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QAMAR DATA 2015
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Table of Contents
Introduction to Accounting
Balance Sheet
Books of Original Entry
Ledgers and the Trial
Balance
Preparation and Analysis of
Financial Statements
End of Period Adjustments
Control Systems
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A. Introduction to Accounting
Concept of Accounting
Types of Business Organizations
Sole Trader
Partnership
Co-Operative Society
Corporations
Nonprofit
Financial Statements
The Accounting Cycle
Accounting Concepts and Conventions
Accounting Processes
Accounting Software’s
B. Balance Sheet
Assets, Liabilities & Capital
Definition & Purpose of Balance Sheet
Balance Sheet Equation
Balance Sheet Headings
Arrangement of Assets and Liabilities
Effect of Transactions on the Balance Sheet
C. Books of Original Entry
Uses of Books of Original Entry
Cash & Credit Transactions
Source Documents
Recording Transactions from Source Documents
General Journal
Sales Journal
Purchases Journal
Returns Inwards Journal
Returns Outwards Journal
Cashbook
Petty Cashbook
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D. Ledgers and the Trial Balance
The Accounting Equation Classification of Accounts
Accounts Rules for Double Entry
Asset of Stock
Expense and Revenue Accounts
Capital and Revenue Expenditure
Basic Double Entry
Balancing of Accounts
The Trial Balance
E. Preparation and Analysis of Financial Statements
Financial Statements
The Valuation of Stock
The Trading and Profit and Loss Account
The Balance Sheet
Accounting Ratios
Mark-Up and Margin Ratios
Stock Turn Ratio
Gross Profit & Net Profit as a percentage of sales Ratios
Liquidity,Current & Acid Test Ratios
Return on Capital employed (ROCE)
Illustration of a Basic Financial Analysis of a Business
F. End of Period Adjustments
Expenses and Revenues
Accruals and Prepayments in the Balance Sheet
Distinction between Bad Debts and Doubtful Debts
Provision for Depreciation
G. Control Systems
The Need for Control Systems
Types of Accounting Errors
Suspense Accounts
The Effect of Accounting Errors on Final Accounts
Control Accounts
Sales Ledger Control Accounts and Purchases Ledger Control accounts
Bank Reconciliation Statement
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CHAPTER # 1
H. Introduction to Accounting
Concept of Accounting
Types of Business Organizations
Sole Trader
Partnership
Co-Operative Society
Corporations
NonProfit
Financial Statements
The Accounting Cycle
Accounting Concepts and Conventions
Accounting Processes
Accounting Softwares
Concept of Accounting
Accounting is the process of identifying, recording, measuring and communicating financial
information which allows balanced judgement and sound financial management decisions.
Account systems have been used throughout history as long as there was need to make financial
decisions.
I. Accounting:
-Identifies, records, measures and communicates information on the finances of a business.
-Focuses or communicates information about entities in monetary terms.
-Provides general financial information which may be used for specific functions by relevant
entities in need of financial information.
-Has the intended effect of assisting the organization in reaching its objectives.
-Illuminates what is being measured, as well as providing summarized information for general
management decision making.
Users of accounting information
Internal users
-Owners of the business – to assess the results of their investment in the business.
-Managers – to plan, control, analyse, and evaluate activities and performance in order to
strengthen policies.
-Employees – to look at the stability of the business, job security and adequacy of salary.
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External users
-Government – to ensure that legal conformity and tax obligations are met by businesses; to
assess impact of business activities on the economy.
-Competitors – to make performance comparisons and strengthen weak areas.
-Suppliers – to determine the credit history of potential customers before committing to supply.
-Customers – To provide after-sales support.
TYPES OF BUSINESS ORGANIZATIONS
A business is an economic entity that engages in activities for financial gain or profit. The structure
of a business in terms of the ownership and management is one of the important tasks of the
entrepreneur. Therefore, the form of organization must be chosen with careful thought. Factors to be
considered are:
The Nature of the activities of the Business
The selection of a particular type of organizational structure is dependent upon the type of business
activity. A partnership or Sole Proprietorship is ideal for a service oriented business, but a Company
or partnership would be better for a manufacturing concern.
Scale of Operation
If the scale of operation is small, a sole proprietorship or partnership form is ideal. But a company
would be better if the scale of operation was very large.
Area of Operation
If the operation of entity is spread over a wide geographic area, the company structure is better, but
if it is confined to a specific region, other forms may be ideal.
Finance
If the initial capital outlay and daily operational costs are very large, a company structure may be the
best option.
Ownership and Control
One should go for a sole proprietorship or partnership when direct control over the business is ideal,
instead of company or co-operative Structure.
Liability
An individual who does not wish for unlimited liability, he may opt for a company but if he can bear
the unlimited liability of business can go for sole proprietorship or partnership.
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Sole Trader
Sole proprietorship is a basically a one person owned business. It is a form of business organization
in which an individual invest his own resources, uses his own organizing abilities in management
and decision making some small business start out as sole traders. Sole Traders sometimes are small
or micro- enterprises which need little capital to start up and may therefore be easy to establish and
operate.
Advantages
-Easier establish and manage than a company
-Decision making is speedy due to its solo nature
-Customers receive special attention due to economies of scale
-Profits are not shared but goes to the sole owner
Disadvantages
-Unlimited liability by the owner
-Problem in raising capital when needed sometimes due to scale of operation and capital outlay
-Sometimes limited managerial skills due to lack of team management
-Lack of competitiveness
-Lack of continuity when owner dies
-Long working hours due to economies of scale
Partnership
A partnership is a form of organization where two to twenty persons are associated to operate a
business entity with a view to earn profit. Each member of such a group is individually known as
„partner‟ and collectively the members are known as a „partnership firm‟.
In order to avoid misunderstandings about how profits/losses are shared, the responsibilities of each
partner, and other ownership, management, and operating decisions the partners usually have a
formal legal partnership agreement which sets out the rights and obligations of each partner.
Some factors to consider in a partnership deed
-The number of partners needed
-Capital invested by each partner
-Interest on capital paid to each partner
-Profit or loss sharing ratio between or among partners
-Salaries paid to partners
-Admission of a new partner
-Dismissal or withdrawal of a partner
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Advantages of Partnerships
-Easily formed
-More people to contribute capital than sole trader
-Greater continuity than sole trader
-Expenses and management of the business are shared
Disadvantages of Partnerships
-Generally unlimited liability of partners
-Possible disagreement among partners
-Each partner is liable for the debt of the business
-Membership limit of twenty partners may sometimes restrict the capital resources of the business
depending on the nature and scale of operations
CO-OPERATIVE SOCIETY
The co-operatives are formed primarily to render services to its members. Generally it also provides
some service to the society. When the purpose of business is to provide service than to earn profit
and to promote common economic interest, the co-operative society is the only alternative.
The main objectives of co-operative societies are:
-rendering service rather than earning profit
-mutual help instead of competition
-self help in place of dependence
On the basis of these objectives, various types of co-operatives can be formed with the objective of
providing different benefits to their members. Some types of co-operatives are outlined below.
Types of Cooperatives
CONSUMER C O-OPER ATIVES
These are formed to protect and strengthen the specific interests of ordinary consumers of society by
making consumer goods available at a fair price.
PRODUCER C O-OPERA TIVES
These societies are set up to strengthen producers who operate on a small scale who face challenges
related to resources for raw material and available markets for finished goods.
MARKETING CO-OPER ATIVES
These are formed by producers and manufactures. Marketing co-operatives eliminate exploitation of
the middlemen when marketing their product.
CREDIT CO-OPERATI VES
These societies are formed to provide financial help to its members.
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FARMING CO-OPERAT IVES
These are formed by small farmers who carry on work together to operate on a larger scale and
thereby share the benefits of large scale farming.
Besides these types, other co-operatives can be formed with the objective of providing different
benefits to its members, like the construction co-operatives, transport co-operatives, co-operatives to
provide education etc.
Characteristics of Co-operatives
MEMBERS VOL UNTARY ASSOCIATION
Individuals with common interest may come together to form a co-operative society. Any person can
become a member of such a co-operative.
MEMBERSHIP
The minimum number of individuals required to form a co-operative society is ten and the
maximum number is unlimited.
BODY CORP ORATE
Registration of a society under the Co-operative Societies Act is a must. Once it is registered, it
becomes a body corporate and enjoys certain privileges just like a joint stock company.
Some of the privileges are:
-It can sue others in court of law.
-It can enter into contract with others
-It has its own common seal.
-It can own property in its name.
-It can enter into contract with others.
-The society enjoys perpetual succession
-It has its own common seal.
-It can own property in its name.
SERVICE MOTIVE
The main motive of any co-operative organization is to provide specific services to its members in
particular and to the society in general.
DEMOCRATIC SET UP
Every member has a right to take part in the management of the society. Each member has one vote.
The Executive Committee, who is elected and responsible to members, look after the daily operations
of the organization.
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SOURCES OF FINANC ES
Co-operative organizations have units of investments called shares which are contributed by
members It can also raise loans and obtain grants from the government.
RETURN ON CAPITAL
The profit earnings on capital subscribed by the members is in the form of a fixed rate of dividend
after deduction from the profit of the co-operative.
Advantages of Co-operative Society
EASY FORMATION
Formation of a co-operative society is relatively easy as compared to a company. Any 10 persons can
form an association and get the entity registered.
LIMITED LIABILITY
The liability of the members is only limited to the extent of capital contributed by them.
OPEN MEMBERSHIP
Any member of society may become a member of a co-operative.
STATE ASSISTANCE
Co-operatives may have the advantage of patronage in the form of exemptions and tax concessions
and financial assistance from the governments.
MIDDLEMAN ’S PROFI T ELIMINATED
Consumers benefit and the profit is maximized. Through the co-operative the consumer members
control their own supplies and by this means the middleman‟s profit is eliminated.
MANAGEMENT
Decision making by members on specific terms are democratized.. Each member has only one vote.
WINDING UP
A co-operative has a fairly stable life. The dissolution of a co-operative firm is quite difficult. It does
not cease to exist in the case of the death, or insolvency or resignation of any member.
Disadvantages of Co-operatives
LIMITED CAPITAL
Due to the specificity of co-operatives the amount of capital that can be generated may sometimes be
limited. This is because of the membership remaining confined to a geographic area or a particular
group of people.
LACK OF MOTIVATION
Co-operatives are basically service oriented more than profit motivated. There might not be
sufficient motivation to manage the co-operatives effectively.
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CORPORATIONS
A corporation is an organization that is made up of many owners who normally are not active in the
decision making and operations of the business. The capital of a limited liability company is divided
into shares which are certificates of ownership (stock) issued by the corporation. The owners of these
shares are called shareholders and the capital of the company referred to as share capital.
Corporations must have at least one shareholder. Corporations are incorporated businesses, are
considered as a separate entity, and this often provide a measure of legal and financial protection for
the shareholders. The shareholders of corporations have limited liability protection, and
corporations have full discretion over the amount of profits Suitability of Joint Stock Company:
A Limited Liability Company may be suitable where the volume of business is quite large, the area of
operation is widespread, the risk involved is heavy and there is a need for huge financial resources
and manpower. It is also preferred when there is need for professional management and flexibility of
operations.
