ACCOUNTANCY A LEVEL(FORM SIX) NOTES – COMPANY ACCOUNT 1.6

(iv) Insurance Policy Method:

Instead of investing the sum in securities, the same is paid by way of an insurance premium to an insurance company which issues an endorsement policy of the amount equal to the sum payable on redemption and maturing on the date when the debentures become repayable.

The premium paid annually is debited to the Debenture Redemption Fund Policy Account and credited to the Cash/Bank Account, and the premium is paid at the beginning of a period.

The same amount will be set aside out of the Profit & Loss Appropriation Account through debiting Profit and Loss Appropriation Account and crediting Debenture Redemption Fund Account.

On the maturity of the policy:

Dr. Cash/Bank Account

Cr. Debenture Redemption Fund Policy Account with sum received on the maturity of the policy and any balance on the Insurance Policy Account shall be taken to the Debenture Redemption Fund (Deb. Red. Reserve) Account.

If a Credit Balance – Dr. Debenture Fund Policy Account
Cr. Debenture Redemption Fund Account

If a Debit Balance – Dr. Debenture Redemption Fund Account
Cr. Debenture Fund Policy Account

On the redemption of the debentures:

Dr. Redeemable Debenture Account / Debenture Redemption
Cr. Cash/Bank Account

The credit balance on the Debenture Redemption Fund Account shall be transferred to a Reserve Account.

Entry:
Dr. Debenture Redemption Fund Account
Cr. Reserve Account

Example:

A company has a debenture on issue of Tshs. 150,000 on 1^st Jan. 1990. It decided to provide for the redemption of the debentures for Tshs. 1,500,000 for 3 years. The annual premium is Tshs. 47,500. Show the necessary ledger accounts to record the above using the Insurance Policy Method.

DR REDEEMABLE DEBENTURE CR

DR DEBENTURE RED. FUND INSURANCE POLICY ACCOUNT CR

DR DEBENTURE REDEMPTION FUND ACCOUNT CR

DR DEBENTURE REDEMPTION ACCOUNT CR

Discount on debenture written off = 5/15 × 750 = 250.

COMPANY FINAL ACCOUNTS

They consist of the Trading Account and Profit and Loss Account. The trading and profit and loss accounts of a company are similar to those of a sole proprietorship, except that in the profit and loss account of the company, the following items can be seen to have been debited to it:

• Debenture Interest
• Directors’ salaries or fees or emoluments
• Audit fees or charges

And to the credit side, apart from the gross profit made, other gains such as dividends received can be shown.

In this section/account, the distribution of profit is shown. It is in this account that appropriation items such as corporation tax payable, proposed dividend, interim dividend, reserve transfer, etc., are listed.

Corporation Tax:

It is a tax levied on a company’s profit.

Dividend:

The term dividend originates from the Latin word “Dividend” meaning to divide. It is that part of the profit of a company which is distributed among its shareholders.

TYPES OF DIVIDEND:

• Interim Dividend
• Proposed Dividend

(a) INTERIM DIVIDEND

The word “Interim” originates from Latin meaning “in the meantime”. It is a dividend which is declared before the close of the company’s financial period.

(b) PROPOSED DIVIDEND:

This is only provided for and so not paid before the accounts are closed. It is shown among items on the Balance Sheet as “proposed dividend” or “unpaid dividend”.

To the credit side of the appropriation account is included such items as the net profit made during the year and balance of profit from the previous year.

DR APPROPRIATION ACCOUNT FOR THE YEAR ENDED 31ST DEC 1999 CR

BALANCE SHEET AS AT 31/12/1999

EXERCISE:

Here is a trial balance of RF Ltd as at 31^st June 2008.

Given the following information as at 30^th June 2008, draw up a set of financial statements for the year to that date.

1. Stock 30^th June 2008 Tshs. 4,937.
2. The share capital consisted of 25,000 ordinary shares of sh. each and 25,000 10 per cent preference shares was proposed to be paid as well as a dividend of 20 per cent on the ordinary shares.
3. Accrued rent Tshs. 700. Directors remuneration Tshs. 2,500.
4. Debentures interest ½ year’s interest owing.
5. Depreciation cost equipment 10 percent reserve, motors 20%.
6. Transfers to Reserve; General reserve Tshs. 2,000. Fixed assets replacement reserve Tshs. 1,000.
7. Provide 50% as corporation tax payable.

