Business accounting 2 - Frank Wood & Alan Sangster

An imprint of www.pearson-books.com New to this edition: ➤ Over 120 brand new review questions for exam practice ➤ Two new chapters on Corporate Governance and Public Sector Accounting ➤ Coverage of International Accounting Standards 2005 ➤ Additional worked examples for areas of difficulty such as ratio analysis Features: ➤ Easy-to-follow explanations of contemporary accounting practice ➤ Clear and logical progression through topics ➤ Activities designed to reinforce your understanding of key concepts ➤ Over 300 review questions, including past Examination Board questions ➤ Regularly updated Companion Website at www.pearsoned.co.uk/wood including further self-test questions and accounting standards updates F R A N K W O O D & A L A N S A N G S T E R 2businessaccountingT E N T H E D I T I O N F R A N K W O O D ’ S 2 T E N T H E D I T I O N F R A N K W O O D ’S W O O D & S A N G S T E R business accounting Every year, thousands of students rely on Frank Wood's best-selling books to help them pass their accountancy exams. 'A classic textbook that has set thousands of students on a straight path since it was first published, Wood & Sangster's Business Accounting can be recommended without reservation to all accounting students.' Dr George Iatridis, University of Athens, Greece and University of Manchester Additional student support at www.pearsoned.co.uk/wood Additional student support at www.pearsoned.co.uk/wood The book is used on a wide variety of courses in accounting and business, both at secondary and tertiary level and for those studying for professional qualifications. It builds on Business Accounting 1 to cover advanced aspects of financial accounting. It also covers introductory aspects of management accounting suitable for use at all levels up to and including professional foundation level courses and first-year degree courses. Business Accounting is the world’s best-selling textbook on bookkeeping and accounting. Now in its tenth edition, it has become the standard introductory text for accounting students and professionals alike. 0273693107_COVER(Wood2) 9/2/05 9:34 am Page 1 FRANK WOOD’S business accounting 2 Visit the Business Accounting, tenth edition Companion Website at www.pearsoned.co.uk/wood to find valuable student learning material including: l Learning objectives for each chapter l Multiple choice questions to help test your learning l Review questions and answers l Links to relevant sites on the web l Searchable online glossary l Flashcards to test your knowledge of key terms and definitions BA2_A01.qxd 10/3/05 1:42 pm Page i Frank Wood 1926–2000 BA2_A01.qxd 10/3/05 1:42 pm Page ii F R A N K W O O D ’ S 2business accounting FRANK WOOD BSc (Econ), FCA and ALAN SANGSTER BA, MSc, Cert TESOL, CA TENTH EDITION BA2_A01.qxd 10/3/05 1:42 pm Page iii Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world. Visit us on the World Wide Web at: www.pearsoned.co.uk First edition published in 1967 Second edition published under the Longman imprint in 1972 Third edition published in 1979 Fourth edition published in 1984 Fifth edition published under the Pitman Publishing imprint in 1989 Sixth edition published in 1993 Seventh edition published in 1996 Eighth edition published under the Financial Times Pitman Publishing imprint in 1999 Ninth edition published in 2002 Tenth edition published in 2005 © Frank Wood 1967 © Longman Group UK Limited 1972, 1979, 1984, 1989, 1993 © Pearson Professional Limited 1996 © Financial Times Professional Limited 1999 © Pearson Education Limited 2002, 2005 The rights of Frank Wood and Alan Sangster to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP. ISBN 0 273 69310 7 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Wood, Frank. Frank Wood’s business accounting, 2 / Frank Wood and Alan Sangster.—10th ed. p. cm. Includes index. ISBN 0-273-69310-7 1. Accounting. I. Title: Business accounting 2. II. Title: Business accounting two. III. Sangster, Alan. IV. Title. HF5635.W8633 2005 657—dc22 2004061993 10 9 8 7 6 5 4 3 08 07 06 05 Typeset in 9.5/11.5pt Sabon by 35. Printed and bound in China. EPC/03 Also available: Frank Wood’s Business Accounting Vol 1 – 0273 681494 Book-keeping & Accounts – 0273 685481 Frank Wood’s A-level Accounting – 0273 685325 BA2_A01.qxd 10/3/05 1:42 pm Page iv v Contents part 1 part 2 part 3 Notes for teachers and lecturers xii Notes for students xiv Special accounts 1 Accounting for branches 3 2 Hire purchase accounts 29 Companies 3 Limited companies: general background 49 4 The issue of shares and debentures 55 5 Companies purchasing and redeeming their own shares and debentures 70 6 Limited companies taking over other