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IMM GSM© of 141 FM101

Financial Management 1 (FM101)

The copyright of all IMM Graduate School of Marketing material is held by the IMM

GSM. No publications may be reproduced without prior written permission from the

IMM GSM.

November 2010


Table of contents

Section A

1. Word of welcome

2. How to use this guide

3. The overall purpose of the subject

4. Pre-knowledge

5. The relationship with other subjects

6. The NQF level and number of credits

7. Prescribed textbook and resources required

8. Curriculum

9. Specific learning outcomes

10. Critical Cross-field Outcomes

11. Assessment details

12. Time-line

4

5

6

7

7

8

8

10

11

12

14

15

Section B

Study Unit 1: Basic accounting concepts and the accounting

equation

1. The nature and roles of accounting and finance

2. Users of accounting information

3. Forms of business ownership

4. Financial and management accounting

5. Financial accounting concepts and terminology

6. The accounting equation

Study Unit 2: Basic accounting concepts and financial statements

1. Basic accounting

2. Company financial statements

19

20

21

23

29

31

36

42

43

62


Study Unit 3: Determine the selling price of merchandise

1. Value added tax (VAT)

2. Determining selling prices

Study Unit 4: Cost classification and terminology

1. Introduction

2. Cost classification in relation to the product or period

3. Cost classification in relation to volume of production

4. Cost classification for control or evaluation

5. Cost classification for decision making

Study Unit 5: Materials

1. Classification of materials

2. Stock control

3. Stock valuation methods

Study Unit 6: Labour, overheads costing

1. Classification of labour

2. Overheads

3. Job costing (absorption costing)

4. Marginal costing

Study Unit 7: Budgetary control and sales variance

1. Operational budgets

2. Flexible budgets

3. Cash budgets

4. Sales variances

Bibliography

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Section A

1. Word of welcome

Welcome to financial management, a central part of the management function

in the firm. Financial management addresses accounting and finance concepts

relevant to all marketers, regardless of the extent of their involvement in the

direct financial affairs of the firm. Decisions to invest in products or markets or

to sell particular products depend to a great extent on the quality of information

provided by the accounting and finance function.

In this learner guide you will find a structured and integrated schedule of

learning material, tutorial notes, time-lines, self-assessment questions and one

assignment. In order to assist you in planning and managing your studies, the

learner guide has been structured according to:

an organisational component (Section A), and

a learning component (Section B).

The purpose of the organisational component is, amongst other things, to

orientate you towards financial management and to inform you about

administrative issues, whilst the purpose of the learning component is to

structure the syllabus in terms of manageable study units. The learning

component will explain what topics are covered, in how much depth, where to

find relevant information pertaining to the subject and ultimately help you to

study the subject as realistically and practically as possible.

To ensure you get the maximum benefit from the study time you have available

it is recommended that you work through the learning guide. This will help you

identify the time you will need to complete the programme and by doing this you

will be able to draw up a detailed and workable study schedule.

Everyone connected with marketing should be a little ‘streetwise’ about

accounting and finance because financial decisions influence every aspect of


business operations. Financial management is a fascinating and enjoyable

subject and it provides frameworks and techniques you will be able to apply in

your day-to-day marketing work.

Good luck and enjoy your studying.

2. How to use this guide

We aim to make you a confident user of financial and management accounting

techniques. The most effective way to achieve this will be to ensure that you

understand and enjoy the module.

The learner guide is especially designed for a student who studies at a

distance. The guide will provide an overview of the total curriculum and will

indicate the learning outcomes, which are essentially the core of this guide. It

will provide you with each major topic that has to be covered, along with the

learning outcomes for each topic, which are systematically explained. The

guide will also indicate how the learning material must be prepared for

examination.

The learner guide should be studied in conjunction with the textbook and does

not replace the textbook.

At the end of each study unit you will find some typical examples of examination

questions which should be used for self-evaluation.

The following icons appear in all of the learning guides of the IMM Graduate

School of Marketing:


indicates learning outcomes.

indicates the sections in the prescribed textbook that you need

to study.

indicates the self-evaluation questions.

3. The overall purpose of the subject

The fundamental aim of this course is to equip you with a thorough

understanding of important financial concepts. These concepts are important

and are applied to and integrated with other areas of learning within the

marketing field of study.

The overall course objectives for Financial Management 1 are to develop

financial literacy on a theoretical and practical level, by

explaining accounting concepts and terminology,

determining selling price of merchandise,

classifying costs into various categories,

demonstrating knowledge of concepts related to materials management,

demonstrating knowledge of concepts related to labour, overheads and

job costing, and

demonstrating an understanding of budgets and budgetary control.


4. Pre-knowledge

It is essential that you are competent in mathematics at NQF level four. If you

are not confident in your mathematical abilities at this level, it is strongly

recommended that you improve or refresh your basic mathematical knowledge

and skills. There are a number of firms offering short skills programmes in

mathematical literacy.

You should know or be able to do the following:

Know the order of mathematical operations

Work with formulas

Calculate ratios

Calculate percentages

Construct, read and interpret graphs and charts.

We will provide you with brief explanations in your learner guide where it is

deemed necessary. It is, however, not possible to create a comprehensive

mathematical guide within this text.

You can also refer to the following book related to business calculations:

Zidel, D. 2004. Basic Business Calculations. Johannesburg: Penguin Books.

An ability to use spreadsheets, such as MS Excel, to do financial calculations

and create charts and graphs is an added advantage.

5. The relationship with other subjects

Financial Management I should not be seen as an entity on its own, but in the

context of the diploma/degree as a whole, since a number of concepts are also

dealt with in other courses.


This course covers fundamental financial concepts that you are required to

know on a theoretical and practical level. The terminology and other topics

included are integrated with other IMM subjects, which in turn, help you to

identify and recognise your prior learning.

Finance as a topic can be boring if you don’t understand the concepts. It can

be, however, an interesting topic or course when being studied in the marketing

context because marketing strategy affects the financial performance of the firm

by generating sales and incurring costs.

6. The NQF level and number of credits

This module forms a compulsory module for the Diploma in Marketing

Management and BBA degree in Marketing Management.

In terms of the new National Qualifications Framework (NQF) it is designed as a

20-credit module offered on NQF level 5.

The IMM Graduate School of Marketing regards Financial Management I as a

first year subject.

7. Prescribed textbook and resources required

The prescribed textbook for this module is:

Cloete, M., and Marimuthu, F. 2008. Basic Accounting for Non-

Accountants. Pretoria: Van Schaik.

The textbook is written in a clear and systematic manner. Always start your

studies by consulting the learner guide and then study the relevant sections in

the prescribed textbook. It is unlikely that you will pass this module if you have

only consulted the learner guide without studying the content of the textbook.

The following textbooks are also recommended:


Marx, J., de Swart, C., Beaumont Smith, M., and Erasmus, P. 2009.

Financial Management in Southern Africa. 3rd edn. Cape Town:

Pearson.

Pizzey, A. 1998. Finance and Accounting for Non-Specialist Students.

Harlow: Prentice-Hall.

Niemand, A., Meyer, L., Botes, V.L., and Van Vuuren, S.J. 2006.

Fundamentals of Cost and Management Accounting. Revised 5th edn.

Durban: LexisNexis.

We would also like to encourage you to make a habit of reading business and

financially orientated literature, magazines and newspapers such as:

1. Business Day

2. Business Report

3. Engineering News

4. Financial Mail

5. FinWeek

You can also subscribe to various newsletters published online by financial

institutions or financially orientated magazines and portals such as:

Financial Mail at http://fm.co.za/

Finance Week at http://www.fin24.co.za/FinWeek

The IMM Marketing Information Centre specialises in the provision of

information for your project and work related needs. They have

over 1500 marketing related books,

prescribed and recommended IMM textbooks,

a range of over 30 marketing and business related journals.

http://fm.co.za/

http://www.fin24.co.za/FinWeek


Calculators

You will need a basic calculator that is typically used at

schools and universities, similar to the one displayed in

the picture. It can perform a variety of functions,

including fraction calculations, percentage calculations,

scientific calculations and statistical calculations.

This type of calculator is adequate for the basic business

calculations that you will have to perform during this

course.

8. Curriculum

This section addresses the overall content of the module. The Financial

Management I curriculum is divided into seven study units. The seven study

units with the corresponding chapters in the prescribed textbook (Cloete &

Marimuthu 2008) are as follows:

Unit Description Relevant Chapters

1 Accounting concepts and terminology Chapters 1 to 4

2 Financial statements Chapter 5

3 Determine selling price of merchandise Chapters 4, 7

4 Cost classification Chapter 8

5 Material and stock management Chapter 9

6 Labour, overhead and job costing, marginal

costing

Chapters 10, 13

7 Budgets and budgetary control Chapters 11, 12


9. Specific learning outcomes

The aim of this course is to emphasise the need for financial literacy on the part

of the marketing specialists. This will be by developing your ability to interpret

financial reports, to apply basic financial techniques to marketing operations

and to understand the essential indicators of the firm’s financial position.

Study

Unit Description Learning Outcomes

1 Explain

accounting

concepts and

terminology

Define the purpose and users of accounting.

Classify items as assets, liabilities or owner’s

equity.

Show the effect of various transactions on the

basic accounting equation.

2 Reading

financial

statements

Describe the accounting cycle.

Explain what year-end adjustments are and its

impact on the financial statements.

Interpret an income statement and balance sheet.

3 Determine

selling price of

merchandise

Calculate cost of sales.

Explain VAT concepts and calculate VAT.

Calculate mark-ups on cost price and selling price.

Calculate selling price (inclusive and exclusive of

VAT).

4 Classify costs

into various

categories

Classify cost in relation to product or period.

Classify behaviour of cost in relation to volume of

production.

Classify cost for control or evaluation.

Classify relevant and non-relevant costs for

decision making.


5 Demonstrate

knowledge of

concepts

related to

materials

management

Distinguish between direct and indirect materials.

Describe stock control concepts, calculate stock

levels and EOQ.

Describe stock valuation methods and calculate

the value of closing inventories using FIFO and the

weighted average method.

6 Demonstrate

knowledge of

concepts

related to

labour

overheads

and job

costing

Distinguish between direct and indirect labour.

Identify overhead costs.

Calculate the cost of a product or a job.

Distinguish between marginal and absorption

costing.

7 Demonstrate

an

understanding

of budgets

and budgetary

control

Describe components of an operational budget.

Draft operational, flexible and cash budgets.

Calculate and interpret sales variances.

10. Critical cross-field outcomes

The critical cross-field outcomes, also known as transferable skills as identified

by the South African Qualifications Authority (SAQA), are essential for your

development as a student within the education and training system, regardless

of the specific area of learning. It is these outcomes that are deemed critical for

your development in the capacity of life-long learning.


The critical cross-field outcomes adopted by SAQA are as follows:

(1) Identify and solve problems in which responses display that responsible

decisions using critical and creative thinking have been made.

(2) Work effectively with others as a member of a team, group, organisation,

and community.

(3) Organise and manage oneself and one’s activities responsibly and

effectively.

(4) Collect, analyse, organise and critically evaluate information.

(5) Communicate effectively using visual, mathematical and/or language

skills in the modes of oral and/or written presentation.

(6) Use science and technology effectively and critically, showing

responsibility towards the environment and health of others.

(7) Demonstrate an understanding of the world as a set of related systems

by realising that problem solving contexts do not exist in isolation.

(8) Reflecting on and exploring a variety of strategies to learn more

effectively.

(9) Participating as responsible citizens in the life of local, national and

global communities.

(10) Being culturally and aesthetically sensitive across a range of social

contexts.

(11) Exploring education and career opportunities.

(12) Developing entrepreneurial opportunities.


The transferable skills identified in this course are as follows:

Taught Practised Assessed

Problem solving X X X

Working in teams

Self-management X X X

Information gathering/research

skills

X X X

Communication skills X X X

Analytical skills X X X

Learning strategies X X X

Responsible citizenship

Cultural sensitivity X

Career development X X

Entrepreneurship

11. Assessment details

There are two assessments involved in terms of the Financial Management 1

module:

Assignment: The assignment contributes 20% to the overall mark for the

module. Assignments will focus on selected chapters, and need to be

typed. Please ensure that you adhere to the general rules of the IMM

Graduate School of Marketing pertaining to the style and format of

assignments. You will be issued with a separate instruction in this

regard.

Examination: The exam incorporates all content covered in the workbook

and constitutes 80% of the final mark for the Financial Management 1

module. The duration of the examination is three hours and the paper

will count 100 marks. The examination paper will consist of multiple


choice and short question type answers, but the majority of the questions

will require an ability to perform calculations as set out in the practice

questions in this guide. Examination results are usually released within

six weeks of sitting the examination.

The final mark, consisting of an assignment mark and an examination mark, is

released in the form of a final percentage (mark out of 100). The grading

system is as follows:

Percentage Scale Description

75% or more Pass with Distinction

50% - 74% Pass

0% - 49% Fail

A timetable of the assessment programme for the semester, including dates for

the assignment to be submitted during the course of the year, is available in the

Calendar of Events for that year. Please refer to the current issue of the IMM

GSM Prospectus. This document and the Student Yearbook provide details of

the IMM GSM assessment policy.

12. Time-line

With distance education, it is very important that you track your progress

against the time-line. The following time-line can be used as a starting point to

set up your personal time-line.

Week Topic/study theme

1 Introduction to accounting, concepts and terminology

2 Accounting equation and accounting cycle

3 Accounting for stock, year-end adjustments

4 Year-end adjustments


5 Company financial statements

6 VAT, mark-up

7 Cost classification

8 Material and stock management

9 Stock valuation

10 Labour, overhead, job costing

11 Marginal costing

12 Budgets and budgetary control

13 Budgetary control and sales variances


SECTION B

Why do I need to know about finance and accounting?

“There is not a chief executive or financial director these days who will deny the vital

importance of establishing and strengthening the bond between the brand and its

users. The problem arises in the language used by marketing people to communicate

the value of those relationships at management forums…

“…It is the way marketing people try to communicate the complex ideas about the

sensitive work they do in creating bonds between brands and their users. This is the

language used to motivate an increase in marketing investment. I have frequently been

told that if we could only prepare analyses and schedules that support a request for a

budget increase in the same way the factory manager motivates money for a new

piece of machinery; we would have a smoother ride.

“But we persist in trying to communicate in ‘soft’ terms that confuse more than explain,

and which marginalises marketing rather than raising the standing of its practitioners to

where they belong, which is at the very front line of income generation. The

gatekeepers of the shareholders’ purse strings want to hear how the new branding

programme will affect the bottom line and what return it will achieve rather than be told

about the consumer psychology behind the campaign. And they want to hear it stated

in financial terms not the obtuse coded vernacular of the world of branding.”