Characteristics of Limited Liability Companies
ARTIFICIAL PERSON
A Joint Stock Company is an artificial person in the sense that it is created by law and does not
possess physical attributes of a natural person. However, it has a legal status.
SEPARATE LEGAL EN TITY
Being an artificial person, a company has an existence independent of its members. It can own
property, enter into contract and conduct any lawful business in its own name. It can sue and can be
sued in the court of law. A shareholder cannot be held responsible for the acts of the company.
COMMON SEAL
Every company has a common seal by which it is represented while dealing with outsiders. Any
document with the common seal and duly signed by an officer of the company is binding on the
company.
PERPETUAL EXISTEN CE
A company once formed continues to exist as long as it fullfils the requirements of law. It is not
affected by the death, lunacy, insolvency or retirement of any of its members.
LIMITED LIABILITY
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The liability of a member of a Joint Stock Company is limited by guarantee or the shares he owns. In
other words, in case of payment of debts by the company, a shareholder is held liable only to the
extent of his share.
TRANSFERABILITY OF SHARES
The members of a company are free to transfer the shares held by them to anyone else.
FORMATION
A Jamaican company for example, comes into existence only when it has been registered, after
completing the formalities prescribed by The Registrar of Companies of Jamaica.
MEMBERSHIP
A company having a minimum membership of two persons and maximum fifty is known as a Private
Limited Company. In the case of a Public Limited Company, the minimum is seven and the
maximum membership is unlimited.
MANAGEMENT
Limited Liability Companies have democratic management and control. Even though the
shareholders are the owners of the company, all of them cannot participate in the management
process. The company is managed by the elected representatives of shareholders known as Directors.
CAPITAL
A Limited Liability Company generally raises a large amount of capital through issue of shares.
Advantages of Limited liability Companies
LIMITED LIABILITY
In a Joint Stock Company the liability of its members is limited to the extent of shares held by them.
This attracts a large number of small investors to invest in the company. It helps the company to
raise huge capital. Because of limited liability, a company is also able to take larger risks.
CONTINUITY OF EXIST ENCE
A company is an artificial person created by law and possesses independent legal status. It is not
affected by the death, insolvency etc. of its members. Thus it has a perpetual existence.
BENEFITS OF LARGE SCA LE OP ERATION
It is only the company form of organization which can provide capital for large scale operations. It
results in large scale production consequently leading to increase in efficiency and reduction in the
cost of operation. It further opens the scope for expansion.
PROFESSIONAL MAN AGEMENT
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Companies, because of complex nature of activities and operations and large volume of business,
require professional managers at every level of organization. And because of their financial strength
they can afford to appoint such managers. This leads to efficiency.
SOCIAL BENEFIT
Corporations offer employment to a large number of people. It facilitates promotion of various
ancillary industries, trade and auxiliaries to trade. Sometimes it also donates money for education,
health, community service and renders help to charitable and social institutions.
RESEARCH AND DEVELOPMENT
A company generally invests a lot of money on research and development for improved processes of
production, designing and innovating new products, improving quality of product, new ways of
training its staff, etc.
Disadvantages of Limited liability Companies
FORMATION IS NOT EASY
The formation of a company involves compliance with a number of legal formalities under the
companies Act and compliance with several other Laws.
CONTROL BY A GROUP
Companies are controlled by a group of persons known as the Board of Directors. This may be due to
lack of interest on the part of the shareholders who are widely dispersed; ignorance, indifference and
lack of proper and timely information. Thus, the democratic virtues of a company do not really exist
in practice.
SPECULATION AND MANIPULATION
The shares of a company are purchased and sold in the stock exchanges. The value or price of a share
is determined in terms of the dividend expected and the reputation of the company. These can be
manipulated.
EXCESSIVE GOVERNMENT CONTROL
A company is expected to comply with the provisions of several Acts. Non-compliance of these
invites heavy penalty. This affects the smooth functioning of the companies.
DELAY IN POLICY DECISIONS
A company has to fulfill certain procedural formalities before making a policy decision. These
formalities are time consuming and, therefore, policy decisions may be delayed.
NONPROFIT
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Nonprofit Organizations are corporations formed for a charitable, civic, or artistic purpose.
Nonprofits are generally exempt taxation on their income, and so they are often called “exempt
organizations.” Nonprofits have substantial responsibilities for reporting their activities, income, and
assets to ensure that they are in compliance with government laws governing charities.
FINANCIAL STATEMENTS
What is a financial statement? What does it tell us? Why should we care? These are good questions
and they deserve an answer.
Financial Statements are summary accounting reports prepared periodically to inform the owner,
creditors, and other interested parties as to the financial condition and operating results of the
business. The purpose of financial statements is to communicate the Group‟s financial information to
its stakeholders, especially shareholders, investors and lenders. Financial Statements uses the
summarized data contained in the Trial Balance to prepare the business‟s financial reports.
Financial Statements provide relevant financial information in a format that is useful in making
important business decisions. Each financial statement tells its own story. Together they serve many
purposes. They form a comprehensive financial picture of the company, the results of its operations,
its financial condition, and the sources and uses of its money. They also allow comparison of
different companies with each other, or to evaluate different year‟s performance within the same
company. Evaluating past performance helps managers identify successful strategies, eliminate
wasteful spending and budget appropriately for the future. It can also help a bank or creditor
evaluate the company for a loan or charge account. And the Government will be interested in
collecting the appropriate amount of income tax. Armed with this information, business managers
will be able to make necessary business decisions in a timely manner.
Financial statements have generally agreed-upon formats. There are three main financial
statements:
-Trading and Profit and Loss Account
-Balance Sheet
-Statement of Cash Flows
The Income Statement
At the end of a financial period, all expense and revenue accounts are closed to a summarizing
account usually called an Income Statement. This is the financial statement that summarizes
revenues and expenses for a specific period of time, usually a month or a year. This statement is also
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called a Profit and Loss Statement. For this reason, all income statement accounts are considered to
be temporary or nominal.
-THE PROFIT AND LOSS ACCOUNT reflects a Period of Time – month, quarter and year. It
shows financial the activity of a business during that period and indicates any profit or loss earned.
-REVENUE - the value of your goods and services which have been delivered to customers
-EXPENSES - costs incurred in earning these revenues.
-NET PROFIT - the excess of Revenue over Expenses, on the Profit and Loss Account.
-NET LOSS - the excess of Expenses over Revenue, on the Income Statement.
The Balance Sheet
The statement of financial position of a business sums up its economic resources, obligations (debts
and other non-current liabilities) and owners‟ capital at a particular point of time. It also shows how
the economic resources contributed by lenders and shareholders are used in the business.
Balance sheet items are classified as assets, liabilities, or capital, and the amount and nature of these
items are shown at a specific date in time.
-ASSETS – Something the company owns that has value
-LIABILITY – Money the company owes to creditors
-CAPITAL – This is the portion that remains after liabilities are subtracted from assets. Capital
includes profit or Loss from the business.
-DRAWINGS – Represent assets taken out by owners of the business
The Balance sheet:
-REFLECTS A MOMEN T IN TIME .
It indicates Assets, Liabilities and Equity of business as of a specific date.
-SHOWS FINANCIAL POSITION OF BUSIN ESS AS OF SPECIF IC DA TE:
Financial Position – what you have/what you owe/what your stockholders have
“Have” – “Owe” = “Value to Owner”
-VALUE OF BUSINESS TO OWNERS .
Assets – Liabilities = Capital
Statement of Cash Flows
The Statement of Cash Flows is the third financial statement. The Cash Flow statement shows the
inflows and outflows of Cash over a period of time, usually one year. The time period will coincide
with the Income Statement. The accounts are analyzed to determine the Sources (inflows) and Uses
(outflows) of cash over a period of time The Statement of Cash Flows removes all accruals, deferrals
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and other non-cash adjustments,. An Income Statement might show a Profit or a Loss, but that says
nothing about how the company‟s Management managed the company‟s money.
Cash Flow Statement:
-Reflects a Period of Time – Month, Quarter, Year
-Shows cash inflows and outflows during period
-Indicates solvency of company during period
THE ACCOUNTING CYCLE
The Accounting Cycle is a sequence of procedures used to record, classify and summarize and
processing accounting information to generate financial statements, on a regular basis. The
accounting cycle during each period starts from recording individual transactions in the books of
accounting and ends at the preparation of financial statements and closing processes.
Steps in the Accounting Cycle
-CAPTURE AND RECORD BUSINESS ACTIV IT IES .
Identify and analyze transactions that need to be recorded, journalize (record) the transactions in the
proper journal.
-CLASSIFY TRANSACTIONS INTO APPROPRI ATE ACCOUNTS .
Post from the journals to the General Ledger and Subsidiary Ledgers.
-PREPARE AN UNADJUSTED TRIAL BALANCE
Enter Trial Balance Information from General Ledger
-MAKE ADJUSTIN G ENTRIES AT THE END OF THE PERIO D
Review accounts and other information to determine if any Adjusting Entries are necessary
-PREPARE AN ADJUSTED TRIAL BALANCE.
This is a Trial Balance after adjusting entries have been made.
-PREPARE FINAL ACCOUNT S
Summarize and Report the balances of Ledger Accounts in financial statements.
-JOURNALIZE AN D POST CLOSINGENTRIES
Record our closing Entries in our General Journal Post our entries from our General Journal to our
General Ledger.
-PREPARE A CLOSING TRIAL BALANCE
The Accounting Cycle
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ACCOUNTING CONCEPTS AND CONVENTIONS
Accounting concepts and conventions as used in accountancy are the rules and guidelines by which
the accountant lives. All accounts and accounting statements should be created, preserved and
presented according to the concepts and conventions.
-These generally accepted accounting principles are a set of rules and practices that are recognized as
a general guide for financial reporting purposes.
-Generally accepted means that these principles must have substantial authoritative support.
Accruals Concept
The Accruals concept assumes that revenue and expenses are taken account of when they occur and
not when the cash is received or paid out. The purpose of this concept is to make sure that all
revenues and costs are recorded in the appropriate statement at the appropriate time. The accrual
concept under accounting assumes that revenue is realised at the time of sale of goods or services
irrespective of the fact when the cash is received. Similarly, expenses are recognised at the time of
services provided, irrespective of when cash is paid.
In brief, accrual concept requires that revenue is recognised when realized, and expenses are
recognised when they become due and payable without regard to the time of cash receipt or cash
payment. Thus, when a profit statement is compiled, the cost of goods sold relevant to those sales
should be recorded accurately and in full in that statement. Costs concerning a future period must be
carried forward as a prepayment for that period and not charged in the current profit statement. For
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example, payments made in advance such as the prepayment of rent would be treated in this way.
Similarly, expenses paid in arrears must, although paid after the period to that they relate, also be
shown in the current period‟s profit statement: by means of an accruals adjustment.
