Walkthrough question two
This chapter walks through a comprehensive question on preparing the statement of profit or loss and the statement of financial position for a limited liability company.
Learning objective
By the end of this chapter, you should be able to:
- Calculate revenue, cost of sales, gross profit, operating profit, profit before financing and income taxes, profit before income taxes, profit (for the year), and total comprehensive income (for the year) from the given information.
- Record the income tax expense in the statement of profit or loss, including the under-/ over-provision of tax in the prior year
- Prepare a statement of profit or loss and other comprehensive income or extracts as applicable.
- Prepare a statement of financial position or extracts as applicable.
Illustration 2: Sokoto Company Ltd
Sokoto Company Ltd is a retail company that has been operating for several years. The following trial balance was extracted from the books of account as at 31 December 2024:
| Debit ($) | Credit ($) | |
|---|---|---|
| Ordinary share capital (50,000 shares) | 200,000 | |
| Retained earnings (1 January 2024) | 133,400 | |
| 8% debenture (issued 1 July 2023) | 200,000 | |
| Land and buildings - cost | 450,000 | |
| Land and buildings - accumulated depreciation | 72,000 | |
| Equipment - cost | 180,000 | |
| Equipment - accumulated depreciation | 54,000 | |
| Inventory (1 January 2024) | 80,500 | |
| Trade receivables | 124,800 | |
| Allowance for irrecoverable debts | 3,600 | |
| Cash at bank | 45,200 | |
| Trade payables | 83,300 | |
| Sales revenue | 935,200 | |
| Taxation | 3,000 | |
| Purchases | 456,000 | |
| Distribution costs | 142,600 | |
| Administrative expenses | 186,400 | |
| Debenture interest paid | 8,000 | |
| Dividend paid | 5,000 | |
| TOTALS | 1,681,500 | 1,681,500 |
Additional information:
- Inventory at 31 December 2024 was valued at $94,200.
- Depreciation for the year has not yet been recorded. Depreciation is fully charged to administrative expenses.
- Buildings: 2% per annum on cost (land value is $150,000)
- Equipment: 20% per annum using the reducing balance method
- At the end of the year, the land was revalued to $200,000
- The allowance for irrecoverable debts should be adjusted to 4% of trade receivables.
- At year-end, distribution costs of $8,400 are outstanding, while the administrative expenses amount of $5,800 was prepaid.
- Debenture interest for the second half of the year remains unpaid.
- Income tax for the year is estimated at $48,600. The balance of taxation in the trial balance relates to over/under provision of tax in the previous year.
Required: prepare for Sokoto Company Ltd:
(a) The statement of profit or loss and other comprehensive income for the year ended 31 December 2024
(b) The statement of financial position as at 31 December 2024.
Suggested solution:
Before you start the solution, make sure you can explain how each item in the additional information affects:
- the statement of profit or loss and other comprehensive income, and/or
- the statement of financial position.
| Item | Statement of profit or loss and OCI | Statement of financial position |
|---|---|---|
| 1. Closing inventory $94,200 | Reduces cost of sales | Current asset (inventories) |
| 2. Depreciation | Added to administrative expenses | Reduces the carrying amount of buildings and equipment |
| 3. Land revalued to $200,000 | $50,000 gain in other comprehensive income | Increases land; revaluation surplus in equity |
| 4. Allowance adjusted to 4% | Increase in the allowance added to administrative expenses | Deducted from trade receivables |
| 5. Distribution costs owing $8,400; administrative expenses prepaid $5,800 | Adds to distribution costs; reduces administrative expenses | Accrued expenses (current liability); prepayment (current asset) |
| 6. Unpaid debenture interest | Adds to finance costs | Accrued expenses (current liability) |
| 7. Income tax estimate $48,600 and the trial balance taxation balance | Income tax expense: the estimate plus the under-provision | Income tax payable: the estimate only (current liability) |
W1: Cost of sales
Calculate the cost of sales.
| Amount ($) | |
|---|---|
| Opening inventory | 80,500.00 |
| Purchases | 456,000.00 |
| Closing inventory | (94,200.00) |
| Cost of sales | 442,300.00 |
W2: Distribution costs
Calculate the distribution costs.
| Amount ($) | |
|---|---|
| Per trial balance | 142,600.00 |
| Accrued distribution costs | 8,400.00 |
| Distribution costs | 151,000.00 |
W3: Administrative expenses
Calculate the administrative expenses.
| Amount ($) | |
|---|---|
| Per trial balance | 186,400.00 |
| Depreciation | 31,200.00 |
| Increase in allowance for irrecoverable debts | 1,392.00 |
| Prepaid administrative expenses | (5,800.00) |
| Administrative expenses | 213,192.00 |
Note: the prepayment is shown as a current asset in the statement of financial position.
- Depreciation charge for the year:
-
Building = ($450,000 cost - $150,000 land) x 2% = $6,000. Land isn’t depreciated, so all $72,000 of the accumulated depreciation relates to the buildings.