businesses 94 7 Taxation in company financial statements 113 8 Provisions, reserves and liabilities 130 9 The increase and reduction of the share capital of limited companies 136 10 Accounting standards and related documents 148 11 The financial statements of limited companies: profit and loss accounts, related statements and notes 183 12 The financial statements of limited companies: balance sheets 205 13 Published financial statements of limited companies: accompanying notes 218 14 Cash flow statements 240 15 Contract accounts 264 Groups 16 Group financial statements: an introduction 277 17 Consolidation of balance sheets: basic mechanics (I) 284 18 Consolidation of balance sheets: basic mechanics (II) 307 19 Intercompany dealings: indebtedness and unrealised profit in stocks 317 20 Consolidated financial statements: acquisition of shares in subsidiaries at different dates 330 21 Intra-group dividends 333 22 Consolidated balance sheets: sundry matters 347 23 Consolidation of the financial statements of a vertical group of companies 356 24 Consolidated profit and loss accounts 369 25 Consolidated financial statements: acquisitions and mergers 378 26 Standards covering subsidiary and associated undertakings and joint ventures 386 BA2_A01.qxd 10/3/05 1:42 pm Page v Contents vi part 4 part 5 part 6 part 7 part 8 part 9 part 10 Financial analysis 27 Accounting ratios 401 28 Interpretation of financial statements 422 Issues in financial reporting 29 Accounting theory 447 30 Current cost accounting 466 31 Social accounting 482 32 Corporate governance 491 33 Public sector accounting 496 34 Accounting for management control 505 Costing 35 Elements of costing 517 36 Absorption and marginal costing 531 37 Job, batch and process costing 555 Budgets 38 Budgeting and budgetary control 573 39 Cash budgets 582 40 Co-ordination of budgets 594 Standard costing and variance analysis 41 Standard costing 615 42 Materials and labour variances 620 43 Overhead and sales variances 638 Planning, control and decision making 44 Break-even analysis 657 45 Interest, annuities and leasing 674 46 Capital expenditure appraisal 689 47 The balanced scorecard 707 The emerging business environment of accounting 48 The supply chain and enterprise resource planning systems 717 49 E-commerce and accounting 724 Appendices 1 Interest tables 731 2 Answers to review questions 735 3 Glossary 804 Index 808 BA2_A01.qxd 10/3/05 1:42 pm Page vi Supporting resources Visit www.pearsoned.co.uk/wood to find valuable online resources Companion Website for students l Learning objectives for each chapter l Multiple choice questions to help test your learning l Review questions and answers l Links to relevant sites on the web l Searchable online glossary l Flashcards to test your knowledge of key terms and definitions For instructors l Complete, downloadable Solutions Manual l PowerPoint slides that can be downloaded and used as OHTs Also: The Companion Website provides the following features: l Search tool to help locate specific items of content l E-mail results and profile tools to send results of quizzes to instructors l Online help and support to assist with website usage and troubleshooting For more information please contact your local Pearson Education sales representative or visit www.pearsoned.co.uk/wood BA2_A01.qxd 10/3/05 1:42 pm Page vii viii Guided tour of the book ISSUES IN FINANCIAL REPORTING part 5 Introduction This part looks at the theories upon which accounting practice is based, considers issues affecting accounting and financial reporting and reviews the place of accounting information in the context of the environment in which business entities operate. 29 Accounting theory 447 30 Current cost accounting 466 31 Social accounting 482 32 Corporate governance 491 33 Public sector accounting 496 34 Accounting for management control 505 Part opening Chapter 36 l Absorption and marginal costing 543 On the full cost basis, only A and D appear to be profitable. Should production of B, C and E be discontinued? You know that production should cease only when the selling price is less than marginal cost. In Exhibit 36.10, you can see if following this brings more profit than following the result of the full cost calculation. You can also see what would have happened if production levels of all products continued as before. Exhibit 36.9 Violet Ltd Products A B C D E Cost per unit: £ £ £ £ £ Direct labour and materials 8 9 16 25 11 Variable manufacturing costs 7 8 10 13 14 Marginal cost 15 17 26 38 25 Fixed costs 5 7 11 15 10 Full cost 20 24 37 53 35 Selling price per unit 30 21 31 80 20 Exhibit 36.10 (1) (2) (3) Following Using marginal Ignore costing full-cost pricing, costing, cease