purchases 20,000 5,000 25,000
22/1/X8 T. Payables 100 27,900 27,900
24/1/X8 Rent 1,200 1,200
24/1/X8 Rates 300 300
24/1/X8 Wages 2,000 2,000
28/1/X8 Salaries 3,600
30/1/X8 Bank 10,000 10,000
31/1/X8 Cash 200 200
31/1/X8 Bal. c/d 8,910 122,635
800 56,695 207,835 80,000 116,615 39,200 28,715 420 56,695 207,835 52,300 500 2,200 43,000 2,500 50 120 28,715
1/2/X8 Bal. C/d 8,910 122,635
87
TUTORIAL NOTES
(i) The cash book above is similar to the one on page 13 except that analysis columns have been inserted on both sides. These columns
have been shaded merely for tutorial purpose so that students can easily distinguish them and grasp the points being made.
(ii) The use of the analytical cash book helps to reduce the number of postings to ledger accounts in the following way:
Receipts
To complete the double entry for the receipts, only the totals of the analysis columns would be posted to the credit of the appropriate
accounts at the end of January instead of crediting the accounts at the dates of the receipts. Thus N80,000; N116,615;and N39,200 would
be respectively posted to the credit of Capital, Sales and Trade Receivables accounts on 31" January 20X8.
(iii) The totals of the “contra” columns on both sides would not be posted to any ledger account because both cancel each other out in the
cash book.
88
5.2.7 Analytical Petty Cash Book
Where there is are large numbers of small cash payments in the operation of a business,
such transactions may be taken out of the main cash book to a separate cash book known
as petty cash book. The use of a petty cash book has the following advantages;-
1. The handling and recording of small cash payments could be delegated to a junior
staff known as the petty cashier. This saves the main cashier from routine work.
2. Since the petty cash book is maintained on analytical basis, its use ensures that
small payments are not posted to the ledger one-by-one as would be the case if
they were recorded in a non-analytical main cash book. In the petty cash book, an
analysis column is maintained for each expense heading. The total of - rather than
the individual amounts in - each column is transferred to the debit of the
appropriate ledger account at the end of the suitable periodic interval thereby
saving the ledger from too much detail.
The petty cash book is maintained on an imprest basis.
5.3 THE IMPREST SYSTEM

The imprest system is one in which small cash payments are accounted for by giving the
petty cashier an amount known as petty cash float or imprest out of which the petty
cashier makes disbursements, each disbursement being supported with duly
authorised/approved Petty Cash Voucher (PCV) signed by the recipient. The amount of
the petty cash float is determined by management and is given to the petty cashier by the
main cashier or any other appointee of management. The petty cashier retains the original
copy of each PCV while the recipient retains the duplicate. At the end of the specified
period or when the float is almost exhausted - whichever occurs first - the petty cashier
shall apply for reimbursement of an amount equal to the total amount disbursed. He shall
submit the petty cash vouchers as evidence of the cash disbursed. If the main cashier is
satisfied, the reimbursement will be made to the petty cashier thus replenishing or
restoring the float to the original amount out of which the petty cashier begins to make
disbursement all over again. The typical format of a petty cash book is as shown below:-
89
Petty Cash Book
RECEIPTS DATE PARTICU PCV PAYMENTS
LARS No. Total Medical Stationery Transpo Tel. & SFP
rt Postage Item
Expense
s
N N N N N N N
X 1/1/x8 Cash float -
3/1/x8 Drugs for driver X x
4/1/x8 Transport fare X x
8/1/x8 Note books X x
10/1/x8 NITEL Bills X
11/1/x8 Postage stamps X X
13/1/x8 Hospital Bills X x X
20/1/x8 Writing materials X x
24/1/x8 Transport Fare X x
25/1/x8 DHL bill X
27/1/x8 EMS Speedpost X X
28/1/x8 First-aid drugs X x X
29/1/x8 Envelopes X x
30/1/x8 Hospital bills X x
31/1/x8 Mende X x
Enterprises
x x x x X x
X 31/1/x8 Reimbursement
31/1/x8 Balance c/d x
Xx xx
X Balance b/d
NB: The last column for SFP (i.e. Statement of Financial Position) Item is included for petty cash
disbursements which are not in respect of expenses but are, rather, in respect of statement of
financial position items like settlement of liabilities or purchase of non-current assets. For more
on statement of financial position items, including non-current assets, turn to pages 34, 37 and 38.
It must be emphasized that it is not ideal to settle liabilities or purchase non-current assets by
petty cash but once in a while this happens.
90
Illustration 1.13:
The following is. a summary of petty cash transactions of a firm for the month of June 20X7. The
business maintains a petty cash float of N50,000.
N
June 1: Petty cash float given to petty cashier -
June 3: Postages 2,000
June 5: Transport fare 4,500
June 8: Cleaning materials 3,500
June 9: Stationery 1,700
June 14: Petrol for delivery van 8,800
June 16: Taxi fare 3,900
June 20: Postages 1,800
June 21: Disinfectant for cleaning toilet 2,800
June 23: Petrol for general manager’s car 6,600
June 24: Service of delivery van 4,000
June 28: Writing Materials 3,100
June 30: Transport fare 1,200
You are required to rule up a petty cash book with columns for Postages, Transport and
Traveling, Cleaning, Stationery and Motor Expenses and enter the month's transactions entering
the re-imbursement on 30th June 20X7 necessary to restore the imprest.
91
PETTY CASH BOOK
RECEI DATE DETAILS PAYMENTS
PTS Total POSTA Trans Cleani Statio Motor
GES p. & ng nery expens
travel. es
N N N N N N N
50,000 1/6/x7 Cash float -
3/6/x7 Postages 2,000 2,000
5/6/x7 Transport fare 4,500 4,500
8/6/x7 Cleaning 3,500 3,500
materials
9/6/x7 Stationery 1,700 1,700
14/6/x7 Petrol for del. 8,800 8,800
Van
16/6/x7 Taxi fare 3,900 3,900
20/6/x7 Postages 1,800 1,800
21/6/x7 Disinfectant 2,800 2,800
23/6/x7 Petrol for GM’s 6,600 6,600
car
24/6/x7 Service of 4,000 4,000
delivery van
28/6/x7 Writing 3,100 3,100
materials
30/6/x7 Transport fare 1,200 1,200
43,900 3,800 9,600 6,300 4,800 19,400
43,900 30/6/x7 Reimbursement -
30/6/x7 Balance c/d 50,000
93,900 93,900
50,000 1/7/x7 Balance b/d -
The double entry for the disbursements during June 20X7 will be completed by posting the total
of each of the payments columns to the debit of the appropriate ledger accounts. For example,
N3,800 will be debited to postages account, N9,600 will be debited to transport and travelling
account and so on.
92
Balancing of Accounts
Having posted the entries for the period to the accounts, it is necessary to balance the accounts
and carry down the balances, if any, to the next period.
To balance an account, the following steps are required:

(i) Add up the entries on both sides
(ii) Into the side with the lower total, insert the balancing figure to make both sides agree,
describing this balancing figure as "balance carried down" or "balance c/d".
(iii) Now both sides will have the same totals and these should be written on the same line
irrespective of the number of entries on either side.
(iv) Immediately below the total line, the balancing figure should be shown on the side
opposite to that into which it was inserted per step (ii) and now described as
"balance brought down" or "balance b/d".
(v) Where an account has only one entry, it shall be balanced by inserting this amount in the
opposite side as “balance carried down”, Both sides are then closed off with double lines.
Below the double lines, the balance will be shown on the same side as the original entry
and described as "balance brought down".
(vi) Where the totals obtained on both sides per step (i) are equal, this means that the account
has no balance to be carried down. The two totals should be written on both sides on the
same line.
(vii) Where the total on the debit side is higher than the total on the credit side, the account is
said to have a debit balance. Where the opposite is the case, the account is said to have a
credit balance.
Illustration 1.14:
The account of a debtor, U. Oduware, in the books of Mr. ROI had the following entries in the
month of June 20X7:
U. Oduware Account
N N
1/6/X7 Balance b/d 20,000 16/6/X7 Bank 30,000
15/6/X7 Sales 50,000 16/6/X7 Discount allowed 1,500
25/6/X7 Returns inwards 4,500
You are required to balance the account at 30th June 20X7.
93
Solution:
The balance at 30th June will be obtained as follows:
U. Oduware Account
N N
1/6/X7 Balance b/d 20,000 16/6/X7 Bank 30,000
15/6/X7 Sales 50,000 16/6/X7 Discount allowed 1,500
25/6/X7 Returns inwards 4,500
_____ 30/6/X7 Balance c/d 34,000
70,000 70,000
1/7/X7 Balance b/d 34,000

from the above, it can be seen that the account of U. Oduware had a debit balance of N34,000 as
at 30th June 20X7.
Illustration 1.15:
The following entries appeared in the account of a creditor, Razaq, in the month of September
20X8. You are requited to balance the account at 30th September. 20X8:
Razaq Account
N N
10/9/X8 Cash 20,000 2/9/X8 Purchases 100,000
18/9/X8 Returns outwards 7,000
Solution:
Illustration 1.16:
The rent account of Mr. ROI had the following entries in the quarter ended 31st Match 20X8.
Extract the balance as at 31st March 20X8 for the purpose of drawing up the trial balance at that
date:
Rent Account
N N
2/1/X8 Cash 2,000
5/2/X8 Bank 2,000
1/3/X8 Bank 2,000
94
Solution:
After balancing, the rent account will look as follows:
Rent Account
N N
2/1/X8 Cash 2,000 31/3/X8 Balance c/d 6,000
5/2/X8 Bank 2,000
1/3/X8 Bank 2,000 _____
6,000 6,000
The balance on rent account at 31st March 20X8 is a debit balance of N6,000.
Illustration 1.17:
The entries in sales account for the month of August 20X7 were as follows:
Sales Account
N N
8/8/X7 Cash 20,000
19/8/X7 Bank 40,000
You are required to extract the balance on the sales account at 31st August 20X7.
Solution:
The balanced sales account will look as follows:
Sales Account
N N
31/8/X7 Balance c/d 60,000 5/8/X7 Cash 20,000
______ 19/8/X7 Bank 40,000
60,000 60,000
95
Illustration 1.18:
The entry in the Medical expenses account in the month of April 20X6 was as shown below. You
are required to extract the balance at 30th April 20X6.
Medical Expenses
N N
18/4/X6 Bank 5,000
Solution:
The balanced medical expenses will look as shown below:
Medical Expenses Account

N N
18/4/X6 Bank 5,000 30/4/X6 Balance c/d 5,000
This account had a debit balance of N5,000 at 30th April 20X6.
Illustration 1.19:
The commission received account of Mr. ROI had the following entry in the month of May 20X8.
You are required to balance the account at 31st May 20X8.
Commission Received Account
N N
24/5/X8 Cash 4,500
Solution:
The balanced account is as shown below:
Commission Received Account
N N
31/5/X8 Balance c/d 4,500 24/5/X8 Cash 4,500
The commission received account had a credit balance of N4,500 at 31st May 20X8.
96
Net profit is, therefore, the excess of all incomes over all expenses. Conversely, the excess of all
expenses over all incomes is net loss.
As already explained, the incomes and expenses recognised in the statement of profit or loss of a
particular accounting period will rarely be equal to the actual amounts respectively received and
paid during that period. It follows therefore that the net profit reported in the statement of profit or
loss will not be the same as the amount of cash in hand/at bank. Indeed, a firm that reports a net
profit on its statement of profit or loss for a particular accounting year may very well show a bank
overdraft balance - rather than cash at bank - on its statement of financial position as at the end of
the year. Conversely, a firm may show a net loss on its statement of profit or loss but have a
positive balance of cash at bank/in hand on its statement of financial position This point usually
confounds persons who arc not knowledgeable in financial accounting but they should note that
this phenomenon is due to the fact that many of the incomes and expenses in the statement of
profit or loss are recognized in one accounting period while they are actually received and paid in
another period.
97
5.4 SUMMARY
The main reason why source and subsidiary books needed to be kept for accounting was
discussed in this chapter. It made clear the uses of the individual documents and the essence, as it
relates to book keeping.
98
1. Write up the various day books that can be found in the following transactions that exist
in the Books of JONATHAN FURNITURE ENTERPRISES
May, 2 2015: Purchased on credit from OYINLOLA P.

30 tons of ‘A’ type nails @ N1,200 per ton
100 tins of wood polish @ N80 each
50 tins of glue @N150 per tin
160 meters of Rexine @ N20 per meter
May, 4 2015: Sold on credit to ONITOOLO D.

8 wooden chairs @N600 each
6 Cain chairs @N300 each
4 wall clock shelves @1,200 each
A 10% discount is allowed on chairs.
May, 6 2015 JONATHAN returned the following items to OYINLOLA P.

22 meters of Rexine
5 tins of wood polish because the life span has expired.
2. State the advantages of books of Prime entry over ledger accounts.
99
3. HENRY STEPHEN BROTHERS commenced the business on 1/3/2015 with cash at Bank
of N10,000
The following transactions took place during the month.
N
March 1: Bought goods from ISAAC W. 10,000
Purchased Warehouse fitting for cash 1,600
March 2: Sold goods to T. Thornado 3,200
Drew cheque for petty cash 800
March 3: Paid Isaac W. on account 6,000
March 4: Sold Goods to Bayo A 4,000
March 5: Received cheque from T. Thornado 3,080
Allowed him discount 120
March 6: Drew cheque for wages 280
March 8: Bought goods for cash 1,200
March 9: Sold Goods to Baboje D. 6,800
March 10: Purchased Goods from Dada 5,200
March 11: Paid Isaac in settlement 3,800
Discount allowed by him 200
March 12: Paid carriage on goods sold 80
March 14: Bought goods from Isaac W. 6,000
March 16: Sold goods to Bayo A 7,200
March 17: Banjo A Paid on account 8,000
March 18: Purchases goods from Matin 3,000
March 19: Sold goods for cash 3,680
March 20: Drew cheques for wages 280
March 21: Sent cheques to Matin 2,880
Discount allowed by him 120
March 22: Sold goods to T. Thornado 5,200
March 23: Bought goods from Isaac W. 9,600
March 25: Sent cheque to Isaac W 8,000
March 26: Received from T.Thornado on account 4,000
March 28: Paid Electricity bill 200
March 28: Paid Rent 320
March 29: Henry Stephen drew from Bank for private use 600
Required:
Enter the above transactions in the proper books.
100
References
Ajileye J. O. and Adetifa O. Get Your Financial Accounting Right Book 1 & 2. Lagos: De Hadey
Publishers.
Limited.
Nig. Ltd.
Frank, W., & Alan, S. (2008). Business Accounting 1 (IFRS Edition). Harlow: Pearson Education
Limited.
Longe, O. A., & Kazeem, R. A. (2012). Essential Financial Accounting. Ogun: Tonad Publishers
Limited.
Remi, Aborode (2006). A practical approach to advanced Financial Accounting, Master Stroke
consulting.
Olanrewaju, O. O. (2012). IFRS PAL – Handy Approach. Lagos: Dimkem Publications Limited.
101
CHAPTER SIX
ACCOUNTING EQUATION

At the end of this Chapter, candidates are expected to know:
 The meaning and various types of capital
 The importance of Accounting Equations
 The various types of liabilities
 The various types of assets
 The contents of the Financial Statements.
6.1 INTRODUCTION
All Accounting information is recorded within the framework of accounting equation.
Accounting equation merely describes the equation effect of a transaction that fully
recorded on the debit and credit side. As one side is gaining, the side is losing. At any
particular point of an organization, the total of the debit side must equal the total of the
credit side.
The Basic Accounting Equation is ASSETS = CAPITAL (liability to owner) at the
commencement of the business. The cash or other assets invested in a business by the
owner are a form of liability of the business to the owner.
As the business progresses, the owner may obtain goods on credit from suppliers or
borrow additional loan from the bank to finance the business. The value of the goods
supplied and the cash received as loan would increase the asset of the business, while
liabilities to the third parties (not owners) would increase. The Accounting Equation
becomes:
ASSETS = CAPITAL + LIABILITIES
6.2 ITEMS USED IN ACCOUNTING EQUATION/ BALANCE SHEET EQUATION

The accounting equation, ASSETS = CAPITAL + LIABILITY represented the two sides
of a Statement of Financial Position. Assets on one side and capital and liabilities on the
other side. The capital and liabilities are claims against the assets. The net worth of the
business is the capital. The net worth is the original capital plus the profits earned (or less
the losses incurred) during the period less the proprietor’s drawings during the same
period.
102
6.3 STATEMENT OF FINANCIAL POSITIONS ITEMS
6.3.1 Assets
An asset is a resource, tangible or otherwise owned and used by a business entity for the
purpose of generating income. An asset yields future economic benefits to the business
entity which owns or controls it. Assets may be non-current assets or current assets
according new term by International Financial Reporting Standards (IFRS).
6.3.2 Non Current Assets

These are properties of the business which meant to be used and expected to bring benefits
to the business for a period of more than twelve months. They can be tangible and
intangible while the intangible ones are known as non-current assets intangible. Expenses
incurred to bring them to the existence are known as Capital Expenditure.
Example of Non – Current assets Tangible are:
Land and Buildings, freehold premises, Motor Vehicles, Plants & Equipments, Furniture
Example of Non – Current assets intangible includes:

Goodwill, Franchises, Patent Right, cost of training and development, staff research and
development expenditure, advertisement cost lasting for more than twelve months.
Investment is another non – current asset. It exist on its own with intention to recover the
monies value involved and at the same time generates return on it up to the point of
recovering the money value. Examples are: Deposits in bank, shares of company own,
Treasury bill loan stock etc.
6.3.3 Current Assets

These are the economic resources of the business which are easily converted to cash or
can be consumed within an accounting period or operation cycle, whichever is longer. E.g.
cash in hand, cash at bank, debtors and receivables, prepaid expenses and stock of goods
meant for resale.
6.4 LIABILITIES
Liabilities are claims against the assets of the business. Liabilities give rise to creditors.
Some of the liabilities may arise from the use of the services or goods of another person
on credit basis; some other liabilities may arise from financing the organization i.e loan
creditors. They are divided into current and long term liabilities.
6.4.1 Current Liabilities

These are the liabilities of the business that are meant to be paid within twelve months.
Examples of current liabilities are trade creditors (supplier of goods on credit), and other
103
payables such as outstanding bills on electricity, salary and wages, taxation, and bank
overdraft.
6.4.2 Long Term Liabilities

These are liabilities that will take more than one year before repayment is due. They are
long – term loans.
A fully worked example now follows illustrating how final accounts of a sole trader are
drawn up from a trial balance.
The cash or other assets invested in a business by the owner are a form of liability of the
business to the owner. Therefore:
ASSETS = CAPITAL (liability to owner) at the commencement of the business.
As the business progresses, the owner may obtain goods on credit from suppliers or
borrow additional loan from the bank to finance the business. The value of the goods
supplied and the cash received as loan would increase the asset of the business, while
liabilities to the third parties ( not owners) would increase. The Accounting Equation
becomes:
ILLUSTRATION 1
JUMOKE, a proprietor of Jummy Enterprises started business with cash of N100,000.
The accounting Equation becomes:
N100,000 (cash) = N100,000 + 0
Assuming, in addition to the cash invested Jumoke introduced N50,000, borrowed from a
bank into the business. The cash position is now N150,000, made up owner’s capital of N
I00,000 and liability of N50,000 from the bank, and the Accounting Equation becomes:
ASSETS = CAPITAL + LIABILTY
N150,000 (cash) = N100,000 + N50,000
Let us now consider the effect of different transactions on the Assets, Capital and Liability
of a business.
(i) Jummy Enterprises spent N40,000 to rent an office and bought Furniture for
N20,000. She also purchased for cash some textiles materials for resale at the cost
of N60,000.
The Accounting Equation will remain as in Scenario 2 above but the composition
of the assets
Will change thus;
ASSETS = CAPITAL + LIABILITY
Furniture + Invnentory of Goods + Rent + Cash = Capital + Liability
N20,000 + N60,000 + N40,000 + N30,000 = N100,000 + N50,000
104
(ii) If the goods have been purchased on credit the accounting equation would be;
ASSETS = CAPITAL + LIABILTY
Furniture + Inventory + Rent + Cash = Capital + Loan +Supplier
N20,000 + N60,000 + N40,000 + N90,000 = N100,000 + N50,000 + N60,000

Let us now consider the effect of profits and drawings on the owners equity/capital
and the accounting equation.
Profits will increase the owner’s equity/capital while drawings would reduce it.
(iii) Let us refer to situation (ii) above, Jummy Enterprises sold all the textiles materials
for N104,000, making a profit of N44,000 (N104,000 - N60,000). The cash from
the sale would increase cash balance by N104,000, while capital is increased by
N44,000.
ASSETS = Capital + LIABILITY
Furniture + Rent + Cash = Original Capital + Profit + Loan + Supply
N20,000 + N40,000+ N194,000 = N100,000 + N44,000+ N50,000+ N60,000
i.e ASSETS = CAPITAL +LIABILITY
N254,000 = N144,000 + N110,000
(iv) In addition to the information in (iii) above, Jummy withdrew N32,000 cash for
private use. The accounting equation becomes
ASSETS = CAPITAL + LIABILITY
N254,000 – N32,000 = N144,000 - N32,000 + N110,000
N222,000 = N112,000 + N110,000
You would notice that though capital is described as a sort of liability, it is not
described with the word ‘liability’. It is only the amount owed to third parties by
the business that is described as liability. The reason is that in the event that the
business ceases to exist, the liabilities to third parties are settled first from the
business assets.
Illustration Two
Don Enterprises presents to you the following relating to its affairs on 1/1/2014.
N
Motor vehicles 4,500,000
Amount owing to suppliers 795,000
Amount due from buyer of goods 145,000
Owing to the bank 1,000,000
Cash in hand 63,450
Fixtures and fittings 1,312,000
105
You are required to:
i. Calculate the assets of the entity
ii. Calculate the liabilities of the entity
iii. Determine the capital of the entity
SOLUTION
i. Assets are: N
Motor vehicles 4,500,000
Amount due from buyers of goods 145,000
Cash in hand 63,450
Fixtures and fittings 1,312,000
6,020,450
ii. Liabilities are N
Amount owing to suppliers of goods 79,500
Owing to the bank 1,000,000
1,079,500
iii Capital = Assets – Liabilities
Capital = N6,020,450 - N1,079,500 = N4,940,950
106
6.5 SUMMARY
Accounting equations were being discussed in this chapter, and various types of Assets and
liabilities were discussed. It emphasized on the essence and guide the accounting equation
provides whenever financial accounting is being prepared.
107
1. State and discuss the accounting applications of four fundamental accounting concepts
2. Why should business separate the transactions of his business from those of his private
life.
3. Discuss the criteria that make a business a Going Concern
4. Write short notes on the following:
i. Historical concept ii. Going Concern iii. Accrual
iv. Business Entity v. Matching
5. The following is a list of the assets and liabilities of business belonging to Andrew
Enterprises. List the assets and liabilities separately and calculate the capital of Andrew
Enterprise.
N
Inventory of Trade 29,200
Loan from Mr. Tunde 30,000
Machinery and Plant 150,000
Office Equipment 71,200
Unpaid bill for inventory 22,800
Cash at Bank 28,400
Delivery vans 68,000
Account Receivables 28,000
6. ROONEY & Co. supplied the following on 1/1/2015

N
Land 5,000,000
Plant & Machinery 35,000,000
Inventory 127,000
Payables 534,940
Receivables 273,750
Income due not yet paid 84,150
Income received not yet due 27,300
Expenses paid not due 14,210
Expenses due not paid 37,230
15% Deposit in bank 3,000,000
Loan to workers 200,000
Goodwill 100,000
Loan from workers 47,000
Cash at bank current account 275,500
Cash on hand 87,500
108
Motor vehicle 4,100,000
Patent Rights 131,500
Treasury Bills 250,000
Bank overdraft 1,450,000
Balance in savings account of the business 22,000
Franchise 175,000
Shares in Nigeria Breweries Plc 300,000
18% Loan from Finance House 30,000,000
You are required to calculate:
a. The value of:
(i) Assets (ii) Liabilities (iii) Capital
b. What is the value of?
i. Tangible Assets ii. Intangible Assets
c. Classify the assets as follows:
i. Non-Current Assets Tangible
ii. Non–Current Assets Intangible
iii. Investments
iv. Current Assets
d. Separate the Liabilities to:
i. Due within One year
ii. Due after One year
109
References
Publishers.
Limited.
Nig. Ltd.
Limited.
Limited.
consulting.
110
CHAPTER SEVEN
DOUBLE ENTRY SYSTEM

At the end of this chapter, candidates are expected to know:
 The theoretical an importance of book keeping
 Double entry system
 Various classifications of accounts
 The importance and uses of Ledger
7.1 INTRODUCTION
Book-keeping is the act of record keeping. That is, book keeping is the way in which
accountants of business entities keep records or events and business transactions that
occur in their various organizations. There are two different methods of keeping such
records:
i. Theoretical method- known as Theoretical Book Keeping.
ii. The practice method- known as Practical Book Keeping.
The theoretical method of keeping book is the subject of chapter Six and Seven while the
practical book-keeping is discussed in chapter Eight. It is worth knowing that both
theoretical and practical book keeping will lead to the same end result. This is seen in
chapter seven.
When the theoretical book-keeping method is used, accounting records are made from
source documents directly into the main accounting books (known as Ledgers) without
passing such record through the day book.
There are certain essential steps to be taken in order to make the entries involved under the
theoretical book-keeping. These steps are stated as follows;
a. There must be a business transaction. A business transaction is an event that can be
expressed in monetary terms.
b. After the business transaction has been identified and established, the next step is to
identify all the ledger accounts that are involved to enable one record the business
transaction identified.
c. Next step is to identify which of these ledger accounts gives, and which of the ledger
account receives. They are then separately and respectively given the names “giver”
and “receive”.
d. In any situations where ledger account gives and at the same time receives, the amount
given should be netted off against amount received to make the ledger account a net
giver or a net receiver.
e. The next step is to remember the rile of double entries which:-
Debit the ledger account that receives (receive ledger account).
111
Credit the ledger account that gives (giver ledger account).
When the recording involves discounts (allowed or and received) the double entries
says:-
Debit the ledger account that loses (loser ledger account)
Credit the ledger account that gains (gainer ledger account)
The various principles and procedures involved in the double entry record keeping will
be highlighted in examples in this and next chapter.
7.2 CLASSIFICATION OF ACCOUNTS

There are two broad classifications of accounts. These are Personal Accounts and
Impersonal Accounts.
7.2.1 Personal Accounts

Personal accounts are the accounts of persons, natural or corporate, who have business
dealings with the organization. The personal accounts comprise of Receivables’ account,
Payables ‘accounts, Capital accounts, drawings account and Bank account.
7.2.2 Impersonal Accounts

Impersonal accounts are the accounts of non-persons. Impersonal accounts are further sub-
divided into Real accounts and Nominal accounts.
Real Accounts relates to tangible assets such as buildings, motor vehicles, furniture and
Inventory. Nominal accounts relate to revenue/incomes, expenses and intangible assets.
Examples of Nominal accounts are:
7.2.3 Revenue Accounts

o Sales Account
o Commission Received account
o Discount received account
o Interest received account
o Salaries and wages account
7.2.4 Expenses Accounts

o Rent account
o Transport and traveling account
o Printing and stationery account
o Purchases account
o Depreciation account
o Repairs & Maintenance account
112
7.2.5 Intangible Assets Accounts
o Goodwill account
o Patents and Trade Marks account
Illustration 1
On 1st August 2015 Koko Lateef decided to set up a business which would trade under the name
of Koko Enterprises. The following are the transactions of the business for the month of August
2015.
2015 August 1 A cash of N250, 000 was paid into the business by Koko Lateef.
2 A bank account was opened for the business and N200,000 of the cash in
hand was deposited into the bank account opened.
Paid rent of premises by cheque N40,000
5 Bought goods N18,500 and paid by cheque.
9 Bought goods N26,000 on credit from John.
13 Sold goods N2,600 for cash
18 Returned unsatisfactory goods N1,400 to John
21 Paid advertising expenses N900 in cash
25 Received commission N500 in cash
28 Paid the amount owing to John by cheque
28 Koko Lateef withdrew N1,000 from the bank for personal use.
Required:
i. Identify the transactions involved and state the steps involved to record the entries.
ii. Enter the transactions in the books of Koko Enterprises for the month of August 2015.
iii. Balance the accounts opened and bring down the balances.
Cash Account
Date Particulars Amount N Date particular Amount N
1/8/15 capital 250,000 2/8/15 Bank 200,000
13/8/15 Sales 26,000 21/8/15 Advert 900
25/8/15 Commission 500 31/8/15 Bal c/d 52,200
276,500 276,500
1/9/x7 Bal b/d 52,200
113
Bank Account
Date Particulars Amount Date particular Amount
2/8/15 Cash 200,000 3/8/2015 Rent 40,000
5/8/15 Purcahses 18, 500
28/8/15 John 24,600
29/8/15 Drawings 1,000
________ 31/8/15 Bal c/d 115,900
200,000 200,000
1/9/15 Bal b/d 115,900
John (Payable) A/C
18/8/15 Rent Out 1,400 9/3/15 Purcahses 26,000
28/8/15 Bank 24,600 _______
26,000 26,000
Capital Account
31/8/15 Bal c/d 250,000 1/8/15 Cash 250,000
1/9/15 Bal b/d 250,000
Drawing A/c
29/8/15 Bank 1,000 31/8/15 Bal c/d 1,000
1/9/15 Bal b/d 1,000
Rent A/C
3/8/15 Bank 40,000 31/8/15 Bal c/d 40,000
Purchases A/C
5/8/15 Bank 18,500 31/8/15 Bal c/d 44,500
9/8/15 John 26,000 _______
44,400 44,500
1/9/15 Bal b/d 45,500
Advertisement A/C
21/8/15 Cash 900 31/8/15 Bal c/d 900
31/8/15 Bal b/d 900
Sales A/C
31/8/15 Bal c/d 2,600 13/8/15 Cash 2,600
1/9/15 Bal b/d 2,600
114
Return Outwards A/C
31/8/15 Bal c/d 1,400 18/8/15 John 1,400
1/9/15 Bal b/d 1,400
Commission A/C
31/8/15 Bal c/d 500 25/8/15 Cash 500
1/9/15 Bal b/d 500
Illustration 2
2015 June 1 Jejelaye started a business with a capital of N100,000 which was paid
into his business bank account.
3 Purchased goods N40,000 on credit from Ben Ltd, paid rent N2,500 by
cheque.
11 Sold goods N15,000 on credit to Local Stores.
14 Withdrew N2,000 from the bank for office use.
Paid advertising expenses N600 in cash
20 Paid Ben Ltd by cheque N30,000
22 Cash sales was N7,500
27 Jejelaye took N500 cash for his personal use.
Bought fixtures N36, 000 and paid by cheque.
State the transactions and steps involved to record them.
Record the above transactions in the books of Jejelaye, balance the account on 30th June and bring
down the balances.
Cash Account
14/6/x1 Bank 2,000 14/6/x1 Advert 6,000
22/6/x1 Sales 7,500 22/6/x1 Bank 800
27/6/x1 Drawing 500
______ 30/6/x1 Bal c/d 400
9,500 9,500
1/7/x1 Bal b/d 400
Bank Account
1/6/x1 Capital 100,000 3/6/x1 Rent 2,500
22/6/x1 Cash 8,000 14/6/x1Cash 2,000
20/6/x1 Ben Ltd 30,000
______ 30/6/x1 Bal c/d 73,500
108,000 108,00
1/7/x1 Bal b/d 73,500
115
Ben (Payable) Ltd
26/6/x1 Bank 30,000 3/6/x1 Purchases 40,000
30/6/x1 Bal c/d 10,000 _____
40,000 40,000
1/7/x1 Bal b/d 10,000
Local (Receivable) Stores A/C

11/6/x1 Sales 15,000 30/6/x1 Bal c/d 15,000
1/7/x1 Bal b/d 15,000
Fixture Account
27/6/x1 Bank 36,000 30/6/x1 Bal c/d 36,000
1/7/x1 Bal b/d 36,000
Purchases Account
3/6/x1 Ben Ltd 40,000 30/6/x1 Bal c/d 40,000
1/7/x1 Bal b/d 40,000
Rent Account
3/6/x1 Bank 2,500 30/6/x1 Bal c/d 2,500
1/7/x1 Bal b/d 2,500
Advertising Account
14/6/x1 Cash 800 30/6/x1 Bal c/d 800
1/7/x1 Bal b/d 800
Capital Account
30/6/x1 Bal c/d 100,000 1/6/x1 Bank 100,000
1/7/x1 Bal b/d 100,000
Drawing Account
27/6/x1 Cash 500 27/6/x1 Bal c/d 500
1/7/x1 Bal b/d 500
Sales Account
30/6/x1 Bal c/d 22,500 11/6/x1 Local Stores 15,000
_____ 22/6/x1 Cash 7,500
22,500 22,500
1/7/x1 Bal b/d 22,500
116
Illustration 3
Enter these transactions into the books of Yoyo & Sons. Use two column cash book (i.e combine
cash and bank account together in one account in the cash Book). Balance the account at the end
of the period.
Feb 1 Amount introduced to the business by the owner.
Cash N6,000, Cheque N2,000
13 Bought goods on credit from N. Bassey N9,000.
14 Cash sales to date N8,000
18 Pay wages in cash N300
23 Sold goods to KC. More on credit N3,000
24 Received Cheque from K.C. More N1,380
25 Bought motor van for cash N8,000
26 Bought goods on credit from Joko & sons N7,000
27 Bought goods on credit from Mukeke & co N3,000
Mar 1 Paid cash into bank N3,000
6 Paid N. Bassey by cheque N2,000
18 Bought good for cash N5,000
20 Sold goods for cash N6,000
22 Sold goods on credit N1,700 to Baba
23 paid Motor expenses in cash N350
24 Sold goods on credit to Yomi Johnson N10,000
25 Withdrew cash from bank N200 for office use
26 Received cheque from Baba N800
27 Collected cash of N1,000 from K.c more
28 Bought goods paying by cheque N2,000
29 Bought furniture & fittings for N4,500 from Kako & Sons on credit.
Two Column Cash Book

Cash Bank Cash Bank
1/2/x1 Capital 6,000 2,000 18/2/x1 Wages 300 -
14/2/x1 Sales 8,000 - 26/2/x1 Motor Van 8,000 -
24/2/x1 k.C. More - 1,300 1/3/x1 Bank 3,000 -
1/3/x1 Cash - 3,000 6/3/x1 N.Bassey - 2,000
20/3/x1 Sales 6,000 - 18/3/x1 Purchases 5,000 -
25/3/x1 Bank 200 - 23/3/x1 Motor expenses 350 -
26/3/x1 Yomi Johnsons - 7,000 25/3/x1 Cash - 200
26/3/x1 Baba - 800 28/3/x1 Purchases - 2,000
27/3/x1 K.C. More 1,000 =____ 31/3/x1 Bal c/d 4,550 9,980
21,200 14,180 21,200 14,180
1/4/x1 Bal b/d 4,550 9,980
117
N. Bassey (Payable) A/c
6/3/x1 Bank 2,000 13/2/x1 Purchases 9,000
31/3/x1 Bal b/d 7,000 ______
9,000 9,000
1/4/x1 Bal b/d 7,000
Joko & Sons (Payable) A/c

31/3/x1 Bal c/d 7,000 26/3/x1 Purchases 7,000
1/4/x1 Bal b/d 7,000
Mukeke & co (Payable) A/c

31/3/x1 Bal c/d 3,000 273/x1 Purchases 3,000
1/4/x1 Bal b/d 3,000
K.C. (Receivable) More

23/2/x1 Sales 3,000 24/2/x1 Bank 1,380
27/3/x1 Cash 1,000
_____ 27/3/x1 Bal c/d 620
3,000 3,000
1/4/x1 Bal b/d 620
Baba (Receivable) A/C

22/3/x1 Sales 1,700 26/3/x1 Bank 800
____ 31/3/x1 Bal c/d 900
1,700 1,700
Yomi Johnson (Receivable) A/C

24/3/x1 Sales 10,000 26/3/x1 Bank 7,000
____ 31/3/x1 Bal c/d 3,000
10,000 10,000
1/4/x1 Bal b/d 3,000
Motor Van A/C

26/2/x1 Cash 8,000 31/3/x1 Bal c/d 8,000
1/4/x1 Bal b/d 8,000
118
Furniture & Fittings A/C
29/3/x1 Kako & Sons 4,500 31/3/x1 Bal c/d 4,500
1/4/x1 Bal b/d 4,500
Kako & Sons A/C

31/3/x1 Bal c/d 4,500 29/3/x1 Fur. & Fitt 4,500
1/4/x1 Bal b/d 4,500
Capital A/c
31/3/x1 Bal c/d 8,000 1/2/x1 Cash 6,000
_____ 1/2/x1 Bank 2,000
8,000 8,000
1/4/x1 Bal b/d 8,000
Wages A/C
18/2/x1 Cash 300 31/3/x1 Bal c/d 300
1/4/x1 Bal b/d 300
Purchases A/C
13/2/x1 Bassey 9,000 31/3/x1 Bal c/d 26,000
26/2/x1 Joko & Sons 7,000
26/2/x1 Mukeke & Co 3,000
18/3/x1 Cash 5,000
28/3/x1 Bank 2,000 ______
26,000 26,000
1/4/x1 Bal b/d 26,000
Motor Expenses A/C

23/3/x1 Cash 350 31/3/x1 Bal c/d 350
1/4/x1 Bal b/d 350
Sales A/C
31/3/x1 Bal c/d 28,700 14/2/x1 Cash 8,000
23/2/x1 K.C. More 3,000
20/3/x1 Cash 6,000
22/3/x1 Baba 1,700
_____ 24/3/x1 Yomi John 10,000
28,700 28,700
1/4/x1 Bal b/d 28,700
119
7.3 SUMMARY
The double-entry recording process has been outlined from the view point of a merchandising
business which is run by a sole proprietor. Good understanding of the elaborate recording
process of the transactions of a merchandising business entity facilitates the mastery of the
record keeping of other forms of business. The elements of the recording process which are
source documents, and importance and was of ledger were elaborately discussed in this chapter.
120
1. Thomas Dunny started business in September 2015. Record the following transactions in his
books of account in double entry form.
September 1: Started business with personal savings of N200,000 cash and N50,000 loan
from Mr. Earney who issued chequ.
September 2: Paid N180,000 cash from the company cash box to the Bank.
September 5: Bought office fittings on credit from Binney & sons for N8,000
September 8: Bought a motor van for N5,600 paying by cheques
September 12: Bought office equipment for N15,000 on credit from Beta Nig. Coy.
September 15: Withdrew N75,000 from the bank and put in company’s cash till
September 17: Paid Binney & sons N7,500 by cheque while the balance was paid by cash
September 19: Repaid N27,000 cash as part of Loan taken from Mr. Earney
2. The following balances appeared in the books of Biney Nig. Ltd on 01-01-2015
N
Capital 14,850
Bank Loan 4,000
Premises 12,000
Machinery 6,500
Transactions on 1st month of 2007 were as follows:

Additional machinery worth N1250 was purchased on credit from M. Messi
6th : Sales of N375 by cheque made
8th : Part of Bank loan N500 was made by cheque
11th : A cheque of N3500 was received from part of the premises sold
14th : Salaries and wages paid by cheque N425
16th : Sales on credit N150 to Dr. Hashim Isa
22nd : Paid M. Messi the amount owing him by cheque
27th : Insurance premium of N50 by cheque
Required:
Open all the necessary T accounts, record the initial balances first and post the transactions
into the accounts.
3. Write short notes on the following types of Accounts and give 10 examples in each case
i. Nominal Account
ii. Real Account
iii. Personal Account
121
4a. What is Ledger?
4b. State the characteristics of a ledger.
4c. Summarize the principle of double entry in one sentence.
5. State the accounts which the following transactions should affect stating clearly (with
reasons) which account should be debited and those to be credited.
i. Started business money in cash
ii. Paid part of the opening cash into the bank.
iii. Bought goods on credit from Ugwu.
iv. Sold goods on credit to Nkiru.
v. A motor car was sold for cash.
vi. Cash purchases.
vii. Nkiru returned goods to us.
viii. We returned goods Ugwu.
ix. Lovina lent us cash.
x. Received commission in cash.
122
References
Publishers.
Limited.
Nig. Ltd.
Limited.
Limited.
consulting.
123
CHAPTER EIGHT
LEDGER BALANCING AND EXTRACTION OF TRIAL BALANCE

At the end of this chapter candidates are expected to know:
 The meaning and importance of trial balance
 Purpose of trial balance
 Ways of balancing ledgers
 The extraction of trial balance
8.1 INTRODUCTION
Trial balance is a statement showing list of balances in a double entry form extracted from
the ledgers to test the arithmetical accuracy of the accounts. The trial balance is drawn up
at a given date after all the postings have been made in the ledgers. The totals of the debit
and credit must be in agreement.
It is also a list of balances from the ledger accounts arranged in two columns of debit and
credit to ascertain the arithmetical accuracy of the entries in the ledger account. Note that
if the double entry principle has been well applied, then the total of the debit entries must
be equal to the total of the credit entries.
8.2 RULES FOR THE IDENTIFICATION OF BALANCES

a. All assets must be debited
b. All expense must be debited
c. Reduction in capital should be debited
d. Reduction in liability should be debited
e. Reduction in income e.g returns inwards should be debited
f. Abnormal provision should also be debited.
g. Capital must be credited
h. All liabilities must be credited
i. Reduction in fixed assets should be credited
j. Reduction in expenses e.g should be credited
k. Normal provisions should be credited.
8.3 PURPOSE OF TRIAL BALANCE

i. Provides a comprehensive lists of all accounts, therefore, it saves time.
ii. It provides data for the preparation of Trading profit and loss and balance sheet
iii. It shows and test the arithmetical accuracy of the entries in the ledger.
124
8.4 PROCEDURES FOR BALANCING THE LEDGERS AND TRIAL BALANCE
i. Post all debit items
ii. Cast all the items on the debit side.
iii. Post all credit items
iv. Cast all the items on the credit side.
v. Compare the two totals
vi. If the debit side is greater, insert the difference on the credit side.
vii. If the credit side is greater, insert the difference on the debit side.
8.5 NATURE OF TRIAL BALANCE

The format of the trial balance is given below. It has columns for debit and credit entries,
because of the principle of double entry adopted, it must balance.
8.6 TRIAL BALANCE (SAMPLE)

DR (N) CR (N)
Capital xx
Non – current Assets:
Plant and Machinery xx
Freehold premises xx
Equipments xx
Motor Vehicles xx
Furniture and fittings xx
Sales xx
Purchases xx
Rent and rates xx
Wages and salaries xx
Inventory at beginning xx
Advertisement xx
Sundry expenses xx
Cash in hand xx
Cash at Bank xx
Bank overdraft xx
Account Receivables xx
Account Payables xx
Bad debts (written off) xx
Provision for doubtful debts xx
Depreciation:
Motor vehicles xx
Furniture and fittings xx
Carriage outwards xx
Carriage inwards xx
Returns inwards xx
Returns outwards xx
Lightning xx
Discount allowed xx
Discount received xx
Drawings xx
5% Loan __ xx
xxx xxx
125
Illustration 1
Use the balances brought down in illustration 1 of the previous chapter to prepare Trial Balance
for the business of Koko Lateef as at 31st August X 7.
Solution 1
Koko Lateef
Trial Balance as at 31/8/X7
Dr Cr
N N
Cash 52,200 -
Bank 115,900 -
Capital - 250,000
Drawings 1,000 -
Rent 40,000 -
Purchases 44,500 -
Advertisement 900 -
Sales - 2,600
Return outward - 1,400
Commission - 500
254,500 254,500
Illustration 2
Use the balances brought down in illustration 2 of the previous chapter prepare a Trial Balance
for Jejelaye’s business as at 30th June 20X1
Solution 2
Jejelaye
Trial Balance as at 30th June X1
Dr Cr
N N
Cash 400 -
Bank 37,500 -
Ben Ltd - 10,000
Fixtures 36,000 -
Capital - 100,000
Drawings 500 -
Purchases 40,000 -
Rent 2,500
Advertisement 600 -
Sales - 22500
132500 132500
126
Illustration 3
Using the balances brought down in illustration 3 of the previous chapter, you are required to
prepare a trial balance for Yoyo & Sons as at 31st March X1
Solution 3
Yoyo & Sons
Trial Balance for as at 31st March X1
Dr Cr
N N
Cash 4550 -
Bank 9980 -
N. Bassey - 7,000
Joko & Sons - 7,000
Mukeke & Co - 3,000
K.C. Moore 620 -
Baba 900 -
Yomi Johnson 3,000
Motor van 8000 -
Koko & Sons - 4500
Capital - 8,000
Purchases 26,000 -
Wages 300 -
Motor expenses 350 -
Sales - 28700
58200 58200
8.7 EXTENDED TRIAL BALANCE

An extended trial balance is a trial balance which is used to effect adjustments on ledger
balances for the purpose of drawing up the final accounts of an enterprise. The extended
trial balance shows the pre-adjustment balances (as extracted from the ledger accounts
and cash book), the adjustment entries and the post-adjustment (i.e final) balances.
Journals are raised in respect of the end –of-year adjustments and effected in the
adjustment columns of the extended trial balance. The major advantage of an extended
trial balance is that it shows the trial balance from the ledger balances to the final
accounts’ figures.
127
Illustration 4
The following trial balance was extracted from the books of Ocholi Enterprises as at 31st
December 20X9.
N N
st
Capital at 1 January 20X9 45,214
Purchases 388,200
Sales 522,900
Salaries and Wages 33,440
Rent and rates 9,860
Receivables 72,300
Sundry expenses 4,142
Bad debt 1,884
Drawings 9,502
Provision for doubtful debt 3,702
Bank 2,816
Payables 34,308
Cash 334
Inventory 82,124
Motor car (at cost) 7,200
Provision for depreciation on motor car 2,100
Discount received 1,500
Carriage inward 872
Bank interest received 250
Commission received ____________ 2,700
612,674 612,674
Additional Information:
i. Inventory at 31st December 20X9 was valued at N99,356.
ii. Rent prepaid at 31st December 20X9 amounted to N1,600
iii. Depreciation is to be provided on the motor car at the rate of 20% per annum.
iv. Salaries and Wages outstanding at 31st December 20X9 amount to N3,012
v. Commission not yet due but already received at the trial balance date was N400.
vi. Additional bad debt of N1,420 is to be written off.
vii. Bank interest of N50 has fallen due but is yet to be received.
viii. Provision for doubtful debt is to be adjusted to 5% of Receivables’ balance.
ix. Drawings of goods costing N800 and cheques N1,200 by the owner are yet to be recorded.
Using extended trial balance, you are required to prepare:

a Statement of profit or loss for the year ended 31st December 20X9.
b. Statement of financial position as at that date.
128
Solution:
OCHOLI ENTERPRISES
Extended trial balance as at 31st December 20X9
Ledger Balances Adjustments Final Balances
(before adjustments) Statement of Profit or Statement of Financial
Loss Position
N N N N N N N N
Capital at 1st January 20X9 45,214 45,214
Purchases 388,204 (ix) 800 387,400
Sales 522,900 522,900
Salaries and wages 33,440 (iv) 3,012 36,452
Rent and rates 9,860 (ii) 1,600 8,260

Receivables 72,300 (vi) 1,420 70,880
Sundry expenses 4,142 4,142
Bad debt 1,884 (vi) 1,420 3,304
Drawings 9,502 (ix) 2,000 11,502
Provision for doubtful debt 3,702 (viii) 158 3,544
Bank 2,816 (ix) 1,200 1,616
Payables 34,308 34,308
Cash 334 334
Opening Inventory 82,124 - - 82124 - -
Motor car (at cost) 7,200 7,200
Provision for depreciation on motor car 2,100 (iii) 1,440 3,540
Discount received 1,500 1,500
Carriage inward 872 872
Bank interest received 250 (vii) 50 300
Commission received 2,700 (v) 400 2,300
Closing Inventory (Statement of profit or loss) (i) 99,356 99,356
Closing Inventory (Statement of Financial (i) 99,356 99,356
Position)
Prepaid rent (ii) 1,600 1,600
Depreciation (iii) 1,440 1,440
Accrued salaries (iv) 3,012 3,012
Commission received in advance (v) 400 400
Accrued bank interest (vii) 50 50
Decrease in provision for doubtful debt (viii) 158 158
612,674 612,674 109,436 109,436 523,994 626,514 192,538 90,018
129
Explanatory Notes on Extended Trial Balance
(i) The Ledger balances represent the trial balance extracted from the ledger accounts and
cash book before any adjustment is made.
(ii) The adjustments are the entries necessitated by the additional information annexed to the
trial balance. The Roman numerals in brackets refer to the number of the related
additional information to the trial balance. This is done purely for tutorial purpose – to
enable readers follow the trail from the question to the solution. Candidates should not
bother doing the same in examination situations.
(iii) The final balances are the balances after effecting the adjustments on the ledger
balances. The following points should be noted on how the final balances are obtained.
 A debit adjustment entry will increase a ledger debit balance (for example, the
debit adjustment entry of N3,012 in respect of accrued salaries and wages
increased the debit balance on salaries and wages account from N33,440 to a
final debit balance of N36,452).
 A debit adjustment entry will reduce a ledger credit balance (for example, the
debit adjustment entry of N400 in respect of commission received in advance
reduced the credit balance on commission received account from N2,700 to a
final credit balance of N2,300).
 A credit adjustment entry will reduce a debit ledger balance (for example, the
credit adjustment entry of N1,200 in respect of cash withdrawn by the owner
reduced the debit balance on bank account from N2,816 to a final debit balance
of N1,616).
 A credit adjustment entry will increase a credit ledger balance (for example, the
credit adjustment entry of N50 in respect of accrued bank interest increased the
credit balance on bank interest account from N250 to a final credit balance of
N300).
(iv) A final balance is shown under the Statement of profit or loss column or Statement of
financial position column depending on where the item belongs. Thereafter, the figures in the
former column are used to prepare the Statement of profit or loss while the figures in the latter
column are used to prepare the statement of financial position (as shown below). Note that the
figures in the Statement of profit or loss column do not balance. Neither do the figures in the
statement of financial position column. The difference between the debits and credits in these
columns represents the net profit (or loss) for the period as can be confirmed from the following
final accounts. In this case, the difference N102,500.
130
OCHOLI ENTERPRISES
Statement of Profit or Loss for the year ended 31st December 20X9
N N
Sales 522,900
Less: Cost of goods sold
Opening Inventory 82,124
Purchases 387,400
Carriage inwards 872
Cost of goods available for sale 470,396
Closing Inventory (99,356)
371,040
Gross Profit 151,860
Add: Other Incomes
Bank Interest 300
Commission received 2,300
Decrease in provision for doubtful debt 158
4,258
156,118
Less: Administrative Expenses
Salaries and wages 36,452
Sundry expenses 4,142
Bad debt 3,304
Depreciation 1,440
53,598
Net profit 102,520
131
OCHOLI ENTERPRISES
Statement of financial position as at 31st December 20X9

N N N
Non-current assets Cost Acc. Depn. NBV
Motor Car 7,200 3,540 3,600
Current Assets
Inventory 99,356
Receivables 70,880
Less: Provision for doubtful debt 3,544
67,336
Prepaid rent 1,600
Accrued bank interest 50
Cast at bank 1,616
Cash in hand 334
170,292
Current Liabilities
Payables 34,308
Accrued salaries 3,012
Commission received in advance 400
(37,720)
132,572
136,232
Net assets
Financed by
Owner’s Equity
Capital at 1st January 20X9 45,214
Add: Net profit 102,520
147,734
Less: Drawings 11,502
136,232
132
8.8 SUMMARY
This chapter elaborately discussed the meaning and importance of trial balance, and ways of
balancing ledgers and the principles of double entry were also discussed.
133
1. Thomas Dunny started business in September 2015. Record the following transactions in his
books of account in double entry form and extract Trial Balance.
September 1: Started business with personal savings of N200,000 cash and N50,000
==loan from Mr. Earney who issued cheque.
September 2: Paid N180,000 cash from the company cash box to the Bank.
September 5: Bought office fittings on credit from Binney & sons for N8,000
September 8: Bought a motor van for N5,600 paying by cheques
September 12: Bought office equipment for N15,000 on credit from Beta Nig. Coy.
September 15: Withdrew N75,000 from the bank and put in company’s cash till
September 17: Paid Binney & sons N7,500 by cheque while the balance was paid by cash
September 19: Repaid N27,000 cash as part of Loan taken from Mr. Earney
The following balances appeared in the books of Biney Nig. Ltd on 01-01-2014
N
Capital 14,850
Bank Loan 4,000
Premises 12,000
Machinery 6,500
Transactions on 1st month of 2007 were as follows:

Additional machinery worth N1250 was purchased on credit from M. Messi
6th : Sales of N375 by cheque made
8th : Part of Bank loan N500 was made by cheque
11th : A cheque of N3500 was received from part of the premises sold
14th : Salaries and wages paid by cheque N425
16th : Sales on credit N150 to Dr. Hashim Isa
22nd : Paid M. Messi the amount owing him by cheque
27th : Insurance premium of N50 by cheque
Required :
Open all the necessary T accounts, record the initial balances first and post the transactions
into the accounts and extract Trial Balance.
134
2. The following balances extracted from Books of CIPM on 31st December, 2014:
N
Freehold 500,000
Capital 814,450
Trade receivables 287,500
Trade payables 261,500
Furniture and fittings 162,500
Rent 9,500
Electricity 6,750
Provision for bad debts – 1/1/2014 2,880
Office equipments (cost N200,000) 155,500
Inventory 1/1/2014 77,500
General expenses 23,500
Rates 6,250
Cash in hand 1,370
Bank overdraft 44,750
Bank charges 3,730
Purchases 607,500
Sales 740,000
Carriage inwards 3,950
Salaries 17,000
Discount allowed 4,850
You are required to prepare a Trial Balance as at 31st December, 2014
3(a) The purpose of a trial balance is to prove the accuracy of the general ledger accounts of a
business. However, the "balancing" of the debit side and the credit side of a trial balance
does not guarantee that there is no error in the general ledger accounts. Required:
(i) State two uses of a trial balance to an entity.
(ii) State four errors that may lead to difference in trial balance total figures.
(iii) State four errors that may not affect the balancing of a trial balance.
135
(b) The following balances were extracted from the books of Omolorun Ltd as 31 December,
2013:
N
Provision for depreciation 85,000
Administrative expenses 776,000
Accounts payables 585,000
Subscription 15,000
Accounts receivables 125,000
Postage and stationery 40,000
Newspapers & periodicals 35,000
Provision for bad debt 85,000
Property, plant and equipment 925,000
Retained earnings 575,000
Audit fees 85,000
Sales revenue 2,500,000
Cost of sales 800,000
Other income 82,000
Cash and bank balances 882,000
Share capital 375,000
Required:
(i) Using the information above, extract a trial balance of Omolorun Ltd at 31 December,
2013.
(ii) Re-compute the entity's capita! for the period under review using the information below:
Drawings N250,000
Net profit for the year N315,000
136
4. From the following information extracted from the books of Obafemi Martins Plc as at
31" December, 2007, you are to extract the company's Trial balance.
N’000
Ordinary shares 9,600
Plant & equipment 6,500
Transfer to Plant & equipment 3,300
Turnover 35,840
Royalties received 300
Salaries & wages 3,680
Taxes less rebates 85
Goodwill 1,000
Land & Buildings 14,500
Accumulated depreciation - Land & Buildings 3,100
Long-term investment 2,300
Purchases 18,500
Bank overdraft 480
Bank balance and cash 3,086
Share premium 300
Inventory 5,600
Profit or loss 1,271
Interest on bank overdraft 30
Provision for staff pension 390
Uninsured fire loss 176
Income tax b/f 1/1/07 1,800
Interim dividend paid 250
Selling & distribution expenses 2,600
Other payables 440
Motor vehicle 1,800
Bank loan 160
5% Unsecured loan stock 1,500
Accumulated depreciation - Motor vehicle 900
Auditor's remuneration 370
General reserve 210
137
5. (a) Define a trial balance.
(b) Does the agreement of a trial balance indicate the correctness of the entries? Give
reasons.
(c) Kamash has the following balances in his books and has requested your assistance
in preparing a trial balance. Please prepare the trial balance to enable Kamash
prepares his financial statements.
N
Inventory of finished goods, 1st January, 2015 2,520
Inventory of raw materials, 1st January, 2015 3,310
Purchase of raw materials 12,530
Sales 32,000
Rates and insurance 750
Plant and machinery 4,800
Office furniture 1,450
Drawings 3,250
Discount allowed 430
Provision for bad debts 320
Factory wages 3,870
Factory power 1,060
Salaries 2,990
Freehold factory 16,000
Delivery vans 3,000
Capital 1st January, 2015 21,500
General office expenses 1,390
Cash in hand 210
Discount received 290
138
6. Mr. Audu is a cement dealer. On 1 February, 2008, his assets and liabilities were as
follows: N
Motor van 5,000
Shop fittings 4,000
Trade receivables - Mensah 500
Agimeh 600
Inventory Cash 3,000
Trade Payables - Kwanda 2,500
Kwetey 1,200
The following transactions took place during the month: N
February 10 Paid rent 70
15 Paid Kwanda on account 400
20 Goods sold on credit to Agimeh 300
23 Purchased goods on credit from Kwanda 150
24 Purchased from Kwetey on credit 80
25 Paid wages 100
28 Paid sundry expenses 50
All receipts and payments were in cash.
(a) Prepare the opening journal to record the transactions;
(b) Post the transactions in the books; and
(c) Extract a trial balance as at month end.
139
7. Mary Oyo Enterprises
List of balances as at 31 December, 2011
Cash 76,155
Bank 149,835
Capital Motor-vehicles 330,000
9% Treasury bills 90,000
Rent 10,800
Furniture and fittings 21,000
Purchases 57,405
Interest income 1,500
Salary 4,980
15% Debenture 30,000
Carriage outwards 2,100
Insurance 900
Discount allowed 900
Interest on Debenture 225
Bad debts 2,100
Drawings 3,600
Returns inwards 240
Returns outwards 330
Sales 96,570
From the list of balances above, you are required to prepare the trial balance.
140
References
Publishers.
Limited.
Nig. Ltd.
Limited.
Limited.
consulting.
141
CHAPTER NINE
ERRORS, CORRECTION OF ERRORS AND SUSPENCE ACCOUNT

At the end of this chapter candidates are expected to know:
 The various types of errors with meaning
 Classifications of errors
 Procedures for correcting errors
 Know the uses of suspense account
 The use of journals for correcting errors
9.1 INTRODUCTION
Errors are mistakes made in accounting records. The mistakes may be made when
recording the day book (journal), posting into the ledger and when extracting balances. It
should be noted that the mere fact that an account prepared balance up is not automatic
evidence that errors has not been committed because not all errors will affect or stop
account from balancing.
Also note that the main purpose of the trial balance is to show the arithmetical accuracy
of the entries in the ledgers. The two sides must be equal. If the debit side is not equal
with the credit side, then there is an indication of error even some of them may not affect
the trial balance.
9.2 CLASSIFICATION OF ERRORS

Errors are classified into two namely:
i. Errors not affecting the trial balance
ii. Errors affecting the trial balance.
9.3 ERRORS NOT AFFECTING THE TRIAL BALANCE

These categories of errors which do allow the trial balance from balancing i.e. in spite of
the existence of these errors, the trial balance totals will agree. These include the
following:
9.3.1 Error of Omission: This error occurs when a transaction is completely omitted from the
books of accounts; it is also an error whereby a transaction is not recorded to the books of
account. i.e. From the debit and credit sides, both sides of the transactions are omitted.
E.g. Purchase of goods N10,000 from Mariam has been completely omitted from the
books of account.
142
9.3.2 Error of Commission: This error occurs when a wrong amount is entered in a wrong
person’s account within the same class of accounts. E.g. Emeka paid N100, 000 for the
goods he purchased on credit but was erroneously registered into Emeke’s account whom
is a customer.
9.3.3 Error of Original Entry: This error involves picking of wrong figure from the source
document and debiting and crediting such figure. E.g. instead of picking N7, 800, it was
mistakenly written as N8, 700 and still goes through normal double entry of debiting and
crediting. It is also known as errors of transaction.
9.3.4 Error of Principle: This is an error whereby a transaction is entered in the wrong class
of account, i.e. incorrect title in being given to a transaction or account. E.g. An expense
for the repairs of motor vehicle (expense) was recorded in the motor vehicle (assets)
account.
9.3.5 Error of Complete Reversal of Entry: this error occurs when the double entry for a
transaction is reversed; resulting in a situation whereby the account that ought to be
debited is credited and the account that ought to be credited is debited.
9.3.6 Error of Transposition: this is a mistake which involve the changing of the places of
numerals making up of an amount. For example, N2,202 may be wrongly posted as
N2,022; N4,466 may be wrongly posted as N4,664 and so on.
9.3.7 Error of Duplication: this error occurs when the same transaction is recorded more than
once in the books of account. E.g. Payment of cash N6,000 to Musa had been entered
twice in the two accounts.
9.3.8 Compensating Error: this is an error that is cancelled out by another set of errors made
in the same books of account. If the debit item is decreased by a figure and one or more
items is/are increased by the same amount on the credit side, the error will become
compensating. On the other hand, if a credit item is increased, there must be a
corresponding decreased of debit item to make the error compensating.
9.4 PROCEDURES TO BE FOLLOWED WHEN CORRECTING ERRORS

In order to correct errors, the following procedures must be followed:
a. Memorize these:
Assets account Dr. Balance
Income account Cr. Balance
Expenses account Dr. Balance
Sales account Cr. Balance
Purchases account Dr. Balance
Liabilities account Cr. Balance
143
b. Identify the type of error(s) involved.
c. Identify the two accounts involved.
d. Interpretation of errors in the ledger.
e. Finally, prepare journal.
Illustration 1:
Show the ledgers and journal entries necessary to correct the following errors;
a. Sales of Motor van N800,000 had been entered in the sales account.
b. Purchase of goods from Blessing N6,500 was completely omitted from the account.
c. Goods of N7,000 returned by Mallam Zambo has been entered into Mallam Zango
account.
d. Sales were overcast by N3,400 as also were motor expenses.
e. Cash paid to James N4,000 was entered on the credit side of his account and debited
to cash account.
f. Purchase of goods from Olaiya N5,900 has been entered into the account as N9,500
g. Payment of cash N3,200 to Nneka has been entered twice in the two accounts.
The questions above will be used for our illustration and the procedures will be followed.
a. Errors of principle.
i. Motor van and sales accounts
ii. Demonstration in the ledgers
Motor van account

No entry
Sales account
Bank N800,000
Corrections of errors
Dr. : Sales account
Cr. : Motor van account
Sales account
Motor van N800,000
Motor van account

Sales N800,000
144
b. Errors of Omission.
i. Purchases and Blessing accounts
Purchase account
No entry
Blessing account
No entry
Dr. : Purchase account
Cr. : Blessing account
Purchase account
Blessing N6,500
Blessing account
Purchase N6,500
c. Errors of Commission.
i. Mallam Zambo and Mallam Zango accounts
Mallam Zambo account

No entry
Mallam Zango account

Returns inwards N,7000
Dr. : Mallam Zango account
Cr. : Mallam Zambo account
Mallam Zango account

N7,000
Mallam Zambo account

N7,000
145
d. Compensating Errors.
i. Sales accounts and Motor expenses accounts
Sales account
Overcast N3,400
Motor expenses account

Overcast by N3,400
Dr. : Sales account
Cr. : Motor expenses account
Sales account
N3,400
Motor expenses account

N3,400
e. Errors of Complete Reversal Entry.
i. Cash accounts and James accounts
Cash account
James (error) N4,000
James account
Cash (error) N4,000
Dr. : James account – (N4,000 x 2) N8,000
Cr. : Cash account – (N4,000 x 2) N8,000
James account
N8,000
146
Cash account
N8,000
f. Errors of Original Entry.

i. Purchase and Olaiya accounts
Purchase account
Olaiya (error) N9,500
Olaiya account
Purchase (error) N9,500
Dr. : Olaiya account – (N9,500 – N5,900) =N3,600
Cr. : Purchase account – (N9,500 – N5,900) =N3,600
Olaiya account
N3,600
Purchase account
N3,600
g. Errors of Duplication.
i. Abiodun and Cash accounts
Abiodun account
Cash N3,200
Cash (error) N3,200
Cash account
Abiodun N3,200
Abiodun (error) N3,200
Dr. : Abiodun account N3,200
Cr. : Cash account N3,200
147
Abiodun account
Cash N3,200
Cash account
Abiodun N3,200
a. Sales of Motor van N800,000 had been entered in the sales account.
b. Purchase of goods from Blessing N6,500 was completely omitted from the account.
c. Goods of N7,000 returned by Mallam Zambo has been entered into Mallam Zango
account.
d. Sales were overcast by N3,400 as also were motor expenses.
e. Cash paid to James N4,000 was entered on the credit side of his account and debited to
cash account.
f. Purchase of goods from Olaiya N5,900 has been entered into the account as N9,500
g. Payment of cash N3,200 to Nneka has been entered twice in the two accounts.
Journal Dr Cr
N N
Sales account 800,000
Motor van account 800,000
Sales of motor van entered in sales account now corrected
Purchases account 6,500
Blessing account 6,500
Purchase of goods from Blessing now corrected
Mallam Zango 7,000
Mallam Zambo account 7,000
Goods returned by Mallam Zambo mistakenly entered in
Mallam Zango now corrected
Sales account 3,400
Motor Expenses account 3,400
Correction of overcast of sales and motor expenses
James account 4,000
Cash account 4,000
Payment of cash to James mistakenly reversed now
corrected
Olaiya account 3,600
Purchase account 3,600
Correction of error of wrong amount
Nneka account 3,200
Cash account 3,200
Double recording of the same transaction now corrected
148
Illustration 2
The following errors were discovered by you after casting the trial balance and still
agree.
Correct the necessary errors in the journal entries.
a. The purchase of a motor van N50,000 is debited to purchase account.
b. The sales of N865,000 from Chukwu was entered in the books as N856,000.
c. A sales of goods N6,000 to Musa has been completely omitted from the books.
d. A purchase of goods, N45,000 from B. John was entered in error in B. Johnson’s
account.
e. The account is overcast by N2,500 as well as rent account by N500 and the
salaries by N2,000.
f. A receipt of cheque of N15,000 from A. Ajayi was entered on the payment side of
the cash book in error and debited to A. Ajayi Account.
Journal Dr Cr
N N
i. Error of Principle 50,000
Motor van account 50,000
Purchase account
Being purchase of fixed asset debited in error to purchase
account now corrected
ii. Error of Original Entry
Purchases account 9,000
Chukwu account 9,000
Being the mistake of entering in the books now corrected
iii. Error of Omission 6,000
Musa 6,000
Sales account
Being correction of omission of sales invoice from sales
journal now corrected
iv. Error of Commission
B. Johnson account 45,000
B. John account 45,000
Being Purchase entered in wrong personal account now
corrected.
149
Compensating Error
Sales account 2,500
Salaries account 2,000
Rent account 500
Being correction of overcast of N2,500 each in the sales
account and the combination of rent and salaries account which
compensated for each other.
vi. Error of Complete Reversal Entry
Bank account 15,000
Ajayi account 15,000
Being A. Ajayi and credited to the bank in error now corrected.
9.5 ERRORS AFFECTING THE TRIAL BALANCE

These are errors which affect the trial balance i.e. they would cause the trial balance
totals not to agree. They include the following:-
9.5.1 Casting Error

This error occurs when adding up entries in the accounts resulting in undercasting or
overcasting.
9.5.2 Partial Reversal of Entry

This is an error whereby the double entry for a transaction is posted to the same side of
the respective accounts. For example, salaries paid may debited to salaries account but
wrongly debited to the cash book.
9.5.3 Error of Transposition

Where an error or transposition affects only one side of the account, it will affect the trial
balance. For example, a cheque of N6,661 received from a debtor may be correctly
debited to the bank account but wrongly credited to the debtor’s account as N6,616
9.5.4 Over/Under- Statement of opening or closing balances.