Source: http://www.brandsandbranding-online.co.za/corporate-finance-101-for-marketers/

The effectiveness of marketing operations can be measured through the

application of various financial analysis activities. None of these analytical

activities can be performed if a person does not have a basic understanding of

accounting and finance fundamentals.


Most of these financial analyses fall into one of four financial activities as

explained below:

The financial situation analysis determines how well marketing activities are

doing. It involves the study of trends, comparative analyses, and assessment of

present financial strengths and limitations of the product, brand or business unit.

Financial information is used to evaluate alternatives as whether to introduce

new products, move into new markets, eliminate a product, expand the sales

force or change the distribution channel.

Financial planning involves the projection of sales, cost forecasts and budgets,

once it has been decided to implement a specific marketing action.

Financial control is about comparing actual results to planned results, with the

objective of keeping an unfavourable results gap as narrow as possible.


Study Unit 1: Basic accounting concepts and the accounting equation

This study unit covers the introduction to accounting, discusses financial

accounting concepts and terminology, and explains the accounting equation.

Mastering the accounting equation is critical in understanding this study unit and

creates the foundation of the remainder of this subject and for future studies in

financial management.

Specific Learning Outcomes

After studying this unit, you should be able to:

Define the purpose of accounting.

Identify the main users of accounting information.

Classify items as assets, liabilities or owner’s equity.

Show the effect of various transactions on the basic accounting equation.

.

1. The nature and roles of accounting and finance


Reading reference

Study Cloete & Marimuthu 2008: Chapter 1 – Definition of accounting.

Financial management addresses accounting and finance concepts relevant to

all marketers, regardless of the extent of their involvement in the financial

information and decisions in the business. Decisions to invest in products or

markets or to sell particular products all depend on the basis of information

provided by the accounting and finance function.

The main purpose of accounting is to provide users with financial information

that will assist them in making informed decisions.

Accounting is a system comprising the following elements:

Gathering financial information that has an effect on a specific business.

Analysing how the financial information will affect the business.

Recording the financial information through proper accounting

processes.

Reporting all financial information for a given period of time so that it can

be read and understood.

Interpreting the summarised information to allow users to make

informed decisions about the business.

You should now be able to master outcome 1.


2. Users of accounting information

Reading reference

Study Cloete & Marimuthu 2008: Chapter 1 – Users of accounting information,

and how useful is accounting information.

2.1 Identifying users of financial information

Financial decisions are influenced by several factors such as the realities of the

external environment, past strategies, management value systems, goals of the

executive management team and internal power relationships. Stakeholders

have expectations or demands, which can influence decisions depending on the

power of the stakeholder or groups of stakeholders. We can define a

stakeholder as an individual or group that can influence the firm’s objectives or

are affected by decisions made by the firm.

Stakeholders can be classified or grouped into two groups, namely internal and

external users of financial information:

Internal External

• Owners

• Managers

• Employees and their

representatives.

• Customers

• Competitors

• Lenders

• Government

• Suppliers

• Investment analysts.


2.2 The needs of users of financial information

Financial information should possess a number of qualities in order to fulfil the

needs of the users thereof. It should be relevant, reliable, provide means to do

comparisons with the past or across different businesses and it should be clear

so that users can understand it. In addition to these qualities, financial

information should also achieve a threshold of materiality or significance,

meaning that it should only be included within reports if it does not clutter them

up or interfere with the user’s ability to interpret financial results.

The timely flow of information helps managers to compare actual performance

to planned performance. Accounting information helps owners of the business

to assess if the managers of the business are also pursuing the goal of wealth

maximisation.

The reasons for using accounting information by different users are set out in

the table below:

User Use

• Owners

• Managers

• Employees

• Customers

• Competitors

• Lenders

• Government

• Suppliers

• Investment

analysts

Determine profitability and financial viability.

Ensure business operates efficiently and solve problem

areas highlighted.

Determine if employer is able to provide stable

employment and remuneration.

Determine if business can provide products over long

period of time.

Competitor intelligence, to maintain competitive edge.

Determine if business can repay loans and interest.

Determine how much taxes and levies should be paid.

Determine if business can pay for goods purchased on

credit.

Determine if business would be good investment, and to

assess risk and return of an investment in business.

You should now be in a position to master outcome 2.


3. Forms of business ownership

Reading reference

Please read Cloete & Marimuthu 2008: Chapter 1 – Basic business forms in

South Africa.

No learning outcome is set for this section but regard the reading as important

background information.

An understanding of the different forms of business ownership is necessary as

the nature of ownership will in the first instance have an impact on the treatment

of owners’ claims, and secondly, the reporting and treatment of financial

information in the financial statements.

3.1 Forms of business ownership in South Africa

In South Africa you may find that businesses are operated as a:

Sole proprietary

Partnership

Close Corporation – Name followed by CC

Private company with limited liability – Name followed by (Pty) Ltd

Public company with limited liability – Name followed by Ltd

Important note:

The Companies Act was signed by the President on the 08th April 2009 and gazetted

in the Gazette No. 32121 (Notice 421). The Act comes into operation on a date still to

be fixed by the President by proclamation in the Gazette.

This Act affects Close Corporations, Private companies and Public companies as

mentioned above.


The new Companies Act has identified two types of companies to be

incorporated under the new act. A company can either be a profit company or a

non-profit company.

A profit company is defined as a company incorporated for the purpose of

financial gain for its shareholders.

A non-profit company is incorporated for public benefit and the income and

property are not distributable to its incorporators. A non-profit company may be

regarded as a successor to the previous Section 21 companies in the current

act.

Profit companies can be:

1) a state-owned company (SOC);

2) a private company (Proprietary Limited) if it is not state-owned and the

Memorandum on Incorporation prohibits it from offering its securities to

the public and restricts the transferability of its securities;

3) a personal liability company (Incorporated) if it meets the criteria for a

private company and the Memorandum of Incorporation states that it is a

personal liability company;

4) a public company (Limited) in any other case.

One of the effects of the new Companies Act of 2008 is the phasing out of close

corporations. No new close corporations may be formed once that Act comes

into operation. Existing close corporations can elect to continue to exist until

deregistered, dissolved or converted into a private company governed under the

new Companies Act. It will be possible for businesses to continue to run their

operations out of an existing close corporation if they so wish.

Another effect is that a private company will still be prohibited from offering its

shares to the public and the transferability of its shares will be restricted but, it

will no longer be subject to a limitation of 50 shareholders.


3.2 Distinguishing between forms of ownership

A sole proprietary dissolves upon the death or retirement of the proprietor. A

partnership must be dissolved upon the death or retirement of one of the

partners and a new partnership agreement has to be drawn up.

We will further distinguish between the forms of ownership on the basis of

liability for debts and capital formation.

Business

Form

Liability Capital

Sole

proprietary

Owner bears unlimited liability

for debts – may lose personal

assets.

Owner provides own capital or

borrows from financial institution.

Partnership Partners jointly and severally

liable for debt of business – may

lose personal assets.

Partners provide own capital or

borrow from financial institution.

Close

Corporation

Members’ liability limited to

amount of money invested in

business – may under certain

circumstances lose limited

liability.

Members provide own capital or

borrow from financial institution.

Private

company

Shareholders’ liability limited to

amount of capital invested in

shares.

Capital is raised by issuing

shares to owners (not public) or

borrowing from financial

institution.

Public

company

Shareholders’ liability limited to

amount of capital invested in

shares.

Capital is raised by issuing

shares to shareholders, or

borrowing from public through

debentures or borrowing from

financial institutions.


3.3 Accounting and legal requirements

We will summarise the differences in accounting requirements between different

forms of business ownership in South Africa.

Business

Form

Legal Financial

statements

Taxation

Sole

proprietary

Very little legal

requirements.

Not regulated. Owner pays tax

in personal

capacity, not as

business.

Partnership Very little legal formalities.

Partnership Agreement.

Not regulated. Partners pay

tax in personal

capacity, not as

business.

Close

Corporation

Founding Statement.

Certificate of Incorporation.

Association Agreement to

regulate relationship

between members.

Financial

statements

prepared but not

required to be

audited.

CC pays tax on

profits of

business – at

preferential

rates available

to CC below

certain

turnover.

Private

company

Memorandum of

Association and

Articles of Association.


Financial

statements

prepared but not

required to be

audited or lodged

with Registrar of

companies.

Company pays

tax on its

profits.

Public

company

Memorandum of

Association and

Articles of Association.


Prospectus.

Minimum subscription

fulfilled.

Certificate to Commence

Business.

Financial

statements audited

and lodged with

Registrar of

companies.

Company pays

tax on its

profits.


Transferring of ownership of shares in public companies (if they are members

and their shares are listed on the JSE) takes place at the JSE Securities

Exchange South Africa (‘the JSE’). The JSE was formally established on 8

November 1887 as a market-place for the shares of South Africa’s many mining

and financial companies.

3.4 Types of business activity

Please read Cloete & Marimuthu 2008: Chapter 1 – Types of business activity.

No outcome is set for this section but regard the reading as important

background information.

We can classify business types by various types of activities, including service

businesses, manufacturers, wholesalers and retailers.

Service businesses

These businesses provide services for which they charge fees. Typical

examples include attorneys, accountants, architects and information,

communication and technology (ICT) companies.

Manufacturers

Manufacturers buy raw materials that they then transform into finished products

which are sold to wholesalers and retailers.

Wholesalers

The term middleman is often associated with wholesalers, because they buy in

bulk from manufacturers and then supply the goods in smaller quantities to

retailers, or the public.


Retailers Retailers buy goods from the wholesalers or manufacturers and sell the goods

to the general public. It is also stated that retailers can be viewed as service

providers for reasons listed below:

Bring goods within reach of the consumer

Allow the consumer to buy on credit

Pay attention to the need of their consumers

Sell goods in small quantities

Make consumers aware of new products on the market

Offer convenience shopping.

The format of financial statements will vary by the type of business. For

instance, service businesses may have a category ‘Fees Collected’ instead of

‘Sales’. One also needs to consider Work-In-Progress as part of inventory in a

manufacturing environment, and that you will not find in a service business.


4. Financial and management accounting

Reading reference

Study Cloete & Marimuthu 2008: Chapter 1 – The accounting field.

Accounting accumulates data for reporting to external and internal users (with

different objectives).

Management accounting seeks to meet the need of the business managers in

the firm and financial accounting seeks to meet the needs of all the other users.

The major differences between the two types of accounting can be found in:

Nature of the reports produced

Level of detail provided in the reports

Regulatory requirements related to the format and timing of accounting

reports

Interval at which reports are prepared

Time horizon – historical or forward looking

Range and quality of information.

You should now be able to master outcome 2.


Self-assessment exercise

Now do Exercise 1 and Exercise 2 in Cloete & Marimuthu 2008: Chapter 1.

Solutions

Exercise 1

1. c

2. a

3. e

4. b

5. d

Exercise 2

2.1 d

2.2 b

2.3 d

2.4 d

2.5 c

2.6 c

2.7 c


5. Financial accounting concepts and terminology

Study reference

Study Cloete & Marimuthu 2008: Chapter 2.

Wealth of a business is measured through the measurement:

Assets – Liabilities = Owner’s equity

It is important to define the terms that will be used throughout this subject and in

subsequent studies in financial management.

Term Definition

Assets Resources controlled by an entity resulting from past events

out of which future economic benefits will flow.

OR

In financial accounting, assets are economic resources.

Anything tangible or intangible that is capable of being

owned or controlled to produce value and that is held to

have positive economic value is considered an asset.

Simply stated, assets represent ownership of value that can

be converted into cash (although cash itself is also

considered an asset).

Non-current assets An item of value with a lifespan of more than one year.

Property, plant and equipment

Financial assets (e.g. investments)

Intangible assets (e.g. patents, trade marks).

Current assets An item of value with a lifespan of less than one year.

Cash

Debtors

Stock.

Liabilities Present obligations resulting from past events, the

settlement of which leads to decreases in economic

benefits.

http://en.wikipedia.org/wiki/Financial_accountancy


OR

In financial accounting, a liability is defined as an

obligation of a firm arising from past transactions or events,

the settlement of which may result in the transfer or use of

assets, provision of services or other yielding of economic

benefits in the future.

Non-current liabilities Obligations of the business which are payable over a period

of more than one year.

Long-term loan

Bond from bank over property.

Current liabilities Obligations of the business which are payable within one

year.

Bank overdraft

Creditors.

Owner’s equity Owner’s interest in the business and comprises capital

contribution less drawings, plus net profit, where:

Income – expenses = Net profit

Income Receipts by a business for normal operations.

Sales

Fees earned

Rent received

Interest received.

Expenses Amounts spent by a business during normal operations

(excluding capital expenses)

Rent paid

Interest paid

Advertising

Salaries.

We will return to a more comprehensive discussion of these terms later in this

unit.

http://en.wikipedia.org/wiki/Financial_accounting

http://en.wikipedia.org/wiki/Assets



Complete Exercise 1 and Exercise 2 in Cloete & Marimuthu 2008: Chapter 2.

You will now be able to master outcome 3


Solutions

Exercise 1

NCA CA NCL CL OE I E

a) Capital X

b) Delivery vehicle X

c) Weekly wages X

d) Sales X

e) Trading stock X

f) Mortgage loan X

g) Telephone account X

h) Debtors (accounts receivable) X

i) Computer X

j) Interest received X

k) Creditor (accounts payable) X

l) Interest paid X

m) Property X

n) Discount allowed X

o) Discount received X

p) Depreciation X

q) Stationery used X

r) Stationery unused (stationery on hand)

X

s) Bank overdraft X

t) Drawings X

u) Photostat machine X

v) Shop fittings X


Exercise 2

ASSET LIABILITY INCOME EXPENSE

a) The monthly rental paid for the shops

X

b) A loan raised from Bee Bank X

c) Amounts owed to Megacity by customers

X

d) Petty cash on hand. X

e) The stock of clothes on hand in each shop

X

f) Amounts owed by Megacity to its suppliers of stock

X

g) Warehouse owned by Megacity used for storing stock

X

h) Wages paid to the shop assistants

X

i) Receipts from customers for the sale of clothes

X

k) Cash at the bank X


6. The accounting equation

Study reference

Study Cloete & Marimuthu 2008: Chapter 3 – The basic accounting equation.

6.1 Basic accounting equation

The three main elements of accounting fit together as follows:

Assets = Owner’s equity + Liabilities

The right hand side of this equation represents all the money that is available to

the business in the long term from the owners and the outside providers of

funds to purchase assets (the left hand side of the equation).

This equation is the Basic Accounting Equation. (BAE)

Important!

Please work through illustrative examples 1, 2 and 3 in the textbook.


