WAEC SSCE - Financial Accounting - 2016 (Essay)

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What is a general journal?

The general journal (also called the journal proper) is a book of original (prime) entry used to record transactions that do not fit into any of the other special day books such as the sales, purchases, returns or cash books. Each entry shows the accounts to be debited and credited, the amounts, and a short explanation called the narration. It provides a first, chronological record of these transactions before they are posted to the ledger.

Six uses of the general journal

1. To record opening entries when a new set of books is started, listing assets, liabilities and capital.
2. To record the purchase and sale of fixed assets on credit (for example, buying machinery on credit).
3. To record the correction of errors in the ledger.
4. To record adjusting and transfer entries at the year end (for example, depreciation, accruals, prepayments, provisions).
5. To record closing entries that transfer balances to the trading and profit and loss accounts.
6. To record other unusual or non-recurring transactions such as bad debts written off, inter-account transfers, and the writing off of goodwill.

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(a) What is depreciation of an asset?

Depreciation is the gradual and permanent reduction in the value of a fixed (non-current) asset arising from use, wear and tear, the passage of time, or obsolescence. It represents the portion of the cost of the asset that is charged against profit in each accounting period over the asset's useful life, so as to match the cost of using the asset with the revenue it helps to earn.

(b) Three causes of depreciation

1. Wear and tear through constant use of the asset in the business.
2. Passage of time (effluxion of time), especially for assets with a legal life such as a lease or patent.
3. Obsolescence, where the asset becomes out of date due to new technology or changes in demand.

(Others: depletion of natural resources; damage or accident.)

(c) Explanation of methods of depreciation

(i) Straight line (fixed instalment) method: An equal amount of depreciation is charged every year over the useful life of the asset. It is calculated as: \[ \text{Depreciation per year} = \frac{\text{Cost} - \text{Scrap value}}{\text{Estimated useful life}} \] The annual charge remains constant, and the book value falls to the scrap value at the end of the life.

(ii) Reducing (diminishing) balance method: A fixed percentage is charged each year, but on the reducing net book value rather than on the original cost. The depreciation charge is therefore highest in the early years and falls each year. For example, at 20% per annum, an asset costing N10,000 is depreciated by \(N2,000\) in year one, then \(20\% \times N8,000 = N1,600\) in year two, and so on.

(iii) Revaluation method: The asset is valued (revalued) at the end of each period, and the fall in value between the opening and closing valuations is treated as the depreciation for the period. That is: \[ \text{Depreciation} = \text{Opening value} + \text{Additions} - \text{Closing value} \] It is commonly used for loose tools, livestock, and small sundry assets that are difficult to depreciate individually.

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Workings (closing work-in-progress taken as D1,500; rent split factory:selling = 5:3, so factory rent = \(50{,}000 \times 5/8 = 25{,}000\)... note the apportionment gives factory D31,250 and selling D18,750 as shown below).

Factory expenses = \(60{,}000 - 5{,}000 \text{ (prepaid)} = 55{,}000\). Rent to factory = \(50{,}000 \times \tfrac{5}{8} = 31{,}250\); rent to selling = \(50{,}000 \times \tfrac{3}{8} = 18{,}750\). Selling expenses = \(3{,}000 + 2{,}500 \text{ (accrued)} = 5{,}500\).

Daudu Manufacturing Company - Manufacturing, Trading and Profit & Loss Account for the year ended 31 December 2012

Trading Account

Profit and Loss Account

Prime cost = D144,500; Cost of production = D238,750; Gross profit = D149,250; Net profit = D122,220.

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(a)(i) Four items on the CREDIT side of the Sales Ledger Control Account

• Cash and cheques received from debtors (receipts)
• Discount allowed to debtors
• Returns inwards (sales returns) from debtors
• Bad debts written off
• Bills receivable accepted by debtors

(Any four. Note: the credit balance carried down of debtors who have overpaid may also appear.)

(a)(ii) Four items on the DEBIT side of the Purchases Ledger Control Account

• Cash and cheques paid to creditors (payments)
• Discount received from creditors
• Returns outwards (purchases returns) to creditors
• Bills payable accepted and honoured
• Set-off / contra transfer to the sales ledger

(Any four.)

(b) Seven types of errors a Trial Balance will NOT reveal

1. Error of omission: a transaction completely left out of the books.
2. Error of commission: a correct amount entered in the wrong account of the same class (for example, posting a sale to Musa's account instead of Musah's).
3. Error of principle: a transaction entered in the wrong class of account (for example, treating the purchase of a motor vehicle as motor expenses).
4. Error of original entry (or error of amount): a wrong figure entered in the source document and carried consistently to both accounts (for example, N540 recorded as N450 on both sides).
5. Complete reversal of entries: the account to be debited is credited and the one to be credited is debited.
6. Error of duplication: the same transaction is recorded twice, on both the debit and credit sides.
7. Compensating errors: two or more errors on opposite sides that cancel out and are equal in amount.

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Key figures drawn from the accounts. Sales N240,000; Gross profit N96,000; Cost of goods sold N144,000; Net profit N8,000; Opening stock N20,000; Closing stock N36,000; Current assets N82,000 (Stock 36,000 + Debtors 39,000 + Cash 7,000); Current liabilities N40,000 (Creditors 28,000 + Accruals 12,000); Shareholders' funds and capital employed N142,000.

