4.

10 Preparation of Financial Statements – Sole trader

Financial Statements are a structure representing the financial position of an organization

and the results of the operations undertaken by the organization.
The objective of preparing financial statements is to provide information about the financial
position, performance and cash flows of an enterprise so that users of financial statements
can make well-informed economic decision. Financial statements also serve as proof of the
results of management’s stewardship of the resources of the enterprise.

A complete set of financial statements would normally consist of:

 Statement of Comprehensive Income;

 Statement of Changes in Equity;
 Statement of Financial Position;
 Statement of Cash Flows; and
 Accounting policies and explanatory notes.

Gororo’s Statement of Comprehensive Income for January 2010

$ $
Net Sales (163 000-7 000) 156 000
Less Cost of Goods Sold
Opening stock ---
Add Net Purchases (153 000-11 000) 142 000
142 000
Less Closing stock (19 000)
“ Drawings of goods (6 000) 117 000

= Gross Profit 39 000

Add Disc. Received 2 000
41 000
Less Expenses
Rent 3 000
Wages 4 000
Insurance 5 000
Stationery 3 000
Telephone 3 000
Postages 1 000
Sundries 2 000
Disc. Allowed 3 000
Total Expenses 24 000
 = Net Profit 17 000

4.12 The Statement of Financial Position

When transfers have been made what remains in the ledger are accounts of assets, liabilities and
capital which are then used to prepare the balance sheet. A balance sheet is a statement of assets
and liabilities which show the financial position of a business at a certain point in time.

Gororo’s
Statement of Financial Position as at 31 January 2010
$ $
Non Current Assets
Delivery van 35 000
Office Furniture 9 000
Cash Register 12 000
56 000
Current Assets
Inventory 19 000
Trade Debtors 45 000
Cash at Bank 71 000
Cash in Hand 23 000
158 000
Total assets 214 000

EQUITY AND LIABILITIES

Equity
Capital at start 100 000
Add Net Profit 17 000
Less Drawings (10 000)
= Capital at end 107 000
Non Current Liabilities
Loan from Barclays 20 000
Current Liabilities
Trade Creditors 72 000
Other Creditors 15 000
87 000
Total Equity & Liabilities 214 000
5.3 Preparation of financial statements of Partnerships

Example
Oscar and Felix are in partnership. They share profits and losses in the ratio: Oscar 60%; Felix
40%. The following trial balance was extracted as at 31 March 2010.

Dr Cr
$ $
Office equipment at cost 6 500
Motor vehicles at cost 9 200
Provision for depreciation at 31.3.2009:
Motor vehicle 3 680
Office equipment 1 950
Stock
Debtors and Creditors 20 960 16 275
Cash at bank 615

Cash in hand 140

Sales 90 370
Purchases 71 630
Salaries 8 417
Office expenses 1 370
Discount allowed 563
Current accounts at 31.3.2010:
Oscar 1 379
Felix 1 211
Capital accounts:

Oscar 27 000
Felix 12 000
Drawings:
Oscar 5 500
Felix 4 000
153 865 153 865

Required
Draw up a set of financial statements for the year ended 31 March 2010 for the partnership

The following notes are applicable at 31.3.2010.

a. Stock $27 340.
b. Office expenses owing $110.
c. Provide for depreciation: Motor 20% of cost, office equipment 10% of cost.
d. Charge interest on capital at 10%.
e. Charge interest on drawings: Oscar $180; Felix $210.

Solution:

Workings:

1. Depreciation: Van = 20% x $9 200 = $1 840

Equipment = 10% x $6 500 = $ 650

2. Interest on Capital: Oscar = 10% x $27 000 = $2 700

Felix = 10% x $12 000 = $1 200

Oscar and Felix Partnership

Statement of Comprehensive for the year ended 31 March 2010
$ $
Sales 90 370
Less Cost of Goods sold:
Opening stock 24 970
Purchases 71 630
96 600
Less closing stock 27 340 69 260
Gross Profit 21 110
Less Expenses
Depreciation (1 840 + 650) 2 490
Office expenses (1 370 + 110) 1 480
Salaries 8 417
Disc. Allowed 563 12 950
Net profit for the year 8160
Oscar and Felix Partnership
Statement of Changes in Equity for the year ended 31 March 2010

