Incomplete Records

1 Introduction

Many traders do not keep good accounting records, and certainly not a ledger system. Typically, they will keep invoices received and copies of invoices issued. Usually they will know what has been paid to suppliers and received from customers. They are often hazy about the amount of cash sales and perhaps cash purchases. In particular, there is a danger that cash sales are deliberately omitted so that income is under-declared and tax fraudulently reduced. In your questions almost any figure could be missing and you have to try to piece together what’s happened so that you can make estimates of profit or other amounts.

This chapter looks at the techniques available.

2 Overview

It is essential to understand the accounting pathway from purchases through to the collection of cash as solving incomplete records problems involves moving up and down the pathway, trying to work out any missing figures.

Stage 1 – purchases

Purchases, payables and payments can all be summarised on the Payables Ledger Control Account (or Total Payables Account):

If any one of these figures is missing, it can be found by drawing up the control account and making it balance by inserting the missing figure.

If there are also cash purchases, they will have to be added to the control account purchases figure.

Stage 2 – Cost of sales

Cost of sales = Opening inventory + Purchases – Closing inventory

Again, any single missing figure can be worked out easily.

If all purchases are on credit, then the purchases figure will be the Credit purchases figure from the control account. Remember, in general the purchases figure will not be the same as the amount paid to suppliers. That’s why the control account is important.

Stage 3 – Sales

Credit sales, cash receipts, opening and closing receivables are linked up in the Receivables Ledger Control Account (or Total Receivables account):

If any one of these figures is missing, it can be found by drawing up the control account and making it balance by inserting the missing figure.

If there are also cash sales, they will have to be added to the control account sales figure.

It would, of course, be quite possible for two items in the control account to be missing, for example, sales and receipts from debtors. That would mean that the control account is of limited use, in which case, another method might also have to be employed. This is where gross profit percentages and mark-ups can be very useful as these link cost of sales and sales.

3 Gross profit percentages and mark-ups

A gross profit percentage (or gross margin) is always defined with respect to the sales value. So a gross profit percentage of 20% means that gross profit is 20% of sales. It can be very useful to set out this information in the form of a ‘cost structure’:

It is vital to get the proportions correct. If you are told that the gross profit percentage is 20%, then that means gross profit is 20% of sales. Therefore put sales at 100, the profit at 20 and the cost of sales at 80 (100 – 20).

If you were told that Cost of Sales = $1,600, then using the proportions in the cost structure:

  Gross profit   =   $1,600 x 20/80   =   $400

  Sales   =   $1,600 x 100/80   =   $2,000

  [or Sales = GP + Cost =   400 + 1,600   =   2,000]

A mark-up percentage is always defined with respect to cost of sales. So a mark-up of 25% would mean that 25% is added to cost to give the selling price. Profits are 25% of costs.

Once again a cost structure is very useful:

It is vital to get the proportions correct. If you are told that the mark-up percentage is 25%, then that means gross profit is 25% of cost of sales. Therefore put cost of sales at 100, the profit at 25 and the sales at 125 (100 + 25).

If you were told that sales = $6,000, then using the proportions in the cost structure:

  Gross profit =   $6,000 x 25/125   =   $1,200

  Cost of sales =   $6,000 x 100/125   =   $4,800

  [or Cost = Sales – GP =   $6,000 – $1,200   =   $4,800]

4 Bringing it together

So, we have looked at the use of control accounts, and mark-ups and gross profit percentages. Now we have to bring these elements together.

5 The cash account

The last piece of the jigsaw is often to work out certain cash amounts, such as how much the owner has withdrawn from the business (drawings). Drawing up a cash account can allow you to find missing items by balance. However, if you don’t know how much cash has come in from customers and how much the owner has taken out in drawings then you will have to do some detective work.

6 Another approach - the accounting equation

Sometimes records are so scarce that there is next to no information about sales, purchases, costs and drawings. This can easily arise when a trader is almost entirely cash-based so that there is no information available from any bank transactions.

However, if the net assets at the start and end of a period can be listed, then there is a way available to estimate profits.

The accounting equation states that:

Increase in net assets over a period = Capital introduced – Drawings + Profits