Matching concept states that the revenue and the expenses incurred to earn the revenue must belong
to the same accounting period. Therefore, the matching concept implies that all revenues earned
during an accounting year, whether received/not received during that year and all cost incurred,
whether paid/not paid during the year should be taken into account while ascertaining profit or loss
for that year. It guides how the expenses should be matched with revenue for determining exact
profit or loss for a particular period.
Accruals Concept
Revenue should be recognized in the accounting period in which it is earned.
Matching Concept
Expenses should be matched with revenues in the period in which the revenues are earned. (i.e. the
need for prepaid expenses)
Significance:
-It helps in knowing actual expenses and actual income during a particular time period.
-It helps in calculating the net profit of the business.
Prudence Concept or Concept of Conservatism
It is this concept more than any other that has given rise to the idea that accountants are pessimistic
boring people!! Basically the concept says that whenever there are alternative procedures or values,
the accountant will choose the one that results in a lower profit, a lower asset value and a higher
liability value. The concept is summarised by the well known phrase „anticipate no profit and provide
for all possible losses‟.
Revenue and profits are included in the balance sheet only when they are realized (or there is
reasonable „certainty‟ of realizing them) but liabilities are included when there is a reasonable
„possibility‟ of incurring them.
The Prudence Concept assumes:
-Assets should not be overvalued
-Liabilities should not be undervalued
-The financial statements does not reflect overstatement or understatement of gains or losses but
neutral
-Profit or revenue only recorded when they are realized.
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Consistency Concept
Because the methods employed in treating certain items within the accounting records may be varied
from time to time, the concept of consistency has come to be applied more and more rigidly. Because
of these sorts of effects, it is now accepted practice that when an entity chooses to treat items such as
depreciation in a particular way in the accounts it should continue to use that method year after year.
If it is NECESSARY to change the accounting method being employed then an explanation of the
change and the effects it is having on the results must be shown as a note to the accounts being
presented.
Separate Entity Concept
The business entity concept states that a business and the owner(s) are two separate Legal Entities.
Being an artificial person, a company has an existence independent of its members. It can own
property, enter into contract and conduct any lawful business in its own name. It can sue and can be
sued in the court of law. A shareholder cannot be held responsible for the acts of the company.
The best example here concerns that of the sole trader or one man business: in this situation you
may have the sole trader taking money by way of „drawings‟: money for his own personal use. Despite
it being his business and apparently his money, there are still two aspects to the transaction: the
business is „giving‟ money and the individual is „receiving‟ money. So, the affairs of the individuals
behind a business must be kept separate from the affairs of the business itself.
This concept restrains accountants from recording of owner‟s private/ personal transactions. It also
facilitates the recording and reporting of business transactions from the business point of view.
Conclusions
These, then, are some basic concepts and conventions on which the accountant bases all of his
accounting work. We can see evidence of such work in the published annual reports and accounts
that all publicly quoted companies are required to prepare and publish. The concepts and
conventions also apply to the millions of businesses world wide that do not publish their accounts.
ACCOUNTING PROCESSES
All accounting information historically has been done manually. In modern society we now have
access to computers that actually performs the same tasks with much improvement.
Computerised accounting systems may be obtained in modular packages or be fully integrated.
Modules include Stock control, sales order processing, purchases order processing, pay roll, fixed
assets, Sales Ledger, Purchases Ledger, debtors‟ and creditors‟ schedule, and general ledger. These
accounting systems follow the basic rules of double entry.
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Most accounting software has these common modules which can be used each by themselves or
combined with other modules in the same packages.
ACCOUNTS RECEI VAB LE – where the business enters money receivable from activities
ACCOUNTS PAYABLE - business records and discharges its financial obligations
GENERAL LEDGER – the company‟s “books”
BILLING – where the company creates invoices to customers
STOCK/INVENTORY - the business maintains inventory management
PURCHASE ORDER – Goods are order as required
SALES ORDER – the business records customer orders for stock items they need
CASH BOOK – the business records money collected and paid out.
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CHAPTER # 2
Balance Sheet
Assets, Liabilities & Capital
Definition & Purpose of Balance Sheet
Balance Sheet Equation
Balance Sheet Headings
Arrangement of Assets and Liabilities
Effect of Transactions on the Balance Sheet
ASSETS, LIABILITIES & CAPITAL
Assets
Assets are things that a company owns and are sometimes referred to as the resources of the
company.
The properties used in the operation or investment activities of a business.
Assets include tangible and intangible items. Tangible items can be physically seen and touched such
as vehicles, equipment and buildings. Intangible items are like pieces of paper (sales invoices)
representing loans to your customers where they promise to pay you later for your services or
product. Some examples of business type assets are cash, debtors, stock of goods, land, and
equipment.
Liabilities
Liabilities are obligations of the company; they are amounts the business owes to others as of the
balance sheet date.
Another liability is money received in advance of actually earning the money.
Usually one of a business‟s biggest liabilities is to suppliers where a business has bought goods and
services and charged them. Some examples of business liabilities are outstanding expense accounts,
creditors, and mortgages.
Capital
It represents the owner‟s rights to the property (assets) of the business. Capital is the monetary value
of the part of the business which belongs to the proprietor. In other words what the business owes
the owner, that is the amount left for the owner after all liabilities (amounts owed) have been paid.
DEFINITION & PURPOSE OF BALANCE SHEET
The Balance Sheet is a statement of financial position of a business at a specific point in time usually
at the end of the month or year. By analyzing and reviewing this financial statement the current
financial “health” of a business can be determined.
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The Balance Sheet sums up the economic resources (assets), obligations (debts and other long-
term liabilities) and the owners‟ Capital at a particular point of time. It also shows how the
economic resources contributed by lenders and shareholders are used in the business. This
statement is called a “balance sheet” because at any given time, Assets must
equal Liabilities plus Capital, in other words, be in balance.
BALANCE SHEET EQUATION
There are three main sections of a Balance Sheet: Assets, Liabilities, and Capital just like the
accounting equation. The balance sheet is derived from our accounting equation and is a formal
representation of our equation.
Items are listed in the Balance Sheet just as in the accounting equation:
Assets = Liabilities + Capital
Assets are normally listed on the left hand side.
Capital is entered on the right hand side.
Liabilities are entered on the left hand side.
Preparation of the Balance Sheet
The balance sheet heading contains the name of the company, the title of the statement, and the date
of the statement.
Entries in the balance sheet are made from transfers from the trial balance. A debit balance in the
trial balance must be transferred to the debit side in the balance sheet; similarly a credit balance in
the trial balance must appear only on the credit side of the Balance Sheet.
There are two basic formats for balance sheet presentation:
-THE HORIZONTAL FORM
In this form the major categories are presented side by side.
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-THE VERTICAL FOR M
In this form the major categories are stacked on top of each other.
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BALANCE SHEET HEADINGS
Fixed Assets
These are items bought in the business not for resale but to be used over a period of several years.
These assets are of a long term nature. Examples of Fixed Assets would include machinery, building
and furniture.
Current Assets
These are items in the business which are used up and change daily in the normal operation of the
business. These are the revenue generating assets and they are of a temporary nature. Examples of
Current assets would include stock of goods for sale, debtors and business cash.
Liability Accounts
Liability Accounts are usually classified (put into distinct groupings, categories, or classifications) on
the balance sheet. The liability classifications and their order of appearance on the balance sheet are:
-CURRENT LIABILITIES
These represent money which the business owes and is obligated to settle within one year. Examples
of current liabilities would include Creditors for goods purchases, and unpaid utility expenses
-LONG TERM LIABILI TIES
These represent money which the business owes and is obligated to settle within one year. Examples
of long term liabilities would include Loan to buy motor vehicle, Mortgage.
Capital
Let‟s illustrate this statement with a simple equation.
Capital at End = Capital at Beginning + Additional Capital Contributed + Profit or (– Loss ) – Draws
Capital is increased by money or property contributed and any profits the business earns from
operation.
Capital is decreased by withdrawals made by the owner or loss by the business.
Drawings represent amounts the owner withdraws from his business for personal use.
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ARRANGEMENT OF ASSETS AND LIABILITIES
Assets may be listed based on how quickly they can be converted into cash which is called the order
of liquidity. In other words, they‟re ranked. The asset most easily converted into cash is listed first
followed by the next easiest and so on. Of course since cash is already cash it‟s the first asset listed.
Assets may be listed based on the difficulty with which they can be converted into cash, called the
order of permanence. These assets are ranked in the opposite order of liquidity; they are ranked from
most difficult to convert to cash, to least difficult to convert to cash.
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EFFECT OF TRANSACTIONS ON THE BALANCE SHEET
Every transaction affects two accounts or items. One account is always debited and the other account
credited.
This means that a balance is always maintained in the records. This is also reflected in the Balance
Sheet where every transaction may affect two items, and a balance is always maintained.
Illustration of how transactions affect the balance sheet
(A)Owner puts $5,000 in the business bank account.
(B)Borrowed $ 4000 cash from E. Dennis.
(C)Bought Motor van for $459 cash
(D)Received cash of $150 from debtor V. Ryan.
(E)Bought Fixtures by cheque of $257.
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CHAPTER# 3
Books of Original Entry
Uses of Books of Original Entry
Cash & Credit Transactions
Source Documents
Recording Transactions from Source Documents
General Journal
Sales Journal
Purchases Journal
Returns Inwards Journal
Returns Outwards Journal
Cashbook
Petty Cashbook
USES OF BOOKS OF ORIGINAL ENTRY
A Journal is an accounting record that is used to record the different types of transactions in
chronological order or date order. Journals are often called or referred to as the books of original
entry. The reason is that this is the first place that business transactions are formally recorded. You
can think of a Journal as a Financial Diary.
Specialized Journals are journals used to initially record special types of transactions such as sales
and purchases. All these journals are designed to record special types of business transactions and
post the totals accumulated in these journals to the General Ledger periodically (usually once a
month).
THE GEN ERAL JOUR NAL
The Journal is a textual record of events (Debit and Credit) that is characterized by the fact that all
the records it contains are in a sequential chronological order. The General Journal is used to record
unusual or infrequent types of transactions. Type of entries normally made in the general journal
include depreciation entries, correcting entries, and adjusting and closing entries.
THE CASH BOOK
The Cash Book is used to record the receipt and payment of money by the business in the form of
cash, or through the business bank account. It contains the cash and bank accounts.
SALES JOURNAL
The Sales Journal is a special journal where Credit sales to customers are recorded. Another name
for this journal is the Sales Book or Sales Day Book.
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PURCHASES JOURNAL
The Purchases Journal is a special journal where Credit purchases from customers are recorded.
Another name for this journal is the Purchases Book or Purchases Day Book.
RETURNS INWARDS JOURNAL
The Returns Inwards Journal is a special journal that is used to record the returns from debtors and
allowances of goods sold on credit. Another name for this journal is the Sales Returns Book.
RETURNS OUTWAR DS JOURNAL
The Returns Outwards Journal is a special journal that is used to record the returns to creditors and
allowances of goods purchased on credit. Another names for this journal is the Purchases Returns
Book.