Capital Current Appropriation Total

Accounts Account Account
Oscar Felix Oscar Felix
$ $ $ $ $ $
Balances – 1 /04/2009 27 000 12 000 1 379 1 211 - 41 590
Net profit for year 8 160 8 160
Interest on Drawings (180) (210) 390 -
Interest on Capitals 2 700 1 200 (3 900) -
Share of Profit 2 790 1 860 (4 650) -
Drawings (5 500) (4 000) (9 500)
Balance on 31 /03/10 27 000 12 000 1 189 61 - 40 250

Oscar and Felix Partnership

Statement of Financial Position as at 31 March 2010

Notes Dr Cr
Non-current assets $ $
Property plant and equipment 2 7 580
Current assets
Inventory 27 340
Debtors 20 960
Bank 615
Cash 140
49 055
56 635

Equity and Liabilities

Capital Accounts: Oscar 27 000
Felix 12 000
Current Accounts: Oscar 1 189
Felix 61
40 250
Non-current Liabilities -

Current Liabilities
Creditors 16 275
Accruals 110
16 385
56 635
Oscar and Felix Ltd
Notes to the Financial Statements for the year ended 31 March 2010

1. Accounting Policy
Financial statements have been prepared on the historical cost basis and incorporate the
following principal policies which have been consistently applied in the previous years.

1.1 Motor Vehicles and Office Equipment

Motor vehicles and office equipment are initially recognized at cost price and then subsequently
measured at historical cost less accumulated depreciation. Depreciation is charged on a straight
line basis, as 20% p.a. on the cost for motor vehicles and 10% p.a. on cost for office equipment
at the end of each year.

1.2 Inventory
Inventory is stated at the lower of cost or net realizable value.

1.3 Revenue
Revenue consists of the value of goods sold to customers and can be measured reliably.

2. Property Plant and equipment

Motor Office Total
Vehicles Equipment
$ $ $
Cost at 31/03/2009 9 200 6 500 15 700
Depreciation at 31/03/2009 (3 680) (1 950) (5 630)
Carrying amount at 31/03/2009 5 520 4 550 10 070
Disposals - - -
Additions - - -
Depreciation for the period (1 840) (650) (2 490)
Carrying amount at 31/03/2010 3 680 3 900 7 580

3. Inventory
Inventory consists of finished goods totaling 27 340
5.4 Practice questions

QUESTION 1

Nyathi and Mpofu are in Partnership, sharing profits and losses in a ratio to their capital
accounts. The trial balance as on 31 December was as follows:
$ $
Premises 23 500
Furniture and fittings 2 750
Motor van 2 000
Provision for bad debts 115
Carriage inwards 142
Returns 288 343
Purchases 11 665
Sales 21 429
Discounts 199
Stock (1/1) 3 865
Debtors, Creditors 2 355 3 569
Salaries 5 055
Rates and insurance 645
Light and heat 522
Capital: Nyathi 18 000
Mpofu 12 000
Current accounts: Nyathi 625
Mpodu 540
Drawings account: Nyathi 2 303
Mpofu 1 500
Rent received 2 514
58 116 58 116

NOTES:
31 December
1. The value of unsold stock is $4 200.
2. Gas bill due for payment amounts to $66.
3. Rates paid in advance $30.
4. Provision for bad debts to be increased to $250.
5. Depreciation: furniture and fittings by 20 percent motor van revalued $1 800.
6. Mpofu is awarded a salary of $1 000 for extra responsibilities.
7. Interest charged on drawings: Nyathi $210
Mpofu $160

Required:
Prepare the financial statements of the partnership for the year ended 31 December. Your
statements should include the statement of changes in equity.

5. Preparation of financial statements

(International Accounting Standard 1- IAS 1)

5.0 Lesson outcomes

On completion of this chapter, you should be able to:

 Explain the purpose of each component of financial statements
 Prepare financial statements of :
 Sole traders [see chapter 4],
 Companies and
 Partnerships.

