Incomplete Records — full notes
Paper No. 1: Financial Accounting · Correction of Errors and Incomplete Records - Incomplete Records
Incomplete Records
1. The core technique: change in net assets
Without a profit or loss account, profit can still be found, because the accounting equation always holds even when nothing was formally recorded:
Closing Capital = Opening Capital + Profit - Drawings + Capital introduced
Rearranged to solve for profit:
Profit = Closing Capital - Opening Capital + Drawings - Capital introduced
Opening and closing capital are each found via a statement of affairs - an informal Statement of Financial Position: Assets - Liabilities = Capital.
2. Worked example - deriving profit
Otieno's Hardware keeps no formal books. At the start of the year: shop fittings KES 200,000, inventory KES 80,000, trade receivables KES 45,000, cash KES 15,000, trade payables KES 60,000.
Opening capital = (200,000+80,000+45,000+15,000) - 60,000 = KES 280,000
At the end of the year: shop fittings (after depreciation) KES 180,000, inventory KES 95,000, trade receivables KES 52,000, cash KES 28,000, trade payables KES 48,000.
Closing capital = (180,000+95,000+52,000+28,000) - 48,000 = KES 307,000
Drawings for the year were KES 90,000. No additional capital was introduced.
Profit = 307,000 - 280,000 + 90,000 - 0 = KES 117,000
No sales figure, no expense records, no ledger - just two snapshots of what the business owned and owed.
3. Mark-up vs margin - not the same percentage
- Mark-up = Gross Profit / Cost of Sales
- Margin = Gross Profit / Sales
Example: cost of sales is 100, mark-up is 25%. Gross profit = 25. Sales = 125. Margin = 25/125 = 20% - not 25%. A 25% mark-up and a 25% margin are different numbers.
4. Using mark-up or margin to find a missing figure
Mark-up known, finding sales: cost of sales KES 480,000, mark-up 20%. Gross profit = 96,000. Sales = 480,000+96,000 = KES 576,000.
Margin known, finding cost of sales: sales KES 600,000, margin 30%. Gross profit = 180,000. Cost of sales = 600,000-180,000 = KES 420,000.
This is how a business without formal sales records can estimate sales from what it knows for certain (purchases, hence cost of sales) and its normal pricing policy.