All nine measures are shown below for completeness (only six are required).

(a) Gross Profit Percentage

\( \text{GP\%} = \dfrac{\text{Gross Profit}}{\text{Sales}} \times 100 = \dfrac{96{,}000}{240{,}000} \times 100 = \mathbf{40\%} \)

(b) Net Profit Percentage

\( \text{NP\%} = \dfrac{\text{Net Profit}}{\text{Sales}} \times 100 = \dfrac{8{,}000}{240{,}000} \times 100 = \mathbf{3.33\%} \)

(c) Return on Capital Employed

Capital employed = Total assets N182,000 less Current liabilities N40,000 = N142,000 (equal to shareholders' funds, since there are no long-term loans).

\( \text{ROCE} = \dfrac{\text{Net Profit}}{\text{Capital Employed}} \times 100 = \dfrac{8{,}000}{142{,}000} \times 100 = \mathbf{5.63\%} \)

(d) Current Ratio

\( \text{Current Ratio} = \dfrac{\text{Current Assets}}{\text{Current Liabilities}} = \dfrac{82{,}000}{40{,}000} = \mathbf{2.05:1} \)

(e) Acid Test (Quick) Ratio

\( \text{Acid Test} = \dfrac{\text{Current Assets} - \text{Stock}}{\text{Current Liabilities}} = \dfrac{82{,}000 - 36{,}000}{40{,}000} = \dfrac{46{,}000}{40{,}000} = \mathbf{1.15:1} \)

(f) Rate of Stock Turnover

Average stock = \( \dfrac{20{,}000 + 36{,}000}{2} = 28{,}000 \).

\( \text{Stock Turnover} = \dfrac{\text{Cost of Goods Sold}}{\text{Average Stock}} = \dfrac{144{,}000}{28{,}000} = \mathbf{5.14\ times} \)

(g) Working Capital

Working Capital = Current Assets - Current Liabilities = 82,000 - 40,000 = N42,000.

(h) Shareholders' Funds

(i) Liquid Assets

Liquid assets = Current assets - Stock = Debtors N39,000 + Cash at bank N7,000 = N46,000.

Interpretation. A 40% gross margin is healthy, but the net margin of only 3.33% and ROCE of 5.63% show that operating expenses (mainly selling and distribution) absorb most of the gross profit. Liquidity is sound: a current ratio of about 2:1 and a quick ratio above 1:1 mean the company can meet its short-term obligations comfortably.

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Workings and treatment

The revised (adjusted) cash book records only the items that the trader had not yet entered but which have already gone through the bank: direct debits, bank charges, standing orders, direct credits, and the correction of the undercast balance. Timing differences (unpresented and uncredited cheques) are NOT entered in the cash book; they go into the reconciliation statement.

(a) Revised (Adjusted) Cash Book as at 31 December 2014

Revised cash book balance = \(4{,}500 + 180 + 320 - (350 + 500 + 70 + 100 + 120) = Le\,3{,}860\) (debit).

(b) Bank Reconciliation Statement as at 31 December 2014

The bank statement therefore shows a favourable balance of Le6,670, which now agrees with the corrected cash book after allowing for the timing differences.

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Preliminary note. A Receipts and Payments account is a summary of cash and bank movements. It mixes capital items (equipment, furniture, deposit transfers) with revenue items, and it ignores accruals and non-cash charges such as depreciation. To produce non-profit final accounts we must (i) find the opening Accumulated Fund through a Statement of Affairs, (ii) convert subscriptions received into subscriptions earned, and (iii) adjust each revenue expense for outstanding amounts and add depreciation.

(a) Statement of Affairs as at 31st December 2013

This statement lists what the club owned and owed at the start of the year. The balancing figure is the Accumulated Fund (the club's capital).

The Accumulated Fund at 1st January 2014 is therefore N7,800.

(b) Subscription Account for the year ended 31st December 2014

Cash received during the year was N7,500 (2013 arrears N1,200 + 2014 N4,000 + 2015 advance N2,300). We adjust for arrears at each year end (an asset, owed by members) and advances (a liability, paid ahead). The transfer to Income and Expenditure is the balancing figure, being the subscription earned in 2014.

Subscription earned and transferred to Income and Expenditure = N6,100.

(c) Income and Expenditure Account for the year ended 31st December 2014

Capital items (purchase of equipment N1,800, purchase of furniture N3,000, transfer from deposit account N3,000) are excluded. Each expense is raised to the amount incurred by adding the outstanding balance, and depreciation is charged.

The club earned a surplus of N13,690 for the year. Total expenditure of N9,410 is deducted from total income of N23,100 to arrive at this figure.

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(a) Three distinguishing features of public and private companies

(Any three.)

(b) Three rights available to an ordinary shareholder

1. The right to attend the annual general meeting, and to vote on resolutions in proportion to shares held.
2. The right to receive a dividend when declared out of the company's profits.
3. The right to share in the surplus assets of the company on winding up, after all creditors and preference shareholders have been paid.
4. The right to receive copies of the company's audited accounts and reports, and to a share of any bonus or rights issue.

(Any three.)