Now do Exercise 1 and Exercise 2 in Cloete & Marimuthu – Chapter 3

You should now be in a position to master outcome 4


Solutions

Exercise 1

1.1 R90 000 + R40 000 = R130 000 (Cash plus + motor vehicle)

1.2 R80 000 (Borrowings)

1.3 R50 000 (Owner investment)

1.4 Assets = Owner’s equity + Liabilities

R130 000 = R50 000 + R80 000

Exercise 2

2.1 Liabilities = R30 000 (40 000 – 10 000)

2.2 Assets = R240 000 (172 000 + 68 000)

2.3 Owner’s equity = R19 000 (72 000 – 53 000)

2.4 Liabilities = R16 000 (40 000 – 24 000)

2.5 Assets = R96 000 (60 000 + 36 000)

2.6 Owner’s equity = R36 000 (80 000 – 44 000)

.

Hint: To solve make use of the BAE in each instance.


6.2 Effect of transactions on the basic accounting equation

Study reference

Study Cloete & Marimuthu 2008: Chapter 3 – The effect of transactions on the

basic accounting equation.

This section is to strengthen your understanding of the BAE and is part of

learning outcome 3.

Every financial transaction, however simple or complex, affects the basic

accounting equation.

Important!

Please ensure that you now work through the examples in the textbook of

transactions affecting the BAE:

Transactions that affect assets and equities only

o Capital contributions

o Loans

o Purchase of assets for cash

o Buying assets on credit

o Payments to creditors

o Withdrawals by the owner

Transactions that give rise to income and expenditure

o Income (cash)

o Income (credit)

o Expenditure (cash)

o Expenditure (credit)

Transactions involving payments by debtors.

It should be noted that the accounting equation neither answers the question as to how

much profit the business has generated nor the question about the financial position of

the business. The accounting equation must therefore be adapted into an income

statement (indicating profits made) and a balance sheet (statement of financial

position).


Self-assesment exercise

Now do Exercises 5, 6 and 7 in Cloete & Marimuthu 2008: Chapter 3.


Solutions

Exercise 5

DATE ASSETS = OWNERS EQUITY +

LIABILITIES

Vehicles Equipment Debtors Bank Capital/

drawings Income/expense

Loan Creditors

1 +15000 +15000

2 +60000 -6000 +54000

3 -2000 -2000

10 +15000 +15000

12 -500 -500

14 +20000 +20000

15 +10000 +10000

17 -3000 -3000

20 -800 +800

24 -1500 -1500

26 -8000 +8000

28 -250 -250

31 +75000 +75000

Exercise 6

DATE ASSETS = OWNERS EQUITY +

LIABILITIES

Vehicles Equipment Debtors Bank Capital/

drawings Income/expense

Loan Creditors

1 +2800 +2800

2 -110 -110

3 -1100 +1100

5 +6000 +6000

6 -200 -200

7 -8400 +8400

8 -1200 -1200

9 +4000 +4000

11 +2600 +2600

12 -1200 -1200

13 -300 -300


Exercise 7

DATE ASSETS = OWNER’S EQUITY +

LIABILITIES ACCOUNT

DEBIT ACCOUNT

CREDIT

1 +18 000 +18 000 Bank Loan

2 -100 -100 Loss on theft

of asset Equipment

3 +70 +70 Bank Loss on theft

of asset

4 +10 000 -10 000 Buildings Bank

5 -120 -120 Drawings Bank

6 +3 000 +3 000 Debtors Sales

7 -800 -800 Wages Bank

+20 050 +2 050 +18 000


Study Unit 2: Basic accounting concepts and financial statements

This study unit addresses basic accounting matters such as the conceptual

framework of basic accounting, the accounting cycle, year-end adjustments and

an introduction to company financial statements.

Mastering the year-end adjustments and an understanding of the components

of the respective financial statements is critical to read financial statements.

Specific learning outcomes

After you have studied this module you should be able to:

Describe the accounting cycle.

Explain what year-end adjustments are and its impact on the financial

statements.

Interpret an income statement and balance sheet.


1. Basic accounting

Study reference

Please read Cloete & Marimuthu 2008: Chapter 4, Section 4.1 – Conceptual

framework.

1.1 Accounting conceptual framework

Qualitative characteristics are the attributes that make the information provided

in financial statements useful to users. The four (4) qualitative characteristics

are understandability, relevance, reliability and comparability.

Understandability

An essential quality of the information provided in financial statements is that it

is easily understood by all users. For this purpose, users are assumed to have a

reasonable knowledge of business, economic activities, accounting, and a

willingness to study the information with reasonable diligence.

Relevance

Information must be relevant and useful to the decision-making needs of users.

Information has the quality of relevance when it influences the economic

decisions of users by helping them evaluate past, present or future events or

confirming, or correcting their past evaluation.

Reliability

Information must be reliable. Information has the quality of reliability when it is

free from material error and bias and can be depended upon by the users to

represent faithfully that which it either purports to represent or could reasonably

be expected to represent.


Comparability

Users must be able to compare the financial statements of a firm through time,

in order to identify trends in its financial position and performance. Users must

also be able to compare the financial statements of different firms in order to

evaluate their relative financial position, performance and changes in their

financial position. Hence the measurement and display of the financial effect on

like transactions and other events must be carried out in a consistent way

throughout a firm and over time for that firm and in a consistent way for different

firms.

Accounting statements rest on four important principles which are so important

that a note to the accounts must warn users if this is not the case. These

principles are:

The going concern – it is assumed that a business is going to continue

its operations in the future.

The matching principal – cost and revenue are matched to reflect the

same time period, i.e., cost of materials or stock purchased will only be

reflected against revenue generated by such materials or stock. Any

materials or stock purchased and not yet used will be carried as a short-

term asset in the balance sheet. This principal is also known as the

‘accruals’ principal.

Prudence (conservatism) – until a deal has been concluded and

completed, profit cannot be counted and the lower asset value or profit

alternatives will be reflected in the financial statements.

Consistency – once a method has been chosen by the accountant to

treat accounting entries, it is essential that the same method is applied in

future years. This will ensure that statements can be compared over

time.


1.2 The accounting cycle Study reference

Study Cloete & Marimuthu 2008: Chapter 4, Section 4.2 – The accounting

cycle.

The accounting cycle is the series of steps that take place in order for financial

statements to be accurately and uniformly produced at the end of an accounting

period which is typically the length of one month, quarter of a year, or a whole

year. Below is a list of the steps you would take to complete the accounting

cycle, listed in the order that you would perform them, and with a brief summary

of each step.

1. A transaction occurs between the business and some other entity. This

transaction could be the revenue from the sale of a product or a payment to

another business for services.

2. A source document is required to substantiate the transaction.

3. Analyse the transaction and how it relates to the accounting balance sheet.

For example, determine which accounts are affected by the transaction and

how they are affected. Record the transaction to a journal such as a sales

journal. Journals are kept in chronological order and may be updated

continuously, daily, or however often it is necessary.

4. Record the transaction to the general ledger. Take all of your entries and

categorise them by the account.

5. Perform a trial balance. Debits and credits need to be equal at the end of an

accounting cycle, so calculate the entries to ensure they match.

6. Prepare adjustments. Just because entries are recognised, does not mean

the work has been performed. Revenue can only be recognised when the

work has been completed, so adjust the entries accordingly. The

adjustment can also be the result of accounting policies, such as provision

for bad debts or depreciation on assets.


7. Perform trial balance with adjustments. Take the adjustments from Step 6

and prepare a trial balance. If the debits and credits do not match, then you

need to adjust them to make sure they do match.

8. Perform closing entries using a general journal. Close the accounts in

preparation of the next accounting cycle. Revenues and expenses need to

be closed out, which means they need to have zero balances. Balances are

moved to the next cycle.

9. Prepare a final trial balance after all closing entries have been made

(summary of the closing entries in the general ledger).

10. Prepare financial statements. From the adjusted trial balance, these

corrected balances are used to prepare the financial statements.

11. Analyse and interpret information contained in the financial statements.

While the actual terminology, timeline, and other factors of the accounting cycle

vary, the above steps represent the general steps included universally in the

accounting cycle. In realistic scenarios, a streamlined process, aided by

computer programs and other devices, allows an accountant to combine some

of these steps and complete the process in less time and with less effort. For

example, often, a computer program allows steps one and two to be combined

and allows the steps to accurately appear on the journal or general ledger

almost instantaneously. Also, calculations performed by a computer or

calculator work to eliminate human errors.


Now do Exercise 1 in Cloete & Marimuthu 2008: Chapter 4.

After you have studied this section you should be able to master learning outcome 1.


Solution

Exercise 1

Shiloh Clothing Income statement for the year ended 28 February 20x2

Sales Less: Cost of sales

63 750 42 500

Gross profit for the year Add: Other income

Dividends received Rent income

30 7 200

21 250 7 230

Gross income for the year Less: Operating expenses

Advertising Bank charges Interest paid Electricity and water Licence Wages Stationery and postage Telephone

540 165

2 860 160 225

7 920 140 270

28 480 12 280

Net profit for the year 16 200


Shiloh Clothing Balance sheet as at 28 February 20x2

Notes Cost price Accumulated depreciation

Book value

Non-current assets Premises

Vehicles

Equipment

70 000 12 500 12 100

70 000 12 500 12 100

94 600 94 600

Investment Shares: JSE

850

850

Current assets Stock Accounts receivable Bank Cash float

13 250 1 500

21 750 250

36 750

TOTAL ASSETS 132 200

Equity & liabilities Owner’s equity

1

99 700

Non-current liabilities Loan: PBS (17% p.a.) Mortgage bond (15% p.a.)

8 000 10 000

18 000

Current liabilities Accounts payable

14 500 14 500

TOTAL EQUITY & LIABILITIES

132 200

Notes: 1) Statement of changes in equity

Capital R98 000 Add: Net profit R16 200 Less: Drawings R14 500

R99 700


1.3 Year-end adjustments Study reference

Study Cloete & Marimuthu 2008: Chapter 4, Section 4.4 – Year-end

adjustments, depreciation.

A number of adjustments can be made at year end, including:

Depreciation

Provision for doubtful debts

Prepaid expenses

Accrued expenses

Accrued income

Income received in advance/prepaid income.

1.3.1 Depreciation

The benefits that a firm obtains from an asset extend over several years. The

life of production machinery may extend over many years, whereas a company-

owned motor car used by a salesman probably has a much shorter useful life.

By accepting that the life of a fixed asset is limited, the accounts of a firm need

to recognise the benefits of the fixed asset as it is ‘consumed’ over several

years. This ‘consumption’ of a fixed asset is referred to as depreciation.

A portion of the benefits of the fixed asset will be used up or consumed in each

accounting period of its life in order to generate revenue. To calculate profit for

a period, it is necessary to match expenses with the revenues they help earn.

In determining the expenses for a period, it is therefore important to include an

amount to represent the consumption of fixed assets during that period (that is,

depreciation).


The Receiver of Revenue (SARS) controls the rate at which depreciation may

be claimed in South Africa because it affects the profits, and consequently, the

amount of tax payable. The rate of depreciation for different types of assets is

published as schedules to Practice Notes. Special accelerated depreciation

rates may also be available as incentive to develop industries or regions.

The basics that underline depreciation are:

The asset should be used to generate income in the course of

conducting business.

The expense should be fairly allocated over the lifetime of the asset.

The asset should be fairly presented in the balance sheet, that is, at book

value.

Important!

Please ensure that you now work through the depreciation examples in the

textbook.




Solution

Exercise 3

TKZ Stores journal entry as at 30 June – Vehicles

Debit Credit

Depreciation Accumulated depreciation on vehicles

7 000 7 000

Workings R35 000 x 20% = 7 000 TKZ Stores journal entry as at 30 June – Furniture and fittings

Debit Credit

Depreciation Accumulated depreciation on furniture and fittings

5 355 5 355

Workings (R42 000 – 6 300) x 15% = 5 355 TKZ Stores income statement as at 30 June

Less: Operating expenses Depreciation (7 000 + 5 355) R12 355

TKZ Stores balance sheet as at 30 June Non-current assets

Cost Accumulated depreciation

Book value

Vehicles Furniture and fittings

35 000 42 000

25 000 (18 000 + 7 000)

11 655 (6 300 + 5 355)

10 000 30 345


1.3.2 Provision for doubtful debts Study reference

Study Cloete & Marimuthu 2008: Chapter 4 – Year-end adjustments, provision

for doubtful debts.

When sales are allowed on credit, the possibility exists that some of the debtors

will not pay their outstanding debt. It is prudent that some provision for doubtful

debt is created in order to give a more accurate report on the expected amount

of outstanding debt, including a provision for doubtful debt.

The amount provided for doubtful debt is estimated as a percentage of the total

amount of debt outstanding and is based on past experience and the economic

climate.

The following situations could arise that relate to the provision of bad debt:

Scenario Debit Credit

Write off a bad debt when a provision for bad debt does not exist

Bad debt acc.

(expense) increase

Debtors control acc.

(current asset) decrease

Create provision for doubtful debt

Bad debt acc.

(expense) increase

Provision for doubtful debt acc.

(negative asset) increase

Increase provision for doubtful debt

Bad debt acc.

(expense) increase


(negative asset) increase

Decrease provision for doubtful debt


(negative asset) decrease

Bad debt acc.

(expense) decrease

Write off a bad debt when provision for bad debt exists


(negative asset) decrease

Debtors control acc.

(current asset) decrease


Important!

Please ensure that you now work through the provision for doubtful debt

examples in the textbook.




Solution

Exercise 4

ZZ Traders journal entry as at 28 February – bad debts

Debit Credit

Bad debts

Debtors control

640

640

Write off bad debt

Debit Credit

Bad debts

Provision for doubtful debts

728

728

Adjust provision for doubtful debts to 5% of outstanding debtors

Outstanding debtors balance R 58 200 – 640 = R57 560

Provision for doubtful debts should be (57 560 x 5%) = R2 878

Currently the provision for doubtful debts is = R2 150

Therefore the provision must be increased by R728 in order to equal R2 878.

ZZ Traders income statement as at 28 February

Less: Operating Expenses

Bad Debts Expense (9 360 + 640 + 728) R10 728

ZZ Traders balance sheet as at 28 February

Current assets

Debtors (58 200 – 640) R57 560

Less: Provision for doubtful debts R2 878


1.3.3 Prepaid expenses Study reference

Study Cloete & Marimuthu 2008: Chapter 4 – Year-end adjustments, prepaid

expenses.

Prepaid expenses refer to payments made in one accounting period but are

only due in the following accounting period. The matching principle requires

that the amounts due in the following accounting period should be excluded

from the expense for the current accounting period.

Important!

Please ensure that you now work through the prepaid expenses examples in

the textbook.

Accrued expenses

Study Cloete & Marimuthu 2008: Chapter 4 – Year-end adjustments, accrued

expenses.

Accrued expenses refer to payments due in the current accounting period but

not yet paid. The matching principle requires that the amounts due in the

current accounting period should be written off against income in the current

accounting period.

Important!


the textbook.


1.3.4 Accrued income Study reference

Study Cloete & Marimuthu 2008: Chapter 4 – Year-end adjustments, accrued

income.