Posting the debit or credit entry for a transaction without posting the corresponding
opposite entry. Omission or mis - statement of the balance on an account when extracting
the trial balance.
When there is no agreement between the debit and credit, then a temporary account
called a suspense account. When correcting errors and only one ledger is being debited or
150
credited, a second ledger account need be created to complete the double entry. This
ledger is called suspense account. This is a temporary account created to record the
difference that originates in the books as a result of errors which throw the trial balance
totals out of balance have to be created through suspense account.
Illustration 3
The trial balance of SUCCESS Enterprise showed a difference of N50,000 and this has
been carried to the credit side of a suspense account. Further investigation revealed the
following errors and omissions:
a. Returns inwards books was overstated by N10,000
b. Purchase day book was undercast by N30,000
c. The closing balance of the cash book had a debit of N200,000 instead of N210,000
d. Credit sales of N25,000 to Ade was credited to his personal account.
e. An amount of N50,000 received from Dauda has not been posted to his account
f. Discounts received and allowed of N25, 000 and N10, 000 had not been posted to the
cash book.
g. Goods worth N600 returned to suppliers were entered in his personal account as
N105,000

i. Journalize the errors
ii. Write up the suspense account.
151
Journal Dr Cr
N N
a. Suspense account 10,000
Returns inwards account 10,000
Being correction of overcast of returns inwards now corrected
b. Purchases account 30,000
Suspense account 30,000
Being the undercast of purchase of N30,000 now corrected
c. Suspense account 10,000
Cash book 10,000
Being correction of misposting of figures now corrected
d. Ade account 50,000
Being correction of reversal of entry in Ade account now
corrected.
e. Suspense account 50,000
Dauda account 50,000
Being correction of omission of N50,000 from Dauda account.
f(i). Suspense account 25,000
Discounts received account 25,000
Being correction of omission of discount received from cash book.
f(ii). Discounts Allowed account 10,000
Being correction of omission of discount allowed from cash book.
g. Supplier account 45,000
Being correction of misposting of figures to account.
Suspense account
Returns inwards 10,000 Balance b/d 50,000
Cash book 10,000 Purchases 30,000
Dauda 50,000 Ade 50,000
Discount received 25,000 Discount Allowed 10,000
Supplier 45,000 ---------
140,000 140,000
152
9.6 SUMMARY
This chapter extensively discussed the various types of errors. It distinguished the errors
affecting trial balance from the one not affecting trial balance. It provided the guides to the
necessary double entries required to correct errors in the accounts.
153
1. The trial balance of Nkiru & Sons failed to agree and the difference of N1185 credit was
kept in suspense Account. The following errors were later discovered as follows:
a. A cash payment of N1325 was entered in the cash book as a receipt
b. Sales and purchases account were overcast by N1752 and N1306 respectively.
c. A sales return of N370 was omitted in the books.
d. Bank charges of N187 was recorded in the cash book only
e. The opening balance of debtors account was brought down as N1175 instead of
N11598
f. Proceed of an old motor vehicle amounting to N1351 was posted to sales account.
i. State the name of each of these errors.
ii. Prepare journal entries to effect the necessary corrections.
iii. Prepare the suspense account.
2. The trial Ugwu Enterprises failed to agree. It was discovered that the Credit side exceeded
the Debit side by N1584 and a suspense account was opened. The following errors were
later discovered as the causes of the discrepancies:
i. Motor Van expenses amounting to N1600 was debited to Motor Van.
ii. The total of discount allowed amounting to N560 was posted to the credit of
discount received account.
iii. A sale of goods N640 to Funmi brothers was correctly entered into the Sales book
but not posted to the customer account in the ledger.
iv. Return outwards account was undercast by N60.
v. Goods worth N120 was returned by S.O Charity although the entry was correctly
made in the return inwards books but was not posted to the customer’s account in the
ledger.
vi. A credit sale of goods for N760 was recorded correctly in the sales book but entered
as N616 in the customer’s account.
vii. The purchases day book was overcast by N140.
You are required to correct the above errors and show the suspense account duely
balanced.
154
3. The trail balance of Ararume Enterprises on 31st Dec 20X1 failed to balance and the
difference was posted to a suspense Account. The following were revealed by an
investigation carried out into the books:
i. The total of one page of the sales day book of N965 was carried forward to the next
pageasN695
ii. A sum of N1,640 paid for wages was not posted to wages account from cash book.
iii. A payment of N784 made to Sankara & Co. was posted to the account of Sankaran
Enterprises.
iv. An amount of N360 posted to furniture account was for repairs of furniture.
v. Purchases day book w as overcast by N1,550.
vi. A payment of Nl25 for postages was credited to postages account
vii. Trade creditors account with an opening balance of N1625 was brought forward as
N1,525.
You are required to prepare:
(a) Journal entries to correct the above errors
(b) The suspense account duely balanced.
155
References
Publishers.
Limited.
Nig. Ltd.
Limited.
Limited.
consulting.
156
CHAPTER TEN
PROVISIONS FOR BAD AND DOUBTFUL DEBTS, ACCRUALS,
PREPAYMENTS AND DISCOUNTS
At the end of this chapter Candidates are expected to understand:
 The various types of provision made in account and their treatment
 Reasons for making provisions
 Characteristics of provisions
 The treatment of accruals and prepayments in the account
 Different types of discounts
10.1 INTRODUCTION
The term provision can be defined as the amount set aside in anticipation of future loss of
income or assts. It can also be defined as the amount set aside for the compensation for
loss in the value of asset used up or amount set aside in connection with future
obligations.
10.2 REASONS FOR MAKING PROVISION

i. To ensure that the profit loss over a defined period is neither overstated nor
understated.
ii. To ensure that future financial obligations of the enterprise are anticipated before
it is due and are adequately met when due.
iii. To ensure that adequate charges are made for the fixed asset used in earning profit
in a particular period of time.
iv. To comply with the various accounting principles; for example, accruals,
matching, prudency and fairness.
v. In some specialized organization such as insurance and banking businesses, some
provisions are made in compliance with the laws that set up and guide the
operation of such businesses.
vi. The association to which the organization belong may also dictate the types of
provisions to make thus provision may be made to keep with such directives.
vii. The types of business organization which a particular entity belong (limited
liability company, partnership or sole proprietorship) will also affect the type of
provision which will be made: for example, the companies and Allied Matter Act
2004 specifically requires limited liabilities companies to make certain provisions.
The sole proprietorship and partnership business do not make such provisions.
157
10.3 CHARACTERISTICS OF PROVISIONS
The following are some of the characteristics of provision:-
i. Provisions normally have credit balances unless when provision is made against
the principles of prudency (example of provision made against the principle of
prudency is provision for discount received).
ii. The balance of provision at the end of the financial year normally appears in
statement of financial position (balances sheet) as a deduction from the item on
which the provision in made.
iii. Provision for a specific period is regarded as an expense or as an income to be
deducted from or added to the income statement before arriving at the net profit
for the year.
iv. The amount of provision in the income statement is normally the increase or
decrease of that provision (that is the difference between the opening and closing
balance of provision) will normally be transferred to the income statement as an
expense or as an income.
v. Provisions made are merely estimates, which may be below or above the actual
figure being provided for.
vi. Charges for provisions don not involve movements of cash. This means that
provision charges are non out of pocket expenses.
vii. When any provision made is no longer needed, it will be cancelled out by
transferring it into the income statement.
10.4 TYPES OF PROVISION

Provisions made in financial accounting can be grouped into three categories:
1. Provisions made to ensure that a conservative profit is obtained. These are:-
a. Provision for doubtful debts
b. Provision for bad debts
c. Provision for discount allowed
d. Provision for unrealized profits
2. Provisions made so as to ensure that future financial obligations are anticipated
and met are:
a. Provision for taxation
b. Provision for settlement of any future liability.
3. Provision to compensate for that part of income statement (fixed asset) used in a
particular period to generate income is provision for depreciation.
All the provisions falling under the three categories above are made in line with
the principles of prudency. A fourth category of provision however exist which is
158
made against the principles of prudency that is the provision that anticipates
income. This provision is known as provision for discount received.
10.5 PROVISION FOR DISCOUNT RECEIVED

This type of provision goes against accounting principle of prudency. This type of
provision is not recognized both in theory and practice of accounting. It is possible for an
enterprise to be aware of the fact that it will be entitled to discounts from some of its
suppliers in future. It is however risky to recognize such discounts before they are
actually received because conditions might change and can make such anticipated
discounts to be forfeited. It is therefore not wise to anticipate such income until it is
actually earned. As a result of this, provision for income to be earned is not normally
made in accounting. Each of the three categories of provisions are briefly discussed as
below:-
10.6 PROVISIONS MADE TO ENSURE CONSERVATIVE PROFIT

As earlier stated these provisions are made up of provision for bad debts. Provisions for
doubtful debts (or often combined and known as provisions for bad and doubtful debts),
provision for discount allowed and provisions for unrealized profits.
10.6.1 Provision for bad debt:

This is provision made by the organization in anticipation of bad debts which may arise
in future. As at the end of the financial period, there may be outstanding debtors. The
enterprise may anticipate that part of the outstanding balance of debts will not be received
when due after a particular financial period. It may however not be possible to determine
at that point the exact amount of the expected loss from the expected bad debt. In order
not to push this loss to a financial period different from which it occurred, a provision
would be made to cover the expected bad debt. This type of provision is known as
provision for bad debts.
10.6.2 Provision for doubtful debt:

This is provision made against debts due to be collected by an organization in future
which are considered as uncertain as to whether or not such debts will be collected when
due. The uncertainty may be as a result of past failure of such customer(s) or occurrence
of certain events which raise doubts as to the certainty of collecting the outstanding debts.
159
10.6.3 Provision for bad and doubtful debt:
Provision for bad debt is made against debts which is certain of becoming in future while
provision for doubtful debts is made against a debt which may or may not actually
become bad. As a result of the similarities in name and meaning of the two terms, they
are sometimes combined and known as provision for bad and doubtful debts. If a
provision for doubtful debt is to be created in addition to a provision for bad debt already
created, such provision for doubtful debt will be based on the balance of trade receivables
less provision for bad debt. This is because it is the balance of the remaining receivables
that are doubtful, since a debt already bad can no longer be doubtful.
10.6.4 Provision for discount allowed:

This refers to provision made by an organization in expectation of discounts that will be
given to customers in future. Like the provisions for bad debts and doubtful debts, such
provision is in connection with the discount that will be given to outstanding customers at
the point where the provision is being made. The expected discounts are discounts that
will be given during the financial period coming after the provision is made.
10.6.5 Provision for unrealized profit:

This refers to provision made to ensure that a profit already recognized on an existing
asset not yet sold or changed into cash is excluded from the income statement and
recognized in future period when such asset is sold or changed into cash.
10.6.6 Provisions against future liabilities

These are provisions made against expected future financial obligations. The organization
may have certain liabilities to settle in future and to ensure that the burden is not sudden
in the financial period when payment will be made, a gradual amount may be set aside
from period to period and added together till the time when that obligation will be due.
10.6.7 Provision for usage of non-current tangible assets

It refers to amount set aside for the usage of non-current assets to earn profit in the
organization. This amount is set aside in each financial period and the additions over
defined financial period are referred to as provision for depreciation. (See next chapter).
10.6.8 Provisions for bad debts, doubtful debts and discount allowed
As a result of the accrual concepts, sales income for the period is the addition of cash
sales plus credit sales. These total sales represent income earned from sales in that period.
160
This is the sales shown in the trading account. The gross profit and net profit for the
period are computed with reference to the sales disclosed in trading account.
At the end of the financial period, some of the customers who purchased on credit would
still have their account outstanding as trade receivables. The outstanding debts will be
collected in future financial period. By then part or all of these debts will remain
uncollected or amount collected will be lower than expected debts (because of discount
allowed), as a result, a loss will occur at the point of such collection. This loss however
relates to previous financial period and it will be a misrepresentation if such loss should
be charged against that period when it occurred.
To guide against charging such loss against the period which it does not relates to,
provision for bad debts, doubtful debts and discounts allowed are made as appropriate in
the period in which they relate rather than the period when the bad debt, doubtful debts
and discount allowed are actually experienced by the entity.
10.7 ACCOUNTING POLICIES

When the decision to make provisions against bad debts, doubtful debts and or discounts
is made, there are certain policies the organization has to establish. These include:
- The amount of provisions which are to be made for each period.
- The method of keeping books for the provisions.
The amount of provision to make in relation to these items is determined by the
accountants assisted by the credit control department. They will be guided by their
specific knowledge of the customers especially the past knowledge in relation to the
pattern of payment of the customers.
To enable us know the true ways the customers make payment customers are generally
classified as specific and general debtors.
i. The specific receivables are those that can be separately and individually
identified and their knowledge of credit worthiness is known. The sensible option
when making provision for bad and doubtful debt for any specific receivables is
to make a full provision to cover any portion of such debt that is doubtful. Hence
one hundred percent (100%) provisions are made against specific doubtful debts.
ii. The general receivables are the remaining receivables after the specific
receivables have been taken away from the total receivables. They are generally
those receivables whose pattern of payment is not well known to the organization.
A policy must be established as to the extent of provision to be made to cover bad
and doubtful debts and discounts, which may arise from the general receivables.
In most cases, a percentage is normally established based on the past experience
of the organization. This percentage can be increased or decreased as the situation
161
dictates in future. The other alternative to the use of percentage is to use an
absolute figure which is arrived at using the prevailing situation at the time the
provision is made. The additions of specifics of specific provision and general
provision will give the total provision for a particular period.
Illustration 1
On 31st March 20x3, the amount owing by the customers of Pako Enterprises Ltd. was
N75000. Five customers of the company A.B.C.D and E were owing N130, N100, N405,
N1300 and N960 respectively included in the N7500. The amount due from B.C. and E were
suspected to be doubtful while the debts of A and D are sure of full collection. The firm
policy is to make a 3% provision on general debtors as doubtful debts.
a. State separately the amount of specific and general receivables as at 31/3/20x3
b. State separately the specific and general provision as at 31/3/20x3
c. State total provision for doubtful debts as at 31/3/30x3.
Solution to 1
a. (i) Specific receivables as at 31/2/20x3
These are the additions of the amount owing by the customers whose names are
stated in the question:
N
Customer A 130
Customer B 100
Customer C 405
Customer D 1300
Customer E 960
Total 2895
(ii) General receivables are the difference between the total receivables and the
specific receivables N7500-N 2895 = N 4605
b. (i) Specific provision is the provision to be made on the specific doubtful debt.
These are 100% of all specific doubtful debts which is
100% of debts of B.C and E
100% of (N100 + N405 + N960)
100% of N1465 = N1465
(ii) General provision is 3% of the general receivables
This is 3/100 x 4605 = N138
c. Total provision for doubtful debts = specific + general provision
= N 1465+N138 = N1603
162
10.8 BOOK-KEEPING
The normal procedure is to keep ledger account for each of the provisions to be
maintained on a continuous basis. For example ledger accounts are separately maintained
for each of the following provision for bad debts, provision for doubtful debts, provision
for discount allowed and provision for discount received (if maintained). In the
alternative, the provision for bad and doubtful debts can be combined together. Another
area of book-keeping in which specific decisions need to be made is how to record the
actual event for which provision is made. Thus decision must be made on how to record
bad debts, bad debts recovered and discounts. The alternatives available in recording
these items are:
i. To send them into profit or loss account without recording them in their
respective provision account.
ii. To send bad debts and bad debts recovered to provision for bad debts account and
discounts to their respective provisions account.
iii. To send bad debts and bad debts recovered to provisions for doubtful debt
account and the discounts to their respective provisions account.
iv. Any other alternative specified.
In maintaining each of the provision accounts, the principle to adopt is to know the
opening and closing provisions in the respective account. The opening provision is
brought forward on the credit side of the ledger account before the total line while the
closing provision is carried to the debt side of the ledger account before the total line and
brought forward to the credit side of the ledger account below the total line. The balance
of the provision account (whether or not any specific items are recorded in the provision
account) is then transferred into the income statement, the closing balance is shown in the
statement of financial position as a deduction from the item on which the provision is
made.
If this principle is used whichever of the alternatives i-iv stated above is adopted the
conclusions produce will be the same.
The recording of provisions may be made along with other transactions when keeping the
books or provisions may only be considered as part of the adjustments to make when
preparing the final accounts of the enterprise. If ledger accounts are kept, the opening and
closing provisions should be established and carried forward as earlier indicated. After all
other entries in the provision accounts have been made, the balancing figure will be
transferred into the income statement while the closing provision (being the one made
against the future occurrence of the perceived event) will be shown in the statement of
financial position.
163
On the other hand, if provision is treated as an adjustment when preparing the final
accounts of the enterprise, the opening provision will be included in the trial balance or
lists of balances and this will either be increased or decreased. The increase or decrease
will be transferred to income statement while the closing balance taken to statement of
financial position.
Illustration 2
Mayo, Kudi and Rita partnership business makes account to 31st March annually. The
decision to establish provisions was made on 1st April 20x0 and the following policies
were established.
i. To make provision for bad debts equals to 2% of receivables.
ii. Provision for doubtful debts 5% of receivables less provision for bad debts.
iii. Provision for discount allowed for the first three years were N270, N540 and
N370 respectively.
iv. Provision for discount received 2½% of trade payables.
On 31st March of each of the following year the balances of receivables and payables
ledgers were as given.
31/3/20x1 31/3/20x2 31/3/20x3
Years ended N N N
Trade receivables 11,426 1,588 10,637
Trade payables 7,639 9,421 6,800
Bad debts 410 372 205
Bad debts recovered 60 69 55
Discount allowed 203 186 410
Discount received 87 94 110
You are required to prepare for each year

a. The necessary provision accounts on the assumption that bad debts, bad debt
recovered and discounts are directly written to the income statement.
b. Show the abridge income statement and statement of financial position of each year.
164
Solution to 2
(a) Provision for Bad Debts Account
31/3/20x1 Balance c/d 229 13/3/20x1 Income statement 229
-______ -____
229 229
31/3/20x2 Balance c/d 316 1/4/20x1 Balance b/d 229
______ 31/3/20x2 Income statement 87__
316__ 316
31/3/20x3 Income statement 103 1/4/20x2 Balance b/d 316
31/3/20x3 Balance c/d 213 _____
316 316
1/4/20x3 Balance b/d 213
Provision for Doubtful Debt Account

560 560
31/3/20x2 Balance c/d 774 1/4/20x1 Balance b/d 560
______ 31/3/20x2 Income statement 214
774 774
31/3/20x3 Balance c/d 521 _____
774 774
Provision for Discount Allowed Account

270 270
540 540
31/3/20x2 Balance c/d 370 _____
540 540
165
Provision for Discount Received Account
31/3/20x1 Balance c/d 191 13/3/20x1 Balance c/d 191
191 191
31/3/20x2 Income statement 45 31/3/20x2 Balance c/d 236
236 236
1/4/20x2 Balance b/d 236 31/3/20x3 Income statement 66
______ 31/3/20x3 Balance c/d 170
236 236
Abridge Profit or Loss Account for Year Ended 31/3/30x1

Bad debts 410 Bad debts recovered 60
Discount allowed 203 Discount recovered 87
Provision for bad debts 229 Provision for discount received 191
Provision for doubtful debts 560
Provision for discount allowed 270
Abridge Statement Financial Position as at 31/3/20x1

Non Current Tangible Assets
Current liabilities Current Assets
Payables 7,639 Receivables 11,246
Less provision for discount 191 7,448 Less provision for bad debts (229)
received
Less provision for doubtful debts (560)
Less provision for discount allowed (270)
10,367
Abridged Income Statement (Profit or Loss Account) for Year Ended 31/3/20x2
Bad debts 372 Bad debts received 69
Discount allowed 186 Discount received 94
Provision for bad debts (increase) 87 Provision for discount received 45
Provision for doubtful debts (increase) 214
Provision for discount allowed (increase) 270
166
Abridged Income Statement of Financial Position as at 31/3/20x2
current Liabilities Current Assets
Payables 9421 Receivables 15,788
Less provision for disc.rec. (236) 9,185 Less provision for bad 316
debt
31/3/20x2 Less provision for 774
doubtful debt
Less provision for disc. 540 (1,630) 14,158
All.
Abridged Income Statement for Year Ended 31/3/20x3

Bad debts 205 Bad debt recovered 55
Discount allowed 410 Discount received 110
Provision for discount received 66 Provision for doubtful debt (decease) 253
Provision for discount allowed (decrease) 170
Provision for bad debt (decease) 103
Abridged Statement of Financial Position (Balance Sheet) as at 31/3/20x3

Non current Assets
Current Liabilities Current Assets
Payables 6,800 Receivables 10,637
Less provision for disc. (170) 6630 Less provision for bad debts 214
Rec.
Provision for doubtful debt 521
Provision for discount 410 (1,144) 9,493
allowed
Workings
1. Provision for bad debts
2/100 x 11426 = N229
2. Provision for doubtful debts:

Receivables balance 11,426
Less provision for bad debts 229
11,197
5/100x 11197 = N560
167
3. Provision for discount received
2½ x 7.639 = N191
100
2/100 x 15,788 = N316
5. Provision for doubtful debts
Receivables balance 15,788
15,472
5/100 x 15,472= N774
2/100 x 10,637= N213
7. Provision for doubtful debts
Receivable’s balance 10,637
10,424
5/100 x 10,424= N521
8. Provision for discount received
2½ x 6.800 = N170
100
Illustration 4
Musheshe enterprises makes account to 31st March annually. The decision to establish provisions
was made on 1st April 20x0 and the following policies were established.
i. To make provision for bad debts equals to 2% of debtors.
ii. Provision for doubtful debts 5% of receivables less provision for bad debts.
iii. Provision for discount allowed for the first three years were N270, N540 and N370.
On 31st March of each of the following year the balances of debtors and creditors ledgers were as
given below:-
31/3/20x1 31/3/20x2 31/3/20x3
Year ended N N N
Trade receivables 11,426 1,588 10,637
Trade payables 7,639 9,421 6,800
Bad debts 410 372 205
Bad debts recovered 60 69 55
Discount allowed 203 186 410
Discount received 87 94 110
168
a. You are required to prepare for each year the necessary provision accounts on the
assumption that bad debts and bad debts recovered are written into provision for bad
debts account and the discounts are written into their respective provisions accounts.
b. Show the abridged income statement and statement of financial position of each year.
Solution to 4
a. Provision for bad debts account
31/3/20x2 Bad debts 410 31/3/20x1 Bad debts recovered 60
31/3/20x2 Bal.c/d 229 31/3/20x1 Income statement 579
639 639
31/3/20x Bad debts 372 1/4/20x1 Bal. b/d 229
Bal. c/d 316 31/3/20x2 Bad debts recovered 69
_______ 31/3/20x2 Income statement 390
688 688
31/3/20x3 Bad debts 205 1/4/20x2 Bal. b/d 316
Bal. c/d 213 31/3/20x3 Bad debt recovered 55
______ 31/3/20x3 Income statement 47
418 418
1/4/20x3 Bal. b/d 213
Provision for Doubtful Debt Account

31/3/20X1 Balance c/d 560 31/3/20X1 Income Statement 560
560 560
31/3/20x 2 Balance c/d 774 1/4/20X1 Balance b/d 560
31/3/20X2 Income Statement 214
774 774
31/3/20X3 Income Statement 253 1/4/20X3 Balance b/d 774
31/3/20X3 Balance c/d 521 774
774 1/4/20X3 Balance b/d 521
169
Provision for discount allowed account
31/3/20X1 Discount allowed 203 31/3/20X1 Income Statement 473
Balance c/d 270 ___
473 473
1/4/20X1 Discount allowed 186 1/4/20X1 Balance c/d 270
31/3/20X2 Balance c/d 540 31/3/20x2 Income statement 456
726 726
31/3/20x3 Discount allowed 410 1/4/20x2 Balance b/d 540
Balance c/d 370 31/3/20X2 Income Statement 240
780 780
Provision for discount received account

31/3/20X1 Income statement 278 31/3/20X1 Discount received 87
___ 31/3/20X1 Balance c/d 191
278 278
1/4/20X1 Balance c/d 191 31/3/20x2 Discount received 94
31/3/20X2 Income statement 139 31/3/20x2 Balance c/d 236
330 330
1/4/20x2 Balance b/d 236 3/3/20x3 Discount received 110
31/3/20x3 Income statement 44 31/3/20X3 Balance c/d 170
280 280
b.i A bridged Income Statement for year ended 31/3/20X1

Provision for doubtful bad debts 560
b.ii A bridged Income Statement for year ended 31/3/20X2

Provision for doubtful bad debts 214
b.iii A bridged Income Statement for year ended 31/3/20X3

Provision for doubtful bad debts 240 Provision for discount allowed 44
170
10.9 PREPAID EXPENSES/PREPAYMENTS
These are expenses which are not yet due but have been paid as at the trial balance date.
They are expenses paid for a period after the statement of financial position date. They
can also be regarded as the value of benefits not yet enjoyed but which had been paid for
as at the trial balance date. In the final accounts prepaid expenses shall be treated as
follows;
In the statement of financial position:

Deduct the prepayments from the expenses shown on the trial balance in order to obtain
the expenses incurred.

Show the prepayments under current assets.
10.10 ACCRUED EXPENSES/ACCRUALS

These are expenses due but which are not yet paid as at the statement of financial
position. They are expenses not yet paid for a period ending at the trial balance date.
They can be regarded as the value of benefits already enjoyed but not yet paid for as at
the statement of financial position date. In the final accounts, accruals shall be treated as
follows.
In the statement of profit or loss:
Add the accrued expenses to the expenses shown on the trial balance to obtain the
expenses incurred.

Show the accruals under current liabilities
Methods of Accounting for Accruals and Prepayments
i. The Arithmetic Approach

Under this approach, the items in accruals and prepayments are shown in the income
statement as an additions and deductions without showing the ledger accounts.
ii. The Ledger Approach

Under this approach, specific ledger accounts are opened to deal with each expense and
income in which accruals and prepayment are involved.
171
10.11 SUMMARY
This chapter made the readers understand various provisions made when preparing financial
accounting for the business. It also emphasized on various types of provisions made in the
preparation of an accounts, and their usage.
172
1. The following trial balance was extracted from the books of Semijeje & Co a sole
proprietor on 31st Dec. 20x3.
Dr Cr
N N
Capital 74,053
Purchases &Sales 73,130 105,460
Returns 618 435
Discounts 194 128
Debtors and Creditors 12,642 15,750
Carriage inwards 290 -
Motor Vehicles 16,700 -
Freehold & property 52,000 -
Office Equipment 7,950 -
Salaries 9,750 -
Electricity 380 -
Insurance 290 -
Rates 400 -
Advertisement 925 -
Rental income - 820
Bad debt 247 -
Salaries in arrears - 700
Electricity prepaid 140 -
Commission received - 1,900
Commission received in advance - 450
Rental income due to received 150 -
Cash at Bank 14,530 -
Stock 1/1/20X3 9,000 -___
199,696 199,696
173
The following additional information were given to the trial balance.
(1) Stock on hand on 31st December 20x3 was valued at N1,150
(2) Expenses in arrears were
Advertisement N1,100
Rent N870
Salaries N530
(3) Prepaid Expenses were
Electricity N60
Rates N410
Insurance N405
(4) Incomes due not yet received were
Commission N230
Rental income N108
(5) Income received but not yet due was
Rent Income N420
You are required to prepare for Semijeje & co:
(a) Income Statement (Trading, profit and loss account) for year ended 3 I/I 27x3
(b) Statement of Financial Position (balance sheet) as at 31/12/x3
2. The trial balance of Yaya Ibrahim & Sons 30th April 20x2 was as follows.
Dr Cr
Capital - 50,000
Leasehold premises 13,000 -
Plant and Equipment 11,000 -
Furniture and Fixtures 6,000 -
Motor Van 7,000 -
Stock 1/5/x1 3,700 -
Agency fees received - 390
Commission received - 180
Advertisement 410 -
Lighting and Heating 430 -
Rent 3,900 -
Insurance 1,300 -
Wages and Salaries 1,800 -
Trade Debtors and creditors 1,850 1,770
6% Loan - 2,000
Purchase and Sales 7,600 18,300
Discounts 20 40
Bad Debts 600 -
Drawings 1,000 -
Cash in hand 2,250 -_____
72,680 72,680
174
The following additional information were given:
(1) Stock on 30th April 20X2 was valued at N9600
(2) Unpaid expenses on 30th April 20x2 v.ere insurance N510 and advertisement N380
(3) Expenses paid in advance were lighting & heating N200 and rent N650
(4) An agency fees of M210 was due but not yet received while another agency fees of N130
not yet due has already been received. A commission of N70 relating to the period
commencing from 1st May 20x2 has been received.
(5) The 6% loan was obtained on 1st January 20x2 but the interest on loan was still
outstanding on 30th April 20x2.
(6) After the preparation of accounts a debt ofN55 written off received by cash and another
debt of N1,100 considered to be good became irrecoverable.
(a) Income Statement (Trading profit and loss account) for the year ended 30/4/x2 (b)
Statement of Financial Position (balance sheet) as at that date.
3. Mukeke Enterprises presents you the following list of balances on 31st of March 20X2.
Mukeke Enterprises
List of balance as at 31st March 20X2
N
Sales 184,000
Stock at 1/4/20X1 7,500
Purchases 150.000
Sales Return 1,300
Purchases Return 1,000
Bad Debt 350
Bad Debt Recovered 306
Discount Allowed 180
Discount Received 218
Fixtures & Fittings 33,500
Motor Vehicles 60,050
Insurance 1,300
Rent 3,900
Commission Received 180
Agency Fees Received 390
Advertisement 410
Lighting & Heating 430
Capita! 50,000
Trade Debtors 400
Cash in hand 4,000
Cash in Bank 9,276
10% Loan 36,000
Trade Creditors 7,502
175
The following additional information were given:-
(1) Stock at 3 1 /3/20X2 was valued at N9.600
(2) Unpaid expenses on 31/3/20X2 were insurance N510 and advertisement N380.
(3) Expenses paid in advance were N
Rent 650
(4) An agency fees ofN21 0 was due but not yet received while another agency fees of N130
not yet due has already been received. A commission of N70 relating in the period
commencing from 1st April 20X2 has been received.
(5) The 10% Loan was obtained on 1st January 20X2 but the interest on loan is still
outstanding.
(6) After the preparation of accounts, a debt of N55 written off was recovered by cash and
You are required to prepare:-
(a) A trial balance as at 31/3/20X2
(b) Income statement (trading profit and loss account) for the year ended 31/3/20X2
(c) Statement of financial position (balance sheet) as at 31/3/20X3
176
References
Publishers.
Limited.
Nig. Ltd.
Limited.
Limited.
consulting.
177
CHAPTER ELEVEN
BANK RECONCILIATION

At the end of this chapter candidates are expected to understand:
 The meaning and importance of bank reconciliation
 The importance of Bank Reconciliation Statement.
 Why bank statement does not agree with cash book balance
 How to reconcile bank statement with cash book balance
11.1 BANK RECONCILIATION STATEMENT

This is a statement prepared in order to reconcile the cash book balance (bank column)
with the balance shown in the bank statement received from the bank. The bank
reconciliation will explain the difference in the two balances.
The two balances may not agree at a particular date as a result of the following:
A. Clerical errors: items may be incorrectly recorded by the book-keeper e.g. errors
of transposition- a cheque of N25, 000 entered as N20,500.
B. Entries appearing in the bank statement but not in the cash book e.g.:
(i) Charges by the bank for rendering services to the customer these are, bank
charges, commission on turnover (COT), interest on overdraft and value added
tax (VAT) e.t.c.
(ii) Payment made by the bank on behalf of the customer, e.g. standing order, direct
debits e.t.c.
(iii) Amount received directly by the bank on behalf of customers, e.g. credit transfers,
direct credit, dividend e.t.c.
(iv) Returned cheques or dishonoured cheques.
C. Unpresented Cheques – cheques drawn by the business and paid to the suppliers
(payables) which the suppliers have not yet presented for collection in the bank
and as such were not reflected in the bank statement.
D. Uncredited Cheques or Lodgements – Cheques or cash collected from the

business customers and paid into the bank but which the bank has not yet credited
to the business account.
178
E. Bank Errors – a situation where the bank by act of omission or commission
wrongly credit or debit the business account. This is rare occurrence except in
examination questions.
F. Cashier Error – where deposit is posted to the wrong account.
11.2 STEPS INVOLVED IN CARRYING OUT BANK RECONCILIATION

The following steps should be followed in carrying out bank reconciliation:
1. Carry out a detailed examination and comparison of the cash book (bank column)
and the bank statement to identify each individual cause of difference.
2. Where the differences is due to either reasons (A) or (B) as explained above,
update the cash book with the items omitted from it but shown correctly in the
bank statement. The balances arrived at after this updating is called “Balance as
per adjusted Cash Book”. The cash book should by now show the correct figure
so far as the firm’s account is concerned.
3. Any remaining causes of differences (i.e unpresented cheques, uncredited
cheques, bank errors and wrong deposit e.t.c.) are explained in the bank
reconciliation.(See format below).
11.3 FORMAT OF BANK RECONCILIATION STATEMENT

1. Where there is a favourable balance in the bank statement
N N
Balance as per bank statement xxx
Add: Uncredited cheque xx
Bank error xx xxx
Less: Unpresented cheque xx
Wrong deposit xx (xxx)
Balance as per adjusted cash book xxx
2. Where there is an overdraft in the bank statement

N N
Balance as per bank statement xxx
Add: Unpresented cheque xxx
Wrong deposit xxx xxx
Less: Uncredited cheque xxx

Bank error xxx (xxx)
Balance as per adjusted cash book xxx
179
ILLUSTRATION 1
The following information was obtained from the books of JESU OYINGBO & CO
relating to its cash book and bank statement for the month of September 2009.
The bank statement was received on 5th of October 2009.
i. The closing balance as per cash book was an overdraft of =N=10,200 while the
bank statement showed a credit balance of =N=11,930.
ii. A cash payment of =N=10,120 was recorded in the cash book under the book
column.
iii. A dividend of =N=10,580 was paid directly to the bank.
iv. A credit transfer of =N=23,440 in settlement of a debt by a customer had not
entered in the cash book.
v. A cheque for rates of =N=10,670 for the month was entered in the cash book as
=N=10,760.
vi. Standing order on insurance for =N=10,200 was paid by the bank.
vii. The bank charges for the month was =N=10,140.
viii. A cheque of =N=12,280 received and entered into the cash book was not credited
by the bank until 7th October, 2009.
ix. Cheques drawn by the business amounting to=N=9,870 were paid by the bank
until 6th October, 2009.
x. A cheque of =N=6,880 lodged by JESU Oyingbo & co was credited to Kudi
Oyingbo & co account.
xi. A dishonoured cheque =N=7,230 was not recorded in the cash book.
a. Prepare an adjusted cash book.
b. Statement of bank reconciliation as at 30th September, 2009.
SOLUTION
Adjusted cash book
N N
Dividend received 10,580 Bal b/d 10.200
Credit transfer 23,440 Standing order 10,200
Cash 10,120 Bank charges 10,140
Rates 90 Returned chq 7,230
Bal c/d 6,460
44,230 44,230
Bal b/d 6,460
180
JESU OYINGBO & CO
STATEMENT OF BANK RECONCILIATION AS AT 30TH SEPTEMBER 2009
N N
Balance as adjusted cash book 6,460
Add: Unpresented cheque 9,870
Bank error 6,880 16,750
Less: Uncredited cheque (11,280)

Balance as per adjusted cash book 11,930
ILLUSTRATION 2
YARO Enterprises maintains a business bank account with Zenith Bank PLC, Mushin
branch, Lagos. The bank statement received on 31st July 2005 showed that the business
has overdrawn its account by N113,000 while the cash book shows that the business has a
balance of N88,190 in its favour in the bank.
Subsequent investigation revealed the following:
a. Cheques 01455, X77432, and DD1825 amounting to N134,500, N83,450 and
N63,590 received from customer and deposited in the bank had not been credited.
b. A cheque issued by Yaro enterprises in payment of credit purchases amounting to
N71,000 had not been presented for payment.
c. A cheque credited by the bank in favour of the business for N39,600 was entered
in the cash book as N36,900.
d. Dividend of N16,800 from Koko ltd had been paid direct to the bank.
e. Bank charges for the month appeared in the bank statement as N13,650.
f. Cheque amounting to N27,000 in favour of Yaro &co was credited to the account
of Yaro Enterprises.
g. The opening balance of cash book was undercast by N3,960.

i. Prepare an adjusted cash book.
ii. Statement of bank reconciliation as at 31st July, 2015.
181
SOLUTION
Adjusted cash book
N N
Bal b/d 88,190 Bank charges 13,650
Dividend 16,800 Standing orders 10,200
Receipt undercast 2,700
Undercast of opening bal 3,960
Bal c/d 98,000
111,650 111,650
Bal b/d 98,000
YARO ENTERPRISES
STATEMENT OF BANK RECONCILIATION AS AT 30TH SEPTEMBER 2015
N N
Balance as bank statement (113,000)
Add: Uncredited cheque:
Chq 01455 13,450
Chq X77432 83,450
Chq DD1825 63,590 281,540
168,540
Less: Unpresented cheque 71,000

Amount wrongly added 27,000 (98,000)
Balance as per adjusted cash book 70,540
182
11.4 SUMMARY
This chapter has discussed the reason why it is necessary that bank reconciliation statement be
prepared from time to time. There would usually be a difference between the records of the
bank and the records of the account holder. Some of the causes of this difference may quite
harmless, whilst others may be quite harmful to the interest of the account holder.
183
1. Ogitek Limited’s bank statement showed an overdrawn balance of N124,000 as at 30th

June, 2015 which did not agree with the cash book balance at the same date, on
investigation, you discover that:
a. Bank charges of N350 shown on the bank statement have not been entered in the
cash book.
b. A cheque drawn for N4700 has been entered in error as a receipt.
c. A cheque of N1800 has been returned by the bank marked ‘refer to drawer’ but it has
not been written back in the cash book.
d. The cheques paid to suppliers for N21400, N7000 and N3000 have not yet been
presented to the bank.
e. The last page of the paying – in – book shows a deposit of N154,200 which has not
yet been credited to the account by the bank.
f. The bank has debited a cheque for N7200 in error to the company’s account.
g. The debit side of the cash book was undercast by N1000.

a. Show what adjustments you would make in the cash book.
b. Prepare a bank reconciliation statement as 30th June 2015.
2. The bank statement for the month of March 2007 and the bank column of the cash book
for the same period for the business of Anuoluwa Enterprises are as follows:
184
Date Details Debit Credit Balance
1/3/20X7 Balance b/f - - 156,000cr
4/3/20X7 Standing order Electricity 12400 - 143600cr
7/3/20X7 Cheque No 201 17830 - 125770cr
11/3 20X7 Interest on Investment - 13460 139230cr
13/3/20X7 Receipt from customers - 25,840 165070cr
17/5/20X7 Cheque 203 14856 - 150214cr
20/3/20X7 Cheque 205 18000 - 132214cr
22/3/20X7 Direct Debit 7500 - 124714cr
27/3/20X7 Cheque 2005 15980 - 108734cr
31/3/20X7 Bank Charges 1059 - 107675cr
Cash Book
1/3/20X7 Bal b/f 165,000 4/3/20X7 Yoyo Enterprises 201 17,830
9/3/20X7 Cheque from Affiong 28,540 7/3/20X7 Students Pye Ltd 202 14,100
19/3/20X7 Cheque from Yerima 27,031 9/3/20X7 Niger & Co. 203 14,856
26/3/20X7 Cheuq form Chukwu 14,068 12/3/20X7 Mama Put & Sons 204 23,500
16/3/20X7 Raphel & Co. 205 18,000
19/3/20X7 Lanta & Sons 206 19,580
28/3/20X7 Salaries 207 27,800
_______ 31/3/20X7 Bal c/d 98,973
234,639 234,639
01/04/X7 Bal b/d 98,973
The following additional information are given:

(a) The Opening balance figure is correctly stated in bank statement.
(b) The correct figure for cheque number 206 is Ml 5,980 while the correct value of cheque
from Affiong is N25,840 and
(c) The direct debit in the bank statement was the monthly subscription made on behalf of
Anuoluwa & sons enterprises another customer of the bank.
185
(a) State the items that are required to update a cash book to make it become adjusted cash
book.
(b) Prepare the adjusted cash book for the business of Anuoluwapo Enterprises.
(c) Prepare a bank reconciliation statement as at 31st March 20X7 for Anuoluwapo
Enterprises.
3. Amaka Enterprises maintains a business bank account with Zenith Bank Plc., Alaba
Market Branch Lagos. The Bank Statement received on 3 1st July 20X5 showed that the
business has overdrawn its account by N11,300 while the cash book shows that the
business has a balance ofM8819 in its favour in the bank.
Subsequent investigations revealed the following:

(i) Cheques 01455, X77432, and DD1825 amounting to N13,450, N8,345 and N6359
received from customer and deposited in the bank had not been credited.
(ii) A cheque issued by Amaka Enterprises in payment of credit purchases amounting had not
been presented for payment.
(iii) A cheque credited by the bank in favour of the business for N3960 was entered in the
cash book as N3690)
(iv) Dividend of N1680 from Zoko Ltd had been paid direct to the bank
(v) Bank charges for the month appeared in the bank statement as N1,365
(vi) Cheque amounting to N2700 in favour of Amaka & Co. was credited to the account of
Amaka enterprises
(vii) The opening balance of cash book was undercast by N396
(a) Prepare adjusted cash book
(b) Prepare a bank reconciliation statement as at 31st July 20x5
4. The bank statement of Aishatu & Co for the month of December 20x3 disclosed the
following information.
(a) (i) A payment of N11,350 on behalf of Adiatu & Co another customer of the bank
was entered into the business account
186
(ii) Cheque book and bank charges were N1,385
(iii) Standing order for electricity charged paid by the bank was N6,350
(b) For the same month the following were obtained from the cash book:
(i) The opening balance was wrongly brought down as N13,671 instead of N11,671
(ii) A payment of N13,471 was recorded as N14,371 while a receipt of N1,250 was
recorded under the cash column,
(iii) The balance on 31/12/x3 was N1,613
(c) When the cash book entries were compared with the bank statement entries, the following
were discovered.
(i) Unpresented cheques were N34.850
(ii) Uncredited lodgement were N17,600
(iii) Cheque amounting to N1,135 returned by a supplier for non payment by the bank
had not been written back to the cash book,
(iv) Dishonoured cheque of N3,785 had not been written into the cash book
After the cash book was updated the balance as per adjusted cash book was reconciled with the
balance as per bank statement.
(a) Prepare the adjusted cash book
(b) Prepare the bank reconciliation statement as at 31/12/X3.
187
References
Publishers.
Limited.
Nig. Ltd.
Limited.
Limited.
consulting.
188
CHAPTER TWELVE
PROPERTY, PLANT & EQUIPMENT, DEPRECIATION AND PROVISION FOR
DEPRECIATION AND DISPOSAL

 The meaning and importance of depreciation
 The causes of depreciation
 Reasons for depreciating assets
 Various methods of depreciation
 Meaning of asset disposal.
12.1 INTRODUCTION
The relevant accounting standards dealing with Accounting for Property, Plant and
Equipment and Depreciation was SAS 3 and SAS 9 respectively but IAS 16 has now
thrown more light to the treatment of this. PPE is classified as a non-current asset in the
statement of financial position.
12.2 DEPRECIATION DEFINED

Depreciation is the proportion of the original cost of non-current tangible asset allocated
as an expense against each accounting period throughout the useful life of that asset. It is
the estimated amount used up in each accounting period out of the historical cost of non-
current tangible asset.
IAS 16 has now rendered a precise definition of Depreciation as the systematic allocation
of the depreciable amount of an asset over its useful life.
12.3 BASIC TERMINOLOGIES

There are some basic terminologies that are used in this chapter, these include:
(1) Historical Cost of the Assets: this is the purchase price of the asset plus all expenses
incurred on it up to the point of usage. This will include delivery cost, legal charges,
installation cost and so on.
(2) Estimated Life Span: This is the estimated number of years which the asset will last
before it is out of use. The life span may be expressed in terms of years or in terms of
level of output to be achieved by the asset before becoming out of use.
(3) Residual Value: This is the estimated amount which the asset will fetch the organization
after its life span and its usage is discontinued. This term is also known as salvage value
or trade in value or disposal value or scrap value.
189
(4) Accumulated depreciation: This is the addition of all depreciation charged since the
asset was bought up to the present time. It is also called aggregate depreciation or
provision for depreciation. It represents the estimated amount used up to date out of the
original cost of the asset.
(5) Net Book Value: This is the original cost of the asset minus accumulated depreciation. It
represents the estimated cost of the asset which has not been used up to date. That is the
amount remaining unused out of the original cost of the asset.
(6) Amortization: This is the portion of the original cost of an intangible asset allocated as
an expense against each accounting period throughout the useful life of that asset.
(7) Depletion: This is the portion of the original cost of a wasting asst allocated as an
expense against each accounting period throughout the useful life of that asset.
(8) Depreciation: Is the portion of the original cost of a wasting asset allocated as an
expense against each accounting period throughout the useful life of that asset.
(9) Disposal: Is the term used for the sale of non-current assets.
(10) Acquisition: Is the term used for the purchase of non-current assets.
Note that the term amortization, depletion and depreciation are different names used for
the same thing. For non-current tangible assets it is called depreciation, for intangible and
fictitious assets it is called amortization while it is called depletion for wasting assets.
12.4 CAUSES OF DEPRECIATION

The following are some of the factors that make assets to depreciate:-
i. Wear and tear due to usage
ii. Obsolescence
iii. Passage of time
iv. Superfluity
v. Fluctuation in Exchange Rate
vi. Management Decision
There are certain factors, which are important and are to be used by accountant in the process
of computing depreciation. These factors are:-
(i) Knowing the historical cost of the asset
(ii) Estimating the useful life of the asset
(iii) Estimating the residual value of the asset
(iv) Selecting an appropriate method of depreciation to use and consistently using that
method.
190
12.5 REASONS FOR DEPRECIATING ASSETS
Some of the reasons for depreciating assets are as follows:-
 To obey the accrual concept
 To obey the matching concept
 It helps in producing an income statement which is true and fair and which can then
be compared with the competing firms that may not own its assets but hired them for
use.
 To know the estimated amount of the historical cost of the asset.
 The techniques involve in calculating depreciation require preparation of estimates.
12.6 METHODS OF COMPUTING DEPRECIATION

The following are some methods available in determining the amount by which an asset
has depreciated over a given period of time:-
(a) The straight line method
(b) The reducing balance method
(c) Revaluation method
(d) Sum of years digit method
12.6.1 The straight line method:

This method of depreciating asset charges depreciation on equal basis for each complete
year throughout the life span of the asset. As a result of this, the amount charged in each
complete year as depreciation is equal. The method is also known as fixed installment
method or uniform rate method.
The amount charged as depreciation is calculated as
Cost-Scrap Value
Estimated Life Span
For an incomplete year the depreciation charged is

Cost-Scrap Value x fraction of the year
Estimated Life Span
The second way of calculating depreciation under the straight-line method is

Depreciation rate x cost –scarp values
Where depreciation rate is given as : 1_____ x 100

Life span 1
191
The advantages of this method include its simplicity in terms of usage. It does not
involve complex calculations. One disadvantage of this method is that it makes some
assumptions that are not possible in real life.
12.6.2 The reducing balance method:

This method involves the application of a constant depreciation rate to the declining book
value of the asset at the beginning of each period. The result is that a declining
depreciation charge is obtained as the asset ages. The depreciation is calculated as
follows:-
Depreciation = Net book value X Depreciation rate
The depreciation rate is obtained using this formula
r-1 – n (s/c)
where r = rate
s = estimated scrap value
c = historical cost
n = estimated life span
This method assumes that as the non-current assets get older the benefit derived from
them decreases while maintenance and repair cost incurred on them increase. One
advantage of this method is that the amount charged as depreciation reflects the
performance of the asset in such a way that the early years when the asset is more
productive and aggressive, the bulk of the historical cost are allocated to these periods.
12.6.3 Revaluation method:

The revaluation method of depreciating asset compares the net book value of non-current
asset at the beginning and at the end of the period and establish the difference. This
difference in the value at the beginning and at the end of the period is regarded as
depreciation for that period.
Assumptions of Revaluation Method
(i) Non-current -asset depreciates with time
(ii) Non-current -asset cannot appreciate in value
(iii) Inflation does not affect the value of the asset
The assets are revalued by experts who may have either the technical knowledge of the
nature of the asset or have adequate business experience in the type of organization or
both to enable him accurately determine the current value of the asset.
192
Advantages of Revaluation Method
(i) It is simple to use compared to the other methods
(ii) It produces the most realistic depreciation because of the use of experts in
determining the value of depreciation.
Disadvantages of Revaluation Method
(i) It may be expensive to use this method especially where professional valuers are
involved since they will have to be paid for their services.
(ii) During the period of inflation, there may be no depreciation rather the asset will
appreciate.
12.6.4 Sum of years digit method:

In this method of charging depreciation, each year in the life span of the asset is allocated
a weight, in such a way that the highest weight is allocated to the first year of the life
span of the asset, and all the subsequent years allocated weight in such a way that the
weight between two consecutive years will be a different of one. The weight allocated to
the last year of the estimated life span of the asset is a one unit weight.
In calculating depreciation for each year, the weight of that period will be expressed as a
fraction of the total weight for the life span and used to multiply the amount to be spread
(that is the cost less scrap value). If for example a Milling Machine was acquired on 1st
of January 20X1 for N43.300, the estimated life span of the machine being 8 years at the
end of which it is estimated to be sold for N3,300. The annual depreciation for each of
the eight years life span can be calculated as follows:-
Years Weight Rate
20X1 8 8/36
20X2 7 7/36
20X3 6 6/36
20X4 5 5/36
20X5 4 4/36
20X6 3 3/36
20X7 2 2/36
20X8 1 1/36
Total 36
Depreciation = Rate x (Cost-Scrap Value)
Cost-Scrap Value = 43,300-3,300=40,000
20 X 1 Depreciation = 8/36 x 40,000 = N8,889
20 X 2 Depreciation = 7/36 x 40,000 = N7,778
20 X 3 Depreciation = 6/36 x 40,000 = N6,667 and so on.
193
Depreciation charged using this method maintains the same trend with those calculated
using the reducing balance method. The reason for this is that both methods assume
decline in performance with the age of asset. The weight allocated above is on the
assumption that the productive capacity of the assets are higher in the earlier years. As
result of this, the bulk of the historical cost should be matched against expected high
value of performance which the asset is expected to achieve during these early periods.
Advantage of sum of year digit method
(1) Simplicity in application compared with the reducing balance method
(2) The method allocates historical cost of the asset according to the age of the asset.
However it should be noted that the mere fact that an asset is new in use does not mean
that the intensity of usage will be very high.
For instance in the example given above, the usage of the machine in 20X1may not
necessarily double the usage made in 20X5. Therefore the weight of 8 allocated to 20X1
and the weight of 4 allocated to 20X5 are questionable.
Illustration 1
This example involves computation of annual depreciation using different methods:-
Soyoyo Enterprises acquires a machine for N50,000 on 1st of January 20X0. The
business makes account to 31st March annually. It was estimated that the machine would
be sold for N2,000 after its ten years life span.
A professional valuer put the value of the machine at 31st March of these years as
follows:
Year 20X0 N47,900
20X1 N40,300
20X2 N33,900
20X3 N27,000
20X4 N22,000
(a) State all possible methods that can be used in calculating the depreciation of this
machine.
(b) For each of the methods stated in (a) above, calculate deprecation for each of the
first five years of the life of the asset.
194
Solution 1
(a) The methods of depreciating the asset that can be used include:-
i. Straight line method
ii. Reducing balance method
iii. Revaluation method
iv. Sum of years digit method
(b) (i) The straight line method:-