altogether and cease producing producing E produce all B, C and E only items £ £ £ Sales: A 100 × £30 3,000 3,000 3,000 B 100 × £21 2,100 2,100 C 100 × £31 3,100 3,100 D 100 × £80 8,000 8,000 8,000 E 100 × £20 2,000 Total revenue 11,000 16,200 18,200 Less Costs: Direct labour and materials: 100 × cost per product (£33) 3,300 (£58) 5,800 (£69) 6,900 Variable manufacturing costs: (£20) 2,000 (£38) 3,800 (£52) 5,200 100 × cost per product Fixed costs (do not change) 4,800 4,800 4,800 Total costs (10,100) (14,400) (16,900) Net profit 900 1,800 1,300 36.12 Using marginal costs Let’s test what you’re just learnt in another example. A company produces five products and has the following cost and sales data. It can sell exactly 100 of each product it manufactures. Total fixed costs are £4,800, apportioned: A £5 (100), B £7 (100), C £11 (100), D £15 (100), E £10 (100), i.e. £4,800 total. Exhibit 36.9 presents this in a table. A wide range of exhibits offer clear examples of accounting practice and methodology. 55 The issue of shares and debentures chapter 4 Learning objectives After you have studied this chapter, you should be able to: l explain the terminology relating to the issue of shares and debentures l describe the steps in the process of issuing of shares and debentures l record the accounting entries relating to the issue of shares and debentures l make the necessary entries in the ledger accounts when shares are forfeited Introduction In this chapter, you’ll learn about the alternatives available to companies when they wish to issue shares and of the various entries to be made in the ledger accounts. You’ll learn about how to record the issue of shares at a price greater than their nominal value and how to record the issue of shares to existing shareholders, rather than to non-shareholders wishing to purchase them. You will also learn about the difference in accounting entries made when debentures (a form of loan capital) rather than shares, are issued. 4.1 Activity 4.1 The issue of shares The cost of issuing shares can be very high. As a result, the number of shares issued must be suffi- cient to ensure the cost of doing so is relatively insignificant compared to the amounts received. When shares are issued, they may be payable, either (a) immediately on application, or (b) by instalments. Issues of shares may take place on the following terms connected with the price of the shares: 1 Shares issued at par. This would mean that a share of £1 nominal value would be issued for £1 each. 2 Shares issued at a premium. In this case a share of £1 nominal value would be issued for more than £1 each, say for £3 each. Note: At one time, shares could be issued at a discount. Thus, shares each of £5 nominal value might have been issued for £3 each. However, this was expressly forbidden in the Companies Act 1980. Why do you think companies may wish to issue shares at a discount and how do you think companies avoid being in this position? Learning objectives outline what you will need to have learned by the end of the chapter. Chapter 8 l Provisions, reserves and liabilities 131 8.3 Activity 8.1 Activity 8.2 8.4 should ever meet a situation where it would suffer loss because of foreign currency exchange rate movements; or it could be a general reserve account that could be used for any purpose. See Section 8.3 for a further look at general reserves. Such transfers are an indication to the shareholders that it would be unwise at the time of the transfer to pay out all the available profits as dividends. The resources represented by this part of the profits should be retained, at least for the time being. Revenue reserves can be called upon in future years to help swell the profits shown in the profit and loss appropriation account as being available for dividend purposes. This is effected quite simply by debiting the particular reserve account and crediting the profit and loss appropriation account. Why do you think special revenue reserves are used, rather than simply leaving everything in the profit and loss account (which is, itself, a revenue reserve)? General reserve A general reserve is one that can be used for any purpose. For example, it may be needed because of the effect of inflation: assume a company needs £4,000 working capital in 20X3 and that the volume of trade remains the same for the next three years but that during that time, the general level of prices increases by 25 per cent: the working capital requirement will now be £5,000. If all the profits are distributed, the company will still have only £4,000 working capital which cannot possibly finance the same volume of trade as it did in 20X3. Transferring annual amounts of profits to a