Accrued income refers to income earned in the current accounting period but

not yet received. The matching principle requires that the income earned in the

current year should be recorded in full in the current accounting period.

Important!


the textbook.

1.3.5 Income received in advance

Study Cloete & Marimuthu 2008: Chapter 4 – Year-end adjustments, income

received in advance.

Income received in advance refers to income earned in the current accounting

period but not yet received. The matching principle requires that the income

received in the current accounting period but only earned in the following

accounting period should be recorded in the following accounting period.

Important!


the textbook.

You should have mastered learning outcome 2 if you have studied the section and have attempted the exercises.



Now do Exercises 5, 6, 7and 8 in Cloete & Marimuthu 2008: Chapter 4.

Solution

Exercise 5

Purchases I/S Cost of sales Loan: ABC Bank B/S Current liab.

Prepaid income B/S Current liability

Depreciation (year)

I/S Expense

Debtors B/S Current asset Refreshments I/S Expense

Wages I/S Expense Equipment B/S Current asset

Rent paid I/S Expense Accumulated depreciation

B/S Non-current asset

Interest received I/S Income Drawings B/S Owner’s equity

Unused stationery

B/S Current asset Prepaid expenses B/S Current asset

Accrued income B/S Current asset Accrued expense B/S Current liability


Exercise 6

Angel Traders Income statement for period ended 30 June 20x0

R R

Gross profit xxx

Add: Other income 24 000

Rent received (13 200 / 11mnths = 1 200pm x 12mnths

14 400

Commission received (11 200 – 1 600) 9 600

Less: Expenses 65 380

Stationery (700 – 100) 600

Water and lights (3 600 + 320) 3 920

Bad debts (560 + 300) 860

Depreciation on machinery 60 000

Angel Traders Balance sheet at 30 June 20x0

ASSETS R R

Non-current assets Note 1 280 000

Current assets 23 300

Debtors (22 300 – 300) 22 000

Stationery on hand 100

Accrued income (rent income) 1 200

Owners equity & liabilities

Liabilities 1 920

Accrued expense (water and lights) 320

Prepaid income (commission received) 1 600

Note 1 Cost Accumulated depreciation

Carrying value

Machinery R400 000 R120 000 (60 000 +

60 000) R280 000


Exercise 7

Hot Chicks Income statement for the year ended 28 February 20x3

Sales Less: Sales returns

564 369

5 729

Net sales Less: Cost of sales

Opening stock Add: Purchases Less: Purchases returns Add: Carriage on purchases

36 982 364 965 (2 984)

3 696

558 640 360 630

Goods available for sale Less: Closing stock

402 659 (42 029)

Gross profit Add: Other income

Rent received Discount received

13 200 3 690

198 010 16 890

Gross income for the year Less: Operating expenses

Carriage on sales Rates and taxes Salaries and wages Telephone Stationery Repairs Insurance Bad debts (1 365 + 1 065) Depreciation (2 290 + 14 600)

5 642 4 320

67 420 3 622 2 913

995 1 985 2 430

16 890

214 900 106 217

Net profit for the year 108 683


Exercise 8

Pretty Princess Delivery Services Income statement for year ended 31 December 20x1

R R

Income: Fees received 49 000

Less: Expenses 31 750

Spares used 10 000

Insurance expense 2 000

Salaries 6 000

Municipal costs 1 500

Rental paid 3 000

Depreciation on office equipment 1 500

Depreciation on delivery 7 000

Interest payable 750

Net income 17 250


Pretty Princess Delivery Services Balance sheet at 31 December 20x1

ASSETS R R

Non-current assets Note 1 13 500


Stock of spares (15 000 – 10 000) 5 000

Debtors 20 000

Expenses prepaid (insurance) (3 000 – 2 000) 1 000

Bank 36 000

Total assets 75 500

OWNER’S EQUITY AND LIABILITIES

OWNER’S EQUITY Note 2 44 250

Liabilities

Current liabilities 31 250

Creditors 30 500

Accrued expense (interest) 750

75 500

Note 1 Cost Accumulated depreciation

Carrying value

R R R

Office equipment 5 000 1 500 3 500

Delivery vehicles 17 000 7 000 10 000

13 500

Note 2 Statement of changes in equity

Capital 30 000 Add: Net profit 17 250 Less: Drawings (3 000)

44 250


2. Company financial statements Study reference

Study Cloete & Marimuthu 2008: Chapter 5, Sections 5.1 and 5.2 – GAAP and

company terminology.

2.1 Generally Accepted Accounting Principles (GAAP)

International Accounting Standards (IAS) are set by the International

Accounting Standards Board (IASB) which is the main body of The International

Accounting Standards Committee (IASC), located in London, England. The

IASB is an independent accounting standard-setting body, consisting of 14

members from nine countries, including the United States.

When the IASB sets a brand new accounting standard, a number of countries

tend to adopt the standard, or at least interpret it, and fit it into their individual

country’s accounting standards. These standards, as set by each

particular country’s accounting standards board, will in turn influence what

becomes Generally Accepted Accounting Principles for each particular country.

The acronym ‘GAAP’ stands for Generally Accepted Accounting Principles.

The IASC does not set GAAP, nor does it have any legal authority over GAAP.

The IASC can be thought of as merely a very influential group of people who

love making up accounting rules. However, a lot of people actually do listen

to what the IASC and IASB have to say on matters of accounting.

The best way to think of GAAP is as a set of rules that accountants follow. Each

country has its own GAAP, but on the whole, there aren’t many differences

between countries – interpretations might vary from country to country, but

everyone tends to agree that a company can’t simply make up billions of dollars


worth of revenue and put it on its books. Every country, in turn, influences the

other countries that follow GAAP.

GAAP are imposed on companies so that investors have a minimum level of

consistency in the financial statements they use when analysing companies for

investment purposes. GAAP cover such things as revenue recognition, balance

sheet item classification and outstanding share measurements. Companies are

expected to follow GAAP rules when reporting their financial data via financial

statements.

That said, keep in mind that GAAP is only a set of standards. There is plenty of

room within GAAP for unscrupulous accountants to distort figures. So, even

when a company uses GAAP, you still need to scrutinise its financial

statements. By law all companies have to use GAAP when preparing financial

statements.

For reporting periods beginning on or after 1 January 2005, South African

statements of GAAP are fully aligned with International Financial Reporting

Standards (IFRS).

2.2 Company terminology

The main difference that distinguishes a company from other forms of

ownership is its limited liability, that is, the owner’s personal assets are

protected.

Four types of profit companies can be identified according to the Companies

Act, 2008:

1) a state-owned company (SOC);

2) a private company (Proprietary Limited) if it is not state-owned and the

Memorandum on Incorporation prohibits it from offering its securities to

the public and restricts the transferability of its securities;


3) a personal liability company (Incorporated) if it meets the criteria for a

private company and the Memorandum of Incorporation states that it is a

personal liability company;

4) a public company (Limited) in any other case.

Of these companies, it is only the public company that can sell shares to the

general public.

2.2.1 Share capital

A public company can issue shares, which is known as share capital. Currently,

if companies have par value shares, it means that the fixed value and amount of

issued shares is indicated in the memorandum of association. In the case of

companies with no par value shares, the memorandum of association only

indicates the amount of issued shares as these shares do not have a fixed

value.

A major change introduced by the new Companies Act (Act No.71 of 2008), is

that a share will no longer have a fixed or nominal value (‘par value shares’), but

will be fixed in number only (‘no par value shares’).

Authorised share capital

Authorised share capital is the total number of shares a company is authorised

to issue according to its Memorandum of Incorporation (previously

memorandum of association) and approved by the Commission (previously the

Registrar of Companies).

A company’s Memorandum of Incorporation must set out the classes of shares,

and the number of shares of each class, that the company is authorised to

issue.

Issued share capital

Companies do not issue all their shares – they retain some of their shares as a

reserve. The portion issued is called the issued share capital. Any unissued


shares can be issued later by the directors, subject to the rules set out in the

Memorandum of Incorporation.

Share premium

Previously if a share was sold at a premium, then the issue price will be the par

value plus an additional premium. So if a 1 cent nominal value share is issued

at R2.01, then the par value was 1 cent and the premium was R2.00 per share.

The company issuing the shares will receive R2.01 for each share issued.

Under the new Companies Act, 2008 shares will no longer have a par value and

the distinction between the par value and the share premium will fall away.

Types of shares

Shareholders of a company receive a share of the profits in the form of

dividends. Dividends are dependent on the type of share they have purchased

as well as the company’s dividend policy.

A company’s Memorandum of Incorporation must set out the classes of shares,

and with respect to each class of shares a distinguishing designation for that

class; and the preferences, rights, limitations and other terms associated with

that class.

2.2.2 Reserves

Reserves are profits retained in the business and can take various forms.

Non-distributable reserves

These reserves are non-trading profits that cannot be distributed to

shareholders and can for example arise from items such as revaluations of

assets and some foreign exchange movements.

Distributable reserves

Distributable reserves are trading profits that have not been paid out by the

company and may be distributed to shareholders at a later stage.


General reserves

Profits that have been retained by the company in order to purchase assets are

set aside under general reserves.

2.2.3 Profits, taxation, reserves and dividends

Companies are liable to pay tax as separate legal entities. Company tax is

payable on profit made during the course of business. Once taxation has been

calculated and provided for payment to the Receiver of Revenue, the remainder

of the profits can be divided between reserves, dividends and retained earnings.

Important!

Please ensure that you now work through Example 1 dealing with:

Provisional tax payments

Tax assessments

Interim dividends

Final dividends

Distribution of net profit earned.

Also work through Example 2 dealing with the preparation of financial

statements.



You should have mastered learning outcome 3 after you have studied the

text and have attempted the exercise.


Solution

Exercise 1

JT Limited Income statement for the year ended 28 February 20x1

Net income before taxation Less: Taxation

107 400 (45 000)

Net income after taxation Transfer to general reserve Less: Preference dividends Less: Ordinary dividends

62 400 (6 000) (6 000)

(24 000)

Retained income for the year Add: Retained income at beginning of year

26 400 6 000

Retained income at end of year 32 400


JT Limited Balance sheet as at 28 February 20x1

Cost Accumulated depreciation

Book value

ASSETS

Non-current assets

Land & buildings 180 000 180 000

Motor vehicles 72 000 26 400 45 600

Equipment 62 400 19 200 43 200

314 400 45 600 268 800

Investment 63 600


Stock 114 000

Debtors 159 000

TOTAL ASSETS 605 400

EQUITY & LIABILITIES

Shareholders’ equity

Issued share capital

Ordinary share capital 240 000

Preference share capital 60 000

General reserve (12 + 6) 18 000

Retained income 32 400

350 400

Non current liabilities 96 000

Long-term loan 96 000

Current liabilities 159 000

Creditors 84 000

Bank overdraft 18 000

Receiver of Revenue (45 - 18)

27 000

Shareholders for dividends (24 + 6)

30 000

TOTAL EQUITY & LIABILITIES 605 400

Note to the balance sheet Authorised share capital

300 000 ordinary shares at R1 each

300 000

70 000 10% preference shares at R1 each

70 000

370 000


2.3 Annual financial statements of public companies

This section together with the next section is intended to give you a complete

picture of annual financial statements of public companies. Please consider this

section as important reading material as it indicates the level of complexity that

accountants and users of financial statements sometimes have to deal with.

Financial statements of public companies have to be prepared according to

specific guidelines as determined by the Companies Act 71 of 2008, which

stipulates that annual financial statements are to be produced in the strict and

complicated international financial reporting standards (IFRS) and the

international auditing standards (IAS).

IFRS financial statements consist of:

A balance sheet

Income statement

Either a statement of changes in equity (SOCE) or a statement of

recognised income or expense (SORIE)

A cash flow statement

Notes, including a summary of the significant accounting policies.

Furthermore, annual financial statements of a public company must also

include:

An auditor’s report

A report by the directors with respect to the state of affairs, the business

and profit or loss of the company, or of the group of companies, if the

company is part of a group

The remuneration, and benefits received by each director, or individual

holding any prescribed office in the company.

The International Accounting Standards Board (IASB) issued an accounting

statement announcing changes to the titles of financial statements as they will

be used in International Financial Reporting Standards (IFRS):


‘Balance sheet’ will become ‘statement of financial position’

‘Income statement’ will become ‘statement of comprehensive income’

‘Cash flow statement’ will become ‘statement of cash flows’.

Entities are not required to use the new titles in their financial statements.

The CFA Institute is a global association of investment professionals

comprising the world’s largest association of investment professionals. With

over 100,000 members, and regional societies around the world, they are

dedicated to developing and promoting the highest educational, ethical, and

professional standards in the investment industry.

The CFA Institute’s Centre for Financial Market Integrity has developed a

comprehensive manual for practitioners interested in guidelines to assisting in

achieving best practice in Excellence in Corporate Reporting:

“A COMPREHENSIVE BUSINESS REPORTING MODEL: Financial Reporting for

Investors”

According to the publication mentioned above, “financial statements should be

reported from the perspective of the shareholder who bears the ultimate risk,

and with the shareholder’s best interests held paramount. Accordingly, they

state that financial statements should be fully transparent and report the fair

values of all assets, liabilities, exchanges, and transactions that could

potentially impact the investor and that all assets and liabilities should be

included in the balance sheet, with no hidden assets, hidden debt, or hidden

obligations.”

Source: http://www.cfainstitute.org/about/strategy/principles/Pages/index.aspx

The following model financial statements were published by Deloitte and are

available from http://www.iasplus.com/fs/fs.htm#2009ifrsmod.


2.3.1 Model income statement

International GAAP Holdings Limited

Consolidated statement of comprehensive income for the year ended 31 December 2009

Notes Year ended 31/12/09

Year ended 31/12/08

CU’000 CU’000 Continuing operations

Revenue 5 140,918 151,840 Cost of sales (87,897) (91,840)

Gross profit 53,021 60,000 Investment revenue 7 3,608 2,351 Other gains and losses 8 647 1,005 Distribution expenses (5,087) (4,600) Marketing expenses (3,305) (2,254) Occupancy expenses (2,128) (2,201) Administration expenses (11,001) (15,124) Finance costs 9 (4,418) (6,023) Other expenses (2,801) (2,612) Share of profits of associates 20 1,186 1,589 Gain recognised on disposal of interest in former associate 20 581 -

Profit before tax 30,303 32,131 Income tax expense 10 (11,564) (11,799)

Profit for the year from continuing operations 13 18,739 20,332 Discontinued operations Profit for the year from discontinued operations 11 8,310 9,995

PROFIT FOR THE YEAR 27,049 30,327

Other comprehensive income Exchange differences on translating foreign operations (39) 85 Net value gain on available-for-sale financial assets 66 57 Net value gain on cash flow hedges 39 20 Gain on revaluation of properties - 1,150 Share of other comprehensive income of associates - -

Other comprehensive income for the year, net of tax 66 1,312

TOTAL COMPREHENSIVE INCOME FOR THE YEAR 27,115 31,639

Profit attributable to: Owners of the Company 23,049 27,564 Non-controlling interests 4,000 2,763

27,049 30,327

Total comprehensive income attributable to: Owners of the Company 23,115 28,876 Non-controlling interests 4,000 2,763

27,115 31,639

continued...