5.1 Purpose and components of financial statements

The financial statements are a structure representation of the financial position of the
entity and the result of the operations undertaken by the entity.

The objective of preparing the financial statements is to provide information about the
financial position (assets, liabilities and equity), performance (income and expenses,
gains and losses), and cash flows of an entity in order to provide useful information to the
uses of the financial statements for making economic decisions. It also serves as proof of
the result of the management’s stewardship of the resources of the entity.
A complete set of financial statements consists of the following;
 A statement of financial position
 A statement of comprehensive income
 A statement of changes in equity
 A statement of cash flows
 Accounting policies and explanatory notes
 A statement of financial position at the beginning of the comparative period when an
entity applies an accounting policy retrospectively or makes a retrospective restatement
of items in its financial statements or when it reclassifies items in its financial statements.

Overall considerations
The following overall considerations must be taken into account when preparing annual
financial statements:

 Fair presentation
 Going concern
 Accrual basis on accounting
 Consistency of presentation
 Materiality and aggregation
 Offsetting
 Comparative financial information

5.2 Preparation of company financial statements

International Accounting Standard 1 (IAS 1) recommends the following layout for the
presentation of company financial statements:

XYZ Ltd
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2010
2010 2009
$000 $000
ASSETS
Non-current assets X X
Property, plant and equipment X X
Investment property X X
Goodwill X X
Other intangible assets X X
Financial assets X X
Invest in associates X X
Deferred tax X X

Current assets X X
Inventories X X
Trade and other receivables X X
Other financial assets X X
Cash and cash equivalents X X
Total assets X X

EQUITY AND LIABILITES

Total equity X X
Equity attributable to owners of plant X X
Share capital X X
Retained earnings X X
Other components of equity X X
Non-controlling interest X X
Total liabilities X X
Non-current liabilities X X
Long-term borrowings X X
Other financial liabilities X X
Long-term provisions X X
Deferred tax X X

Current liabilities X X
Trade and other payables
Short-term borrowings X X
Current position of long-term borrowings X X
Short-term provisions X X
Other financial liabilities X X
Current tax payable X X
Total equity and liabilities X X

XYZ Ltd
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31
DECEMBER 2010

(Illustrating the classification of expenses by function )

2010 2009
$000 $000
Revenue X X
Cost of sale (X) (X)
Gross profit X X
Other income X X
Distribution cost (X) (X)
Administrative expenses (X) (X)
Other expenses (X) (X)
Financial cost (X) (X)
Share of profit of associates X X
Profit before tax X X
Income tax expenses (X) (X)
Profit for the year X X
Other comprehensive income:
Exchange differences on translating foreign operations X X
Available for sale financial assets X X
Cash flow hedges X X
Gains on property revaluation X X
Actual gains on defined benefit plans X X
Share of other comprehensive income of associates X X
Income tax relating to components of other income (X) (X)
Other comprehensive income for the year, net of tax X X
Total Comprehensive Income for the year X X
Profit attributable to:
Owners of the parent X X
Non-controlling interest X X
X X

Example

The following information has been extracted from the books of account of B Ltd as at
31 December 2009:
Dr Cr
$000 $000
Administration expenses 242
Cash at bank and in hand 157
Cash received on sale of fittings 3
Corporation tax (over-provision for the previous year) 10
Deferred taxation 60
Depreciation of fixtures, fittings, tools and equipment (1 Jan 2009) 132
Distribution costs 55
Factory closure costs 30
Fixtures, fittings, tools and equipment at cost 340
Profit and loss account (at 1 Jan 2009) 40
Purchases of equipment 60
Purchases of goods for resale 855
Sales 1 500
Share capital (500 000 authorized, issued and
fully paid ordinary shares of $1 each) 500
Stock (at 1 Jan 2009) 70
Trade creditors 64
Trade debtors 500 ______
$2 309 $2 309