Annual Depreciation = Cost- Scrap Value
Life Span
OR
Annual Depreciation = Depreciation Rate x Cost-Scrap Value
Using first method
Annual Depreciation = 50,000 – 2,000 = N4,800
10
Year 20X0 Depreciation (3 months only) = 3_ x 4,800 = N1,200
12
N
20x 1 Depreciation 12 months = 4,800
20X 2 Depreciation 12 months = 4,800
Note: It is assumed that depreciation is calculated on pro-data basis. Hence the first
year’s depreciation is based on three months 1st January to 31st March.
12.6.5 Reducing Balance Method:

Depreciation = Rate x Net Book Value at the beginning of period.
Rate = 1 = n s/c
Where N = estimated life span = 10 years
S = estimated scrap value = N2,00
C = historical cost = N50,000
R = 1- 10 2,000
50,000
R = 1- 10 0.05
1-0.7248
= 0.28 or 28%
195
Depreciation for each year is
Year 20 x 0 depreciation 28 x 50,000 x 3 = N3.500
100 12
Year 20 x 1 net book value at beginning of year = 50,000 – 3,500 = N46.500
Depreciation 28 x 46,500 = N13,020
100
Year 20 x 2 net book value at beginning of year = 46,500 – 13,020 = N33.480
Depreciation 28 x 33,480 = N9, 374
100
Year 20 x 3 net book value at beginning of year = 33,480-9,374 = 24, 106
Depreciation 28 x 24,106 = N 6, 750
100
Year 20 x 4 net book value at beginning of year = 24, 106 6.75 = 17,356
Depreciation 28 x 17.356 = N4, 860
100
Revaluation Method: Depreciation value beginning of period – value at end of period.
Year 20 x 0 N 50, 000 – N 47, 900 = N 2, 100
Year 20 x 1 N 47,900 – N 40, 300 = N 7, 600
Year 20 x 2 N 40,300 – N 33, 900 = N 6, 400
Year 20 x 3 N 33, 900- N 27, 000 = N 6, 900
Note: That depreciation in year 20 x 0 is not reduced by the fraction of 3/12 because the
cost of N 50,000 is as at 1st January while the N 17, 900 is as at 31st of March. The
difference of N 2, 100 is the amount of charge for the period of three months (1st January
31st march) and not for a year.
12.6.6 Sum of Years Digit Method:

Depreciation = Weight of the year x (Cost –Scrap Value)
Total Weight Throughout life span
Cost – Scrap Value = N 50,000 – N 2,000 = N 48, 000
Total weight over life span = 1+2+3+4+5+6=7+8+9+10 = 55
196
Weights of each period are as follows:
Years Weight
20 x 0 10
20 x 1 9
20 x 2 8
20 x 3 7
20 x 4 6
20 x 5 5
20 x 6 4
20 x 7 3
20 x 8 2
20 x 9 1
Total weight 55
N
Year
20 x 0 Depreciation = 10 x 48.000 X 3 2.182
55 12
20 x 1 Depreciation = 9 x 48, 000 = 7,856
55
20 x 2 Depreciation = 8 x 48,000 = 6, 982
55
20 x 3 Depreciation = 7 x 48,000 = 6.109
55
20 x 4 Depreciation = 6 x 48,000 = 5.236
55
Illustration 2
This example shows how to calculate depreciation using straight line method and also the two
methods of keeping records for assets and depreciation.
Benue Ltd makes accounts to 31st December annually. The business acquired a generating
machine for N 60,347 on 1st of January 20 x 0 with an estimated life span of 12 years and
estimated scrap value of N 347.
From the information given above, you are required to calculate;
(a) Depreciation for the first three years of the life of the asst using straight line method.
(b) State the methods available in keeping the records for the assets and its depreciation.
(c) Show the ledger accounts using each of the methods mentioned in (b) above.
197
Solution 2
(a) Straight Line Method of Depreciation
Cost-Scrap Value = N 60, 347- 347
Estimated Life Span 12 = N 5,000
Year ended 31/12/20 x 0 Depreciation = N 5,000
Year ended 31/12/ 20 x 1 Depreciation = N 5,000
Year ended 31/12/20x 2 Depreciation = N 5,000
(b) There are two available methods

 The Cost Method
 The Net Book Value Method
The ledger accounts involved in each of these methods are:-
(i) The cost method (the machine account and the provision for depreciation on
machine account).
(ii) The net book value method (the machine account)
ci. Book Keeping Under the Cost Method

Machine Account
N N
1/12/20 x 0 Bank 60,347 31/12/20 x 0 Bal c/d 60,347
1/12/20 x 2 Bal b/d 60,347 31/12/20 x 1 Bal c/d 60,347
1/12/20 x 2 Bal b/d 60, 347 31/12/20 x 2 Bal c/d 60,347
1/12/20 x 3 Bal b/d 60,347
Provision for Depreciation on Machine Account

N N
31/12/20 x 0 Bal c/d 5.000 31/12/20x0 Income Statement 5.000
31/12/20 x 1 Bal c/d 10,000 1/1/20 x 1 Bal b/d 5,000
_____ 31/12/20 x1 Income Statement 5,000
10,000 10,000
31/12/20 x 2 Bal c/d 15000 1/12/20 x 2 Bal b/d 10,000
_____ 31/12/20 x 2 Income Statement 5,000
15,000 15,000
1/12/20 x 3 Bal b/d 15,000
198
ci. Book -Keeping Under Net Book Value method
Machine Account
N N
1/1/20 x 0 Bank 60,347 31/12/20x0 Income Statement 5,000
______ 31/12/ 20 x 0 Bal c/d 55,347
60347 60,347
1/1/20 x 1 Bal b/d 55,347 31/12/20 x 1Income Statement 5, 000
_____ 31/ 12/ 20 x 1 Bal c/d 50,347
55,347 55,347
1/12/20 x 2 Bal b/d 50,347 31/12/20 x 2 Income Statement 5,000
_____ 31/12/20 x 2 Bal c/d 45,347
50347 50,347
1/1/20 x 3 Bal b/d 45,347
199
12.7 SUMMARY
This chapter discussed the necessity for depreciation as well as the methods of calculating
depreciation. It made the readers to understand the assets that would be depreciated. It has
also explained that fixed assets may be disposed off due to the following reasons and form the
disposal may take:
- Sales for cash
- Scraping an asset without being able to sell.
- Trade-m of an old depreciable asset for a new one.
200
1. List and discuss extensively the causes of depreciation.
2. Do you see any sense in depreciation being charged to profit and loss account as an
expense despite that no cash outflow like rent, salaries etc) justify your stand.
3. A Motor Van costs N25,000. It’s estimated useful life is 4 years after which it will be
sold for scrap N400.
Calculate the depreciation for each year using:
(i) The reducing balance method
(ii) Straight line method
(iii) Sum of the digits method
4. Michael Enterprises provides for depreciation on straight line method while Nkechi &
Sons provides on reducing balance method on motor vehicle at 10%. Coincidentally,
they both have the same following transactions.
Jan. 1, 2010, motor vehicle a/c stood @ N100,000 and provision for depreciation only on
any asset that is used for 12 months in a year.
Required
Show the relevant Ledger Accounts for the year ended 31/12/13 in the books of both
companies separately.
5.
(a) List 7 fixed assets that depreciate in value.
(b) List 3 fixed assets that do not depreciate in value but rather appreciate in value.
(c) List 2 assets that cannot be practically depreciated due to their nature.
201
References
Publishers.
Limited.
Nig. Ltd.
Limited.
Limited.
consulting.
202
CHAPTER THIRTEEN
CONTROL ACCOUNTS

 The meaning and uses of control accounts
 The advantages of control accounts
 Sources of information for control accounts
13.1 INTRODUCTION
In a small organization, it may be possible for one person to maintain all the ledger
accounts. Where a business maintains a large number of accounts it will become
necessary to divide the ledger into sections and to assign the recording of each section to
different persons. The main areas to which such ledgers can be divided are in the
subsidiary ledger, debtors ledger and creditors ledger; the general ledger. In very large
organizations the sub-division may further be divided among employees.
13.2 THE NATURE AND FUNCTIONS OF CONTROL ACCOUNTS

A control account is an account, the balance of which reflects the aggregate balances of
many related subsidiary accounts which are part of the double entry system. It is a
memorandum record only, it does not form part of the double entry system but it is kept
using double entry principle. Control accounts can be kept in respect of customers (sales
ledger) accounts, suppliers (bought ledger) accounts and expenses.
Control accounts are maintained to facilitate easy detection of errors because they act as a
check on the entries in the various ledgers. Where the trial balance totals are not equal,
balances in each ledger can be added together and compared with the balance in
respective control accounts. Ordinarily the two should be equal, where there is difference,
such ledger that fails to reconcile with the control account will be investigated rather than
all the ledger accounts.
Control accounts are also called self-balancing ledgers because the total debtors and total
creditors balances in the general ledger should be equal to the aggregate of the balances
in the respective individual accounts in the subsidiary ledger.
203
Merits of Control Accounts
 They can be used to locate errors more easily.
 They make it difficult to commit fraud because they are normally under the control of
responsible officers and their preparation is separate from the clerks who maintain the
individual ledger accounts.
 They provide information about the total debtors and total creditors thereby making
management of the debtors and creditors account easy.
 They allow for account set – off
13.3 SOURCES OF INFORMATION FOR CONTROL ACCOUNTS

Information recorded in control accounts are obtained from:
 Debtors and creditors accounts
 Returns inwards and outwards accounts
 Bills payable and receivable accounts
 Dishonoured cheques
 Cash paid to creditors and cash received from debtors (obtained from the cash book)
 Discount received and discount allowed accounts
 Sales day book and purchases day book
13.4 ACCOUNT RECEIVABLES OR SALES LEDGER ACCOUNT

Sales Ledger Control Account is the Account containing the summary of all receivables’
or customers’ accounts. What is posted to the debit side of this account is the aggregate
of all the items recorded on the debit side of receivable accounts. The same thing applies
to the credit side of the account.
Summary of entries
(i) Debit – Credit sales from sales day book
- Dishonoured cheques from customers
- Debit notes issued
Credits: (a) cash received from receivables as recorded

(b) Discount allowed as recorded in the cashbook
© Set off between sales ledger control and purchases ledger
Control account
(d) Bad debts written off
(e) Returns inwards as recorded in sales return day book.
204
13.5 ACCOUNT PAYABLES OR PURCHASES LEDGER CONTROL ACCOUNT
This is the account containing the summary of all the accounts of the payables or
suppliers in the purchases ledger.
Summary of entries in Purchases Ledger Control Accounts

Debit Entries
(a) Payment to customers obtained from the cash book
(b) Returns outwards
(c) Cheques paid to suppliers from the cash book
(d) Discount received from the memorandum column on the credit side of the
(e) Cash book
(f) Credit notes
(g) Transfer between sales ledger control and purchases ledger control accounts.
Credit entries
(a) Credit purchases obtained from the purchases day book
(b) Cash refund from suppliers
(c) Dishonored bills payable
NOTES
Cash sales refund not be debited to the sales ledger control account also not be credited to
purchases ledger control account.
Illustration 1
The book-keeper in charge of the Ledger makes his accounts total N113, 712 while the
clerk in charge of the B Ledger makes his Ledger balances total N16, 812.
Draw up the two Control Accounts and draw any conclusion you can from them.
A B
N N
Jan 1 Balances on Creditors (Credit side) 18,400 13,600
Jan 1 Balances on Creditors Ledger (debit side) 150 184
Jan 1 – 31 Purchases 114,512 17,372
Jan 1 – 31 Returns 11,000 1,625
Jan 1 – 31 Sundry charges by suppliers 1,200 144
Jan 1 – 31 Cheques paid to suppliers 17,980 13,420
Jan 1 – 31 Discount received from suppliers 1,420 1,180
Jan 31 Balances carried down to debit side 150 132
205
Solution 1
AJI FATHER ENTERPRISES
PAYABLES LEDGER CONTROL ACCOUNT A
2006 N 2006 N
Jan Balance b/d 150 Jan 1 Balance b/d 18,400
1 – 31 Returns 11,000 1 – 31 Purchases 114,512
1 – 31 Bank 17,980 1 – 31 Sundry charges 1,200
1 – 31 Disc. Received 1,420 31 Balance c/d 150
31 Balance c/d 113,712 _________
134,262 134,262
Feb 1 Balance b/d 150 Feb 1 Balance b/d 113,712
PAYABLES’ LEDGER CONTROL ACCOUNT B.

2006
N N
Jan Balance b/d 184 Jan 1 Balance b/d 13,600
1 – 31 Bank 13,420 1 – 31 Purchases 17,372
1 – 31 Disc. Received 1,180 1 – 31 Sundry charges 144
1 – 31 Returns 1,652 31 Balance c/d 132
1 – 31 Balance c/d 14,812 _________
31,248 31,248
Feb 1 Balance b/d 132 Feb 1 Balance b/d 14,812
The Control Accounts reveal that there is a difference of N2,000 between the Control
Account for the B Ledger (N16,812 – N14,812) which is the total discovered by the book
keeper in charge of that Ledger. The A Ledger seems to be correct. The obvious solution
is to check the Ledger entries in the B Ledger very carefully.
Illustration 2
Receivables Statements or Statements of Account
Receivables statements are documents sent periodically, usually once a month, by a seller
to his customers showing the position of their accounts up to a certain date. Each
statement gives the particulars of the invoices, debit notes and credit notes that the seller
has sent to the customer during a month, payment made and how much the customer
owes the seller and when the amount will be due for payment. The statement is often a
copy of the customer’s account in the seller’s books.
206
Illustration 3
The following transaction took place between Sisi Eko Enterprises of 2, Balinga Street,
Lagos and her customer Ambrose & Co of 10 Dennis Avenue, Ikeja in January 20x 1.
2nd Jan 20x1 Invoiced goods worth N23,120 on invoice number 426
9th Jan 20x1 Invoiced goods worth N16, 240 on invoice number 489
16th Jan. 20x1 Ambrose & Co paid a sum of N25,140 with cheques
22nd Jan. 20x1 invoiced goods worth N52,910 on invoice number 563
25th Jan. 20x1 Credit note number 1326 for N6,000 was sent
Required:
Prepare a Receivables Statement to show these transactions.
Solution 3
SISI EKO Enterprises
2, Balinga Street, Lagos.
Date of Details Invoice/ Debits Credits Balances
Invoice Credit
January Note No N N N
2nd Goods 426 23,120 23,120
th
9 Goods 489 16,240 39,360
16th Payment Cheque 25,140 14,220
nd
22 Goods 563 52,910 67,130
25th Credit note 1326 6,000 61,130
Amount due on 31st January 61,130
Cash discount terms: 5% for payment within 15days.
207
13.6 SUMMARY
The readers would by now have realized that a control account is a control tool, in that if use,
helps to check the accuracy of the entries in the individual accounts on the ledger to which it
relates. However, a control accounts suffers the same disability that the trial-balance
208
1. Extracts from the books of JK Ltd shows the following balances for the month of June 20x6
N
st
Sales ledger balances – 1 June 20x6 4,702
st
Purchases ledger balances – 1 June 20x6 2,757
th
Sales Journal balances – 30 June 20x6 37,437
Purchases Journal balances – 3oth June 20x6 40,800
Returns Inwards 910
Returns Outwards 749
Receipts from Customers – Cash 38, 529
Payment to Customers 35,415
Bad debt written off 115
Sales ledger set off 209
Purchases ledger set off 110
th
On 30 June 20x6, It was discovered that a supplier was paid twice in error for N157. The
amount was refund on that date.
You are required to determine the sales and purchases ledger balances at 1st July 20x6.
2. Given the following figures, prepare the sales ledger control account. Opening balance;
Debit N6100 Opening balance Credit N215; Credit sales N61450: Dishonoured cheque
N1300; Cash received N25460 Cheque received N28300; Discount allowed N215, Bad
Debts N1000; Return Inwards N1410, Closing balance Debit balance N12567 and Credit
balance N181.
209
3. Obong trading concern supplied the following figures extracted from the ledgers for the
month of January 20X3.
N
Opening balance of purchase ledger credit 13,000
Opening balance of purchase ledger debit 450
Set off 1,370
Transfer (credit) 120
Credit purchases 37,700
Interest on overdue balance 170
Returns outwards 610
Cash paid to creditors 18,200
Cheque 23,200
Closing balance credit balance 6,800
Closing balance debit balance 70
You are required to prepare purchases ledger control account for the month of January 20X3.
210
References
Publishers.
Limited.
Nig. Ltd.
Limited.
Limited.
consulting.
211
CHAPTER FOURTEEN
SINGLE ENTRY AND INCOMPLETE RECORDS

At the end of this chapter candidates are expected to:
 Know the meaning of single entry and incomplete records
 Steps involved in solving incomplete records problem
 How to make single entry to double entry.
14.1 INTRODUCTION
The term ‘single entry’ is applied to any system which does not provide for the double
entry system aspect of transaction; while the alternative term; incomplete ‘records‘ is
often applied to books of account kept on such single entry or incomplete double entry
system. Pure ‘single entry’ recognizes only the personal aspect of transactions, and,
consequently, the only essential books are personal ledgers for recording transactions
with debtors and creditors. In practice, however, a cashbook is invariably kept, but, with
this exception, the impersonal aspect of transactions is usually left entirely unrecorded.
The following steps are involved in solving incomplete records problems:
1. Turning the available record for single entry and incomplete recording to complete
record. This is done by recording the dual aspect of all transactions.
2. Preparation of final accounts from the available information in (1) above. In order to
accomplish the task above the following procedures are undertaken:
a. Preparation of opening statement of affairs to determine the opening capital of the
business. It is the statement of all assets and claim over the asset (liabilities) at the
beginning of the period; otherwise called a balance sheet.
b. Knowledge of control account in order to compute the credit sales, credit purchases and
any other item like expenses is required.
c. Knowledge of accounting ratio to compute missing figures in the account is required.
d. Knowledge of the principle involved in double entry to write up all necessary accounts.
e. Ability to locate and correct errors is required.
f. Principles involved in depreciating assets and providing for provisions is required.
In most cases, the examiners normally require candidates to prepare:
1. Opening statement of affairs.
2. Computation of profit from two balance sheets.
3. Debtors and Creditors control account.
4. Trading, profit and loss account.
5. Balance sheet as at end of the period.
212
ILLUSTRATION 1 (Computation of profit from two statements of financial position)
JOSEPH made available the following information of his assets and liabilities:
31/12/09 31/12/08
=N= =N=
Plant and Machinery 4,200 5,000
Furniture and Fittings 1,600 2,000
Stock 900 700
Receivables 1,250 1,050
Payables 600 500
Bank balance 1,800 1,200
Cash in hand 400 300
Rent owing 80 50
Insurance prepaid 90 70
Drawing 500 --
You are required to draw to up

a. Statement of affairs as at 31st December, 2008.
b. Computation of profit from the information above relating to two the statement of
financial positions.
SOLUTION (a)
STATEMENT OF AFFAIRS AS AT 31ST DECEMBER, 2008.
N N
Non-current Assets:
Plant and Machinery 5,000
Furniture and Fittings 2,000
7,000
Current Assets:
Inventory 700
Receivables 1,050
Bank balance 1,200
Cash in hand 300
Insurance prepaid 70 3,320
10,320
Current Liabilities:
Payables 500
Rent owing 50 (550)
Opening Capital 9,770
213
STATEMENT OF AFFAIRS AS AT 31ST DECEMBER, 2009.
N N
Non-current Assets:
Furniture and Fittings 1,600 5,800
Current Assets:
Inventory 900
Receivables 1,250
Bank balance 1,800
Cash in hand 400
Insurance prepaid 90 4,440
10,240
Payables 600
Rent owing 80 (680)
Closing Capital 9,560
Determination of Net profit:

Closing capital 9,560
Add drawing 500
10,060
Less Opening capital 9,770
Net Profit 290
ILLUSTRATION 2
The following is the summarized cash book of ALADE SUNMONU for the year ended 31st
December, 2010.
Cash book
Opening balance 23,430 Cash to trade payables 110,560
Cash from trade receivables 182,350 Salaries 10,800
Additional capital 60,000 Postages 2,400
Drawings 25,000
Bal c/d 98,980
265,780 265,780
214
Additional information:
1/1/10 31/12/10
=N= =N=
Inventory 5,600 3,400
Payables 9,800 10,510
Salaries owing 3,200 750
Rent prepaid 440 670
Motor Van 10,000 8,000

a. Statement of affairs as at 1st December, 2010.
b. Total Receivables and Total Payables Control account.
c. Trading, profit or loss account for the year ended 31st December, 2010.
d. Statement of financial position as at 31st December, 2010.
SOLUTION
a. STATEMENT OF AFFAIRS AS AT 1ST DECEMBER, 2010.
=N= =N=
Non - current Assets:
Motor Van 10,000
Current Assets:
Inventory 5,600
Receivables 12,020
Cash balance 23,430
Rent prepaid 440 51,490
51,490
Payables 9,800
Salaries owing 3,200 (13,000)
Opening Capital 38,490
b. Receivables Control
Balance c/f 9,880
Cash received from debtors 182,350
192,230
Bal b/f 12,020
Sales 180,210
215
c. Payables Control
Cash paid to creditors 110,560
Balance c/f 10,510
121, 070
Bal b/f 9,800
Purchases 111,270
d. Salaries account
Cash paid 10,800
Balance c/f 750
11, 550
Bal b/f 3,200
Profit and Loss (difference) 8,350
e. Rent and Rates account
Cash paid 5,700
Balance b/f 440
11, 550
Bal c/f 670
Profit and Loss (difference) 5,470
f. Capital account
Cash account 6,000
Balance b/f 38,490
Bal c/f 98, 490
216
ALADE SUNMONU
TRADING, PROFIT OR ACCOUNT
FOR THE YEAR ENDED 31ST DECEMBER, 2010
=N= =N=
Subscription 180,210
Less: Cost of sales:
Add Purchases 111,270
116,870
Less Closing inventory (3,400)
Cost of goods sold (113,470)
Gross Profit 66,740
Less: Expenses
Salaries 8,350
Postages 2,400
Depreciation 2,000 (30,560)
Net Profit 36,180
STATEMENT OF FINANCIAL POSITION AS AT 31ST DECEMBER, 2010
COST DEPRE NBV
NON – CURRENT ASSETS: =N= =N= =N=
Motor Van 10,000 2,000 8,000
CURRENT ASSETS:
Inventory 3,400
Receivables 9,880
Cash 98,980
Rent Prepaid 670
112,930
LESS: CURRENT LIABILITIES:
Payables 10,510
Salaries owing 750 (11,260)
Net current asset 101,670
Net Asset 109,670
FINANCED BY:
Capital 98,490
Add: net profit 36,180
134,670
Drawings (25,000)
109,670
217
14.2 SUMMARY
This chapter explained the essence and reasons why some businessmen and women needs to
set a proper accounting functions and the double-entry principles to be observed. It
emphasized the steps involved in solving incomplete records problems, and how to make single
entry to double-entry in accounting.
218
Question 1
A group of eight young men formed Tileyi Fuyi singers on 1st January 2016. The Band leader,
Songito, introduced a capital of N250000 and Musical instrument worth N325000. A club house
was built in January 2016 at a cost of N278500. Average weekly income from the club house
was N5000 for 50 weeks. Each member of the band drew monthly allowance of N2000
You are given the following additional information:

(a) Income from special outings in 1997 amount to N120000
(b) Printing and stationery N128000
(c) Advertising/Public relation expenses N40000
(d) Booking/Public relation management fee 10% of club’s revenue
(e) Bank charges N26736
(f) Instrument purchased has an estimated life span of 5 years and the club house, has a lease
year of 20. All payments were made through the Bank.
Prepare the operating account for the year ended 31st Dec 2016 and the balance sheet at that date.
Question 2.
A company Olalekan limited started its operation with N3 Million. At the end of the year its net
worth has increased to N3.6million. The company made a gross profit equivalent to 50% of its
initial capital and the cost of sales is normally 70% of its annual sales. The total expenses
amounted to N450000.
You are required to construct the company’s statement of trading and profit or loss accounts for
the year. Show all workings.
Question 3. The following was extracted from the book of Alhaji Halidu at 31st Dec 1990.
N N
Open balance 1,348 Cash paid to creditors 21,149
Cash sales 12,476 Salaries 11,900
Cash receive from debtors 36,584 Advertisement 2,000
Electricity 246
Rent and rate 712
Drawing 1,800
_____ Bal. c/d 6,167
50,408 50,408
219
Additional information
a. Balance at; 1st Jan 1990 31st Dec, 1990
N N
Stock 4,118 6,278
Debtors 5,600 7,860
Creditor for;
Purchases 6,380 6,900
Electricity 140 172
b. Rent and rate repaired 1/1/90 was N80 and 31/12/90 was N120
c. Fixed asset original cost N15000
Net book value 1/1/90 N10600
d. Provision for depreciation is at 10% on cost.
You are required to prepare
i. Trading and profit and loss account for the year ended December 1990.
ii. The balance sheet as at that date.
4. Below the summary of the bank account of Mr Okai, trading as Okai and brother for
the year ended 31/12/98
BANK ACCOUNT
1998 N 1998 N
1st Jan 1998 bal b/d 10,000 Supplier 150,000
Customers 180,000 Office expenses 20,000
Cash sales 100,000 Salaries 40,000
Purchases 36,000
Insurance 3,000
Drawing 16,000
31/12/98 bal c/f 25,000
290,000 290,000
220
You are given the following addition information:
1st Jan 1998 31st Dec 1998
N N
Stock 100,000 104,000
Debtors 50,000 60,000
Trade creditors 86,000 92,000
Expenses creditors 4,000 3,600
In addition to the above, Mr Okai has a motor van worth N80,000 on 1st January 1998
which is to be depreciated at the rate of 10% per annum.
Required to:
a. calculate the
i. opening capital
ii. Total sales
iii. Total purchase
iv. Total expenses
b. prepare the trading and profit and loss account for the year ended 31st December 1998
and a balance sheet as at that date.
5. Mejus Obiaku is atrader who resides in his own premises. He had not kept his book on
the double entry principle nor had he balanced his cash book but you ascertain the
following particular for the year ended 31st December 1996.
AT 31/12/95 At 31/12/96
N N
Stock 2000 500
Bank balance 17000 45300
Rent outstanding unpaid 2000
Creditors 6000 1000
Debtors 19000 20000
221
Transactions during 1996 were as follows.
a. the sales are mostly on credit bases. No records of sales have been made but N160000
has been received, N142000 by cheque and N18000 in cash from person to whom goods
have been sold.
b. Expenses paid during the year are:
By cheque: salary N3000. General expenses N2700. By cash rent N6500
c. Supplier for goods were paid N108,000 during the year.
d. The owner took N250 cash per week for 52 weeks as drawing
e. The fix asset was furniture which was value at 31/12/95 N4500, this is to be depreciated
10% per annum.
Required prepare:
i. Statement of affairs as at 31/12/95
ii. Two column cash book as at 31/12/96
iii. Trading profit and loss account for the year ended 31st Dec 1996.
ATS ICAN
222
References
Publishers.
Limited.
Anishere-Hameed, R.A. (2016) Principle of Accounting , Molofin- Nominee publisher,
Lewis Lagos.
Nig. Ltd.
Limited.
Ibrahim, R.A & Kazeem, R.A.(2015) Essential financial accounting Tonad publishers Ltd, Ibafo
Igben,R.O. Advanced financial accounting, fourth edition,ROI Publishers Ltd Lagos.
Limited.
consulting.
223
CHAPTER FIFTEEN
ACCOUNTS FOR NOT FOR PROFIT MAKING ORGANISATION

 The meaning of not for profit making organization
 The various accounts kept
 The sources of income for a Not profit making organization.
I
15.1 INTRODUCTION
Not for profit organization can be defined as those organizations which are established
not for the objective of making profit and distributing such profit to their members in
form of interest on capital or dividends but retain such profit in the business organization
to pursue the objective for which the business is established. Examples includes: Clubs,
Charitable organizations, Trade Unions, Churches, Mosques, Red Cross, Boys Scout
e.t.c.
15.2 FEATURES OF NOT FOR PROFIT ORGANISATION

i. They are not set up to make profit.
ii. Funds are available from members’ contribution.
iii. Promotion of welfare activities to members.
iv. Surpluses are not distributed as dividend.
15.3 RECEIPT AND PAYMENT ACCOUNT

This is a statement of cash actually received and paid during a given period, receipts
being debited and payment credited. The receipts and payments account is the cash book
of not for profit organization.
15.4 INCOME AND EXPENDITURE ACCOUNT

This is the account which shows the summary of revenue and running costs of a non-
profit making organization. It follows the same principles as the profit and loss account
of a trading concern. It is part of the double entry, and income is shown on the credit side
and expenditure on the debit side. The balance represent surplus of income over
expenditure and vice versa.
224
15.5 SOURCES OF INCOME
Non-profit making organization differs in purpose and character, but we shall concentrate
here on sports clubs, social clubs or societies, charities, churches and mosques. They will
obtain their income from various sources including:
i. Membership subscription or contribution.
ii. Payments for Life Membership.
iii. Profit from bar sales.
iv. Profit from sales of food in the club restaurants or cafeteria.
v. Profit from social events, such as dinner, dances and competitions.
vi. Interest received from investments.
vii. Donations.
viii. Gifts, Entrance fees, pledges and offerings.
ix. Fines, grants or aids.
ILLUSTRATION 1
The following assets and liabilities appeared in the books of EKO CLUB on 31st August, 2010.
=N=
Club House at cost 20,000
Furniture 15,000
Subscription for 2011 received in 2010 840
Club Van 45,000
Bar creditors 3,220
Sports Equipment 6,500
Bar Trading Inventory 3,800
Bar Receivables 4,650
Accrued Bar Wages 320
Cash and Bank 2,420
The receipts and payment accounts for the year to 31st August, 2010 is as follows:
Receipts =N= Payments =N=
Balance 1/9/10 2,420 Bar Wages 3,250
Subscription 36,030 Sport Equipment 14,340
Bar Takings 18,640 Match Expenses 9,630
Sales of Tickets 14,900 Secretary Salary 1,950
Donations 8,860 Bar Expenses 2,310
Bar Suppliers 8,890
Land for sport Complex 35,000
General Expenses 1,570
Balance 31/08/10 3,910
80,850 80,850
225
The following additional information is made available:
i. Bar trading inventory as at 31/8/10 was =N=4,110 while bar wages due but not paid
=N=180.
ii. Depreciation to be provided on all assets except land at 10% on cost.
iii. Bar receivables and payables at 31/8/10 are =N=3,850 and =N=3,840 respectively.
Subscription received included =N=630 for2011.

i. Bar Trading account.
ii. Income and Expenditure account for the year ended 31/8/10 and;
iii. A balance sheet as at that date.
SOLUTION (i)
EKO CLUB
BAR TRADING PROFIT OR LOSS ACCOUNT
FOR THE YEAR ENDED 31ST AUGUST, 2010.
=N= =N=
Bar Sales 17,840
Less: Cost of bar sales:
Opening inventory 3,800
Purchases 9,510
13,310
Less: Closing inventory 4,110
Cost of sales 9,200
Bar Gross Profit 8,640
Less: Expenses:
Bar wages 3,110
Bar expenses 2,310 5,420
Bar Net Profit 3,220
226
(B) STATEMENT OF INCOME AND EXPENDITURE ACCOUNT
FOR THE YEAR ENDED 31ST AUGUST, 2010
=N= =N= =N=
INCOME:
Bar Profit 3,220
Subscription 36,240
Income from match (14,990-9630) 5,270
Donations 8,860
53,590
Less: EXPENDITURE:
Secretary Salary 1,950
Depreciation 10,084 13,604
Surplus 39,986
(C) STATEMENT OF FINANCIAL POSITION AS AT 31ST AUGUST, 2010
COST DEP. NBV
NON CURRENT ASSETS: =N= =N= =N=
Land 35,000 _ 35,000
Club House 20,000 2,000 18,000
Furniture 15,000 1,500 13,500
Sports Equipment 20,840 2,084 18,756
Club Van 45,000 4,500 40,500
135,840 10,084 125,756
CURRENT ASSETS:
Bar Inventory 4,110
Cash and Bank 3,910
11,870
Bar Payables 3,840
Subscription in advance 630
Accrued Wages 180 (4,650)
Net Current assets 7,220
NET ASSETS 132,976
FINANCED BY:
Accumulated Fund 92,990
Add: Surplus for the year 39,986
132,976
227
WORKINGS:
1. STATEMENT OF CLUB’S ACCUMULATED FUND
=N= =N=
Assets:
Club house at cost 20,000
Furniture 15,000
Club Van 45,000
Sports Equipment 6,500
Bar inventory 3,800
Bar receivables 4,650
Cash and Bank 2,420
97,370
Less: Liabilities:
Bar payables 3,220
Accrued bar Wages 320 (4,380)
ACCUMULATED FUND 92,990
2. BAR WAGES ACCOUNT =N=

Bank 3,250
Balance carried down 180
3,430
Balance brought down (320)
Bar Trading 3,110
3. BAR RECEIVABLES
Balance carried down 3,850
Bank 18,640
22,490
Balance brought down (4,650)
Sales 17,840
4. BAR PAYABLES
Bank 8,890
12,730
Balance brought down (3,220)
Purchases 9,510
228
5. SUBSCRIPTION ACCOUNT
Bank 36,030
36,870
Balance carried down (630)
Income and Expenditure 36,240
ILLUSTRATION 2
The following is a summary of the Cash Book of LEKKI CLUB for the year ended to 31st
December, 2011
Receipts =N= Payments =N=
Balance 1/1/10 3,600 Bar supplies 60,000
Subscription: Wages 21,000
For year 2009 850 Printing & Stationery 1,400
For year 2010 25,750 New furniture 6,500
For year 2011 1,000 General Expenses 18,300
Bar Taking 80,000 Balance 31/08/10 4,000
111,200 111,200
The following information is obtained:

1/1/10 31/12/10
=N= =N=
Freehold Premises 50,000 50,000
Inventory of restaurant and bar supplies 6,180 5,480
Trade payables for restaurant and bar supplies 4,500 4,900
Accrued Wages 250 300
At 31st December, 2010, Club furniture was valued at =N=36,200 and during 2009 =N=800 had
been received in respect of members subscriptions for the year2010.The club does not take credit
for subscription in arrears.

i. Income statement for bar and restaurant for the year 2010.
ii. Statement of Income and Expenditure account for the year ended 31/12/10 and;
iii. A statement of financial position as at that date.
229
SOLUTION
LEKKI CLUB
INCOME STATEMENT
FOR THE YEAR ENDED 31ST DECEMBER, 2010.
=N= =N=
Bar Sales 80,000
Less: Cost of bar sales:
Opening inventory 6,180
Purchases 60,400
66,580
Less: Closing inventory 5,480
Cost of sales 61,100
Bar Gross Profit 18,900
B) STATEMENT OF INCOME AND EXPENDITURE

FOR THE YEAR ENDED 31ST DECEMBER, 2010
=N= =N=
INCOME:
Subscription 27,400
Bar Profit 18,900
46,300
Less: EXPENDITURE:
Printing and Stationery 1,400
Depreciation 21,050 40,750
Surplus 5,550
(C) STATEMENT OF FINACIAL POSITION AS AT 31ST AUGUST, 2010

COST DEP NBV
NON CURRENT ASSETS: =N= =N= =N=
Freehold Premises 50,000 _ 50,000
Furniture 36,200 _ 36,200
86,200 86,200
CURRENT ASSETS:
Inventory 5,480
Cash and Bank 4,000
9,480
230
Payables 4,900
Subscription in advance 1,000
Accrued Wages 300 (6,200)
Net Current assets 3,280
NET ASSETS 89,480
FINANCED BY:
Accumulated Fund 83,930
Add: Surplus for the year 5,550
89,480
WORKINGS:
1. STATEMENT OF CLUB’S ACCUMULATED FUND
=N= =N=
Assets:
Freehold Premises 50,000
Furniture (36,200-6500) 29,700
Inventory 6,180
Bank 3,600
89,480
Less: Liabilities:
Bar Payables 4,250
Accrued bar Wages 250 (5,550)
ACCUMULATED FUND 83,930
2. WAGES ACCOUNT =N=

Bank 21,000
21,300
Balance brought down 250
231
3. BAR PAYABLES
Bank 60,000
64,900
Balance brought down 4,500
Purchases 60,400
4. SUBSCRIPTION ACCOUNT
Bank 60,000
64,900
232
15.6 SUMMARY
This chapter covered the needs that arises to draw-up the final accounts of a Not-for-Profit
making organization that does not have proper double-entry records, the procedure for doing
so. The procedure for preparing final account in a single-entry situation was also discussed.
233
Question 1
The Reliable Social Club, supply you with the following information in respect of their operation
for the year ended 30th September 2014.
Summary of Receipts and Payments

N N
Bal. at bank 1/10/13 6,636 Salaries Wages 18,732
Membership subscription paid 980 Bar supplies 70,560
For: Year ended 30/9/13 48,468 Rent 10,920
Year ended 30/9/14 560 Rates 3,080
Year ended 30/9/15 4,480 Christmas Bonus to staff 4,368
Entrance fees 79,520 Lighting & Cleaning 9,100
Bar taking 10,696 Prize awards 5,180
Competition receipt 11,200 Postage & printing 8,400
6% Bank loan Deposit with Building
Society 11200
________ Bal. at Bank 30/9/94 21000
162540 162540
(1) Bal stocks were N7840 on 30th Sept. 2014, N700 were prizes in hand, and N7040 were
owed to bar supplier on that date.
(2) The rent was paid for 18 months ended 31/3/16.
(3) The balance at 30/9/13 were as follows. Furniture and equipment N67200, Deposit with
Building society N11200, bar stocks N9200 prizes in hand N7840, owing for bar
suppliers.
(4) Interest on the building society Deposit is at 17% per annum. The interests retained
within the fund.
(5) The bar attendant is to receive a bonus of 5 percent on the bar taking in excess of an
average of N5600 per month for the year to 30/9/14.
(6) For making use of his personal car for the club during the year, the secretary is to be
allowed N200 per month.
(7) Subscription unpaid at 30/9/14 amounted to N1400
(8) The Bank loan was obtained on 1st February 2014.
(9) Depreciation of 10% per annum is to be written off on furniture and equipment.
234
(i) An account showing the profit on the bar.
(ii) Income and expenditure account for the year ended 30th Sept. 2014.
(iii) A statement of financial position as at that date.
Question 2
You have been elected the auditor of your club. At the end of the financial year, the financial
secretary, who is a banker, submitted the account set out below for audit. If you agree with the
presentation you are required to prepare a Balance Sheet from the accounts and if you disagree,
you are then required to criticize, amend and comment on the accounts and prepare a Balance
Sheet as at 31st December, 2015
FEMCO CLUB
Income and Expenditure Account 31st December 2015
N N
Entrance fees (60 x 60) 3600 Salaries & wages 3350
Fees from life
Membership (20 x 20) 1040 Secretary’ salary 1700
Annual subscription 3128 Rent & rates 2528
Subscription in advance 130 Printing & postage 272
Interest on treasury stock 240 Repairs to premises 648
Sundry receipts 124 Interest on bank loan 114
Balance from last year 2472 Balance c/f 2122
10734 10734
Bal. b/d 2122
Treasurer’s Note
Subscriptions in arrears N242, sundry trades men’s bill N84 were outstanding at 31st December,
but have since been paid.
The secretary’s salary though sanctioned by the committee has not yet been paid. The treasury
stock purchased several years ago cost N3940.
The lease (sixteen years to run) cost N4248, Bank loan secured on premises remain at N2000.
235
Question 3
On 1st January2014, the books of Ekiti Social Club show the follow:
N
Club House 14000
Furniture 875
Motor Van 2800
Bank and Cash 3062
Bank loan 3500
Subscription owing 210
Subscription paid in advance 700
Unpaid printing charges 437
During the year ended 31st December 2014, the club had the following transactions:
Payments N
Printing charges 875
Interest on loan 175
Bank Loan-repaid 1750
Salaries of Staff 1137
Stationery 175
Postage 35
Furniture 1400
Receipts: N
Subscription 6125
Donations 1225
Entrance fees 262
Raffle draw 2625
Concept show 2100
Note: Subscription amounting to N300 was outstanding.
Required:
Prepare an Income and Expenditure accounts for the year and a statement of financial position as
at that date.
236
References
Publishers.
Limited.
Lewis Lagos.
Nig. Ltd.
Limited.
Igben,R.O. Advanced financial accounting, fourth edition, ROI Publishers Ltd Lagos.
Limited.
consulting.
237
CHAPTER SIXTEEN
FINANCIAL STATEMENT
At the end of this chapter candidates are expected to:
 Know the meaning of financial statement
 Know various provisions made in financial statement
 Know various types of companies
 Know various types of Reserves in the account
16.1 INTRODUCTION
A company can be defined as a body corporate (i.e. an aggregation of persons or
individuals), having a distinct legal personality created by or under:
(i) Companies and Allied Matters Decree (C.A.M.A) of 1990, or
(ii) An enabling statute of government
This chapter only deals with:

o companies formed under C.A.M.A. 1990; and
o financial statements that are prepared for internal use of management.
The preparation of financial statements for publication is dealt with in volume 2 of this
book.
16.2 TYPES OF COMPANIES

(a). Limited Company: There are two types of limited companies. The first type are
companies limited by shares in which the liability of members, in the event of
liquidation, is limited to the amount remaining unpaid on shares allotted to them.
(b). The other type of limited companies are companies limited by guarantee in
which the liability of members is limited to the amount which they have agreed to
contribute in the event of liquidation.
(c). Unlimited Company: This is a company in which the liability of members

extends beyond the amount remaining unpaid on the shares allotted to them i.e. in
the even of liquidation, if the assets of the company are insufficient to meet its
debts, members will required to contribute their personal resources towards
settling the company’s debts.
238
(d). Private Company: This is a company which has the following characteristics:
 Rights of transfer of shares restricted
 Number of members limited to 50
 The public cannot subscribe for its shares
(e) Public Limited Company: This is a limited company other than a private
limited company. Its shares may or may not be quoted on the Inventory exchange.
All companies quoted on the Inventory Exchange are public limited companies
but not all public limited companies are quoted on the Inventory Exchange. An
example of a public limited company that is not quoted on the Inventory
Exchange is Nigeria Port Plc, a company formed by the federal government
under the provisions of a special enabling statute.
16.3 PECULIAR FEATURES OF A COMPANY’S FINANCIAL STATEMENTS

There are some peculiar items which appear only in the financial statements of a
company. These include:
1. Director’s fee/remuneration and auditors’ fees
These should be deducted before arriving at the profit before tax.
2. Share Capital
(i) Authorized share capital: This is the amount of capital (stipulated in the
memorandum of association) which the company has been authorized to raise.
(ii) Issued Capital: This is the portion of the authorized capital which has been issued
to subscribers.
(iii) Called-up Capital: This is the portion of the issued capital on which the directors
have called upon the shareholders to pay the installment due.
(iv). Paid-up capital: This is the portion of the called – up capital which has been
paid-up by the shareholders.
3. Taxation
Unlike other business forms, companies are chargeable to tax in their own name.
The taxation provision on current year’s profit is deducted from the profit before
tax and shown in the statement of financial position under the current liabilities.
If necessary, the taxation charged to the statement of profit or loss will be
adjusted for over –or under-provision for tax on the preceding year’s profit.
For example, if the provision for tax on current year’s profit is N100,000 and
there is over-provision for tax on prior year’s profit amounting to N5,000, the
239
taxation charged to current year’s statement of profit or loss would be N95,000
[i.e. N100,000 minus N5,000]. On the other hand, if there is under provision for
tax on prior year’s profit amounting to say N8,000, the taxation charged to current
year’s statement of profit or loss would be N108,000 [i.e. N100,000 plus N8,000].
4. Statement of Changes in Equity

This statement replaces what used to be known as appropriation account in the
period prior to the adoption of IFRS by Nigeria. The statement of changes in
equity sets out the changed in equity – share capital and reserves – during the
reporting period. Among the items normally dealt with in this statement are:
 transfers to/(from) reserves; and
 dividend paid.
5. Reserves
Reserves are amounts set aside out of profits earned by the company which are
not intended to meet any liability, contingency, commitment or diminution in
value of assets known to exist at the statement of financial position date. Reserves
may be voluntarily created by directors (as in the case of sinking fund reserves
and general reserves) or statutorily required (as in the case of statutory reserves
of banks). These reserves are transferred to the appropriate reserves accounts out
of profit after tax when the final accounts are drawn up. Other reserves are the
direct result of capital incomes or surpluses earned by the company which would
not be included in the reported profit for the period (e.g. premium on issue of
shares). Reserves constitute part of equity and may be capital or revenue.
6. Capital Reserves are not distributable to members in the form of cash dividends.
Such reserves include:
i. Share premium*
ii. Capital redemption reserve fund.
iii. Gain on revaluation of assets (or revaluation reserve)*
iv. Pre – incorporation profits*
v. Profit on forfeited shares.*
7. Revenue reserves are distributable to members in the form of cash dividends.

They include:
i. Retained profits.
ii. Debenture premium*
iii. Profit on redemption of debentures*
iv. General Reserves,
240
*Surpluses which are not included in the reported profit for the period.
Students are sometimes needlessly confused when asked to state the similarities and
dissimilarities between reserves and provision.
8. Debentures
A debenture is a written acknowledgement of a debt owed by a company
normally containing provisions/clauses on payment of interest and repayment of
capital. Debentures should be disclosed in the statement of financial position
under non-current liabilities unless they are due for payment within 12 months’
time in which ease the debentures will be shown under current liabilities.
9. Proposed Dividend
This is the amount of dividend which has proposed by the company’s directors
but yet to be approved by members at the annual general meeting. In the period
prior to the adoption of IFRS, proposed dividend was charged in the appropriation
account and shown in the statement of financial position under current liabilities.
This treatment has since changed with the adoption IFRS. Now, proposed
dividend is not recognized in the financial statements other than giving details
thereon in the notes to the financial statements. In effect, proposed dividend is
no longer recognized as:
 An appropriation of profit; and
 A liability in the statement of financial position.
The reason for the change in the treatment of proposed dividend is that it does not
satisfy the criteria for liability as defined in IAS 37. This standard defines a
liability as a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits. The same standard goes on to define an obligating
event as an event that creates a legal or constructive obligation that results in an
entity having no realistic alternative to settling that obligation.
The proposal made by directors for the payment of dividend does not crease an
obligation on the company to pay the dividend until the owners of the company –
the shareholder – approve the proposal at the annual general meeting. The
approval by the shareholders constitutes the obligating event which establishes a
binding obligation on the company to pay the dividend. Until this obligating event
takes place, the proposed dividend shall not be recognized in the financial
statements other than disclosing it in the notes as a contingent liability. The
following is the definition of contingent liability given by the same IAS 37 – the
241
relevant part being the (a) part with the key words/phrases underlined – clearly
showing that proposed dividend is a contingent liability:
(a) a possible obligation that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of the entity; or
(b) a present obligation that arises from past events but is not recognized because:
(i) It is not probable that an outflow of resources embodying economic
benefits will be required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability.
10. Dividend declared after Reporting Date

By the time proposed dividend is approved by shareholders at the annual general
meeting, the next accounting period would have begun. The approval – or,
declaration – of the dividend shall be accounted for in accordance with IAS 10
Events after the Reporting Period. The question is: should it be recognized as a
liability in the financial statements? IAS 10’s answer to this question is an
unequivocal No. Such dividend can only be disclosed in the notes to the accounts.
Quoting directly from paragraphs 12 and 13 of IAS 10:
If an entity declares dividends to holders of equity instruments (as defined in IAS

32 Financial Instruments: Presentation) after the reporting period, the entity
shall not recognize those dividends as a liability at the end of the reporting
period.
If dividends are declared after the reporting period but before the financial
statements are authorized for issue, the dividends are not recognized as a liability
at the end of the reporting period because no obligation exists at that time. Such
dividends are disclosed in the notes in accordance with IAS 1 Presentation of
Financial Statements
11. Interim Dividend Paid

This is the dividend paid by directors in respect of current year pending the
determination, at the end of the year, of the actual dividend for the year. Being an
appropriation of profit, interim dividend is charged against profit
in statement of changes in equity of the period in which it is paid. No other
treatment is required in respect thereof.
242
16.4 COMPANY VERSUS OTHER BUSINESS FORMS
Points Sole Partnership Company
Proprietorship
i). Maximum number One Generally limited to 20 50 for private company
of members except in the professional while there is no maximum
partnerships such as a for public limited company
firm of accountants
ii) Minimum number of One Two Two

members
iii) Legal personality None None

Legal entity
iv) Capital As the owner As the partners agree

Maximum issued capital wishes
cannot exceed the
authorized capital stated in
the M of A.
v) Profit-sharing As the owner As the partners agree profit can be distributed

wishes only after the directors
have proposed dividend
and the shareholders
approve it.
vi) Taxation Not chargeable to tax Not chargeable to tax Chargeable to tax
vii) External Audit Not compulsory Not compulsory Compulsory
viii) Books of accounts Not legally Not legally Legally

compulsory under
compulsory compulsory C.A.M.A. 1990
ix) Liability of members/ Unlimited Unlimited except in Limited except in

unlimited owners limited
partnership company
243
x) Management vested in the Vested in the partners vested in directors
owner appointed by member
(i.e. ownership is
separated from
management)
xi) Death of members/ terminates the life dissolves the partnership No disturbance;
owner of the business except the surviving legal personality
partners agree otherwise continues
16.5 FINANCIAL STATEMENTS FOR INTERNAL USE

The content of the final accounts of a company for the internal use of management is
subject to the dictates of the directors. On the other hand, financial statements that are to
be published (for external users who are not normally able to dictate the content) are not
subject to the dictates of directors. Published financial statements are described as
general purpose financial statements by IAS 1 Presentation of Financial Statements
which defines them as financial statements intended to meet the needs of users who are
not in a position to require an entity to prepare reports tailored to their particular
information needs. IAS 1 prescribes the rules for preparing general purpose financial
statements.
16.6 CONTENT OF FINANCIAL STATEMENTS OF A COMPANY

IAS lists the content of financial statements as:
i. a statement of financial position (formerly known as balance sheet) at the end of
each year;
ii. a statement of profit or loss and other comprehensive income (formerly known as
profit and loss account) for each year;
iii. a statement of changes in equity for each year;
iv. a statement of cash flows for each year;
v. notes, comprising a summary of significant accounting policies and other
explanatory information; and
vi. a comparative statement of financial position, where necessary.
Despite the fact that this chapter and this volume of the book does not deal with
published financial statements, it must be emphasized that, for classroom and
examination purposes, the preparation of financial statements for internal would still
broadly follow the rules prescribed for preparation of published financial statements
except for the following simplifications:
244
 financial statements for internal use would exclude items (iv), (v) and (vi); and
 less – detailed and less-complex questions.
Formats of Items (i) to (ii)

The formats of the three items that make up financial statements for internal use now
follow not in the order in which they are listed in IAS 1 but in the order in which they are
prepared in practice:
ROI Limited
Statement of Profit or Loss and Other Comprehensive Income for the year ended 31st Dec.
20X4
N N
Sales Revenue (net of sales returns) x
Less: Cost of Sales

Opening Inventory x
Purchases (net of purchases returns) x
Carriage inwards x
Cost of goods available for sale x
Closing Inventory (x)
Cost of goods sold x
Wages** x
Cost of sales x
Gross profit x
Other Incomes (e.g. interest, rent, commission,

Discount & decrease in provision for bad/doubtful debts) x
x
Administrative expenses
Salaries (x)
Rent and rates (x)
Printing and stationery (x)
Postages and telephone (x)
Depreciation (x)
Other admin. Expenses (x)
(x)
245
Distribution costs
Sales commissions (x)
Salaries (x)
Advertising and marketing (x)
Transport and travelling (x)
Depreciation (x)
Other distribution costs (x)
(x)
Finance costs (e.g. interest on loans and overdraft) (x)
x
Taxation (x)
Profit/(loss) for the year x
Other Comprehensive Income
Gain on revaluation of non-current assets x
Actuarial gains/(losses) on defined benefit plans x
Gains/(losses) on translation of foreign currency balances x
x
Total comprehensive income for the year x
ROI Limited
Statement of Changes in Equity for the Year ended 31st December, 20X4
Share Revaluation Share General Retained Total
Capital Reserve Premium Reserve Earnings
N N N N N N
Balance at 1st January, 20X4 x x x x x x
Effect of change in accounting x ______ x x
policy _
Effect of correction of prior period ______ x ______ ______ x x
errors(s) _
Restated balance at 1st January, x x x x x x
20X4
Changes in equity for the year:
Issue of shares x x x
Total comprehensive income for x x x
the year
Dividend (x) (x)
Transfer to general reserve _____ ______ ______ x (x) ____
Balance at 31st December, 20X4 x x x x X x
246
ROI Limited
Statement of Financial Position as at 31st December, 20X4
N N N
ASSETS Cost Accum. NBV
Depn.
Non-current assets
Land and buildings x x x
Plant and Machinery x x x
Furniture and fittings x x x
Motor vehicles x x x
x x x
Long – term Investments x
Current Assets
Inventory x
Trade Receivable (net of provision for bad debt) x
Short-term Investments x
Prepayments x
Accrued income x
Cash at bank x
Cash in hand x
x
Total assets x
EQUITY AND LIABILITIES

EQUITY
Share capital x
Resources:
Capital redemption reserve x
Share premium x
Revaluation reserve x
General reserve x
Retained Profit x
(x)
Total Equity x
247
Non-Current liabilities
Bank loans x
Current Liabilities
Payables x
Taxation x
Dividend payable x
Bank overdraft x
x
Total Equity and Liabilities x
Illustration 24.1:
You are given the following trial balance of Nikky Ltd. as at 31st Dec. 20X1:
DR. CR.
N N
Authorised and Issued Share Capital:
Ordinary shares of 50 kobo each 100,000
12% redeemable preference shares of 50 kobo each 100,000
Share premium 50,000
Retained earnings at 1/1/X1 50,000
10% Debentures 100,000
Inventory 200,000
Motor vehicles at cost 100,000
Provision for depreciation on motor vehicles 60,000
Machinery at cost 120,000
Provision for depreciation on machinery 50,000
Buildings at cost 230,000
Sales 750,000
Purchases 350,000
Discounts 3,000 1,000
Returns 3,000 1,000
Carriage on purchases 2,000
Advertising 10,000
Payables 145,000
Receivables 200,000
Provision for doubtful debts 6,000
Provision for taxation at 1/1/X1 35,000
Taxation paid 30,000
Debenture interest 5,000
Bank balance ________ 5,000
1,453,000 1,453,000
248
You are also given the following information:
(a) General expenses include:
(i) Rates for 12 months ended 31/3/X2 N4,000
(ii) Insurance for 12 months ended 31/12/X1 N2,000, half of which relates to the
director’s private yacht.
(b) The charge for audit services N10,000 needs to be included.
(c) The provision for tax on profits for the year ended 31/12/X1 is to be made at N48,000.
(d) A debtor for N20,000 had gone bankrupt. The provision for doubtful debts is to be 5% of
receivables.
(e) Closing Inventory at 31/12/X1 was N180,000.
(f) Depreciation is to be provided on motor vehicles at N20,000 and on machinery at
N10,000. The buildings are to be revalued upwards by N30,000.
(g) The directors resolved to:
 propose a dividend of 10 kobo per ordinary share; and
 transfer N10,000 to general reserves.
(h) The preference shares are redeemable in 20X6.
You are required to draw up the financial statements of the company, for internal use, for
the year ended 31st December 20X1.
Solution:
Nikky Limited
Statement of Profit or Loss and Other Comprehensive Income for the year ended 31st
December 20X1
N N
Sales 750,000
Sales returns (3,000)
747,000
Purchases 350,000
Purchases returns (1,000)
551,000
Cost of goods sold (371,000)
Gross profit 376,000
Add: Discount received 1,000
377,000
249
Administrative Expenses
General expenses (W. 1) 198,000
Depreciation of motor vehicle 20,000
Depreciation of machinery 10,000
Audit fees 10,000
(238,000)
Distribution Costs
Discounts allowed 3,000
Advertising 10,000
Increase in provision for bad debt
[(5% X N180,000) – N6,000] 3,000
Bad debts 20,000
(36,000)
Finance Cost
Debenture interest [10% X N100,000] 10,000
Preference dividend [12% X N100,000] 12,000
(22,000)
Profit before taxation 81,000
Taxation (W .2) (43,000)
Profit for the year 38,000
Other Comprehensive Income
Gain on revaluation of buildings 30,000
Total comprehensive income for the year 68,000
Nikky Limited
Statement of Changes in Equity for the Year ended 31st March, 20X2
Share Revaluation Share General Retained Total
Capital Reserve Premium Reserve Earnings
N N N N N N
Balance at 1st January, 20X1 100,000 - 50,000 - 50,000 200,000
Changes in equity for the year:
Total comprehensive income for the 30,000 38,000 68,000
year
Transfer to general reserve _______ __________ _______ 10,000 (10,000) -
_ _
Balance at 31st December, 20X1 100,000 30,000 50,000 10,000 78,000 268,000
250
Nikky Limited
Statement of Financial Position as at 31st December 20X1
N N N
Non-Current Assets Cost/Val. Acc. Depn NBV
Buildings 260,000 - 260,000
Machinery 120,000 60,000 60,000
Motor Vehicles 100,000 80,000 20,000
480,000 140,000 340,000
Current Assets
Inventory 180,000
Receivables (N200,000 – N20,000) 180,000
Less: Provision for doubtful debt (5% X N180,000) (9,000) 171,000
Prepaid Rates 1,000
Director’s current account (N2,000 ÷ 2) 1,000 353,000
Total Assets 693,000
EQUITY
Authorized, Issued and Called-up Share Capital:
200,000 ordinary shares of 50k each 100,000
Reserves: 30,000
Share premium 50,000
General reserves 10,000
Retained profits 78,000 168,000
Total Equity 268,000
Non-current liabilities
200,000 12% redeemable preference
shares of 50 kobo each (see Note) 100,000 200,000
Current Liabilities
Payables 145,000
Accrued expenses (N10,000 + N5,000) 15,000
Preference dividend payable (12% X N100,000) 12,000
Provision for taxation 48,000 225,000
Total Equity and Liabilities 693,000
251
WORKINGS
(W.1) General Expenses N
General expenses per trial balance 200,000
Less:
Prepaid rates [3/12 X N4,000] (1,000)
Insurance on director’s private yacht [N2,000 ÷ 2] (1,000)
198,000
(W.2) Taxation Account

N N
Taxation paid 30,000 Balance b/d 35,000
Balance c/d 48,000 Profit or Loss (balancing figure)
43,000*
78,000 78,000
Bal. b/d 48,000
Tutorial Note on Treatment of Redeemable Preference Shares

In the past, prior to the adoption of IFRS in Nigeria, preference share-capital (redeemable or
otherwise) were accounted for as the part of shareholder’s funds and preference dividend were
treated as an appropriation of profit.
The current treatment prescribed by IFRS is to classify redeemable preference share-capital as a
liability thus giving, for financial reporting purposes, priority to the financial substance of
preference shares above their legal form. Also, the dividend on redeemable preference shares is
now treated as a charge against profit by including it as a finance cost in the statement of profit
or loss to be deducted before obtaining the reported profit.
The reasons for the change in treatment are:
i. There exists an obligation to pay back to the holders (i.e. the company has to redeem the
shares).
ii. The obligation arose from a past event – the initial classification and issue of the shares
as redeemable.
iii. The redemption would result in outflow of resources embodying economic benefits when
payment is made.
iv. The company incurs a cost of using the fund by way of preference dividend, the rate of
which, once specified at the time of issue, cannot be changed at will by the directors.
Note that the first three points are the essential characteristics of a liability as defined in IAS 37:
a present obligation of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits.
252
16.7 SUMMARY
At the end of this chapter readers would have sufficiently familiarized themselves with
procedures and requirements for incorporating a limited liability company. Accounting for
various services of capital will not be a problem, and readers should also be able to prepare
company’s accounts. Also what constitute financial statement would not be strange.
253
1. The following Trial Balance was extracted from the books of MESIOYE
ENTERPRISE on 31st December, 2015:
DR CR
N N
Purchases 368,400
Sales 517,900
Drawings 14,100
Returns inwards 7,300
Returns outwards 6,200
Discounts allowed 10,200
Discounts received 8,400
Receivables 45,000
Payables 57,100
Inventory 34,300
Freehold premises@ cost 46,000
Motor vehicles@ cost 12,000
Furniture @ cost 2,500
Provision for depreciation on motor vehicles 4,500
Provision for depreciation on furniture 1,000
Cash at Bank 5,000
Cash in hand 1,900
Salaries 40,600
Printing & Stationery 3,600
Electricity and water 14,900
Insurance 6,800
Provision for bad debt 200
Bad debt written off 400
Capital 70,000
Rent received 3,800
Commission received 11,200
680,300 680,300
254
The following information should be taken into account:
i. Inventory at 31st December 2015 was valued at N31,800
ii. Accrued expenses at 31st December 2015 were salaries N1,800 and electricity
N80
iii. Prepaid expenses at 31st December 2015 were insurance N400 and general
expenses N500
iv. Adjust provision for bad debt to 20% of receivables and create provision for
discount allowed at 1% of receivables.
v. Commission due but not yet received at 31st December 2015 amounted to N800
vi. Charge depreciation on non – current assets as follows:
- Furniture : 20% on cost
- Motor vehicles : 10% on cost
vii. Rent received in advance at 31st December 2015 amounted to N200.
viii. Goods costing N1200 were taken by the owner for private use. This was yet to be
recorded in the books.
ix. Following the recommendations of a professional valuer, Mr. Mesioye intends to
revalue freehold premises at N60,000.
a. Statement of Profit or Loss and other Comprehensive Income for the year ended
31st December 2015.
b. Statement of Financial Position as at that date.
Mukeke Nigeria Limited presents you the following list of balances on 31st of March 20X2.
255
Mukeke Nigeria Limited
List of balance as at 31st March 20X2
N
Sales 184,000
Stock at 1/4/20X1 7,500
Purchases 150.000
Sales Return 1,300
Purchases Return 1,000
Bad Debt 350
Bad Debt Recovered 306
Fixtures & Fittings 33,500
Insurance 1,300
Rent 3,900
Commission Received 180
Agency Fees Received 390
Advertisement 410
Capita! 50,000
Trade Debtors 400
Cash in hand 4,000
Cash in Bank 9,276
10% Loan 36,000
Trade Creditors 7,502
The following additional information were given:-
(1) Stock at 3 1 /3/20X2 was valued at N9.600
(2) Unpaid expenses on 31/3/20X2 were insurance N510 and advertisement N380.
(3) Expenses paid in advance were N
Rent 650
256
(4) An agency fees ofN21 0 was due but not yet received while another agency fees of N130
not yet due has already been received. A commission of N70 relating in the period
commencing from 1st April 20X2 has been received.
(5) The 10% Loan was obtained on 1st January 20X2 but the interest on loan is still
outstanding.
(6) After the preparation of accounts, a debt of N55 written off was recovered by cash and
You are required to prepare:-
(a) A trial balance as at 31/3/20X2
(b) Income statement (trading profit and loss account) for the year ended 31/3/20X2
(c) Statement of financial position (balance sheet) as at 31/3/20X3
3. The trial balance of Yaya Ibrahim & Sons 30th April 20x2 was as follows.
Dr Cr
Capital - 50,000
Leasehold premises 13,000 -
Plant and Equipment 11,000 -
Furniture and Fixtures 6,000 -
Motor Van 7,000 -
Stock 1/5/x1 3,700 -
Agency fees received - 390
Commission received - 180
Advertisement 410 -
Lighting and Heating 430 -
Rent 3,900 -
Insurance 1,300 -
Wages and Salaries 1,800 -
Trade Debtors and creditors 1,850 1,770
6% Loan - 2,000
Purchase and Sales 7,600 18,300
Discounts 20 40
Bad Debts 600 -
Drawings 1,000 -
Cash in hand 2,250 -_____
72,680 72,680
257
The following additional information were given:
(1) Stock on 30th April 20X2 was valued at N9600
(2) Unpaid expenses on 30th April 20x2 v.ere insurance N510 and advertisement N380
(3) Expenses paid in advance were lighting & heating N200 and rent N650
(4) An agency fees of M210 was due but not yet received while another agency fees of N130
not yet due has already been received. A commission of N70 relating to the period
commencing from 1st May 20x2 has been received.
(5) The 6% loan was obtained on 1st January 20x2 but the interest on loan was still
outstanding on 30th April 20x2.
(6) After the preparation of accounts a debt ofN55 written off received by cash and another
(a) Income Statement (Trading profit and loss account) for the year ended 30/4/x2 (b)
Statement of Financial Position (balance sheet) as at that date.
4. The following trial balance was extracted from the books of Semijeje & Co a sole
proprietor on 31st Dec. 20x3.
Dr Cr
N N
Capital 74,053
Purchases &Sales 73,130 105,460
Returns 618 435
Discounts 194 128
Debtors and Creditors 12,642 15,750
Carriage inwards 290 -
Motor Vehicles 16,700 -
Freehold & property 52,000 -
Office Equipment 7,950 -
Salaries 9,750 -
Electricity 380 -
Insurance 290 -
Rates 400 -
258
Advertisement 925 -
Rental income - 820
Bad debt 247 -
Salaries in arrears - 700
Electricity prepaid 140 -
Commission received - 1,900
Commission received in advance - 450
Rental income due to received 150 -
Stock 1/1/20X3 9,000 -_
199,696 199,696
The following additional information were given to the trial balance.