Consolidated statement of comprehensive income for the year ended 31 December 2009 – continued


Year ended 31/12/08

CU’000 CU’000 Earnings per share 14 From continuing and discontinued operations Basic (cents per share) 132.2 137.0

Diluted (cents per share) 115.5 130.5

From continuing operations Basic (cents per share) 84.5 87.3

Diluted (cents per share) 74.0 83.2


2.3.2 Model balance sheet


Consolidated statement of financial position at 31 December 2009

Notes 31/12/09 31/12/08 01/01/08

CU’000 CU’000 CU’000 Assets Non-current assets

Property, plant and equipment 15 109,783 135,721 161,058 Investment property 16 1,936 132 170 Goodwill 17 20,285 24,060 23,920 Other intangible assets 18 9,739 11,325 12,523 Investments in associates 20 7,402 7,270 5,706 Deferred tax assets 10 - - - Finance lease receivables 26 830 717 739 Other financial assets 22 10,771 9,655 7,850 Other assets 23 - - -

Total non-current assets 160,746 188,880 211,966

Current assets Inventories 24 31,213 28,982 29,688 Trade and other receivables 25 19,735 16,292 14,002 Finance lease receivables 26 198 188 182 Other financial assets 22 8,757 6,949 5,528 Current tax assets 10 125 60 81 Other assets 23 - - - Cash and bank balances 23,446 19,778 9,082

83,474 72,249 58,563 Assets classified as held for sale 12 22,336 - -

Total current assets 105,810 72,249 58,563

Total assets 266,556 261,129 270,529

continued...



Consolidated statement of financial position at 31 December 2009 – continued

Notes 31/12/09 31/12/08 01/01/08

CU’000 CU’000 CU’000 Equity and liabilities Capital and reserves Issued capital 28 32,439 48,672 48,672 Reserves 29 4,237 3,376 1,726 Retained earnings 30 110,805 94,909 73,824

147,481 146,957 124,222 Amounts recognised directly in equity relating to assets classified as held for sale 12 -

-

-

Equity attributable to owners of the Company 147,481

146,957

124,222

Non-controlling interests 31 24,316 20,005 17,242

Total equity 171,797 166,962 141,464

Non-current liabilities

Borrowings 32 20,221 31,478 28,014 Other financial liabilities 34 15,001 - - Retirement benefit obligation 39 508 352 739 Deferred tax liabilities 10 4,646 3,693 2,593 Provisions 35 2,294 2,231 4,102 Deferred revenue 41 219 95 41 Other liabilities 36 180 270 -

Total non-current liabilities 43,069 38,119 35,489

Current liabilities Trade and other payables 37 16,373 21,220 52,750 Borrowings 32 22,446 25,600 33,618 Other financial liabilities 34 116 18 - Current tax liabilities 10 5,270 5,868 4,910 Provisions 35 3,356 3,195 2,235 Deferred revenue 41 355 52 63 Other liabilities 36 90 95 -

48,006 56,048 93,576 Liabilities directly associated with assets classified as held for sale 12 3,684

-

-

Total current liabilities 51,690 56,048 93,576

Total liabilities 94,759 94,167 129,065

Total equity and liabilities 266,556 261,129 270,529


2.3.3 Model cash flow statement (direct method)


Consolidated statement of cash flows for the year ended 31 December 2009


Year ended 31/12/08

CU’000 CU’000 Cash flows from operating activities Receipts from customers 211,032 214,487 Payments to suppliers and employees (165,666) (181,378)

Cash generated from operations 45,366 33,109 Interest paid (4,493) (6,106) Income taxes paid (13,848) (13,340)

Net cash generated by operating activities 27,025 13,663

Cash flows from investing activities Payments to acquire financial assets (3,163) (2,163) Proceeds on sale of financial assets 938 1,712 Interest received 2,315 1,313 Royalties and other investment income received 1,137 884 Dividends received from associates 30 25 Other dividends received 156 154 Amounts advanced to related parties (738) (4,311) Repayments by related parties 189 1,578 Payments for property, plant and equipment (22,932) (11,875) Proceeds from disposal of property, plant and equipment 11,462 21,245 Payments for investment property (10) (12) Proceeds from disposal of investment property - 58 Payments for intangible assets (6) (358) Net cash outflow on acquisition of subsidiaries 44 (477) - Net cash inflow on disposal of subsidiary 45 7,566 - Net cash inflow on disposal of associate 360 -

Net cash (used in)/generated by investing activities (3,173) 8,250

Cash flows from financing activities Proceeds from issue of equity shares 414 - Proceeds from issue of convertible notes 4,950 - Payment for share issue costs (6) - Payment for buy-back of shares (17,011) - Payment for share buy-back costs (277) - Proceeds from issue of redeemable preference shares 15,000 - Proceeds from issue of perpetual notes 2,500 - Payment for debt issue costs (595) - Proceeds from borrowings 17,122 26,798 Repayment of borrowings (37,761) (23,209) Proceeds from government loans 2,610 - Proceeds on disposal of partial interest in a subsidiary 213 - Dividends paid on redeemable preference shares (613) - Dividends paid to owners of the Company (6,635) (6,479)

Net cash used in financing activities (20,089) (2,890)

Net increase in cash and cash equivalents 3,763 19,023 Cash and cash equivalents at the beginning of the year 19,400 561 Effects of exchange rate changes on the balance of cash held in foreign currencies (80)

(184)

Cash and cash equivalents at the end of the year 46 23,083 19,400

2.4 Reading financial statements


In this section we will describe the financial statements with reference to the

model financial statements provided in the previous pages.

2.4.1 Income statement

The income statement measures the operating performance during a given

accounting period. It reflects the normal operating transactions, and includes

losses or gains on the disposal of assets and other non-recurring and

extraordinary events. Unlike the balance sheet, which shows the condition of a

firm at a specific point in time, the income statement measures the income over

a period.

Revenue is measured at the fair value of the consideration received or

receivable. Revenue is usually reduced for estimated customer returns,

rebates and other similar allowances.

Cost of Sales (C.O.S. for short) is the expense a company incurred in

order to manufacture, create, or buy inventory. It includes the purchase

price of the raw material as well as the expenses of turning it into a

product. The table that follows shows the cost of sales calculations for a

trading firm and a manufacturing firm, respectively.

Trading Company Manufacturing Company

Opening Stock

Plus Purchases

Plus Other Charges

(customs duty, freight, railage)

Less Closing Stock

Opening Stock

Plus Manufacturing Labour

Plus Raw Material

Plus Manufacturing Overhead

Less Closing Stock

Gross profit is the total revenue subtracted by the cost of generating

that revenue. It tells you how much money a business would have made


if it didn’t pay any other expenses such as salaries, general

administration expenses and income taxes.

Investment revenue comprises rental income earned through

investment properties and interest received earned through assets such

as bank deposits.

Other gains and losses arise from items such as:

Gain/(loss) on disposal of property, plant and equipment

Gain/(loss) on disposal of available-for-sale investments

Government grants received for staff retraining

Net foreign exchange gains/(losses)

Gain/(loss) arising on effective settlement of legal claims.

Distribution expenses are costs to the business when sending its

finished goods out to customers and may also include payroll costs

(salaries, commissions, and travel expenses of executives, salespeople

and employees), involved in sales.

Marketing expenses advertising expenses a company incurs in selling

the products or services.

Occupancy expenses include rent, depreciation and amortisation,

utilities, maintenance, insurance, rates and taxes, and other expenses of

premises occupied by the business.

Administration expenses consists of salaries paid to employees not

directly involved in the selling of the product, research and development

costs, and other miscellaneous charges that must be subtracted from the

company’s income.

Finance cost relates to interest paid on bank overdrafts, loans and

financial lease obligations.


Income tax represents the sum of the tax currently payable and deferred

tax. The tax currently payable is based on taxable profit for the year.

Taxable profit differs from profit as reported in the income statement

because of items of income or expense that are taxable or deductible in

other years and items that are never taxable or deductible.

2.4.2 Balance sheet

Assets

Assets are grouped into non-current assets and current assets.

Non-current assets are assets intended for continuing use over a period

longer than 12 months. Examples include:

Property, plant and equipment

Investments

Goodwill

Other intangible assets.

Intangible assets cannot be seen or touched and include items such as

goodwill, patents, brands and trade marks.

Goodwill in financial statements arises when a company is purchased for

more than the fair value of the identifiable assets of the company. The

difference between the purchase price and the sum of the fair value of

the net assets is by definition the value of the ‘goodwill’ of the purchased

company.

Although goodwill is technically an intangible asset, goodwill and

intangible assets are usually listed as separate items on a company’s

balance sheet.

The International Financial Reporting Standards (IFRS) require that all costs, both

tangible and intangible involved in the purchase of one company by another to be


reported. However, it is not easy to accurately value intangible assets such as brands.

In an article in Business Day, Dr. Roger Sinclair, Professor of marketing at the

Witwatersrand and MD of valuation firm BrandMetrics, wrote an article “Measuring

Value: when fair seems foul”, on the difficulty of valuing brands where he referred to the

Barclays-ABSA deal. Barclays Bank had to report the ABSA brand value in their

balance sheet, but at a value which Dr. Sinclair regards to be a very unrealistic

valuation. The ABSA brand was only valued at £172m or about R1,8bn as reported in

Barclays Bank annual financial statements, when ABSA earned R4.5bn in the year of

the takeover and had assets worth R80bn. He comments that “The notion of brands as

assets is very new to accountants and it will take some time for them to understand that

they differ drastically from what they are used to.”

Current assets are those that form part of the circulating capital of a

business. They are replaced frequently or converted into cash during the

course of trading. The most common current assets are:

Inventory (stock)

Trade receivables (debtors or account receivables)

Cash.

The inventory of a manufacturer is composed of three groups:

Raw materials to be used in the product

Partially finished goods in process of manufacture

Finished goods ready for shipment to customers.

The generally accepted method of valuation of the inventory is cost or

market, whichever is lower. This gives a conservative figure. Where this

method is used, the value for balance sheet purpose will be cost, or

perhaps less than cost if, as a result of deterioration, obsolescence,

decline in prices, or other factors, less than cost can be realised on the

inventory. Inventory valuation includes an allocation of production and

other expenses as well as the cost of materials.


Trade receivables represent the amount due from customers but not yet

collected. When goods due are shipped prior to collection, a receivable is

recorded. Customers are usually given 30, 60, or 90 days in which to pay.

Experience shows that some customers fail to pay their bills, either because of

financial difficulties or some catastrophic event befalling their business.

Therefore, in order to show the trade receivable item at a figure representing

expected receipts, the total is after a provision for doubtful accounts.

Cash represents notes and coins and money on deposit in the bank.

Prepaid expenses may arise for a situation such as this: During the

year, insurance premiums and advertising charges for the next year are

paid. Those insurance premiums and advertising service are as yet

unused at the balance sheet date, so there exists an unexpended item,

which will be used up over the next 12 months. If the advance payments

had not been made, the company would have more cash in the bank. So,

payments made in advance from which the company has not yet

received benefits, but for which it will receive benefits next year, are

listed among current assets as prepaid expenses.

Capital and reserves

Issued capital and reserves

Issued capital refers to the funds invested in the firm by the owners or

shareholders. This section of the balance sheet also shows any

reserves that have been retained in the firm. The reserves can be either

classified as distributable or non-distributable reserves. Distributable

reserves can be handed out to shareholders by way of dividend

payments.

Retained earnings

When a firm generates a profit, management has one of two choices:

they can either pay it out to shareholders as a cash dividend, or retain

the earnings and reinvest them in the business. When the executives

decide that earnings should be retained, they have to account for them


on the balance sheet under Shareholder Equity. This allows investors to

see how much money has been put into the business over the years.

Liabilities

Liabilities are debts owed to other parties. Non-current liabilities are

debts incurred by the firm that are not payable within the next 12 months

such as secured or unsecured loans.

Current liabilities are debt owed and payable within the next 12 months

such as accrued expenses, creditors and bank overdrafts. An accrued

expense is a debt that has been incurred or has accumulated over a

period of time and must be paid but has not yet been paid.

Contingent liabilities are debts that the firm may be faced with in future.

Examples of contingent liabilities include legal disputes, guarantees or

assets financed with residual values. These are revealed in the notes to

the balance sheet.

2.4.3 The cash flow statement

The cash flow statement forms part of the annual financial statements and tells

us where the cash came from went to and what happened to the balance sheet

for the period in question. Unlike the income statement that explains changes

in one balance sheet item only, i.e. retained earnings, the cash flow statement

explains the sources from which the firm acquired its funds and the uses to

which they were put.

The cash flow statement comprises four sections that can broadly be labelled

as

cash flows from operating activities,

cash utilised in investing activities,

cash flows from financing activities, and

cash and cash equivalent summation.


The current income statement and balance sheet for the current and previous

year is required for construction of the cash flow statement.

Cash from operating activities

Typically this section will reflect the income from normal trading activities such

as the trading profit plus depreciation (remember that depreciation is not a cash

expense). The net result of changes to working capital (current assets and

current liabilities) is also reflected in this section of the cash flow statement.

Finally other expenses such as dividend payments and taxation are subtracted

to arrive at the net cash flow from operating activities.

Cash utilised in investing activities

This section will reflect expenditure such as the replacement of properties,

fixtures, equipment and vehicles for the purpose of maintaining or expanding

the current level of activities in the firm. It may also reflect the proceeds on

disposal of properties, fixtures, equipment and vehicles.

Cash flows from financing activities

The firm is also funded by external sources. In this section changes to the

external sources of funds are reflected. It may include items such as the

redemption of preferential shares, buyback of shares, issuing of shares,

increasing or decreasing interest-bearing debt.

Cash and cash equivalent summation

The final section of the cash flow statement shows the net increase or decrease

in cash and cash equivalents for the current year. The cash and cash

equivalents balance from the previous year are added to this number to arrive

at the cash and cash equivalent for the current year.


Important!

Buy a newspaper that normally publishes financial news and locate the annual

financial statements of a company of your choice (preferably a retailing

business). Now practice your skill to read the financial statements.

You could also find the annual financial statements for a listed company on the

company website – usually under the heading ‘Investor relations’.

This concludes the section on the reading of financial statements and the study

unit on accounting concepts and terminology.


Study Unit 3: Determine the selling price of merchandise

This study unit addresses the concept value added tax, and the calculation of

selling price of merchandise (inclusive and exclusive of VAT) using mark-up on

cost and selling price.