PROFIT & TRADING & LOSS APPROPRIATION ACCOUNT & BALANCE SHEET

BALANCE SHEET AS AT 30TH JUNE 2008

HIRE PURCHASE ACCOUNTING

HIRE PURCHASE TRANSACTIONS

As a system of trading, hire purchase is governed by the Hire Purchase Act. Under this system, the buyer agrees to pay for the goods by installments.

The property in goods remains with the seller and the buyer pays hire charges over a stipulated period of time at the end of which he pays a further amount called an option to purchase/option fee which then gives him ownership. The buyer obtains possession of the goods and uses them, but ownership of the goods will pass from the seller to the buyer when the latter pays the final installment. If the buyer fails to pay any installment, then the seller will be entitled to take back the goods (repossess) and the buyer shall have no claim over the installments he already paid.

ACCOUNTING PART

1. Buyer’s books.
2. Seller’s books.

Hire-purchase transactions in the buyer’s books

Goods which are dealt with are usually fixed assets such as motorcars, refrigerators, etc.

The hire purchase price actually consists of two elements:

1. Cash “cost” price
2. Hire purchase interest

This acts as compensation to the seller for delay in receiving a full payment at once and also for covering some attendant risks.

N.B.

It is a normal accounting policy to treat hire purchase transactions as actual sales or purchases, because the intention of the buyer is to pay the whole amount through installments.

Methods of writing off the hire purchase interest:

1. Straight line / fixed installment method.
2. Sum of the digits method (or rule of 78 method).
3. Actuarial method.

This interest should be written off to Profit & Loss Account over the period of the hire purchase contract.

Straight line method

Under this method, the hire purchase interest is written off on a straight line basis. Therefore, the hire purchase interest per installment due = (Total hire purchase interest) / (Total number of installments).

Sum of the years’ digits method

This is an arithmetical method of apportioning the hire purchase interest in approximate proportion to the amount outstanding at any time.

Procedure

1. Number the installments, e.g., 3 installments:

1

2

3

2. Assign the highest digit to the first installment and digit one to the last installment.

Installment digits

1 – 3

2 – 2

3 – 1

3. Sum up the digits: 6

4. Apportion the hire purchase interest, e.g., Hire Purchase interest = Tshs 36,000

1^st Year hire purchase interest = 3/6 × 36,000 = 18,000

2^nd Year hire purchase interest = 2/6 × 36,000 = 12,000

3^rd Year hire purchase interest = 1/6 × 36,000 = 6,000

Buyer’s books continue

Actuarial method

This is a method of writing off the hire purchase interest based on the reducing balance phenomenon.

This method can be used in the presence of the following items:

• Cash price
• Deposit (not necessary)
• Rate of interest
• Number of installments together with their respective amounts

Working:

METHOD OF RECORDING

There are two alternative methods of recording.

Method A

Accounting entries:

With the cash “cost price”

With the proportion of the H.P interest when installment is due

With the deposit + installment paid

N.B. Balance on the vendor account represents the unpaid portion of the cash price, which should be included under current liabilities in the Balance Sheet.

METHOD B

1. Dr. Fixed Assets Account with the cash price
2. Dr. H.P Interest Suspense Account with the total H.P interest
3. Cr. Vendors Account with total H.P price.

With the proportion of the H.P interest when installment is due

With the deposit + installment paid

N.B. The balance on the vendor account less the balance of hire purchase interest suspense account shall be included in current liabilities in the balance sheet.

Example

On 1^st Jan 1991, Contractor’s Ltd bought a hydraulic crane from Hi-lift Ltd on hire purchase. The terms of the H.P contract were initial deposit of Tshs 40,000 payable followed by 3 installments of Tshs 37,978 on 1^st Dec in each of the next three years from 1991 onwards. The cost of the crane for cash purchase would have been Tshs 120,000. Interest is charged on the balance outstanding on 31^st Dec at the rate of 20% p.a. The final year of both companies ends 31^st Dec.

Required

1. What was the amount of H.P. Interest included in the H.P price?
2. What amount of interest could be allocated in each of three years if the sum of digits method were used?
3. Prepare the relevant ledger accounts in Contractor’s Ltd ledger for each of the three years ended 31^st Dec 1991, 1992, 1993 based on the assumption that Contractor’s Ltd charges depreciation on its fixed assets using a straight line method in addition to 20% p.a interest rate.

Solution

DR HI-LIFT COMPANY ACCOUNT CR