Additional information:
1 The company was incorporated in 2000.
2 The stock at 31 Dec 2009 (valued at the lower of cost or net realizable value) was estimated
to be worth $100 000.
3 Fixtures, fittings, tools and equipment all related to administrative expenses. Depreciation is
charged on them at a rate of 20% per annum on cost. A full year’s depreciation is charged in
the year of acquisition, but no depreciation is charged in the year of disposal.
4 During the year to 31 Dec 2009, the company purchased $60 000 of equipment. It also sold
some fittings (which had originally cost $20 000) for $3 000 and for which depreciation of
$15 000 had been charged.
5 The corporation tax based on the profits for the year at a rate of 35% is estimated to be $100
000. A transfer of $40 000 is to be made to the deferred taxation account.
6 The company proposes to pay a dividend of 20c per ordinary share.
REQUIRED:

In so far as the information permits, prepare B Ltd’s Statement of Comprehensive Income for the
year to 31 Dec 2009, and a Statement of Financial Position as at that date in accordance with the
requirements of IAS 1 and the Companies Act.
Solution

B Ltd
Statement of Comprehensive Income for the year ended 30 December 2009.
Notes $000
Revenue 1 500
Cost of sales (70 + 855 – 100) 825
Gross profit 675
Distribution costs (55)
Admin. Costs (242 + 76 + 2) (320)
300
Other costs – closure of factory (30)
Profit before tax 5 270
Income tax expense 6 (130)
Profit for the year 140
Total comprehensive income for the year 140

B Ltd
Statement of changes in equity for the year ended 31 December 2009.

Share Retained Total

Capital Earnings Equity
$000 $000 $000
Balance at1 Jan 2009 500 40 540
Changes in equity for 2009
Comprehensive income 140 140
Dividend proposed (100) (100)
Balance at 31 December 2009 500 80 580

B Ltd
Statement of Financial Position at 31 December 2009

ASSETS Notes $000

Non-current Assets
Fixtures, fittings tools and equipment 2 187

Current Assets
Stocks 3 100
Trade debtors 500
Cash and bank 157
TOTAL ASSETS 944

EQUITY & LIABILITIES

Equity
Share capital 4 500
Retained earnings 80
580
Non-current liabilities
Deferred Tax 100

Current liabilities
Trade Creditors 64
Current tax 100
Proposed dividends 100
Total equity and liabilities 944

B Ltd
Notes to the Financial Statements for the year ended 31 December 2009

1. Accounting Policy
Financial statements have been prepared on the historical cost basis and incorporate the
following principal policies which have been consistently applied in the previous years.

1.1 Fixtures, Fittings and Equipment

Fixtures, fittings, tools and equipment are initially recognized at cost price and then subsequently
measured at historical cost less accumulated depreciation. Depreciation is charged on a straight
line basis, as 20% on the cost of assets on hand at the end of each year.

1.2 Inventory
Inventory is stated at the lower of cost or net realizable value.

1.3 Revenue
Revenue consists of the value of goods sold to customers and can be measured reliably.

2. Fixtures, fittings, tools and equipment $000

Carrying amount at 1 Jan 2009 208
Cost 340
Depreciation for the period (132)
Disposals (20 – 15) ( 5)
Additions 60
Carrying amount at 31 Dec 2009 187
Cost 340
Accumulated depreciation 193

3. Inventory
Inventory consists of finished goods totaling 100 000

4. Share Capital
Authorised and fully issued
500 000 ordinary shares of $1.00 each 500 000

5. Profit before tax

Profit before tax is stated after charging the following:
Income
Other income – Profit on sale of non-current asset 300
Expenses:
Depreciation 76 000
Factory closure costs 30 000

6. Income tax expense

Current tax expenses 100 000

Calculations:
$000
1. Administration costs
Depreciation of fixed assets ($380 000 x 20%) 76
Loss on disposal (20 – 15 – 3) 2
Other admin. Expenses (given) 242
320
2. Taxation charge
Current fax expense 100
Deferred tax 40
Overprovision at 1 Jan 2009 ( 10)
130
3. Depreciation
Accumulated depreciation at 1 Jan 2009 132
Accumulated depreciation in respect of asset sold ( 15)
117
Depreciation for the year 76
Accumulated depreciation at 31 Dec 2009 193

13. The time value of money

13.0 Learning Outcomes:

On completion of this chapter, you should be able to:

 Perform basic financial calculations
 Discuss the time value of money as applied to investments

13.1 Key notations

FV - Future Value FVIF - Future Value Interest Factor (1+i)t

PV - Present Value PVIF - Present Value Interest Factor 1/(1+i)t
i - Interest Rate per period
t - Number of time periods

Time value of money attempts to answer the following questions.