(1) Stock on hand on 31st December 20x3 was valued at N1,150
(2) Expenses in arrears were
Advertisement N1,100
Rent N870
Salaries N530
(3) Prepaid Expenses were
Electricity N60
Rates N410
Insurance N405
(4) Incomes due not yet received were
Commission N230
Rental income N108
(5) Income received but not yet due was
Rent Income N420
You are required to prepare for Semijeje & co:
(a) Income Statement (Trading, profit and loss account) for year ended 3 I/I2/x3
(b) Statement of Financial Position (balance sheet) as at 31/12/x3
259
References
Publishers.
Limited.
Lewis Lagos.
Nig. Ltd.
Limited.
Limited.
consulting.
260
CHAPTER SEVENTEEN
MANUFACTURING ACCOUNT

At the end of this chapter, candidates are expected to know and understand
 The meaning of manufacturing account
 The composition and contents of manufacturing account such as:
 Prime cost, factory overhead, production cost, cost of sale etc and their
relationship.
17.1 INTRODUCTION
Manufacturing Account is prepared by manufacturing businesses to ascertain the cost of
goods manufactured during the account period. The Manufacturing account would
precede the Trading, Profit or Loss Account. The combination of all three Accounts is
known as Manufacturing, Trading, Profit or Loss Account. A manufacturing company
would operate all the three accounts for the following reasons;
 To ascertain the cost of goods produced
 To ascertain the Gross profit earned on the sale of the goods
 Profit and Loss Account shows the overall Net Profit or Loss of the company
 To ascertain the manufacturing profit if any.
FORMAT FOR MANUFACTURING ACCOUNT, AND STATEMENT OF

PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME.
The formats- for Manufacturing Trading, Profit or Loss Account can either be horizontal
or vertical.
261
HORIZONTAL FORMAT
ADEX PLASTICS
MANUFACTURING ACOUNT AND STATEMENT OF PROFIT OR LOSS
AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED
31ST DECEMBER, 2015.
N N
Opening inventory of Raw Materials xx Market value of goods produced c/d xxx
Purchases of Ram Materials xxx
Purchases Returns (x)
Carriage on Raw Materials xx
Cost of Raw Materials Available for used xx
Closing inventory of Raw Materials (x)
Cost Raw Materials consumed xxx
Direct wages/Manufacturing Wages xx
Direct Expenses ( e.g Royalty) xx
PRIME COST xxx
FACTORY OVERHEADS
Depreciation of Plant & Machinery xx
Factory light & heating xx
Foreman’s Salaries xx
Factory rent xx
Factory insurance xx
General factory Expenses xx
Other factory overheads xx xxx
Opening Work in progress xxx
Closing Work in progress (xx) xxx
Cost of production xxx
Manufacturing Profit (Mark up) if any xxx
xxxx xxxx
Opening inventory of finished goods xxx Sales xxxx

Add: Cost of production xxx
Add; Purchases of finished goods (if any) xxx
Add; Carriage inward xxx
Cost of finished goods available for sale xxx
262
Less; closing inventory of finished goods (xx)
Cost of goods sold xxx
Gross Profit c/d xxx
xxx xxxx
Gross Profit b/d xxx
EXPENSES: Discount received xxx
Selling Expenses Commission received xxx
Discount allowed xxx
Commission of salesmen xxx
Salaries of salesmen xxx
Bad debt xxx
Advertising xxx
Carriage outward xxx
Depreciation of delivery van xxx
Increase / decrease -
in prov. For bad debt xxx
xxx
Administration Expenses
Office rent and rates xxx
Lightning xxx
Insurance xxx
Salaries xxx
Office machine depreciation xxx xxx
xxx
Distribution Expenses
Carriage outwards xxx
Lightning of warehouse xxx
Packaging Materials xxx xxx
Net Profit xxx
xxx xxx
263
VERTICAL FORMAT
MANUFACTURING ACOUNTAND AND STATEMENT OF PROFIT OR LOSS AND

OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31ST DECEMBER,
2015.
N N
Opening inventory of Raw Materials xxx
Purchases of Raw Materials xxx
Purchases returns (xxx)
Carriage inwards on Raw Materials xxx
Cost of Raw Materials Available for use xxx
Closing inventory of Raw Materials (xxx)
Cost of Raw Materials consumed xxx
Direct wages (Manufacturing wages) xxx
Direct Expenses (e.g Royalty) xxx
PRIME COST xxx
Add: Factory overheads

Depreciation of Plant and Machinery xxx
Factory Light & Heating xxx
Foreman’s salary xxx
Factory rent xxx
Factory insurance xxx
General Factory Expenses xxx
Other Factory overheads xxx xxx
Opening work in progress xxx

Closing work in progress (xxx) xxx
Cost of Goods produced xxx
Add: Manufacturing Profit ( if any) xxx
Market value of goods produced xxx
Sales xxx
Less; sales Returns (xxx) xxx
264
Less: cost of goods sold
Opening inventory of finished goods xxx
Cost of produced xxx
Purchased of finished goods (if any) xxx
Purchases returns (xxx)
Carriage of finished goods xxx
Cost of Goods available for sales xxx
Closing inventory of finished Goods (xxx)
Cost of Goods Sold (xxx)
Gross Profit xxx
Add / (Deduct): (increase)/decrease in provision for
Unrealized profit on stock, if any xxx
Add: Manufacturing Profit (if any) xxx
Add: other incomes:
 Discount received xxx
 Rent received xxx
 Interest received xxx
 Commission received xxx xxx
xxx
Less: Administrative Expenses:
Admin. Salaries xxx
Office Electricity xxx
Office rent and rates xxx
Printing and stationery xxx
Admin. Insurance xxx
Depreciation of office Equipment xxx
Other Admin Expenses xxx (xxx)
Less: Selling and Distribution Expenses:

Salesmen’s salaries and commission xxx
Bad debt xxx
Advertising xxx
Discount allowed xxx
Carriage outwards xxx
Increase/(decrease) in provision for bad debt xxx
Depreciation of delivery vans xxx (xxx)
Net Profit xxx
265
Illustration 1
KOMO SUNSHINE is a manufacturing company and has presented the following balances for
the year ended 30th September, 2009
N
Inventory of raw materials at 1/10/2008 60,000
Purchases of raw materials 80,000
Returns outwards 4,000
Manufacturing Wages 80,000
Office salaries 56,000
Depreciation of Plant and Machinery 1,200
Inventory of raw materials 30/09/2008 52,000
Factory Expenses 33,600
80% of rent and rates relates to the factory
You are required to prepare the Manufacturing Account for the year ended 30th
September, 2015.
SOLUTION 1
KOMO SUNSHINE
MANUFACTURING ACCOUNT FOR THE YEAR ENDED 30TH SEPTEMBER, 2015
N N N
Raw Materials:
Purchases 80,000
140,000
Less: Returns outwards 4,000
Cost of raw materials available for use 136,000
Less: Closing inventory (52,000)
Cost of raw materials consumed 84,000
Manufacturing Wages 80,000
PRIME COST 164,000
Factory Overheads:
Depreciation of plant & machinery 11,200
Factory Expenses 33,600
PRODUCTION COST 234,400
266
ILLUSTRATION 2
The following balances were extracted from the accounts of OJOMIRIN GARI PROCESSING
INDUSTRY for the year ended 31st December, 2015.
N
Raw Materials purchased 100,000
Direct wages 40,000
Salaries 10,000
Carriage on raw materials 2,600
Carriage on finished goods 3,400
Sales 250,000
Factory expenses 12,000
Insurance 8,000
Rent 20,000
Printing and Stationery 900
Fuel and Power 1,600
Royalties 2,000
Returns outward (raw material) 3,920
Return inwards 2,760
Provision for bad debts 760
Bad debts written off 1,570
Receivables 10,000
Payables 7,000
Plant and machinery (cost) 90,000
Delivery van (cost) 20,000
Bank balance 4,500
Drawing 1,000
Capital 95,330
Additional Information
(a) Inventory 1st Jan 2015 31st Dec. 2015

N N
Raw Materials 12,000 8,000
Work –in-progress 15,000 6,000
Finished goods 6,000 4,700
267
(b) 75% of rent and insurance expenses are chargeable to manufacturing account.
(c) Plant and machinery were valued at N80,000 on Jan. 1st 2015, N5,000 is to be provided
for its depreciation for the year.
(d) Delivery van which was bought in the year is to be depreciated at 5% per annum.
(e) The 60% of the salaries is for the salesmen while 40% is for office staffs

(a) Manufacturing Account
(b) Statement of Profit or Loss and other comprehensive income for the year ended 31st
December, 2015 showing all the necessary cost classifications in respective account.
(c) Statement of financial position as at 31st December, 2015.
SOLUTION 2
OJOMIRIN GARI PROCESSING INDUSTRY
MANUFACTURING ACCOUNT FOR THE YEAR ENDED 31ST December, 2015
RAW MATERIALS: N N
Opening 12,000
Purchased 100,000
Less: Return outward (3,920) 96,080
Add: carriage inward 2,600
Cost of raw material available 110,680
Less: closing inventory (8,000)
Cost of raw materials consumed 102,680
Direct wages 40,000
Direct Expenses 2,000
PRIME COST 144,680
FACTORY OVERHEAD:
Factory insurance (75%) 6,000
Factory rent (75%) 15,000
Fuel and power 1,600
Depreciation on plant & machinery 5,000 39,600
WORK IN PROGRESS
Opening 15,000
Less: Closing 6,000 9,000
Production cost of goods completed c/f 193,280
268
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31ST DECEMBER, 2015
N N N
Sales 250,000
Less: return inwards (2,760)
Net sales 247,260
Less: Cost of Goods Sold

Opening stock of finished goods 6,000
Add: production cost of goods completed b/f 193,280
Less; closing stock of finished goods (4,700) 194,580
Gross Profit 52,660
Less Expenses
Administrative Expenses
Office rent (25%) 2,000
Office insurance (25%) 5,000
Office salaries (40%) 4,000
Printing and Stationery 900 11,900
Selling and Distribution Expenses
Salesmen Salaries 6,000
Carriage outward 3,400
Depreciation on Delivery van 1,000
Bad debts written off 1,570
Provision for doubtful debts 760
Discount allowed 2,160 14,890 (26,790)
Net Profit 25,870
269
STATEMENT OF FINANCIAL POSITION AS AT 31ST DECEMBER, 2015
COST ACCUMULATED NET BOOK
DEPRECIATION VALUE
NON – CURRENT ASSETS: N N N
Plant and Machinery 90,000 15,000 75,000

Delivery van 20,000 1,000 19,000
110,000 16,000 94,000
CURRENT ASSETS
Inventory – Raw Materials 8,000
- Finished goods 6,000
- Work in progress 4,700
Receivables 10,000
Bank Balance 4,500
33,200
Less: CURRENT LIABILITY
Payables (7,000)
Working capital 26,200
Net Assets 120,200
Financed By N
Capital 95,330
Add: Net Profit 25,870
121,200
Less: Drawings (1,000)
120,200
270
17.2 SUMMARY
This chapter discussed extensively what the owner of manufacturing entity needs to know on
how much is the cost of goods produced. This knowledge is necessary in order to:
(i) Fix appropriate selling price for the goods.
(ii) Curb wastages and inefficiencies.
(iii) Compare costs of goods manufactured with competitors cost.
It also acquainted the readers with the concept of mark-up on cost of goods produced or
manufacturing profit.
271
1.(a) The following items of cost relate to a manufacturing company
i. Direct material cost
ii. Direct labour costs.
iii. Indirect material cost
iv. Indirect labour cost
v. Indirect expenses
Define each of the elements of cost and give two examples of each
(b) Distinguish between the following terms:

i Raw material available and raw materials consumed
ii. Factory expenses and office expenses.
2. Adetaji is a Manufacturer of clay pots. The following balances have been extracted from the
books of the business of the business for the year ended 31/12/12.
DR (N) CR (N)
st
Inventory as at Jan. 1 2011
- Raw Material 28,000
- Work in progress 12,200
- Finished goods 23,100
Wages:Direct 33,300
Indirect 12,000
Capital 65,000
Receivables & Payables 15,000 10,200
Drawings 1,700
Factory equipment (Cost of N61000) 53,300
Office equipment (Cost of N25500) 20,000
Purchases of raw materials 180,000
Wages & Salaries 12,500
Rent & Rates 7,000
Insurance 1,500
Lighting 3,000
Sales 350,100
Bank Balance 21900 _________
426120 426120___
272
Additional Information:
(1) Inventory at 31st Dec. 2012 N
Raw Materials 35,200
Work in progress 17,200
Finished Goods 16,220
(2) Factory equipment is to be depreciated at 20% p.a. At cost and office equipment at 10% p.a.
on book values.
(3) Rent & Rates, Insurance and Lighting were apportioned on the basic of area occupied; office
building (1/3) and factory (2/3)
(4) The Manufactured goods were transferred to the warehouse at a value of N260,400:00

(a) Manufacturing, Trading, profit or loss account for the year ended 31/12/2012
(b) The Statement of financial position as at that day
3. The following information was extracted from the book of Yakubu Mohammad, a
manufacturer of cosmetics for the year ended 31st October 2000.
Stock on November 2000 N
Manufactured goods 94,400
Raw materials 30,000
Deprecation on plant & machinery 130,000
Printing and stationary 9,300
Purchase
Manufactured goods 127,400
Carriage inwards (finished goods) 5,000
Raw materials purchase 1,272,600
Carriage inward (raw materials) 34,100
Debtors 217,400
Cash at bank 171,000
Repairs to machinery 250,000
Office rent and rate 650,000
Carriage outward 23,300
Factory rent and rate 227,100
Cash in hand 5,700
Manufacturing wages 702,900
Travelling expenses 27,900
Sales 29,944,200
Capital 778,200
Creditors 217,900
Additional Information
273
a. Stock on 31st October 2000
Raw materials N20, 000
Finished goods N279, 400
b. Goods manufactured are to be debited to the sales department net realized value of
N2,715,000
You are required to prepare manufacturing, trading, profit or loss accounting for the year
ended 31st October 2000.
4. The following balances are extracted from the book of Olawuyi manufacturing
company.
N
Sales of raw material 1st July, 1997 170,000
th
Stock of raw materials 30 June 1998 130,000
Manufacturing wages 410,000
Work in progress 1st July 1997 100,000
Work in progress 30th June 1998 139,600
Office rent and rates 18,200
Sales 196,000
Carriage on materials 5,600
Stock of finished goods 1st July 1997 120,000
th
Stock of finished goods 30 June1998 160,000
Depreciation on factory machinery 18,000
Purchase of raw materials 600,000
Return Inwards 40,000
Stock of raw materials 30th June 1998 130,000
Selling expenses 180,000
Office salaries 106,000
274
From the above balance you are required to prepare the account to show the following:
a. Cost of raw materials used
b. Prime cost production
c. Cost of production
d. Gross profit on manufactured goods
e. Cost of goods sold
f. Gross profit on sales
g. Net profit
Note: Manufactured goods are transferred to sales department at a market value of N1,300, 000.
Question 4
a. The following items of cost relate to a manufacturing company
i. Direct materials cost
ii. Direct labour cost
iii. Indirect materials cost
iv. Indirect labour cost
v. Direct expenses
Define each of the elements of cost and give two example of each
b. Distinguish between the following items:
i. Raw materials available and raw materials consumed
ii. Factory expenses and office expenses.
275
References
Publishers.
Limited.
Lewis Lagos.
Nig. Ltd.
Limited.
Limited.
consulting.
276
CHAPTER EIGHTEEN
PARTNERSHIP ACCOUNT
18.0 LEARNING OBJECTIVES:
 The meaning of Partnership
 The composition of Partnership and Partnership agreement
 The partnership final account
 The meaning and treatment of goodwill in partnership account
18.1 PARTNERSHIP DEFINED

A partnership is a relation which subsists between persons carrying on a business in
common with a view to profit - Partnership Act 1890.
18.2 PARTNERSHIP AGREEMENT

The formal agreement drawn up to regulate the conduct of a partnership business is
known as a partnership deed. The partnership deed shall, inter alia, cover the following
points:
(i) The amount of capital to be contributed by each partner.
(ii) Whether the capital accounts are to be fixed, drawings and profits being adjusted
on current accounts, or whether the capital accounts are to be fluctuating,
drawings and profits being adjusted on capital accounts.
(iii) The ratio in which profits/losses are to be shared among the partners
(iv) The rate at which interest is to be allowed on partners’ capital
(v) The rate at which interest is to be charged on partners’ drawings
(vi) The amount of salary receivable by partners
(vii) Whether current accounts, if any, are to bear interest and, if so, at what rate
(ix) The method of calculating goodwill in the event of death, retirement or
admission of partner(s)
(x) The method of treating the premiums on life insurance policies, if any, and
how the proceeds of the policies are to be shared amongst the partners.
In the absence of express or implied agreement to the contrary, the Partnership Act 1890
the following rules apply, inter alia:
(i) Profits/ losses shall be shared equally
(ii) Interest shall not be allowed on partners’ capital
(iii) Interest shall not be charged on partners' drawing
(iv) Interest shall be allowed on partners' loans at 5% per annum
(vii) No partner shall be entitled to receive salary.
277
18.3 PARTNERSHIP'S FINAL ACCOUNTS
The final accounts of a partnership are similar to those of a sole trader to a large extent,
except for following points of difference.
(i) In the case of a partnership, an account known as appropriation account is
drawn up after the net profit/loss has been ascertained on the statement of profit or
loss. The appropriation account shows the details of how the net profit or loss of
the partnership is allocated to the partners. Items debited to the appropriation
account include interest on capital, salary of partners and partners’ share of profit
while items credited include interest on drawings and partners’ share of loss.
(ii) In the presentation of the owners' equity on the statement of financial position, a
different approach is adopted in the case of a partnership from the way the same
information is presented in the case of a sole trader. In a partnership, all items
(such as drawings, interest on drawings, interest on capital, interest on partners'
loans, partners' salaries and share of profit) affecting the stake of partners are
posted to partners' capital or current accounts after which the balances on these
accounts are carried to the statement of financial position.
18.4 METHODS OF ACCOUNTING FOR PARTNER'S EQUITY/INTEREST

18.4.1 Fluctuating Capital Method
Under this method, the items affecting the partners' equity are adjusted on the capital
accounts. The following items are therefore debited to the capital accounts:
 Drawings,
 Interest on drawings, and
 Share of loss
 Conversely, the following items are credited to tie capital accounts:
 Interest on capital,
 Salary of partners,
 Interest on partners' loans, and
 Share if profit.
This method derives its name from the fact that the balances on the capital accounts
fluctuate from one period to the other.
278
18.4.2 Fixed Capital Method
Under this method, the items affecting the partners’ equity as listed in (i) above, are adjusted
on current accounts instead of the capital accounts. This ensures that the balances on the
capital accounts remain fixed from one period to the other except the partners introduce
additional capital, revalue tangible assets or raise adjustments for goodwill during the period.
Note:
1. For every item affecting the partners’ equity as recorded in the capital accounts in the case of
the fluctuating capital method (or in the current accounts in the case of the fixed capital
method), the opposite but corresponding entry is to be found in the appropriation account, the
only exceptions being, drawings and interest on partners' loans both of which will not appear in
the appropriation account.
2. In the case of partners' salary, the amount credited to the capital account or current account, as
the case may be, is the portion not yet received by the partners as at the year-end. However, the
whole of the partners' salary shall be debited to the appropriation whether the salary had already
been received by the partners or not.
3. Interest on partner's loan shall be credited to partner's capital account (or current account) only
if it is yet to be received by the partner as at the statement of financial position date. Unlike in
the case of partner's salary, however, interest on partner's loan (irrespective of whether it is
outstanding or has been paid) shall be charged in the statement of profit or loss before net profit
or loss is ascertained. This is due to the fact that whereas partner's salary is regarded as a
distribution of profit to the partner, interest on partner's loan is regarded as a charge against
profit i.e. an expense to be deducted before arriving at net profit or loss.
The following are the formats of the profit and loss appropriation account and the partners’
current accounts:
279
FORMAT OF APPROPRIATION ACCOUNT
Appropriation Account for the year ended………….
N N
xx
Net Profit
Add: Interest on drawings: Alade xx
Bala xx
Chukwu xx
xxx
xxxx
Less: Salary: Alade x

Bala x
Chukwu x
(x)
Interest on capital: Alade x
Bala x
Chukwu x
(x)
xxx
Divisible profits
Share of profits: Alade xx

Bala xx
Chukwu xx (xxx)
NIL
FORMAT OF CURRENT ACCOUNTS
Current accounts
Alade Bala Chukwu Alade Bala Chukwu
N N N N N N
Drawings x x x Balance b/d x x x
Interest on drawing x x x Salary x x x
Balance c/d x x x Interest on capital x x x
Interest on loans x x x
Share of profit x x x
x x x x x x
Balance b/d x x x
280
18.5 WHY ARE PARTNERS’ SALARIES CHARGED IN THE APPROPRIATION
ACCOUNT WHILE EMPLOYEES’ SALARIES ARE CHARGED IN THE
STATEMENT OF PROFIT OR LOSS?
Partners’ salaries
The partners are the entrepreneurs of the firm. They obtain, combine, organize and
control the other factors of production (i.e. the resources of the firm) including employees
for the purpose of generating income for the firm. In their capacity as entrepreneurs, their
reward is the profit made by the firm.
Partner’s salaries, therefore, represent a preferential distribution of profits of the firm to

the partners before, the residue of profits (i.e. divisible profits) are distributed to them in
the agreed profit sharing ratio.
From the points raised above, it is clear that partners' salaries are not part of the operating
costs to be treated in the statement of profit or loss. Being a distribution of profits,
partners' salaries are charged in the appropriation account after the net profit of the firm
had been ascertained.
Employees’ Salaries
Employees are part of the resources used by the partners in the operations of the firm.
Salaries of employees are the reward for their labour. This implies that the employees'
salaries are part of the operating costs of the firm. They are, therefore, charged in the
statement of profit or loss in order to ascertain the net profit or loss of the firm.
18.6 WHAT IS THE AMOUNT OF PARTNERS’ SALARIES TO BE DEBITED TO

THE APPROPRIATION ACCOUNT AND CREDITED TO THE PARTNERS’
CAPITAL OR CURRENT ACCOUNT?
This depends on how much of the salary had already been paid to the partner(s). There
are three possible scenarios as analyzed below:
Assume that a partner is entitled to an annual salary of N100,000. At the accounting year-
end, the partner’s salary shall be dealt with in the appropriation account and the partner’s
capital/current account as follows depending on which of the 3 situations applies:
281
Details Treatment
1 The partner had not received any salary during the Debit the appropriation
year. account with salary of
Therefore, the partner’s salary would not appear on the N100,000 and credit the
trial balance. partner’s capital/current
account with the same amount.
2 The partner had received only part of the salary, say Debit the appropriation
N80,000 during the year. Therefore, this amount would account with salary of
appear on the trial balance on the debit side. N100,000 and credit the
partner’s capital/current
account with the outstanding
salary of N20,000
3 The partner had received the whole salary N100,000 Debit the appropriation
during the year. Therefore this amount would appear account with salary of
on the trial balance on the debit side. N100,000 but no salary should
be credited to the partner’s
capital/current account
NB: (i) In all three instances, the whole salary of N100,000 is debited to the
appropriation account because that is the sum incurred by the firm during the
year.
(ii) In each case, only the outstanding salary is credited to the partner’s capital/current
account.
ILLUSTRATION 18.1:
Taribo and West formed a partnership on 1st January 2010. The partnership agreement contains
the following:
(i) The partners fixed capitals are Taribo N30,000 and West N24,000
(ii) West to receive a salary of N1,800 a year.
(iii) Interest on capital is to be calculated at 5% per annum.
(iv) Interest is to be charged on drawings at the rate of 2%
(v) Taribo and West to share profits in ratio 3:2 respectively.
During the year to 31st December 2010, drawings were Taribo N2,250, West N1,750 and the net
profit was N13,500. The partners decided to maintain fixed capital accounts:
282
You are required to show:
(a) The appropriation account for the year ended 31st December, 2010;
(b) The partners' current account; and
(c) Statement of financial position (extract) as at 31st December 2010
Solution:
(a) Taribo and West
Appropriation Account for the year ended 31st December, 2010
N N N N
Salary – West 1,800 Net Profit 13,500
Interest on capital: Interest on drawings:
Taribo (5% X 30,000) 1,500 Taribo (2% X 2,250) 45
West (5% x 24,000) 1,200 West (2% x 1,750) 35
2,700 80
Share of profits:
Taribo (3/5 X 9,080) 5,448
West (2/5 x 9,080) 3,632
9,080
13,580 13,580
(b) Current Accounts

Taribo West Taribo West
N N N N
Drawings 2,250 1,750 Salary west - 1,800
Interest on drawings 45 35 Interest on capital 1,500 1,200
Balance c/d 4,653 4,847 Share of profits 5,448 3,632
6,948 6,632 6,948 6,632
Balance b/d 4,653 4,847
Illustration 18.2:
Shoe, Bag and Belt are in partnership sharing profits and losses in ratio 3:2:1 respectively.
Interest is charged on drawings at the rate of 10% per annum and credited at the same rate in
respect of capital account balances.
Bag is to be credited with a salary of N2,000 per annum. In the year ended 31st December 2011,
the net profit of the firm was N50,400. The partners’ drawings of Shoe N3,000; Bag N7,200 and
283
Belt N4,800 were taken in two equal installments by the partners on 1st April 2011 and 1st
October 2011:
The balance on the partners’ accounts at 31st December 2011 were as follows (all credited
balances):
Capital Current
Account Account
N N
Shoe 30,000 750
Bag 20,000 1,340
Belt 16,000 220

(i) Prepare the firm's appropriation account for the year ended 31st December, 2011:
(ii) Partners' capital accounts and current accounts; and
(iii) Abridged statement of financial position as at 31st December 2011.
Solution
(i). Shoe, Bag and Belt
Appropriation account for the year ended 31st December 2011
N N
Net Profit 50,400
Add: Interest on drawings (W.I):
Shoe 150
Bag 360
Belt 240
750
51,150
Less: Salary – Bag (2,000)
Interest on Capital:
Shoe (10% x 30,000) 3,000
Bag (10% X 20x000) 2,000
Belt (10% X 16,000) 1,600
(6,600)
Divisible profits 42,550
Share of profits:
Shoe (3/6 X 42,550) 21,275
Bag (2/6 X 42,550) 14,183
Belt (1/6 X 42,550) 7,092
42,550
284
(iii) Capital Account
Shoe Bag Belt Shoe Bag Belt
N N N N N N
31/12/11 Balance c/d 30,000 20,000 16,000 1/1/11 Balance b/d 30,000 20,000 16,000
1/1/12 Balance b/d 30,000 20,000 16,000
Current Account
Shoe Bag Belt Shoe Bag Belt
N N N N N N
31/12/11 Balance c/d 3,000 7,200 4,800 1/1/11 Balance b/d 750 1,340 220
31/12/11 Int. on drawings 150 360 240 31/12/11 Salary - 2,000 -
31/12/11 Balance c/d 21,875 11,963 3,872 31/12/11 Int. on cap. 3,000 2,000 1,600
31/12/11 Share of profit 21,275 14,183 7,092
25,025 19,523 8,912 25,025 19,523 8,912
1/1/X8 Balance b/d 21,875 11,963 3,872
(iii) Shoe, Bag and Belt

Statement of Financial Position (extract) as at 31st December 2011
N N
Capital Accounts - Shoe 30,000
- Bag 20,000
- Belt 16,000
66,000
Current Accounts - Shoe 21,875
- Bag 11,963
- Belt 3,872 37,710
103,710
WORKINGS
(W.I) Calculation of Interest on Drawings
Shoe N
1/4/11 - 31/12/11 : N1,500 x 10% X 9/12 = 112.50
1/10/11 – 31/12/11 : N1,500 X 10% X 3/12 = 37.50
N3,000 150.00
285
Bag N
1/4/11 - 31/12/11 : N3,600 X 10% X 9/12 = 270
1/10/11 – 31/12/11 : N3,600 X 10% X 3/12 = 90
N7,200 360
Belt N
1/4/11 - 31/12/11 : N2,400 X 10% X 9/12 = 180
1/10/11 – 31/12/11 : N2,400 X 10% X 3/12 = 60
N4,800 240
18.7 GOODWILL
GOODWILL DEFINED
Goodwill can be defined as the value of the commercial advantages which a business
entity enjoys over its competitors.
18.8 FACTORS CREATING OR CONTRIBUTING TO GOODWILL

The goodwill possessed by a firm may be due to the following factors, among others:
(a) Quality of the firm's product or service
(b) Personal reputation of the partners
(c) Complete or partial monopoly power enjoyed by the firm
(d) Favourable location of the business premises
(e) Possession of efficient and well-trained employees
(f) Possession of trade marks, patents or franchise
(g) Possession of well-known business name,
18.9 TYPES OF GOODWILL
18.9.1 Purchased Goodwill

This type of goodwill arises when one business entity acquires (i.e. purchases) control of
another business entity. In this instance, goodwill is simply the excess of the fair value of
purchase consideration over the fair value of the separable net assets acquired. In
accordance with IFRS 3 Business Combinations, an intangible asset, such as goodwill,
that is acquired in a business combination shall be measured at a cost which is its fair
value at the acquisition date. This type of goodwill satisfies the recognition criteria set by
IAS 38 – Intangible Assets. For this reason, it is carried as an asset in the acquirer's
statement of financial position.
286
18.9.2 Inherent Goodwill
This is the goodwill that internally generated in the firm i.e. it does not arise as a result of
the purchase of another business. According to IAS 38, internally generated goodwill is
not recognized as an asset for the following reasons:
 its cost cannot be measured reliably;
 it is not an identifiable resource controlled by the entity, that is it is not separable nor
does it arise from contractual or other legal rights
18.10 NATURE OF GOODWILL IN THE BOOKS OF A PARTNERSHIP

While there is an unanimous agreement as to the existence of inherent goodwill, no such
agreement exists as to the appropriate method of valuing it.
The very subjectiveness of goodwill valuation is the reason IAS 38 forbids its recognition
as an asset. It is therefore not nor proper to raise an account for inherent goodwill in a
partnership unless a fundamental change is about to take place that would after the
respective rights and stakes of the partners. The events that would give rise to such
fundamental change in the respective rights and stakes of partners are:
(i) Admission of a partner
(ii) Death/retirement of a partner
(iii) Change in profit-sharing ratio.
Note that if goodwill exists but is not shown in the books, the capitals of the partners are
understated to the extent of their respective share of the unrecorded goodwill. Also,
where goodwill is already show in the books but subsequent appreciation or depreciation
in the value thereof is not recorded, the partners’ capitals are understated or overstated to
the extent of their respective share of the unrecorded appreciation or depreciation in the
value of the goodwill.
Thus, the IAS 38 stipulation that inherent goodwill should not be recognized as an asset
is itself a recognition of the fact that where there is no change in the fundamental
arrangements in a partnership, it I not necessary to show goodwill – or subsequent
appreciation or depreciation in its value – in the books. If however, there is going to be a
change in the fundamental arrangements partnership such that the respective rights and
stakes of the partners will be altered, it becomes necessary to make appropriate
adjustments for inherent goodwill.
287
18.11 METHODS OF CALCULATING THE VALUE OF INHERENT GOODWILL
As already stated, the valuation of goodwill is one area of financial accounting where
objectivity and precision are absent. In many cases, the method chosen to value goodwill
is arbitrary and is often dictated by the custom of the trade in which the firm is engaged.
The following are among the more common methods of valuing goodwill.
18.11.1 Purchase of Average Profit

Under this method, the net profits for a number of past years are averaged and
multiplied by a chosen number. Thus two years' purchase of average profits implies that
the average profits will be multiplied by 2 to obtain the value of goodwill.
ILLUSTRATION 18.3:
The profits of a partnership firm for the five years ended 31st December 20X7 were as
follows:
Year Profit
N
20X3 10,000
20X4 6,000
20X5 3,000
20X6 5,000
20X7 7,000
The firm intends to admit a new partner on 1st January 20X8. For this purpose, the partners have
decided to value goodwill at 2 years' purchase of average profits.
Solution:
Using simple average profits:
Goodwill = 10,000 + 6,000 + 3,000 + 5,000 + 7,000 X 2yrs
5yrs 1
= 31,000 X2
5 1
= N12,400
Using weighted average profits:

Each year's profit is multiplied by a weight to get the total weighted profits which is divided by
the total weights to obtain the weighted average profit. The weights are allocated in ascending
288
order (i.e. one weight to the earliest year and five to the latest year) as shown in the calculations
below unless you are otherwise told:
(a) (b) (c) (d)
Year Weight Profit Weighted Profit
[(b) X (c)]
N N
20X3 1 10,000 10,000
20X4 2 6,000 12,000
20X5 3 3,000 9,000
20X6 4 5,000 20,000
20X7 5 7,000 35,000
Total 15 86,000
Weighted average profit = N86,000

15
= N5,733
 Goodwill = N5,733 X 2yrs
= N11,466.
Alternatively, the weighted average profit may be computed by allocating the weights in
descending order as shown below:
(a) (b) (c) (d)
Year Weight Profit Weighted Profit
[(b) X (c)]
N N
20X3 5 10,000 50,000
20X4 4 6,000 24,000
20X5 3 3,000 9,000
20X6 2 5,000 10,000
20X7 1 7,000 7,000
Total 15 100,000
Weighted average profit = N100,000

15
= N6,667
 Goodwill = N6,667 X 2yrs
= N13,334.
289
(ii) Purchase of Average Gross Fee Income
This method, frequently adopted by professional firms (solicitors, architects, accountants
etc) is similar to the above except that the chosen factor is applied to the average gross
fee income instead of net profit.
(iii) Purchase of Average Super Profits

Super profits are the profits in excess of the amount necessary to pay a fair return on the
capital employed in the business. Alternatively, super profits can be described as the
excess of actual profits of the firm over the normal profit of comparable businesses. The
purchases-of-super-profits method of valuing goodwill applies a given factor to the past
average super profits, in some cases, forecast super profits are substituted for past super
profits.
Illustration 18.4:
The facts are the same as in illustration 8.3. In addition, you are to assume that normal
profits, based on the profits of comparable firms, is N3,000 per annum. The partners have
decided to value goodwill at 4 years’ purchase of the average super profits over the last
five years.
Compute the value of goodwill.
Solution:
Average profit = N31,000 = N6,200
5
Less: Normal profit per annum = N3,000
Average super profit = N3,200
 Goodwill = N3,200 X 4 = N12,800
(iv) Capitalization of Super Profit

Under this method, the average super profit is capitalized at an appropriate rate of return
which takes account of the risk and uncertainty involved in the particular line of business
of the firm. The figure obtained is the present value of the perpetual annuity of the super
profit. Alternatively, the present value of the annuity of the super profit for a suitable
number of years may be calculated as the value of goodwill.
NB: In arriving at the net profits under method (i) or super profits under methods (iii) and
(iv) above, it is necessary to deduct a fair remuneration for partners in respect of their
services to firm, if the information is available.
290
Illustration 8.5:
A partnership firm had net tangible assets of N200.000 a 31st December 20X7. The normal rate
of return in the industry in which the firm operates is 20%. The partners are contemplating a
change in profit sharing ratio to take effect on 1st January 20X8. The profit of the firm for the
year was N45,000. Calculate the value of the firm's goodwill at 31/12/X7.
Solution:
N
Actual profit for the year 45,000

Less: Normal profit or, net tangible assets
employed = N200,000 x 20% = 40,000
Super profit 5,000
Goodwill = Capitalised value of super profit at 20%

= N5000 = N25,000*
0.20
* The firm's normal profit on the net tangible assets employed is N40,0000 which is lower
than the actual profit of N45,000. For the firm to have earned a profit higher than
N40,000, it must have been in possession of some assets (apart from the net tangible
assets of N200,000) which were not shown on its balance (i.e. intangible assets).
If the extra profit of N5,000 was generated with intangible assets, then the value of the
intangible asset that generated it at the rate of return of 20% must be the amount obtained
by dividing N5,000 by 20% i.e. N25,000. The intangible asset is the goodwill.
(v) Excess of value of a business over the value of net tangible assets
Under this method, the value of the business as a going concern is ascertained and the
value of the net tangible assets deducted there from to obtain the value of goodwill.
Illustration 18.6:
A and B trading in partnership are considering admitting C into the firm on 1st January 20X8.
For this purpose they agreed that goodwill be valued and appropriate adjustments raised at that
date. The projected future annual profit of the firm is N12,000 and total partners' remuneration is
projected at N4,000 per annum.
291
At 1st January 20X8, the value of the net tangible assets of the firm is N60,000 and expected
yield is 10% per annum.
You are required to calculate the value of the firm's goodwill at that date.
Solution:
N
Projected future annual profit 12,000
Less: Projected annual partners’ remuneration 4,000
(a) 8,000
Expected yield (b) 10%

N
Capital value of the business = a ÷ b = 80,000
Value of net tangible assets 60,000
Value of intangible assets (i.e. goodwill) 20,000
18.12 REVALUATION OF ASSETS

Revaluation of assets is the upward or downward review of the book value of assets. The
revaluation of the assets of a partnership is usually necessitated by the same factors,
mentioned earlier, that give rise to the adjustment for goodwill. The surplus or loss
arising from the revaluation of assets, like any other profit or loss of the business, will be
shared among the partners in the ratio in which they had sharing profits/losses.
The surplus or loss on revaluation is transferred to the partners' capital accounts unless
the examiner instructs otherwise. On the other hand, the revaluation of assets referred to
here is not necessarily on non-current assets alone and is occasioned by an event - such as
admission of partners, retirement/death of partners or change in profit sharing ratio -
which brings thee going concern of the existing partnership to an end and begins a 'new
one'. Even though no entries are passed to close the books of the firm, it must be
emphasized that once an admission, retirement/death or change in profit sharing ratio
takes place in a partnership, it marks the end of one business and the beginning of another
one. Therefore, any surplus or loss on the revaluation of assets occasioned by any of
these events written off to the partners' capital accounts in their profit sharing ratio.
292
In view of the foregoing, it must be pointed out that revaluation of non-current assets
carried out in a partnership under circumstances other than admission of partners,
retirement/death of partners and change in profit sharing ratio while the firm is still a
going concern will be dealt with as outlined in chapter 4 on pages 104 - 109.
18.13 ADMISSION OF A PARTNER

When a partner is to be admitted, the in-coming partner will usually introduce an amount
as his capital. In addition, he may be required to pay an amount for the share of goodwill
which he is coming in to take.
In adjusting for goodwill, its value may or may not be retained in the books. It is usual,
but not compulsory, for the partners to decide not to retain goodwill in the books if the in-
coming partner pays for his share of goodwill.
In addition to the adjustment for goodwill, some of the other assets of the firm may be .
After the admission of the new partner, a decision may be reached not to retain the
revalued amounts of the assets, in which case the pre-revaluation values of the assets will
be re-instated.
Accounting Entries
i). To bring goodwill into the books:
Dr: Goodwill Account with the value of goodwill shared
Cr: Partners' Capital Accounts in their old profit-sharing ratio.
ii). Total amount introduced by the new partner:

Dr: Bank/Cash Account with the total sum introduced
Cr: Capital Account of new partner by the new partner
iii). Reversal of goodwill, if it is not to be retained in the books:

Dr: Partners' Capital Accounts with the value of goodwill shared
Cr: Goodwill Account in the new profit-sharing ratio
iv). Revaluation of assets:
(a) Increase in value of assets:
Dr: Assets Accounts with the increase in
Cr: Revaluation Account the value of assets.
293
(b) Decrease in value of assets:
Dr: Revaluation Account with the decrease in
Cr: Assets Accounts the value of assets
(c) Gain/Loss on revaluation of assets:

Dr: Revaluation Account with the gain on revaluation shared
Cr: Partners’ Capital Accounts in the old profit-sharing ratio.
OR
Dr: Partners’ Capital Accounts with the loss on revaluation shared

Cr: Revaluation Account in the old profit-sharing ratio.
v). To restore the revalued assets to their original values, if necessary:

(a) Reverse entries (iv) (a) and (b)
(b) Reverse entry (iv) (c) in their new profit-sharing ratio
Note:
Where the in-coming partner pays for his share of goodwill and the partners decide that
goodwill should not be retained in the books, the adjustments can be made without
opening a goodwill account, if there is no change in the relative profit sharing ratio of
the old partners thereby replacing entries (i) to (iii) above with the following entries.
The amount paid by the in-coming partner for his share of goodwill will be debited to
bank/cash account and credited to the capital accounts of the old partners in their old
profit-sharing ratio. Thereafter, the amount paid by the in-coming partner for his capital
will be debited to bank/cash account and credited to his capital account. These
adjustments may be summarized as follows:
i). DR: Bank/Cash a/c with the amount paid by the new partner for
CR: Capital accounts of old partners his share of goodwill in their old profit-
sharing ratio
ii). DR: Bank/Cash a/c with the amount paid by the
CR: Capital Account of new partner new partner for his capital.
Illustration 18.7: Goodwill to be retained in the books

Ayo and Bello had been in partnership business sharing profits/losses in ratio 2:1
respectively. At 31st December 20X6, the statement of financial position of the
partnership was as follows:
294
ASSETS N N N
Non-current assets
Land and buildings 5,250
8,325
Current Assets
Inventory 4,500
Receivables 3,000
Less: Provision for doubtful debt (150)
2,850
Cash at bank 300
7,650
Total Assets 15,975

Capital accounts: A 8,500
B 3,500
12,000
Current Liabilities
Payables 3,975
Total equity and liabilities 15,975
On 1st January 20X7, C was admitted into the partnership to take one-fifth of profits while the
relative profit-sharing ratio of A and B remains the same. C paid she sum of N4.500 for his
capital. The goodwill of the firm was valued at N6,000. For the purpose of the admission of C,
some assets of the firm were revalued at the following amounts:
Land and building N8,000
Plant and Machinery N5,000
Inventory N4,325
You are required to show the ledger entries necessary upon the admission of C and the statement
of financial position of the firm after the admission.
295
Solution:
Capital Account
A B C A B C
N N N N N N
Balance c/d 15,500 7,000 4,500 Balance b/d 8,500 3,500 -
Goodwill 4,000 2,000 -
Bank - - 4,500
Revaluation 3,000 1,500 -
15,500 7,000 4,500 15,500 7,000 4,500
Balance b/d 15,500 7,000 4,500
Goodwill Account
N N
Capital – A 4,000 Bal. c/d 6,000
Capital – B 2,000
6,000 6,000
Bal. b/d 6,000
Bank Account
N N
Bal. b/d 300 Bal c/d 4,800
Capital – C 4,500
4,800 4,800
4,800
Revaluation Account
N N
Inventory 175 Land and buildings 2,750
Capital – A 3,000 Plant and Machinery 1,925
Capital – B 1,500
4,675 4,675
296
Land and buildings Account
N N
Bal. b/d 5,250 Bal. b/d 8,000
Revaluation 2,750
8,000 8,000
Bal. b/d 8,000
Plant & Machinery Account

N N
Bal. b/d 3,075 Bal c/d 5,000
Revaluation 1,925
5,000 5,000
Bal. b/d 5,000
Inventory Account
N N
Bal. b/d 4,500 Revaluation 175
Bal. c/d 4,325
4,500
4,500
Bal. b/d 4,325
A, B and C
Statement of financial position as at 1st January 20X7
N N N
Non – current assets
13,000
Intangible Asset
Goodwill 4,325
Receivables 3,000
Less: Provision for doubtful debt 150
2,850
Cash at Bank 4,800
11,975
30,975
297
Capital Accounts: A 15,500
B 7,000
C 4,500
27,000
Current Liabilities
Payables 3,975
ILLUSTRATION 18.8.: Goodwill not to be retained in the books

The facts are the same as in illustration 8.7 except that C also paid N1,200 for his share of
goodwill. It was therefore decided that the necessary adjusting entries should be passed without
retaining the goodwill in the books. The partners also decided to re-instate the original values of
the revalued assets.
You are required to make the required adjustment and show the statement of financial position of
the new firm immediately after the admission of C.
Solution:
Capital Accounts
A B C A B C
N N N N N N
Goodwill 3,200 1,6001,200 Bal. b/d 8,500 3,500 -
Revaluation 2,400 1,200900 Goodwil 4,000 2,000 -
Bal. c/d 9,900 4,2003,600 Bank - - 5,700
15,500 7,000 5,700 15,500 7,000 5,700
Bal. b/d 9,900 4,200 3,600
Goodwill Account
N N
Capital – A 4,000 Capital – A 3,200
Capital – B 2,000 Capital – B 1,600
Capital – C 1,200
6,000 6,000
298
Bank Account
N N
Bal. b/d 300 Bal. c/d 6,000
Capital 5,700
6,000 6,000
Revaluation Account
N N
Inventory 175 Land & Building 2,750
Capital – A 3,000 Plant & machinery 1,925
Capital – B 1,500
4,675 4,675
Land & Buildings 2,750 Inventory 175

Plant & Machinery 1,925 Capital – A 2,400
Capital – B 1,200
_____ Capital – C 900
4,675 4,675
Land and Buildings Account

N N
Balance b/d 5,250 Revaluation 2,750
Revaluation 2,750 Bal. c/d 5,250
8,000 8000
Bal. b/d 5,250
Plant and Machinery Account

N N
Balance b/d 3,075 Revaluation 1,925
Revaluation 1,925 Balance c/d 3,075
5,000 5,000
Bal. b/d 3,075
299
Inventory Account
N N
Bal. b/d 4,500 Revaluation 175
Revaluation 175 Bal. c/d 4,500
4,675 4,675
Bal. b/d 4,500
A, B and C
Statement of financial position as at 1st January 20X7
Non – Current assets N N N
8,325
Current Assets
Inventory 4,500
Receivables 3,000
Less: Provision for doubtful debt (150) 2,850
Cash at bank 6,000
13,350
Total Assets 21,675

Capital Account – A 9,900
-B 4,200
-C 3,600
17,700
Current Liabilities
Payables 3,975
______
300
WORKINGS
Calculation of New Profit Sharing Proportions
A B C
2 1
Old profit sharing proportions /3 /3 -
2 1
One-fifth share given to C - /15 - /15 +3/15
8 4 3
New profit sharing proportions /15 /15 /15
From this calculation, it can be seen that before C’s admission, A’s share of profit was twice that
of B and after C’s admission, A’s share of profit continued to be twice that of B. thus, C’s
admission has not altered the relative profit sharing ratio A and B.
Alternative Approach
Since C was able to pay for his share of goodwill and, for this reason, it was decided not to retain
goodwill in the books, it is possible to pass the necessary adjustments without opening goodwill
account as was done in the solution above. In this alternative approach, the capital accounts and
bank accounts will look as follows:
Capital Accounts
A B C A B C
N N N N N N
Revaluation 2,400 1,200 900 Balance b/d 8,500 3,500 -
Bal. c/d 9,990 4,200 3,600 Bank 800 400 4,500
12,300 5,400 4,500 12,300 5,400 4,500
Balance b/d 9,900 4,200 3,600
Bank Account
N N
Bal. b/d 300 Bal. c/d 6,000
Capital - A 800
-B 400
-C 4,500 ______
6,000 6,000
Balance b/d 6,000
301
NB:
i). This alternative approach can be used only when there is no change in the relative profit
sharing ratio of the old partners.
ii). As can be seen, the partners' capital accounts and the bank account balances remain the
same.
iii). The entries in the other accounts remain the same, so they are not repeated.
iv). The first approach will work in all cases whether the relative profit-sharing ratio of the
partners changed or not.
18.14 ADMISSION OF A PARTNER DURING THE YEAR

When a partner is admitted during the year, the partners may decide not to close the
books of the firm but to continue with the records until the end of the year when the
necessary adjustments will be made.
Technically, there has been two partnership businesses during the year – the one in
existence up to the admission of the new partner and the one that commenced from the
date of admission to the year – end. The two partnerships will have different agreements
regarding the allocation of profits – if nothing else changes, the profit-sharing ratio will
definitely change. Whereas there were actually two different partnerships during the year,
there will be only one trial balance at the year-end. The problem then arises as to how the
profits of the year will apportioned between the periods prior to and after the date of
admission.
In apportioning the profit, the following rules apply:

(i). Gross profit should be apportioned in proportion to the sales of the respective periods
unless you are otherwise told.
(ii). Expenses that are related to sales such as salesmen’s commission, discount allowed, bad
debt, carriage outwards, advertising e.t.c should be apportioned in proportion to sales
A strong argument can be made that bad debt is an administrative expense and not a
selling expense. However, a stronger argument can also be made to counter this position.
The balance seems to tilt towards treating bad debt as a selling expense. So unless you
told otherwise, bad debt should be apportioned in proportion to sales.
Even though the necessary adjustments were not made at the date of admission, the cash
introduced by the in-coming partner might have been credited to a suspense account. At
the end of the year, when the adjustments are being made, this amount would be
transferred out of the suspense account to the capital account of the new partner. If
302
necessary, adjusting entries for goodwill and revaluation of assets will be made in the
normal way already outline.
ILLUSTRATION 18.9:
Sea and Land were in partnership sharing profits and losses equally and taking interest on
capital at 8% per annum while Forest acts as their general manager receiving a bonus of
6% of the gross profit. In addition to the bonus, Forest receives a salary of N2,500
monthly.
On 1st September, 20X2, the partners admitted Forest under the following conditions:
i. Forest shall be entitled to 1/5th of profit while the relative profit sharing ratio of Sea and
Land remains unchanged.
ii. He is to introduce N50,000 as his capital.
iii. He is to pay for his share of" goodwill but goodwill is not to be retained in the books.
iv. The goodwill of the firm at that date was valued at N37,500.
v. The salary and bonus to which Forest had earlier been entitled as a general manager
should stop forthwith.
In order to give a true reflection of the value of the assets of the firm at 1st September
20X2, the partners agreed to revalue their land & buildings at N142,000 and motor
vehicle and other equipment at N120,000
The firm charges depreciation on the motor vehicles and other equipment at 20% per
annum. The trial balance of the firm at the end of 20X2 before giving effect to the
adjustments necessitated by the admission of Forest was as shown below:
303
Trial Balance as at 31st December 20X2
DR CR
N N
Capital Accounts – Sea 150,000
- Land 75,000
Current Account – Sea 39,000
- Land 35,000
Land and Buildings 90,000
Equipment and vehicles 105,000
Suspense 57,500
Sales 600,000
Inventory 30,000
General Manager’s Salary 20,000
General Manager’s bonus 5,250
Receivables and Payables 54,250 19,500
Business expenses - 75,000
Bank 30,000
Cash 12,500
Purchases 406,000 ________
902,000 902,000
You are to assume that business expenses were incurred evenly throughout the year and the gross
profit was earned as follows:
January to August: 65%
September to December: 35%
100%
The amount introduced by Forest had been credited to a suspense account pending the date when
proper adjustment will be made. Closing inventory at 31st December 20X2 was valued at
N46,000.
You are to prepare:
(i). Trading and statement of profit or loss for the year ended 31st December 20X2
(ii). Statement of financial position as at that date.
(iii). Partners’ capital and current accounts for the year.
304
Solution:
i). Sea, Land and Forest
Statement of profit or loss for the year ended 31st December, 20X2
Sea & Land Sea, Land Total
& Forest
Jan – Aug. Sept – Dec.
N N N N N N
Sales 600,000
Less: Cost of goods Sold
Purchases 406,000
Goods available for sale 436,000
390,000
Gross Profit 136,500 73,500 210,000
Less: Expenses
General Manager’s Salary 20,000 - 20,000
General Manager’s Bonus
(6% X N136,500) 8,190 - 8,190
Business expenses 50,000 25,000 75,000
Depreciation (W4) 14,000 8,000 22,000
(92,190) (33,000) (125,190)
Net Profit 44,310 40,500 84,810
Appropriation Account
Less: Interest on Capital:
Sea 8,000 5,180 13,180
Land 4,000 3,180 7,180
Forest ____- 1,333 1,333
(12,000) (9,693) (21,693)
Divisible Profits 32,310 30,807 63,117
Share of Profits:
Sea 16,155 12,323 28,478
Land 16,155 12,323 28,478
Forest ____-_ 6,161 6,161
32,310 30,807 63,117
305
(ii). Sea, Land & Forest
N N N
Non-current assets
Land and buildings (W.3) 142,000
Equipment and vehicles (W .4) 112,000
254,000
Current assets
Inventory 46,000
Receivables 54,250
Bank 30,000
Cash 12,500
142,750
Total Assets 396,750
Capital Accounts:
- Sea 194,250
- Land 119,250
- Forest 50,000
363,500
Current Accounts:
- Sea 2,658
- Land 658
- Forest 10,434 13,750
377,250
Current liabilities
Payables 19,500
_______
306
(iii) Capital Accounts
Sea Land Forest Sea Land Forest
N N N N N N
1/9X2 Bal. c/d 194,250 119,250 50,000 1/1/X2 Bal b/d 150,000 75,000 -
1/9/X2 Suspense 3,750 3,750 50,000
1/9/X2 Revaluation 40,500 40,500 -
194,250 119,250 50,000 194,250 119,250 50,000

1/9X2 Bal. b/d 194,250 119,250 50,000
Current Accounts
Sea Land Forest Sea Land Forest

N N N N N N
1/1/X2 Bal. b/d 39,000 35,000 - 31/12/X2 Int. on capital 13,180 71,180 1,333
31/12/X 2 Bal c/d 2,658 658 10,434 31/12/X2 Share of profit 28,478 28,478 6,161
31/12/X2 Bonus (W.6) - - 2,940
41,658 35,658 10,434 41,658 35,658 10,434
1/9X2 Bal. b/d 2,658 658 10,434
Workings
(W.1) Suspense Accounts
N N
1/9/X2 Capital – Sea 3,750 1/9/X2 Bal b/d 57,500
- Land 3,750
- Forest 50,000 ______
57,500 57,500
(W.2) Revaluation Accounts

N N
1/9X2 Capital - Sea 40,500 1/9/X2 Land & Building 52,000
- Land 40,500 1/9X2 Equipment & Vehicle 29,000
81,000 81,000
307
(W.3) Land & Building Accounts
N N
1/9/X2 Bal b/d 90,000 31/8/X2 Bal c/d 142,000
31/8/X2 Revaluation 52,000 _______
142,000 142,000
(W.4) Equipment & Vehicle
N
NBV at 1/1/X2 105,000
Less: Depreciation for Jan – Aug. 20X2 [20% X N105,000X 8/12] 14,000
NBV at 31/8/X2 91,000
Add: Revaluation surplus at 1/9/X2 29,000
Revalued amount at 1/9/X2 120,000
Less: Depreciation for Sept – Dec. 20X2 [20% X N120,000 X 4/12] (8,000)
NBV at 31/12/X2 112,000
(W.5) Interest on Capital
January to August 20X2

N
8
Sea: 8% X 150,000 X /12 = 8,000
Land: 8% X 75,000 X 8/12 = 4,000
12,000
September to December 20X2

The interest on capital for September to December 20X2 will be based on the adjusted capital
account balances at 1st September 20X2 [See capital accounts in part (iii)]:
N
Sea: 8% X 194,250 X 4/12 5,180
Land: 8% X 119,250 X 4/12 3,180
Forest: 8% X 50,000 X 4/12 1,333
9,693
(W.6) Accrued General Manager’s Bonus N

Bonus due to Forest = 5% X N136,500 8,190
Less: Bonus already paid per trial balance 5,250
Outstanding bonus 2,940
308
NOTE: The amount of credited to suspense account N57,500 is made up of Forest’s capital of
N50,000 and N7,500 being 1/5th of goodwill [i.e. 1/3 X 37,500 = N7,500].
The N50,000 should be credited to Forest’s capital account. As for the N7,500 paid for
his share of goodwill, this amount has been credited to the capital accounts of Sea and
Land in the ratio in which both share profits.
18.15 GUARANTEE OF PROFITS TO A PARTNER

Sometimes when a new partner is admitted, one or more of the old partners may
guarantee the new partner a minimum share of profit. Should the share of profit of the
guaranteed partner using the agreed profit sharing ratio fall short of the minimum, the
shortfall will be made good out of the share of profit of the guaranteeing partners in the
ratio in which they share profits unless otherwise agreed.
In this circumstance, the following points must be settled.
(i) The duration of the guarantee

(ii) Whether the principle of short-workings, as in royalty accounts, applies. If this
principle applies the amount made up to the guaranteed partner will be carried
forward against him to be taken out of his share of profit in subsequent year(s)
provided that his share does not fall below the guaranteed minimum. For
examination purpose, assume that the principle of short-workings does not apply
ILLUSTRATION 18.10:
A and B who had been trading in partnership for many years and had been sharing profits and
losses equally admitted C on 1st January 20X6. The profit sharing ratio was adjusted to 2:2:1
respectively.
Among the terms of C's admission is the guarantee made by A and B that C's share of divisible
profit will not fall below N150,000.
During the year ended 31st December 20X6, the divisible profit of the firm was N500,000.
You are required to compute the shine of profit for the year ended 31ST December 20X6.
309
Solution:
In the first instance, the agreed profit sharing ratio of 2:2:1 will be applied to the to the divisible
profit of N500,000 to see if C's share will be equal to or higher than the guaranteed minimum. If
that is the case, no adjustment is called for.
If, however, C's share is lower than the guaranteed minimum, it would be necessary to do an
adjustment by adding the shortfall to C's share and deducting same amount from the respective
share of A and B in the ratio in which they share profit which, in this illustration, is equal.
The required calculations are set out below:

A B C Total
N N N N
Share of divisible profit of N500,000
In ratio 2:2:1 respectively 200,000 200,000 100,000 500,000
C’s shortfall borne by A and B equally (25,000) (25,000) 50,000 -______
175,000 175,000 150,000 500,000
18.16 RETIREMENT/DEATH OF A PARTNER

When a partner retires or dies, the out-going partner or the representative (i.e. estate) of
the dead partner is entitled to have the asses, including the goodwill, of the firm revalued.
This would ensure that his capital account balance and, by implication, the sum due to
him is appropriately increased or decreased by his share of the appreciation or
depreciation revealed by the revaluation.
The sum due to the out-going partner or the estate of the dead partner may be paid
immediately by the firm. If the firm is unable to do so. any of the following arrangements
may be agreed upon:
(i) Amount due credited to a loan account

The loan may be paid by installments with interest accruing on the outstanding balance.
Alternatively, the loan may be paid at a specified date together with accumulated interest
up to the date of repayment.
(ii). Amount due settled by way of an annuity

Agreement may be made to pay the out-going partner or the representative of the dead
partner an annuity either for a certain number of years or for the life time of the retired
partner or the representative of the dead partner.
310
In this case, the amount due is transferred to the credit side of an annuity suspense. This
account is debited annually with the annuity paid while it is credited with interest at a
fixed rate per annum or the diminishing balance. The Statement of profit or loss takes the
charge for the interest. If the annuitant dies before the credit balance on the annuity
suspense account is exhausted, the remaining balance is profit to the continuing partners
and will be transferred to their capital accounts in their profit-sharing ratio.
If the credit balance on the annuity suspense account is exhausted during the lifetime of
the annuitant, subsequent installments will be borne by the continuing partners and
debited to their current accounts.
Accounting Entries
i). To bring goodwill into the book.-:
DR: Goodwill Account with the value of goodwill shared to
CR: Partners Capital Account the partners in their profit-sharing ratio
ii). Revaluation of assets:

(a) Increase in value of assets:
DR: Assets A/c with the increase in the value of the assets
CR: Revaluation A/c
(b) Decrease in value of assets:

DR: Revaluation A/c with the decrease in the value of assets
CR: Assets A/c
(c) Gain/Loss on revaluation of assets:

DR: Revaluation A/C with the gain on revaluation shared in
CR: Partners' Capital A/C the pre-retirement profit-sharing ratio.
Or
DR: Partners’ Capital A/C with the loss on revaluation shared in
Revaluation A/C the pre-retirement profit-sharing ratio.
iii). Payment of the amount due to the out-going partner:

DR: Capital account of the out-going with the amount of the credit balance
partner On the capital account of the out-
CR: Bank/Cash account going partner.
311
iv). Transfer of amount due to the out-going partner to loan account:
DR: Capital account of out-going with the amount due to the
partner out-going partner.
CR: Loan account
v). Transfer of amount due to the out-going partner to annuity suspense account:
DR: Capital account of out-going with the amount due to
partner the out-going partner.
CR: Annuity suspense A/c
vi). Reversal of goodwill, if necessary, after retirement of partner:

DR: Capital accounts of continuing with the value of goodwill shared in
partners post-retirement profit-sharing ratio.
CR: Goodwill A/c
vii). Reversal of revaluation of assets, if necessary:

(a) Reverse entry (ii) (a) or (b) as appropriate.
(b) Reverse entry (ii) (c) in the post-retirement profit-sharing ratio.
ILLUSTRATION 18.11: Amount due to Ex-Partner Credited to Loan Account.