Mastering VAT calculations and mark-up is critical to ensure accurate

calculation of selling prices.



Calculate cost of sales.

Explain VAT concepts and calculate VAT.

Calculate mark-ups on cost price and selling price.

Calculate selling price (inclusive and exclusive of VAT).

Study reference


Study Cloete & Marimuthu 2008: Chapter 7 – Value added tax.

1. Value added tax

1.1 Introduction

Value-added tax (more commonly known by its abbreviation, VAT) is an indirect

tax levied by vendors on the supply of goods or services. Vendors, who are

registered for VAT, are generally obliged to charge and collect VAT on taxable

supplies from their customers or clients on behalf of SARS.

VAT is levied and accounted for at the prescribed rate, which is presently 14%

(standard rate), and is ultimately paid by the final consumers of goods and

services. For certain goods and services, a special rate of 0% VAT (zero rate) is

applied, while a limited range of goods and services are exempt. VAT is also

levied on the importation of goods and services.

VAT is only charged on taxable supplies made by a vendor. Taxable supplies

include supplies for which VAT is charged at either the standard rate or zero

rate, but does not include:

Salaries and wages

Hobbies or any private recreational pursuit (unless the hobby becomes a

business)

Private sale of personal or domestic items

Exempt supplies (see section further on in this study unit).

1.2 Vendors

When a business is registered as a vendor, it means two things:

The vendor must collect VAT from customers and pay this VAT to SARS.


The vendor can claim back any VAT that is paid on anything bought for

the business.

If the turnover (the total of all the sales, without subtracting the costs) of a

business is more than R1,000,000 per year, then the business must be

registered as a vendor by completing VAT101 and VAT127. When you start a

business and you think the turnover will be more than R1m, then you have to

register as a vendor.

If the turnover of the business is less than R1m per year, the owner can choose

to register or not if taxable supplies of more than R50,000 per year is made. If

you register, this is called voluntary registration. It takes a lot of effort and work

to pay VAT to SARS regularly and to keep all the records the SARS wants a

vendor to have. If you don’t have to register, it is only a good idea to register if

the business buys lots of things from suppliers and can claim back VAT to

reduce the amount of VAT you owe SARS.

If the business is a sole trader or a partnership, the owners must register in their

own names. If the business is a CC or a company, the owners must register in

the name of the business.

1.3 Types of supply

Supplies fall into two categories:

Taxable supplies (standard rate and zero rate)

Exempt supplies.

1.3.1 Taxable supplies

Standard rate

Standard rated supplies are taxed at the rate of 14%.

Zero-rate


Zero-rated supplies of goods and services are subject to VAT at the rate of zero

percent. Vendors who make zero rated supplies may recover related input tax

unless it is specifically prohibited. The application of the zero rate to any

transaction must be supported by documentation acceptable to SARS.

Zero-rated supplies include:

Exports

Goods rented out for use outside South Africa

Going concern sales

International transport of goods and/or passengers

Services relating to foreign land

Processing and repairing imported goods which are to be re-exported

Services rendered physically outside South Africa

Certain services rendered to non-residents

The sale of maize meal, bread, milk, fresh fruit and vegetables, rice,

vegetable oil, eggs, legumes and certain other specified basic foodstuffs

Certain gold coins, including Kruger Rands

Gold supplied to the SA Reserve Bank, SA Mint or to any registered

bank.

1.3.2 Exempt supplies

Exempt supplies are supplies of goods or services on which VAT is not

chargeable at either the standard rate or the zero rate and does not form part of

taxable turnover. If a business makes only exempt supplies, it cannot register

as a vendor for VAT purposes. Accordingly, VAT incurred on any expenses in

order to make exempt supplies may not be claimed as input tax.

Exempt supplies include the following:

Financial services (interest, life insurance, medical schemes, provident,

pension and retirement annuity funds)

Donated goods or services sold by non-profit bodies (e.g. church

bazaars)


Renting a dwelling for use as a private home (but not holiday

accommodation)

Passenger transport in South Africa by taxi, bus, or train

Educational services (crèches, primary and secondary schools,

universities, and other institutions registered under an educational Act).

1.4 Paying VAT

1.4.1 Input tax

A vendor can claim back any VAT that is paid on anything bought for the

business. The VAT which the vendor can claim back is called an input credit

and it means tax charged and payable by

a supplier on the supply of goods or services made by that supplier to a

vendor, or

the vendor on the importation of goods, or

a vendor on excise duty in certain circumstances.

The notional input tax paid by a vendor in respect of second-hand and

repossessed goods (see ‘Notional input tax’ below).

‘Notional input tax’ may be claimed by a vendor in certain circumstances, that

is, he/she may claim an amount of input tax which he/she has not actually paid

to the supplier. This applies in respect of

Second-hand goods acquired by the vendor from a non-registered

vendor for the purpose of making a taxable supply, and

goods repossessed by the vendor under an instalment credit agreement.

1.4.2 Output tax

The VAT that is charged by a vendor to customers is called output tax. Output

tax is the tax charged in respect of the supply of goods and services by a

vendor, a supply deemed to have been made during the tax period. For

example, the following transactions are deemed to be supplies for the purposes

of VAT:


where goods have been removed from stock for private consumption,

where payment has been received from the State in respect of a taxable

supply of goods and services,

receipt of an indemnity payment under a contract of insurance,

provision of certain fringe benefits, and

certain other adjustments that is, bad debts recovered debit and credit

notes.

1.4.3 VAT payable/refund

Output tax less the input tax in a particular tax period equals the amount

payable/refundable to/by SARS.

Example:

A canning factory buys pineapple pieces from a farmer (registered for

VAT) for R1.14 (including 14c VAT). The factory sells the tin of pineapple

pieces to a supermarket for R2.00 (excluding VAT), and charges VAT of

28c (R2.00 x 14%) on the sale. The total selling price would thus be

R2.28. The 28c VAT is the supermarket’s input tax and the canning

factory’s output tax. The supermarket sells the tin of pineapple pieces to

the customer (not registered for VAT) for R3.42 inclusive of VAT (R3.00

+ 0.42c VAT). The 42c VAT is the supermarket’s output tax. There is no

input tax on the 42c as the customer is not a vendor.

Important!

Please ensure that you now work through illustrative examples 1 and 2.


Registration threshold

The registration threshold is amended from time to time. At the time of writing

this learner guide the values in the table were applicable.

Total value of taxable supplies for any 12 month period

Compulsory R1 million (previously R300 000)

Voluntary – 1 March 2010 R50 000 (previously R20 000)

Paying VAT to SARS

If you are registered as a VAT vendor you will have to pay the VAT over to

SARS every few months depending on the category that the business falls into.

Frequency of returns

Months Total value of taxable supplies for any 12 month period

Bi-monthly Up to R29 999 999

Monthly From R30 million

4 monthly Up to R1.5 million (only for small businesses)

6 monthly Up to R1.5 million (only for farming businesses)

Annually Only for inter group letting or administration company or trust fund.


2. Determining selling prices

Study reference

Study Cloete & Marimuthu 2008: Chapter 4.3 – Retailers.

2.1 Retailers

Retailers buy products from wholesalers and sell to consumers to make a profit.

A profit is made by adding a mark-up to the cost of the product. The selling

price includes this mark-up and should be high enough to cover the amount

paid for the product plus business expenses plus a profit.

Cost price R1,000

+ Mark-up R 250

= Selling price R1,250

2.2 Accounting for stock

The products purchased for resale are called trading stock. The way in which

trading stock is controlled and accounted for is very important to the profitability

of the business.

In a retailing business stock is accounted for by using either the perpetual or

periodic method.

2.2.1 Perpetual method

According to the perpetual method the selling price and the cost price are

known for each item sold. It is therefore easy to work out how profitable each

item is by matching selling price to cost price of the good.


The amount of mark-up (the amount by which the selling price exceeds the cost

price) is known as gross profit.

Gross profit = selling price less cost price

2.2.2 Periodic method

Firms that trade in large volume of goods may find the perpetual method

unpractical and will rather adopt the periodic method.

As long as the retailer sells all his stock, the calculation of gross profit is the

same as in the perpetual method. With the periodic method the retailer will

calculate the cost price of goods sold by using the formula:

Cost of sales = opening stock plus purchases less closing stock

Periodic physical stock take will be required under this method.

Under the periodic method various items affect the purchases account:

Carriage on purchases

Railage in, freight in

Cost of transporting goods purchased to the

business premises. It increases the value of

purchases.

Purchases returns

Returns outwards

Goods returned to the supplier. It decreases the

value of purchases.

Customs/import duties Cost of bringing goods into the country. It increases

the value of purchases.

Under the periodic method sales returns affect the sales account:

Sales returns

Returns inwards

Goods returned by the clients. It decreases the

value of sales.

The sales account is unaffected by:

Carriage on sales

Railage out, freight out

Cost of transporting goods sold to the client. It is

treated as a normal operating expense.


Important!

Please ensure that you now work through Example 3, Chapter 4, in the

textbook.

You should now understand how the cost price of the product is determined.


2.3 Mark-up on cost price

Study reference

Study Cloete & Marimuthu 2008: Chapter 7, Section 7.5 – Mark-up.

2.3.1 Percentage mark-up on cost price

Turning a profit is paramount when running a business. In order to make a

profit, you need to calculate a mark-up on the price you are going to charge for

goods or services. Determine what price mark-up to charge for your product or

service by following these steps.

Step 1 Determine your product/service cost. How much did it cost you?

The cost includes the price paid for an item or materials plus carriage

on purchases, plus customs/import duties plus the labour required for

processing less purchases returned. Additional expenditures, such as

breakage or spoilage, may also be counted as part of cost.

As an example, let’s assume the product cost is R1.40.

Step 2 Determine the percentage mark-up you wish to apply. Research your

industry to apply a mark-up that will be competitive. In this example,

we will use 30 percent.

Step 3 Convert the percentage mark-up to a decimal. In this case, a 30

percent mark-up would translate to 0.30 (30 divided by 100).

Step 4 Subtract the decimal in STEP 3 from 1. In this example, 1 minus 0.30

equals 0.70.

Step 5 Compute the total selling price by taking the cost from STEP 1 and

dividing it by the result from STEP 4. In this example, R1.40 is divided

by 0.70. The result is R2.00, which should be the total selling price.

Step 6 Calculate the price mark-up by subtracting the product cost from the

selling price. In this example, the R2.00 selling price minus the R1.40

product cost gives you a price mark-up of R0.60.


2.3.2 Impact of VAT

VAT must be excluded from mark-up calculations to ensure that goods are not

overpriced. ‘Marked price’ refers to the price including VAT and the term

‘selling price’ refers to the amount which is received excluding VAT.

Cost price Mark-up Selling price VAT @ 14% Marked price

R100 R10 R110 R15.40 R125.40

100% 10% 110%

100% 14% 114%

Reminder: Sales (turnover) is reported in the income statement excluding VAT.



You should now be able to master learning outcome 3 as well as 4.


Solutions

Exercise 1

Vat = 14/100 x R900 = R126 Marked price (Vat inclusive) = R900 + R126 = R1 026 Or using formula = 114 / 100 x R900 = R1 026

Exercise 3

a) Cost price = 100% / 140% x R1260 = R900

(Mark up is on cost price, therefore cost is 100% and selling price is 140%)

b) Selling price = 100% / 60% x R640 = R1 067

(Mark up is on selling price, i.e. gross margin, therefore selling price is 100% and cost is 60%.)

c) Mark up % = R845 – R650 x 100 R650 1

= 30%

Exercise 5

Cost price % mark up Selling price

R100 50% on selling price R200

R150 40% on cost price R210

R280 30% (R84) R364


Study Unit 4: Cost classification and terminology

This study unit addresses the classification of costs into their various

categories.

Mastering cost classification is important as you will require this knowledge to

make cost control and pricing decisions.



Classify cost in relation to product or period.

Classify behaviour of cost in relation to volume of production.

Classify cost for control or evaluation.

Classify relevant and non-relevant costs for decision making.


1. Introduction

In financial accounting, costs and expenses are used interchangeably. In

managerial accounting, costs differ from expenses. An asset is a cost. As

future economic benefit of an asset decreases, the original cost of the asset

expires and the cost becomes an expense. Expenses are matched with

revenues on the income statement. A good example for understanding a cost

and expense would be a fixed asset. When it is purchased, it is a cost to an

entity and is shown on the balance sheet. When the fixed asset is used, it is

depreciated and a portion of the cost becomes a depreciation expense, which is

included in the income statement and matched with the revenue generated

during the period.

Study reference

Please read Cloete & Marimuthu 2008: Chapter 8 – Cost classification and

terminology.

2. Cost classification in relation to the product or period

The classification of costs and expenses begins by relating them to the different

phases in a business’s operation. In a manufacturing firm, total operating costs

consists of manufacturing costs and non-manufacturing costs.

2.1 Manufacturing costs

During the manufacture of products, we incur direct materials cost, direct labour

costs and manufacturing overheads (comprising indirect labour and indirect

materials). We can classify direct labour and direct material jointly as prime

cost. We can also classify direct labour and manufacturing cost as conversion

cost.

2.2 Non-manufacturing costs


Costs associated with an accounting period rather than with a specific product

can be classified as non-manufacturing costs, such as marketing expenses and

administrative expenses.

3. Cost classification in relation to volume of production

Some costs change in proportion to units produced, some only slightly react to

changes in production, and others don’t change at all. The factors impacting

changes in costs are cost drivers and are discussed below.

3.1 Fixed costs

Fixed costs are costs that do not vary as volume varies and include

depreciation on plant and equipment (if it is allocated on a straight line basis),

rentals, salaries of administration staff and general office expenses.

Important!

Please ensure that you now work through the fixed cost illustrative example in

the textbook.


Although the total fixed cost remains the same as the number of units produced

changes, the fixed cost per unit changes. The more units are produced, the less

the fixed cost per unit is.

3.2 Variable costs

Variable costs are costs that vary in explicit relation to changes in volume; such

material used in production, manufacturing labour costs and delivery expenses

and sales commission.


Important!

Please ensure that you now work through the variable cost illustrative example

in the textbook.

3.3 Semi-variable, semi-fixed or mixed costs

These costs contain both a fixed and a variable portion. The fixed portion is the

basic charge for having a service ready and obtainable, e.g. telephone rental

charge. The variable portion represents the charges made for the actual use of

the service, e.g. the call charges.

Important!

Please ensure that you now work through the semi-variable cost illustrative

example in the textbook.

4. Cost classification for control or evaluation

Some costs are not controllable by a manager and should therefore not form

part of his/her performance evaluation. The criteria for judging this should be

whether the manager has power to authorise or allow a particular cost, in which

case it is regarded as a controllable cost.

5. Cost classification for decision making

Decision making among various alternatives or actions should be based on

costs and revenue that are relevant to the choice.

