Accounting Course Book 1

Accounting Course

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What is Accounting? Recording data Classifying & summarising Communicating Information “Accounting is the system a business uses to measure its financial performance by recording and classifying all the transactions such as sales, purchases, assets and liabilities in an accepted standardised format” Recording transactions helps to provide the information needed to evaluate a company’s past performance, present condition and future prospects. What is Bookkeeping?

• The part of accounting that is concerned with recording data • The term comes from manually recorded data in handwritten books • Now most accounting is done electronically by computers • Bookkeeping is the process of recording data relating to accounting

transactions “Accounting is concerned with the uses which accountants might make of the bookkeeping information given to them”

The Accounting Equation

The accounting equation keeps all the business accounts in balance. It represents what the business owns = what the business owes Resources supplied by the owner = Resources in the business Key term: Something of value owned by the business is called an Asset In order to start a business, the owner usually has to put some money down to finance the business operations. e.g. you start a company and invest £5000 of your own money to get the business started. Since you, the owner provide this money, it is called owner’s equity or Capital. The money is an asset for the company. Key term: The Resources supplied by the Owner is called Capital So the equation can now read Capital = Assets At this stage the business’s assets are equal to the Capital. If you were to close the business down at this point, you would receive all of its assets. Usually people other than the owner supply some assets. Key term: the name given to amounts owing is Liabilities

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Because a company usually has liabilities, (amounts owed by the business), as well as assets, this equation might not be an accurate representation of the business’s status. If the business has liabilities, these also need to be taken into consideration. e.g. you take a loan of £10,000 from the bank to help with the costs of starting up the business. This loan increases assets by £10,000 but it is also a liability for the company. Assets (£15,000) = Liabilities (£10,000) + Capital (£5,000) Now the company’s assets consist of the money you invested and the loan you took from the bank. The liabilities appear before the owner’s equity in the equation because your creditors have first claim on the company’s assets. The most common way for the equation to be represented is as above: Assets = Liabilities + Capital or alternatively as Assets = Capital + Liabilities or Capital = Assets – Liabilities * Where assets represent resources and liabilities represent who supplied the resources. No matter how this equation is presented the totals of both sides will ALWAYS equal each other – no matter how many transactions are made. Assets An asset is something of value that is owned by the business. There are 2 types of Assets, fixed assets and current assets.

• Fixed

Fixed assets are those that are used in the running and operating of the business that it will retain for at least a year, e.g. land, buildings, equipment, fixtures and fittings and vehicles. Another type of fixed asset is goodwill. This is any advantage that enables a company to earn better profits than its competitors, such as a well-regarded brand name, this is called an ‘intangible asset’ because it has only a hypothetical value.

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• Current

Current assets are those that the business uses on a day-to-day basis and that can be quickly be converted into cash. Aka liquid assets as they can be quickly liquidated into cash, e.g. cash in hand, money in the bank, debtors, stock and work in progress. Assets are listed in descending order of liquidity, i.e. as close to cash as you can get, (with cash in hand being the closest and at the bottom of the list of our equations with assets on the balance sheet).

Liabilities Include amounts owed by the business for goods and services supplied to the business and expenses incurred that have not yet been paid for, (not forgetting funds borrowed by the business, i.e. loans). There are two types of liability, current and long term.

• Current

These are those that are due for payment within a relatively short period of time. They include your creditors, overdrafts and hire purchase or lease payments due within the next 12 months.

• Long Term

These are obligations that will not become due for a comparatively long period of time, usually not within the next 12 months. They include mortgages, other loans and hire purchase, lease agreements that do not have to be paid within one year.

Trade Credit – Creditors Those who we owe money to as a business Debtors Those who owe the business money Capital Capital is often referred to as the Owners Equity or Net Worth It includes funds invested in the business by the owner, it may come from the owners putting in money or their own, or it may be raised by selling shares in a company. Capital includes profits retained for use in the business, less any profits paid out of the business to the owner.