Funmi, Remi and Titi were partners in the fashion business. They had been sharing profits in
ratio 3:2:1 respectively. Titi retired from the partnership on 31st March 20X1. Goodwill of the
firm which had not been previously recorded was valued at N6,000. The assets of the firm were
revalued at the following amounts:
N
Furniture 3,000
Receivables 4,100
At 31st March 20X1, the statement of financial position of the firm was as follows:
312
Statement of financial position as at 31st March 20X1
N N N
Non-current assets
Furniture 4,000
20,000
Current assets
Inventory 3,500
Receivables 4,800
Bank/Cash 1,700
10,000
Total Assets 30,000
Capital Accounts:
- Funmi 10,000
- Remi 8,000
- Titi 7,000
25,000
Current Liabilities
Payables 3,500
Accruals 1,500
5,000
30,000
Due to the lean financial resources of the firm, it was unable to pay Titi’s entitlement at the date
of her retirement. She therefore agreed that the amount due to her be transferred to a loan
account to be paid over six equal yearly installments, each installment to include principal and
interest on the outstanding balance at 5% per annum. The first installment was paid on the 1st of
April 20X1, while the remaining installments will be paid every year-end.
(i) Partners Capital Account
(ii) Goodwill Account
(iii) Revaluation Account
(iv) The statement of financial position of the firm immediately after Titi’s Retirement
(v) Loan account (up to liquidation of the loan).
313
Solution:
(i) Capital Accounts
Funmi Remi Titi Funmi Remi Titi
N N N N N N
Loan - - 8,880 Balance b/d 10,000 8,000 7,000
Bal. c/d 15,400 11,600 - Goodwill 3,000 2,000 1,000
Revaluation 2,400 1,600 800
15,400 11,600 8,800 15,400 11,600 8,800
Bal. b/d 15,400 11,600 -

N N
Capital: Funmi 3,000 Balance c/d 6,000
Remi 2,000
Titi 1,000 _______
6,000 6,000
Bal. b/d 6,000
(iii) Revaluation A/C

N N
Furniture 1,000 Land & Buildings 8,000
Motor vehicles 1,500
Receivables 700
Capital – Funmi 2,400
Capital – Remi 1,600
Capital – Titi 800 ______
8,000 8,000
314
(iv) Funmi and Remi
Statement of Financial position as at 1st April 20X1
N N N
Non-current assets
Furniture 3,000
25,500
Intangible Asset
Goodwill 6,000
Current Assets
Inventory 3,500
Receivables 4,100
Bank/Cash 1,700
9,300
Total Assets 40,800

Capital Accounts:
- Funmi 15,400
- Titi 11,600
27.000
Non-current Liabilities
Loan (Titi) 8,800
Current Liabilities
Payables 3,500
Accruals 1,500
5,000
As shown on the statement of financial position above, the amount due to Titi on her retirement –
which have been converted to a 5% loan – is N8,800. She is to be repaid this loan in six equal
annual installments with the first installment being paid immediately (Year 0) and the remaining
installments being paid annually thereafter (i.e. from Year 1 to Year 5). Interest is to be paid on
the outstanding balance at the rate of 5% per annum.
Since the present value of the stream of equal annual cash flows (i.e. annuity) required to settle
the loan, at the discount rate of 5%, must be equal to the amount of the loan (i.e. N8,800), the
annual repayment can be computed using the annuity formula (modified to recognize the fact
that the first installment is payable immediately) as expressed below:
315
P = a + a[1 – (1 + r)-n]
r
where: P = the present value (i.e. the amount of the loan N8,800)
a = the annual repayment
r = the interest rate
n = the number of years which in this case is 5 because the first
of the six installments is payable in Year 0.
We will now substitute for the known variables and solve for a, the unknown variable:
8,800 = a + a[1- (1+0.05)-5]
0.05
8,800 = a + a(1 – 1.05-5)
0.05
8,800 = a + a(1 – 0.7835)
0.05
8,800 = a + 0.2165a
0.05
8,800 = a + 4.33a
8,800 = 5.33a
 a = 8,800
5.33
= N1,651
316
Titi’s loan account, written up to the eventual liquidation of the loan, will look as follows:
(v). Loan (Titi) Account

N N
31/3X1 Bal. c/d 8,800 31/3X1 Capital – Titi 8,800
1/4/X1 Bank 1,651 1/4X1 Bal. b/d 8,800

31/3/X2 Bank 1,651 31/3X2 Interest (5% X 7,149) 357
31/3/X2 Bal. c/d 5,855 ______
9,157 9,157
31/3/X3 Bank 1,651 1/4/X2 Bal. b/d 5,855

31/3/X3 Bal. c/d 4,497 31/3/X3 Interest (5%X5,855) 293
6,148 6,148
31/3/X4 Bank 1,651 1/4X3 Bal. b/d 4,497

31/3/X4 Bal. c/d 3,071 31/3X4 Interest (5% X 4,497) 225
4,722 4,722
31/3/X5 Bank 1,651 1/4/X4 Bal. b/d 3,071

31/3/X5 Bal. c/d 1,574 31/3/X5 Interest (5% of 3,071) 154
3,225 3,225
31/3X6 Bank 1,651 1/4/x5 Bal. b/d 1,574

____ 31/3/X6 Interest (5% X 1,574) 77 *
1,651 1,651
* Rounded down from N79 to N77 to compensate for earlier rounding errors.
ILLUSTRATION 18.12:
In illustration 18.11 above, the annuity formula was modified to incorporate the fact that the first
of the six annual installments was paid to Titi immediately. This is why n in the formula is 5
instead of 6.
If, however, the first installment is payable to Titi one year after her retirement with the
subsequent installments being paid every year – end, n would be 6 and the calculation of the
annual repayment would be made using the annuity formula as shown below:
317
P = a[1 – (1 + r)-6]
r
8,800 = a + a[1- (1+0.05)-6]
0.05
8,800 = a + a(1 – 1.05-6)
0.05
8,800 = a + a(1 – 0.7462)
0.05
8,800 = a + 0.2538a
0.05
8,800 = 5.076a
 a = 8,800
5.076
= N1,734.
In this case, Titi’s loan account, written up to its eventual liquidation, will look as follows:
Loan (Titi) Account
N N
31/3X1 Bal. c/d 8,800 31/3X1 Capital – Titi 8,800
31/3/X2 Bank 1,734 1/4X1 Bal. b/d 8,800

31/3/X2 Bank 7,506 31/3X2 Interest (5% X 8,800) 440
9,240 9,240
31/3/X3 Bank 1,734 1/4/X2 Bal. b/d 7,506

31/3/X3 Bal. c/d 6,147 31/3/X3 Interest (5%X7,506) 375
7,881 7,881
31/3/X4 Bank 1,734 1/4X3 Bal. b/d 6,147

31/3/X4 Bal. c/d 4,720 31/3X4 Interest (5% X 6,147) 307
6,454 6,454
31/3/X5 Bank 1,734 1/4/X4 Bal. b/d 4,720

31/3/X5 Bal. c/d 3,222 31/3/X5 Interest (5% of 4,720) 236
4,956 3,225
31/3/X6 Bank 1,734 1/4/x5 Bal. b/d 3,222

31/3/x6 Bal. c/d 1,649 31/3/X6 Interest (5% X 3,222) 161
3,383 3,383
31/3/X7 Bank 1,734 1/4/X6 Bal. b/d 1,649

____ 31/3/X7 Interest (5% X 1,649) 85 *
1,734 1,734
* Rounded up from N82 to N85 to compensate for earlier rounding errors.

318
ILLUSTRATION 18.13:
Assume that the facts are the same as in illustration 8.11 except that the continuing
partners decided that goodwill should not be retained and that the previous values of the
revalued assets be restored. The profit-sharing ratio of the continuing partners was
adjusted to ratio 2:1 respectively.

(i) Partner’s capital accounts
(ii) Goodwill account
(iii) The statement of financial position after Titi’s retirement
Solution:
(i) Capital Account
Funmi Remi Titi Funmi Remi Titi
N N N N N N
Loan - - 8,800 Bal. b/d 10,000 8,000 7,000
Goodwill 4,000 4,000 - Goodwill 3,000 2,000 1,000
Bal. c/d 3,200 1,600 - Revaluation 2,400 1,600 800
8,200 8,000 -
15,400 11,600 8,800 15,400 11,600 8,800
Bal. b/d 8,200 8,000 -

N N
Capital – Funmi 3,000 Capital – Funmi 4,000
Capital – Remi 2,000 Capital – Remi 2,000
Capital – Titi 1,000 _______
6,000 6,000
319
(iii). Funmi and Remi
Statement of financial position as at 1st April 20X1
N N N
Non – Current assets
Furniture 4,000
20,000
Current assets
Inventory 3,500
Receivables 4,800
Bank/Cash 1,700
10,000
Total Assets 30,000
Capital Accounts:
- Funmi 8,200
- Titi 8,000
16,200
Non-Current Liabilities
Loan (Titi) 8,800
Current Liabilities
Payables 3,500
Accruals 1,500
5,000
320
ILLUSTRATION 18.14: Settlement of amount due to ex-partner by payment of annuity.
X, Y and Z were partners in a firm sharing profits and losses in ratio 3:2:1 respectively. X
retired from the firm on 31st December 20X4, the determined amount of his share in the business
being N20,000.
X agreed that the balance due to him should be commuted to an annuity of N3,000 the first
payment being made on the following day and subsequent payments on 1st January of each year.
X died after receiving the fifth annuity payment.
Show the annuity suspense account assuming that the outstanding amount earned interest at the
rate 6% per annum. Make calculations to the nearest naira.
Solution:
Annuity Suspense Account
N N
31/12/X4 Balance c/d 20,000 31/12/X4 Capital – X 20,000
1/1/X5 Bank 3,000 1/1/X5 Balance b/d 20,000

31/12/X5 Balance c/d 18,020 31/12/X5 Interest [6% X 17,000] 1,020
21,020 21,020

31/12/X6 Balance c/d 15,921 31/12/6 Interest [6% X 15,020] 901
18,921 18,921

31/12/X7 Balance c/d 13,696 31/12/X7 Interest [6% X 12,921] 775
16,696 16,696
1/1x8 Bank 3,000 1/1/X8 Balance b/d 13,696

31/12/X8 Balance c/d 11,338 31/12/X8 Interest [6% X 10,696] 642
14,338 14,338

31/12/X9 Capital – Y 5,559
-Z 2,779 ______
11,338 11,338
321
18.17 MEASURES TO ENSURE AVAILABILITY OF CASH TO PAY OFF EX-
PARTNER(S)
In order to ensure that cash will be available to pay the amount due to an out-going or
dead partner, the firm may decide to set aside money to invest in securities or take an
insurance policy on the lives of the partners.
18.18 INVESTMENT
If the firm chooses the option of investing in securities, the required amount will be
invested annually. The dividends or interests received on the investments are usually re-
invested. When the need for the cash arises (i.e. when a partner retires or dies), the
investments are realized an any profit or loss thereon credited or debited to the statement
of profit or loss.
18.19 LIFE INSURANCE POLICY

If the firm chooses the option of life insurance policy for the partners, this usually takes
the form of a joint policy on the lives of the partners.
The policy may be recorded in either of 2 ways:

(i). The premium paid is regarded as an ordinary business expense and is, therefore, debited
to the statement of profit or loss while the cash book is credited. This approach treats the
insurance policy as an off-statement of financial position transaction. i.e. the policy does
not appear on the statement of financial position. When the policy becomes payable, by
the death of one of the partners, or the policy is surrendered in the case of retirement of a
partner, the amount received from the insurance company is treated as a “profit” to be
credited to the partners’ accounts in. the profit-sharing ratio (unless the partners had
agreed on a different ratio) while the cash book is debited.
(ii) The premium is treated as an investment so that the insurance policy appears on the
statement as an asset representing an insurance policy fund of the same amount. When
the premium is paid, the life insurance policy account is debited while the cash book is
credited. At the same time, the statement of profit or loss is debited with the same amount
while the life insurance fund account takes the credit. If the firm so decides, any
appreciation in the value of the policy is, at the end of the year, debited to the life
insurance policy account and credited to the life insurance fund account. Where there is a
diminution in the value, the reverse entry is passed.
322
When a partner dies or when the policy is surrendered due to the retirement of a partner,
the amount received from the insurance company is debited to the cash book while the
life insurance policy account is credited. The balance on the life insurance policy account
is then shared among the partners in their profit-sharing ratio or in any other agreed ratio
and debited or credited to the partners 'capital accounts the opposite but corresponding
entries being posted to the life insurance policy account. Thereafter, the credit balance on
the life insurance fund account is shared among the partners in their profit-sharing ratio
(unless the partners had agreed to a different ratio) debiting the life insurance fund
account and crediting the partners capital accounts.
ILLUSTRATION 18.15:
X, Y and Z trading in partnership had been sharing profits in ratio 3:3:2 and they took a joint life
insurance policy some years ago under which the annual premium, payable in advance on 1st
January every year, is N10,000. On 31st December 20X4, the credit balance on the life insurance
fund account was N245,000 represented by a debit balance of the same amount on the life
insurance policy account. At that date, the life insurance policy was revalued upwards by
N5,000 to give effect to the appreciation in its value.
On 1st January 20X5, the premium for that year was paid. On 31st December 20X5, Y died and
on 1st January 20X6, the surviving partners collected from the insurance company the sum due
on the death of Y, N36,000. They also surrendered the rest of the policy for N150,000 at the
same date.

(i) Life Insurance Policy Account
(ii). Life Insurance Fund Account
(iii). The abridged statement of financial position of the firm as at 31st December 20X4
323
Solution:
(i) Life Insurance Policy Account

N N
31/12/X4 Balance b/d 245,000 31/12/X4 Balance c/d 250,000
31/12X4 Life Insurance Fund _5,000 ______
250,000 250,000
1/1/X5 Balance b/d 250,000 31/12/X5 Balance c/d 260,000

1/1/X5 Cash book (Insurance Premium) 10,000 _______
260,000 260,000
1/1/X6 Balance b/d 260,000 1/1/X6 Bank (360,000 + 150,000) 510,000

1/1/X6 Capital – X 93,750
-Y 93,750
-Z 62,500 ________
510,000 510,000
31/12/X4 Balance b/d 250,000 31/12/4 Balance b/d 245,000

_______ 31/12/X4 Life Insurance Policy 5,000
250,000 250,000
31/12/X5 Balanced c/d 260,000 1/1/X5 Balance b/d 250,000

_________ 1/1/X5 Insurance Premium 10,000
260,000 260,000
1/1/X6 Capital - X 97,500 1/1X6 Balance b/d 260,000

-Y 97,500
-Z 65,000 ______
260,000 260,000
324
(iii) X, Y and Z
Abridged statement of financial position as at 31st December 20X4
N
Assets:
Life Insurance Policy 250,000
Financed by:
Life Insurance Fund 250,000
18.20 RETIREMENT/DEATH OF A PARTNER DURING THE YEAR

When a partner retires or dies during the year, the necessary adjustments may not be
passed until the end of the year when the trial balance is drawn up. The profit/loss for the
year will be apportioned between the periods prior to and after the date of
retirement/death in the same manner as in admission during the year. After necessary
adjustments, the balance show to be due to the retired or dead partner will be discharged
in any of the ways already mentioned earlier on page 175.
ILLUSTRATION 18.16:
X, Y and Z had been in partnership for some years sharing profits and losses in ratio
2:2:1 respectively after making provision for interest on capital at the rate of 5% per
annum and annual salaries of N40,500 and N36,000 for X and Y respectively. On August
31st, 20X7, Y decided to retire and the partners agreed to credit Y with interest at 8% per
annum on the balance on his capital account after crediting him with his share of
goodwill (valued at N18,750) pending settlement on 1st January 20X8.
The sum of N7,500 was paid to Y on 31st December 20X7 and the partners had
withdrawn all profits to 31st December 20X6. N1,500 is to be provided on furniture and
fittings as depreciation while Inventory at 31st December 20X7 was valued at N15,000.
The partners decided not to close the books of the firm when Y retired but to use the
accounts for the year ended 31st December 20X7 as the basis of settlement. After Y’s
retirement the profit sharing ratio of X and Y was adjusted to 3:2 respectively.
Gross profit and expenses are to be apportioned on time basis unless otherwise indicated.
325
The following trial balance was extracted from the books as at 31st December 20X7:
DR. CR.
N N
Purchases 270,000
Sales 450,000
Inventory 22,500
Bank 12,090
Furniture and fittings (NBV) 24,000
Repairs and maintenance (N255 of which relates
To 4 months to 31/12/X7) 2,520
Provision for bad debt at 31/12/X6 3,000
Bad debt written off (August 20X7) 300
Salaries and wages 60,000
Receivables 25,455
Payables 17,550
Loan – Y 7,500
Salary – X 40,500
-Y 24,000
Capital – X 30,000
-Y 25,000
-Z 20,000
Drawings – X 15,000
st
- Y (to 31 August 20X7) 15,000
-Z 13,500
Office expenses 9,900
Medical expenses 3,285 _______
545,550 545,550
The bad debt provision was no longer required as at 31st August 20X7.
You are required to prepare final accounts for year ended 31st Dec. 20X7 and show Y’s
loan account.
326
Solution:
X, Y and Z
Statement of profit or loss for the year ended 31st December 20X7
JAN. – AUG. SEPT. – DEC.
TOTAL
N N N N N
Sales 450,000

Purchases 270,000
Goods available for sale 292,500
277,500
Gross profit 115,000 57,500 172,500
Less: Expenses
Repairs and maintenance 2,265 255 2,520
Provision for bad debt no longer
Required (3,000) - (3,000)
Bad debt 300 - 300
Salaries and wages 40,000 20,000 60,000
Office Expenses 6,600 3,300 9,900
Medical Expenses 2,190 1,095 3,285
Interest on Y’s loan (W.2) - 618 618
Depreciation 1,000 500 1,500
49,355 25,768 75,123
Net profits 65,645 31,732 97,377
Appropriations
Less: Salaries – X 27,000 13,500 40,500
-Y 24,000 - 24,000
51,000 13,500 64,500
Interest on capital:
-X 1,000 625 1,625
-Y 833 - 833
-Z 667 396 1,063
2,500 1,021 3,521
Divisible Profits 12,145 17,211 29,356
Share of profits:
X 4,858 10,327 15,185
Y 4,858 – 4,858
Z 2,429 6,884 9,313
12,145 17,211 29,356
327
X and Z
Statement of financial position as at 31st December, 20x7
N N N
Non-current assets 22,500
Furniture and fittings (24,000 – 1,500)
Good will 18,750
Current assets
Inventory 15,000
Receivables 25,455
Bank 12,090
52,545
Total Assets 93,795

Capital Account – X 39,310
–Y 20,626
59,936
Current liabilities
Payables 17,550
Y’s loan 16,309
33,859
_____________________________________Loan Account – Y
N N
31/12/X7 Bank 7,500 1/9/X7 Capital Account – Y (W.I) 23,191
31/12/X7 Balance c/d 16,309 31/12/X7 Interest on Loan (W.2) 618
23,809 23,809
1/1/X8 balance b/d 16,309
WORKINGS
(W.I) Calculation of amount due to Y at date of retirement
N N
Y’s capital account balance 1/1/X7 25,000
Less: Drawings of Y 15,000
10,000
328
Add: Interest of Y’s capital (Jan. – Aug. 20X7) [25,000 x 5% x 8/12] 833
Y’s share of profit for January to August [N12,145 x 2/5] 4,858
Y’s share of goodwill at 31/8/X7 credited to his capital account
[N18,750 x 2/5] 7,500
13,191
23,191
(W.2) Accrued interest on Y’s loan for September to
December 20X7 = N23,191 x 8% x 4/12 = N618.
(W.3)_________________________________Loan Account – Y
X Z X Z
N N N N
31/8/X7 Balance c/d 37,500 23,750 1/1/X7 Balance b/d 30,000 20,000
31/8/X7 Goodwill 7,500 3,750
37,500 23,750 37,500 23,750
31/12/X7 drawings 15,000 13,500 1/9/x7 Balance b/d 37,500 23,750
31/12/x& Balance c/d 39,310 20,626 31/12/X7 Interest on capital 1,625 1,063
31/12/X7 Share of profit 15,185 9,313
54,310 34,126 54,310 20,626
1/1/X8 balance b/d 39,310 20,626
(W.4) Interest on capital for September to December 20X7:- X : N37,500 x 5% x 4/12 = N625
Y : N23,750 x 5% x 4/12 = N396.
N1,021
CHANGE IN PROFIT- SHARING RATIO
When the partners change their profit-ratio, this alters the respective rights and stakes of
the partners resulting in a gain to one or more partners and a loss to the other partner(s).
At the date of the change in profit sharing ratio, mo adjustment is called for in the books
of accounts provided the following conditions hold.
(i) Goodwill already exists in the books and its value is considered to be correct or
goodwill does not exist in the books and it is considered that the firm does not
possess goodwill.
(ii) The book values of the other assets on the statement of financial position at that
date represent their fair - values i.e. true economic worth.
Where there is a change in profit sharing ratio and goodwill is not already in the
books – even though the firm actually possesses goodwill – and the values of the
329
other assets at that date do not reflect their economic worth, it is necessary to raise
proper adjustments. This ensures that as the new profit sharing ratio takes effect,
the assets of the firm and the capital balances of the partners are restated to reflect
the correct amounts. This would mean bringing goodwill into the books and
revaluing the other assets. The following entries are therefore required.
i.) To bring goodwill into the books:

DR: Goodwill a/c with the value of goodwill shared
CR: Partners’ capital accounts in old profit sharing ratio
ii.) Revaluation of assets:

a) Increase in value of assets:
DR: Assets a/c with the increase in the value of assets
CR: Revaluation a/c
b) Decrease in value if assets:

DR: Revaluation a/c with the decrease in the value of assets
CR: Assets a/c
c) Surplus or loss on revaluation:

DR: Revaluation a/c with the surplus on revaluation
CR: Assets a/c share in old profit sharing ratio.
OR
DR: Partners’ capital accounts with the loss on revaluation
CR: Revaluation a/c share in old profit sharing ratio.
With the entries above, goodwill would have been brought into the books; the other
assets and the partners’ capital accounts balances would have been restated to their
correct amounts and the new evaluations are thereby retained in the books.
330
18.21 SUMMARY
This chapter has discussed partnership accounts covering areas such as:
(i) Procedure for formation and drafting of partnership agreement.
(ii) Format, contents and preparation of final accounts.
(iii) Treatment of Goodwill, when and how to revalue partnership assets.
(iv) Changes in partnership relationship as a result of admission, retirement, death of a partner
and allocation to a profit sharing ratio.
331
1. The statement of financial position of coke, fanta and sprite on 31st December 2014 was as
follow:
Statement of Financial Position on 31st December 2014
Capital Accounts N’000 N’000 Fixed Assets N’000
Coke 2,000 Premises 3,000
Fanta 2,000 Equipment 720
Sprite 1,000 5,000 Fixtures & Fittings 810
Current Accounts Current Assets

Coke 360 Stocks 1,780
Fanta (210) Account Receivable 430
Sprite 90 240 Cash 110 2,320
Current Liabilities
Account Payable 640
Bank overdraft 970 1,610 000
6,850 6,850
The partners had been sharing profit or loss equally. They agreed to change their profit or loss to
Coke ½ Fanta and Sprite 1/6 on 1st January 2014 as a result of change in the profit and loss ratio,
the following decision were taken:
a. Assets were revalued as follows:
N’000
i. Premises 5,500
ii. Equipment 600
iii. Fixtures & Fittings 800
iv. Inventory 1,650
v. Account Receivable 410
b. Goodwill of the firm was agreed to N1200 however goodwill account is not to be
retained in the books.
You are required to prepare the following accounts:
i. Revaluation Account
ii. Partners Capital Account
iii. Statement of financial position after the transactions above has been completed.
2. Aye, Aka and Mara are in partnership as manufacturer. The partnership agreement contain
the following provisions.
332
i. Interest of 6% per annum is to be allowed on patters fixed capitals
ii. Annum salaries of N1,0648 arid N8360 shall be credited to Aye and Mara.
iii. Interest of 7 12% to be allowed on loan advanced by any partner.
iv. The balance of profit and loss shall be shared in ratio 4:3:1 to Aye, Aka
and Mara. Respectively. However, where Mara share is less than N9500, the
deficiency will be borne by Aye and Aka in their profit sharing ratio.
The following trial balance was extracted at 31st Dec. 1996.
Capital:
N N
Aye 190,000
Aka 142,250
Mara 47,500
SCurrent accounts: Aye 3,258
Aka 761
Mara 815
Stock 111/96 – Raw materials 26,220
Work in progress 17,252
Finished Goods 31,730
Purchase of Raw Materials 190,988
Carriage of raw materials 3,306
Distribution expenses 6,209
Factory expenses: direct 21,736
Factory expenses: Indirect 9,272
Factory wages: Direct 54,522
Indirect 32,399
Administration expenses 46,581
Selling expense 36,024
Patents 15,200
Plant and machinery at cost 312,892
Provision for depreciation on machinery1/9/96 144,613
Freehold premises at cost 167,960
Trade creditors 69,570
Sales 509,200
Partners Drawings – Aye 36,480
Aka 30,400
Mara 24,320
Cash at bank 11,400
Loan account - Aye 38,000
Bad debt written off 3,230
Trade debtors 66,574 _______
1145456 1145456
Additional information
333
a. Stock at 13th December 1996 were valued at cost as follows
Raw materials - 27740
Work-in-progress- 18468
Finished goods- 31084
b. Plant and machinery is to be depreciated at 15% on the book value.
c. The following expenses were owed at 31st Dec 1996:
Factory wages – Directs N1718, indirect N890
Administration expenses - N2060
d. Payment in advance – administration expenses N1520.
You are required to prepare the manufacturing, trading and profit and loss account of
Aye, Aka and Mara for the year ended 31st December, 1996 in statement from a balance e
sheet as at the date: shown clearly.
a. Cost of raw materials consumed
b. Prime cost of production
c. Factory overhead
d. Factory cost of finished goods.
3. Fortune and smiles are partnership, sharing profit in the ration of 3 to 2. The partnership
deed contains the following.
i. 7.5% per annum shall be allowed on their fixed capital accounts and current
accounts.
ii. 8% shall be charged on drawing annually.
iii. Smiles shall be entitled to a partnership salary of n27360 per annum.
iv. Interest on partnership loan shall be 10% per annum.
The following further information was extracted from their account records at 30th Sept,
1996.
Fortune Smiles
N N
Capital accounts 152000 76000
Current Accounts 1/10/95 5320CR 1140CR
Drawings 46000 38000
Provision for bad debt at 1/10/95 was N5400
334
The drawing were made on the following dates.
Fortune Smiles
N N
December 31/1995 18000 Dec. 1995 18000
May 1, 1996 22000 June 30, 1996 20000
The net profit for the year ended 30th Sept 1996 was N95000 before the following
adjustments.
i. A provision for doubtful debt is to be revised to 6% on debtors, standing in the
books as N14000
ii. Interest on the loan of 34200 advanced by fortune on 30th Oct. 1995 had neither
been paid nor provided for.
iii. Some items of stock with a consignee at invoiced value of N17100 were included
in the accounts on 30/09/96 at the amount. Stocks were consigned throughout the
year at cost plus 50%.
The profit and loss appropriation account of fortune and smile for the year ended
31/12/96 and the partner’s current account.
4. Ocean, river and stream had been in partnership for many years. Their agreement was as
follows:
a. Profit and loss sharing ratio shall be ocean ½ river 1/3 and stream 1/6.
b. Interest on capital shall be allowed at 8% per annum and on drawings at 10% per
annum.
c. Stream shall collect a salary of N2500 per annum.
d. The partners guaranteed stream a minimum share of divisible profit (excluding
interest on capital and his salary) of N4000.
335
The trial balance as at 30th Sept. 1995 had been extracted from the books of Ocean, river,
and stream.
N N
Freehold land and building (NBV) 42000
Fixture and fitting (NBV) 16000
Motor vehicle (NBV) 13000
Stocks 9000
Debtors 6000
Balance at bank 2500
12% loan from Rivers 6022
Interest payable on 12% loan 16300
Capital account 1/10/94: 978
Ocean 30000
River 20000
Stream 15000
Current account 1/10/94:
Ocean 1000
River 700
Drawings
Ocean 9000
River 7500
Stream 15000
Net profit for the year ______ 30000
120000 120000
Note:
a. Partners drawing were taking on the same day on May 1, 1995.
b. The 12% loan was balance sheet of the partners as at 30/9/95
You are required to prepare the partner current accounts for the year ended 30/9/95 and
the balance sheet of the partner as at 30/9/95. Submit all your workings.
336
References
Publishers.
Limited.
Lewis Lagos.
Nig. Ltd.
Limited.
Limited.
consulting.
337
CHAPTER NINETEEN
ISSUE OF SHARES

 The meaning of share and share capital
 Various types of shares and their importance
 The accounting treatment of issuing of shares and share capital
19.1 INTRODUCTION
Shares are units of ownership of a limited liability company. They are the small units,
each of equal amount, into which the capital of a company is divided.
The division of the capital of a company into shares enables a variety of persons to take
up the shares of the company, each according to his financial ability. A company is thus
able to raise capital from a much wider range of persons than other forms of businesses.
As a result, a company is usually able to raise a much larger amount of capital than a
partnership or sole trader.
A company raises its capital either by subscription amongst the friends of the promoters
or by public offer. Sometimes, the shares are issued to existing shareholders either free of
charge or for cash consideration. At other times, the shares of a company may be issued
to persons owed by the company in settlement of such liabilities.
19.2 TYPES OF SHARES
19.2.1 Ordinary Shares

These are shares whose holders receive dividend only after the preference shareholders
have received dividend. They are regarded as the risk bearers because they bear the
heaviest loss in the event of liquidation of the company. On the other hand, the surplus
profits after appropriation and surplus of assets in the event of liquidation belong solely
to ordinary shareholders unless the Articles of Association stipulate otherwise.
19.2.2 Preference Shares

These are shares which have the following characteristics:
 Their holders receive dividends at specified rates;
 Their holders receive dividends ahead of ordinary shareholders; and
338
 Their holders are not entitled to partake in the surplus in liquidation unless the Articles of
Association stipulate otherwise.
Preference shares may be any of the following types:
* Redeemable preference shares:
These are preference shares which the company is under obligation to redeem at a
specified date.
* Irredeemable preference shares:

These are preference shares which the company is not obliged to redeem unless and it is
in liquidation.
* Cumulative Preference Shares:

These are preference shares in respect of which unpaid arrears of dividends are
accumulated yearly and carried forward until profits are available to pay the dividends
at which time the whole of accumulated preference dividends must be paid before
ordinary dividends are paid.
* Non-cumulative preference shares:

These are preference shares in respect of which arrears of dividends are not carried
forward if there are no profits to pay the dividends in any year.
19.2.3 Deferred or Founders’ Shares

The holders of these shares are not entitled to receive dividends until the ordinary
shareholders have received dividends. They are however entitled, like the other classes of
shareholders, to attend and vote at the Annual General Meeting.
19.3 TYPES OF ISSUES

19.3.1 Public Issue
This is the issue of shares of a company to members of the public. This issue is normally
preceded by the issue of a prospectus by the company. The prospectus is the document
which sets out such salient details regarding the offer(e.g. a brief history of the company,
the past financial statements of the company in abridged form, a projection of future
earnings and the mode of payment for the shares) as would assist potential investors to
assess the company.
339
The issue of the prospectus amounts to an invitation to treat to potential investors whose
application for the shares amounts to an offer which the company is at liberty to accept or
reject.
19.3.2 Private Placement

This is the issue of the shares of a company to selected persons. The basis of selection of
the persons is usually arbitrary and subjective. A private placement is not usually
preceded by the issue of a prospectus.
19.3.3 Bonus Issue

This is the issue of fully-paid ordinary shares of a company to existing ordinary
shareholders in proportion to their existing shareholding. Bonus shares are issued to
share holder free of charge because the shares are paid up from the existing reserves of
the company. Bonus issue is sometimes referred to as capitlisation issue because its effect
is that existing reserves are capitalized into paid-up capital thereby reducing the reserves
and increasing the paid-up capital by exactly the same amount. Another name for bonus
issue is scrip issue.
Bonus issue is a non-cash distribution of profits, therefore shareholders do not pay

income tax on bonus shares received unlike is the case with cash dividends on which the
shareholders pay income tax.
19.3.4 Right Issue

This is the issue of shares of a company to existing shareholders in proportion to their
existing shareholding at a price known as rights price. The rights price is usually higher
than the par value but lower than the market value (market price). The attraction of this
issue to the existing shareholders is that they have an opportunity to acquire more shares
of the company at a price lower than the market price. In a rights issue, a shareholder has
to take one of the following three options.
(a) Take up the rights

The shareholder takes up the shares allotted to him and pays the required sum to the
company.
340
(b) Renounce the rights
The shareholder does not take up the shares but authorizes the directors of the company
to offer the shares to any other interested person(s). The directors must then pay to the
shareholder who renounced the rights any amount received above the rights price.
(c) Sell the rights

The shareholder does not take up the shares but sells the rights himself to any interested
person(s) for an agreed amount. Thereafter, the person(s) to whom the rights are sold
shall pay the rights price to the company.
19.3.5 Conversion Issue

This is the issue of shares of a company in exchange for convertible securities of the
such as convertible debentures. An advantage of this kind of issue to holders of such
securities is that it enables them to acquire the company’s shares as well as the benefits
accruing to shareholders. The advantages of conversion issue to the company include the
fact that it is thus able to settle its debt without paying cash.
19.4 DEFINITION OF SOME TERMS

19.4.1 Issue Price
This is the price at which shares are issued to subscribers.
19.4.2 Par Value (or Nominal Value)

This is the face value of the shares as stated in the company’s memorandum of
association
19.4.3 Rights Price

This is the price at which rights shares are issued to existing shareholders.
19.4.4 Conversion Price

This is the price at which shares are exchanged for convertible securities.
19.4.5 Share Premium.

Where shares are issued at a price higher than the par value, the excess is known as share
premium or premium on share. This should be credited to a separate account known as
Share Premium Account. Under the C.A.M.A. 1990, section 120, the share premium
account balance must not be reduced in any manner except as follows:
341
i. to pay up bonus shares;
ii. to provide premium payable on redemption of redeemable preference shares;
iii. to write off preliminary expenses; and
iv. to write off share issue expenses, commission paid on shares and discount allowed on
shares.
It should be noted that only strong and profitable companies can successfully issue their
shares at a premium.
19.4.6 Discount on Shares

Where shares are issued at a price than the par value, the difference is known as the on
shares. Section 121 of the C.A.M.A. 1990 stipulates that the issue of shares at a discount
is unlawful unless:
i. the class of shares to be issued at a discount is already in issue;
ii. the issue is authorized by resolution passed in general meeting and is, thereafter,
approved by the court;
iii. the resolution specifies the maximum rate of discount;
iv. the shares are issued within one month of the court’s approval or within such extended
time as the court may allow; and
v. every prospectus relating to the issue contains the particulars of the discount.
19.4.7 Forfeiture of shares

If a shareholder fails to pay any call or installment on the due date, the directors of the
company are empowered by section 140 of the C.A.M.A. to forfeit the shares provided
the defaulting shareholder has been served at least a 14-day notice within which he must
pay the outstanding call or installment together with accrued interest thereon and the
notice has expired without the outstanding sum being received.
A person whose shares have been forfeited shall cease to be a member of the company in
respect of the forfeited shares. The directors are also empowered to sell or dispose of the
forfeited shares to another person on such terms or in such manner as they deem fit.
N.B. After forfeiture of shares, the balance on the share premium account would no longer be
proportionate to the balance on the share capital account. If, for example, shares of N2
each were issued for N2.50, the premium account would, after the last installment is
called up, always be 25% of the balance on share capital account provided none of the
shares are subsequently forfeited.
342
The reason why forfeiture of shares would cause the balance on the share premium
account not to be proportionate to the balance on the share capital account is that whereas
the share capital account balance would be reduced by the called-up value of the forfeited
shares, the share premium account would not be reduced when shares are forfeited. This
is due to the fact that section 120 of the C.A.M.A. 1990, as noted above, clearly specifies
the allowable reasons for which share premium account balance can be reduced and
forfeiture of shares is not one of them. Therefore, to reduce share premium account
balance because shares are forfeited would be unlawful.
ACCOUNTING ENTRIES FOR PUBLIC AND PRIVATE PLACEMENT

1. Application monies received:
DR: Bank A/c with total application
CR: Application A/C monies received
2. Refund to rejected applicants:

DR: Application A/c with the amount
CR: Bank A/c refunded
3. Close of application account at the end of application stage:

DR: Application A/c with credit balance
CR: Allotment A/c on the application account.
4. Shares allotted:
DR: Allotment A/c with the value (application instalment plus allotment
CR: Share Capital A/c allotment installment less premium, if any) of
shares allotted
5. Monies received on allotment:
DR: Bank A/c with the amount received on allotment (i.e. cash
CR: Allotment A/c due on allotment less excess application monies, if
any).
6. Calls made (i.e. 1st Call, 2nd call, ……..final call):

DR: Call A/c with the nominal value
CR: Share capital A/c due on the call.
7. Monies received on call:

DR: Bank A/c with the actual amount received
CR: Call A/c on the call.
343
8. Premium included in installment:
DR: Allotment A/c or Call A/c with the premium included in the installment.
CR: Share premium A/c
9. Unpaid Call:
DR: Call in Arrears A/c with calls due
CR: Call A/c but not received
10. Calls received in advance:

DR: Call A/c with calls received
CR: Call in Advance A/c but not yet due.
N.B: The call in advance account will be closed to the share capital account when
the call that was received in advance falls due. Thereafter the actual monies
received on that call is recorded as in (7) above.
11. Shares forfeited:

DR: Share Capital A/c called-up value of
CR: Forfeited Shares A/c shares forfeited.
12. Transfer of unpaid calls on the forfeited shares to the forfeited shares account:
DR: Forfeited Shares A/c with the unpaid calls on
CR: Call in Arrears A/c the shares forfeited.
N.B: At this stage, the credit balance, on the Forfeited Shares Account represents the
nominal value already paid-up by the defaulting allottees before the forfeiture.
13. Re-issue of forfeited shares:

DR: Forfeited Shares Re-issued A/c with the called-up value
CR: Share Capital A/c of shares re-issued.
14. Transfer of nominal value already paid-up by previous holders of the re-issued shares to
the Forfeited Shares Re-issued Account:
DR: Forfeited Shares A/c with the credit balance on the forfeited
CR: Forfeited Shares A/c shares account relating to the re-issued
shares.
344
15. Monies received on Re-issue:
DR: Bank A/c with the sum received on re-issue
CR: Forfeited Shares Re-issued A/c
16. Premium on Re-issue:

DR: Forfeited Shares Re-issued A/c with credit balance on the
CR: Share Premium A/c forfeited shares re-issued account.
Notes: (i) In the entries summarized above, application account and allotment
account are separated. Alternatively, both can be combined as one
account known as application and allotment account.
Where this method is used, entry 3 shall not be necessary and all
references to application account or allotment account in entries
1,2,4,5 and 8 above shall be taken to mean application and allotment
account.
(ii) Also, the forfeiture of shares and the re-issue of the forfeited shares are
entered in separate accounts namely forfeited shares account for the
former and forfeited shares re-issued account for the latter.
Alternatively, both the forfeiture of shares and their subsequent re-issue

can be entered in the forfeited shares account only. Where this method
is used, forfeited shares re-issued account in entries 13, 15 and 16
shall be replaced with forfeited shares account and entry 14 shall be
unnecessary.
ILLUSTRATION 19.1: Under-Subscription

Applications were invited by the directors of Highyield Limited for 300,000 ordinary shares of
50kobo each at 55kobo per share payable as follows:
On application 35k
On allotment 10k (including premium of 5k per share)
st
On 1 Call 6k
nd
On 2 call 4k
345
Applications were received for 280,000 shares and it was decided to give full allotment to all
applicants.
An applicant to whom 800 shares had been allotted failed to pay the amount due on 1st call.
During the first call, holders of 5,000 shares paid, along with their 1st call monies, the installment
due on the 2nd call. The 800 shares were forfeited immediately after the 1st call and later re-issued
for 10k each after the second call.
Required:
Show the necessary journal entries and ledger accounts to record the above transactions.
Solution:
Journal Entries DR. CR.

N N
Bank Account 98,000
Application & Allotment Account 98,000
Being application monies received in respect
of 280,000 shares at 35 kobo per share
Ordinary Share Capital Account 112,000
Share Premium Account 14,000
Being 35 kobo on application and 10 kobo on
allotment (including 5 kobo premium) per
share on 280,000 shares allotted
Bank Account 28,000

Being allotment installment received (10 kobo
Per share) on 280,000 shares allotted.
1st Call Account 16,800

Being first call (6 kobo per share) on 280,000 shares.
346
Bank Account 16,952
Calls in arrears Account 48
Call in advance Account 200
Being first call monies (6k per share) received
On 279,200 shares, unpaid first call monies on
800 shares and 2nd call monies (4k per share)
received on 5,000 shares
Ordinary Share Capital Account 368

Forfeited shares Account 368
Being called – up value (46k per share) of 800
shares forfeited.
Forfeited Shares Account 48

Call in arrears Account 48
Being write – off of unpaid calls in respects of 800 shares forfeited. Call in advance Account
200
nd st
Being 2 call monies received during 1 call now
transferred to share capital account.
Bank Account 10,968

2nd Call Account 13,968
Being 2nd call monies received on 274,200
shares.
Forfeited Share Account 400

Being nominal value of 800 shares re-issued
After 2nd call at 50k per share.
Bank Account 80
Forfeited Shares Account 80
Being proceeds (10k per share) of 800 shares
re – issued.
347
Ledger Accounts
Application & Allotment Account
N N
Ordinary Share Capital 112,000 Bank (application monies) 98,000
Share Premium 14,000 Bank (allotment monies) 28,000
126,000 126,000
Ordinary Share Capital Account

N N
Fortified Shares 368 Application & Allotment 112,000
Bal. c/d 140,000 1st Call Account 16,800
Call in advance 200
2nd Call Account 10,968
________ Forfeited Shares 400
140,368 140,368
Bal. b/d 140,000
1st Call Account

N N
Ordinary Share Capital 16,800 Bank 16,952
Call in advance 200 Call in arrears 48
17,000 17,000
Call in arrears Account

N N
st
1 Call 48 Forfeited Shares 48
Call in advance Account

N N
st
Ordinary Share Capital 200 1 Call 200
348
2nd Call Account
N N
Forfeited Shares Account

N N
Call in arrears 48 Ordinary Share Capital 368
Ordinary Share Capital 440 Bank 80
448 448
Share Premium Account
N N
Bal. c/d 14,000 Application & Allotment 14,000
Bal. b/d 14,000
ILLUSTRATION 19.2: Over-Subscription

Mercantile Company Limited has an authorized share capital of N500,000 all in ordinary shares
of N1 each. On 1st January, 20X6 the company offered for sale N300,000 ordinary shares at
N1.50 each payable as follows:
On applications N0.30
On allotment N0.60 (including the premium)
On 1st Call N0.25
On 2nd Call N0.20
On 3rd call N0.15
When the applications register was closed, applications had been received for 500,000 shares.
The directors dealt with the situation as follows:
(a) Rejected 50,000 applications

(b) Gave full allotment to applicants for 200,000 shares
(c) Allotted the rest pro-rata, using excess application monies to off-set part of the amount
due on allotment.
349
All fees expected were received on allotment. On 1st call, three shareholders holding in total
10,000 shares did not pay their call fees. On 2nd call, fees on another 5,000 shares were not
received.
Before the 3rd call was due, the directors decided to forfeit the holding of the 10,000 shares and
these were immediately reissued for N1.10 each. This was equally paid for.
All fees expected on 3rd call were received with the exception of fees on the 5,000 shares
mentioned above.
(a). The journal entries
(b). The ledger accounts to record these transactions
(c). The abridged Statement of financial position after the 3rd call.
Solution:
(a) Journal Entries
DR. CR.
N N
Bank Account 150,000
Being application monies (30k per share) received
On 500,000 shares

Bank Account 15,000
Being refund to rejected applicants for 50,000 shares

Being 30k on application and 60k on allotment
(including 50k premium) per share on 300,000 shares allotted.
Bank Account 135,000

Being monies received on allotment i.e. 60k per share
on 300,000 shares allotted less excess application
money of 30k per share on 150,000 shares (Note 2)
350
Being first call of 25k per share on 300,000 shares
Bank Account 72,500

Call in arrears Account 2,500
Being first call monies (25k per share) received on
290,000 shares and first call monies in arrears on
10,000 shares
2nd call Account 60,000

Being 2nd call (20k per share) on 300,000 shares
Bank Account 57,000

2nd call Account 60,000
Being 2nd call monies (20k per share) received on
285,000 shares and 2nd call monies in arrears on 15,000 shares.

Forfeited Shares Account 8,500
Being called – up value (85k per share) of 10,000 shares
forfeited after 2nd call.

Being unpaid calls of 45k per share (25k on 1st call and
20k on 2nd call) on 10,000 shares forfeited now written off
Forfeit Shares Account 8,500

Being called – up value (85k per share) of 10,000 shares
re – issued before 3rd call.
351
Bank Account 11,000
Being proceeds (N1.10 per share) of re – issue of
10,000 shares.