5.1 Relevant costs

The costs which should be used for decision making are often referred to as

‘relevant costs’. CIMA defines relevant costs as ‘costs appropriate to aiding the

making of specific management decisions’.

To affect a decision a cost must be:


a) Future oriented: Past costs are irrelevant, as we cannot affect them

by current decisions and they are common to all alternatives that we

may choose.

b) Differential/Incremental: Meaning expenditure which will be incurred

or avoided as a result of making a decision. Any costs which would

be incurred whether or not the decision is made are not said to be

incremental to the decision.

c) Cash flow: Expenses such as depreciation are not cash flows and are

therefore not relevant. Similarly, the book value of existing equipment

is irrelevant, but the disposal value is relevant.

Other terms:

d) Opportunity costs: Value of potential benefit that is lost or sacrificed

when one course of action is chosen above another.

e) Common costs: Costs which will be identical for all alternatives are

irrelevant, e.g. rent or rates on a factory would be incurred whatever

products are produced.

f) Sunk costs: Another name for past costs, which are always irrelevant,

e.g. dedicated fixed assets, development costs already incurred.

g) Committed costs: A future cash outflow that will be incurred anyway,

whatever decision is taken now, e.g. contracts already entered into

which cannot be altered.

All costs are considered as avoidable except sunk costs and future costs that

do not differ between alternatives.

Important!

Please ensure that you now work through the illustrative examples in the

textbook.




You should now be able to master the learning outcomes for this unit.


Solutions

Exercise 1

1.1 Raw materials used to manufacture products (product / direct materials) 1.2 Wages of workers who handle material during the production process

(product / direct labour) 1.3 Advertising costs (period / marketing or selling) 1.4 Depreciation of a vehicle used by the managing director (period / admin) 1.5 The production manager’s salary (product / man. overheads) 1.6 Lease payments on manufacturing equipment (product / man.

overheads) 1.7 Lease payments on vehicles used by sales personnel (period / marketing

or selling) 1.8 Depreciation on manufacturing equipment (product / man. overheads) 1.9 Rent on factory building (product / man. overheads) 1.10 Cleaning material used by production workers (product / man.

overheads)

Exercise 2

2.1 Prime cost = D/M + D/L = 100 000 + 150 000 = 250 000

2.2 Conversion cost = D/L + M/O = 150 000 + 75 000 = 225 000

2.3 Product cost = 100 000 + 150 000 + 75 000 = 325 000

2.4 Period cost = 120 000

2.5 Total variable cost = (40% x 75 000) + (70% x 120 000) = 114 000

2.6 Total fixed cost = (60% x 75 000) + (30% x 120 000) = 81 000


Exercise 3

Cost behaviour

Cost Variable Fixed Mixed

3.1 Leather used to manufacture basketballs X

3.2 Cleaning material used in the factory X

3.3 Wages of assembly line workers paid per hour

X

3.4 Salary of factory supervisor X

3.5 Depreciation on factory plant and machinery X

3.6 Electrical costs of running machinery X

3.7 Rental of factory building X

3.8 Rates and taxes on factory building X

3.9 Manufacturing equipment leased at a flat rate per month plus an additional cost based on the number of hours that the machine is operated during the month

X

3.10 Telephone costs (including line rental) X

3.11 X- ray film used in a medical centre. X

3.12 Buns used to make hamburgers at a fast food outlet.

X

3.13 Maintenance of plant and machinery charged at a flat rate per month plus an addition cost based on the number of maintenance hours worked.

X

3.14 Shipping costs of a manufacturer where no monthly contract exists, i.e. the manufacturer is charged per product shipped.

X

3.15 Advertising for a retailer where a monthly contract exists.

X

3.16 Commission paid to sales personnel. X

3.17 Insurance on office building. X


Study Unit 5: Materials

This study unit addresses the management of materials. After completion of

this unit you will be able to identify direct and indirect materials. You should be

able to demonstrate knowledge of the various stock control methodologies and

should be able to calculate the economic order quantity and value of stock

using FIFO and the weighted average method of stock valuation.

Mastering material management is important as you will require this knowledge

to minimise cost of materials which is a crucial component of the pricing of the

firm’s products.



Distinguish between direct and indirect materials.

Describe stock control concepts, calculate stock levels and EOQ.

Describe stock valuation methods and calculate the value of closing

inventories using FIFO and the weighted average method.


1. Classification of materials Study reference

Study Cloete & Marimuthu 2008: Chapter 9, Section 9.1 – Classification of

materials.

1.1 Direct material

Raw material converted into a finished product through a manufacturing

process is classified as direct material. Direct materials can easily be seen in

the final product:

Steel -> Motor car

Wood -> Furniture.

1.2 Indirect material

Material used in the conversion process that contributes to the finished product

through a manufacturing process is classified as indirect material. Indirect

materials cannot be easily seen in the final product:

Chemicals added to iron ore for manufacture of steel - > Steel -> Motor car

Glue used to bind wood -> Furniture.

1.3 Work-in-progress

Raw material that has been partially converted into a finished good, e.g.

furniture partially fitted together, must be classified as work-in-progress. It must

also be noted that work-in-progress is a combination of three cost elements,

namely material, labour and overhead costs.

1.4 Finished goods

Products that have passed through the entire process of manufacturing and are

ready for sale are classified as finished goods.


1.5 Stock

Stock is the sum total of all indirect material, direct material, work-in-progress

and finished goods that the enterprise has at any given point in time.

2. Stock control Study reference

Please read Cloete & Marimuthu 2008: Chapter 9, Section 9.2.

2.1 Introduction

Although the authors of the prescribed text use the term stock, the term

inventory is also used in financial terms.

Inventory depends heavily on sales and can be classified as raw materials,

work-in-progress and finished goods. Inventory management is a difficult task

and errors in establishment of inventory levels can lead to a loss of sales or

excessive carrying costs.

Inventory management centres on the balancing of costs that increase with

larger inventory holdings (storage and security) and a set of costs that decline

with larger holdings (ordering costs, lost sales prevented). Good inventory

management will result in relatively high inventory turnover, low write-off of

obsolete or deteriorated inventories, and fewer lost sales due to stock-outs.

This in turn will contribute to a high profit margin and return on investment.

The investment in inventory (stock) for most manufacturing firms can be

substantial and therefore requires a systematic approach for control purposes.

A stock control system should consider:


Stock level recording and monitoring

Forecasting future demand

Quantity and timing of stock orders.

The main objective is to minimise total costs associated with stock. These

costs are classified into three groups, namely:

Carrying costs

Ordering costs

Stock-out costs.

2.2 Carrying costs

Carrying costs are those costs associated with the storage of the stock and

include:

Storage charges (rent, heating and lighting, air-conditioning and

refrigeration)

Staffing costs of stores personnel

Equipment and maintenance

Security and insurance charges

Cost associated with stock taking, recording and auditing

Handling charges

Obsolescence (items no longer required) and deterioration (e.g.

corrosion)

Theft, evaporation and vermin damage (rats and other pests)

Interest on capital invested in stock.

2.3 Ordering costs

Ordering costs are those costs associated with the obtaining the stock and

include:

Administrative costs of purchasing the stock

Transportation costs.


2.4 Stock-out costs

Stock-out costs are those costs associated with not having sufficient stock to

meet the customer’s needs. These costs are intangible and include:

Loss of contribution and profit as customer will now buy from competitor

Loss of future sales can occur if frequent stock outs are experienced, as

customer will direct purchasing power to other suppliers in future

Cost of stoppages in production in the case of manufacturing firms

Extra cost to meet urgent small orders.

2.5 Lead time

The time taken from when an order is placed with supplier until it arrives on the

firm’s premises is known as lead time.

2.6 Economic order quantity

In order to provide inventories at the lowest cost, it is important to determine the

optimal inventory level. A commonly used approach to determine the optimal

order level is based on the economic ordering quantity (EOQ) model. The

equation for the EOQ is:

Important!

Please ensure that you now work through the EOQ illustrative example in the

textbook.

2.7 Reorder level (ROL)

The ROL is the level of stock at which a replenishment order should be placed.

The reorder level depends on the lead time and the usage during the lead time.


It allows for the worst situation to occur without the danger of running out of

stock, e.g. maximum usage of stock at time where supplier takes maximum time

to deliver.

The order point is simply calculated as follows:

Order point = Usage x lead-time

Both components are expressed in the same time frame, e.g. days or weeks as

applicable.

2.8 Minimum stock level (MinSL)

An additional factor to be considered in determining the inventory level is the

concept of the minimum or safety stock. The safety stock acts as buffer for

delays in delivery as well as increases above the average sales rate per week

caused by seasonal demand or promotional activities.

2.9 Maximum stock level (MaxSL)

MaxSL is the maximum level of stock for which storage space would be

required.

2.10 Average stock level (AveSL)

The average units in stock reflect the average stockholding for a year. It can be

calculated as follows:

Average units in stock = EOQ/2 + Safety stock



Now do EOQ Exercise 1 in Cloete & Marimuthu 2008: Chapter 9.

Solution

Exercise 1

EOQ = √ 2 x Annual requirement x order cost

Carrying or holding cost per unit

EOQ = √ 2 x (3 500 x 50 weeks) x R45

R30

EOQ = √ 2 x 175 000 x R45

R30

EOQ = √ 15 750 000

R30

EOQ = 725 units of raw material


3. Stock valuation methods

Study reference

Study Cloete & Marimuthu 2008: Chapter 9, Section 9.3 – Stock valuation

methods.

3.1 Introduction

The value of stock on hand at the end of a given period can be calculated using

a variety of methods including:

First-in-First-Out method (FIFO)

Weighted average method

Standard price method

Market price method

Replacement value method

Increased amount method

3.1.1 First-in-First-Out method (FIFO)

According to the FIFO method, material purchased first is used first, i.e. oldest

stock is issued first at the price at which it was originally purchased. The result

is that stock on hand will be valued at the cost of stock more recently

purchased.

3.1.2 Weighted average method

According to this method, material purchased is added to that already in stock.

An average price must be determined after each purchase by dividing cost of

total stock on hand by number of units on hand.


Important!

Please ensure that you now work through the stock valuation illustrative



Now do stock valuation Exercises 1 and 2 in Cloete & Marimuthu 2008: Chapter

9.



Solution

Exercise 1

Material WG – stores ledger card first-in-first-out for Jan 20x1

Date RECEIVED ISSUED BALANCE

Units Price Amount Units Price Amount Units Price Amount

01 160 3,50 560,00

02 500 4,20 2 100,00 500 4,20 2 100,00

06 160 3,50 560,00 500 4.20 2 100,00

140 4,20 588,00 360 4,20 1 512,00

360 4,20 1 512,00

16 180 2,25 405,00 180 2,25 405,00

20 360 4,20 1 512,00 180 2.25 405,00

10 2,25 22,50 170 2,25 382,50

Closing stock value = R382,50 Material WG – stores ledger card weighted average for Jan 20x1



01 160 3,50 560,00

02 500 4,20 2 100,00 660 4,03 2 660,00

06 300 4,03 1 209,00 360 4,03 1 451,00

16 180 2,25 405,00 540 3,44 1 856,00

20 370 3,44 1 272,80 170 3,43 583,20

Closing stock value = R583,20 Workings

02 Total cost / Total units = (R560,00 + R2 100,00) / (160 + 500)

= R2 660 / 660 u

= R4,03

16 Total cost / Total units

= (R1 451,00 + R405,00) / (360 + 180)

= R1 856,00 / 540 u

= R3,44


Exercise 2

Retailers Ltd stock item XXX – stores ledger card first-in-first-out for April 20x1


Units Price Amount Units Price Amount Units Price Amount 01 30 50 1 500,00

02 10 50 500,00 20 50 1 000,00

07 20 75 1 500,00 20 75 1 500,00

15 40 100 4 000,00 40 100 4 000,00

20 20 50 1 000,00

20 75 1 500,00

15 100 1 500,00 25 100 2 500,00

25 45 125 5 625,00 45 125 5 625,00

30 12 100 1 200,00 13 100 1 300,00

45 125 5 625,00

Cost of sales = R500 + R1 000 + R1 500 + R1 500 + R1 200

= R5 700 Gross Profit = 20/100 x R5 700

= R1 140 Retailers Ltd stock item XXX – stores ledger card weighted average for April 20x1



01 30 50,00 1 500,00

02 10 50,00 500,00 20 50,00 1 000,00

07 20 75 1 500,00 40 62,50 2 500,00

15 40 100 4 000,00 80 81,25 6 500,00

20 55 81,25 4 468,75 25 81,25 2 031,25

25 45 125 5 625,00 70 109,38 7 656,25

30 12 109,38 1 312,56 58 109,38 6 343,69

Closing stock value = R5 801,38 Workings: 07 Total cost / total units 15 Total cost / total units

= (R1 000 + R1 500) / (20 + 20) = (R2 500 + R4 000) / (40 + 40) = R2 500 / 40 = R6 500 / 80 = R62,50 = R81,25

25 Total cost / total units = (R2 031,25 + R5 625) / (25 + 45) = R7 656,25 / 70

= R109,38


Study Unit 6: Labour, overheads and job costing

This study unit addresses the management of labour, overheads and

calculating the cost of a product or a job. After completion of this unit you will

be able to distinguish between direct and indirect labour, and calculate

overhead absorption rates. You should also be able to distinguish between

marginal and absorption costing and be able to apply marginal costing to typical

short-run decisions.

Mastering these concepts is important as you will require this knowledge to

ensure accurate pricing of the firm’s products.



Distinguish between direct and indirect labour.

Identify overhead costs.

Calculate the cost of a product or a job.

Distinguish between marginal and absorption costing.


1. Classification of labour Study reference

Study Cloete & Marimuthu 2008: Chapter 10 – Classification of labour.

Labour is the physical and/or mental effort used to manufacture a product or to

produce a service. Labour can be classified as direct or indirect labour.

1.1 Direct labour

Direct labour is the effort of personnel creating a product (such as assembly-line

workers) and can be physically traced to the creation of the product.

1.2 Indirect labour

Supervisory staff and maintenance staff’s labour in a production environment

cannot be physically traced to a specific product and is therefore regarded as

indirect labour.

2. Overheads

In a manufacturing environment all costs other than direct materials and direct

labour are regarded as overhead costs and this is organised into three

categories, namely indirect materials, indirect labour and other manufacturing

overheads.

Various examples are provided to explain these three categories of overhead

costs.


3. Job costing (absorption costing)

Industries where different products, jobs or batches use the same

manufacturing facility use job costing systems. Typical examples include

printing, shop fitting, furniture manufacturing and so on.

Typically these enterprises must provide quotations for jobs before the job is

started and therefore an estimate of overhead costs must be determined to

ensure that all costs (including direct material and direct labour) are recovered.