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Capital, also called net worth, is essentially what is yours. Using the Accounting Equation it is the value of the business as represented by subtracting its liabilities from its assets, and shows what would be left if you paid off everyone that the business owes money to. * Capital = Assets – Liabilities If there are no business liabilities, the net worth is equal to the amount of the assets of the business. Making a loss effects Capital, assets are reduced so Capital is reduced. Exercises Example of Transaction Effect Owner pays Capital to Bank ↑ Asset (Bank) ↑ Capital Buy goods by cheque ↑ Asset (goods) ↓ Asset (Bank ) Buy goods on Credit ↑ Asset (Stock) ↑ Liability (Creditor) Sale of Goods on Credit ↑ Asset (Debtor) ↓ Asset (Stock ) Sale of Goods (Cheque) ↑ Asset (Bank) ↓ Asset (Stock ) Pay Creditor ↓ Asset (Bank ) ↓ Liability (Creditor) Debtor pays money owing by cheque ↑ Asset (Bank) ↓ Asset (Debtor) Owner takes money out for own use ↓ Asset (Bank ) ↓ Capital Owner pays Creditor using private money ↓ Liability (Creditor) ↑ Capital Complete the gaps in the following table:

ASSETS (£) LIABILITIES

(£) CAPITAL (£) a 55,000 16,900 38,100 b 51,600 17,200 34,400 c 36,100 7,600 28,500 d 119,500 15,400 104,100 e 88,000 26,000 62,000 f 159,000 49,000 110,000

Which of the items in the following list are liabilities and which are assets? a) Motor vehicles asset b) Premises asset c) Creditors for goods liability d) Stock of goods asset e) Debtors asset f) Owing to bank liability g) Cash in hand asset h) Loan from D. Jones liability i) Machinery asset j) Capital liability

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The Balance Sheet Report

The Balance Sheet provides a snapshot of your business at a specific point in time. You will usually need to produce your balance sheet at the close of business on a certain day, such as the last day of each month. Why Produce a Balance Sheet Report? Your company’s Balance Sheet represents the position of your business at the time that you produce the report, as your assets and liabilities vary day to day. The report shows the difference between what you owe and what you own – this difference shows you what your company is actually worth. Understanding Balance Sheet Accounts The balance sheet shows what your company owns, (your assets) and what it owes, (your liabilities). It also displays your company’s capital – this is the difference between the assets and liabilities and is also known as the net assets or net worth of the business. Producing a Balance Sheet Report The categories used to construct your Balance Sheet report are the account types of Assets, Liabilities and Capital. These account types were outlined previously in these notes – see above. To calculate your business’s net worth, these categories are used according to the Accounting Equation: Assets = Liabilities + Capital The Assets less liabilities figure, (also called Net Assets), that appears on the Balance Sheet should equal the value of Capital, (and Reserves), at the bottom of the report. This is your business’s net worth and represents what your business is worth at this point in time. Examples of the Accounting Equation and the Balance Sheet are shown below.

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Example 1

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Example 2

Balance Sheet

The Classic Wine Company

£ £ FIXED ASSETS Equipment 3,000

CURRENT ASSETS Bank 12,650 LESS CURRENT LIABILITIES (0) NET CURRENT ASSETS 12,650 TOTAL ASSETS 15,650 LESS LONG TERM LIABILITIES 10,000 NET ASSETS 5,650

CAPITAL 5,650

Example 3

Assets Liabilities Capital 2,000 400 5,000 3,000 1,000 100 700

8,800 3,400 5,400

Capital = £5400

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Example 4

Balance Sheet 31/12/2005

A. Foster

£ £ FIXED ASSETS fixtures 5,500 motor vehicles 5,700 11,200

CURRENT ASSETS stock 8,800 debtors 4,950 cash at bank 1,250 15,000

LESS CURRENT LIABILITIES creditor (2,450) NET CURRENT ASSETS 12,550 NET ASSETS (Fixed + Net Current Assets) 23,750

CAPITAL 23,750

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Example 5

a) asset (bank) liability (creditor) b) asset (fixtures) asset (bank) c) asset (goods) liability (creditors) d) asset (cash) capital (cash) e) asset (bank) liability (loan) f) asset (bank) asset (debtor) g) asset (goods) liability (creditor) h) asset (building) asset (bank)

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Example 6

Balance Sheet 07/05/05

C. Sangster

£ £ FIXED ASSETS fixtures 4,500 4,200 8,700 CURRENT ASSETS stock of goods 5,720 debtors 3,000 cash at bank 5,450 cash in hand 400 14,570 LESS CURRENT LIABILITIES creditor (2,370) NET CURRENT ASSETS 12,200 NET ASSETS (Fixed + Net Current Assets) 20,900