Being premium on re – issue of 10,000 shares.
3rd Call Account 45,000

Being 3rd call (15k per share) on 300,000 shares
Bank Account 44,250

Call in arrears Account 750
3rd Call Account 45,000
Being 3rd call monies (15k per share) received on
295,000 shares and 3rd call monies in arrears on 5,000 shares
(b) Ledger Accounts

Application & Allotment Account
N N
Bank (refund) 15,000 Bank (application monies) 150,000
Ordinary Share Capital 120,000 Bank (allotment monies) (Note 2)135,000
Share Premium 150,000 ______
285,000 285,000
Ordinary Share Capital Account

N N
Forfeited Shares 8,500 Application & Allotment 120,000
Bal. c/d 300,000 1st Call 75,000
2nd Call 60,000
Forfeited Shares 8,500
_______ 3rd Call 45,000
308,500 308,500
Bal. b/d 300,000
352
Share Premium Account
N N
Bal. c/d 156,500 Application & Allotment 150,000
_______ Forfeited Shares 6,500
156,500 156,500
1st Call Account

N N
_______ Call in arrears 2,500
75,000 75,000
Call in arrears Account

N N
st
1 call 2,500 Forfeited Shares 4,500
2nd Call 3,000 Bal. c/d (see Note 1) 1,750
3rd Call 750 ______
6,250 6,250
2nd Call Account

N N
_______ Call in arrears 3,000
60,000 60,000
Forfeited Shares Account

N N
Call in arrears 4,500 Ordinary Share Capital 8,500
Share Premium 6,500 ______
19,500 19,500
353
3rd Call Account
N N
______ Call in arrears 750
45,000 45,000
(c) Mercantile Company Limited
Abridged Statement of Financial Position after 3rd Call

N
Current Assets
Call in arrears 1,750
Called – up Capital:
300,000 Ordinary Shares of N1.00 each 300,000
Reserves:
Share Premium 156,500
Explanatory Notes:
1. The balance of N1,750 on call in arrears account represents the total unpaid calls (20k on
2nd call and 15k on 3rd call) in respect of 5,000 shares. The balance will continue to be
carried until the arrears are paid by the defaulting shareholders or the shares are forfeited
by the directors. If the latter happens, the balance will be written off to the forfeited
shares account.
2. In examination questions on issue of shares where the shares oversubscribed, it is usual

that the directors decide to:
i. reject some applications;
ii. give full allotment to some applicants while giving pro – rata allotment to others;
and
iii. retain the excess application monies received from those who were given pro –
rata allotment to be set off against subsequent installment due from them.
354
19.5 REJECTION OF APPLICATIONS
When the shares of a company are over-subscribed (as in this illustration where 300,000 shares
are offered but 500,000 shares are applied for), the directors are placed in a position very similar
to that of a seller of goods for which demand exceeds supply. Just like such a select can afford to
turn back some customers, the directors can afford to reject some applications. Of course, some
of these applications will have been rejected on the grounds that they violate the rules of the
Securities and Exchange Commission.
It must be said that even where shares are under-subscribed, as in illustration 25.1, rejection of
applications can also take place on the grounds that they violate the rules of the Securities and
Exchange Commission. However, the directors would not be as rigorous as would be the case if
the shares were over-subscribed. In any case, rejection of applications is very rare in examination
questions in which shares are under-subscribed.
Full Allotment to Some Applicants, Pro – rata Allotment To Others and Retention of
Excess Application Monies
After refunding the sum due to the rejected applicants, it will usually be the case that the
remaining applications still exceed the number of shares on offer. Since the directors cannot allot
more shares than are on offer, it is clear that not all of the remaining applicants can get full
allotment of the number of shares they applied for.
On the basis of criteria to be determined by the directors, some of the applicants will receive full
allotment of the number of shares they applied for while others will receive only a proportion of
the number of shares they applied for. With respect to the applicants who did not receive full
allotment, the company would be in possession of excess application monies which is the
amount already paid by those applicants on those shares not allotted to them. Since these
shareholders are now liable for subsequent allotment and calls on the shares allotted to them, the
company will usually retain the excess application monies against the subsequent allotment and
calls.
For illustration, assume that an applicant, Mr. X, applied for 1,000 shares on which he paid 50k
per share (i.e. total of N500) and he is allotted only 700 shares, the company would be in
possession of excess application monies on the unallotted 300 shares amounting to N150 (i.e.
300 shares X 50K = N150). Assume also that, under the terms of the issue, Mr. X is due to pay
allotment installment.
355
19.6 SUMMARY
This chapter has discussed issues relating to company account, and various ways of raising
capital for the business. It elaborately discussed meaning of share and share-capital, along with
their importance to the company.
The accounting treatment of issuing shares and share capital were covered in this chapter.
356
1. Duncan Ltd issued 100,000 ordinary share of N1 each as follows:

Application 10k
Allotment 40k (including premium)
First call 30k and Final Call 30k. The number of application received were 115,000, of
this 6,000 applications were rejected outright and the money refunded while the balance
were allotted pro-rata using excess application fees to offset amount due on allotment. All
monies due were received on allotment and calls except monies due on final call on 8,300
ordinary shares.
You are required to prepare the following ledgers accounts:
i. Bank Account
ii. Application Account
iii. Allotment Account
iv. First Call Account
v. Final Call Account
vi. The abridge statement of Financial position of Duncan Ltd after balancing the
above ledgers.
2. JOAS PLC. Has authorized capital of 15,000. Ordinary share of N1 per share. On 1 st
January 2000 it issued 8,000,000 shared at a price of N5.20 per share payable as follows.
Per share N
Application 1.00
Allotment 2.00 (premium)
First and final call 2.20 (premium)
Total 5.20
357
Application were receive for 10,000,000 shares of which 2 million were rejected and the
money refunded to the applicants.
The call were duly made and the sum received.
You are required to prepare ledger account to record the share issue.
3. Abbas Plc. Who had been in business for many years, decided to make a public issue of
7,000,000 ordinary share of N1.00 at per premium of N1.25 each payable as follows:
N0.45 per share on application
N1.60 on allotment (including premium)
N0.20 on first and final call
Application were received for 10,000,000 share, of the 1,500,000 were rejected and the
money refunded to the applicants
The balance were allotted prorate and express money transferred to allotment account.
All the sum due to application and allotment were received but a holder of 15,000 share
default on first call. These shares were later re-issued at a premium of N0.45.
a. Pass the necessary journal entre for the above transaction in the books of Abbas PLC.
b. Show the balance sheet extract before the forfeiture of share and after the forfeiture of
shares.
358
References
Publishers.
Limited.
Lewis Lagos.
Nig. Ltd.
Limited.
Limited.
consulting.
359
CHAPTER TWENTY
INTERNAL CONTROL SYSTEM
 The meaning and importance of Internal Control System
 The elements of Internal Control System
 The features of Internal Control System
 The meaning of Audit Risk
 Various types of audit Risk
20.1 INTRODUCTION
Internal control system is the whole system of control, financial and otherwise
established by the management in order to carry on the business of the enterprise in an
orderly and efficient manner and ensure adherence to management policy, safe guard the
assets and secure as far as possible the competence and the accuracy of the record.
20.2 FIVE ELEMENTS OF AN EFFECTIVE CONTROL SYSTEM:

1. Control Environment:- This is set by the tone of management, its philosophy and
management style, the way in which authority is delegate, the way in which staffs are
organized and developed, and the commitment of the board of directors. According to the
institute of internal auditors, control environment is the attitude and actions of the board
and management regarding significance of control within the organization. It provide the
structure and the discipline for the achievement of the primary objectives of the system. It
consist of:-
a. Philosophy and operation is style of management
b. Organizational structure
c. Human resource policies and practices
d. Delegation of authority and assignment of responsibility
e. Personnel competence
2. Risk assessment:- This should be conducted for each business within the organization,
and should consider for example, internal factors (e.g. complexity of the organization,
organizational changes, staff turnover level and the quality of staff) and the external
factors (e.g. changes in industry and economic conditions, technological changes e.t.c).
The assessment should also consider risks that are controllable and risks that are not
controllable.
3. Control activities:- these are policies and procedures that ensures mat decisions and
instructions are carried out. This exist at all level of management.
360
4. Information and Communication:- Information gathered must be communicated to the
right people so that they can carry out their responsibilities.
5. Monitoring:- The internal control system is associated with internal audit, as well as
general supervision
20.3 CONDITIONS FOR EFFECTIVE OR FUNCTIONAL INTERNAL CONTROL

SYSTEM
1. The objective of internal control must be communicated to all staff
2. The management should not override the laid down control
3. Internal control system must be documented for future reference
4. Personnel in charge of handling the company’s transactions should have adequate
training, expenses and efficiency
5. There should be clearly organizational structure showing the division of duties
6. There should be a periodic preview of the laid down controls by management
7. Internal control should not be too complex
8. It must be emphasized that the objective of internal control is to limit the occurrence
of error and fraud to the barest minimum, no matter how effective a client control
system is, errors and fraud can occur by collision, abuse of authority, human errors
and management conceptions
20.4 CONTROL ACTIVITIES (TYPES OF INTERNAL CONTROL)

The Audit Practice Committee (APC) provides a list of internal control as shown below:
1. Physical control
2. Arithmetical and accounting
3. Personnel
4. Management
5. Organization
6. Supervision
7. Segregation of audit
8. Authorization and approval
1. Physical Controls:- These are controls or measures and procedures to protect physical
assets against theft or unauthorized access and use.
The Control measures Necessary to Achieve these are;- Physical custody of assets which
involves procedure designed to limit access to authorized personnel only, access can be
direct, e.g. being able to enter the warehouse or indirect, that is by documentation e.g.
personnel knowing the correct procedures, may be able to extract goods by doing the
361
right paper work. And in the case of valuable, portable, exchangeable or desirable assets
(share certificates) in a safe should be with procedures for the custody of use of the keys,
use of passes to restrict access to the warehouse, use of password to restrict access to
particular files.
2. Accounting and Arithmetical Control:- These controls are designed to ensure that
transactions are correctly calculated, recorded and processed. The objective of this
control is to ensure that transactions are duly checked for arithmetical accuracy and
currently processed in the accounting system. The Control Measures Necessary to
Achieve these are:-
i. Ensure the controls in the recording function which checked that the transactions
have been authorized, they are all included and that they correctly recorded and
accurately processed.
ii. Ensure procedures checking the arithmetical accuracy of the records, the
maintenance and checking of totals, reconciliations, control accounts, trial
balance, accounting for documents.
3. Personnel Controls:- These controls are developed in order that staff allocated to duties
are capable and sufficiently motivated to ensure that they carry out their duties efficiently
and effectively with complete integrity. It is also designed to ensure the engagement of
personnel with the requisite qualification and experience in discharging functions, the
personnel being well motivated discharge their function with complete integrity.
4. Authorisation and Approval: These controls are designed to ensure that transactions are
duly authorized and approved by responsible officials within predetermined limit. It is a
good practice for the approval control to be exercised after due authorization as this will
serve as an internal check on authorization. This requires that the documents to be
processed should be authorized by a responsible officer within the clearly defined
limitation of authority.
5. Management Controls:- These involve the periodic review by management of the
activities of the enterprise. This is controlled outside the day to day routine functions in
order to control the business activities and system. This may include the establishment of
an internal audit department or the use of budget or management account to control
operation. This control can be discharged by setting up an effective internal audit system
that will have a responsibility to recommendations for improvement on management
control and the business activities with the use of budget and forecast in addition to
internal control.
6. Organisation Controls:- They are the controls within the enterprise which define the
responsibilities of all persons within the organization. They specify the lines of authority.
The controls are the ones usually depicted in organizational charts to ensure that
362
operation within the enterprise are carried out, in a well-defined manner, which promote
orderliness and efficiency. It is a plan of the organization to assist to define and allocate
responsibilities and identify lines of reporting. It is important that every employee should
know the practice power delegated to him and to whom he should report.
7. Segregation of Duties controls:- These are controls which ensure that the major
functions in the transactions are not carried out by the same person or group of persons.
This ensures that no one person or group of persons is responsible for all aspect of
transaction from the beginning to the end. This is fundamental to a good internal control
system. The involvement of more individuals reduces the risk of accidental error or
deliberate fraud. The main objective is to minimize the risk of fraud and errors by
ensuring that the work of one person is checked by another person in the process of
carrying out the transaction. This control is designed to ensure that a single personnel
does not possess a transaction from inception to completion.
8. Supervision Controls:- These controls are designed to ensure that the duties of
subordinate are subjected to an independent review and supervision of a superior which
means the work of one person are to be reviewed by a more experienced person. These
are controls exercised by higher level management on their subordinate. They are
designed to ensure that the company is operating as intended.
20.5 AUDIT OF INTERNAL CONTROL

The audit approach involved here is the compliance test which is a test that provide audit
evidence that the internal control have been applied as prescribed by the management for
big companies, where there may not be adequate internal control system, the auditor only
perform substantive test which is a test of transactions balances including analytical
review which seeks to provide audit evidence as the completeness, accuracy, and validity
of transactions in the financial records.
20.6 DOCUMENTATION OF INTERNAL CONTROL

Different techniques may be used by auditors to document information relating to
accounting and internal control system selection of a particular technique is a matter of its
judgement. The techniques could be one or combination of the following:-
(a) Narrative note
(b) Flowchart
(c) Questionnaires
(d) Internal control evaluation questionnaires
363
 Narrative Note:-
This is the documentation of internal control by way of note the information generated
from observation and enquiries is written down on working papers for future reference.
 Flow chart:-
This is the most effective method of record complex system. It is a pictorial or diagram
representation of internal control system.
 Internal Control Questionnaire-ICQ:-
The ICQ is that instrument used by auditors in systems appraisal. It consist of a structured
series of questionnaires which taken together probe thoroughly into a system.
 The Internal Control Evaluation Questionnaire (ICEQ):
This is similar to the ICQ. The evaluation of internal control is fundamental to an
audit. it is through this questionnaire that an auditor determines:
- The nature and the extent of his audit procedure;
- The draft of letter of weakness; and
- Draws the attention of the management to the weakness in the system.
20.7 AUDIT RISK

Audit risk is the risk that auditors may give an inappropriate audit opinion on financial
statement.
It has three forms or components:-
1. Inherent risk:- It is the susceptibility of an account balance or class transactions to
material misstatement either individual or when aggregated with misstatement in
order to balance or classes, irrespective of related internal controls
2. Control Risk:- It is a risk that misstatement could occur in an account balance or
class of transactions and mat could be a material, either individually or when
aggregated with misstatement in other balance or classes, would not be prevented or
detected and corrected on a timely basis by the accounting and internal control
systems
3. Detection risk:- It is the risk that auditors substantive procedures (test of utensils of
transactions and balance or analytical procedures) do not detect a misstatement that
exist in an account balance or class of transactions mat could be material, either
individually or when aggregated with misstatement in other balance or classes.
At the audit planning stage the auditor should consider:- The likelihood of error in the
light of inherent risk, and the system of internal control (control risk) in order to
determine the extent of work and hence the level of detection risk required to satisfy
themselves mat the risk error in the financial statements is efficiently low.
364
20.8 REPORTING TO MANAGEMENT
It is important that the auditor should report on any material weakness in internal control
which came to his attention during the course of an audit to the management, such report
is commonly called management letter, letter of weakness, domestic report, internal
control letter, internal control memorandum, management control letter, control report,
management control memorandum.
20.9 CARRY-OVER-FRAUD OR TEEMING AND LANDING

The term carry-over-fraud is used to express method of misappropriation of cash received
by falsifying records of subsequent transactions. If, for example, a cheque for N20,000 is
received in full settlement of a debt by Tola, this may be misappropriated. Tola’s debt
therefore is still shown as outstanding. At a later date, a cheque for N20,000 is received
from Tunji. In order not to leave Tola’s account in debit for too long a period, which
might cause the other staff concerned to send a reminder to Tola, the most recent cheque
from Tunji is entered as received from Tola and is posted to Tola’s account. Tunji’s
account is now shown as unpaid, and the foregoing procedure may be repeated. The
situation could be complicated by the splitting of amount over various accounts and more
than one misappropriation may be the course of being covered at the same time.
20.10 INTERNAL CONTROL ON CARRY-OVER-FRAUD

The internal control procedure should be arrived at ensuring that all cash and cheque
received by post are accounted for and accurately recorded in the books and that all such
receipt are promptly deposited in the bank intact. The following procedures are
recommended also:-
i. A responsible official should be appointed to be in charge of the opening of the
mails.
ii. Measures should be introduced to prevent interception of mail within receipt and
openings such as the use of locked bags (P.M.B) private mail bags.
iii. Two persons to be present at the opening of mails (dual control).
iv. All cheques and other negotiable instrument should be immediately given a
restrictive person, e.g. account payee only, not negotiable.
v. Details of the receipt (date, payee, amount, cash, cheque, or other) should
immediately be entered in a cash book or pre-list of money receipt the list should
be signed by both parties present.
vi. There should be regular independent comparison of the post list with banking
records.
365
ADVANTAGE OF INTERNAL CONTROL
The main advantage of internal control from the auditor’s point of view:-
a. Detailed work of audit may be restricted as sectional auditing in debt can be
applied.
b. It can be used to determine the extent of work to be done on an audit and the
amount to be charged depends on the extent of work.
c. Weaknesses in the internal control system are precautions as to the course of
action to take by the auditor.
20.11 LIMITATION OF INTERNAL CONTROL SYSTEM

1. A good internal control system cannot turn a poor manager to a good one.
2. The system can only provide reasonable assurance regarding the achievement of
the objectives, all internal control systems are at risk from mistake or errors.
3. Internal control systems can be by-passed by collusion and management override.
4. Controls are only designed to cope with routine transactions and debts.
5. There are resource constraints in provision of internal control system, limiting
their effectiveness.
366
20.12 SUMMARY
This chapter has discussed the meaning of internal control and internal control system as an
organization. It covered and explained the elements of internal control system; and audit risk.
367
1a. Explain the term “Internal Control System”
1b. Discuss briefly features of Internal Control System.
1c. What are the limitations of Internal Control System?
2. What do you understand by Audit Risk? Briefly discuss forms of audit risk.
368
References
Publishers.
Lewis Lagos.
Nig. Ltd.
Limited.
ICAN STUDY PACK(2014) Advanced Audit & Assurance. Emile Wolf
Millichamp, A.H. (1987), An instructional manual for accounting students fourth edition DP
publications Ltd, Hants.
369
PART B
CHAPTER TWENTY ONE
INTRODUCTION TO FINANCIAL MANAGEMENT

 Meaning of financial management
 the fundamental principles and objectives of financial management
 The key officers in the finance section and their functions
 Segregation of their individual functions.
21.1 INTRODUCTION
Strategic financial management is defined in the CIMA Official Terminology as ‘the
identification of the possible strategies capable of maximizing an organization’s net
present value, the allocation of scarce capital resources among the competing
opportunities and the implementation and monitoring of the chosen strategy so as to
achieve stated objectives’.
Financial management connotes responsibility for obtaining and effectively utilizing the
funds necessary for the efficient operation of an enterprise. The finance function centers
around the management of funds, raising and using them effectively. It therefore covers
all functions concerned in attempting to ensure that financial resources are obtained and
used in the most effective way to secure attainment of the objectives of the organization.
Financial management is a wide subject that brings together much of the materials that
are found in other subjects and uses other disciplines as its tools. Despite this, it is an
interesting course that brings the best out of an average student.
Financial management involves the use of accounting knowledge, economic models,

mathematical rules, systems analysis and behavioural science for the specific purpose of
assisting management in its functions of financial planning and control.
It draws on related subjects in the following ways:-
21.1.1 Financial Accounting

The balance sheet of a given company could be regarded as a statement of the results of
financial management. A “healthy balance sheet” indicates skillful financial
management.
370
21.1.2 Management Accounting
Management accounting gives the techniques of information generation such as costs and
profitability of projects, the projection of cash flows, the effect of departure from
previous established plans.
21.1.3 Laws
The law governs almost everything which a financial manager does e.g. payment of
dividends is subject to restriction of the law; raising of funds by means of share issue
needs compliance with the company law.
21.1.4 Economics
Economics help the Financial Manager to have knowledge of what goes on outside the
business world.
21.1.5 Behavioural Science

Enables Managers to understand the behaviour of investors.
21.1.6 Quantitative Methods

Statistical and mathematical techniques through quantitative methods and the Financial
Manager combine to give a reasonable forecast and risk analysis e.g. variance
measurement is useful in risk analysis, time series is useful in forecasting.
In conclusion, the financial Manager needs to have a good knowledge of financial
accounting, management accounting, law and economics in order to discharge his
functions as required effectively.
21.2 BASIC OBJECTIVE OF FINANCIAL MANAGEMENT

There is little agreement in the literature as to what the objectives of firms are or even
what they ought to be. However, most writers on financial management make the
assumption that the primary objective of a firm is to maximize the wealth of its
shareholders i.e. to maximize the market value of the company’s equities.
Although it is generally agreed that the financial objective of the firm should be the
maximization of owner’s economic welfare, however, there is disagreement as to how the
economic welfare of owners can be maximized. Two well-known and widely discussed
criteria which are put forth for this purpose are:
 Profit maximization and
 Wealth maximization
371
21.2.1 Profit Maximization as a Primary Objective
Traditionally, the business has been considered as an economic institution. As such, it
has developed a common and unique measurement of efficiency vis profit. It is therefore,
rational to assume profit maximization as a natural business objective. The
appropriateness of this objective is justified on any of the following counts:
 A human being, performing any economic activity rationally, aims at utility
maximization. It is argued that utility can be easily measured in terms of profits.
Thus, profit maximization is justified on the ground of rationality.
 Profit maximization ensures economic natural selection and in the ultimate end only
profit maximisers survive.
 The firm by pursuing its objective of profit maximization also maximizes social
economic welfare.
 A free competitive capital market, in spite of the absence of competition in product
markets will allocate monopoly rights over capital to those who can use it most
profitably.
Thus, profit maximization will be a motive force to acquire the monopoly powers in
the imperfect product markets.
21.2.2 Profit Maximization as a Primary Objective

 It is argued that profit maximization is a consequence of perfect competition and in
the face of imperfect modern markets today, it cannot be a legitimate objective of the
firm.
 It is also argued that profit maximization as a business objective developed in the
early 19th century, when the characteristic features of the business structure were self-
financing, private property and single entrepreneurship. The only aim of the single
owner then was to enhance his individual wealth and personal power, which could
easily be satisfied by the profit maximization objective. However, in the
contemporary placing of things, ownership and management are separated. In this
changed business structure, the owner manager of the 19th century has been replaced
by professional manager who has to reconcile the conflicting objectives of the parties
connected with the business firm. In this new business environment, profit
maximization is regarded as unrealistic, difficult, inappropriate and immoral.
21.2.3 The objective also suffers from the following limitations:

 Accounting profits are not the same as “economic” profits. Accounting profits can be
manipulated to some extent by choices of accounting policies.
372
 A company might make an accounting profit without having used its resources in the
most profitable way possible. There is a difference between the accounting concepts
of historical cost and economic concept of opportunity cost which is the value that
should have been obtained by using resources in their most profitable alternative way.
 Profits are reported every year (with half-year interim results for quoted companies).
They are measures of short-term performance, whereas a company’s performance
should ideally be judged over a long term.
 Profits on their own take no account of the volume of investment that it has taken to
earn the profit. Profits must be related to the volume of investment to have any real
meaning. Hence, measures of financial achievement such as
(1) accounting return on capital employed
(2) earnings per share (EPS)
(3) yields on investment, such as dividend yield as a percentage of stock market value
are usually calculated to enhance better interpretation.
21.3 WEALTH MAXIMIZATION AS A PRIMARY OBJECTIVE

The use of the objective of wealth maximization or net present worth maximization has
been advocated as an appropriate and operationally feasible criterion to choose among the
alternative financial actions.
Wealth maximization means maximizing the net present value (or wealth) of a course of
action. The net present value of a course of action is the difference between the gross
present value of the benefits of that action and the amount of investment required to
achieve those benefits. The gross present value of a course of action is found out by
discounting or capitalizing its benefits at a rate which reflects their timing and
uncertainty.
A financial action which has a positive action resulting in negative NPV should be
rejected because if accepted it would cause diminution in existing wealth.
Between a number of desirable mutually exclusive projects the one with the highest NPV
should be adopted. The wealth or NPV of the firm will be maximized if this criterion is
followed in making financial decisions.
21.4 THE STAKEHOLDERS’ THEORY

The traditional view is that the firm is run in order to maximize the wealth of the
shareholders, there is an alternative view that the firm is a coalition of different groups:
(a) Equity shareholders
(b) Preference shareholders
(c) Lenders
373
(d) Employees
(e) Suppliers and
(f) Customers
Each of these groups must be acknowledged and paid a minimum ‘return’ since the
withdrawal of their contribution/services may lead to the closure of the company. Any
excess wealth created by the firm should be and is the subject of bargaining between
these groups. This alternative view referred to as the ‘stakeholders’ theory’, implies that
maximization of shareholders’ wealth as a company’s objective is defective since in
practice, most companies may not survive should they decide to pursue solely the
objective of shareholders’ wealth maximization.
21.5 NON-FINANCIAL OBJECTIVES

Another reason for arguing that a company’s primary objective is not to maximize the
wealth of its ordinary shareholders is that a company will have important non-financial
objective-which acts as a limitation on its financial objectives. Examples are:
(1) To provide for the welfare of employees
(2) To provide for the welfare of management
(3) To contribute to the welfare of the society as a whole, i.e. to be socially
responsible/to be a good corporate citizen.
(4) To give highest quality service to customers.
Some of these non-financial objectives may be inconsistent with the objectives of

profit/wealth maximization. However, non-financial objectives do not cancel out
financial objectives but they do mean that the simple theory of company finance that the
sole purpose of financial management is to maximize the wealth of shareholders, is too
simplistic and incorrect.
Financial objectives have to be compromised in order to satisfy non-financial objectives.
21.6 JUSTIFICATION FOR SHAREHOLDERS’ WEALTH MAXIMIZATION

AS A COMPANY’S PRIMARY OBJECTIVE
This is anchored on the following premises:
(1) That it is all-embracing i.e., it would take care, in the long run, all other company
objectives including maximization of profits, sales revenue, maximum target market
share, level of employee turnover, satisfaction of management staff etc.
(2) That ordinary shareholders of a company are the legal owners and should attract the
maximum attention in the determination of objectives.
374
(3) That equity shareholders are the residual investors which means that any excess returns
from investment must belong to them.
In the final analysis, a company must decide for itself its unique pool of objectives that
will ensure the continual existence of the company. This decision may not be that simple
because the objectives of the different contributors may be contradictory.
21.7 AGENCY THEORY

A possible conflict can arise when ownership is separated from the day-to-day
management of an organization. In larger companies, the ordinary shares are likely to be
diversely held, and so the actions of shareholders are likely to be restricted in practical
terms. The responsibility of running the company will be with the board of directors,
who may only own a small percentage of the shares in issue.
The managers of an organization are essentially agents for the shareholders, being tasked
with running the organization in the shareholders’ best interests. The shareholders,
however, have little opportunity to assess whether the managers are acting in the
shareholders’ best interests.
21.8 THE THREE CORE DECISION AREAS IN FINANCIAL MANAGEMENT

These are three core decision areas in financial management viz:-
(i) Investment decision
(ii) Financing decision
(iii) Dividend decision
21.8.1 Investment Decision

This involves the identification of viable projects i.e. it deals with the appraisal of
projects using various techniques to determine those that are viable.
21.8.2 Financing Decision

This involves the identification of the appropriate source(s) of finance that would be used
to finance the projects. Consideration is usually given to:
a) the cost associated with each source
b) the characteristic of each source
c) the level of risk of the project under consideration
d) pattern of cash flows from the project
e) availability of each source
f) taxation and
g) the amount involved before the final selection is made
375
21.8.3 Dividend Decision
Here attention is focused on the compensation required by the providers of funds i.e. this
is the determination of the appropriate amount to be paid as dividend and the profit that
would be ploughed back to finance expansion in the company.
21.9 THE FINANCE MANAGER

The Finance Manager is a key personnel who is responsible for the day-to-day financial
services and record keeping of the organization.
He must have a proper understanding of these aspects of legislation which impact upon
corporate organizations. Such legislation will include Companies Acts, health and safety
regulations, laws relating to consumer protection and consumer rights to contract and
agency, employment law and laws relating to protection of the environment.
A Finance Manager will need to familiarize himself with taxation law as well as establish
the reasons why all aspects of business taxation are relevant to financial strategy.
Additionally he must be conversant with the section on corporation tax which impinges
both on policy formulation and decision-making, this topic being important for
investment appraisal.
Other aspects of taxation to be recalled include the tax shield relating to the taking on of
debt in a company’s capital structure, while he should be aware of foreign tax credits
relating to double taxation agreements, whereby most countries give credit sin respect of
income remitted to other countries which has already been taxed in the host country.
The Finance Manager should know the workings and implications of tax havens, which
are used by large organizations – usually multinational corporations – to defer payment
of tax on funds earned prior to them being remitted to the parents company’s host
country or used for investment purposes. Such havens will be expected to impose only
low rates of tax on income earned by resident subsidiaries or low withholding taxes on
dividends remitted, to have satisfactory financial services able to provide adequate
support facilities and to possess political and currency stability.
21.10 THE MAIN FUNCTIONS OF THE FINANCE MANAGER

These can be summarized as follows:
1. Investment Decision
2. Financing Decision
3. Dividend Decision
376
4. Liquidity Management
5. Tax Management
6. Risk Management
7. Asset Management
21.10.1 ENVIRONMENTAL FACTORS OF THE FINANCE MANAGER

A finance manager must be conversant with the following factors:
i. Financial Environment
ii. Economics Environment
iii. Business Environment
21.10.1.1 Financial Environment

The financial manager must have sound knowledge of the functions of the following
institutions:
- Central Bank of Nigeria,
- Nigeria Deposit Insurance Corporation,
- Bank of industry,
- Nigeria Agricultural Cooperative & Rural Development Bank
- Africa Export-Import Bank (AFREXIM)
- Nigeria Export-Import Bank (NEXIM)
- Africa Development Bank
- International Monetary Fund
- LONDON CLUB
- PARIS CLUB
- WORLD BANK etc
21.10.1.2 Economics Environment

A Finance Manager must know the implications of inflation, taxation, mergers and
acquisition and how finance is linked with other finance functions.
21.10.1.3Business Environment
He needs to have a solid knowledge of happening within the business community
including the appreciation of the function of the following bodies MAN, NACCIMA,
NASSINACIN etc.
377
21.10.2 PRINCIPAL FUNCTIONS OF THE FINANCE MANAGER
The finance manager is responsible for the following:
1. Development of financial strategy
2. Treasury management
3. Long-term planning
Each of these is further broken down as follows:
21.10.2.1 Development of Financial Strategy
a. determination of financial objectives,
b. planning of capital structure,
c. short and long-term planning
21.10.2.2 Treasury Management

a. forex management
b. cash forecasting
c. insurance
d. working capital
e. credit policy
f. raising of funds
21.10.2.3 Long-Term Planning

a. Mergers and Acquisitions
b. Capital budgeting
21.10.3 Structure of the Finance Function

The structure of the finance function varies from one company to another. The factors
which determine the type and size of the finance function include:
- size of the company
- nature of its business
- structure in the finance function of competitors
- growth requirements and potentials
Finance Director
Finance Controller Treasurer
Chief/Financial Management Credit Treasury

Accountant Accountant Manager Manager
378
21.11 THE JOB DESCRIPTION OF THE FINANCE CONTROLLER, TREASURER
AND INTERNAL AUDITOR
21.11.1 FUNCTIONS OF THE FINANCE CONTROLLER

- Maintains the company’s financial procedures and systems.
- Preparation of payroll
- Management information
- Cost analysis
- Preparation of financial statements
- Appraisal of long-term projects
- Maintenance of book-keeping and other financial records
- Determination of the company’s financial objectives
- Formulation and determination of the company’s capital structure
- Planning and control
- Reporting and interpreting
- Tax administration
- Government reporting
- Protection of capital assets
21.11.2 Functions of the Treasurer

- Raising of funds
- Investment of funds on short-term basis
- Management of working capital
- Issuance of company’s securities
- Management of pensions with trustees
- Management of company’s interest in other organizations
- Risk management
- Foreign exchange management
- Mergers and acquisitions plans
- Insurance as appropriate
- Banking and custody
- Credit collection
- Investor relations
379
21.11.3 Functions of the Internal Auditors
- Installation of company’s financial system and procedures
- Ensuring compliance with such system/procedures
- Providing operation and financial information for decision making process
- Reviewing the efficiency and effectiveness of operations
- Reviewing existing accounting systems and related controls
- Investigation needs of management
380
21.12 SUMMARY
This chapter has discussed financial management and fundamental principles and objectives of
financial management. It enabled the reader distinguished various decisions to be taken by the
finance managers towards achieving the stated objectives of the organization. It aid the reader to
segregate the individual finance officers functions within the organization.
381
1. Private sector companies have multiple stakeholders who are likely to have divergent
interest.
Required:
(a) Identity five stakeholder groups and briefly discuss their financial and other
objective.
(b) Examine the extent to which good corporate governance procedures can help
manage the problems arising from the divergent interests of multiple stakeholder
groups in private sector companies.
2. Justify and criticize the usual assumptions made in financial management literature that
the objective of a company is to maximize the wealth of its shareholders. (Do not
consider the problems of how this wealth is to be measured).
3. The objective of financial management is to maximize the value of the firm.
Required:
Discuss how the achievement of this objective might be compromised by the conflicts
which may arise between the various stakeholders in an organization.
4. Discuss whether or not the objectives of directors of a quoted company are likely to
conflict with those of the company’s shareholders.
5. When determining the financial objectives of a company, it is necessary to take three
types of policy decision into account investment policy, financing policy and dividend
policy.
Required:
(a) Discuss the nature of these three types of decision, commenting on how they are inter-
related and how they might affect the value of the firm (that is the present value of
projected cash flows).
(b) Discuss the different functions of the treasury and financial control departments of an
organization and comment on the relative contributions of these who departments to
policy determination and, the setting and achievement of financial objectives.
382
References

Hassan, M. M. (2011). Financial Management in Nigeria Local Government. Ibadan: University
Press Plc.
ICAN STUDY PACK (2014). Strategic Financial Management Emile Wolf
Limited.
Oyetade, Biyi (2008). Financial Management. Lagos: Olas Ventures.
Pandey, M. I. (2011). Essential of Financial Management. Lagos: First Publishers.
consulting.
Robert O. I. (2016). Financial Accounting Made Simple 4th Ed. Lagos: ROI Publishers.
383
CHAPTER TWENTY TWO
CAPITAL BUDGETING DECISIONS
 The meaning and importance of Capital Budgeting
 The basic appraisal techniques – ARR, PBP, NPV and IRR
 The relevant cashflows that are particularly associated with NPV and IRR
calculations.
22.1 INTRODUCTION
The continued existence of any company is not predicated on its investment on short-
term basis but rather on its long-term investment strategies.
A company that has liquidity problems will no doubt have to devise a short-term
investment strategy in order to see the company through the liquidity problems.
Thereafter, the company will need to undertake long-term investments which are the pre-
requisite to the concept of “on-going concern” basis.
Any company that makes short-term investment its main stay, will expectedly fizzle out
of existence within the shortest possible time.
One of the major problems of the finance houses that collapsed in recent times, has been
that of over concentration on short-term projects for quick profits. Indeed the quick
profits came but since the foundation upon which they operated was not good enough,
they collapsed. One of them known as the Forum Savings Limited made waves up till
the year 1992 before going down.
In this chapter, three core decision areas were highlighted:-

(i) Investment decision
(ii) Financing decision
(iii) Dividend decision
Any topic in Financial Management will either cover the three decision areas, two or at
least one. Whereas Dividend Policy covers the Dividend Policy, Sources of Finance is the
topic that covers financing while capital budgeting takes care of Investment decision.
We need to the three core decision areas one after the other for detailed study and
understanding. Our first major topic will be dealing with Investment decision, this topic
384
is called Capital Expenditure Decision which is under the umbrella of capital Budgeting.
Capital budgeting involves all investments in long-term projects. It is the process of
selecting alternative long-term investment opportunities i.e. it is the process of
committing the company’s funds into long term projects. These projects would normally
have life spans exceeding one accounting period. The procedures involved in capital
budgeting decisions are as follows:
- Identification of possible projects (investment profile/portfolio)
- Evaluation of projects
- Authorization of projects
- Development
- Monitoring and control of projects
- Post audit
22.2 CHARACTERISTICS OF CAPITAL BUDGETING

Capital expenditures differ from day-to-day ‘revenue’ expenditures because:
(1) they involve large outlay
(2) the benefits will accrue over a long period of time, usually well over one year and
often much longer, so that the benefits cannot all be set against costs in the current
year’s Profit or Loss account.
(3) they are very risky
(4) they involve irreversible decision
22.3 METHODS OF APPRAISAL

There are two methods of appraisal
i. The traditional/conventional method
ii. The modern/discounted cash flow method.
22.3.1 THE TRADITIONAL/CONVENTIONAL METHOD

There are two techniques under this method
i. The Accounting Rate of Return - ARR
ii. The Payback Period – PBP
22.3.1.1 ACCOUNTING RATE OF RETURN ARR

This technique is assessed by calculating the return on investment (ROI) i.e. it is based on
Return on Capital Employed – ROCE. ARR is entirely an accounting based technique of
investment appraisal. It makes use of the accounting concepts of accounting profits and
“capital employed” hence it uses accounting profit instead of economic profit.
385
It can be calculated as follows:
ARR = Estimated total profits x 100
Estimated initial investment
or ARR = Estimated total profits x 100

Estimated average investment
or ARR = Estimated average profits x 100 This is the most popular and acceptable
formula where the examiner is silent.
or ARR = Estimated total profits x 100

Estimated initial investment
Illustration 22-1:
Ebonyi Plc is to undertake a project requiring an investment of N100,000 on necessary plant and
machinery. The project is to last for 5 years at the end of which the plant and machinery will
have net book value of N20,000. Profits before depreciation are as follows:
Yr Profit (N)
1 40,000
2 44,000
3 48,000
4 52,000
5 58,000
You are required to calculate the ARR of the project.
Solution 22-1:
Workings:
i. Calculation of depreciation
Cost - N100,000
NBV - N 20,000
Accum. Depr - N 80,000
Average depr/year = N80,000/5 i.e. N16,000
386
ii. Calculation of Average Investment
This is calculated by adding the initial investment to the net book value and divide the
product by 2.
PLEASE NOTE
Where the NBV is zero, that zero is a figure hence, add zero to the initial investment and
divide by 2.
Initial investment N100,000

NBV N 20,000
N120,000
Average investment = N120,000/2 i.e. N60,000
ARR = Estimated average profits x 100

= N32,400 x 100
N60,000 i.e. 54%
DECISION RULES
A. INDEPENDENT PROJECTS
1. Accept if the project has an ARR that is equal to or greater than that set by the
management.
2. Reject if the project has an ARR that is less than that set by the management.
B. MUTUALLY EXCLUSIVE PROJECTS

1. Select the project with the highest ARR
2. Ensure that the project selected has an ARR that is equal to or greater than that set
by the management.
ADVANTAGES OF ARR
1. It is simple to calculate and understand
2. Unlike the payback period, it considers the profit over the entire life of the
project.
3. It uses readily available accounting data.
4. It presents the analysis in terms of a familiar percentage figure that can be easily
understood and interpreted by all the users of the data.
5. It could be used to compare performance for many companies.
387
DISADVANTAGES OF ARR
1. It suffers from definition problems, in that it can be calculated in several ways.
2. It takes no account of the time value of money.
3. There are no rules for setting the minimum acceptable ARR by the management.
4. There is no clear definition in accounting of profit and capital employed.
5. It uses accounting profit rather than cash as the measure of benefit.
6. When dealing with mutually exclusive projects, it will favour a project having an
ARR of 10% on N100,000to a project having an ARR of 8% of N1,000,000.
7. It ignores risk and management’s attitude to risk.
22.3.1.2 PAY BACK PERIOD

Capital is invested in a project, money is ‘tied up’ until the project begins to earn profits,
which pay back the investment. Money tied up in one project cannot be invested
anywhere else until the profits come in. Management should be aware of the benefits of
early repayments from an investment, which will provide the money for other
investments. This is where the importance of payback period comes in.
The CIMA’s official terminology defines payback as follows:

“The period, usually expressed in years, which it takes the cash
inflows from a capital investment project to equal the cash outflows”.
 The payback period technique – PBP – is used to determine how quickly a project
repays its outlay.
 It concentrates on how rapidly the project pays back its outlay.
 It can be calculated in two ways depending on whether:
i. the cash flows are constant – annual constant cash flows i.e. the same amount
every year or
ii. Non-constant (irregular) cash flows.
i. If the annual cash flows are constant

The PBP is calculated as follows:
= OUTLAY/ACCF (Annual Constant Cash Flow)
ii. If the cash flows are not constant
the PBP is calculated by recouping as follows:
388
Yr Outlay Cash flow Balance
0 (T) (T)
1 A (T) + A
2 B (T) + A + B
3 C (T) + A + B + C until the balance is zero
Illustration 22-2:
Adamawa Plc is to undertake a project requiringN1,000,000 outlay.
Required: What is the PBP if
(a) the project generates N250,000 annually
(b) the project has the following cash flow profile
Yr CF
1 200,000
2 220,000
3 230,000
4 220,000
5 195,000
Solution 22-2:
(a) PBP = Outlay i.e. 1,000,000
ACCF 250,000 = 4 years
(b) YR OUTLAY CF BALANCE

0 (1,000,000) (1,000,000)
1 200,000 (800,000)
2 220,000 (580,000)
3 230,000C (350,000)
4 220,000 (130,000)
5 195,000 -
130
= 4 /195 years i.e.4.67 years
DECISION RULES
1. Accept if the project has a PBP that is equal to or less than that set by the
management.
2. Reject if the project has a PBP that is greater than that set by the management.
389
B. MUTUALLY EXCLUSIVE PROJECTS
1. Select the project with the least PBP.
2. Ensure that the project selected has a PBP that is equal to or less than that set by
the management.
ADVANTAGES OF PBP
1. It is simple to calculate and understand.
2. Of all the appraisal techniques, it is the least affected by uncertainties. The reason is that
it focuses on the shortness of projects as far as life span is concerned as it places
emphasis on liquidity because the lower the PBP the more liquid the company becomes.
Forecasting errors due to long term estimates are therefore reduced.
3. Unlike ARR, it uses cash profit instead of accounting profit. Cash profit is superior to
accounting profit.
4. It serves as a “first screening process” i.e. as a simple initial screening process for new
projects.
5. It is often used in risk analysis in that it is believed that the higher the payback period of a
project, the riskier the project.
DISADVANTAGES OF PBP
1. Unless the DCF payback period is used, it ignores the time value of money.
2. There are no rules for setting the maximum acceptable PBP by the management.
3. If ignore the cash flows after the payback period.
4. It may lead to excessive investment in short-term projects.
5. It takes account of the timing of cash flows but not the variability of those cash flows.
6. It is unable to distinguish between projects with the same payback period.
7. It suffers definition problems of what the outlay is and where the payback period starts
from e.g.
(a) What is the outlay of the project below?
(b) What does the PBP start?
Yr 0 1 2 3 4 5
CF (5,000) 3,000) (2,500) 3,500 (2,000) 4,000
390
22.3.1.3 PBP RECIPROCAL
An alternative way to express the PBP is the payback period reciprocal which is the
inverse of PBP. i.e. _1_ x 100%
PBP
22.3.1.4 PBP WITH BAIL OUT FACTOR

With this technique, the possibility of using the scrap value to rescue a project while
calculating its payback is considered.
Illustration 22-3:
Yemco Nig. Plc is to undertake a project having the following data:
Yr Outlay Cashflow Scrap Value
0 (100,000) -
1 30,000 20,000
2 30,000 15,000
3 30,000 12,000
4 40,000 -
5 20,000 -
You are required to calculate a PBP using the scrap value as the bail out factor.
Solution 22-3:
Yr CF S/Value Cum CF
0 (100,000) -
1 30,000 20,000 30,000
2 30,000 15,000 60,000
3 30,000 12,000 102,000
4 40,000 - -
5 20,000 - -
Decision:Therefore, the payback period is 3 years.

N. B. The scrap value occurs at the end of the year and so there can be no fraction.
22.3.2 THE MODERN/DISCOUNTED CASH FLOW METHOD

The two techniques under this method are:
1. The Net Present Value - NPV
2. The Internal Rate of Return – IRR
391
THE MODERN/DISCOUNTED CASH FLOW METHOD
These are investment appraisal techniques which use discounted each flows to evaluate
projects. There are two variants of DCF method:
1. The Net Present Value (NPV) technique and
2. The Internal Rate Return (IRR) technique or DCF Yield.
Both techniques are superior to the ARR and PBP techniques earlier discussed.
Three important points about DCF are that:

a. They look at the cash flows of a project and not at the accounting profits.
b. Like the PBP technique. DCF is concerned with liquidity and not profitability.
c. They take account of the timing of the cash flows by discounting the cash flows. The
effect of discounting is to give a bigger value per N1 for cash flows in earlier years than
later years e.g. N1 earned in year 2 will have a bigger value than that of year 3, that of
year 3 will in turn have a bigger value than the value of N1 earned in year 5.
Before discussing NPV and IRR techniques, it is necessary to discuss certain

concepts:
i. Concept of present value
ii. Concept of Annuity
iii. Concept of Perpetuity
1. CONCEPT OF PRESENT VALUE

This concept is derived from compound interest.
Let P represent Principal (Initial amount), r to represent rate of interest and FV to
represent compounded sum (i.e. future value).
We can generalize that:
FV = P (1 + r)n …………………………… (i)
Where “n” is the time period (in years)
Therefore, if we know the future cash flow (FV) and the rate of interest (r), we can derive
P (the present value i.e. value in year 0), so that
P = FV
(1-r)n …………………………..(2)
P = FV + FV + FV + FV + FV
1 2 3 4
(1+r) (1+r) (1+r) (1+r) (1+r)n
392
2. CONCEPT OF ANNUITY
Where FV is a constant stream of cash flow to be received over a period of time at a
given rate of interest, the PV of all the cash flows can be derived as follows
FV 1 1___ The annuity factor being 1 - 1____

(1 + r)n (1 + r)n
r
3. CONCEPT OF PERPETUITY
Where a constant stream of cash flows is to be received indefinitely or over a large
number of years, the PV of the constant sum (A) is equal to
PV = _A_
r
22.3.2.1 NET PRESENT VALUE
The NPV technique recognises that different Naira arising at different time period will
not command the same value. Therefore a higher value per NJ is given for year I cash
flow than that of year 2 while that of year 2 will also be higher than that of year 3 and so
on at the same discount rate.
If the discount rate is not applied i.e. if the time value of money is not recognised, all
transactions will appear undiscounted.
Illustration 22-4:
The following are the information provided by YANKS LIMITED using the Net Present
Value method. Advise the company on which of the projects T, M, and X is the most
viable and should be accepted.
PROJECT T PROJECT M PROJECT X

Cost of Initial Investment 1,000,000 1,800,000 1,500,000
Receipts from the projects:
Year 1 400,000 100,000 500,000
2 500,000 300,000 100,000
3 600,000 500,000 900,000
4 700,000 700,000 100,000
5 800,000 1,200,000 400,000
Assume that the cost of is 10%.
393
Solution
Yanks Limited
Project T
Year Cash Flow Df@10% Present Value
0 (1,000,000) 1 (1,000,000)
1 400,000 0.9090 363,600
2 500,000 0.8264 413,200
3 600,000 0.7513 450,780
4 700,000 0.6830 478,100
5 800,000 0.6209 496,720
NPV 1,202,400
Project M
0 (1,800,000) 1 (1,800,000)
1 100,000 0.9090 90,900
2 300,000 0.8264 247,920
3 500,000 0.7513 375,650
4 700,000 0.6830 478,100
5 1,200,000 0.6209 745,080
NPV 137,650
Project M
0 (1,500,000) 1 (1,800,000)
1 500,000 0.9090 454,500
2 100,000 0.8264 82,640
3 900,000 0.7513 676,170
4 100,000 0.6830 68,300
5 400,000 0.6209 248,360
NPV 29,970
Decision
Yanks Limited is advised to invest in project N1,202,400 is advised to invest in project ‘T’
because it has the highest Net present value.
394
DECISION RULES
INDEPENDENT PROJECTS
(1) Accept if the project has a positive NPV.
(2) Reject if the project has a negative NPV.
MUTUALLY EXCLUSIVE PROJECTS

Select the project with the highest positive NPV.
ADVANTAGES OF NPV
(1) It recognizes the time value of money.
(2) NPV gives absolute measure of profitability which immediately reflects in the share
holders’ wealth.
(3) It gives a clear accept /reject recommendation.
(4) Unlike the PBP it uses all the cash flows over a project’s lifespan.
(5) For every project there is an NPV, whereas the IRR of certain projects will be in multiple
which is not good for decision making e.g
Yr Cr
0 (250,000)
1 555,000
2 (307,400)
the IRRsare6% and 16% as calculated below using quadratic equation.
-b +b2 - 4ac
2a
-b +b2 - 4ac
2a
-555 +5552 - 4 x -250 x -307.4

2 x -250
- 555 +308,025 - 307,400

-500
- 555 +625
-500
395
-555 + 25 &- 555 – 25
-500 -500
1.06 - 1 & 1.16 – 1

6% & 16%
(6) Unlike the ARR, it uses cash profits instead of accounting profits.
(7) NPVs for several projects can be aggregated.
Projects A B C Total
NPV 300 240 180 =720
(8) During the period of inflation the WPF criterion can be adjusted to accommodate relevant
changes in the discount rates.
Yr 0 1 2 3
CF (500) 480 490 540
Rates 10% 10% 15% 18%
NPV (500) + 480 + 490 + 540
0 1 2
(1.1) (1.1) (1.15) (1.18)3
(9) The cost of capital used for the calculation of NPV is the market discount rate which is
superior to other rates.
(10) During a period of capital rationing, the NPV criterion (discounted profitability index)
will always give a correct ranking of projects.
(11) Risk can readily be incorporated into the cost of capital to be used for appraisal.
22.3.2.2 Internal Rate of Return

This is also known as the cut off rate, the hurdle rate, the DCF yield, the target rate, the
marginal efficiency cost of capital, DCF rate of return and the break-even cost of capital.
It is the rate that equates the PV of all cash inflows with the PV of all cash outflows i.e. it
is the rate that equates the NPV to zero.
IRR is peculiar to a particular project and the JRR calculated indicates that borrowing at a
rate higher than the IRR calculated will make the project to be unviable. If a lower rate is
applied to finance the project, it will become viable.
IRR is calculated using a two step-approach
STEP 1 - TRIAL AND ERROR

By good reasoning, you will at this point be required to apply two different rates that will
produce two opposing NPVS -one positive and the other negative.
396
STEP 2 – INTERPOLATION
From the calculations done in Step 1 above, relevant figures relating to the formula below
are applied to generate the IRR.
IRR = LR + NPVLR x (HR – LR)

NPVLR – (NPVHR)
Where:
LR is lower rate
HR is higher rate
NPVLR is the NPV of the lower rate i.e. the positive NPV
NPVHR is the NPV of the higher rate i.e. the negative NPV
Illustration 22-5:
Calculate the IRR of a project having the following cash flows:
Year NCF
0 (3,610)
1 1,000
2 2,000
3 3,000
Solution 22-5:
Trial & Error
Year NCF DCF @ 15% PV DCF @ 26% PV
0 (3,610) 1 (3,610) 1 (3,610)
1 1,000 0.87 870 0.79 790
2 2,000 0.76 1,520 0.63 1,260
3 3,000 0.66 1,980 0.50 1,500
760 (60)
Interpolation
IRR = LR + _____NPVLR ___ x (HR – LR)
NPVLR – (NPVHR)
= 15 + ___760___ x (26 - 15)

760 + 60
= 15 + 760 x (11)
820
= 15 + 10.20
= 25.20%
397
DECISION RULES
Accept if the project has an IRR that is equal to or greater than that set by the
management. Alternatively accept a project if it has an IRR that is greater than the cut-off
rate stipulated by the management or if its (project) IRR is higher than the cost of
borrowing.
b. MUTUALLY EXCLUSIVE PROJECTS

Select the projects that have an IRR that is greater than the cut-off rate indicated.
ADVANTAGES OF IRR
(1) The IRR rates are presented in form of familiar figure that can easily be interpreted by the
users of the data.
(2) IRR though peculiar to a given project avoids disputes that characterise the choice of the
appropriate cost of capital to use when appraising projects.
22.4 SPECIAL ITEMS - DCF COMPUTATION (NPV & IRR)

Whenever NPV and IRR are to be calculated, please watch out for the following items
that are pitfall areas, hence they are normally used by examiners to test students in-depth-
knowledge.
1. DEPRECIATION
This is an accounting derivation and does not involve the physical movement of cash
and as such should be disregarded.
2. INTEREST
The essence of compounding and discounting is to account for the time value of money,
if interest is brought into the computation of NPV and IRR it will amount to double
counting. It should be disregarded.
3. SUNK COSTS
That is historical cost, it represents an amount that has already been incurred prior to the
investment under consideration e.g. research and development (where already
incurred),preliminary expenses, etc. It should be considered irrelevant.
398
4. OVER HEAD RECOVERY/ABSORPTION RATE/FIXED COSTS
All these costs are irrelevant. It is only when they are incremental in nature thatthe
incremental amounts will become relevant.
5. OPPORTUNITY COST
If I have a personal car and I want to start running a cub business with my personal car. I
need to place a value on the car as representing my investment. If the market places Nx
on the car, my investment in the cab business is Nx and should be treated as an outflow.
The fact is it represents an income forgone.
6. WORKING CAPITAL
This should be treated as an outflow in year 0 and recovered in full at the end of the
project’s life unless otherwise slated.
7. INCREMENTAL CASH FLOWS

If a company or project has been in existence earning/incurring a given amount prior to
the project under consideration, this current earnings/costs are not relevant. It is the
amounts by which the current earnings and costs will increase that should be considered
relevant.
8. RELEVANT YEAR
Cash flows arising at the beginning of a year should be treated in the provisions year.
While cash flows arising at the end of a year should be treated in the same year.
9. EXISTING ASSET
Where an existing asset will be used in addition to a new one, the market estimate of that
existing asset is to be treated as an outflow in year 0 and its scrap value as an inflow at
the end of the project’s life.
However, where the existing asset will be sold/scrapped/traded-in, the market estimate of
the existing asset is to be treated as an inflow in year 0 and its scrap value as an outflow
at the end of the project’s life.
399
22.5 SUMMARY
This is a capital expenditure decisions, which this chapter has been able to discussed extensively.
It aids the reader to understand what to perform before decision to embark on any business and
their interest. It discussed the factors that determined the profitability and viability of any
projects; before the execution.
400
1. A machine will cost N1,000,000 and will provide annual net cash inflow of N300,000 for
six years. The cost of capital is 15%. Calculate the machine’ net present value and the
internal rate of return. Should the machine be purchased?
2. A project cost N810,000 and is expected to generate net cash inflows of N400,000,
N350,000 and N300,000 over its life of 3 years. Calculate the internal rate of return of the
project.
401
References

Press Plc.
Limited.
consulting.
402
CHAPTER TWENTY THREE
SOURCES OF FINANCE
 The meaning and importance of sources of fund in Financial Management
 The various sources of finance
 The classification of sources of finance into short-term and long-term, medium-
term and long-term.
23.1 INTRODUCTION
In lecture chapter twenty one, we identified three broad decision areas in Financial
Management namely:
 Investment decision
 Financing decision
 Dividend decision
Investment decision involves identification of the various investment opportunities,

evaluation of the opportunities and selection based on the funds available. Under
Financing Decision, we identify the different sources of funds, the costs associated with
each source, the characteristics of each source and the availability of each source. In this
lecture, we focus attention on the financing decision with special reference to sources of
finance.
We can classify sources of finance into three:

(1) Short-term sources - those repayable within one year
(2) Medium-term sources - those repayable within 1-3 years
or sometimes 1-5 years
(3) Long-term sources - available for 5 years or longer
23.2 SOURCES OF SHORT-TERM FUNDS

Short-term methods of finance are suitable for funding shortages in working capital. They
should not, if it can be avoided, be used to finance long-term investments. It is prudent to
have some current assets financed by long-term capital, otherwise the company will have
a negative working capital.
403
Funding Assets
Short Current
Long Fixed
The main sources of short-term funds are:

(1) Bank credit (bank overdraft)
(2) Commercial papers
(3) Trade credits
(4) Debt factoring
(5) Invoice discounting
(6) Bill discounting
(7) Accruals
(8) Acceptance Credits (Bankers Acceptances)
23.2.1 BANK CREDIT (BANK OVERDRAFT)

Commercial Banks sometimes allow their customers to overdraw their accounts up to a
certain limit, overdraft interest is charged on the day-to-day overdrawn position. While
the bigger customers may be charged at “Prime rate” (a little above the bank’s base rate)
the smaller customers may be required to pay a premium over and above the Prime rate.
The overdraft charges are deductible for tax purpose
Bank overdrafts are usually available for up to one year, but can be rolled over. They are
usually unsecured, but under certain conditions, banks may require collaterals.
Additionally, banks may evaluate the credit worthiness of customers through financial
statements and cash flow projections before granting the facility.
At times, the bank may require the customer to keep a “compensating balance” with it
usually between 10 - 20%, thus forcing the borrower to be a chequeuing customer.
The main cost of bank overdraft is the interest charge.
23.2.2 COMMERCIAL PAPER

This is an instrument used by large concerns to raise short-term funds from the money
market. It is usually issued on behalf of the company by an issuing house (normally a
merchant bank). The issuing house docs not guarantee the notes but assists in finding
investors to buy them. The investors effectively lend directly to the company issuing the
notes. The issuing house charges a commission for the service.
404
Commercial papers usually carry a stated coupon rate, and the maturity date ranges
between 30 and 270 days. Commercial Papers with maturities of more than 270 days are
required by the Securities and Exchange Commission Decree of 1988 to be registered
with the Sec Commission. The costs of a commercial paper is made up of two
components:
• the coupon rate say 15% per annum
•an issuing house commission, usually 0.5% flat on the amount raised.
This cost would have to be compared with the costs of other short-term sources before
the final decision is made.
23.2.3 TRADE CREDITS

The credit from suppliers is a major source of business finance, especially to small
companies. This source of finance could be very expensive if it includes cash discount
offer, and such an offer is not taken.
The effective cost of not taking a discount can be calculated as follows:

Cost = % age discount X 365
100 - % age discount maximum payment period
less maximum discount period
Trade credit has the advantage of being readily available without formal arrangement. It
can be relied over and therefore will become a continuous source of finance.
The other costs associated with trade credits can be identified as:
• pressures from suppliers
• reduction in credit rating if payment is delayed beyond the final due date.
23.2.4 FACTORING
Factoring involves raising funds on the security of the company’s debt so that the cash is
received earlier than if the company waited for the debtors to pay.
There are two main types of factoring:

(a) SERVICE FACTORING
In the case of service factoring, the factor buys from the company its invoiced debt, in
effect the company passes to the factor all the work of the company’s debt collection and
debtor accounting. Payment to the company by the factor for the debt is made on an
average settlement date based on the maturity date of the debt. In effect the company is
relieved of the risk of bad debt and a single guaranteed payment is made in place of the
405
piece meal realisation which would occur if the company collected its own debt. The
charge for this service is based on turnover.
DISADVANTAGES OF SERVICE FACTORING

(1) The debtor is always aware of the existence of the factor since all invoices and statements
will be sent out by, and payments made to the factor.
(2) Payment is made by the Factor to the company on the average date of which the debts fall
due for settlement. There is therefore no significant increase in the cash resources
available to the Company.
3
Client Company 2 Factor
1 4
Debtor
Key: 1. Client sells goods to debtor

2. Client sells debt to factor
3. Factor makes payment to Client
4. Debtor makes payment to factor
(b) SERVICE AND FINANCE FACTORING
This type of factoring involves not only the provision of accounting facilities but also of
immediate finance since the factor on buying the debt makes an immediate payment to
the company of up to 90% of the face value of the debt in addition to paying the service
charge, the company must also pay the finance charge to the factor with or without
recourse. Factoring with recourse attracts 5%charge while factoring without recourse
attracts a negotiated charge.
3
Client Company Factor
2
1 4
Debtor
406
2. Client sells debts to factor
3. Factor makes immediate payment to the company up to 90% of the FSV
of debts.
4. Debtor makes payment to factor
23.2.5 INVOICE DISCOUNTING

Inspite of the fact that by accepting a company a factor will thoroughly investigate the
company’s affairs in order to satisfy himself that the business is properly managed. There
is still a fear that the use of a factor indicates financial instability. Consequently, many
potential users of debt factoring have refrained from using the facilities available, this
reluctance has given rise to a method of confidential invoice factoring which has become
known as invoice discounting.
Under this method, debts are sold to the factor who makes an immediate payment of an
agreed percentage of the face value of the debt sold. No sales accounting service is
supplied by the factor, rather only finance is supplied for which interest is charged, in
effect, a factor buys the debt and appoints the company as agent to collect those debts.
2
Client Company 3 Factor
5
1 4
Debtor Debtor
2. Client sells debts to factor
3. Factor makes immediate payment to the company up to 80%of the face
value of debts.
4. Client collects debts as agent for factor
5. Client repays advance from factor
23.2.6 BILLS DISCOUNTING

A bill of exchange is normally prepared by the supplier of goods (account payable) for
endorsement/ acceptance by the customer (account receivable). This is common with
export sales. The supplier (seller) can obtain immediate cash after the goods have been
dispatched by discounting the bill with the bank/discount house.
407
23.2.7 ACCRUALS
Deferment of tax payments and wages are the commonest examples in this method. Tax
laws provide that tax liabilities should be due for payment after one year. Also employees
work for a period of one month before receiving their pay. These form interest-free
sources of short –term finance. The cost of postponing tax payment is normally a penalty
or a fine, while the cost of postponing wage payments will be to dampen employees’
morale. Employees may respond with absenteeism, reduced efficiency or seek
employment elsewhere. A firm must use this source of finance carefully and only as a
last resort.
23.2.8 ACCEPTANCE CREDIT/BANKERS ACCEPTANCE

This source of finance is similar to bills of exchange. The only difference is that it is a
bank which guarantees/undertakes to liquidate the debt on maturity in ease of a default.
Such bill becomes readily discountable in the money market because a bank has accepted
on carried out by the provider of the fund (discount house) will normally cover the credit
worthiness and reputation of the bank providing the guarantee/acceptance. Banker’s
acceptance (Acceptance credits) are issued for period varying between 2 months and 12
months.
23.2.9 FRANCHISING
Franchising is a method of expanding a business on less capital than otherwise needed.
For suitable business, it is an alternative to raising extra capital for growth. Under a
franchising arrangement, a franchisee pays a franchisor for the right to operate a local
business under the franchisor’s trade name. The franchisor must bear certain costs
(possibly for architect’s work, establishment costs, legal costs, marketing costs and the
costs of other support services) and will charge the franchisee an initial franchise fee to
cover set-up costs, relying on the subsequent regular payments by the franchisee for
operating profit. These regular payments will be a percentage ofthe franchisee’s
turnover.
Although the franchisor will probably account for a large part of the initial investment
cost of a franchisee’s outlet, the franchisee will be expected lo contribute a share of the
investment himself. The franchisor may well help the franchisee to obtain loan to provide
his share of the investment cost.
408
The advantages of franchises to the franchisor are as follows:
 The Capital outlay needed to expand the business is reduced substantially.
 The image of the business is improved because the franchisees will be motivated to achieve
good results and will have the authority to take whatever action think fit to improve results.
The advantage of a franchise to the franchisee is that he obtains ownership of a business for
an agreed number of years (including stock and premises, although premises might be leased
from the franchisor) together with the backing of a large organisation’s marketing effort and
experience. The franchisee is able to avoid some of the mistakes of many small businesses,
because the franchisor has already learnt from his own past mistakes and develop a scheme
that works.
23.3 MEDIUM TERM SOURCES

The main sources of medium - term funds are:
1. Bank Term Loan
2. Venture Capital
3. Project Finance
4. Equipment Leasing
5. Sale and Leaseback
6. Hire Purchase
7. Mortgage
23.3.1 BANK TERM LOAN

This is similar to bank overdraft except that it is available for a longer period. Also, it
carries a higher interest charge because of the longer period covered. The collateral
security required for bank term loan is often higher than bank overdraft, and banks would
also carry out a more stringent evaluation of the company and the project for which the
fund is required. In short the degree of control over bank term loan is higher than bank
overdraft.
23.3.2 VENTURE CAPITAL

Venture capital represents funds invested usually in a new enterprise i.e. monies which
are invested in a commercial venture with highly uncertain chance of success; hence,
such monies are called risk capital and seed money. There are several stages involved in a
venture capital funding. Seed money is needed to develop a concept-product or service-
and plan.
Although usually, these needs are small, (several hundred thousand Naira or less) funded
409
By the entrepreneur, his or her family, or friends, on rare occasions venture capitalists
will provide such financing. The next stage is start-up or first-round financing. This
financing is used to fund further research and development and to formulate initial
marketing and production plans. Typically, second-round financing is used to get
production and selling efforts launched. Although this could occur with first-round
financing, it often falls in the second round. Third -round and perhaps subsequent rounds
financing are used when a company is producing and selling a product or service but
where cash outflow exceeds cash inflow deficit occurs.
23.3.3 PROJECT FINANCE

This is a self-liquidating facility with the following characteristics:
a) The financial standing of the borrower is not important.
b) The proceeds from project should be sufficient to repay the capital together with
the interest.
c) The project/property financed will serve as security.
23.3.4 EQUIPMENT LEASING

This is a financial arrangement to finance the purchase of an asset through a finance
company or a leasing company or a bank. There are two types of lease, namely finance
lease and operating lease.
23.3.4.1 Finance Lease

This is where the risk and benefit of ownership have been substantially transferred to the
lessee.
23.3.4.2 Operating Lease

A lease where the risk and benefit of ownership remain with the lessor.
23.3.5 SALE AND LEASEBACK

This is a situation where an asset previously owned by a company is disposed off and
immediately repossessed through a leasing contract.
23.3.6 HIRE PURCHASE (VENDOR CREDIT)

This is an arrangement under which the hirer, in return for the use of an asset undertakes
to make periodic payments to the owner of the asset. He is expected to assume ownership
of the asset after the payment of the last instalment.
410
23.3.7 MORTGAGE
An alternative to sale and leaseback is mortgaging. It may be possible for a company to
arrange to borrow money by means of a mortgage on freehold property. The most likely
institutions that are prepared to lend on such a basis are insurance companies, investment
companies, and pension funds. Building societies are reluctant to lend to companies and
there are in any case limitations on the amount they can lend in any year to corporate
borrowers; they may be more willing to grant mortgages to the proprietors of small-
unincorporated businesses. Repayments of principal plus interest may be spread over a
long period of time. The rate charged is somewhat in excess of base interest rate.
23.4 LONG-TERM SOURCES

The main sources of long-term funds are:
1. Equity Capital
2. Preference Share capital
3. Debenture Stock Capital
23.4.1 EQUITY CAPITAL/ORDINARY SHARE CAPITAL

The traditional form of capital is equity capital. The holders of this capital are the owners
of the business. The right of current shareholders to maintain their fractional ownership
of a company by buying a proportional number of shares of any future issue of shares is
known as preemptive right. It is also called subscription privilege or subscription right.
Shareholders are claimed to have a general preemptive right to anything of value that the
company may wish to distribute as well as the ultimate control of the company’s affairs.
Shareholders bear a huge portion of the entire risks associated with the company; hence
they expect a higher rate of return than most other providers of finance. Other features
are, that they expect and are entitled to a share of the profits of the company in the form
of dividends, subject to the recommendation of the directors and after all prior claims
have been met.
The ordinary shareholders have voting powers of rights attached to their investments.
They cannot redeem or reclaim their investment except by selling their shares or in the
event of liquidation.
Ordinary shares could take the form of preferred, deferred or founders’ ordinary shares.
Preferred ordinary shares usually receive a fixed rate of dividend, before the other
ordinary shareholders. They may also be entitled to a further share of profit after their
411
fixed entitlement (dividend). Deferred ordinary shares arc usually residual recipients after
all claims including preferred ordinary shareholders have been settled. Deferred shares
could be given to the sellers (owners) of a company acquired by another company. These
serve as deferred payment for the purchase of the company held back until enough profits
emerge. These types of deferred ordinary shares are called founders’ shares.
23.4.2 RAISING OF EQUITY CAPITAL

The methods of raising equity funds or putting a company in a position for raising equity
finance in future, which are particularly available to quoted companies, include:
1. STOCK EXCHANGE INTRODUCTION

This is not a method of raising new capital, but of getting permission to “deal” i.e.
introducing the shares of the company to the market. The company after quotation will
have access to finance in the capital market in the future.
2. OFFER FOR SALE

In this method, the shares are offered to the public including the existing shareholders
through the agency of an issuing house. At the end of an offer for sale the nominal share
capital of the company remains unaltered and the proceeds of sales go to the vendor
(existing shareholders) and not the company. Offer for sale is not a fresh issue of shares,
but sale of existing shares by existing shareholders. This is the method being used by the
Bureau of Public Enterprise (BPE) previously known as the Technical Committee on
Privatisation and Commercialisation (TCPC)– to sell the Federal Government’s shares in
the privatised enterprises.
3. OFFER FOR SUBSCRIPTION

In this method, the company itself through the agency of an issuing house offers fresh
issues to the public. The idea here is lo raise supplementary capital for the company.
The proceeds of issue go to the company and the number of shares outstanding at the end
of the exercise will increase.
-INITIAL PUBLIC OFFER (IPO)

The first sale of shares by a private company to the public. IPOs are often issued by
smaller, younger companies seeking the capital to expand, but can also be done by large
privately owned companies looking to become publicly traded.
412
-SEASONED EQUITY OFFER
An offer of shares or bonds by a company that is already listed on a stock exchange. In
contrast to an initial public offering by a company which is being listed for the first time.
A seasoned offer can be in the form of an offer for sale to the public as a whole or a
placing with a restricted set of institutional investors.
-HOT ISSUE
An issue that is in high demand and sells at a premium over the public offering price on
the first day of trading.
-GUN JUMPING
The illegal practice of soliciting orders to buy a new issue before registration of the initial
public offering (IPO) has been approved by the Securities and Exchange Commission
(SEC).
Trading securities on the basis of information that has not yet been disclosed to the
public.
The theory behind gun jumping is that investors should make decisions based on the full
disclosure in the prospectus, not on the information disseminated by the company that has
not been approved by the SEC. If a company is found guilty of “jumping the gun”, the
IPO will be delayed.
4. OFFER FOR SALE BY TENDER

Here, the company offers the shares for sale at a minimum price level. Applications are
then requested for the sale of the shares at prices determined by the various investors. The
final price will be the price that will clear all available shares; this is called the striking
price. The stock exchange will ensure that all shares are finally taken up at the same
price.
5. PLACING OF SHARES
In this method the shares are offered to a specific group of investors usually insurance
companies, pension funds or any other institutional investors.
6. RIGHT ISSUES
In this method, additional finance is obtained from the existing shareholders. This method
avoids issuing costs if finance is to be obtained from the public. It confirms the financial
stability of the company and the price at which the shareholders buy the rights is usually
below the market price of the company after the rights issue.
413
23.4.3 DEBENTURE STOCK
These are loans of a long-term nature. These could be secured or unsecured. Debenture
represents the document, which acknowledges the indebtedness to the company. In
practice the term “debentures” may be restricted to secured loans. The main features are;
1. They are not entitled to voting rights,
2. They are fixed interest securities entitled to annual interest payments,
3. The interest elements are tax deductible,
4. They could be redeemable, irredeemable or convertible.
5. The principal amounts are usually secured on the assets of the company and could
have,
(a) Floating charge or
(b) Fixed charge or
(c) A combination of (a) and (b).
A floating charge covers all the assets, as they exist from time to time excluding assets
subjected to fixed charge. A floating charge does not prevent the company from buying
and selling assets in the normal course of its business.
A fixed charge is on one or more specific assets. If the company fails to pay interest, or
the principal, or attempts to dispose of an asset charged, then a receiver may be appointed
to take possession of the asset and sell it for the benefits of the debenture holders.
Debentures could be redeemable or irredeemable: The date for redemption is usually

written in form of a range (e.g. 2001-2010). The date will be agreed upon at the time of
negotiating the loan.
Some debentures are irredeemable in which case no date is set for redemption but the
borrower can redeem the debt whenever he wishes and force the debenture holders to
settle.
A borrower may redeem a debenture earlier than the due date because of any of following
reasons:
1. To take advantage of falling interest rates;
2. To make use of surplus funds;
3. To release assets by a fixed charge for usage as collateral.
Debenture stocks could also be in which case the holder has an option to convert the
debenture within a given time period into equity stock at a specified price. If this option
is not exercised then the debenture will continue its normal term to redemption.
414
Cap is an agreement which sets a maximum rate of interest for a borrower while floor is
an agreement which sets a minimum rate of interest for a borrower.
Financial sweetners usually refers to equity, options, such as warrants or conversion

privileges, attached to a debt security.
An indenture is a legal contract between the borrower and the lender that covers every
detail regarding a bond issue.
23.4.4 PREFERENCE SHARE

Preference share is usually a more expensive source of finance than debenture stock.
This is because debentures are less risky and usually have tax shield (benefit). Other
features of preference shares are that they are not entitled to any voting rights normally,
and their interest in the company is represented by dividend payment and principal
repayment.
Preference shares could be preferred or deferred, cumulative, participating, redeemable.