THE PETTY CASH BOOK
This is just a fancy name that describes a special fund that is set up and used for minor and
unanticipated cash expenses where a cheque can‟t be written or the amount is so small that you don‟t
want to write a cheque. The petty cash account is based on the Imprest System which is a system of
cash disbursement, cash expenditure and reimbursement of that expenditure.
Cash & Credit Transactions
Cheques
A Chequeis a document/instrument (usually a piece of paper) that orders a payment of money from a
bank account. Technically, a cheque is a negotiable instrument instructing a financial institution to
pay a specific amount of a specific currency from a specified transactional account held in the
drawer‟s name with that institution. Both the drawer and payee may be natural persons or legal
entities.
The person writing the cheque, the drawer, usually has a current account where their money was
previously deposited. The drawer writes the various details including the money amount, date, and a
payee on the cheque, and signs it, ordering their bank, known as the drawee, to pay that person or
company the amount of money stated. Cheques are a type of bill of exchange and were developed as a
way to make payments without the need to carry large amounts of gold and silver
Credit Cards
Think of credit as borrowed money. This money is made available to you, but it must be repaid
within an agreed amount of time. Credit cards provide a line of revolving credit. Credit cards
eliminate the need for carrying cash or checks. A typical plastic card includes the customer‟s name
and a series of numbers that represent the applicable network, bank and account. The numbers in
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aggregate are referred to as the “account number” or “card number”. The front also features the
card‟s expiration date and the issuer‟s logo.
The back of the card has a horizontal magnetic strip and a signature box that must be signed by the
card holder. The account number and a three- to four-digit card identification number or security
number are often listed as well.
Credit cards enable you to reserve a hotel room, airline tickets and concert tickets, replace lost or
stolen items in person, over the phone or through email. They offer convenience and some special
perks for using them, such as travel insurance and gift certificates. They can be used almost
everywhere.
TYPES OF CREDIT CA RDS
Credit card products come in a wide assortment these days. Some credit card programs will ease
their terms and conditions and offer perks for people with stellar credit, such as travel insurance,
concierge service and free entertainment. Other credit card program may help a person re-establish
their credit.
Not all cards are for everyone. The ability to get a credit card will depend on whether you qualify.
This is determined by whether you have a history of establishing credit and your ability to pay bills
on time.
Here are the most common types of credit cards:
-Standard Credit Cards
-Reward Cards
-Secured Credit Cards
CREDIT CARDS: PROS AND CONS
PROS
-You can use them practically everywhere, especially overseas.
-They can boost your purchasing power because they can be used to buy goods and services over the
phone, through the mail and online.
-They provide financial backup in the event of an emergency, such as an unexpected healthcare cost,
job loss or auto repair.
-They allow you to purchase items and pay them off in monthly installments. They offer discounts at
stores and rewards. For instance, when you make purchases using the credit card you can collect
points; these points accumulate and can be used to get free items, such as airline tickets.
-Some cards may offer cash back as an incentive to use the card.
-They can help build your credit history.
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-They keep a record of your expenses, helping you to monitor your financial activities.
-They help raise your credit score, when you pay balances down by the due date. This improved
credit history paves the way for lower rates borrowing rates on other loans, including a mortgage.
-Credit cards allow you the right to dispute billing errors and defective merchandise.
-They allow you withhold payments.
CONS
-Credit cards can have their disadvantages, though, especially when they‟re used in an unwise
manner.
-Some consumers feel compelled to spend more money than they have.
-Consumers may continuously roll over a balance for several months.
-When you default on credit card payments, you are charged with late fees and interest, increasing
your debt load.
-Carrying a large amount of credit cards also isn‟t too favorable in the eyes of lenders.
-Acquiring too much credit card debt can ruin your credit score.
-Studies have indicated credit card debt as a significant factor in consumer bankruptcies.
-Credit card fraud is a possibility.
Debit Cards
A debit card is a plastic card that provides the cardholder electronic access to his or her bank
account/s at a financial institution. Some cards have a stored value with which a payment is made,
while most relay a message to the cardholder‟s bank to withdraw funds from a designated account in
favor of the payee‟s designated bank account. The card can be used as an alternative payment
method to cash when making purchases
In many countries the use of debit cards has become so widespread that their volume of use has
overtaken the cheque and, in some instances, cash transactions. Like credit cards, debit cards are
used widely for telephone and Internet purchases.
However, unlike credit cards, the funds paid using a debit card are transferred immediately from the
bearer‟s bank account, instead of having the bearer pay back the money at a later date.
Debit cards usually also allow for instant withdrawal of cash, acting as the ATM card for withdrawing
cash and as a check guarantee card. Merchants may also offer cashback facilities to customers, where
a customer can withdraw cash along with their purchase.
The widespread use of debit and check cards have revealed numerous advantages and disadvantages
to the consumer and retailer alike.
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ADVANTAGES OF DEB IT C ARDS
-A consumer who is not credit worthy and may find it difficult or impossible to obtain a credit card
can more easily obtain a debit card, allowing him/her to make plastic transactions. For example,
legislation often prevents minors from taking out debt, which includes the use of a credit card, but
not online debit card transactions.
-For most transactions, a check card can be used to avoid check writing altogether. Check cards debit
funds from the user‟s account on the spot, thereby finalizing the transaction at the time of purchase,
and bypassing the requirement to pay a credit card bill at a later date, or to write an insecure check
containing the account holder‟s personal information.
-Like credit cards, debit cards are accepted by merchants with less identification and scrutiny than
personal checks, thereby making transactions quicker and less intrusive. Unlike personal checks,
merchants generally do not believe that a payment via a debit card may be later dishonored.
-Unlike a credit card, which charges higher fees and interest rates when a cash advance is obtained, a
debit card may be used to obtain cash from an ATM or a PIN-based transaction at no extra charge,
other than a foreign ATM fee.
DISADVANTA GES OF DEBI T CARDS
-Use of a debit card is not usually limited to the existing funds in the account to which it is linked,
most banks allow a certain threshold over the available bank balance which can cause overdraft fees
if the user‟s transaction does not reflect available balance.
-Many banks are now charging over-limit fees or non-sufficient funds fees based upon pre-
authorizations, and even attempted but refused transactions by the merchant (some of which may be
unknown until later discovery by account holder).
-Many merchants mistakenly believe that amounts owed can be “taken” from a customer‟s account
after a debit card (or number) has been presented, without agreement as to date, payee name,
amount and currency, thus causing penalty fees for overdrafts, over-the-limit, amounts not available
causing further rejections or overdrafts, and rejected transactions by some banks.
SOURCE DOCUMENTS
Source Documents are the original sources of information that provide documentation (proof) that a
transaction has occurred such as sales invoices (tickets), invoices from suppliers, contracts, checks
written and checks received , promissory notes, and various other types of business documents.
These documents provide us with the information needed to record our financial transactions in our
bookkeeping records. If you recall, a transaction is any event or condition that must be recorded in
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the books of a business because of its effect on the financial condition of the business, such as buying
and selling.
Source documents detail the particulars of transactions that include the date, name, address, terms,
and product description among other relevant pieces of information. Types of source documents
include cash receipts, canceled checks and invoices. Source documents may be paper-based business
forms or electronic documents.
-They are used for initial input to the accounting system. The transactions they record can be entered
into the first of the accounting records – the journals.
-They assist internal control of the resources of the business – making sure that there is
documentary evidence that a transaction took place such as the purchase or sale of items and the
receipt and payment of money (that is, it makes it more difficult for people to misappropriate or steal
cash or other items).
-They are part of the audit trail for as long as those documents are required to be kept by law or
policy. Of such, they are a part of the record keeping process.
Here is a summary of some types of sources documents and their uses:
Sales Invoice
This document is sent to request payment for monies owed, for goods that were delivered, or
services that were rendered.
FEATURES OF INVOIC E
Invoices are numbered to keep track of sent invoices
Invoice usually includes the following information:
-Name, address of seller and purchaser
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-Date of sale
-Description of sale (goods or services)
-Quantity and unit price of what has been sold
-Details discount if it is provided
-Total amount of invoice plus sales tax if applicable
-Other (date of payment, terms of sale)
Purchases Invoice
This document is received in request payment for monies owed, for goods that were delivered, or
services that were rendered. It is identical to The Sales Invoice but is called a Purchases Invoice when
the purchaser receives it.
Credit Note
This document is sent by a supplier to a customer to reduce the liability of the customer. In essence it
is a negative invoice that is issued when goods are returned, when there was an overpayment, or
when some other event has occurred that has the effect of reducing the amount that the customer
owes to the supplier.
Debit Note
This document is sent from a customer to a supplier to request a credit note in respect to an
overpayment or return of goods.
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Receipt
This is a written document that confirms that money has been received as a down payment, account
settlement or installment.
Petty Cash Voucher
This Document records in numeric order the specific amounts paid out in petty cash, to whom the
payments are made and for what purpose.
RECORDING TRANSACTIONS FROM SOURCE
DOCUMENTS
Journals use the information from the source documents to create a chronological listing of all
business transactions and detailed information about each transaction.
Journals are preliminary records where business transactions are first entered into the accounting
system. The journal is commonly referred to as the book of original entry. Specialized Journals-are
journals used to initially record special types of transactions such as sales and purchases in their own
journal
Why Use Special Journals
-Groups and records transactions of a like nature. A familiar example is recording all cash received
by a business in one place.
-Saves time with summary and less frequent postings to the General Ledger.
-Allows a business to have different individuals responsible for different journals thereby increasing
internal controls and allocating the record keeping workload.
GENERAL JOURNAL
The Journal is a textual record of events (Debit and Credit) that is characterized by the fact that all
the records it contains are in a sequential chronological order.
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Debit and Credit
Journals can be viewed as pages of a book. Each page has lines and columns. A journal page has
columns for the date, account name, and two columns for dollar amounts, referred to as the Debit
and Credit columns.
Entries are transferred (Posted) from the journal to the ledger pages on a regular basis.
When do we use Debit or Credit?
When to use a debit or credit to record a journal entry is one of the biggest problems for beginning
accounting students. It doesn‟t have to be difficult, if you remember a few simple rules.
All journal entries follow the rules of debit and credit. Remember the Accounting Equation?
-INCREASE IN A SSETS is reported on the DEBIT side of a journal entry.
-DECREASE IN ASSET S is reported on the CREDIT side of a journal entry.
Functions of the General Journal
-BUYING AND SELLING OF FI XED ASSETS ON CRED IT
2009 June 1, Bought furniture on credit from Kull dunne for $1 000.
-RETURN OF FI XED ASSETS
2009 June 5, $1,000 Furniture returned to Kull Dunne.
-TRANSFER OF CREDITORS
We owed Bee Bobby $500. On June 10 2009 Bee Bobby‟s business is taken over by Rune Crumbe
who we will know owe the $500.
-SETTLEMENT OF DEBT
2009 June 15 We receive machinery valued $250 from Carl reeves in settlement of his debt of
$500.