Steps involved in job costing

Step 1 – Calculate the overhead absorption rate (OAR)

The calculation of the OAR is dependent on the labour intensity vs. capital

intensity of the business. In a capital intensive business it would be appropriate

to use machine hours to allocate the overhead costs. In a labour intensive

business it would be appropriate to use labour hours or labour cost to allocate

overhead costs.

Some common OAR methods are:

Materials cost basis

Units of production

Machine hours basis

Direct labour hours

Direct labour cost.

At the time of providing the quote the actual costs will not be available and it is

for this reason that the appropriate budgeted elements will be used to determine

the allocation.

Step 2 – Calculate the cost price of the job

The cost of the job is the total of the following elements:


Total job cost = Direct material + Direct labour + Overheads (applied to the

job)

Step 3 – Calculate the selling price of the job

The selling price is:

Total job cost + Mark-up = Selling price

Step 4 – Determine if overheads were over or under applied

At the end of the financial year applied overheads and actual overheads are

totalled to determine if there was an over or under allocation of overhead costs.

If applied overheads exceed actual overheads, it means that overheads were

over applied. If it was over applied it means that customers were paying too

much for overheads. It then also means that the selling price was inflated

(leading to higher profit for the business). The opposite may also hold true.

Important!

Please ensure that you now work through the job costing illustrative example in

the textbook.


Now do job costing Exercises 1 and 2 in Cloete & Marimuthu 2008: Chapter 10.


Solution

Exercise 1

1.1 Budgeted overhead = 5 714 724

Budgeted units of production 2 745 000

= R 2,08 per unit of production

1.2 Budgeted overhead x 100 = 5 714 724 x 100

Budgeted direct materials cost 4 505 094

= 126,85% of direct materials cost

1.3 Budgeted overheads = 5 714 724

Budgeted machine hours 515 450

= R 11,09 per machine hour

1.4 Budgeted overhead = 5 714 724

Budgeted direct labour hours 1 342 000

= R 4,26 per direct labour hour

1.5 Budgeted overhead x 100 = 5 714 724 x 100

Budgeted direct labour cost 5 160 112

= 110,75% of direct labour cost


Exercise 2

OAR = Budgeted overhead = R960 000

Budgeted machine hours 600 000

= R1,60 per machine hour

Overheads applied to Job 6815 are: - R1,60 x 6000 machine hrs = R9 600

2.1

Total cost of Job 6815

Direct materials 24 000

Add: Direct labour 10 000

Prime cost 34 000

Add: Applied overheads (R1,60 X 6000) 9 600

Total cost 43 600

2.2

The mark up should be sufficient to

a) cover the cost of the job as well as

b) make a profit.


4. Marginal costing Study reference

Study Cloete & Marimuthu 2008: Chapter 13 – Marginal costing.

(Please note learning outcome 4 is now applicable)

4.1 Introduction

Marginal costing is also known as direct or variable costing. Under the

absorption costing method, both the fixed and variable costs are included in the

unit costs. The marginal costing method only includes the variable cost in the

unit cost of a product.

Important!

Please ensure that you now work through the income statements according to

the marginal and absorption costing illustrative example in the textbook.

4.2 Decisions using marginal costing

Three types of decisions can be made using marginal costing, namely:

1. Special order decisions

2. Dropping a product or department

3. Key factor/limiting factor decisions.

Any decision made using the marginal costing approach must provide a positive

contribution to be acceptable.

4.2.1 Special order decisions

From time to time a business may find that it has spare capacity and it is offered

a special order, below normal prices, which will take up the unused capacity.


The decision is based on whether or not the special order will provide a

contribution towards the fixed costs.

Important!

Please ensure that you now work through the special order illustrative example

in the textbook.

4.2.2 Dropping a product or department

A business may be under the impression that a product or department is

unprofitable. A consideration to drop the product or department can be made

using the marginal costing approach.

Important!

Please ensure that you now work through the illustrative example in the

textbook.

4.2.3 Choice of product where a limiting factor is present

A business may be able to produce a range of products but experience a

shortage of either materials or labour. A decision as to which product should be

produced can be made using the marginal costing approach.

Important!

Please ensure that you now work through the illustrative example in the

textbook.





Solutions

Exercise 1

Absorption costing approach Sales R900 000 Less: Production cost of sales 570 000

(350 000 + 220 000) Gross profit 330 000 Less: General overheads 180 000 Net profit 150 000 Marginal costing approach Sales R900 000 Less: Marginal costs 350 000 Contribution 550 000 Less: Fixed costs

- Production 220 000 - General 180 000

Net profit 150 000

Exercise 2

Calculation of surplus capacity 100 / 80 x 40 000 = 50 000 Therefore surplus capacity = 10 000 Calculation of variable cost per unit 400 000 / 40 000 = R10 per pack The special order will produce the following contribution:

Sales (10 000 x R13) R130 000 Less: Marginal costs (10 000 x R10) R100 000 Contribution R30 000

→ Accept the order as it produces R30 000 towards the payment of fixed costs. Profit once the order is accepted:

Sales (40 000 x R20) + 130 000 R930 000 Less: Marginal costs (50 000 x R10) R500 000 Contribution R430 000 Less: Fixed costs R160 000 Net profit R270 000


Exercise 3

3.1

Pinetown Ballito Amanzimtoti

Budgeted ticket sales Less: Variable costs

3 200 000 2 000 000

2 400 000 1 620 000

1 600 000 1 380 000

Film hire Wages & salaries Variable overheads

1 000 000 600 000 400 000

800 000 500 000 320 000

780 000 320 000 280 000

Contribution Less: Fixed costs

1 200 000 600 000

780 000 480 000

220 000 420 000

Net profit/loss 600 000 300 000 (200 000)

3.2 No. The Amanzimtoti cinema should not be closed because it provides a positive

contribution of R220 000 towards the covering of the fixed costs.


Study Unit 7: Budgetary control and sales variance

This study unit addresses the control of budgets. Upon completion of this unit

you should be able to demonstrate an understanding of the master budget and

you should also be able to draft operational, flexible and cash budgets.

Mastering these concepts is important as you will be required to plan for your

department and then exercise control by having a sound understanding of

concepts covered in the previous units as well as new knowledge gained in his

unit.



Describe components of an operational budget.

Draft operational budgets.

Draft flexible budgets.

Draft cash budgets.

Calculate and interpret sales variances.


1. Operational budgets Study reference

Study Cloete & Marimuthu 2008: Chapter 11, Section 11.2 – Operational

budgets.

An operational budget is prepared for a specific department or cost centre. All

operational budgets are combined into the master budget which includes a

budgeted income statement and a budgeted balance sheet. The

interrelationship between budgets is illustrated in the textbook.

Operating budgets consist of smaller budgets, namely:

1. Sales budget (depends on sales forecast)

2. Production budget (based on sales budget)

3. Direct materials usage budget (based on production budget)

4. Direct materials purchases budget (based on usage and stock levels of

raw materials)

5. Inventory budget (informed by direct materials budgets, work-in-progress

and finished product budgets)

6. Direct labour budget (depends on production budget)

7. Manufacturing overheads budget (depends on production budget)

8. Sales and administrative budgets (informed by current structure as well

as planned new sales budget).

Important!

Please ensure that you now work through the operational budget illustrative




Now do operational budget Exercise 1 in Cloete & Marimuthu 2008: Chapter 11.


Solution

Exercise 1

Sales budget Widget

Projected sales units 10 000 Selling price per unit R100 Total sales R1 000 000

Production budget

Widget

Sales units 10 000 Add: ending inventory 880 Total required units 10 880 Less: opening inventory 800 Units to be produced 10 080

Raw material budget – Widget Material S Material O

Production requirement 10 080 10 080 Units of material required per widget 5 10

Raw material usage 50 400 100 800 Add: ending inventory 4 950 13 200

Total required raw material 55 350 114 000 Less: opening inventory 4 500 12 000

Units to be purchased 50 850 102 000 Unit cost per kg R3 R4 Total cost of raw material R152 550 R408 000

Labour budget Machinery Assembly

Production requirement 10 080 10 080 Required hours per unit 1 0.5 Total hours required 10 080 5 040 Rate per hour R6 R8 Total labour cost R60 480 R40 320

Closing stock of finished goods budget

Raw materials: S (5 x R3) R15,00 O (10 x R4) R40,00 Direct labour: Machinery (1 x R6) R6,00 Assembly (0,5 x R8) R4,00 #Overheads: Machinery (1 x R4,96) R4,96 Assembly (0,50 x R9,92) R4,96 Cost of one unit produced R74,92 Closing inventory – units 880 Value of closing finished goods R65 929,60

#Overhead calculation Machinery department OAR = Budgeted overheads / Budgeted labour hours

= R50 000 / 10 080hrs = R4,96


Assembly department OAR = Budgeted overheads / Budgeted labour hours

= R50 000 / 5040hrs = R9,92

2. Flexible budgets Study reference

Study Cloete & Marimuthu 2008: Chapter 11, Section 11.3 – Flexible budgets.

A flexible budget is designed to allow cost levels to be changed to suit the

actual level of activity and is therefore useful for planning and control. It does

require a thorough understanding of cost behaviour. Performance control

reports should be using the flexible budget approach to control costs.

Important!

Please ensure that you now work through the flexible budget and performance

reports illustrative example in the textbook.


Now do flexible budget Exercise 1 in Cloete & Marimuthu 2008: Chapter 11.


Solution

Exercise 1

Costs based on various production levels

Units

cost p/u

48 800 61 000 73 200

Indirect labour Supplies Power Repairs Variable overheads Depreciation Fixed overheads

2 0,10 0,20 0,05 0,15

97 600 4 880 9 760 2 440 7 320

61 000 30 500

122 000 6 100

12 200 3 050 9 150

61 000 30 500

146 400 7 320

14 640 3 660

10 980 61 000 30 500

213 500 244 000 274 500

Performance report based on 48 800 units

Actual Budgeted Variance

Indirect labour Supplies Power Repairs Variable overheads Depreciation Fixed overheads

120 475 6 100

11 956 2 379 6 100

61 000 30 500

97 600 4 880 9 760 2 440 7 320

61 000 30 500

22 875 U 1 220 U 2 196 U

61 F 1 220 F

238 510 213 500 25 010 U


3. Cash budgets Study reference

Study Cloete & Marimuthu 2008: Chapter 11, Section 11.3 – Cash budgets.

A cash budget is designed to help an enterprise to anticipate its future cash

needs. This is an extremely important exercise as one of the main reasons for

business failure is poor cash management.

The budget is constructed by translating all budgets into cash terms and shows

detailed inflows and outflows. The point is to establish when cash flow

restraints will be experienced and therefore give management the opportunity to

seek alternative sources of finance.

Provision for bad debts and depreciation are two non-cash items and should

therefore never appear in the cash budget.

A cash budget is constructed following the format:

Opening cash balance Rxxx

Add: Cash receipts Rxxx

Total cash available Rxxx

Less: cash payments Rxxx

Closing cash balance Rxxx

Important!

Please ensure that you now work through the cash budget illustrative example

in the textbook.



Now do cash budget Exercise 1 in Cloete & Marimuthu 2008: Chapter 11.


Solution

Exercise 1

Cash budget of EPC Company

SEPTEMBER OCTOBER

Opening balance 22 250 13 400

Add: Cash receipts 178 750 219 500

Debtors 158 750 219 500

Loan 20 000 nil

Less: Cash payments (187 600) (222 600)

Merchandise purchases 90 000 120 000

Salaries and wages 22 500 25 000

Advertising 65 000 72 500

Rent payments 4 500 4 500

Equipment purchased 5 000 nil

Interest on loan 600 600

Loan repayment nil nil

Closing balance 13 400 10 300

Analysis of cash collected from credit sales

SEPTEMBER

July (3% x R125 000) 3 750

August (70% x R150 000) 105 000

September (25% x R200 000) 50 000

158 750

OCTOBER

August (3% x R 50 000) 4 500

September (70% x R200 000) 140 000

October (25% x R300 000) 75 000

219 500


4. Sales variances

Study reference

Study Cloete & Marimuthu 2008: Chapter 12, Section 12.1 – Sales variances.

Sales variances are as important to control as production variances. A sales

variance can be the result of a variance in price or a variance in quantity sold.

The sales variance resulting from quantity sold may be resulting from a variance

in sales mix or variance in volume sold.

Sales price variance is calculated as the difference between actual price sold

and standard price per unit for the number of units sold and is expressed in the

formula:

(AP – SP) x AQ

Sales quantity variance is calculated as the difference between budgeted

number of units sold and actual number of units sold at the standard price per

unit and is expressed in the formula:

(AQ – SQ) x SP

Too many external factors play a role in variance of sales and full variance

analysis may be a fruitless exercise.

Important!

Please ensure that you now work through the sales variance illustrative

examples in the textbook.



Now do sales variance Exercises 1and 2 in Cloete & Marimuthu 2008: Chapter 12.



Solution

Exercise 1

1.1 Sales price variance = (AP – SP) x AQ

= (1.20 – 1.00) x 10000*

= R2 000 F

R12 000 / R1,20

= 10 000 units

Or Actual sales – standard sales

= 12 000 – (10 000 x 1)

= 12 000 – 10 000

= R2 000 F

1.2 Sales quantity variance = (AQ – SQ) x SP

= (10000* – 9000*) x R1

= R1 000 F

* R12 000 / R1.20

* R9 000 / R1.00

1.3 Total sales variance = Sales price variance + sales quantity variance

= R2 000 F + R1 000 F

= R3 000 F


Exercise 2

2.1 Sales price variance

(AP – SP) x AQ

Ras = (4.75 *– 4.80) x 18 000 = R 900 U

Som = (2.12*– 2.10) x 82 000 = R1 640 F

Total sales price variance = R 740 F

* R85 500 / 18 000u = R4.75

* R173 840 / 8 200u = R2.12

2.2 Sales quantity variance =

(AQ – SQ) x Standard gross profit per unit

Ras = (18 000 – 15 000) x 2.55 = R 7 650 F

Som= (82 000 – 75 000) x 0.99 = R 6 930 F

Total sales quantity variance = R14 580 F


Conclusion

Congratulations you have completed Financial Management 1. You have

worked through this guide and should now have mastered the basics of

financial accounting and cost and management accounting.

We wish you well in the examination and trust that you will find that the contents

of this learner guide provide useful practical application in your marketing

career.


Bibliography

Cloete, M. and Marimuthu, F. 2008. Basic Accounting for Non-

Accountants. Pretoria: Van Schaik.

De Beer, L. 2005. (n.d.) Accounting for accounting standards. [Online]

Available: http://www.saica.co.za/ [2005, January 20].

Duncan, F. 2005. South Africa has high standards of financial reporting.

[Online] Available: http://www.moneyweb.co.za/ [2005, January 20].

Zidel, D. 2004. Basic Business Calculations. Johannesburg: Penguin

Books.

http://www.saica.co.za/

http://www.moneyweb.co.za/

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