Cumulative preference shares would have their dividend income accumulated and paid at
future dates if the company has liquidity problems. Participating preference are entitled to
a fixed dividend income per year (these may be cumulative) plus a future share in any
oilier profits. In some cases, this further share could be after the ordinary shareholders
have been paid a certain dividend. Preferred and deferred preference stock e
characteristics similar to preferred and deferred ordinary shares.
ADVANTAGES AND DISADVANTAGES OF CONVERTIBLE LOAN STOCK

(a) From the point of view of a borrower, convertible loan stock has the following
advantages:
(i) Provided the company has good prospects, it will be possible to offer convertible
loan stock at a lower interest rate than debentures.
(ii) If the company is just starting up or is developing a new product, so that returns
will initially be small, convertible loan stock provides cheap fixed interest
funding, and the conversion date can be planned to coincide with the growing
availability bf profits sufficient to pay acceptable dividends.
(iii) When money is in short supply, the incentive of a future share in profits may
encourage lenders who would not otherwise invest in the company.
415
(iv) If the company is in need of permanent capital but the market price of shares is
currently depressed, the issue of convertible loan stock can be used as delaying
tactics in the hope that the conversion period will Coincide with higher share
prices, thus giving the company as much money as possible per share issued.
(b) From the point of view of the lender

By taking convertible loan stock he ensures a fixed income in the early years while he
wants to see whether the business is successful. If it prospers and the price of the
ordinary shares rises then he can take advantage of both favourable conversion terms and
also the opportunity of participating in the available profits. If the business is not
successful, then he will accept redemption of his loan stock, or will be able to sell it at a
price, which at least reflects its fixed interest earning power.
23.5 FACTORS AFFECTING A COMPANY’S CHOICE OF FINANCE

a) Length of the Project: The general rule in financing is that the maturity of the finance
should match the length of the project it is to be used for. Therefore a long-term
investment requires long-term finance and a short-term investment requires short-time
finance. If short-term finance were used for a long-term project then the company would
be in a vulnerable position if that finance were withdrawn. If a long-term finance is raised
when a company only requires it for a short-term period, it may then have idle cash
around.
b) Pattern of Cash Flow: This generally means how long the investment period last before
cash flow commences. A long period during which a company has to spend money
without generating any revenue will present problems in terms of liquidity. Using
financing whose pattern of repayment fits the project cash flow can alleviate this. The
best source of finance in terms of liquidity is equity since the annual dividend can be
small or zero and can be varied according to circumstances.
A bank loan, however, generally carries interest payment and the possibility of capital
repayment of the loan may result in substantial cash payments even if no cash is being
generated by a project.
c) Level of Risk: A project with a high level of risk will probably require some form of
equity finance, the use of debt with the burden of interest and capital repayment whatever
the outcome of the project would substantially increase the risk of insolvency.
416
d) The Cost of Finance: Clearly a company should see to minimize the cost of finance it
raises, this is important because the cost of finance would affect the weighted average
cost of capital (WACC) and by extension the value of the company.
e) Debt Capacity: The ability to use debt finance for a new project can be valuable in terms
of the tax savings on debt’s interest. An important feature of the project which in fact
determines debt capacity is the type of asset involved and their Values as security for
loan.
f) Control: Existing shareholders will only maintain their level of control over an
organisation if retained earnings or right issues are used for finance. Any other external
finance will to a certain extent involve loss of control even debt finance where although
voting control is not affected the creditor may take charges on asset or enforce
restrictions on a company in other aspects.
g) The Need for Future Finance: Many projects do not just need capital initially but
require additional finance for future expansion. The use of convertibles may be attractive
in these situations.
23.6 STOCK DIVIDEND/SCRIP DIVIDEND

A stock dividend involves the payment of a dividend in the form of extra shares.
As an alternative to paying out cash dividends during a year, a company may choose to
pay a stock dividend (scrip dividend). This is essentially a transfer to the shareholder of a
number of additional equity share without the shareholder having to subscribe additional
cash. From the company’s point of view this offers the advantage of preserving liquidity,
for no cash leaves the company. The number of equity shares is increased, but as long as
the annual increase is not too large, and the retained earnings are invested to yield a
satisfactory rate of return the share price should not fall. The advantage to the shareholder
is that he receives a dividend, which he can convert into cash whenever he wishes by
selling his shares.
23.7 SCRIP ISSUE

This is the capitalization of the reserves of a company by the issues of additional shares
to existing shareholders in proportion to their holdings, usually at no cost.
A script issue is also called bonus issue or capitalization issue. The declaration of bonus
shares will increase the paid up share capital and reduce the reserves and surplus of the
company. The total net worth is not affected by the bonus issue.
417
DIFFERENCES BETWEEN SCRIP DIVIDEND AND SCRIP ISSUE
1. With scrip dividend new shares are issued at full market price. This will lead to the
creation of share premium.
Whereas in a scrip issue the shares are issued at nominal value.
2. Scrip dividend attracts withholding tax while scrip issue does not attract withholding tax.
3. Scrip dividend is not necessarily issued to all shareholders. It may be optional. While
scrip issue is issued to all the shareholders.
23.8 STOCK SPLIT

A stock split is a new share issue designed to replace an existing one, with a net increase
in the number of shares in issue, the effect is a fall in the share price, but by less than the
extent of the increase in the size of the issue e.g. if a share is trading at N6 and stock split
doubles the number of shares in issue, in theory the share price should fall to N3. In
practice it may fall to N3.10 because the lower price increases the marketability of the
shares. This means that, in effect, shareholders have received a dividend of 20k per N6
share.
23.9 REVERSE STOCK SPLIT

This is the opposite of stock split. A reverse stock split is a financial strategy of
consolidating the nominal value of an existing share issue and a corresponding decrease
in the number of shares in existence. A company currently having 1,000,000 50k shares
may decide to increase its nominal value to N1. This in effect will reduce the number of
shares to 500,000 only.
418
23.10 SUMMARY
The various sources of finance or fund have been discussed by this chapter. It classified the
sources of finance into short, medium and long term which makes the reader to distinguish
between them.
419
1. What is Right issue? What are its advantages and disadvantages from the company’s and
shareholder’s point of view?
2. What is ordinary share? How does it differ from a preference share and debenture?
Explain its most important features.
420
References
Abdulrasaq A. (2009). Financial Management. Lagos: Corporate Publishing.
Press Plc.
Limited.
421
CHAPTER TWENTY FOUR
WORKING CAPITAL MANAGEMENT

 The meaning and importance of Working capital and Working capital
management
 The efficient uses and management of working capital and
 The concepts f over and under-capitalization.
24.1 INTRODUCTION
No matter the amount spent on equipment, plant and machinery, buildings etc if the
ingredients required for production are not efficiently managed, the entire amount
committed to the project will become a waste. This is why this topic is so crucial and it
needs to be appreciated as such.
Working capital refers to the items that are required for the day-to-day production of
goods to be sold by a company. It can be defined as the excess of current assets over
current liabilities. It is the same as net currents assets. It represents the amount that is
invested in assets that are expected to be realised within the year’s trading. It is not a
permanent investment but as the name implies it is continually in use, being turned over
many times in year. It is used to finance production, to invest in stock and to provide
credit for customer-its main components being stock, debtors, creditors and cash. These
assets are needed for the day-to-day manufacturing and or trading activities of a business.
They can be funded either by short-term finance that is current liabilities, or by medium -
and long-term finance.
The relationship between current assets and current liabilities is such that the current
asses should be twice the size of current liabilities hence it is said that the ideal current
ratio (current assets / current liabilities) is generally accepted to be 2:1 (i.e. I/ 2 of current
assets should be financed by long term funds) but this proportion can obviously be varied
in practice, depending on the circumstances of an individual company or organisation.
Similarly, the ideal quick ratio (current assets minus stocks/current liabilities) is 1:1,
although in practice, companies often have a much lower quick ratio than this. These
liquidity ratios are indications of how solvent a company is. A company will not become
insolvent overnight, deterioration in these ratios are indications of insolvency. If a
company is unable to renew its short term liabilities (i.e. if the bank suspends its
overdraft facilities, or creditors demand immediate payment on delivery for supplies)
422
there would be a danger of insolvency unless the company is able to realise sufficient
amount of its current assets quickly into cash. A current ratio of 2:1 and a quick ratio of
1:1 are regarded to be indicative that a company is reasonably well protected against the
dangers of insolvency through insufficient liquidity.
24.2 OPERATING/CASH OR WORKING CAPITAL CYCLE

Operating or working capital cycle is defined as the period between the payment of cash
creditors (i.e. cash out flow)and the receipt of cash from debtors (i.e. cash inflow)
CASH
RAW
MATERIALS
DEBTORS
WORK IN
PROGRESS
FINISHED
GOODS
24.2.1 The operating cycle is the length of time it takes to acquire inventory of raw materials,
convert them to finished products, sell them and collect cash from sales. Thus operating
cycle begins life as inventory, it is converted to accounts receivables when it is sold and it
is finally converted to cash when we collect cash from sales.
24.2.2 The cash cycle is the number of days that passes before we collect the cash from sales
measured from when we actually pay for the inventory. Cash cycle is therefore the
difference between operating cycle and the accounts payable period.
Differences:
Operating cycle tells a complete story of time it takes to convert inventory procured to cash
through collection of sales, whereas cash cycle explains the time interval between when
inventory procured is paid for and is converted to cash through sales.
423
Operating cycle tells the financial implications of various policies of a firm in its working
capital management. Cash cycle on the other hand attempts to explain the time interval required
by a firm to meet its financial obligation.
24.3 OVER CAPITALISATION (UNDER TRADING)

Over capitalisation occurs where a company commits excessive capital into the
company’s trading activities, so that there are excessive stocks, debtors and cash, and
very few creditors. If a company manages its working capital inefficiently, i.e. if working
capital is excessive and the company becomes over - capitalised the return on capital
employed would be lower than what it should be and long term funds would be
unnecessarily "tied up" when they could be invested elsewhere to earn profits.
Over-capitalisation should not exist if there is good management of working capital, but
the "warning signals" of excessive working capital would be poor accounting ratios.
The ratios below are to judge whether the investment in working capital is reasonable are;
(a) Sales/Working capital. The volume of sales as a multiple of the working capital
investment should indicate whether in comparison with previous years or withsimilar
companies, the total volume of working capital is too high.
(b) Liquidity ratios. A current ratio in excess of 2: 1 or quick ratio in excess of 1:1may
indicate over - investment in working capital.
(c) Turnover periods. Excessive turnover periods for stocks and debtors or a lowperiod of
credit taken from suppliers would indicate whether the volume ofstocks or debtors is
unnecessarily high, or the volume of creditors too low.
THE TURNOVER PERIODS MAY BE CALCULATED AS FOLLOWS

1. Raw Materials = Average RM stock X 12 months OR Closing Stock X 12 months OR
Annual purchases 52 weeks OR Annual purchases 52 weeks OR
365 days 365 days
2. Work in Progress = Average WIP X 12 months Closing WIP X 12 months

*cost of production p.a. 52 weeks OR Cost of Sales 52 weeks
365 days 365 days
3. Finished Goods = Average FG X 12 months Closing FG X 12 months

Cost of sales p.a. 52 weeks OR Cost of sales p.a. 52 weeks
365 days 365 days
424
4. Drs T/O periods = Average creditors X 12 months Closing Drs X 12 months
(Average collection Credit Purchases p.a. 52 weeks OR Sales p.a. 52 weeks
Period) 365 days 365 days
5. Crs T/O periods = AverageCreditors X 12 months Closing Crs X 12 months

(Average payment Cost of sales p.a. 52 weeks OR Purchases p.a. 52 weeks
Period) 365 days 365 days
QUESTION 24-1
The table below gives information extracted from the annual accounts of Management Plc for the
past three years.
You are required to calculate the length of the working capital cycle year by assuming 365 days
in the year.
Management Plc - Extracts from annual accounts

Year 1 Year 2 Year 3
N N N
Stocks: raw materials 108,000 145,800 180,000
Work-in-progress 75,600 97,200 93,360
Finished goods 86,400 129,600 142,875
Purchases 518,400 702,000 720,000
Cost of goods sold 756,000 972,000 1,098,360
Sales 864,000 1,080,000 1,188,000
Debtors 172,800 259,200 297,000
Trade creditors 86,400 105,300 126,000
SOLUTION 24-1 Year 1 Year 2 Year 3

1. Raw materials = RM stock x 365 days
Purchases 76.0 75.8 91.3
2.Work In Progress = WIP____ x 365 days

Cost of sales 36.5 36.5 31.0
3. Finished goods = Finished goods x 365 days 41.7 48.7 47.5

Cost of sales
425
4. Drs T/O periods = Debtorsx 365 days 73.0 87.6 91.3
(Average collection Sales
period)
5. Crs T/O periods = Creditorsx 365 days (60.8) (54.8) (63.9)

(Average collection Sales
period) _____ _____
Total length of cycle 166.4 193.8 197.2
24.4 UNDER CAPITALISATION (OVERTRADING)

Overtrading occurs when a company tries to do too much, too quickly with too little
capital, so that it is trying to support too large a volume of trade with the little capital
resources at its disposal. An overtrading business can be operating at a profit,
nevertheless it will eventually run into serious trouble because it is short of fund and
these liquidity troubles stem from the fact that it does not have enough capital to provide
the cash to pay its debts as they fall due. It is not always easy to convince the
management that problem lies ahead because the business is making profit. Many good
and successful businesses have been built up with a controlled amount of overtrading,
problems only arise when overtrading gets out of control, and a business finds it
increasingly difficult to pay its debts when they fall due. With overtrading a business
sinks gradually into ever- increasing liquidity problem-without its managers realising that
the problems are worsening. It should be appreciated that uncontrolled overtrading does
not happen overnight as the under listed symptoms are to herald, its emergence.
24.4.1 SYMPTOMS OF OVERTRADING

(a) A rapid increase in sales turnover.
(b) A rapid increase in the volume of current assets and possibly also of fixed assets, Stock
turnover and debtors turnover periods might slow down, which means that the rate of
increase in stocks and debtors would be even greater than the rate of increase in sales
turnover.
(c) Increase in assets financed by a small increase in proprietors’ capital (e.g. retained
profits) while most increases are financed by:-
(i) trade creditors (repayment period to creditors become much slower)
(ii) encroachment on the limit approved for overdraft.
(d) Over head costs might increase substantially, so that net profit margins fall.
(e) Gross profit ratio might fall, because of higher purchase costs.
(f) Some debt ratios and liquidity ratios will alter dramatically, e.g.
426
(i) ratio of working capital to sales will decline.
(ii) ratio of debtors to trade creditors will decline
(iii) current and acid test ratios will fall.
(iv) proportion of total assets financed by proprietors’ capital will decline and the
proportion financed by credit will rise - GEARING.
24.5 MANAGEMENT DECISION ON WORKING CAPITAL

The management of the various components of working capital involves determining the
optimal level at which the controllable ones should be maintained at a particular time.
(i) Level of funds that the management is ready to allocate to the different forms of current
assets.
(ii) How the current assets should be financed e.g. short or long term.
(iii) The relationship between the levels of fixed assets and current assets.
24.6 OVERTRADING - EFFECTS

(a) Growth stagnation - company finds it difficult to undertake profitable projects
(b) Opportunities to invest in attractive short-term ventures are lost.
(c) Operating plans/budget becomes difficult to implement and thus the profit target will not
be achieved.
(d) The company may lose its reputation by its failure to fulfill short-term obligations.
(e) Rate of return on investment slumps as fixed assets are not efficiently utilised for the lack
of working capital funds.
QUESTION 24-2
Ajileye Nigeria Ltd is a new manufacturing company that is to engage in the production of shoe
soles and leather works.
The company’s budget for its first year of operation is as shown below:
N N
Sales 3,600,000
Direct Materials 1,200,000
Direct Labour 900,000
Overheads 600,000 (2,700,000)
900,000
You are given the following additional information.
1. Debtors - 40% will pay within 30 days of sales, the next 40% will pay within45 days and
the balance within 60 days.
2. Raw materials - will be in store for 36 days on average.
3. Work-in-progress - the production cycle will be 72 days.
427
4. Finished Goods - will be in store for 45 days on average.
5. Creditors - suppliers of raw materials will give credit of 27 days. Further more,60% of
the over heads will be supplied on credit of 15 days.
Required:
a. Calculate the amount of working capital required by the company.
b. List the various methods of financing working capital.
Note: Assume 360 days in the year.
SOLUTION 24-2
(a) Working capital required by the company.
Debtors N N
40% of N3.6m x 30 = 120,000
360
20% of N3.6m x 45 = 180,000
360
20% of N3.6m x _60 = 120,000 420,000
360
Raw Materials N1.2m x 36 = 120,000
360
Work-in-Progress
-Rm N1.2m x 72 = 240,000 390,000
360
-Conversion N1.5m x 72 x 50% = 150,000 390,000
360
Finished Goods N2.7m x 45 = 337,500
360
Creditors
- Raw Materials N1.2m x 27 = 90,000
360
- Overheads 60% of N600,000 x 15 = 15,000 (105,000)
360 1,162,500
(b) Methods of Financing Working Capital
1. Overdraft
2. Factoring
3. Franchising
4. Equity - Permanent Component of working capital
5. Acceptance credit
428
6. Retained earnings
7. Commercial papers.
QUESTION 24-3
Osogbo Breweries Limited is considering a change of its credit policy, which will result in a
slowing down in the average collection period from one to two months. The relaxation in credit
standards is expected to produce an increase in sales in each year amounting to 25% of the sales.
Sales price per unit N10
Variable cost per unit N8.50
Current sales per annum N2.4 million
The required rate of return on investment is 20%
Assume that the 25% increase in sales would result in additional stocks of N100,000 and
additional creditors of N20,000.
Advise the company on whether or not to extend the credit period offered to customers, if:
(a) all customers take the longer credit of 2 months;
(b) existing customers do not change their payment habits, and only the new customers take
a full 2 months’ credit
SOLUTION 24-3
Osogbo Breweries Limited
(a) Contribution/Sales ratio =15%
Increase in sales= 25% of N2,400,000 i.e.N600,000
Increase in contribution = 15% ofN600,000 i.e.N90,000
N
New Debtors (2/12 x N3m) 500,000
Existing Debtors 1/12xN2.4rn (200,000)
Increase in debtors 300,000
Increase in stocks 100,000
Increase in creditors (20,000)
Net Investment in working capital 380,000
Return on additional working capital N90,000 x 100=23.7%
N380,000
The return on the additional working capital is worthwhile.
429
(b) Increase in sales N600,000
N
Increase in debtors 2/12 x N600,000 = 100,000
Increase in stocks 100,000
Increase in creditors (20,000)
Increase in additional working capital 180,000
Return on additional working capital N90,000 x 100 =50%

N180,000
Decision: In both cases (a) and (b) the additional investment in working capital is worthwhile.
QUESTION 24-4
Benue Limited achieves a current sales level of N1,800,000 per annum. The cost of sales is 80%
of this amount, but bad debts average 1% of total sales value, and the annual profit is:
N
Sales 1,800,000
Costs of sales 1,440,000
360,000
Bad debt (18,000)
Profit 342,000
The current debt collection is 1 month, and the management of Benue Limited considers that by
easing credit terms, sales would be increased as follows:
Present Policy Proposed Option
Additional sales - 25%
Average collection period 1 month 2 months
Bad debts (% of sales) 1% 3%
The company requires a 20% return on its investments. If the costs of sales are 75% variable and
25% fixed, and on the assumptions that:
(a) There will be no increase in fixed costs from the extra turnover;
(b) There would be no increase in average stocks or creditors;
What is the preferable policy 1 proposed option, or the present policy?
430
SOLUTION 24-4
Proposed Option
N
Additional sales (25% of N1.8m) 450,000
Less: Variable costs (60% of N450,000) (270,000)
180,000
Less: Additional bad debt

(N67,500-N18,000) (49,500)
Less: Cost of finance
20% x N225,000 (45,000)
Additional Profit 85,500
Recommendation: Proposed option is better as profit will increase by N85,500.
NOTES
1. Present sales = N1.8m
2. Additional sales 25% of N1.8m = N450,000
3. New Bad debts 3% of N2.25m = N67,500
4. Present Bad debts 1% of N1.8m = N18,000
5. Percentage of variable cost to sales
N1,440,000x 75% = 60%
N1,800,000
6. Present Investment in working capital
Debtors 1/12 x N1.8m = N150,000
7. New Investment in working capital
Debtors 2/12 x N2.25m = N375,000
8. Additional Debtors = N225,000
i.e. N375,000-N150,000
431
24.7 FACTORS AFFECTING THE AMOUNT OF INVESTMENT IN WORKING
CAPITAL
(a) Production cycle
(b) Nature of business
(c) Size of business
(d) Business fluctuations
(e) Credit policy
(f) Availability of credit
(g) Dividend policy
(h) Operating efficiency
(i) Price changes
24.8 SOURCES OF WORKING CAPITAL FINANCE

(i) Equity
(ii) Bank overdraft
(iii) Creditors
(iv) Taxation
(v) Factoring
(vi) Invoice discounting
(vii) Loans etc
432
24.9 SUMMARY
Working capital and working capital management is a strong financial tools that assist the
manager to perform well in their areas of functions. This chapter made it clear to the reader why
it is not advisable to over-stock or under-stock. It also made it clear to the reader to understand
the components of working capital.
433
1. Explain the concept of working capital. Are gross and net concepts of working capital
exclusive? Discuss
2. Briefly explain factors which determine the working capital needs of s firm.
3. Explain the cost of liquidity and illiquidity. What is the impact of these costs on the level
of current assets?
434
References

Press Plc.
Limited.
435
CHAPTER TWENTY FIVE
RISK AND COST OF CAPITAL
25.1 INTRODUCTION
Risk occurs where it is not known what the future outcome will be but where the various
possible outcomes may be expected with some degree of confidence from knowledge of
past existing events. The risk in an investment or portfolio of investments is the risk that
the actual return will not be the same as the expected return.
25.2 TYPES OF RISK

 Unsystematic Risk/Alpha Risk
 Systematic Risk/Beta Risk
25.2.1 Unsystematic Risk:

This is also known as diversifiable, unique, non- specific, residual and a non-market imposed
risk. The risk only affects a particular security, which can be eliminated and the risk is
specifically associated with fortunes and misfortunes of particular companies. This is caused
by various events such as:
 Quality of management
 Location
 Dependency on Limited market
 Nature of the products etc
This risk is also called Avoidable Risk
25.2.2 FORMS OF UNSYSTEMATIC RISK

 Business risk i.e business activity of the company
 Finance risk i.e the mode of financing the company
 Management risk i.e inefficient management or loss of key personnel
25.2.3 Systematic Risk

This is also known as non-diversifiable, non-specific, general and market imposed risk. It
is caused by any of the following:
 Inflation
 Economic Problems
436
 Political problems
 War
 Death of the President etc
It is also known as unavoidable risk
25.2.4 FORMS OF SYSTEMATIC RISK

 Market risk i.e change in the attitude of investors in the market
 Interest rate risk i.e this affect holders of fixed income securities as well as equity
investors.
 Purchasing Power risk i.e where there is a fall in the power of money
 Political risk i.e war
25.2.5 MEASUREMENT OF RISK

Risk can be measured with various methods such as:
 Expected value method
 Standard deviation/variance/co-efficient of variation
 Probability – Normal distribution
 Triple Assessment method
 Certainty equivalent method
 Risk adjusted discount rate method
 DCF Payback period
 Shorter Payback period
 Conservative estimates method
 Capital Asset Pricing Method
 Finite Horizon method
 Simulation etc
25.2.6 MEASUREMENT OF RISK USING CERTAINTY EQUIVALENT METHOD

In this method the cash flows are adjusted to compensate for risk. The uncertain cash
flows are first converted to riskless or certainty equivalent cash flow. That certainty
equivalent cash flow are the discounted at a risk less discount rate or risk free cost of
capital to generate a risk – adjusted NPV. The major setback of this method is that the
adjustment to be made is subjectively decided by the management of the firm.
437
ILLUSTRATION 1
The management of SKN PLC is considering a project with the following expected cash flows.
Year CF
(N)
0 (90,000)
1 80,000
2 50,000
3 50,000
The risk-free cost of capital is 10% and because of the uncertainty about the future cash flows,
management decides to reduce the to “certainty equivalent” by taking 70%, 60% and 50% of the
years 1, 2 and 3 cash flows respectively.
Required:
Calculate the project’s viability based on the information provided
SOLUTION
SKN PLC
The risk adjusted NPV of the project would be:
Year CF certainty factor risk less CF Df@10% PV
0 (90,000) x 100% = (90,000) 1 (90,000)
1 80,000 x 70% = 56,000 0.91 50,960
2 50,000 x 60% = 30,000 0.83 24,900
3 50,000 x 50% = 25,000 0.75 18,750
4,610
The project would be considered viable as it has a positive NPV of N4,610.
25.3 MEASUREMENT OF RISK USING CAPITAL ASSET PRICING METHOD (CAPM)

Capital asset pricing model was developed by theoreticians is an attempt to simplify traditional
portfolio theory as it relates to investment in securities, which is based on series of assumptions,
where it believes that the investors are risk averse and act rationally to minimize the risk in their
portfolio in line with their desired level of returns and with benefit of diversification. Capital
assets pricing model is an alternative method of calculating cost of equity capital and the
minimum required rate of return which is made up of :
 Risk free rate i.e basic rate which all projects must earn if it is completely free from risk.
 The risk premium i.e this is calculated by applying the project beta factor to the difference
between market return and the risk free rate of return.
Thus, the minimum required rate of return is made up of : RISK FREE RATE + RISK
PREMIUM (Rf + β (Rm-Rf)
Rs= Rf + B (Rm-Rf)
438
Where;
Rs = The return of the security
Rf = The risk free rate
Rm = The market rate of return
β = Beta factor (measurement of risk)
Where RF is the risk-free rate and Rm − Rf is market portfolio and the riskless rate. This
difference is often called the expected excess market return or market risk premium.
Note that we have dropped the over bar denoting expectations
to simplify the notation, but remember that we are always thinking about expected returns
with the CAPM.
We now have the tools to estimate a firm’s cost of equity capital. To do this, we need to
know three things:
1 The risk-free rate, RF
2. The market risk premium, Rm – Rf
3. The company beta, b
ILLUSTRATION ONE
Assume RENAL PLC is 100 per cent equity financed: that is, it has no debt.
RENAL PLC is considering a number of capital budgeting projects that will double its size.
Because these new projects are similar to the firm’s existing ones, the average beta on the new
projects is assumed to be equal to Renal’s existing beta. Assume that the risk-free rate is 4.5 per
cent
Required:
What is the appropriate discount rate for these new projects, assuming a market risk premium of
8.4 per cent?
We estimate the cost of equity, RS, for Renal as
Rs= Rf + B (Rm-Rf)
RS = 4.5% + (8.4% × 1.04)
= 4.5% + 8.74%
= 13.24%
Note:
Two key assumptions were made in this example:
(a) The beta risk of the new projects is the same as the risk of the firm; and
(b) The firm is all equity-financed. Given these assumptions, it follows that the cash flows of the
new projects should be discounted at the 13.24%
439
ILLUSTRATION TWO
TRAORE Ltd wants you to determine its minimum required rate of return, if the risk free rate is
7%, market rate of return is 10% and the company has a beta factor of 1.2.
Required: Determine the company minimum required rate of return
Solution
TRAORE LIMITED
Minimum required rate of return = Rf+β(Rm - Rf)
= 7+ 1.2 (10-7)
= 10.6%
ILLUSTRATION THREE
SOL CAMPBELL will like you to determine its minimum required rate of return if the risk free
rate of return is 6%. The market rate of return is 11%. Standard deviation of return on the market
as a whole is 40%, the covariance of returns on market with returns for the shares of Ayo Limited
over the same period has been 19.2%.
Solution
We have different method of or formulas that can be used in computing Beta factor such as:
 Covariance of security and market
Variance of the market
 Beta factor = rxos
Om
Where r = co-relation with the market
Os = standard deviation of security
Om = standard deviation of market
 Beta factor = Excess Return on security
Excess Return on market i.e Rs - Rf
Rm - Rf
Beta factor = 0.192
(0.4)2
= 1.20
Minimum required rate of return = 6 + 1.20 ( 11-6)
= 12%
440
25.4 DIVERSIFICATION OF RISK
 Divide the portfolio into first class fixed income securities and equities, this guarantees a
regular income from the first group and capital appreciation from the other group,
 Classify the funds into short – term and long term investments to take care of liquidity.
 Spread the funds among well rated industries.
 Aim at geographical spread.
In conclusion, Non-Systematic risk can be diversified away, thus, investors will only be
concerned with Systematic risk and with CAPM, while the main focus will be Beta factor (B)
i.e the measurement of risk.
25.5 COST OF CAPITAL

Cost of capital generally refers to the minimum rate of return required by providers of various
capital of an organization. It is the required return necessary to make a capital budgeting project,
such as building a new factory, worthwhile. It therefore represents a financial standard for
allocating the firm’s funds supplied by owners, creditors and other investors to the various
investment projects in the most efficient manner.
The project’s cost of capital is the minimum acceptable rate of return on funds committed to
project. The minimum acceptable rate or the required rate of return is a compensation for time
and risk in the use of capital by the project.
SIGNIFICANCE OF THE COST OF CAPITAL

Cost of capital is a concept of vital importance in the financial decision making. It is useful as a
standard for;
 Evaluating investment decisions
 Designing a firm’s debt policy
 Appraising the financial performance of top management
Evaluation of Investment Decisions

The primary aim of measuring the cost of capital is its use as a financial standard for evaluating
the investment projects. In NPV method, an investment project is accepted if it has a positive
NPV. The project’s NPV is calculated by discounting its cash flows by the cost of capital. In this
sense, the cost of capital is the discount rate used for evaluating the desirability of an investment
project. An investment project that provides a positive NPV when its cash flows are discounted
by the cost of capital makes a net contribution to the wealth of shareholders, and where the
project has a zero NPV; it means that its cash flows have yielded a return just equal to the cost of
441
capital and the acceptance or rejection of the project will not affect the wealth of the
shareholders.
In the Internal Rate of Return method (IRR), the investment project is accepted if it has an
internal rate of return greater than the cost of capital in this context, cost of capital is the
minimum required rate of return on an investment project, which is also known as cut off, or the
target, or the hurdle rate.
Designing Debt Policy

The debt policy of a firm is significantly influenced by the cost consideration. In designing the
financing policy, that is, the proportion of debt and equity in capital structure, the firm aims at
minimizing the overall cost of capital.
25.6 APPRAISAL OF THE FINANCIAL PERFORMANCE OF TOP MANAGEMENT

The cost of capital can also be used to evaluate the performance of top management, and such
evaluation will involve a comparison of actual profitability of the investment projects undertaken
by the firm with the projected overall cost of capital and the appraisal of the actual costs incurred
by management in raising the required funds.
The cost of capital plays a useful role in dividend decision and investment in current assets.
25.7 THE CONCEPT OF THE COST OF CAPITAL IN DECISION MAKING

Decision making is a process of choosing among alternatives, and in investment, the investors or
the manager encounter innumerable competing investment opportunities to choose from, for
instance one may invest his savings of N50,000 either in 11% one year Government Bond or
12% Bank Fixed Deposit of one year in a Bank. In both cases, the investment opportunities
reflect equivalent risk, if one decide to deposit the fund in the bank, the action taking here is the
foregone of the opportunity of investing in Government Bond, one has incurred an opportunity
cost equal to the return on the foregone investment opportunity, which is 11% in case of the
investment. Opportunity cost is rate of return foregone on the next best alternative investment
opportunity of comparable risk.
 Investors’ Opportunities and values

In the case of companies, there is always disagreement between management and ownership.
In an all-equity financed company, investment decisions are made by management but the
capital is supplied by shareholders. Therefore, a question may be raised who’s opportunity
cost, that is, the required rate of return should be considered in evaluating the investment
projects? If the firm’s objective is to maximize the owners’ wealth, then the investment
projects should be analyzed in terms of their values to investors. But in a situation where it
442
happens in an owner-manager’s firm, the manager will use his required rate of return, but
where the manager make investment decisions, and you supplied funds to finance the
investment projects. The required rate of return will depend on the investment opportunities
of equivalent risk outside the firm available to you. In a situation where you appoint a
manager to manage your business, the manager has the responsibility for the investment
decisions. The question is now whose opportunity cost should the manager use? Since you
are the supplier of the funds to the firm and manager is acting on once behalf, the manager
will be require to your required rate of return in making the investment decisions.
Assuming, where the capital of the firm is contributed by other stakeholders or investors, and
the firm is owned by many shareholders, the manager should consider the owners’ required
rate of return in evaluating the investment decisions.
 Stakeholders’ claims
A firm’s investment projects are financed by funds supplied by other stakeholders
(Preference, creditors etc). The investors hold different claims on the firm’s assets and cash
flows, and they are exposed to different degree of risks. The debt holders have a priority
claim over the firm’s assets and cash flows. The firm is under a legal obligation to pay
interest and return principal. Since the firm’s cash flows are uncertain, there is a probability
that it may default on its obligation to pay interest and principal. Preference shareholders hold
claim prior to ordinary shareholders but after other debt-holders. Preference dividend is fixed
and known, the firm will pay it after paying interest but before paying any ordinary dividend.
 Risk Differences
Investors and stakeholders will require different rates of return on various securities since
they have different degree of risk attach to their investment. Higher the risk of a security, the
higher the rate of return demanded by investors and stakeholders. In a profit maximization
firm, ordinary share is most risky, investors will require highest rate of return on their
investment in ordinary shares. Preference share is more risky than debt; therefore, its required
rate of return will be higher than debt. The determination of cost of capital to every firm
depends on the capital structure of those firms.
The capital structure of a typical company will include the following types of long-term
capital;
(a) Ordinary share capital
(b) Preference share capital
(c) Debenture
To determine the optimal finance combination, a company will need to calculate the cost of
each particular finance being used and also the combined cost of capital that is, the composite
cost of capital.
443
25.8 TYPES OF COST CAPITAL
There are various types of cost of capital depending on the capital structure of the firm
such as
 Cost of Equity Capital (ke)
 Cost of Preference (kp)
 Cost of Debt (kd)
 Weighted cost of capital (WACC)
 Cost of Retained Earnings
25.8.1 COST OF EQUITY CAPITAL (Ke)

This refers to the minimum required rate of return on equity capital, which equates the PV of the
expected dividends with the market value of the equity. It reflects the return shareholders would
obtain if cash flows were paid out as dividends. Firms may raise equity capital internally by
retaining earnings or could distribute the entire earnings to equity shareholders and raise equity
capital externally by issuing new shares. In both cases, shareholders are providing funds to the
firms to finance their capital expenditures. Therefore, the equity shareholders’ required rate of
return will be the same whether they supply funds by purchasing new shares or by foregoing
dividends which could have been distributed to them. It also reflects the returns shareholders
would obtain if cash flows were paid out as dividends. It is based on dividend model, which
states that ex-dividend share price is:
Do + d1 + d2 + d3 + --------------- dn
(1+ke)1 (1+ke)2 (1+ke)3 (1+ke)n
where ;
d = the constant dividend per share
ke = cost of equity capital
n = year ( i.e time period)
assuming the dividend continues forever, the ex-dividend share price is,
Market value = d/ke
Thus, the cost of capital equals: ke = dividend/market value i.e ke = d/market value of share
ILLUSTRATION ONE (WHERE DIVIDEND HAS BEEN PAID)

FAHN PLC has 1,000,000 ordinary shares of N1 each currently quoted @ N1.20, the company’s
current dividend of 15k was paid last week and this dividend will remain constant to perpetuity.
Required; Determine the cost of capital of FAHN PLC
444
Solution
The company pays constant dividend thus its cost of equity will be
DIVIDEND__
MARKET VALUE
Ke= .15
1.2
Ke = 12.5%
ILLUSTRATION TWO ( WHERE DIVIDEND IS YET TO BE PAID)

10million ordinary shares currently valued @ 300k per share of Temitope Plc. A dividend of
N6m is due for payment.
Required; Calculate the cost of equity capital
Ke = dividend x 100%
Market value of share
Ke = 6million x 100%
30million – 6million
Ke = 25%
Note : the market value of 300k given is cum-div because the dividend has not been paid but
about to be paid
DETERMINATION OF COST OF CAPITAL WITH GROWTH

Investors or shareholders will normally expect dividends to increase year by year and not to
remain constant in perpetuity. The fundamental theory of shares states that the market price of a
share is the present value of the discounted future cash flows of revenues from the share, thus the
market value given an expected constant annual growth in dividends would be:
Market Value (Mv) Do (I + g) + Do (I + g)2
( I + ke) ( I + ke)2
Where:
Mv = current market price (Ex-div)
Do = current net dividend
Ke = shareholders cost of capital
g = expected annual growth in dividend payment
However it is easy to assume a constant expected dividend growth rate in perpetuity, thus,
445
Mv = Do(I+g)
Ke-g and :
Ke = Do(I+g) + g OR D1 X 100%
Mv Mv
Where D1= Do (I+g) or payable in year one
Do = current dividend / latest/ payable
g = ex – dividend share price
ILLUSTRATION THREE
BROWN Plc has 1,000,000 ordinary shares of N1 each currently quoted @N1.30, the company’s
current dividend of 20k per share is about to be paid and this dividend will grow @ a rate of 5%
to perpetuity. Determine the company cost of capital.
Solution
Cum – div price 1.30
Less dividend (0.20)
Ex- dividend price 1.10
Thus; the company growth at the rate of 5% per annum
Ke = Do (I+g) + g
Mv
Ke = .20(I+.05) + 0.05
1.10
Ke = 24.09%
25.8.2 COST OF PREFERENCE SHARE CAPITAL (Kp)

This is the minimum rate of return required by preference shareholders in order to maintain their
existing market price. It depends on the nature of the preference share capital; it can be
redeemable and irredeemable. It is calculated as follows:
Kp = d/ Mvp x 100%
Where:
Kp = cost of preference share capital
d = Latest/current dividend paid/ payable
Mvp = market value of preference share ex-dividend
446
ILLUSTRATION ONE
A company has in issue preference with nominal value of 25k. The dividend is 5k per annum.
What is the cost of preference share?
Solution
Kp = 5 X 100
25 1
Kp = 20%
25.8.3 COST OF DEBENTURE CAPITAL (kd)

This is the minimum rate of return required by debenture holders in order to maintain their
existing market value. It can be redeemable and irredeemable. It is calculated as follows:
Kd = F (I + t)
Mvd x 100%
Where:
Kd = cost of debt capital
F = Latest / current interest paid / payable
Mvd = Market value of debt ex- dividend
t= corporation tax rate
ILLUSTRATION ONE
XYZ Plc has in issue, 12% N500m irredeemable debentures currently valued @ N84. Interest is
due for payment within the next 2 weeks. Corporation tax rate is 35%.
Required: |
calculate the cost of the debenture capital.
Solution
kd = F(1-t) X 100
Mvd
Kd = 12(1.35) X 100
84-12
447
Kd = 12(0.65) X 100
72
Kd = 7.8 X 100
72
Kd = 10.83%
25.8.4 WEIGHTED COST OF CAPITAL (WACC)

This is also known as the composite of capital, as it represents the aggregate of the cost of the
various sources of finance in use. In calculating the weighted cost of capital, the firm must first
estimate the cost of each type of capital being used. The proportion of total capital coming from
each source then weights the cost. The weighted costs are then added to give the overall cost of
capital that is known as the WEIGHTED COST OF CAPITAL.
The weighted cost of capital is used as the discount rate in the appraisal of new investment.
WAAC can also be calculated as using a tabular approach as follows:
TYPE MARKET VALUE COST OF CAPITAL HASH TOTAL

Equity A x m = mA
Preference B x n = nB
Debt C x z = zC
ABC mAnBzC
Kw Hash total x 100

Market value
In Decision Making, Cost of Capital assists the various investors in determining thee kind and type
of investment to embark on.
448
25.9 SUMMARY
This chapter discussed the meaning and importance of risk. It emphasized on the measurement
of risk associated with business. It elaborately informed the reader the essence and the
importance of minimum required rate of returns on every investment intended to embark upon by
the organization.
449
1. PETER CROUCH most recent balance sheets are:-

N
NET ASSETS 67,500
Represented by:-
Ordinary shares of 50k each 52,500
67,500
The beta of the company’s asset is 0.85 while that of the debt is 0.20. Return on government
bond is currently 12% while the return on the market securities is 17%. The ordinary shares are
currently quoted at N 2.10 per share while the market value of the debenture is 89%.
Required:- Using the capital asset pricing model, determine the company’s appropriate cost of
capital assuming the rate of company tax is 30%.
450
References
Abdulrasaq A. (2009). Financial Management. Lagos: Corporate Publishing.
Press Plc.
Limited.
consulting.
451
CHAPTER TWENTY SIX
CAPITAL STRUCTURE AND LEVERAGE
 The components of the company’s capital structure
 Strategies to manage the capital of the organizations
 Various types of Risks and techniques used in managing risk
 Various techniques in measuring the cost of individual capital
26.1 INTRODUCTION
Capital Structure of a company refers to medium, long term, and the permanent capital and the
relationship between them. The capital includes ordinary share capital, reserves and long term
borrowings in the form debentures. Sometimes company relies on short term borrowing like
Bank overdraft and short term trade credit for considerable part of their capital structure.
It is regarded as a good finance strategy practice to finance long term projects with permanent or
long term capital while short term projects are financed with short term loans. If there is debt in a
company’s capital structure, such a company is termed a geared company. If the company
maintains the proportion of these sources of finance, the weighted average cost of capital
(WACC) will remain unchanged.
The market value of equity is not dependent on the size of dividends and the cost of equity alone,
but it also depends on the WACC.
There are two main theories about the effect of changes in gearing on WACC and share value,
namely;
 The traditional view
 The net operating income approach
26.1.1 The traditional view

This states that debt capital is cheaper than equity and that as such a company can increase its
value by borrowing up to a reasonable limit (optimal level of gearing).
26.1.2 The Net Operating Income Approach

This states that the way a company finances its operations is irrelevant in the determination of
the company’s market value. The theory states the issue of cost of debt rising after a given point
does not hold. The assumptions of the net operating income approach are as follows;
 Cost of debt will remain constant regardless of the level of gearing
 The WACC will remain unchanged as the gearing increases
 The cost of equity will rise in such a way as to keep the WACC
452
Illustration
ABC Limited has N10,000 of debt at 10% interest, and earn N10,000 a year before interest is
paid. There are 4,500 issued shares, and weighted average cost of capital of the company is 20%.
Required;
(i) What is the company’s market value
(ii) What is the cost of its equity capital?
(iii) What is the market value per share of its equity?
Suggested Solution
(i) Market value of the company
N
Earnings 10,000
Weighted Average cost of Capital 20%
Company’s total market value (N10,000/0.20) N50,000
(ii) Cost of its equity capital;
N
Company’s total market value (N10,000/0.20) 50,000
Less: Market value of debt (10,000)
Market value of Equity 40,000
Ke = dividend/Mkt value
Ke = N10,000- N1,000 = .225 x 100 22.5%
N40,000
(iii) Market value per share = N40,000
4,500 N8.89
Illustration Two
Assuming the company above issued N10,000 additional debt @10%
Interest to repurchase shares at the price calculated in (iii) above. If the WACC remains
unchanged.
(i) Calculate the number of shares that were repurchased?
(ii) What is the new cost of the equity capital?
(iii) What is the new market value per share of its equity?
Solution
(i) No shares repurchased = N10,000
N8.89 = 1,125 shares
(ii) New cost of equity capital (ke)N10,000 - N2,000 x 100
30,000 26.67%
(iii) New market value per share = N30,000
(NEW SHARES = 4,500-1,125) 3,375 = N8.89
453
Risk is the variability in returns, the higher the variability the higher is the risk. This is measured
using standard deviation or co-efficient of variation. It is also comprises of Business risk and
Financial risk which were introduced by Modigliani and Miller.
26.2 BUSINESS RISK

This is the variability of the firm’s operating income (that is the income before interest)
associated with the industrial sector in which the firm operates and the competitive advantage
possessed by the company within that industry. The risk will be influenced by the following
factors such as;
 The variability of sales volumes
 Prices over the business cycle
 The variability of input cost
 The degree of market power
 The Level of growth
Business risk is determined by general business and economic conditions and it does not related
to the firm’s financial structure.
26.2.1 DETERMINANTS OF BUSINESS RISK

 Type of industry i.e it vary from one industry to the other
 Stage of product life cycle i.e the risk of introduction and decline stage of the product
 Degree of operating leverage i.e relationship between fixed cost and variable cost, the higher
the fixed cost of production, the higher the business risk.
26.3 FINANCIAL RISK

This is the additional variability in returns to shareholders that arises because the financial
structure contains debt. It is risk over and above the normal business risk, which is associated
purely with debt finance, financial risk is nil in a company financed solely by equity.
It should be noted that increasing proportion of debt raises the firms fixed financial costs and at
high gearing level there is an increased probability of the firm not only failing to make a return to
shareholders, but also failing to meet the interest cost obligation and thus raising the likelihood
of insolvency.
26.4 GEARING
This simply means the actual mix of debt and equity financing chosen. The term gearing and
leverage are used interchangeably. This could be of:
 Operating Gearing
 Financial Gearing
454
26.4.1 OPERATING GEARING
This simply means the extent to which the firm’s total costs are fixed.
26.4.2 FINANCIAL GEARING

This is concern with the proportion of debt in capital structure. Net income to shareholders in
firms with high financial gearing is more sensitive to changes in operating profits.
It can be measured in different ways, where the ratio of total market of debt and market value of
equity is measured.
VD = VE
A highly geared company is one with large proportion of debt financing.
A Low geared company is one with a low proportion of debt financing an-all-equity financed
company and it is referred to as ungeared company.
26.4.3 FORMS OF GEARING

 Gearing Ratio = Fixed Interest Capital + Preference Share Capital
Shareholders’ Funds
This expresses the relationship between the balance sheet net assets value financed by capital
on which is a fixed interest commitment and they are not financed by equity.
 Gearing Ratio = Fixed Interest Capital + Preference Share Capital
Capital Employed
This shows what proportion of the company’s assets is required as security for prior claims
and by implications, what further security borrowing might safely be undertaken.
 Gearing Ratio = Total Debt
Shareholders’ funds
 Income Approach of Gearing Ratio = Interest on Debt
EBIT
EBIT (Earnings before Interest and Tax)
Illustration
DAV NOTCH PLC is machine tools with the following capital structure as at 31st December
2010.
N
Ordinary shares of N1 500,000
Capital Reserves 400,000
Revenue Reserves 600,000
1,500,000
9% Perpetual Debentures 400,000
15% Perpetual Debentures 600,000
2,500,000
455
The current yield on debentures of this risk class is 12%. The current share price is 550k an
earnings per share are 110k.
The company is considering an expansion plan which will cost N1,000,000 and which will
increase earning by N200,000 per annum for foreseeable future. There are two possible ways to
raise the funds required;
(i) An issue of 12% debentures which will increase the return required by shareholders to
22% to compensate for the higher risk due to the increase in gearing or;
(ii) An issue of 200,000 new shares at 500k to a consortium of Institutions. This will reduce
the return required by shareholders to 19% because of the reduction in gearing.
Required;
(a) Calculate the capital gearing of the company as at 31st December 2010 using Book value
approach.
(b) Calculate the capital gearing of the company as at 31st December 2010 using market
value approach.
(c) Explain why the market value is superior
(d) Calculate the capital gearing of the company after the issue of N1 million debentures
using the market value approach.
(e) Calculate the capital gearing of the company after the issue of 200,000 ordinary shares
using the market value approach
Solution
DAV NOTCH Plc
N
(a) Total equity value 1,500,000
Total debt at book value 1,000,000
2,500,000
Gearing Ratio = Debt

Capital Employed
= N 1,000,000 x 100 = 40%
N 2,500,000
(b) N N
Equity at MV (500,000 x N5.50) 2,750,000
MV of: 9% perpetual debt= (MV=Nf 36000 = 300,000
Kd 0.12
15% perpetual debt N 90,000/0.12 = 750,000 1,050,000

Value of the company 3,800,000
456
Gearing ratio =N1, 050,000 x 100 = 27.63%
N 3,800,000
(c) The market value approach is superior to book value approach because it takes into
account the expected future earnings potentials of the assets under the control of the
company rather than the past results of these assets.
(d) Post project MV of equity N

Existing earnings N1.10 x 500,000 550,000
Earnings from project 200,000
EBIT 750,000
Interest (120,000)
630,000
N
Earnings yield or
Value of equity N630, 000/0.22 = 2,863,636
Value of debt N 1050,000 + N1, 000,000 2,050,000
Value of company = 4,913,636
Gearing ratio = 41.75%

(e) EBIT as above = 750,000
Yield = 19%
MV of equity N750,000/0.19 = N3,947,368
MV of Equity N750,000/0.19 = 3,947,368

Value of debt = 1,050,000
4,997,368
Gearing ratio = 21.01%
IMPACT ON THE COST OF EQUITY

The implication of the foregoing is that in all-equity financed company, the return on equity
simply reflects the Business risk which the shareholders are exposed. However, as the company
starts to use debt financing and so introduces financial risk as well as the business risk, the return
required by shareholders starts to rise.
457
IMPACT ON THE COST OF DEBT
It is not only the shareholders of the company that bear the financial risk, so also the lenders.
Shareholders will expect extra return above that for the business risk, to compensate them for the
financial risk held. Meanwhile, the lenders will be willing to take a lower return than the return
required
458
26.5 SUMMARY
The readers would by now have realized that there are different ways of financing company’s
activities. This chapter discussed extensively what the components of capital structure are, and
means of measuring the cost of individual capital and strategies to adopt in managing the capital
of the organizations.
459
1. To what extent is it fair to argue that the capital gearing of a company is irrelevant?
2. Discuss how interested parties, other than debenture holders, will be affected by high
gearing levels, and describe what protective measures they can take.
3. Explain why financial gearing might be important to a company.
460
References

Press Plc.
Limited.
consulting.
461
CHAPTER TWENTY SEVEN
INTERPRETATION OF FINANCIAL STATEMENT AND INVESTMENT ANALYSIS

 The meaning and purpose of financial statement
 Importance and uses of financial statement to the users
 Various mechanisms used in measuring the performance and liquidity in the
organization
27.1 INTRODUCTION
The process of understanding the risk and profitability of a firm (business, sub-business
or project) through analysis of reported financial information, by using different
accounting tools and techniques.
Interpretation of financial statement means analyzing of the financial statement so as to
assist the accounting information users in making business decision.
27.2 USERS OF FINANCIAL STATEMENT

 Owner of the business
 Potential investors
 Management of the business
 Workers or Employees
 Trade unions
 Customers
 Suppliers
 Competitors
 Government
 Quasi Government
 Financial analysts and consultants
 Locality where the business operates
 The Public at larges
27.3 DECISIONS MADE BY USERS OF FINANCIAL STATEMENT

 Make decision as to whether to invest or to divest
 Make decision as to whether or not to liquidate the business or to combine it with
existing ones or to sell or to enter into joint venture or partnership.
 Use as a guide in projecting what will happen in future
462
 To measure the strength and weaknesses, opportunities and threats facing the business
 To access the contributions of the organisation to her immediate community in terms
of infrastructural development
 Measure the performance of the business in terms of profitability, liquidity, credit
worthiness, solvency, collection and payment periods and riskiness.
27.4 TOOLS USED FOR ANALYZING AND INTERPRETATION OF FINANCIAL

