PRINCIPLES AND PRACTICE OF FINANICIAL ACCOUNTING FOR ACCOUNTING TECHNNICIANS SCHEME WEST AFRICA (ATSWA) SECOND EDITION STUDY PACK i Copyright©2009 by Association of Accountancy Bodies in West Africa (ABWA). All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of the copyright owner. Including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Published by ABWA PUBLISHERS Akintola Williams House Plot 2048, Michael Okpara Street Off Olusegun Obasanjo Way Zone 7, P.O. Box 7726 Wuse District, Abuja, FCT Nigeria. DISCLAIMER This book is published by ABWA, however, the views are entirely that of the writers. ii PREFACE INTRODUCTION The Council of the Association of Accountancy Bodies in West Africa (ABWA) recognized the difficulty of students when preparing for the Accounting Technicians Scheme West Africa examinations. One of the major difficulties has been the non-availability of study materials purposely written for the Scheme. Consequently, students relied on text books written in economic and socio-cultural environments quite different from the West African environment. AIM OF THE STUDY PACK In view of the above, the quest for good study materials for the subjects of the examinations and the commitment of the ABWA Council to bridge the gap in technical accounting training in West Africa led to the production of this Study Pack. The Study Pack assumes a minimum prior knowledge and every chapter reappraises basic methods and ideas in line with the syllabus. READERSHIP The Study Pack is primarily intended to provide comprehensive study materials for students preparing to write the ATS WA examinations. Other beneficiaries of the Study Pack include candidates of other Professional Institutes, students'-of Universities and Polytechnics pursuing first degree and post graduate studies in Accounting, advanced degrees in Accounting as well as Professional Accountants who may use the Study Pack as reference material. APPROACH The Study Pack has been designed for independent study by students and as such concepts have been developed methodically or as a text to be used in conjunction with tuition at schools and colleges. The Study Pack can be effectively used as a course text and for revision. It is recommended that readers have their own copies. iii STRUCTURE OF THE STUDY PACK The layout of the chapters has been standardized so as to present information in a simple form that is easy to assimilate. The Study Pack is organised into chapters. Each chapter deals with a particular area of the subject, starting with learning objective and a summary of sections contained therein. The introduction also gives specific guidance to the reader based on the contents of the current syllabus and the current trends in examinations. The main body of the chapter is subdivided into sections to make for easy and coherent reading. However, in some chapters, the emphasis is on the principles or applications while others emphasise methods and procedures. At the end of each chapter is found the following: PRINCIPLES & PRACTICE OF FINANCIAL ACCOUNTING • Summary • Points to note (these are used for purposes of emphasis or clarification); • Examination type questions; and • Suggested answers. HOW TO USE THE STUDY PACK Students are advised to read the Study Pack attempt the questions before checking the suggested answers. iv FORWORD The ABWA Council, in order to actualize its desire and ensure the success of students at the examinations of the Accounting Technicians Scheme West Africa (ATSWA), put in place a Harmonisation Committee, to among other things, facilitate the production of Study Packs for students. Hitherto, the major obstacle faced by students was the dearth of study texts which they needed to prepare for the examinations. The Committee took up the challenge and commenced the task in earnest. To start off the process, the existing syllabus in use by some member Institutes were harmonized and reviewed. Renowned professionals in private and public sectors, the academia, as well as eminent scholars who had previously written books on the relevant subjects and distinguished themselves in the profession, were commissioned to produce Study Packs for the twelve subjects of the examination. A minimum of two Writers and a Reviewer were tasked with the preparation of a Study Pack for each subject. Their output was subjected to a comprehensive review by experienced imprimaturs. The Study Packs cover the following subjects: PARTI 1. Basic Accounting processes and Systems 2. Economics 3. Business Law 4. Communication Skills PART II 1. Principles and Practice of Financial Accounting 2. Public Sector Accounting 3. Quantitative Analysis 4. Information Technology PART III 1. Principles of Auditing 2. Cost Accounting 3. Preparing Tax Computations and Returns 4. Management Although, these Study Packs have been specially designed to assist candidates preparing for the technicians examinations of ABWA, they should be used in conjunction with other materials listed in the bibliography and recommended text. PRESIDENT, ABWA v ACKNOWLEDGEMENTS The ATSWA Harmonisation Committee, on the occasion of the publication of theSeco edition of the ATSWA Study Packs acknowledge the contributions of the following groups of people. The ABWA Council, for their inspiration which gave birth to the whole idea of having a West African Technicians programme. Their support and encouragement as well as financial support cannot be overemphasized. We are eternally grateful. To The Councils of Institute of Chartered Accountants of Nigeria (ICAN) and Institute of Chartered Accountants of Ghana (ICAG), for their financial commitment and the release of staff at various points to work on the programme and for hosting the several meetings of the Committee, we say kudos. The contributions of various writers, reviewers, imprimaturs and workshop facilitators, whose spent precious hours writing and reviewing the Study Packs cannot be overlooked. Without their input, we would not have had these Study Packs. We salute them. Lastly, but not the least, to the members of the Committee, we say well done. Chairperson, ATSWA Harmonisation Committee. vi Chapter One 1.0 Learning Objectives 1.1 Introduction 1.2 Distinction Between Capital and Revenue Expenditure 1.3 Significance of the Distinction 1.4 Depreciation of Fixed Assets 1.4.1 Causes of depreciation 1.4.2 Purposes of Depreciation 1.5 Methods of Computing Depreciation 1.5.1 Straight Line Method 1.5.2 Reducing Balance Method 1.5.3 Sum of the years’ Digits method 1.6 Advantages and Disadvantages of three methods 1.6.1 Straight line method 1.7 Accounting Entries in respect of Acquisition and disposal of Fixed Assets 1.8 Summary Chapter Two 2.0 Accounting for non-profit organisation 2.1 Receipts and payments Accounts 2.2 Income and Expenditure Accounts 2.3 Preparation of Final Accounts Chapter Three 3.0 Learning Objective 3.1 Introduction 3.2 Accounting Cycle 3.3 Double Entry Systems 3.3.1 The General Rule of keeping double entry system 3.4 Trial Balance 3.4.1 Objective of Trial Balance 3.4.2 Types of Trial Balance 3.4.3 Errors that are not revealed by the trial balance from list of Balance 3.5 Adjusting process 3.5.1 Accounting Procedures for end of period adjustments. 3.6 Extended Trial Balance 3.6.1 Typical worksheet for Extended Trial Balance 3.6.2 Procedure for setting up a work sheet for extended Trial Balance 3.7 Final Accounts for Sole Trader 3.7.1 Networth or Equity for Sole Trader 3.7.2 Drawings 3.7.2 Taxation and Sole Trade Account 3.7.4 Income Statement 3.7.5 Statement of Financial Position vii 3.8 Summary of Financial position 3.9 Multiple Choice and Short Answer Questions 3.9.1 Solution to MCQ and SAQ Chapter Four 4.0 Learning Objective 4.1 Introduction 4.2 Accounting for VAT 4.3 Incidence of Tax 4.3.1 Illustration 1 4.4 Multiple Choice questions 4.4.1 Solution to MCQ and SAQ Chapter Five Theory of Accounting, Accounting Standards and Guidelines 5.0 Learning Objectives 5.1 Introduction 5.2 The Need for Regulation 5.3 IASB framework 5.3.1 Objectives of Financial Statements 5.3.2 Underlying Assumptions 5.3.4 Elements of Financial statements 5.4 Presentation of Financial Statement 5.5 Requirements of IASI 5.6 Inventory –IAS 2 5.7 Accounting Policies, changes in Accounting Estimates and ERRORS-IASB. 5.8 Property, Plant and Equipment – IAS 16 5.9 Multiple Choice and Short-answer Questions 5.9.1 Solution to MCQ and SAQ Chapter Six Partnership Accounts 1 6.0 Learning Objectives 6.1 Introduction 6.2 Definition of Partnerships 6.3 Formation of Partnership 6.4 Partnership Agreement 6.5 Rules Applicable in the Absence of Partnership Agreement 6.6 Accounts Peculiar to Partnership 6.7 MCQ and SAQ 6.7.1 Solution to MCQ and SAQ Chapter Seven Partnership Account 2 7.0 Learning Objectives 7.1 Change in the structure of Partnership viii 7.2 Goodwill 7.2.1 Accounting 7.3 Revaluation of Assets and Liabilities 7.3.1 Bookkeeping in respect of Revaluation 7.4 Admission of a new partner 7.6 Amalgamation of Partnership 7.7 Dissolution of Partnership 7.8 Conversion of Partnership of Limited Liability Company 7.9 Summary 7.10 MCQ and SAQ 7.11 Solution to MCQ and SAQ Chapter Eight 8.0 Learning Objectives 8.1 Introduction 8.2 Types of companies 8.2.1 Company Limited by Shares 8.2.2 Company Limited by Guarantee 8.2.3 Unlimited Company 8.3 Public and Private Companies 8.3.1 Private company 8.3.2 Public Company 8.3.3 Name of Company 8.4 Difference between companies and Partnership 8.5 Procedures required for formation of Companies 8.5.1 Content of Memorandum of Association of a Company 8.5.2 Contents of Articles of Association 8.5.3 Other information relating to formation of companies 8.6 Capital Structure of companies 8.6.1 Ordinary Share Capital 8.6.2 Preference Share Capital 8.6.3 Basis of Issuing share Capital 8.6.4 Other Important Terminologies in share issues 8.7 Debentures 8.8 Accounting for issue of shares 8.9 Summary 8.10 Multiple Choice and Short Answer 8.10.1 Solution to MCQ and SAQ Chapter Nine 9.0 Learning Objectives 9.1 Introduction 9.2 Preparation of Manufacturing Account 9.2.1 Objective of manufacturing Account 9.2.2 Division of cost 9.2.3 Prime cost ix 9.2.4 Production cost 9.2.5 Total cost 9.2.6 Format of manufacturing Account 9.2.7 Adjustment in manufacturing Account 9.2.8 Ascertainment of Profit or Loss on manufactured Goods 9.3 Other Information required for preparation of financial statements 9.3.2 Classification of Expenses 9.3.3 Statement of comprehensive Income 9.3.4 Statement of Financial position 9.3.5 Presentation of Dividends 9.3.6 Statements of changes in Equity 9.4 Summary 9.5 MCQ and SAQ questions Chapter Ten Statements of Cash flows and value Added 10.0 Learning Objectives 10.1 Introductive 10.2 Limitation of statement of cashflows 10.3 Differences Between cash flows and profits 10.4 Classification of cash flows 10.5 Preparation of statement of cashflow 10.6 Method 10.6.1 Direct method 10.6.2 Indirect method 10.7 Investing method 10.8 Financing Activities 10.9 Value Added Statement 10.10 MCQ and SAQ 10.10.1Solution to MCQ and SAQ Chapter Eleven Analysis and Interpretation of Financial Statement 11.0 Learning Objectives 11.1 Chapter Contents 11.2 Users of Financial Statements and their Information Needs 11.2.1 Users of Financial Statement 11.2.2 Information needs of interested groups 11.3 Basis of Comparison 11.4 Summary of Basic Accounting Ratios 11.5 Calculation of Basic ratios and their interpretation 11.5.1 Profitability Ratios 11.5.2 Liquidity Ratios 11.5.3 Activity/Efficiency Ratios 11.5.4 Investors/Stock Market Ratios 11.5.6 Gearing/Leverage Ratios x