How much will $10,000 placed in a bank account at the beginning of the year paying 5% per
year compounded annually be worth at the end of the year?

Answer: Principal + Interest

$10,000 + $10,000 x 0.05 = $10,500
Steps
Factor out the $10,000, we will have
10,000 x (1.05) = $10,500
This leaves (1.05) as the factor.

Q1 Find the value of $10,000 earning 5% interest per year after two years compounded
annually.

Solution: Start with the amount after one year and multiply by the factor for each year.
[Amount after one year] x (1.05)
= [$10,000 x (1.05)] x (1.05)
= $10,000 x (1.05)2
= $11,025.
Note:
So (1+i)t = (1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)… ·(1+i) for “t” times

Compound Interest means interest earned at the end of a period also starts earning interest. This
is in contrast to Simple Interest where only the Principal earn interest. In all cases in this module
we will assume compound interest unless otherwise stated.
13.2 Calculating the Future Value (FV)

FV = PV x (1+i)t [1]

Q2 Find the value of $10,000 after 10 years. The investment earns 5% per year.

FV = $10,000·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)
FV= $10,000·(1.05)·(1.05)·(1.05)·(1.05)·(1.05)·(1.05)·(1.05)·(1.05)·(1.05)·(1.05)
FV = $10,000 x (1.05)10
= $10,000 x 1.62889
= $16,289

Q3 Find the value of $10,000 after 10 years. The investment earns 8% for four years
and then earns 4% for the remaining six years.

FV = $10,000·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)
FV= $10,000·(1.08)·(1.08)·(1.08)·(1.08)·(1.04)·(1.04)·(1.04)·(1.04)·(1.04)·(1.04)
FV = $10,000 x (1.08)4 x (1.04)6
FV = $17,214.53

13.3 Calculating the Present Value (PV):

Same idea, but begin at the end. Rearrange the Future value equation to look like this:
PV = FV÷ [(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)·(1+i)]
PV = FV ÷ (1+i)t [2]

Q4 How much do I need to invest at 8% per year, in order to have $10,000 in:

a. One year? PV=10,000 ÷ (1.08) = $9,259.26

b. Two years? PV = $10,000 ÷ (1.08) ÷ (1.08)

OR $10,000 ÷ (1.08)2 = $8,573

c. Ten years PV = $10,000 ÷ (1.08)10 = $10,000 ÷ 2.1589 = $4,632

13.4 Calculating the Interest Rate

Start with same relationhsip: FV = PV x (1+i)t
Solve for i.
(1+i)t =FV/PV.
i = (FV/PV)1/t-1.
Q 5 An investor deposits $10,000. Ten years later it is worth $17,910. What rate of
return did the investor earn on the investment?

Solution:
 $17,910 = $10,000 x (1+i)10
(1+i)10 = $17,910/10,000 = 1.7910
(1+i) = (1.7910) 1/10 = 1.060
i = .060 = 6.0%

13.5 Finding the Future Value

Q6 Find the value of $10,000 today at the end of 10 periods at 5% per period.

FV = PV x (1+i)t The

value of an asset is given by the present value of the cash flows of the asset. It is the sum of the
discounted cash flows from the asset. The model below is used to calculate the present value of a
series of future cashflows.

PV = FV ÷ (1+i)t = FV x (1+i)-t
e.g. The
present

value of $10,000 to be received at the end of 10 periods at 8% per period.

FUTURE VALUE WHEN RATES OF INTEREST CHANGE.

FV = PV x (1+i1) x (1+i2) x (1+i3) x … x (1+it).

Example:

Q7 You invest $10,000. During the first year the investment earned 20% for the year.
During the second year, you earned only 4% for that year. How much is your
original deposit worth at the end of the two years?