STATEMENT
 Trend analysis based on absolute value i.e looking at figures over past records and
comparing these figures stating the differences in absolute values and suggesting reasons
for that.
 Trend analysis based on percentages i.e the performance or the event given will be
expressed in percentage(s) instead of absolute figure or as an addition to absolute
figures.
 Detailed analysis of statement of cash flow i.e this provides information about the cash
receipts and payments of an enterprise over a given period of time
 Detailed analysis statement of value added i.e this statement shows the wealth created
by the reporting entity and how such wealth have been applied to financial statement
users especially the employees, the government, and the providers of capital
 Analysis of statistical and quantitative information included in Annual Report i.e
this shows the statistical and other quantitative information included in annual report
inform of pie charts, bar charts, histogram and other presentation which are shown in
pictorial form to highlight some performances in the current financial year and in some
cases relate this past year
 Computation and interpretation of significant ratios i.e. this show the important
aspect of account analysis. It involves calculating significant ratios and reading meaning
to the ratios computed so as to make judgment and draw conclusions which will be used
by financial statement users to make business decision.
27.5 FINANCIAL STATEMENT ANALYSIS consists of:-

1) Reformulating reported financial statements,
2) Analysis and adjustments of measurement errors, and
3) Financial ratio analysis on the basis of reformulated and adjusted financial
statements. The first two steps are often dropped in practice, meaning that financial ratios
are just calculated on the basis of the reported numbers, perhaps with some adjustments.
Financial statement analysis is the foundation for evaluating and pricing credit risk and
for doing fundamental company valuation.
463
1) Financial statement analysis typically starts with reformulating the reported
financial information. In relation to the income statement, one common reformulation is
to divide reported items into recurring or normal items and non-recurring or special
items. In this way, earnings could be separated into normal or core earnings and
transitory earnings. The idea is that normal earnings are more permanent and hence more
relevant for prediction and valuation. Normal earnings are also separated into profit after
tax (PAT) and net financial interests’ costs. The statement of financial position balance
sheet is grouped, for example, in net operating assets (NOA), net financial debt and
equity.
Without analyzing financial data from your small business firm, you, as the owner, would
be flying blind. Even if the financial end of things is not your favorite part of your
business and you intend to outsource as much of it as possible, you still have to
understand it. Why? Because you have to understand the output you receive from your
accountant or other financial professional in order to operate your business. For example,
if your accountant tells you that your profit is N100,000 for the year, you must
understand what went into allowing you to make that N100,000. You may not have to
know as many details as the accountant, but you certainly have to understand the big
picture.
It's best to start with the basics in order to understand your financial position. Maybe
you’ve been schooled in finance and accounting and, if so, consider this a review. If not,
then here we go on a short session in understanding and analyzing your financial
position.
The first thing you have to get up to speed on is the financial statements that you or your
financial professional will generate for your business firm. These financial statements
will help you determine your firm's financial position at a point in time and over a period
of time as well as your cash position at any point in time. Many small businesses fail
because the owner loses a grip on the firm's financial position. If you understand financial
statements, that won't happen to you.
The comprehensive Income Statement

The comprehensive income statement (formerly known as profit and loss statement). It is
the major statement for measuring your firm's profitability over a period of time. You
develop the income statement in a step-by-step process starting with the amount of
revenue you have earned. Then you subtract each item your firm has expensed to see
what your profit or loss is after each is deducted. You can prepare comprehensive income
statements for a short period of time like a month, if you need that type of information.
For tax purposes, you can extend that out and develop your income statement for the tax
464
year. The primary purpose of the income statement is to report a company's earnings to
investors over a specific period of time usually one year. Years ago, the comprehensive
income statement was referred to as the Profit or Loss Statement, and has since evolved
into the most well-known and widely used financial report. Many times, investors make
decisions based entirely on the reported earnings from the income statement without
consulting the statement of financial position (formerly known as balance sheet) or
statements of cash flow.
Using Income Statement Analysis to Calculate Expenses, Earnings, Financial Ratios

and Profit Margins
To a serious investor, income statement analysis reveals much more than a company's
earnings. It provides important insights into how effectively management is controlling
expenses, the amount of interest income and expense, and the taxes paid. Investors can
use income statement analysis to calculate financial ratios that will reveal the rate of
return the business is earning on the shareholders' retained earnings and assets (in other
words, how well they are investing the money under their control). They can also
compare a company's profits to its competitors by examining various profit margins such
as the gross profit margin, operating profit margin, and net profit margin.
As we progress through this seminar, you must remember basic truth that a business is
only worth the profit that it will generate for its owners from now until doomsday,
discounted back to the present, adjusted for inflation. The income statement is the “report
card” of those earnings, which ultimately determine the price you should be willing to
pay for a business.
Profitability:
Profitability is one of the most important but under emphasized measures of financial
performance. True profitability analysis requires true earnings information. To get an
accurate picture accrual net income is used. Tracking of business net income can be a
very useful tool.
Steady income and profits are desirable while erratic profits can signal instability. Net
Income from operations is used to figure profitability ratios that do not include gain/loss
on sale of the result.
ROA: return on assets: Ability to generate income in relation to the total assets. This
ratio indicates how well resources are producing profits. It shows how a firm is using its
assets.
ROA = Net income adjusted for interest expense/ total assets
465
ROE: return on equity: Another name is return on investment (ROI). This ratio
expresses the naira in profit that a business makes for every naira of equity in the
business. Efficient management results in high return.
ROE = Net income/ net worth (equity).
Financial Efficiency Ratios:

Measures how efficiently a business uses its assets to produced revenue and how
effective the production and operating decisions are.
Asset turnover ratio: measures capital efficiency. It relates the profit margin to the asset
base.
ATR = Gross revenue/total asset (average). Note: capital refers to the naira
amount of assets contributed to the business.
Operational ratios:
Operating expense ratio:
OE = operating expenses (excluding interest & depreciation)/gross revenue. This ratio is
the key to measure financial efficiency. It answers this question, “How much does it take
for this business to generate N1.00 of revenue?”
Depreciation expense ratio:
DE = depreciation expense/gross revenue. This ratios measure the percentage
cost of depreciation in a business.
Interest expense ratio:
IE = Interest expense/gross revenue. This ratio measures the percentage cost of
interest in a business.
Repayment capacity Ratios:

Measure the ability to repay term debt and leases. Also uses outside income and business
income allowing one to evaluate the ability to repay regardless of the source. Examples
of repayment capacity ratios are:
Term debt & capital lease coverage
Capital replacement and term debt repayment margin
Summary of Ratio
1. Percentage Gross Profit on Turnover = (Gross Profit) / (Sales) x 100.
2. Percentage Gross Profit on Cost of Sales = (Gross Profit) / (Cost of Sales) x 100.
3. Percentage Net Income on Turnover = (Net Income) / (Sales) x 100.
4. Percentage Total Expenses on Turnover = (Total Expenses) / (Sales) x 100.
466
5. Percentage Operating Profit on Turnover = (Operating profit) / (Sales) x 100.
6. Percentage Operating Profit on Cost of Sales = (Operating Profit) / (Cost of Sales)
x 100
STATEMENT OF FINANCIAL POSITION

The statement of financial position is a statement showing what you own (assets) and what you
owe (liabilities and equity). Your assets must equal your liabilities (debt) plus your equity
(owner's investment). You have used your liabilities and equity to purchase your assets. The
statement of financial position shows your firm's financial position with regard to assets and
liabilities/equity at a point in time. I want to go through statement of financial position (balance
sheet) ratios to help you determine the financial health of a company.
You will note that most of these statements of financial position ratios are basic, but with
investing, the simple ratios and ideas are often the best, overlooked and forgotten.
Solvency Ratios
Solvency Ratios are quick and easy to calculate and easy to interpret.
The objective is to see whether a company has enough cash, assets and low debt to continue
operations without running into financial trouble.
Quick Ratio
Quick Ratio = (Current Assets – Inventories) / Current Liabilities
The quick ratio measures a company’s ability to meet its short-term obligations with its most
liquid assets. The higher the quick ratio, the better the position of the company.
Current Ratio
Current Ratio = Current Assets / Current Liabilities
An even simpler variant to the quick ratio and is used to determine the company’s ability to pay
back its short term liabilities. You’ll see this statement of financial position ratio everywhere.
If the ratio is below 1, it raises a warning sign as to whether the company is able to pay its short
term obligations when due. It doesn’t mean the company will go bankrupt, but is something that
has to be looked at. If a company has a low current ratio year after year, it could be a
characteristic of the industry where companies operate and high debt levels.
Debt/Equity Ratios
Total Debt/Equity Ratio = Total Liabilities / Shareholders Equity
Long Term Debt/Equity Ratio = Long Term Debt / Shareholders Equity
Short Term Debt/Equity Ratio = Short Term Debt / Shareholders Equity
467
There are different variations of the debt to equity ratios, but the objective of these financial
ratios is to determine how a company has been financing its growth.
A high ratio means that the company has been growing due to debt. Not all debt is bad, but if the
number is exceedingly high, remember that the company has to pay off the loan as well as
interest payments.
An important factor to consider then is to determine whether the returns generated from the debt
exceeds the cost of debt (i.e. interest).
Activity Ratios
Activity financial ratios measure how well a company is able to convert its assets in the balance
sheet into cash or sales. By analyzing the activity ratios, you can see how efficient and well run a
company is.
These financial metrics aren’t just for the company, but also measures the people behind the
business and how well they are running the show.
Days Sales Outstanding (DSO)

Days Sales Outstanding = (Receivables / Revenue) x 365
Cash is king and a business capable of converting its receivables into cash quickly is a great sign
of health and efficiency.
A low DSO number means that it takes a company fewer days to collect its accounts
receivable. A high DSO number shows that a company is selling its product to customers on
credit and taking longer to collect money.
Days Inventory Outstanding (DIO)

Days Inventory Outstanding = (Inventory / COGS) x 365
This financial ratio is used to measure the average number of days a company holds inventory
before selling it.
This ratio is industry specific and should be used to compare competitors. A company like
Boeing will have vastly different DIO than a company like Amazon where inventory turnover is
high.
Days Payable Outstanding (DPO)

Days Payable Outstanding = (Accounts Payable / COGS) x 365
Days Payable Outstanding shows the time in days a business has to pay back its creditors. On the
flip side, it also shows how long the company can utilize the cash before paying it back.
The longer a company can delay payments, the better.
468
Cash Conversion Cycle:
Cash Conversion Cycle = DIO + DSO – DPO
Putting DIO, DSO and DPO together, you get the cash conversion cycle.
The entire cash conversion cycle is a measure of management effectiveness. The lower the better
and a great way to compare competitors.
Turnover Ratios
Receivables Turnover = TURNOVER / Average Accounts Receivables
The receivables turnover ratio is one that is categorized as an activity ratio because it measures
the company’s effectiveness in collecting its credit sales.
Inventory Turnover = COGS / Average of Inventory
Inventory is money. It costs money to buy; it costs money to just hold it because it takes up a lot
of overhead if it isn’t cleared out. You waste shelf space, the product gets old and it may have to
be sold at a fraction of the price just to get rid of it.
Inventory turnover is important for companies with physical products and is best used to
compare against peers. After all, the inventory turnover for a retailer like Wal-Mart is going to be
very different to a car company like Ford.
Average Age of Inventory (Days)

Average Age of Inventory = Average of Inventory / Revenue
Average age of inventory is just the inverse of Inventory Turnover.
This statement of financial position metric is helpful in checking the quality, as well as the
health.
Inventory to Sales Ratio

Inventory to Sales = Inventory / Revenue
A rather simple and less used ratio. It is mostly useful when you track it year over year or every
quarter. The objective is to see how inventory is being managed as it will signal potential
problems with cash flow. An increase in the inventory to sales ratio can indicate that
your investment in inventory is growing more rapidly than sales or sales are dropping Vice versa,
if the inventory to sales ratio drops, it could mean that your investment in inventory is shrinking
in relation to sales.
This is a high level balance sheet ratio but it will point you in the right direction when you need
to dive deeper into inventory trends.
469
Capital Structure Ratios
Capital structure is looking at the company’s debt and equity. The following ratios all help to
show you how much a company is using debt to run the business.
These are easy statement of financial positions ratios to understand and offer a quick check for
red flags.
Long Term-Debt as % of Invested Capital = Long Term Debt / Invested Capital
Short Term-Debt as % of Invested Capital = Short Term Debt / Invested Capital where Invested
Capital = Shareholders Equity + Total Liabilities – Current Liabilities – Excess Cash
Debt to Equity Ratios

Watch how these ratios have trended in order to understand whether the company is in a difficult
situation or not. If a company operates on high leverage and has maintained a high debt ratio, it
is not as alarming as a company with a low debt ratio suddenly showing a spike in the debt ratio.
Long-term-Debt to Total Debt = Long Term Debt / Total Debt
The long term debt ratio is an indicator that the company does not have enough cash to run future
operations. Look into the deal for the debt, what the interest payments are, what level of
operation the company has to achieve in order to remain within the debt covenant.
Short Term-Debt to Total Debt = Short Term Debt / Total Debt
If the short term debt ratio is high, this is a big warning sign. The debt payment is coming due
and has to be re-negotiated or paid off with a new loan.
There are situations where a high short term debt ratio will cause high levels of uncertainty and
the stock to sell off.
Total Liabilities to Total Assets = Total Liabilities / Total Assets
A broad ratio to show the level of liabilities on the balance sheet compared to the assets.
Price to Working Capital = Price / Working Capital per Share: where Working Capital =
Current Assets – Current Liabilities
Working capital is the absolute lifeblood of a company. Most fast growing and successful
businesses die due to a lack of working capital. That’s why most companies went public in the
first place; to get more working capital from the public market.
A high working capital ratio shows whether the business can continue to operate without
troubles. For retailers, you would want subtract inventory from the working capital equation to
get a better picture.
INVESTMENT RATIOS:
1. Dividend per Share:
The DPS ratio is very similar to the EPS: EPS shows what shareholders earned by way of
Profit for a period whereas DPS shows how much the shareholders were actually paid by
470
Way of dividends. The DPS formula is:
DPS = Dividends paid to Shareholders / ordinary shares ranking for dividend
OR DPS = Dividends paid to Shareholders/average common shares outstanding.
2. Dividend Yield:
The dividend yield ratio allows investors to compare the latest dividend they received
with the current market value of the share as an indicator of the return they are
earning on their share. Note, though, that the current market share price may
bear little resemblance to the price that an investor paid for their shares. Take a
look at the history of a business's share price over the last year or two and you
will see that today's share price might be a lot higher or a lot lower than it was
a year ago, two years ago and so on.
The formula for the dividend yield is
Dividend Yield = Annual Dividends / Current Market Share Price
3. Price Earning Ratio:

The P/E ratio is a vital ratio for investors. Basically, it gives us an indication of the
confidence that investors have in the future prosperity of the business. A P/E ratio of 1
shows very little confidence in that business whereas a P/E ratio of 20 expresses a great
deal of optimism about the future of a business. Here's the formula;
P/E = Current Market Share Price / EPS.
STATEMENT OF CASHFLOW
The statement of cash flows is a relatively new in financial statement in comparison to the
comprehensive income statement or the statement of financial position. This may explain why
there are not as many well-established financial ratios associated with the statement of cash
flows. To calculate free cash flow:-
Free cash flow = Cash Flow Provided by Operating Activities – Capital Expenditures.
This statistic tells you how much cash is left over from operations after a company pays for its
capital expenditures (additions to property, plant and equipment). There can be variations of this
calculation. For example, some would only deduct capital expenditures to keep the present level
of capacity. Others would also deduct dividends that are paid to stockholders, since they are
assumed to be a requirement.
The cash flow from operating activities section of the statement of cash flows is also used by
some analysts to assess the quality of a company's earnings. For a company's earnings to be of
"quality" the amount of cash flow from operating activities must be consistently greater than the
company's net income. The reason is that under accrual accounting, various estimates and
471
assumptions are made regarding both revenues and expenses. When it comes to cash, however,
the money is either in the bank or at hand.
In conclusion, analysis of financial statement for investment decisions is very important in all
facets of an organisation because it serves as control to the management, the funds providers and
potential investors. It also confirm the efficiency and judicious way of how funds are been
utilized.
Free cash flow = Cash Flow Provided by Operating Activities – Capital Expenditures.
The profit and loss account and statement of financial position of ROY NIGERIA PLC, as at
31st 2011 and 2010 are as follows.
2011 2010
N’000 N’000
Turnover 2,713,285 3,089,973
cost of sales 1,907,285 1,954,626
Gross Profit 805,866 1,135,347

Operating
Expenses 664,738 553,645
Trading Profit 141,128 581,702
Exceptional items 176,157 5,848
Other income 72,859 37,085
Interest charges 105,976 80,273
Profit on ordinary activities before tax 284,168 532,666
Tax on Profit on ordinary activities after tax 69,938 191,265
Profit on ordinary activities after tax 214,230 341,401
Debenture Redemption Reserve - 10,000
Dividend Proposed 132,875 199,313
Retained Profit for the year 81,355 132,088
Reserved at the beginning of the year 464,434 332,346
Transfer from Redemption Reserve 40,000 -
Transfer to General Reserve 585,789 464,434
472
STATEMENT OF FINANCIAL POSITIONA AS AT 31ST DECEMBER
2011 2010
N'000 N'000
Fixed Assets/Non-Current
Assets 260,739 260,739
Long term investment 106 160
260,899 260,899
Current Assets
Inventory 1,387,073 1,456,182
Bank & Cash Balances 792,059 525,574
2,489,454 2,561,632
Payables (Due within one year) 1,557,347 1,479,217
Net Current Assets 932,107 1,082,415
Payables (Due after one year) 8,700 10,795
Provision for liabilities &
charges 179,713 258,701
992,463 1,073,818
Capital &
Reserves
Called up share capital @ 50k
each 332,188 332,188
Reserves 660,275 741,630
992,463 1,073,818
Market price of shares 60k/ share 45k/ share
You met the CEO of ROY NIGERIA Plc & Financial controller to discuss the figures, and they
explained that the reduction in trading profit was due to various adverse economic,
infrastructural & socio-political factors prevalent in 2011.
473
i. Gross profit margin
ii. Return on Capital Employed
iii. Net Profit margin
iv. Current Ratio
v. Debtors Collections period
vi. Proprietary Ratio
vii. Earnings per share
viii. Dividend per share
ix. Price Earnings Ratio
474
2011 2010
1. Gross profit margin = GP x 100 = 1,135,347 x 100 = 36.7% 805,866 x 100 = 29.7%
Sales 1 3,089,973 1 2,713,285 1
2. ROCE = Net profit x 100
CE 1 = 341,401 x 100 = 34.4% 214,230 x 100 = 19.95%
992,463 1 1,073,818 1
3. Profit Margin= Net profit x 100
Sales 1 341,401 x 100 = 11.05% 214230 x 100 = 7.89%
3,089,973 1 2,713,285 1
4. Current ratio = Current asset
Current liability 2,489,454 = 1.6:1 2,561,632 = 1.73:1
1,557,347 1,479,217
5. Debtors period=
Av.debt x365 (579,876 + 310,322)365 = 53 days 579,876 x 365 = 78 days
Credit sales 3,089,973 2,713,285
6. Proprietary ratio
= Shareholders fund 992,463 x 100 1,079,818 x 100
Long-term Capital 992,463 +8,700 +179,713 (1,079,818 + 10,79+25701)
= 84.04% = 79.94%
7. Earnings per share =
(PAT – Pref. dividend) 314,401 x 100 = 51k 214,230 x 100
No. of ordinary shares (332,188 x 2) 1 (332,188 x 2) 1
8. Dividend per share =

Gross dividend 199, 313 x 100 = 30k 132,875 x 100
(no of share) (332,188 x2) 1 (332,188 x 2) 1
9. Price earnings ratio 60 = 1.18 45 = 1.41

= M.price 51 32
EPS
475
27.6 SUMMARY
This chapter discussed and made the readers to understand the importance of ratios as a tool used
measuring the performance, activity, liquidity and solvency of the business. It also discussed
means and tools used in the interpretation of investment analysis.
476
1. Distinguish between performance and investment ratios
2. Explain the term Cash Flow statement and highlight its components.
3. What do understand by ratio analysis?
477
References

Press Plc.
Limited.
consulting.
478
CHAPTER TWENTY EIGHT
THE NIGERIAN FINANCIAL MARKET

 The meaning and importance of financial market
 The differences between capital and money markets
 Instruments traded in financial markets
 The meaning of convertible and non-convertible securities
28.1 INTRODUCTION
A financial market is a market for finance that is a market for the financial resources and
funds required by companies and organizations involved in productive processes. An
overriding objective of financial market is the provision of conducive atmosphere or
environment for the fair allocation or channeling of financial resources for the surplus
units to the deficit (usually productive units of the economy. This is known as
intermediating role of financial markets; hence key operators in the market are seen as
financial intermediaries.
28.2 KEY DISTINGUISHING FEATURES OF FINANCIAL MARKETS

a) Absence of specific trading locations. This means that many transactions are concluded
on telephones and other telecommunication media.
b) Assets traded I financial markets are usually intangible in the sense that they consist
mainly of instruments sharing financial claims of one party on another.
In Nigeria, like most part of the world, financial market consist of two major segments
namely:
THE MONEY MARKET - This is the market for short term funds and short term
financial transactions. Short term could mean any period from one day to three years or in
some place, five years. However, in Nigeria, the Money Market Association of Nigeria
defines short term as any period between one day and eighteen months. This definition is
guided by Central Bank of Nigeria’s classification of some short term instruments.
Money market transactions involved the purchase and sale of financial instruments,
foreign currencies, Naira.
The money markets in Nigeria are operated by banks and other financial institutions.
Although the money markets largely involve borrowing and lending by banks, some large
companies, parastatals, as well as government through the Central Bank of Nigeria
479
(CBN), are involved in money market operations. These operators in the money market
bridge the gap between cash receipts and payments of companies through the usage of
financial instruments.
The Nigerian Money Market consists of:

i. The Market for Treasury Bill.
This involves the purchases and discount of treasury bills form with the Central Bank of
Nigeria. Treasury bills are promissory notes, which the Federal Government of Nigeria
uses to borrow money for short periods, usually 90/91 days.
ii. The Interbank Market
This is the market in which bank lend short term funds to one another
iii. The Certificate of Deposit Market
A market fortrading in papers that signify the indebtedness of banks to depositors for
specific periods.
iii. The Commercial Paper and Acceptance Market
This is a market popularly used by large and well known companies to finance their
short investments, especially working capital, by issuing transferable promissory notes,
v. The Inter-Company Market
This is direct short term lending between companies any financial intermediation. In
Europe, this is known as financial disintermediation
vi. Stabilisation securities:
This is usually issued by CBN to mop up excess cash balances in the banking system. It
is intended to curb inflation.
i) THE CAPITAL MARKET - This is the market for long term financial transactions.
Long term generally covers period of about five years or more, but sometimes it may be a
shorter period. The capital market is regarded as the sustaining end of the financial
markets. This is because users of funds operate on a going concern basis, i.e. with the
intention to remain in business and produce indefinitely; and so such should be sustained
through long term funding from the capital market.
480
28.3 CAPITAL MARKETS IN NIGERIA
There are several ‘places’ for raising long term capital market in Nigeria;
1. THE STOCK EXCHANGE
The stock exchange is the market where:
i) Quoted companies (i.e. large public limited companies whose shares
are quoted the stock exchange) can raise new funds by issuing new shares or loan
stock; (This is the concept of the PRIMARY MARKET)
ii) Investors can pull up and sell ‘second-hand’ stocks and shares (i.e. stocks and
shares that are already in issue) most dealings in the stock exchange are in
second-hand securities, rather than in new capital issues, but it is the existence of
this ready market for selling shares that make investor so willing to buy share on
the first place. In other words the stock market would not be such an effective
market for raising new capital unless it provisos investors with an easy way of
selling their shares whenever they wanted to: (This is the fundamental concept of
the SECONDARY MARKET).
2. THE SECOND-TIER SECURITYMARKET(SSM)

This is a market where companies who are not big enough to obtain full listing on the
Stock Exchange can raise new capital by issuing shares, like the main stock exchange the
SSM is also a market for ‘second-hand’ shares. The SSM is regulated by the Stock
Exchange.
3. THE ‘GILTS’ OR GILT EDGED MARKET

This is the market for the government’s long term debt securities. The government can
raise new funds by issuing gilt-edged loan stock, and issued gilts are also traded ‘second
hand’. Gilts are sometimes regarded as "risk free* investments, because it is improbable
that federal Government would ever default on the payment of its debts as and when they
fall due. Gilt-edged securities are normally securities that carry minimum risk as regards
regular payment of interest on due dates and redemption at stated time.
4. BANKS
Banks are approached directly by firms and individuals for medium term loans as well as
short term loans or overdrafts. The major commercial banks and many merchant banks,
are increasingly willing to lend medium term capital, especially to well established
companies. Capital can also be obtained from development banks such as NIDB, ND1C
and NACB
481
5. MORTGAGE BANKS
There is also a market where individuals obtain capital to buy or renovate their homes or
real estate with mortgage facilities from mortgage banks or from Primary Mortgage
Institutions (PMIs) the size of this market has been expanded now, with the licensing of
many primary mortgage finance institutions.
6. INSURANCE COMPANIES
Insurance companies can lend directly to business entities. They are a stable source of
long term capital.
28.4 MAJOR FORMS OF CAPITAL

Firms obtain long term or medium term capital in one of the following ways in Nigeria:
a. As Share Capital (Equity Capital)
Most share capital issued to raise funds will be in the form of ordinary share capital (as
distinct from preference share capital) and ordinary shareholders are the owners or
members of the company.
b. As Loan Capital (Debt Capital)

Long-term loan capital might be raised in the form of a mortgage or debenture. The
lender will usually want some security for the loan, and the mortgage deed or debenture
deed will specify the security. This is also known as Debt Capital or Debenture Stock
Debenture technically speaking represents the security offered hence, referred to ‘secured
loans’ Debt may be redeemable, irredeemable, convertible or with warrants.
LENDERS OF CAPITAL IN THE CAPITAL MARKET

The lenders or provider of capital include private individuals who buy stocks and shares
on the stock exchange. However, there are some important institutional investors i.e.
institutions which specialize in lending capital in order to make a return. These include:
a. PENSION FUNDS
Pension funds invest the pension contributions of individuals who subscribe to a pension
fund, and of organizations with a company pension fund. There is a statutory requirement
of a minimum investment of pension funds in the stock market in Nigeria.
b. INSURANCECOMPANIES
These invest insurance premium paid on insurance policies by policy holders. If you
think about it, insurance companies like pension funds must do something with the
premiums they receive and in practice, they invest the money to earn a return.
482
i. INVESTMENT TRUST COMPANIES
These are companies whose business is investing the stock and shares of other
companies and the government. In other, words, they trade in investment
instruments.
INVESTMENT TRUST AND UNIT TRUSTS

Investment Trusts - are companies which invest in a wide range of securities. Their
shares are bought and sold on the stock exchange and unlike unit trusts where the number
of units can be varied at times, they are not open-ended.
Differences
1. Investment trusts are companies whereas unit trusts are trusts.
2. Unit trusts area open-ended in the number of units that can be traded while the
number of shares in issue of an investment trust will be fixed for quire long
periods.
3. Investment trust can introduce some gearing into their capital structure. Unit
trusts cannot borrow any money to invest insecurities.
4. Investment trust can be bought and sold in the stock exchange whereas unit
trusts are bought and sold to the managers.
5. The prices of investment companies quoted on the exchange are determined by
the forces of supply and demand. The prices of unit trust are largely independent
of those forces since unit trusts can be created or liquidated at will.
6. The way management charges are calculated different. In general those of
investment trusts are lower.
7. Investment trusts are not allowed to advertise, unlike unit trusts. To an extent
this explains why exclusively institutional investors such as pension funds now
hold the shares of many investment trust.
8. Investment trusts are taxed identically to other companies i.e. franked income is
not taxable, unfranked income is subbed to corporate tax.
Investment Trust - Merits

1. Shares can usually be obtained at a discount to net asset value.
2. Share can be dealt with on the stock exchange.
3. The optimal gearing structure can benefit both company and shareholders.
4. Management fees are lower than its trusts.
483
5. The investor can gain managerial expertise and diversification which might not be
possible with a direct investment in (say) equities.
6. The company is perpetual while trusts are limited in the length of their existence.
7. Possibly the asset will be realised if a pension fund makes a take-over bid.
8. Profit can be ploughed back for expansion.
Demerits
1. Often the share capital is small and therefore only a limited number of parties interested
in buying shares.
2. The number of share in existence is fixed for long periods where as the number of units
in a write trust can be varied at anytime.
3. The yield is often low
4. They are forbidden to advertise
5. Larger investment trusts are often inflexible in their dealing.
28.5 BASIC DOCUMENT OF A UNIT TRUST SCHEME

a. The Trust Deed: The principal document governing the relationships, powers, rights and
duties of the duties of the parties in a unit trust transaction vis, the right manager, the
trustee and the unit holders. It is entered not by the manager and trustee. It is properly
referred to as the constitution (contact) of the scheme.
b. The Prospectus: This is the document prepared by the manager with the approval of the
trustee; setting out the objectives of the scheme. It is designed to help a prospective unit
holder take a decision whether or not to purchase unit under a unit scheme. For this
purpose the law requires the prospectus should contain every material fact and that it
should not omit any fact that may be material in the circumstance of the scheme.
c. Other document: There are two categories. They are those pertaining to the public e.g.
circulars, advertisements, letters etc and form and reports which are required to be
submitted by an operator or a participant in order to obtain the necessary arbitration and
registration.
28.6 PRINCIPAL PARTICIPANTS

In a typical unit trust scheme, there are three principal factors. These are the manager, trustee and
unit holders. There are however a few other auxiliary actors. They include investment advisers,
brokers, dealers and registrars.
Unit Holder: Is the person (individual or corporate bodies) who invests his money in unit trusts
by purchasing units reform. His expectation is that he realises goods returns on his investments.
Although he is not a party to the trust deed, he takes benefit of the reform.
484
Demerits
1. Management fees are higher for investment trustee.
2. Units can only be dealt with by trust managers
3. Because the trusts are forbidden to borrow, the benefits of gearing are lost.
4. Unit trust has a limited life which means that the unit holder will be forced to reinvest
periodically.
5. Some larger trusts lack flexibility and specialized trusts are often risky
6. Since income is fully distributed profits are not ploughed back for expansion.
UNIT TRUST COMPANIES

These are similar to investment trust companies, in the sense that they invest in stock and shares
of other companies. However, they can sell portion or ‘units’ of these investment to individual
investor. For example, a unit trust company might create a proportion i.e. their proportion of the
portfolio.
Unit Trust
A unit trust is a scheme designed to enable individuals and/or corporations pool together their
resources for another corporate legal entity to make investment while they hold units as evidence
of the resource so contributed. The corporate legal entity is referred to as the manager while
those who pool in the resources are known as unit holders. In addition to the manager and the
unit holders, there is a trustee in whom is vested all the manager and the unit holders, there is a
trustee in whom is vested all the resources pooled as well as any property or asset purchased with
the resources. In simple terms therefore, a unit trust can be defined as arrangement whereby
property is held on trust for investors. The unit scheme is constituted by a trust deed regulating
the rights, power, and duties of the three parties to the scheme.
The trustee’s role is primarily to ensure the protection of the investors (i.e. unit holders) by
monitoring the managers’ administration of the scheme and by holding all the assets.
It should be noted however that it is only the manager and the trustee that are parties to the trust
deed. White a unit holder is not a party to the deed, he only has some rights conferred by the trust
treated by the deed.
Duty of Manager:- To invest the resources in the common pool, such investment normally
cover any areas which the manager thinks is viable enough to take in profits but this is subject to
485
some certain restrictions. His duty consists of marketing the scheme, managing the scheme’s
portfolio of investments and generally administering the scheme.
The Trustee:- The trustee of the unit scheme, a bank orinsurance company, is vested with the
asset of the trust scheme, in effect it is the legal owner of the scheme’s portfolio, which the unit
beneficiary ownership in such assets.
A unit trust scheme may be flexible or fixed. It is fixed where neither the term nor the number of
units in the scheme is determined. A unit trust should be distinguished from an investment trust.
An investment trust is a limited company with a fixed share capital. A deed investment trust are
referred to us an investment trust company since they are incorporated.
Since an investment trust is incorporated with a fixed capital, only new shares issued for
purchase for intending buyers. The only other way he can purchase the share in an investment
company is to do so from an existing holder and this is usually through stockbroker, especially
for shares listed on the stock exchange.
In the case of a unit trust on the other hand, an intending purchaser can buy from the manager at
any time, if there is none available, the manager can always create new units.
While the shareholder of an investment trust or any company can sell directly to an intending
buyer, this is not always possible in the case of trusts, as units are only available through the
manager.
Applicable Laws and regulations

a. General principles of law (common law) which is applicable wherever there is not
specific statutory stipulation.
b. Companies and Allied Matters Decree (1940)
c. Securities and Exchange Commission (SEC) Decree, 1988
d. SEC regulations !989
e. Trustee Investment Acts 1957 and 1962
f. Exchange Control Acts 1962 and related enactment.
g. SEC rules and regulations on Unit Trust Scheme
These rules and regulations are still in draft form, but they provide an insight into the thinking of
the commission on the regulatory issues relevant to the establishment and operation of the unit
trust scheme.
486
E. VENTURE CAPITAL ORGANISATION
These are organisations that specialise in raising funds for the use of business ventures.
Continental Merchant Bank of Nigeria Plc has set up a venture capital company and other
merchant Banks are likely to follow such in the near future.
F. BANKS AND OTHER FINANCIAL INSTITUTIONS

Banks are traditional providers of long term finance. However in Nigeria, a tot of constraints
have hindered the role of banks in this based transaction in both markets must be appraised or
assessed on the grounds of the mix of volume, rate and tenor to properly identify the threats or
advantages of the bank’s immediate and future profitability and liquidity.
28.7ALLOTMENT OF SHARES
The directors of the company cannot allot shares to the prospective investors unless:
(i) They have been authorised to do so by the company in a general meeting or the article of
the company.
(ii) The amount of the minimum capital stated in the prospectus has been subscribed for and
the subscribed amount has actually, been received by the company.
(iii) The maximum amount of capital offered for subscription has been fully subscribed, or if
not there is an express provision in the offer allowing allotment to be made even though
the full amount has not been subscribed.
28.8 PROCEDURE FOR ALLOTMENT OF SHARES

Upon the acceptance of applications, letters of allotment are issued to applicants by the directors
of the issuing company. Letters of allotment are temporary deeds of title to shares given to
persons named thereon. This applies to prospectus offers and right issues only.
In the case of offer for sale, letters of acceptance are issued, through there are no practical
differences between them. They contain the following details:
(i) The name of the issuing company
(ii) The allotee’s name
(iii) Details of the issue
(iv) Calculation of the allotment - whether based on the amount applied for or existing
holding.
(v) Time table stating the date and time by which payment (if any) must be made.
(vi) The last date for splitting, renunciation, and registration
(vii) The date when share certificates will be issued
(viii) Renunciation and registration forms.
487
28.9 THE SHARE CERTIFICATE
The share certificate states the names of the company and shareholder, number and types of
share held and the amount paid on them.
A share certificate is not negotiable like an allotment letter because it has been registered and
entered in the company’s register of members. Prima facie, it is an evidence of title and should
therefore be well kept. If lost or destroyed, the company may issue a duplicate on receipt of an
indemnity signed by the holder and guaranteed by a bank, insurance company or a stock broker.
With the introduction of Central Securities Clearing System (CSCS) into the operation of the
Nigerian capital market, the issue of physical certificates by companies’ registrars is being
addressed in favour of total elimination.
28.10 THE CENTRAL SECURITIES CLEARING SYSTEM (CSCS)

The Central security Clearing System (CSCS) rests on the concept which provides an integrated
central depository clearing (electronic/book entry transfer of shares from seller to buyer) and
settlement (payment for bought securities) for all stock market transactions.
28.11 FUNCTIONS OF CSCS LIMITED

The specific functions performed by the CSCS limited include the following:
(a) Serving as Central depository for all share certificates of quoted securities including new
issues, sometimes not quoted on the stock exchange and-certificates for foreign investors
with CSCS limited for safe keeping, Citibank N. A through the Nigerian International
bank Limited (NIB) has been appointed as the custodian bank;
(b) Serving as sub-registry for all quoted securities, maintained in conjunction with the
registrars of quoted companies. Shareholders are able to ascertain their current holdings
in a particular security through a statement obtainable form CSCS Limited, through their
stock broking firms.
(c) Serving as a clearing and custodian agency for local and foreign instruments and, Issuing
central identification numbers to stockholders.
28.12 COMPENENT OF CSCS

The CSCS is composed of the following
1) The depository, and
2) The Stock Exchange back office
The Depository is where certificates of all shares to be traded on the floors of the Nigerian Stock
Exchange are deposited tor the account of the selling stockbroker prior to being eligible for
488
trading on a particular day. The settlement system of stock which the sellers’ accounts are
reduced and the buyers’ accounts increased.
The stock exchange Back-office is the computer system with which the daily call-over system
currently interfaces until such a time (last quarter of 1998 is been proposed) when the Automated
Trading System module is installed. This is expected to function much in the same way as the
Stock Exchange Automated Quotation System of the London Stock Exchange.
28.13 HOW THE CSCS WORKS (FLOW OF ACTIVITIES)

A diverse range of inter-locking activities in which the CSCS is involved constantly go on in
regard to buying and selling of stocks, with the roles of key operators (investor, stockbrokers,
bank, the registrar, CSCS Depository and the (NSE) inter-woven. This is graphically represented
below.
THE CSCS PROCESS FLOW
STOCKBROKER
INVESTOR REGISTRAR
CSCS CSCS
STOCKBROKER’ NSE
S BANK
CSCS
The chart above shows, the investor’s first point of call is the stock bruiting firm. The stock
broking firm performs the following functions:
(i) Nomination of two accredited stock brokers/officials to CSCS (only one of them is
allowed to transact with CSCS limited on behalf of the company at any given time)
(ii) Maintaining only one Trading account at any point in time with one of the four
designated stockbrokers’ banks, namely Citizens International bank limited. Diamond
Bank Limited, Nigeria International Bank Limited and FSB International Bank Plc.
(iii) Instructing the bank to obey CSCS instruction as it relates to the Trading Account
maintained.
489
(iv) Receiving orders/instructions from investors.
(v) Verifying clients’/investors1 signature from the registrars.
(vi) Attesting to the genuineness of certificates deposited with the CSCS Depository,
(vii) Giving up-date information and advice to clients/shareholders.
(viii) Giving contract note to the investor as evidence of a contract between them.
(ix) Depositing investors’ securities with CSCS depository (not later than 2 p.m.) at least a
day before the Trading Day, and
(x) Depositing investors’ Transfer Forms with CSCS at the end of each transaction.
In regard to stock market securities trading, the registrars deal only with the stock broking firms
who act on behalf of investors/shareholders. Specially, registrars performs the following
functions:
(i) Verifying and attestation/authentication of investors’ claims as presented through the
stock broking firm.
(ii) Return of attested/verified certificate(s) and the signed Transfer Form(s) to the stock
broking firm who will then lodge the certificate(s) with the CSCS Depository for trading;
(iii) Answering shareholders’ enquiry relating to their shareholding.
(iv) Updating shareholders register, with the stock movement details sent to registrars from
CSCS in hard copies at agreed intervals;
(v) Payment of dividend warrants, and
(vi) Sending to CSCS, register of shareholding in new issues, bonus shares, rights issues, etc,
in hard copies.
At the CSCS, a number of activities take place to facilitate the trading of securities. All shares to
be traded on the floors of the Stock Exchange must have their certificates deposited with the
Depository of CSCS Limited for the Account of the dealing member for trading eligibility. Also,
it is mandatory that certificate(s) to be lodge with the Depository be accompanied by a
completed Certificate Deposit Form (CSCS DOOI) with the summary of its/their lodgments.
Though system-generated account number is taken by the CSCS, the book-entry in addition,
reflects the account number on the lodge certificates. Other aspects of the procedure at the CSCS
include the following:
(a) Financial position of each stock broking firm must be received by CSCS from the stock
brokers’ bank on or before 9.30 a.m. daily.
(b) A copy of authenticated financial position of each stock broking firm is forwarded to the
Call-Over Chairman before trading session.
(c) Issuing of receipt to stockbrokers to cover securities deposited and approved.
490
Once this procedure is completed, the stockbroker heads for the Nigerian Stock Exchange for
trading.
In regard to trading of securities and in the context of the CSCS, the Stock Exchange provides
the following services.
(a) Provision of the venue for trading in capital market securities through stockbrokers.
(b) Arranging for Buy-in market when short-selling occurs.
(c) Checking and validating with CSCS officials, deals done on a daily basis.
(d) Transmitting to CSCS, via diskettes, verified transactions that are captured by the NSE
Bank Office after cancellation of any over-trading on a daily basis.
(e) Informing the CSCS of closure dates of companies’ register.
Once again, at the CSCS transactions obtained from the NSB back-office are processed with
stockbrokers1 stock accounts being debited and credited accordingly. These transactions usually
have a forward value date of Transaction Day plus 5 days (T+5) or on the day settlement occurs
on deals done on a particular transaction day. It is also important to add here that stockbrokers’
daily financial commitments to each other are communicated to the stockbrokers’ banks via
diskettes supported by hard copy and by fax.
Stock brokers’ banks’ role in relation to CSCS operations can be briefly outlined as follows:
(a) They permit trading accounts to be operated only on the basis of written instructions by
either the dealing member who maintains the trading account, or those contained in the
CSCS schedule.
(b) They are not to permit trading accounts to be used for purpose other than that of effecting
settlement of CSCS transactions. However, they may make withdrawals to pay for sales
made on behalf of the shareholders.
(c) They are to ensure that the settlement of CSCS transactions is done primarily through
inter-bank transfer effected through the Nigerian inter-Bank Settlement System (NIBSS).
(d) They perform settlement of the deals done on the floor of the NSE. In this regard, they
are expected to follow the procedure detailed out below:
On or before 930 a.m. on each working day, the stock brokers’ banks forward to CSCS Limited,
a schedule of the balances on trading accounts that are maintained with them containing the date,
member’s name and the balance on the particular trading accounts. The CSCS then dispatches its
own schedule which specifies the transaction details of the stockbrokers to the stockbroker’s,
banks on or before 5.00 p.m. on each working day. It is now the duty of the stock brokers’ bank
to ensure that debit entries are passed to the trading accounts, on or before the close of business
on the Transaction Day, using the CSCS schedule. Also, on or before the close of business on the
491
transaction Day, the stockbrokers’ banks are to ensure that the trading accounts maintained with
them are credited tor such amounts as are specified in the CSCS schedule. It should be noted,
however, that the amount credit would not show up in the balance of the selling broker until
settlement occurs i.e. T + %. Neither will instructions issued by dealing members on trading
accounts be processed by the stockbrokers’ banks until the debit entries for the Transaction Day
have been passed.
Finally, amounts credited to the Trading Accounts on the Transaction Day ("T) have forward
value date of transaction day plus five (5) working days (T + 5); that is, amounts credited to the
trading account can be utilised by stockbrokers on the fifth working day following the
transaction day. Fig 10-2 further illustrates the CSCS delivery system.
TRADING EXCHANGE
FLOOR Trade BACK OFFICE
Day’s Trade
Allocation
Trades Stock Brokers
System
Clearing House
Settled Trade
Released
Instruction
Movement Release
Movement Status Instruction
Instruction Information
Dr/Cr Advise
Depository
Bank
Balance
Information
CSCS DELIVERY SYSTEM
28.14 BENEFITS DERIVABLE FROM THE CSCS

Though the CSCS is a relatively new idea in the capital market in Nigeria, it holds out a number
of benefits both for the investor, the quoted company, the capital market itself and the stock
broking firm. These are summarised below:
492
(1) For the investor
(a) Problems associated with loss of stolen certificates and certificates not yet
issued/delivered will no longer exist as physical certificates will no longer be
issued.
(b) Risk is minimised and there is more room for speculations by investors since all
transactions (buying and selling) are concluded in five days.
(2) For the quoted company
(a) Huge cost associated with production of share certificates and making transfers by
company registrars is eliminated.
(b) The valuable man-hours hitherto spent on signing of certificates are now better
used elsewhere.
(c) Trades on companies’ securities would increase.
(d) There would result an increase in the companies’ market capitalization and net
worth.
(3) For the capital market
(a) The market would witness more transparency
(b) Investors’ confidence in capital market operations would increase
(c) The market would have higher turnover
(d) Foreign investors would be attracted to the market
(e) The market’s liquidity an4 vibrancy would be given a boost.
(4) For the Stock broking Firm
(a) There is prompt inter-member money and stock settlement
(b) There are no more problems of certificate delivery.
(c) The efficiency of stock broking firms are enhanced
(d) There is reduction in stockbrokers’ operation costs.
28.15 INTERNATIONAL STOCK EXCHANGE OPERATIONS

An international Stock Exchange is one whose operational network is internationalized i.e.
dealings in securities on such an Exchange cuts across the geographical boundary in which it is
located. As such, it is an international market for security trading which meets all standards of an
efficient capital market. An example of International Stock exchange is the London Stock
Exchange. The council of the Stock Exchange is the governing body of the Stock Exchange is
the London Stock Exchange. The council of the Stock Exchange is the governing body of the
Stock Exchange, presiding over the activities of the market. Since June 1987, it has 25 member
with a quarter to a third drawn from outside interests. The remainder of the council membership
is a balanced representation form within the market, the council members set rules, administer
and enforce standards, as well as govern the activities of the SEC staff. The Stock Exchange
493
Council is assisted in its work by a number of standing committees. Member-firms who
participate in such committees gain a lot of influence through the more than 2500 employees
who run the Stock Exchange services and computer systems through which Stock Exchange
member-firms conduct their business. Using other standing committees for setting and
enforcement of market rules, the council is thus able to face matters of general policy and ensure
the maintenance of high standards or regulation.
28.16 FUNCTION OF MEMBERS

There are four types of member firms on the London Stock Exchange, namely:
(1) Brokers/Dealers: These function both as agency brokers and as brokers/dealers. As
agency brokers, they represent clients in a single capacity, obtaining the best price
available for them from ma.rk.et makers. As brokers/dealers, they act in dual capacity -
as agency brokers and as principals buying and selling shares on their own account by
quoting a two way price.
(2) Market-makers: These are firms registered for making firm buying and selling prices at
ail times in specific securities. They enjoy same privileges as jobbers. For example, they
have the ability to borrow at favourable terms. Examples are Gilt-edged market makers
(GEMMS).
(3) Inter-dealer Brokers (IDB’s): These are specialist firms in the gilt-edged market.
Sometimes, a market maker funds itself folding an uncomfortably large amount of a
particular stock that another market maker is desperate to buy. Naturally, neither of them
will be willing to expose its books by publicly acknowledging its position, IDE’s serve as
to between by posting bids and offers for large amounts of stock on the IDB dealing
screens. This however, is done with a strict code of conduct and dealing.
(4) Stock Exchange Money Brokers (SEMBs): These are specialist firms which arrange for
GEMM’s to ‘borrow’ stock to satisfy immediate demands, to be returned at a later date.
The stock comes from approved institutions (mostly insurance companies and pension
funds) for whom the facility is a useful extra source of income. SEMB’s are recognised
as crucial to market-makers’ confidence in their ability to settle.
28.17 THE STOCK EXCHANGE AUTOMATED QUOTATIONSYSTEM (SEAQ)

This is a computerized information system run by the Stock Exchange, It provides screen-
based information on the state of the market and dealings to brokers/dealers, both in their offices
and on the trading floor, and to major investing institutions or other subscribers to the system.
Information is fed through the established TOPIC system (Teletext Output of Price Information
by Computer System) to the TOPIC terminals. It is the Stock Exchange’s videotext terminal
network. It has three levels of information service, namely:
494
(a) LEVEL I: This is called the investor Service, meant for the investing institutions, which
are not members of the Stock Exchange. It is plays the best bid and offer prices for each
security on the database. For Alpha Stocks, the number of transactions reported in the last
five minutes and the total
(b) LEVEL II: This is called the Deliver Service for members of the Stock Exchange. The
various competing market; makers’ price are displayed for each security with the number
of shares for which the quotation is valid. The best quote in the case of Alpha and Best
stocks are shown in yellow band.
(c) LEVEL III: This is available to market-makers and allows them to update their prices
input trading information i.e. the prices at which they are prepared to trade, and the
volume for which these prices are binding.
28.18 STOCK CLASSIFICATION

Stock traded on the London Stock Exchange are classified according to investor’s interest
in them and the level of information which is required to be displayed on the SEAQ
system to serve the needs of the market. The classifications, which change along with
changes in investors’ interest, are as follows:
(1) Alpha Securities: These are the largest and the most liquid stocks in the market. Up to
ten (10) or more competing market-makers deal in Alpha securities which fall within the
100 shares index of the Financial Times.
(2) Beta Securities: They are the next 500 to 600 most actively traded securities. Though
the price display and trade reporting obligation for member firms are the same as for
alpha securities, trade details are not published in real-time on SEAQ but shown the next
day in the daily official list.
(3) Gamma Securities: These are securities of smaller companies. There are about 2000
Gamma stocks, which Securities’ prices on the SEAQ may be firm or indicative
depending on what is declared by market makers on the screen display.
(4) Delta Securities: These are largely illiquid stocks with very few market makers as
participants. An index is maintained on TOPIC to allow firms to identify market makers
prepared to deal in them and the indicative mid-prices are also displayed on TOPIC
screens.
28.19 THE DEALING AND TRANSFER SYSTEM

For Alpha and Beta securities, the stock broker/dealer calls up on the SEAQ screen the
page displaying the relevant securities, selects the market maker showing the best
bid/offer price. He then telephones the market maker to place the order. For Gramma and
Delta securities, However, the broker makes further enquiries as to prices. For all
495
categories of security, the market maker must enter the price and the number of share
dealt into the computer within five minutes of the transaction being executed. All trades
are published in the next day’s Stock Exchange Daily Official List. If alpha, trades are
published immediately on SEAQ.
28.20 CONTRACT NOTE

After a deal, the broker sends the client a contract note showing full .details of the
transaction and the time the deal was struck. It contains details such as name and address
o broker or dealer, name of client, the fact that it is a purchase or sale, whether broker or
dealer is an agent/principal, bargain date, time of deal, number of shares, price,
commission, contract levy, VAT, stamp duty, total cost of proceeds and settlement date.
28.21 A PURCHASE OR SALE?

If the deal is a purchase, the broker registers the purchase and the new owner with the
company concerned and sends the client in due course a certificate evidencing ownership.
If a sale., the client receives form the broker, usually along with the contract note, a
transfer form the client must sign and return along with the covering certificate to the
broker, for onward transmission by the broker to the company or nay other body
concerned so that the seller’s name is removed from the holder’s register.
28.22 BEARER/UNREGISTERED SECURITIES

Bearer securities exist in a situation where the name of the owner is not recorded in the
company’s or any other issuing body’s share/shareholders’ register. Though dealing costs
of bearer securities are the same as for registered securities, the difference is in transfer.
Bearer securities, generally, have the following characteristics;
(1) Certificates do not include the holder’s name, hence, no transfer form.
(2) Ownership is transferable by mere physical deliver, buyer, either directly by the seller or
through a broker.
(3) No transfer stamp duty is paid (except on the original issue)
(4) The risk of loss and forgery is very high.
(5) Payment of interest and dividends is problematic, as there is no register of holders.
Holders have to chase information regarding dividends, new issues, meetings and
company reports. Interests and dividends are paid by registrars or paying agents.
496
28.23 STOCK EXCHANGE SETTLEMENT AND TRANFER PROCEDURE
After the broker/dealer has carried out the, say "buy" instruction of a customer and has
issued the contract note to the customer, then the Stock Exchange system by which
securities are paid for and transferred into the customer’s name begins. The two basic
methods of settlement are as follows:
(1) For cash settlement: This concerns bargaining in securities which are on cash basis and
for which payment is due the day after the bargain is struck e.g. gilt-edged securities.
(2) For account settlement: This concerns all normal dealings in registered shares and
industrial fixed interest stocks. The settlement procedure is through the Stock Exchange
computerised settlement system known as TALISMAN (Transfer Accounting, Lodging
for investors and Stock Management for Jobbers).
In this system, all stock exchange member firms are required to report details of their
bargains to the checking system each day. The checking system validates these details
and produces overnight reports for each member firm which provides details of matched
and unmatched bargains. Only matched bargains are passed on to TALISMAN where
they form the basis of settlement.
28.24 BULLS AND BEARS

These are speculators, distinct from investors in the stock market, the bull buys in the
hope of selling for higher price before the end of the ‘"account". A stale bull buys shares
in anticipation of a short-term rise, which fails to occur. A stale bull who lacks cash and
does not wish to sell at a loss may be also to "carry the bargain over" into the next
account by a "cash and new" deal.SS
The bear is the opposite of the bull. He sells shares he does not own. A bear who owns
the share he sells, in anticipation of a fall, is called a ‘‘covered bear".
A bullish market connotes a rising market due to optimism in the economy, and typified
by buying. A bearish market on the other hand, is a falling market typified by selling due
to pessimism about the economy on the part of investors who are willing to take over or
take gains under the safety of cash.
28.25 CONTANGO
A method of carrying a stock market transaction over to the next account allows shares to
be sold for settlement on the normal account day and immediately repurchased on
settlement on the following account day. The sale and purchase are carried out at the
same price (marking up price), based on the price ruling at the close of business on the
last day of the Account.
This is a kind of privilege, and the charge +for it is called “Contango”.
497
28.26 SUMMARY
This chapter made the readers to understand the importance of financial markets, capital market
in Nigeria and major form of capital. It extensively discussed the mode of issuing shares and
operation of Nigeria stock exchange.
498
1. Many financial decisions made by firms and investors will offer them choices or option
sin the future. Give examples of such options from your study of financial management.
2a. What risks might an industrial company face as a result of interest rate movements?
b. Explain the main financial instruments which a company can use to reduce these risks.
3a. What do you mean by interest rate swap? What are the key advantages?
b. You are the new finance Director of Very Big (VB) Plc. The company wishes to borrow
N100 million for five years. At a fixed rate of interest this will cost 14%p.m. and at a
floating rate of NIBOR + 1%.
A bank has offered to arrange an interest rate swap for three years with a smaller
company AB Plc which can borrow floating rate debt at NIBOR + 2%, and fixed rate
borrowing at 153/4%. The bank will charge each of the two parties N50,000 (one off).
Because of the existing balance of their debt portfolios VB wishes to services a floating
rate loan and AB wishes to service a fixed-rate loan.
Required:
i) Do you think there is an opportunity for an interest rate swap contract?
Ii) If your answer to (b) (i) is yes, design an interest rate swap that will be equally attractive
to the two companies.
iii) What is the net benefit to your company for each of the three years?
4a. Identify and briefly comment on the benefits of swaps to the corporate treasurer.
b. Explain the types of risk associated with participating in swaps.
c. Consider the following information:
Right Plc wishes to borrow N300 million on a fixed interest rate basis for a period of three years.
The treasurer has reported that the company can borrow at NIBOR plus 100 basis points or issue
three-year bonds at 6.5%. Herbert Plc also wishes to borrow N300m for three years, but is
seeking a floating rate deal. Its treasury department advises that it could issue fixed rate bonds at
6.0% or borrow at NIBOR plus 75 basis points.
Ignoring any associated fees for arrangement and administration by a third party, show how an
interest rate swap would work to reduce borrowing costs for rights Plc and Herbel Plc. Assume
that any arbitrage benefits are equally distributed to the two companies.
499
References
Abdulrasaq .A.(2009). Financial Management. Lagos: Corporate Publishing.

Press Plc.
Limited.
consulting.
500

Accounting and Finance For Managers

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Accounting and Finance For Managers

Uploaded by

Copyright:

Available Formats

1

ACCOUNTS AND FINANCE FOR MANAGERS

ACCOUNTING AND FINANCE FOR MANAGERS

CIPM House, 1 CIPM Avenue, Off Obafemi Awolowo Way,

CHAPTER ONE: INTRODUCTION TO ACCOUNTING 17

CHAPTER TWO: STATUTORY AND REGULATORY FRAMEWORK

CHAPTER THREE: FINANCIAL REPORTING AND

CHAPTER FOUR: CAPITAL AND REVENUE ITEMS 59

CHAPTER FIVE: SOURCE DOCUMENTS AND SUBSIDIARY BOOKS 69

CHAPTER SIX: ACCOUNTING EQUATION 96

CHAPTER EIGHT: LEDGER BALANCING AND EXTRACTION

CHAPTER NINE: ERRORS, CORRECTION OF ERRORS AND

CHAPTER TEN: PROVISIONS FOR BAD AND DOUBTFUL DEBTS,

CHAPTER TWELVE: PROPERTY, PLANT & EQUIPMENT,

CHAPTER THIRTEEN: CONTROL ACCOUNTS 197

CHAPTER FIFTEEN: ACCOUNTS FOR NOT FOR PROFIT MAKING

CHAPTER SIXTEEN: FINANCIAL STATEMENT 232

CHAPTER SEVENTEEN: MANUFACTURING ACCOUNT 255

CHAPTER TWENTY: INTERNAL CONTROL SYSTEM 354

CHAPTER TWENTY TWO: CAPITAL BUDGETING DECISIONS 378

CHAPTER TWENTY THREE: SOURCES OF FINANCE 397

CHAPTER TWENTY FOUR: WORKING CAPITAL MANAGEMENT 416

CHAPTER TWENTY SIX: CAPITAL STRUCTURE AND LEVERAGE 446

CHAPTER TWENTY EIGHT: THE NIGERIAN FINANCIAL MARKET

1.2 THE HISTORICAL DEVELOPMENT OF ACCOUNTING

1.3 REGULATORY FRAMEWORK

1.4 THE PURPOSE OF ACCOUNTING

1.5 BOOKKEEPING AND ACCOUNTING

1.6 IMPORTANCE OF BOOK KEEPING:

1.7 ACCOUNTING DEFINED

1.9 THE NEED FOR ACCOUNTING INFORMATION

1.10 QUALITIES OF GOOD ACCOUNTING INFORMATION

1.11 USERS AND THEIR INFORMATION NEEDS

1.12 The Work of an Accountant

1.12.1 Members in Public Practice

1. Define Accounting, and critically examine its importance

2. Differentiate between Book keeping and Accounting?

3. In broad terms, what is the purpose of Accounting?

4. Identify the users of accounting information and their importance

5. The knowledge of Accounting is useful in any organization, even in the church.

Explain this statement.

2.2 STATUTORY FRAMEWORK

2.3 REGULATORY FRAMEWORK

2.5 HISTORY OF INTERNATIONAL ACCOUNTING STANDARDS BOARD

2.6 STRUCTURE OF THE FOUNDATION

2.7 THE IFRS INTERPRETATIONS COMMITTEE (IIC)

The IFRS Advisory Council (IAC)

2.8 LIST OF IASs ISSUED BY THE IASC AND ADOPTED BY IASB

2.9 FINANCIAL REPORTING COUNCIL (FRC)

2.11 STRUCTURE OF FRC

Functions of the Board of FRC

2.12 PROCESS LEADING TO ISSUE OF SAS

2.13 LIST OF SAS ISSUED TO DATE

2.14 WHY ARE ACCOUNTING STANDARDS NECESSARY?

2.15 STATEMENTS OF ACCOUNTING STANDARDS

2.16 APPLICATION OF IFRS AND SAS IN NIGERIA

and regulatory framework in basic accounting such as;

- The changes in global accounting standards.

- The regulatory rules guiding accounting globally

- How to prepare simple financial statement.

1. Trace the evolution of international accounting standard.

2. List the composition and functions of board of financial reporting council