-OPENING ENTRIES
On July 1 2009 V. Nemhard Opens his books of accounting to start business. At that date His
records reflect:
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ASSETS:
Premises $2 000
Fixtures and Fittings $1 000
Machinery $600
Motor Vehicle $400
Stock of goods $200
Debtors:Vanne Style $100
Pryce Goonie $60
Bank $40
Cash $50
LIABILITIES :
Creditors: Evelyn Dianne $250
Devlin Cole $200
CAPITAL :
$4 000
The Above transactions are journalized by date order below.
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SALES JOURNAL
The Sales Journal is a special journal where Credit sales from customers are recorded.
Steps in journalising Credit sales
The following credit sales transactions are Journalised below:
2009
July 3 Sold goods on credit to Yule Terry for $!00
July 10 Credit sales to jerry Hulle $200
July 20 Sold stock for credit $300 to Larry Hadman
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PURCHASES JOURNAL
The Purchases Journal is a special journal where Credit purchases from suppliers are recorded.
Steps in journalising Credit Purchases
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The following credit purchases transactions are Journalised below:
2009
July 5 Credit purchases from Karnot Webb $400
July 7 Goods purchased on credit $500 from Harlot Mcqueen
July 15 Bought goods on credit 4600 from Clement Rhoden.
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RETURNS INWARDS JOURNAL
The Sales Return & Allowances Journal is a special journal that is used to record the returns and
allowances of goods sold on credit.
Steps in Journalizing Returns Inwards
The following Returns Inwards transactions are Journalised below:
2009
July 6 Goods returned from Yule Terry $ 10
July 13 Returned goods from Jerry Hulle $20
July 26 Returns Inwards from Larry Hadman $30
RETURNS OUTWARDS JOURNAL
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The Purchase Returns and Allowances Journal is a special journal that is used to record the returns
and allowances of merchandise purchased on account.
Steps in journalising Rturns Outwards
The following Returns Outwards transactions are Journalised below:
2009
July 9 Goods returned to Karnot Webb $40
July 14 Returned goods to Harlot Mcqueen $50
July 31 Returns Outwards to Clement Rhoden $60
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CASHBOOK
The Cash Book is used to record the receipt and payment of money by the business in the form of
cash, or through the business bank account. It contains the cash and bank accounts.
Columns are set up for:
-THE DATE
-DETAILS
Entries are made for the other account to enter to complete double entry
-FOLIO
The reference is entered for the book and page number for the other account to complete double
entry
-DISCOUNT ALLOWED
This is an incentive for speedy settlement of credit sales. All Discount Allowed merely listed here.
-DISCOUNT RECEIVED
This is an incentive for speedy settlement of credit Purchases. All Discount Received merely listed
here.
-CASH AND BANK RECEIPTS
Types of Transactions Recorded:
Cash product sales / fees
Cash collected on customer accounts
Any other receipt (source) of cash
-CASH AND BANK PA YMENTS
Types of Transactions Recorded:
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Cash paid for expenses
Cash payments to our suppliers on account or cash purchases
Cash purchase of supplies
Any other cash payment
The following Cash Book transactions are entered below:
2009
May 1 Balances brought forward for Cash $100 and Bank $2 000
May 2 Cash sales $250. paid directly into the bank
May 3 Bought motor van for cash $200
May 5 Cash sales $ 250
May 8 Paid rent by cheque $150
May 10 Paid wages by cheque $120
May 18 Received cheque of $90 from debtor B.Butler, Discount Allowed $10
May 19 Paid cheque $200 to creditor C. Bare. Discount Received $20
May 22 Received cheque of $50 from debtor S.Combs, Discount Allowed $5
May 24 Paid cheque $30 to creditor V. Bryan, Discount allowed $30
May 24 Withdrew cash from the bank $20 for personal use
May 28 Cash of $20 was deposited to the bank account
PETTY CASHBOOK
Another name that is sometimes used to refer to Petty Cash is an “imprest fund”. This is just a fancy
name that describes a special fund that is set up and used for minor and unanticipated cash expenses
where a cheque can‟t be written or the amount is so small that you don‟t want to write a cheque.
Some examples include buying pizza for the staff, postage stamps, minor office supplies, paper
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towels, and cleaning supplies. A pre-numbered voucher or ticket should be filled out and approved
for each expenditure. When the balance in the fund becomes low a check from your regular bank
account should be issued and cashed to replenish the fund and the expenses recorded in your
accounting records. Surprise counts of petty cash should occasionally be done to make sure that
employees are not “borrowing” from this source of cash. Counting the fund is very easy. The total
amount of the tickets and the cash on hand should equal to the fund‟s established balance.
The petty cash (actual cash and all the supporting vouchers and receipts) is normally kept in a locked
drawer or box and one individual is assigned or designated as the custodian of the fund. The
custodian is responsible for all the petty cash activity. Individuals should also be designated who
have the authority to approve payments using petty cash. This could also be the custodian of the
fund.
How do you set up a Petty Cash Fund?
Determine the balance or amount of cash needed during a month to handle cash payments for such
items as stamps, COD shipments, office supplies, or any other types of payments where writing a
check is not practical. This balance is referred to as a “float”.
Designate an individual or petty Cashier to handle the petty cash book.
Payment is made to the Petty cashier for the amount determined to be needed (The Cash Float), who
then places the funds in a locked drawer or box. The accounting records would be to debiting Petty
Cash and crediting Cash in the Cash Book.
How do you operate the Petty Cash Fund?
All petty cash disbursements are made from this fund. A book or worksheet is maintained that
records all the payments made and why and what for they were made. Your chart of accounts is used
to determine what account(s) to charge the payment to.
A pre-numbered ticket or voucher is approved, signed by the person receiving the cash, and prepared
for each expenditure made from the fund and any supporting documents such as an invoice or
receipt is attached when the voucher is settled for.
The total of the cash in the fund plus the total of all the tickets and vouchers should always equal the
balance established for the fund. In other words if your petty cash fund amount is $500, the total of
the tickets paid and the currency on hand should equal $500.
Surprise counts of petty cash should occasionally be performed in order to make sure that employees
are not “borrowing” this cash.
How do you replenish the Petty Cash Fund when it “runs out” of cash?
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At the end of a month or whenever the amount of currency (actual cash) in the fund becomes low a
summary is prepared of all the settled vouchers assigning the payments made to the appropriate
expense or other categories (accounts) which is used to record the debits to the expense and other
accounts and the total credit to the cash account in the Cash Disbursements Journal.
The current balance of the fund should also be checked by adding up all the currency still on hand
and the total of all the vouchers and tickets. This total should agree with the balance assigned to the
fund. In other words, if the funds assigned balance is $500 the total of all the tickets and vouches
and currency should equal to $500.
A cheque is then prepared and made payable to the Petty Cash Custodian and recorded in the Cash
book.
How do you increase or decrease the Float?
To increase the Petty Cash fund balance, you simply prepare a check made out to the Petty Cash
Custodian for the amount of the increase to the Petty Cash Fund. For example, if your current fund
balance is $100.00 and you want to increase the Petty Cash fund to a balance of $200.00, you would
issue a check for $100.00 and record the cheque in your Cash Disbursements Journal as a debit to
your Petty Cash Account and a credit to your Cash In Bank Account.
The following Petty Cash Book transactions are entered below:
2010
November 1 Cash of $5 000 deposited to Petty Cash account from cash book
November 2 Wages of $100 paid to casual Labourer
November 3 Stamps were bought for $300.
November 5 Floor Polish bought for $50
November 6 Office Worker paid Taxi Fare to travel to special meeting
November 7 Painter paid wages for repainting wall in kitchen
November 10 Office Worker paid Bus Fare to travel to special meeting
November 12 Paper bought for general office purpose
November 19 Bought brushes $60 to clean canteen and office floors
November 21 Ink bought for office use
November 22 Paid a creditor Paul Freddy $400 out of Petty Cash
November 30 Cash of $1 700 deposited to Petty Cash account from cashbook as reimbursed of cash
used throughout the month of November Petty Cash Float balance remains $5 000
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CHAPTER # 4
Ledgers and the Trial Balance
The Accounting Equation Classification of Accounts
Accounts Rules for Double Entry
Asset of Stock
Expense and Revenue Accounts
Capital and Revenue Expenditure
Basic Double Entry
Balancing of Accounts
The Trial Balance
THE ACCOUNTING EQUATION
We have often heard the expression “the books are in balance” in reference to the accounting records
of a business. This relates to the use of the double-entry system of accounting, which says that every
transaction will affect two accounts. Because the monetary values are equal we say the transaction is
“in balance.” Accounting is based on a simple rule, called the accounting equation.
Using a two pan scale as illustration, the Accounting Equation is really:
The accounting Equation describes items owned by the business on one hand, and the financing of
these items on the other hand.
Assets are the items owned by the business and are represented on the left side of the equation.
Capital and Liabilities represent the financing activities of the business and are represented on the
right side of the equation
Assets may include land and buildings, machinery, motor vehicles, fixtures, cash on hand and
money in the bank, as well as debts owed by customers.
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Liabilities represent money owed by the business due to borrowings and credit arrangements
including amounts owed by the business for goods and services supplied and unpaid expenses
incurred by the business.
Capital is the amount of resources supplied by the owner. This includes investments by the owner
as well as retained profits from ongoing business operations.
The accounting equation uses “simple math” and involves only addition and subtraction.
Regardless of the number of transactions, the Accounting Equation will always balance. The
respective values of assets, capital and liabilities may change but total assets will always be equal to
the total of capital and liabilities. This is because:
Assets = Capital and Liabilities
any item owned by the business must come from some source of financing
Types of Ledgers
Accounting entries are made in books called Ledgers. Most businesses use the following ledgers:
-SALES LEDGER : This book contains the personal accounts for customers or debtors.
-PURCHASES LEDGER : This book contains the personal accounts for suppliers or creditors.
-GENERAL LEDGER : The remaining double-entry accounts such as those related to capital, fixed
assets, expenses and revenues ( except for cash account and bank account ) are entered in the
general ledger.
CLASSIFICATION OF ACCOUNTS
All accounts may be grouped in two broad categories or classifications. These are personal and
impersonal.
Personal Accounts: These are the accounts that have the names of debtors (customers) or
creditors (suppliers). They are therefore personal to this extent.
Impersonal Accounts: These non-personal accounts may be divided into Real Accounts and
Nominal Accounts.
-REAL ACCOUNTS - These accounts are tangible in nature and represent accounts that records
possession such as machinery, furniture, premises and stock.
-NOMINAL ACCOUNT S – These accounts are intangible in nature and represent accounts that in
which expenses, revenues and capital are recorded.
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CLASSIFICATION OF ACCOUNTS
Rules of Entry for general Accounts
An account is divided into two sides, a left side called the debit side and a right side called the credit
side. The title of the account is written in the center at the top of each account.
ACCOUNTS RULES FOR DOUBLE ENTRY
-When INCREASING an ASSET account we make a DEBIT ENTRY .
-When DECREASING an ASSET account we make a CREDIT ENTRY .
-When INCREASING a CAPITAL/LIABILITY account we make a CREDIT ENTRY .
-When DECREASING a CAPITAL/LIABILITY account we make a DEBIT ENTRY .
Illustration of basic accounting entries
2009
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June 1 Owner started business „ToyWare‟ with $5,000 cash in hand.
June 5 The business borrowed $10,000 cash from C.Wuggot.
ASSET OF STOCK
Stock refers to all items that a business normally engages in buying or selling to make a profit. Stock
is an asset because it represents goods owned by the business .In accounting certain terms have
specific or restricted meaning but these terms may have a different meaning outside the context of
accounting. In Accounting the term Purchases refers to buying of stock only. Sales refer to selling of
stock only. There are items which may occasionally be bought and sold by a business which are not
stock. These items are fixed assets which are bought not for resale but to be used in the business for a
long time.
Goods may be bought and sold for cash or on a credit basis. When goods are sold on credit the
customer becomes indebted to the business and is called debtors. Debtors are a form of asset and
represents customers who owe the business money usually for items sold on credit. When goods are
bought on credit the business becomes indebted to the supplier and is called creditors. Creditors are
a form of liability and represents suppliers to whom the business owes money usually for items
bought on credit.
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There are four basic movements of stock, two representing increases in the asset of stock and two
representing decreases in stock; Each movement requiring its own accounting entry. These
movements are:
Increase of Stock
-PURCHASES of stock: The Purchase Account will be debited because purchases represent
increases in the asset of stock.
-RETURNS INWARDS of stock: Returns Inwards represent goods returned to the business by
customers. These goods were previously sold so they are also referred to as sales returns. The asset of
stock will increase by the goods returned in, therefore the Returns Inwards (or Sales Returns)
Account will be debited. Goods are sometimes returned due to excess amount received by customers,
wrong type, damaged goods, or inferior quality.
Decrease of Stock
-SALE of stock: The Sales Account will be credited because sales represent decrease in the asset of
stock due to the leaving of stock.
-RETURNS OUTWARDS of stock: Returns Outwards represent goods returned out to suppliers
by the business. These goods were previously purchased so they are also referred to as purchases
returns. The asset of stock will decrease by the goods returned out, therefore the Returns Outwards
(or Purchases Returns) Account will be credited.
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EXPENSE AND REVENUE ACCOUNTS
Expenses
These represent the daily cost to keep the business in effective operation. Expenses would include
light , water bills, telephone charges, wages and salaries, cleaning, transportation, stationery used,
and insurance. All expense accounts are debited.
Revenues
Revenues represent the monetary value of goods and services that have been delivered to customers.
Revenues would include rent received, commissioned received and discount received. All revenue
accounts are credited.
Profit
Profit is the excess of revenues over expenses for an accounting period. It is represented by
revenues minus expenses for the accounting period. Profits will have an increasing effect on increase
capital.
Loss
Loss is the excess of expenses over revenues for an accounting period. Loss will decrease capital.
Drawings
Drawings represent the monetary of any asset which the owner takes out of the business for his
personal and private use. The drawings account is debited.
CAPITAL AND REVENUE EXPENDITURE
Capital Expenditure is directly related to fixed assets in that it is incurred when money is spent by
a business to either:
-Buy a fixed asset, or
-Increase the value of a fixed asset in existence.
Revenue Expenditure is not directly related to acquiring fixed assets, but relates to the everyday
cost to operate a business. Revenue expenditure is chargeable to the Trading and Profit and Loss
Account as an expense, while capital expenditure will reflect increase value for fixed assets in the
balance sheet. If the two classification are done incorrectly then the error will affect reported profit,
and the closing capital and value of assets in the balance sheet.
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BASIC DOUBLE ENTRY
2010
May 1 Owner started business Gummy Sweets with $5 000 cash in hand.
May 3 The business borrowed $10 000 from C. Wuggot which was put to the bank account.
May 4 Bought goods on credit for $400 from M. Dyall.
May 6 Goods returned to M. Dyall $50.
May 11 Rent Received by cheque $200
May 14 Paid wages by cheque $30
May 16 Owner took $ 250 cash from business for personal use
May 19 Sold goods on credit to H. Hannis for $200.
May 23 Goods returned from H. Hannis $20.
May 26 Paid M. Dyall $150 by cheque.
Posting Entries to the General and Subsidiary Ledgers
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BALANCING OF ACCOUNTS
The respective accounts for most businesses are closed off at the last day of each month and
reopened for the first day of the following month. The steps by which this is done is referred to as
balancing off the accounts. An account balance is the difference between the totals on the debit side,
and the totals on the credit side of the account of the same account. The account balance always
belongs to the greater side.
The account balance is entered on the lesser side at the end of the month as a balance carried down.
This may be written as „balance c/d‟. When the account is reopened the first day of the following
month the same balance is entered on the opposite side as a balance brought down. This may be
written as “balance b/d.‟
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If the debit side exceeds the credit side, the account is said to have a „debit balance‟. If the credit side
exceeds the debit side, the account is said to have a „credit balance.‟
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THE TRIAL BALANCE
The double entry system of accounting states that every transaction will affect two accounts. If the
first account is debited then the second one will be credited or vice versa. It means that every value
that is placed on the debit side of a first account must be placed on the opposite credit side of a
second account.
To ensure that a proper matching credit entry for every debit entry is being observed a Trial Balance
is prepared. A trial Balance is said to be a statement of arithmetic proof to ensure that proper double
entry is being done. This statement is made of a list of account balances arranged according to
whether they are debit balances or credit balances.
Steps to Trial Balance Entry
-The accounts should first be entered.
-The accounts should secondly be balanced off.
-The accounts balances should be entered in the Trial Balance on the same side as the balance b/d in
the accounts.
-Total both debit and credit columns.
If the totals of both columns are not equal then it means that there may be one or more accounting
errors. If both column totals are in agreement then it is assumed that proper double entry was
observed.
The Uses and limitations of the Trial Balance
-The Trial Balance assists in detecting accounting errors
-It provides closing balance figures for accounts to enter for Final Accounts
-It provides a summary of relevant accounts to assist management in making decisions.
The trial Balance will only detect some types of accounting errors. There are roughly seven errors
which will not be revealed by the trial balance. These errors will be looked at separately a little later.
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CHAPTER # 5
Preparation and Analysis of Financial Statements
Financial Statements
The Valuation of Stock
The Trading and Profit and Loss Account
The Balance Sheet
Accounting Ratios
Mark-Up and Margin Ratios
Stock Turn Ratio
Gross Profit & Net Profit as a percentage of sales Ratios
Liquidity,Current & Acid Test Ratios
Return on Capital employed (ROCE)
Illustration of a Basic Financial Analysis of a Business
FINANCIAL STATEMENTS
Financial Statements are summary accounting reports prepared at stated time periods to inform the
owner, creditors, and other interested parties as to performance of the business. Financial
Statements uses summarized data to prepare the business‟s financial reports.
Financial statements have generally agreed-upon formats. There are three main financial
statements:
-Trading and Profit and Loss Account
-Balance Sheet
-Statement of Cash Flows
Each financial statement provides a different perspective Combined the financial statements provide
a general overview of the company, the impact of its activities, its financial strength, and an overview
of its cash flow. Evaluating allows directors to formulate effective strategic policies, and implement
factors that will increase efficiency.
THE VALUATION OF STOCK
The closing stock figure at the end of the year may be valuated used several methods.
First in, First Out (FIFO) Method
This method of valuating closing stock assumes that stock of goods are sold in order of those which
were first purchased ( First In) being sold first (First Out).
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Last In, First Out (LIFO) Method
This method of valuating closing stock assumes that stock of goods are sold in order of those which
were last purchased ( Last In) being sold first (First Out).
Average Cost (AVCO) Method
The average cost of each item of stock in hand is recalculated whenever there is a receival of new
stock of goods. The new average cost is calculated by adding the old average cost to the unit cost of
the new item of stock and divide by two.
Below is a fully worked example:
From the following figures calculate the closing stock value using the FIFO, LIFO and AVCO method
of stock valuation.
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THE TRADING AND PROFIT AND LOSS ACCOUNT
One of the main aims of operating a business is to make profit. Profit is calculated in a Trading and
Profit and Loss Account. This is divided in a Trading Account which calculates the Gross Profit for
the period, and a Profit and Loss Account which calculates Net profit for the period.
THE TRADIN G ACCOUNT ─ calculates the profit made strictly from trading activities. Trading
involves buying and selling. In the trading account the cost of goods sold is subtracted from Net Sales
for the period to calculate Gross Profit.
COST OF GOODS SOL D ─ the value of the goods sold at cost.
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NET SALES ─ the actual sales made after all adjustments have been made for goods returned.
GROSS PROFIT ─ this is the excess of Net Sales over Cost of Goods Sold.
GROSS LOSS ─ this is the excess of Cost of goods sold over Net Sales.
At the end of a financial period, all expense and revenue accounts are closed to a summarizing
account usually called a Profit and Loss Account. This is the financial statement that summarizes
revenues and expenses for a specific period of time, usually a month or a year.
THE PROFIT AND LOSS ACCOUNT reflects a Period of Time – Month, Quarter, Year. It shows
financial the activity of a business during that period and indicates any profit or loss earned.
REVENUE ─ is the value of goods and services which have been delivered to customers.
EXPEN SES ─ costs incurred in earning these revenues.
NET PROFIT ─ is the excess of Revenue over Expenses, on the Profit and Loss Account.
NET LOSS ─ is the excess of Expenses over Revenue, on the Income Statement.
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THE BALANCE SHEET
The statement of financial position of a business sums up its economic resources, obligations (debts
and other non-current liabilities) and owners‟ capital at a particular point of time. It also shows how
the economic resources contributed by lenders and shareholders are used in the business.
Balance sheet items are classified as assets, liabilities, or capital, and the amount and nature of these
items are shown at a specific date in time.
ASSETS – Something the company owns that has value.
LIABILITY – Money the company owes to creditors.
CAPITAL – This is the portion that remains after liabilities are subtracted from assets. Capital
includes profit or Loss from the business.
DRAWINGS – Represent assets taken out by owners of the business
The Balance Sheet:
REFLECTS A MOMEN T IN TIME
It indicates Assets, Liabilities and Equity of business as of a specific date.
SHOWS FINANCIAL POSITION OF BUSINESS AS OF SP ECIF IC DAT E:
Financial Position – what you have/what you owe/what your stockholders have “Have” – “Owe” =
“Value to Owner”
VALUE OF BUSINESS TO OWNERS
Assets – Liabilities = Capital
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The effect of Net Profit or Net Loss on the Balance Sheet
In the balance sheet net profit is added to capital because profit increases capital. It also follows that
in net loss will be subtracted from capital because a loss will reduce the owners capital.
Working Capital
This is the excess of current (or short term) assets over current (or short term) liabilities. To calculate
working capital the total of Current liabilities is subtracted from the total of Current assets.
Working Capital may be used as a tool for solvency. The calculation involves strictly short term items
and therefore working capital reveals the assets of the business that are most easily converted to cash
in the short term. This has significance for the liquidity or solvency of the business or its ability to
deal with short term payments. In the long run fixed assets may be sold to offset immediate cash
obligations.
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The calculation of working capital
ACCOUNTING RATIOS
A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values taken
from an enterprise‟s financial statements. Often used in accounting, there are many standard ratios
used to try to evaluate the overall financial condition of a corporation or other organization.
Financial ratios may be used by managers within a firm, by current and potential shareholders
(owners) of a firm, and by a firm‟s creditors. Security analysts use financial ratios to compare the
strengths and weaknesses in various companies.
Financial ratios quantify many aspects of a business and are an integral part of the financial
statement analysis. Financial ratios are categorized according to the financial aspect of the business
which the ratio measures.
Financial ratios allow for comparisons:
-between companies
-between industries
-between different time periods for one company
-between a single company and its industry average
Ratios generally hold no meaning unless they are benchmarked against something else, like past
performance or another company. Thus, the ratios of firms in different industries, which face
different risks, capital requirements, and competition, are usually hard to compare.
Profitability ratios
Profitability ratios measure the company‟s use of its assets and control of its expenses to generate an
acceptable rate of return. These are concerned with the return on investment for shareholders, and
with the relationship between return and the value of an investment in company‟s shares.
Activity ratios (Efficiency Ratios)
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Activity ratios measure the effectiveness of the firm‟s use of resources. Activity ratios measure how
quickly a firm converts non-cash assets to cash assets.
Liquidity ratios
These measure the availability of cash to pay debt.
Debt ratios (leveraging ratios)
Debt ratios measure the firm‟s ability to repay long-term debt. Debt ratios measure financial
leverage.
Market Ratios
If shares in a company are traded in a financial market, the market price of the shares is used in
certain financial ratios. Market ratios measure investor response to owning a company‟s stock and
also the cost of issuing stock. These are concerned with the return on investment for shareholders,
and with the relationship between return and the value of an investment in company‟s shares.
If shares in a company are traded in a financial market, the market price of the shares is used in
certain financial ratios.
MARK-UP AND MARGIN RATIOS
Mark-up is profit expressed as a fraction or as a percentage of the cost of good.
Margin is profit expressed as a fraction or as a percentage of the sales price.
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http://wizznotes.com/accounts/preparation-and-analysis-of-financial-statements/mark-up-and-
margin-ratios
STOCK TURN RATIO
Stock turn provides an indication as to how fast or slow stock is been sold. It also indicates the
efficiency of the business in terms of its control of stock levels. Assuming that gross profit percentage
remains constant, a faster sale of stock will mean increases in profits from sales; likewise a slower
sale of stock could mean decreases in profits.
The formula for stock turn is:
The Average stock is calculated as ( opening stock + closing stock ) ÷ 2
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GROSS PROFIT & NET PROFIT AS A PERCENTAGE OF
SALES RATIOS
Gross Profit as a percentage of sales
Sales revenue does not tell the total picture of performance. The sales revenue of a business may
significantly increase with only marginal increase in actual gross profit. Gross profit as a percentage
of sales provides information on the profitability of sales; that is the gross profit per $100 of sales.
The formula is:
Net profit as a percentage of sales
Net profit as a percentage of sales provides information on the profitability of sales; that is the net
profit per $100 of sales.
The formula is:
LIQUIDITY, CURRENT & ACID TEST RATIOS
Liquidity Ratios
The ability of a business to meet current financial obligations such as loan repayments, expenses and
creditors is crucial to its continued existence. A business is said to be „liquid‟ when it is able to pay its
debts on time. It is equally important that the business collect from debtors their outstanding
amounts on time. Two ratios directly related to the liquidity or solvency of businesses, are
the Current Ratio and the Acid Test Ratio.
Current Ratio
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This ratio provides indication of the business to meet its short term financial commitments. The
comparison is made with (current) assets which will become liquid within a year and (current)
liabilities which should be paid within the same period of one year. This will indicate if the business
has enough short term assets to meet its short term payments. The formula for current ratio is:
Acid Test Ratio
Acid test ratio indicates the ability of the business to meet it short term payments given the situation
where all debtors settle and all creditors are paid at the same time. The formula for Acid Test ratio is:
RETURN ON CAPITAL EMPLOYED (ROCE)
Capital employed is basically the effective capital that is being used in the business. The average of
the capital account for the year i.e. (opening capital + closing capital) ÷ 2 may be used as
capital employed. Most people start a business with the hope to make satisfactory returns on their
capital employed. The formula for capital employed is:
This shows that effective use of capital is very crucial to the success of a business. Company A has
made a return of 30% net profit on its capital. Company B has only made a return of 10% net profit
on its capital although it has three times the value of capital.
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ILLUSTRATION OF A BASIC FINANCIAL
ANALYSIS OF A BUSINESS
As seen from the table above, Adam Wesley is very liquid, enjoying a high liquidity ratio of 16. This is
augers well for the future.
The Gross Profit margin on sales is also attractive. A 35% profit margin on sales signals that Adam
Wesley should recoup his investment and then some.
The Current Ratio may be a bit too high, suggesting that some of the cash or bank can be invested
rather than resting in the bank or remaining as cash in hand. Cash or bank is best held in such
amounts as will be needed to fund the daily working of the business and no more. On a positive note,
it is better to have this ratio too high, as all Adam Wesley needs to do to regularize this, is to invest
some of the extra liquidity. If the converse is the case, the business may have to take a loan or risk
running into overdraft.
Notwithstanding the positive return on investment at the end of the day, the investor must, however,
look at the rate of return they desire on their investment because ultimately it makes little sense to
operate a business to achieve a rate of return which is lower than could have been obtained had the
money been invested in a money market instrument, for instance.
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CHAPTER # 6
End of Period Adjustments
Expenses and Revenues
Accruals and Prepayments in the Balance Sheet
Distinction between Bad Debts and Doubtful Debts
Provision for Depreciation
EXPENSES AND REVENUES
Reasons for adjustments in revenue and expense accounts
The Accruals Concept of accounting states that in calculating net profit the expenses for the period
should be subtracted from the revenues generated in the same period. The process by which the
revenues and expenses for the period are ascertained is referred to as matching expenses with
revenues.
At the end of each accounting period some adjustments may be needed for some expense and
revenue accounts. This is due to some of these accounts having outstanding balances as well as
having prepayments and advanced revenues advance.
Entries for prepaid expenses and accrued expenses at the beginning and end of a
period
Entries for advance revenues at the beginning and end of a period
Below is an example:
On January 1, 2010 the following balances among other balances stood in the books of T. Tyler.
(a)Light owing $100
(b)Rates prepaid $700
(c)Commissions Received outstanding $1000
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During the financial year ending December 31, 2010 the following transactions were recorded:
1. Paid light by cheque $900
2. Paid rates by cash $1000
3. Received Commission by cheque $2500
At the end of the financial period December 31, 2010 the following accounts showed balances:
1. Light expense owing $200
2. Rates prepaid $$100
3. Commission received outstanding $500
You are required to write up the accounts including the correct amount to transfer to The Profit and
Loss Account ended December 31, 2010, and any balances to be carried forward to 2011.
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ACCRUALS AND PREPAYMENTS IN THE BALANCE
SHEET
Prepaid expenses represented assets of the business. The total of prepaid expenses will be listed in
the balance sheet immediately under debtors as a current asset.
Accrued expenses are a form of current liability and will be listed in the balance sheet under current
liabilities.
DISTINCTION BETWEEN BAD DEBTS AND DOUBTFUL
DEBTS
When debtors fail to settle their accounts for items sold on credit a bad debt will occur.A bad debt is
an amount that is written off by the business as a loss to the business and classified as an expense
because the debt owed to the business is unable to be collected, and all reasonable efforts have been
exhausted to collect the amount owed. This usually occurs when the debtor has declared bankruptcy
or the cost of pursuing further action in an attempt to collect the debt exceeds the debt itself.
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The debt is immediately written off by crediting the debtor‟s account and therefore eliminating any
balance remaining in that account. A bad debt represents money lost by a business which is why it is
regarded as an expense.
Doubtful debts are those debts which a business or individual is unlikely to be able to collect. The
reasons for potential non payment can include disputes over supply, delivery, and conditions of
goods or the appearance of financial stress within a customer‟s operations. When such a dispute
occurs it is prudent to add this debt or portion thereof to the doubtful debt reserve. This is done to
avoid over-stating the assets of the business, as trade debtors are reported net of Doubtful debt.
When there is no longer any doubt that a debt is uncollectable the debt becomes bad. An example of
a debt becoming uncollectable would be: – once final payments have been made from the liquidation
of a customer‟s limited liability company, no further action can be taken.
To be considered as deductible, debts:
-must be a bona-fide debt, and
-worthless within the taxable year
An Ageing Debtors Schedule is set up where the debts are scheduled according to their age starting
with from youngest to the oldest debts. This will assist in the calculation of bad debts, where the
older debts are given a higher probability of bad debt, as well to determine those older debts that
may not be collectible.
Provision for Bad Debts
A provision for bad debts is an estimation for bad debts on the balance of debtors at the end of the
financial period.
-This bad debts provision expense attempts to allow as accurate as possible a calculation for bad
debts for the year in which the debt occurred.
-It also allows for as accurate a figure for debtors at the date of the balance sheet.
Accounting entries for Bad Debts and Provision for Bad Debts
Both Bad debts and Provision for bad Debts are expenses and are therefore entered to Profit and
Loss Account. However, only Provision for bad debts is entered to the balance sheet.
Below is an example
Enter up the Bad Debts account, Provision for Doubtful Debts Account, The Profit and Loss Account
extracts, and Balance Sheet extracts for the relevant years from the table below.
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PROVISION FOR DEPRECIATION
Depreciation refers to two very different but related concepts:
(1) The decrease in value of assets (fair value depreciation)
(2) The allocation of the cost of assets to periods in which the assets are used (depreciation with the
matching principle).
Causes of depreciation
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The former affects values of businesses and entities. The latter affects net income. Generally the cost
is allocated, as depreciation expense, among the periods in which the asset is expected to be used.
Such expense is recognized by businesses for financial reporting and tax purposes. Methods of
computing depreciation may vary by asset for the same business. Methods and lives may be specified
in accounting and/or tax rules in a country. Several standard methods of computing depreciation
expense may be used, including straight line, and reducing balance methods. Depreciation expense
generally begins when the asset is placed in service.
Factors to consider when calculating depreciation
Depreciation is the gradual decrease in the economic value of the fixed assets of a business, either
through physical depreciation, obsolescence or changes in the demand for the services of the asset in
question.
While depreciation expense is recorded on the income statement of a business, its impact is generally
recorded in a separate account and disclosed on the balance sheet as accumulated depreciation,
under fixed assets, according to most accounting principles. Accumulated depreciation is known as a
contra account, because it separately shows a negative amount that is directly associated with
another account.
Depreciation expense is charged against accumulated depreciation. Showing accumulated
depreciation separately on the balance sheet has the effect of preserving the historical cost of assets
on the balance sheet. If there have been no investments or dispositions in fixed assets for the year,
then the values of the assets will be the same on the balance sheet for the current and prior year.
Methods for calculating depreciation
There are several methods for calculating depreciation, generally based on either the passage of time
or the level of activity (or use) of the asset.
-Straight-line Method
Straight-line depreciation is the simplest and most-often-used technique, in which the company
estimates the disposal value of the asset at the end of the period during which it will be used to
generate revenues (useful life) and will expense a portion of original cost in equal increments over
that period. The disposal value is an estimate of the value of the asset at the time it will be sold or
disposed of; it may be zero or even negative. Disposal value is also known as scrap value or residual
value.
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-Reducing Balance Method
Depreciation may be given as a fixed percentage annually and may be applied on cost in the first
year, but in subsequent years applied on the reduced balance or net book value of the previous year.
This method is called the reducing balance method.
Below is an Example
A motor van was bought on January 1, 2009 for $10 000. It has an estimated life of ten years with an
annual depreciation of 10% straight line method. Calculate the annual depreciation for 2009 to 2011
and make entries to Provision for Depreciation Account─Motor Van, and Balance Sheet.
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CHAPTER # 7
Control Systems
The Need for Control Systems
Types of Accounting Errors
Suspense Accounts
The Effect of Accounting Errors on Final Accounts
Control Accounts
Sales Ledger Control Accounts and Purchases Ledger Control accounts
Bank Reconciliation Statement
THE NEED FOR CONTROL SYSTEMS
All accounting information systems have controls or checks in place to ensure accounting errors and
irregularities are minimized. Given the division of the accounting function carried out by various
persons these controls become very relevant to ensure the accounting system is working in harmony.
Common control systems include:
-Suspense Accounts
-Control Accounts
-Bank Reconciliation Statements
TYPES OF ACCOUNTING ERRORS
A Trial Balance is said to be a statement of proof done arithmetically to prove that proper double was
observed in making accounting entries. The assumption is that the Trial balance totals will not agree
whenever there is an accounting error. There are several errors in fact which will not affect the
agreement of the trial balance totals. This means that there are two basic types of accounting errors:
-Errors WHICH DO NOT affect the Trial balance totals
-Errors WHICH DO affect the trial balance totals
The correction of all accounting errors must be journalized by way of the General Journal.
Accounting errors not detected by the trial balance are listed below:
ERROR OF OMISSION ─ this occurs when a transaction is completely left out or omitted from the
accounting entries.
-ACCOUNTING ERROR : Credit purchases of goods $100.from Al Binno omitted from the records.
The omitted entries will need to be entered.
The correction is journalized below:
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ERROR OF COMMISSI ON – This occurs where proper double entry is observed except an entry is
made to the wrong personal account.
-ACCOUNTING ERROR : Cash of $200 received from debtor V. Green entered correctly to cash but
incorrectly to W. Green‟s account.
The error will need to be corrected in W. Green‟s account and entered correctly to V. Green‟s
account.
The correction is journalized below:
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ERROR OF PRINCIPLE – This occurs where an entry is made to the wrong classification of
account.
-ACCOUNTING ERROR : Cash of $400 paid for motor expenses correctly credited to cash account
but incorrectly debited to motor van account.
The incorrect entry will need to be subtracted from motor van account and correctly entered to
motor expense account.
The correction is journalized below:
COMPENSATING ERRORS – These occur where two or more accounting errors cancel out their
effect on the trial balance.
-ACCOUNTING ERROR : Purchases account is overcast or overstated by $500; while $500 is
omitted from the rent account.
An account is said to be overcast when its total is in excess of the correct amount, and under-cast
when the total is less than the correct amount.
$500 will need to be deducted from the purchases account and $500 added to the rent account.
The correction is journalized below:
ERROR OF ORI GINAL ENTRY – With this type of error the accounts are entered correctly except
with the wrong figures.
-ACCOUNTING ERROR : Cash drawings of $1000 entered to both Cash and Drawings accounts as
$100.
$900 is needed to be added to both accounts to correct the errors.
The correction is journalized below:
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COMPLETE REVERSA L OF ENTRIES – When accounting entries are mistakenly reversed the
entries are still debited to one account and credited to another.
-ACCOUNTING ERROR : Cash Payment for Furniture $77 debited to Cash account and credited to
Furniture account.
The values of the entries to make corrections will need to be doubled. This is because the first entry is
to correct the mistake and the second entry represents the actual entry.
The correction is journalized below:
TRANSPOSITION ERR OR – A Transposition Error occurs when entries are made to the correct
account but the figures are not entered in the correct order.
-ACCOUNTING ERROR : Goods $25.returned inwards from W. Wugget entered to both accounts
as $52.
Both accounts will need to be decreased by $27 to make corrections
The correction is journalized below:
SUSPENSE ACCOUNTS
When the trial balance totals do not agree and the errors cannot be found immediately the difference
is put to an interim account until the errors are located. Since the errors are put to suspense the
account is refereed to as a Suspense Account. The suspense account balance is entered in the Trial
Balance on the same side of the balance in the suspense account.
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If the errors are not located by the end of the financial period, then the suspense account will be
entered in the Balance Sheet. Whenever the errors are located they are taken from the Suspense
Accounts and corrected in the account containing the error.
Below is an example:
The trial balance at December 31, 2009 for Wally West showed a difference reflecting a shortage of
$100 on the credit side. A suspense account is opened and the difference of $100 is put to the credit
side of the account. Net Profit was calculated to be $20,000.
March 5 of 2010 the following errors were found from the previous years errors.
(a) Credit purchases to K. Kenny $250 entered as $100 to both accounts.
(b) Cash sales $550 entered correctly to cash account but incorrectly entered to sales account as
$500.
(c) Drawings from bank $750 entered correctly to drawings account, but omitted from bank
account.
(d) Cash received from a debtor D. Marvin $1200 is correctly entered to cash account, but credited
to D. Marvin‟s account as $1900.
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THE EFFECT OF ACCOUNTING ERRORS ON FINAL
ACCOUNTS
Where accounting errors represent items normally entered for Final Accounts then the original
incorrect profit figure would need to be adjusted to calculate the correct figure for profit. A statement
of Corrected Net Profit would be prepared to calculate the correct profit.
A statement of corrected Net Profit for the above error is illustrated below
CONTROL ACCOUNTS
A Trial Balance is said to be a statement of proof done arithmetically to prove that proper double was
observed in making accounting entries. The assumption is that the Trial balance totals will not agree
whenever there is an error. With the division of accounting records into different books of entries it
becomes difficult to identify a specific accounting error due to the number of books to search. What
is needed is a form of Trial balance for each ledger so that only those ledgers with errors need
searching. This simplifies the accounting work. This need is met by Control Accounts.
A Control Account is a general ledger account that provides summarized information on the detailed
balances of the individual records maintained in a subsidiary ledger. Subsidiary Ledgers provide the
detail information about what makes up the balance in the control account.
Uses of Control accounts
-Assist in locating errors example in books like the sales ledger and purchases ledger.
-Minimizes fraud by assisting the scrutiny of records.
-Acts as an aid to management by providing summarized accounting information.
SALES LEDGER CONTROL ACCOUNTS AND PURCHASES
LEDGER CONTROL ACCOUNTS
Two of the most common Control Accounts are Sales Ledger Control Accounts and Purchases Ledger
Control Accounts. After posting all transactions the balance of the Control Account and the sum of
the detailed records in the Subsidiary Ledger should always be the same. In other words, a control
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account deals with summarized information while a subsidiary ledger deals with detailed
information. Because the control accounts contain summarized information they are also called total
accounts. Therefore a control account for a Sales Ledger can be called a Sales ledger Control accounts
or Total Debtors Account. A control account for a Purchases Ledger can be called a Purchases Ledger
Control account or a Total Creditors Account.
Sources of information for entries in Control Accounts
Significance of the balances on the control accounts
The closing balances on the sales ledger control accounts should be equal to the sum total of the
closing balances on the individual debtor accounts in the sales ledger. It follow as well that the
closing balances on the purchases ledger control accounts should be equal to the sum total of the
closing balances on the individual creditor accounts in the purchases ledger. If the respective
balances are not in agreement then it would suggest some form of irregularity in the records which
would need investigation.
BANK RECONCILIATION STATEMENT
The bank columns of the cashbook records money paid out and received by the business bank
account. Both the bank and business concerned should have identical records of these transactions
since both records refer to the same transactions. The bank will regularly send to the business
concerned a copy of its related transactions. This is called a bank statement.
The business will check its cash book bank entries against the entries in the bank statement. The
differences found many times are due to:
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-GENUINE RECOR DING ERRORS
-FRAUD
-THE DIFFERENC E IN TIM E when the entries to the cashbook of the business and the bank‟s
records are made; most of the time it is due to this third factor.
Items which may cause a time difference in making entries to the cash book and the
bank’s records
UNPRESENTED CHEQUES
These are cheques paid out and recorded by the business but have not been received by the bank for
payment. Unpresented cheques will therefore be found on the payment side of the cashbook but not
on the bank statement.
LATE LODGEMENTS
These are cheques received and recorded in the cashbook by the business which have not been
lodged, or were lodged late, so were not entered on the bank statement. Late Lodgements will be
found on the receipts side of the cashbook but not on the bank statement.
STANDING ORDER S
A business may instruct its bank to make regular payments to stated entities on its behalf. These
would have been entered on the bank‟s records first and would therefore be found on the payment
side of the bank statement but not in the cash book of the business.
DIRECT DEBITS
These represent payments where the creditor is given permission to withdraw the payments directly
from business bank account. These would first be recorded by the bank. Direct Debits are found on
the payment side of the bank statement but not in the cash book.
BANK CHARGES
These represent payments of the business for some services provided by the bank. These payments
would automatically be withdrawn from the business account by the bank so would first be on the
bank‟s records. Bank Charges would be found on the payment side of the bank statement but not in
the cash book.
CREDIT TRANSFERS
These represent funds transferred to the business bank account from another account through the
banking system. This would first be entered on the bank‟s records. Credit Transfers are found on the
receipts side of the bank statement but not in the cash book.
DISHONOURED CHEQUES
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If a cheque is received by the business and lodged to the bank but later discovered by the bank to
have some irregularity, the bank will not accept the cheque. This dishonoured cheque would first be
recorded by the bank. Dishonoured cheques will be found on the payment side of the bank statement
but not in cashbook of the business.
Below is an example:
The bank columns in the cash book for May 2011 and the bank statement for the same month for C.
White are shown below.
You are required to:
(a) Update the cashbook with the correct balance as on May 31, 2011
(b) Draw up a bank reconciliation statement, reconciling the corrected cash book balance with the
bank statement balance.
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THANKS
THIS PRESENTAION NOT FOR COPY IT‟S ONLY MY KNOWELWDGE THAT WHAT I GET SO
MADE IN PROPER FORM …..IF YOU ALL DO IT BETTER THAN ME PLEASE SHARE ME I LIKE
TO KNOW ABOUT WHAT OVER ALL ACCOUNTS,,,,,…..
TAHNKS
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