The first reconciliation that Amanda attempted was to reconcile her cash book with the bank statement she had received. The bank had debited her account with £85 300, made up of:
(1) First repayment of loan, £50 000 (2) Interest on loan, £20 000
(3) Bank charges of £15 300, including £600 penalty charges for overdraw- ing without authorisation.
Amanda was surprised by this, but she put the above through her books, as transaction number 19, and decided to see her accountant to see what could be done. Her next reconciliation was reconciling the purchase ledger
with suppliers’ statements, and these were found to be in order. However, reconciling the sales ledger was much more difficult. Her age debt list (simply a list of debtors analysed by age, showing not overdue, 30 days overdue, 60 days overdue, etc.) showed that her credit control procedures were not good enough and while her debtor insurance would ensure that she got paid in the end, her insurance did not cover her for returned goods. She had to deal with the returned goods from CDZ Limited and felt that, in order to maintain goodwill, she had to reimburse that company with £500 it cost to return the goods to her.
Of course, she had to make a ‘judgement’ as to the value of the goods returned.
She believed that she could sell 199 cases to cost cutter stores for £41 per case, but if these stores found out that they were buying returns rejected by other companies, they might not want to deal. If this happened, then eventually the goods would have to be written off.
The entries required to account for this returns are:
(1) Credit CDZ Limited £10 500 (sales ledger)
(2) Debit sales £10 000 and debit ‘delivery costs’ £500 (3) Debit stock £8000 and credit cost of sales £8000
(4) Credit stock £40 and debit stock losses £40 for the case written off (5) Credit stock for £199 and debit stock losses £199, for the reduction in
value of returned stock
Based on the prudence concept, stock is valued at the lower of cost and net realisable value, where net realisable value is defined as the selling price less the cost of getting the goods to the customer. In this case, it will cost £398 to deliver 199 cases, which is equal to £2 per case. If the selling price is going to be
£41 per case and it will cost £2 per case to get them to the cost cutter stores, then the net realisable value is £39 per case. As this is lower than the cost of £40 per case, this stock has to be written down to £39 per case. In Amanda’s case, all her purchases are at the same price, but usually prices change over time. In such cases, stock is usually charged to cost of sales on a first in first out (FIFO) basis.
These entries are shown as transaction 20 in Figure 1.1. After these adjustments, stock is valued at £95 761 and this figure is reconciled to the actual stock counted:
£
Now Amanda must note that while she is committed to buying 12 000 cases per year, in her first year she has sold only 9600 cases. It could be argued that a contingency reserve should be created to allow for the fact that Amandamay in the future have to make a £10 000 penalty payment to Zehin Foods plc. She chose not to; but, again, this is a matter of judgement that can materially affect her declared profit.
The final reconciliation is to do with assets. Firstly, Amanda wanted to make sure that the goodwill in her Balance Sheet reflected what the secret recipe was really worth, given the experience of her first year of trading. She had paid
£40 000 for it, but concluded that £25 000 was a more reasonable valuation and reduced goodwill in the Balance Sheet to this figure. This reduction in value is called ‘impairment’ and is shown as transaction 21 in Figure 1.1.
Secondly, the fixed assets have to be depreciated. Most assets are depreciated using the straight line method. Straight line means that the net cost of the asset is depreciated at the same rate over the life of the asset. Suppose an asset was bought for £30 000 and at the end of 6 years it was estimated that it would be sold for £6000, then the net cost of the asset would be £24 000 and the annual depreciation charge would be £4000.
Another method of depreciation is by using the reducing balance method. This method calculates the depreciation over the expected life of the asset, but on the basis of its written-down value, not original cost. Also, the asset’s estimated residual value is ignored. Assets such as cars and vans are usually depreciated this way as they depreciate more in their earlier years than in the later years, although to compensate the cost of repairs increases over time. Suppose a car was bought for £30 000 and it was estimated that it would sell for £10 000 at the end of 4 years, then by using the reducing balance method, depreciation would be calculated as follows:
£
Asset at cost 30 000
Depreciation in year 1 7500
Written-down value 22 500
Depreciation in year 2 5625
Written-down value 16 875
Depreciation in year 3 4219
Written-down value 12 656
Depreciation in year 4 3164
Written-down value (at the end of year 4) 9492
Depreciation for Amanda’s fixtures and fittings and van is shown as transaction 22 in Figure 1.1.
Now the assets have been reconciled, the only other matter is to deal with the matching concept and this means dealing with accruals and prepayments, so that in timing terms the sales and the costs associated with those sales match.
The entries for accruals and prepayments are:
Accruals– debit the appropriate expense and credit accruals.
Prepayments– debit prepayments and credit the appropriate expense.
The entries for Amanda’s accruals are shown as transaction 23 in Figure 1.1 and the entries for Amanda’s prepayments are shown as transaction 24 in Figure 1.1. Once these entries are completed, each account is ‘balanced off’, so that only the net balance is showing. This is shown in Figure 1.1. Each of these balances is then listed in the form of a Trial Balance, as shown in Figure 1.2.