CAPITAL 20,900

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The Double Entry System In a manual bookkeeping system, transactions are all recorded in a book called a ledger. Each page of the ledger represents an individual named account, such as the bank account. An account is a record of all transactions of a particular type, for example bank, sales or stock transactions, or relating to a particular customer or supplier. (In SAGE, these accounts are called nominal accounts or Nominal Records, and they are stored in the Nominal option. There is a separate Nominal Record for each account. The program uses these records to keep track of the transactions you enter). The basic principle of double entry bookkeeping is that: every time a transaction takes place, (whether it is a sale, purchase or other type of transaction), it consists of two sides. There is the entry on the account that ‘gives’ the money and the corresponding entry on the account that ‘receives’ it. A transaction needs two entries in the accounts. The first shows the destination of the money received and the second entry shows where the money comes from. In a double entry accounting system, every transaction affects at least two of your accounts, so you make at least two entries – hence the name. One entry is called a debit entry and the other is called a credit entry. The basis of the system is that transactions are entered into a set of accounts within the accounting books. An account is a place where all the information referring to a particular asset, liability or capital is recorded, e.g. office equipment, buildings, etc. An account is a record of all transactions of a particular type, for example bank, sales or stock transactions, or relating to a particular customer or supplier. Also, remember that each account should be shown as a separate page in the accounting books.

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Manual Double Entry and T Accounts Manual nominal accounts are structured in a ‘T’ format. The T divides the page into three areas: the account name and the two halves that are the debit and credit columns. Debit (Dr) in the left column of the account Credit (Cr) in the right column of the account * Every transaction affects two or more accounts Decide which accounts are involved The total of the debits must equal the total of the credits Remembering Debits and Credits using PEARLS There is a principle you can use to help remember which account to debit and which to credit. It is known as PEARLS because of the order in which it places the nominal account categories: Purchases – raw material purchases, purchases of items for resale Expenses – wages, stationery, petrol, rent Assets – debtors, equipment, property, vehicles Revenue – sales Liabilities – loans, mortgages, creditors, VAT Source of Funds – capital, owner’s equity, retained earnings from previous year

To increase PEA accounts, post a Debit entry To decrease PEA accounts, post a Credit entry To increase RLS accounts, post a Credit entry To decrease RLS accounts, post a Debit entry

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A simplified version of PEARLS may be uses as follows:

• To increase an asset we make a debit entry • To decrease an asset we make a credit entry • To increase a liability/capital we make a credit entry • To decrease liability/capital we make a debit entry

Accounts To Record Entry in the account Assets an increase +

a decrease - debit credit

Liabilities an increase + a decrease -

credit debit

Capital an increase + a decrease -

credit debit

Capital = Assets ― Liabilities To increase each item Credit Debit Credit

To decrease each item Debit Credit Debit

Using the above rules the accounts will appear as following: Capital Account (Any) Asset Account (Any) Liability Account

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Answers to the Review Questions – Lesson 3 1. 2.

M.Kelly

Balance Sheet as at 30th June 2005

£ £ FIXED ASSETS Office Machinery 9,000 CURRENT ASSETS Stock of Goods 1,550 Debtors 275 Cash at Bank 5,075 6,900 LESS CURRENT LIABILITIES Creditors (900) NET CURRENT ASSETS 6,000 NET ASSETS (Fixed + Net Current Assets) 15,000

CAPITAL 15,000 3. a) asset (vehicle) liability (creditor) b) asset (bank) liability (loan) c) asset (bank) asset (goods) d) asset (cash) capital (cash) e) asset (goods) asset (debtor) f) asset (goods) liability (creditor) g) asset (cash) capital (cash) h) asset (bank) liability (creditor)

ASSETS LIABILITIES CAPITAL

2000 1400 5000 3000 3500 2800 100

13400 4400 11700

Capital = 9000

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4.

F.Dale

Balance Sheet as at 30th November 2005

£ £ FIXED ASSETS Equipment 11,500 Motor Vehicle 6,290 17,790 CURRENT ASSETS Stock of Goods 6,150 Debtors 5,770 Cash at Bank 7,280 Cash in Hand 40 19,240 LESS CURRENT LIABILITIES Creditors (3950) NET CURRENT ASSETS 15,290 NET ASSETS (Fixed + Net Current Assets) 33,080

CAPITAL 33,080

F.Dale

Balance Sheet as at December 2005

£ £ FIXED ASSETS Equipment 12,880 Motor Vehicle 6,290 19,170 CURRENT ASSETS Stock of Goods 6,720 Debtors 4,870 Cash at Bank 7,010 Cash in Hand 100 18,700 LESS CURRENT LIABILITIES Creditors (4540) NET CURRENT ASSETS 14,160 NET ASSETS (Fixed + Net Current Assets) 33,330

CAPITAL 33,330

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Exercises for Double-Entry Accounts The Effects and Actions of Double Entry Accounts are to be written as follows:

Effect Action Increases/Decreases Asset, Liability and or Capital Debit/Credit the Account and the workings can be written out in the T Accounts as below: Dr Cr

Date Details Amount £ Date Details

Amount £

Dr Cr


Amount £

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1. The Proprietor starts the business with £1000 on 1 August 2005. The effects of this transaction are as follows:

Effect Action Increases Asset (cash) Debit the Cash Account Increases Capital (cash) Credit the Capital Account

Dr CASH Cr

Date Details Amount £ Date Details Amount £

2005 Aug 1st Capital 1000

Dr CAPITAL Cr


2005 Aug 1st Cash 1000

* It is Vital to write the date of the transactions, cross reference them in the details to cross reference where it has come from and where it has gone.