Solution:
FV = PV x (1+i1) x (1+i2)
= $10,000 x (1.20`) x (1.04) = $12,480.
13.6 Where Compounding is done more than once in a year:
Up to this point, we have used years as the only time period. Actually, all the previous examples
could have been quarters, months, or days. The interest rate can be paid for any period. What is
important is that the interest rate and time period must correspond.

Example:
Problem 1.
Find the value of $10,000 earning 5% interest per year after two years.

Problem 2.
Find the value of $10,000 earning 5% interest per quarter after two quarters.
Both problems have same answer
$10,000 x (1.05)2 = $11,025.

However:
In the first problem t refers to years and i refers to interest rate per year.
In the second problem t refer to quarters and i to interest rate per quarter.

FVt = PV x (1+i)t.

t = number of periods
i = interest for the period.

Alternatively:

FVtm = PV x (1+i/m)tm.

m= periods per year,

t= number of years,
i = interest per year [APR – Annual Percentage Rate].

Example:

What will $1,000 be worth at the end of one year when the annual interest rate is 12% [This is
the APR.] when interest is compounded:

Annually: t=1 i =12% , therefore FV1 = PV x (1+i)1

= $1,000 x (1.12)1
 = $1,120.00

Quarterly: t=4i = 3% (12÷4), therefore FV4 = PV x (1+i)4

= $1,000 x (1.03)4
= $1,125.51
Monthly: t=12 i =1%, therefore FV12 = $1,000 x (1.01)12
= $1,000 x (1.126825)
= $1,126.83

Daily: t = 365, i = (12%÷365) = 0.032877%

FV365 = $1,000 x (1.00032877)365
= $1,000 x (1.12747)
= $1,127.47.

13.7 Practice Questions

QUESTION 1

a) How much must you deposit today in a bank account paying interest compounded
quarterly if you wish to have $10,000 at the end of 3 months given an interest rate of 5%
p.a.? Answer: $9,877

b. If you wish to have $50,000 at the end of 24months, if the bank pays 8% p.a.?
Answer: $42,675

c. If you wish to have $6,000 at the end of 12 months, if the bank pays 9% p.a. ?
Answer: $5,489

QUESTION 2

a) What rate of interest [APR] is the bank charging you if you borrow $77,650 and must
repay $80,000 at the end of 2 quarters, if interest is compounded quarterly?
Answer: 6.0% p.a.

b. What rate of interest [APR] is the bank charging you if you borrow $49,000 and
must repay $50,000 at the end of 3 months, if interest is compounded monthly?
Answer: 8.0% APR

QUESTION 3

George wants to buy a house at the end of year 4 at which time he thinks he will have saved
enough. His intention is to invest a certain amount at the end of each month at 18% per annum
compounded monthly. Calculate how much George must invest at the end of each month for the
next four years if he must raise $150 000 by the end of year 4.

QUESTION 4
Mathamsanqa Godongwana completed a Postgraduate Diploma in Management at NUST two
years ago. He is currently employed as a Sales Manager at Ascot Clothing (Pvt) Ltd in
Bulawayo.

Since attending a workshop at NUST on Entrepreneurship a month ago, Mathamsanqa has been
thinking deeply on how he could raise funds to start his own retail business. He believes that he
could invest a regular sum of money at the end of each month for a period of five years in order
to raise a capital amount of $20 000 with which he should start ‘ Godongwana Fashions (Pvt)
Limited’.

After visiting a number of banks and other finance houses, Mathamsanqa found that these
institutions offered a variety of investment schemes. However, he seemed to be attracted by the
NMB Bank scheme that guaranteed a nominal rate of 15% per annum monthly compounding for
investments of five years and above.
You have been approached by Mathamsanqa for advice on a number of issues:

a) Calculate for Mathamsanqa the regular sum of money to be invested at the end of each
month in order to raise the requisite capital amount.

b) Determine how much Mathamsanqa could invest today at 15% p.a. monthly
compounding for five years in order to raise the $20 000.

c) Many new businesses collapse at their infancy, advise Mathamsanqa on ALL issues
that he must know or understand in relation to the efficient management of
financial resources in a retail business of his dream.