general reserve instead of paying them out as dividends is one way to help overcome this problem. In terms of the amount of working capital, what is the difference between doing this and leaving the amount transferred in profit and loss? On the other hand, it may just be the conservatism convention asserting itself, with a philo- sophy of ‘it’s better to be safe than sorry’, in this case to restrict dividends because the funds they would withdraw from the business may be needed in a moment of crisis. This is sometimes over- done, with the result that a business has excessive amounts of liquid funds being inefficiently used when, if they were paid out to the shareholders, who are, after all, the owners of the busi- ness, the shareholders could put the funds to better use themselves. This then leaves the question of the balance on the profit and loss appropriation account. If it is a credit balance, is it a revenue reserve? Yes. If profits are not distributed by way of dividend, they are revenue reserves until such time as they are converted into share capital or transfered to other reserves. Capital reserves A capital reserve is a reserve which is not available for transfer to the profit and loss appropri- ation account to swell the profits shown as available for cash dividend purposes. Most capital reserves can never be utilised for cash dividend purposes – notice the use of the word ‘cash’, as it will be seen later that bonus shares may be issued as a ‘non-cash’ dividend. Let us look at the ways in which capital reserves are created. Activities occur frequently throughout the book to test your understanding of new concepts. BA2_A01.qxd 10/3/05 1:42 pm Page viii ix Chapter 23 l Consolidation of the financial statements of a vertical group of companies 361 23.6 Profit and Loss £000 £000 Minority interest S1 3 P 60 Minority interest S2 14 S1 15 Cost of control S1: pre-acquisition 4 S2 35 Cost of control S2: pre-acquisition 9 Cost of control: goodwill written off 20 Balance to consolidated balance sheet 60 110 110 General Reserve £000 £000 Cost of control 80% × 10 8 S1 balance b/d 10 Minority interest 20% × 10 2 10 10 Now, let’s look at the same example but, this time, with the addition of proposed dividends. A worked example with proposed dividends Taking the same companies as in Example 1 but in this case the companies have proposed divi- dends at 31 December 20X5 of P Ltd £16,000; S1 Ltd £5,000; S2 Ltd £20,000. The balance sheets would have appeared: Balance Sheets as at 31 December 20X5 P Ltd S1 Ltd S2 Ltd £000 £000 £000 Fixed assets 40 4 27 Investments Shares in S1 41 Shares in S2 25 Net current assets (as before) 19 6 28 Dividends to be received (80% of S1) 4 (75% of S2) 15 104 50 55 £000 £000 £000 Share capital 40 10 20 Profit and loss as at 31.12.20X4 24 5 15 Retained profits for 20X5 (see below) 24 20 – 48 25 15 General reserve 10 Proposed dividends 16 5 20 104 50 55 Note: Retained profit P S1 S2 Net profits 20X5 36 10 20 Less Proposed dividends (16) ( 5) (20) 20 5 – Add Dividends receivable P 80% of S1 × 5 4 S1 75% of S2 × 20 15 – 24 20 – Part 3 l Groups 282 16.9 Teaching method This topic can be taught and learnt using either of two methods. One is to focus on the journal entries required; this is quite abstract and, many feel, more difficult to understand than the other method. Accordingly, the method used in this book for teaching consolidated financial state- ments is that of showing the adjustments needed on the face of the consolidated balance sheet, together with any workings required to explain the amounts included. This approach is adopted because: 1 We believe our job is to try to help you to understand the subject, and not just to be able to perform the necessary calculations. We believe that, given a clear explanation of what is happening, the necessary accounting entries are much easier to understand. Showing the adjustments on the face of the balance sheet gives a ‘bird’s-eye view’ so that it is easier to see what is happening, rather than having to laboriously trace your way through a complex set of double-entry adjustments made in ledger accounts. 2 This would be a much lengthier and more costly book if all of the double entry accounts were shown. It is better for a first look at consolidated financial statements to be an introduction to the subject only, rather than both an introduction and a very detailed analysis of the subject. If you can understand the consolidated financial statements shown in this book, you will have a firm foundation which will enable you, in your future studies, to tackle the more difficult and complicated aspects of the subject. Learning outcomes You should now have learnt: 1 Ordinary shareholde