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2. A van is bought for £275 cash. Effect Action Increases Asset (vehicles) Debit the Vehicle Account Decreases Asset (cash) Credit the Cash Account

Dr VEHICLE Cr


2005 Aug 2nd Cash 275

Dr CASH Cr


2005 Aug 2nd Van 275

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Account to be Debited Account to be Credited a Office Machinery (Asset) D.Isaacs Limited (Creditor - Liability) b C. Jones (Creditor - Liability) Capital Account (Liability) c Cash (Asset) N. Fox (Debtor - Asset) d P. Exeter (Creditor - Liability) Cash (Asset) e D. Isaacs (Creditor - Liability) Office Machinery (Asset) f Cash (Asset) N. Lyn (Debtor - Asset) g Vehicle (Asset) Cash (Asset)

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Date Effect Action May 1st Increases Asset (Bank) Debit Bank a/c (£1000) Increases Capital of Owner Credit Capital a/c (£1000) Date Effect Action May 3rd Increases Asset (Machinery) Debit Machinery a/c (£275) Increases Liability (Creditor) Credit Unique Machines a/c (£275) Date Effect Action May 4th Decreases Asset (Cash in bank) Credit Bank a/c (£200) Increases Asset (Petty Cash) Debit Petty Cash a/c (£200) Date Effect Action May 7th Increases Asset (Vehicles) Debit Vehicles a/c (£180) Decreases Asset (Petty Cash) Petty Cash a/c (£180) Date Effect Action May 10th Decreases Asset (Machinery) Credit Machinery a/c (£15) Increase Asset (Debtor) Debit D. Bardes a/c (£15) Date Effect Action May 21st Decreases Asset (Machinery) Credit Machinery a/c (£27) Decreases Liability (Creditor) Debit Unique Machines a/c (£27) Date Effect Action May 28th Increases Asset (Cash in bank) Debit Bank a/c (£15) Decreases Asset (Debtor) Credit D. Bardes a/c (£15) Date Effect Action May 30th Increases Asset (Vehicles) Debit Vehicle a/c (£420) Decreases Asset (Cash in Bank) Credit Bank a/c (£420) Date Effect Action May 31st Decreases Asset (Cash in Bank) Credit Bank a/c (£248) Decreases Liability (Creditor) Debit Unique Machines a/c (£248)

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Dr BANK Cr


2005 2005 May 1st Capital 1000 May 4th Petty Cash 200May 28th D. Bardes 15 May 30th Vehicles 420 May 31st Unique Machines 248

Dr CAPITAL Cr


2005 2005 May 1st Bank 1000

Dr MACHINERY Cr


2005 2005 May 3rd Unique Machines 275 May 10th D. Bardes 15 May 21st Unique Machines 27

Dr UNIQUE MACHINES Cr


2005 2005 May 3rd Machinery 275May 21st Machinery 27 May 31st Bank 248

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Dr PETTY CASH Cr


2005 2005 May 4th Bank 200 May 7th Vehicles 180

Dr VEHICLES Cr


2005 2005 May 7th Petty Cash 180 May 30th Bank 420

Dr D. BARDES Cr


2005 2005 May 10th Machinery 15 May 28th Bank 15

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Date Effect Action 01/07/05 Increases Asset (Bank) Debit Bank a/c £2500 Increases Capital of Owner Credit Capital a/c £2500 Date Effect Action 02/07/05 Increases Asset (Office Furniture) Debit Office Furniture a/c £150 Decreases Asset (Bank) Credit Bank a/c £150 Date Effect Action 03/07/05 Increases Asset (Machinery) Debit Machinery a/c £750 Increases Liability (Creditor) Credit Planers Ltd a/c £750 Date Effect Action 05/07/05 Increases Asset (Vehicle) Debit Vehicle a/c £600 Decreases Asset (Bank) Credit Bank a/c £600 Date Effect Action 08/07/05 Decreases Asset (Office Furniture) Credit Office Furniture a/c £60 Increases Asset (Debtor) