Financial Accounting Notes

Eduvos and the Flipped Classroom

  • Before the session: Students review myLMS content, complete practice activities, and prepare questions.
  • During the session: Active learning, Q&A, debates, practice exercises, and higher-order thinking.
  • After the session: Revise recommended concepts and focus on learning opportunities on myLMS.

Key Points from Lesson 1

  • Users and Uses of Accounting Information:
    • General public, employees, labor unions, investors, customers, lenders, suppliers, management, government agencies.
  • Qualitative Characteristics of Financial Statements:
    • Relevance: Predictive or feedback value, timely basis.
    • Faithful Representation: Complete, neutral, free from error and bias, prudent (substance over form).
    • Enhancing Qualitative Characteristics:
      • Comparability, verifiability, timeliness, understandability.
  • Bookkeeping and Accounting Cycle:
    • Step 1: Transactions occur; source documents summarize them.
    • Step 2: Journals summarize source documents.
    • Step 3: General ledger summarizes journals.
    • Step 4: Trial balance summarizes the general ledger.
    • Step 5: Statement of profit or loss and other comprehensive income summarizes financial performance, and the statement of financial position measures financial position (A=E+LA = E + L).

Lesson 2: Topics to be Covered

  • Types of accounts and transactions.
  • Accounting concepts and the accounting equation.
  • Cash and credit transactions and source documents.
  • Ledgers and journals.
  • Balancing accounts.
  • Inventory systems.

Chart of Accounts

  • Non-current Assets: Land and buildings, furniture, equipment, vehicles, machinery, investments.
  • Current Assets: Debtors (Accounts receivable), inventories, cash and cash equivalents (bank, short-term savings, petty cash), prepaid expenses, income receivable (accrued income).
  • Equity: Capital, retained income, drawings (for personal use by the owner).
  • Income: Sales, fees earned, services rendered, rental income, interest income, discount received, commission received, donations received, credit losses recovered.
  • Expenses: Cost of sales, purchases, carriage on purchases, insurance, discount allowed, donations made, depreciation, water and electricity, fuel, petrol and oil, salaries and wages, stationery, advertising, bank charges, repairs and maintenance, telephone, interest expense, credit losses (bad debts), rental expense.
  • Non-current Liabilities: Debentures, long-term loans, mortgage bonds.
  • Current Liabilities: Short-term loans, creditors (accounts payable), bank overdraft, taxes due, income received in advance, accrued expenses.

The General Ledger

  • Collection of asset, equity, liability, income, and expense accounts.
  • Account: A record to which changes in value are recorded.
  • Takes the form of a T.
  • Components:
    • Date
    • Contra Account
    • Folio
    • Amount

T-Account: Increases and Decreases

  • Assets: Increase (Debit), Decrease (Credit), Balance (Debit)
  • Liability: Increase (Credit), Decrease (Debit), Balance (Credit)
  • Capital: Increase (Credit), Decrease (Debit), Balance (Credit)
  • Drawings: Increase (Debit), Decrease (Credit), Balance (Debit)
  • Income: Increase (Credit), Decrease (Debit), Balance (Credit)
  • Expenses: Increase (Debit), Decrease (Credit), Balance (Debit)

Misconceptions About Debits and Credits

  • Debit entries are not always increases, and credit entries are not always decreases.
  • Debit: Increase for assets, expenses, and drawings; decrease for equity, liabilities, and income.
  • Credit: Decrease for assets, expenses, and drawings; increase for equity, liabilities, and income.

Debits and Credits: DEAD CLIC

  • DEAD:
    • Drawings
    • Expenses
    • Assets
    • Debtors (+ - accounts)
    • Increase on the Debit side.
  • CLIC:
    • Capital
    • Liabilities
    • Income
    • Creditors (- + accounts)
    • Increases on the Credit side.

Ledger Account Explained

  • (1) Date: Day, month, and year of the transaction.
  • (2) Contra-Account: Account with the opposite accounting treatment.
    • Example: If Bank is debited and Accounts Receivable is credited, then Accounts Receivable is the contra-account for Bank, and vice versa.
  • (3) Folio Number: Used for reference to source documents.
  • (4) Value: Enter the value of the transaction.

Illustrative Example 1: Typo Office Services

  • Step 1: Identify the accounts.
  • Step 2: Assess whether there is an increase or decrease in the respective accounts.
  • Step 3: Categorize the accounts and apply the debit and credit rules to determine the impact on the account.

Transaction Examples with DEAD & CLIC Rules

Transaction 1
  • Purchased equipment from Suppro Ltd for R40 000, paid immediately by cheque/EFT.
    • Accounts: Bank and Equipment.
    • Change: Decrease in Bank, increase in Equipment.
    • Impact: Equipment (Debit R40 000), Bank (Credit R40 000).
Transaction 2
  • Rendered services for R11 100 to C. Kruger on credit.
    • Accounts: Accounts receivable & Services rendered.
    • Change: Increase in accounts receivable, increase in services rendered.
    • Impact: Accounts Receivable (Debit R11 100), Services Rendered (Credit R11 100).
Transaction 3
  • Purchased equipment from SunT Ltd for R30 000 on credit.
    • Accounts: Equipment and Payables.
    • Change: Increase in Equipment, increase in Payables.
    • Impact: Equipment (Debit R30 000), Payables (Credit R30 000).
Transaction 4
  • Received R5 000 from C. Kruger as payment on his account.
    • Accounts: Bank and Accounts Receivables.
    • Change: Increase in Bank, decrease in Accounts Receivable.
    • Impact: Bank (Debit R5 000), Accounts Receivable (Credit R5 000).
Transaction 5
  • Paid SunT Ltd R10 000 via EFT.
    • Accounts: Accounts Payable & Bank.
    • Change: Decrease in Accounts Payable, decrease in Bank.
    • Impact: Accounts Payable (Debit R10 000), Bank (Credit R10 000).
Transaction 6
  • Rendered services and received R8 900.
    • Accounts: Services Rendered and Bank.
    • Change: Increase in Bank, increase in Services Rendered.
    • Impact: Bank (Debit R8 900), Services Rendered (Credit R8 900).
Transaction 7
  • Paid monthly salaries of R21 500.
    • Accounts: Salaries and Bank.
    • Change: Increase in Salaries, decrease in Bank.
    • Impact: Salaries (Debit R21 500), Bank (Credit R21 500).
Transaction 8
  • Owner A. Cruzer deposited R50 000 of his own funds into the business bank account.
    • Accounts: Capital and Bank.
    • Change: Increase in Bank, increase in Capital.
    • Impact: Bank (Debit R50 000), Capital (Credit R50 000).
Transaction 9
  • Owner A. Cruzer bought a bicycle for his son and paid R1 000 via EFT from the business bank account.
    • Accounts: Drawings and Bank.
    • Change: Increase in Drawings, decrease in Bank.
    • Impact: Drawings (Debit R1 000), Bank (Credit R1 000).
Transaction 10
  • Purchased a computer for R15 000 from PC Mania and paid a deposit of R5000.
    • Accounts: Computers, Bank and Payables.
    • Change: Increase in Computers, decrease in Bank, increase in Payables.
    • Impact: Computers (Debit R15 000), Bank (Credit R5 000), Payables (Credit R10 000).

T-Accounts Example

  • Recording the transactions of Typo Office Services in T-accounts.
  • List of transactions (same as above).

Activity 1: The General Ledger (Pretty Lady Carpet Cleaners)

  • Transactions for May 2021 are provided.
  • Required: Prepare the General Ledger, properly balanced, for all transactions.
  • Show how general ledger accounts change under perpetual and periodic inventory systems.

Activity 2: The General Ledger (X's Green Gardening Services)

  • Transactions for June 2021 are provided.
  • Required: Prepare the General Ledger, properly balanced, for all transactions.

Perpetual vs. Periodic Inventory Systems

  • Perpetual Method: Continuous updating of inventory balances; records updated after each purchase and sale.
    • Example: Checkers, where inventory is automatically updated after each sale.
  • Periodic Method: Inventory balances are updated only at the end of the accounting period or periodically (quarterly/semi-annually).
    • Purchases are debited to purchases accounts, not directly to inventory.
    • Small businesses (cafés or hardware stores) typically use this system because they lack resources for a perpetual system.

Inventory System Transactions

  • Differences between Perpetual and Periodic systems illustrated through examples involving inventory purchases, additional costs, returns, sales, and owner's personal use. (See table for detailed account debits and credits for each transaction under both systems.)
Perpetual Inventory System
  • When inventory is sold, two entries are recorded:
    • One for sales revenue.
    • Another to update cost of sales and reduce inventory.
Periodic Inventory System
  • When inventory is sold, only one entry is recorded to depict sales revenue.
  • Cost of sales is calculated at the end of the accounting period.

Perpetual and Periodic Example

  • Illustrative example: Differences in accounting treatment under perpetual and periodic inventory systems.

Transactions List:

  • Purchased inventory for R15 000 and paid via EFT.
  • Paid R500 from petty cash for carriage on purchases.
  • Sold inventory of R7 500 on credit for R12 375.
  • Returned R1 000 of goods previously purchased on credit to the supplier.
  • A customer returned goods previously sold for R1 980 cash. The cost price was R990.

Profit Calculation: Perpetual vs. Periodic

  • Entities keep inventories to meet customer demand, replenished periodically.
  • Amount spent on purchasing merchandise during a period may differ from the cost of merchandise sold during the same period.
  • Trading entities purchase merchandise to sell at a profit.
  • Gross profit = Sales - Cost of goods sold.
  • Operating expenses deducted from gross profit to arrive at net profit.

Profit Calculation Process

  • Sales
  • Less: Cost of sales
  • Gross profit
  • Less: Expenses
  • Net Profit

Formula:

NetProfit=Sales−CostofSales−ExpensesNet Profit = Sales - Cost of Sales - Expenses

Gross Profit Nature

  • GrossProfit=Sales−CostofGoodsSoldGross Profit = Sales - Cost of Goods Sold

  • Example: Article bought for R80, sold for R120 (administrative and marketing expenses of R20).

  • Gross profit = R120 - R80 = R40.

  • Operating expenses not considered in gross profit calculation.

  • Gross profit calculation gives an indication of entity's performance in selling merchandise at a profit, irrespective of other activities.

Example: Microwaves

  • Total Purchases: 100 microwaves at R550 each = R 55 000
  • Total Sales: 75 microwaves at R879 each = 65 925
  • Sales (75 microwaves x R879 per unit) = 65 925
  • Less: Cost of Sales = (41 250)
  • Gross = R24 675

Gross Profit Percentage

  • Expressed as a percentage of either the selling price or the cost.
  • Determining the gross profit percentage:
    • (GrossProfit)÷(Sellingprice)x100/1(Gross Profit) ÷ (Selling price) x 100/1
    • Gross profit percentage = R40 ÷ R120 x 100/1= 33.3%

Gross Profit Percentage on Cost (Mark-up)

  • GrossProfit÷Costx100/1Gross Profit ÷ Cost x 100/1
  • Gross profit percentage on cost = R40÷R80x100/1=50R40 ÷ R80 x 100/1 = 50%

Price Policy

  • Trading entity aims for a fixed gross profit percentage.
  • Price policy is executed by adding the mark-up to the cost of merchandise.
  • Example: A trading entity wants to earn a gross profit of 20% on cost, an article with a cost of R40 should be marked at R48.
  • Selling price of item = R40 + 20%(40) = R40 +R8 = R48

Factors Affecting Gross Profit

  • Depending on the accounting system:
    • actual selling prices and discounts allowed;
    • actual cost;
    • loss of goods; and
    • accuracy of physical inventory count and measuring inventories.

Perpetual Inventory System: Profit Calculation

  • R
  • Sales (less sales returns) xx
  • Less: Cost of sales (xx)
  • Gross Profit = xx
  • Add: Other income xx
  • Less: Expenses (xx)
  • Net profit xx
  • Cost of Sales are updated with each sale and each sales return.

Periodic Inventory System: Profit Calculation

  • R
  • Sales (less sales returns) xx
  • Less: Cost of sales (see calculation below) (xx)
  • Gross Profit = xx
  • Add: Other income xx
  • Less: Expenses (xx)
  • Net profit xx

Calculation of Cost of Sales:

  • R
  • Opening Inventory
  • Add: Purchases (less purchases returns)
  • Add: Carriage on purchases
  • Less: Closing Inventory
  • Cost of sales xx

Profit Calculation Scenario

  • A business had 6 000 units @ R3 per unit on hand on 1 January 2020.
  • During the year 12 000 units were acquired @ R3.20 per unit and 250 units were returned to the supplier.
  • R1 200 was paid for carriage on purchases.
  • 4 000 units @ R3.20 was in stock according to the stock take on 31 December 2020.
  • 13 750 units were sold @ a selling price of R6 per unit.
  • The business earned rental income of R24 000 and incurred operating expenses of R36 000.