-
Equipment = ($180,000 - $54,000) x 20% = $25,200
- Allowance for irrecoverable debts
| Description | Amount ($) |
|---|---|
| Per trial balance (Opening balance) | 3,600.00 |
| Increase in allowance for irrecoverable debts | 1,392.00 |
| Closing balance (4% of $124,800 trade receivables) | 4,992.00 |
W4: Finance expense
Calculate the finance expense.
| Amount ($) | |
|---|---|
| Debenture interest paid | 8,000.00 |
| Accrued (outstanding) interest | 8,000.00 |
| Finance expense | 16,000.00 |
The debenture interest for the year is $16,000 (8% of $200,000). Only $8,000 appears in the trial balance because that is the amount paid during the year. The remaining $8,000 is unpaid at the year-end, so it must be accrued.
W5: Income tax expenses
| Amount ($) | |
|---|---|
| Current year income tax | 48,600 |
| Under tax provision | 3,000 |
| Income tax expense | 51,600 |
The taxation figure in the trial balance has a debit balance, so it represents an under-provision from the prior year. The current year income tax ($48,600) is shown as a current liability (income tax payable) in the statement of financial position. A credit balance here would instead represent an over-provision from the prior year, which reduces the current year’s income tax expense.
The following workings are used in the statement of financial position.
W6: Property, plant and equipment
Prepare the PPE schedule to determine the amount for the SOFP.
| Buildings | Land | Equipment | Totals | |
|---|---|---|---|---|
| Cost | 300,000.00 | 150,000.00 | 180,000.00 | 630,000.00 |
| Accumulated depreciation (1/1/2024) | (72,000.00) | - | (54,000.00) | (126,000.00) |
| Carrying amount (1/1/2024) | 228,000.00 | 150,000.00 | 126,000.00 | 504,000.00 |
| Depreciation for the year | (6,000.00) | - | (25,200.00) | (31,200.00) |
| Revaluation surplus | - | 50,000.00 | - | 50,000.00 |
| Carrying amount (31/12/2024) | 222,000.00 | 200,000.00 | 100,800.00 | 522,800.00 |
Revaluation surplus (Land) = Fair value - Carrying amount = $200,000 - $150,000 = $50,000
This revaluation surplus of $50,000 is presented in other comprehensive income and creates a revaluation reserve under equity in the statement of financial position.
W7: Trade receivables
Adjust the trade receivables for the SOFP.
| Amount ($) | |
|---|---|
| Per trial balance | 124,800 |
| Allowance for irrecoverable debts | (4,992) |
| Trade receivables | 119,808 |
W8: Accrued expenses
Determine the accrued expenses for the SOFP.
Hint: Add all the accrued expenses (to be shown as current liabilities) in the statement of financial position.
| $ | |
|---|---|
| Debenture interest accrued (w4) | 8,000 |
| Distribution costs accrued (w2) | 8,400 |
| Accrued expenses | 16,400 |
W9: Prepayments
Determine the prepaid expense balance for the SOFP.
Hint: Add all the prepaid expenses (to be shown as a current asset) in the statement of financial position.
| $ | |
|---|---|
| Administrative expenses prepaid (w3) | 5,800 |
W10: Retained earnings
Hint: You can only complete this after calculating profit for the period. Profit for the year is obtained from the statement of profit or loss.
| Amount ($) | |
|---|---|
| Opening balance (per trial balance) | 133,400 |
| Profit for the year | 61,108 |
| Dividend paid | (5,000) |
| Retained earnings | 189,508 |
Statement of profit or loss and other comprehensive income
Prepare the statement on your own before you check the answer.
Sokoto Company Limited Statement of profit or loss and other comprehensive income for the year ended 31 December 2024
| Note | $ | |
|---|---|---|
| Sales revenue | 935,200.00 | |
| Cost of sales | 1 | (442,300.00) |
| Gross profit | 492,900.00 | |
| Distribution costs | 2 | (151,000.00) |
| Administrative expenses | 3 | (213,192.00) |
| Operating profit | 128,708.00 | |
| Profit before financing and income taxes | 128,708.00 | |
| Finance expense (debenture interest) | 4 | (16,000.00) |
| Profit before income taxes | 112,708.00 | |
| Income tax expense | 5 | (51,600.00) |
| Profit for the year | 61,108.00 | |
| Other comprehensive income | ||
| Gain on revaluation of land | 6 | 50,000.00 |
| Total comprehensive income for the year | 111,108.00 |
Statement of financial position
Prepare the statement on your own before you check the answer.
Sokoto Company Ltd Statement of financial position as at 31 December 2024
| Note | $ | $ | |
|---|---|---|---|
| Non-current assets: | |||
| Property, plant and equipment | 6 | 522,800.00 | |
| Current assets: | |||
| Inventories | 94,200.00 | ||
| Trade receivables | 7 | 119,808.00 | |
| Prepaid expenses | 9 | 5,800.00 | |
| Cash at bank | 45,200.00 | ||
| Total assets | 787,808.00 | ||
| Equity and liabilities | |||
| Equity: | |||
| Ordinary share capital (50,000 shares) | 200,000.00 | ||
| Retained earnings | 10 | 189,508.00 | |
| Revaluation surplus | 50,000.00 | 439,508.00 | |
| Non-current liabilities: | |||
| 8% debenture | 200,000.00 | ||
| Current liabilities: | |||
| Trade payables | 83,300.00 | ||
| Accrued expenses | 8 | 16,400.00 | |
| Income tax payable | 5 | 48,600.00 | 148,300.00 |
| Total equity and liabilities | 787,808.00 |
Notice how the profit for the year from the statement of profit or loss (w10) flows directly into retained earnings in the statement of financial position. This is the main link between the two statements.