Mark-Ups, Margins - Introduction

In this lesson, you will learn how to apply mark-up percentages and gross profit margins.

Going back to Trading Inventory

Earlier I pointed out that:
When buying trading inventory, the business will pay a
COST PRICE (all costs incurred to bring inventory to its
location and condition of sale) and will then add PROFIT
to receive a SELLING PRICE (the price a customer pays) at
which the goods are sold.
It is every entrepreneur's priority to make as much.
profit as possible without losing any clients due to
excessive mark-ups.

The mark-up, the gross margin and VAT

  • The mark-up is the amount added to the cost price
    of a product to arrive at the selling price.

  • Mark-up and gross profit are different terms for
    the same thing.

  • The profit/mark-up amount may be expressed as a
    percentage of either the cost price or the selling
    price of the product.

  • the cost price, then this percentage is referred to as the
    mark-up percentage.

  • If the profit is express as a percentage of the selling price,
    then this percentage is known as the gross profit
    percentage.

  • The mark-up is used by the Junior Bookkeeper to
    determine the cost price of a product if the selling price is
    unknown

The mark-up and the gross margin

The gross margin is used by the Senior Bookkeeper
and Managerial Accountant to determine the ability
of gross profit to cover overheads.

These percentages tend to create confusion in
practice, learning example 3B on page 82 will make
it a bit more understandable.

EXAMPLE 3 B

(VAT calculations, mark-ups and margins)
The following costing formula is very important in the quest to ascertain a business's mark-
up percentage and/or gross margin:

Cost price
(Excl. VAT)

Gross profit amount
(Excl. VAT)

Selling price
(Excl. VAT)

When dealing with mark-up percentages or gross margins, we always work with the VAT
EXCLUSIVE prices.
Source: Maritz & Hibling, 2022

Illustration 1

Assume it costs a manufacturer R 200 (excluding VAT) to produce one unit of their product,
called Hypo X. The manufacturer would like to add a mark-up of 50% to their product
before selling it to the wholesaler. The manufacturer's costing ratio will be:

Cost price
(Excl. VAT)

Gross profit amount
(Excl. VAT)

Selling price
(Excl. VAT)

R 300
60 = 150
R 200
R 100

OR:

100
50
Source: Maritz & Hibling, 2022

Illustration 2

The selling price of the manufacturer now becomes the cost price of the wholesaler (in
terms of VAT exclusive prices, remember!). Let's further assume that the wholesaler wishes
to add a mark-up of 25% to their product. The wholesaler's costing ratio will be:

Cost price
(Excl. VAT)

Gross profit amount

Selling price
(Excl. VAT)
(Excl. VAT)

R 300
R 75
R 375

OR:

100
25

125
Source: Maritz & Hibling, 2022

Illustration 3

Other useful formulas that could be used in solving mark-up related problems involve the
calculation of the cost price, if only the selling price and the mark-up percentage or gross
margin are known:

Study the scenario and complete the questions that follow: Firepit

The following information applies to Firepit, a business trading with crates of firewood. Firepit uses the periodic inventory system.

Required:

  1. Calculate the closing inventories at 28 February 2023.
  2. Calculate the gross profit for February 2023.
  3. Calculate the mark-up percentage. Use 2 decimals if applicable.
  4. Calculate the gross profit margin. Use 2 decimals if applicable.

(10 Marks)

Study the scenario and complete the questions that follow: Adiah CC

Since 2018, Adiah CC has been purchasing generators for resale at a profit. The following information is available for the year ended 31 December 2023:

Required:

  1. Determine the cost of sales for Adiah CC on 31 December 2023. (9 Marks)

  2. Determine the gross profit for Adiah CC on 31 December 2023 (4 Marks)Item Units Price PerUnitInventory on 1 January 2023 15 generators R5 500Total purchases 120 generators R5 500Total sales 115 generators R8 000Source: Kavai, 2023

  3. Cost of sales on 31 December 2023:
    R
    Opening Inventory (15 x R5 500) 82 500
    Add: Purchases (120 x R5 500) 660 000
    Subtotal (i.e. goods available for sale) 742 500
    Less: Closing Inventory (15 +120 – 115 = 20 x R5 500) (110 000)
    Cost of Sales = 632 500

  4. Gross Profit on 31 December 2023:
    R
    Sales (115 x R8 000) 920 000
    Less: Cost of Sales (632 500)
    Gross profit = 287 500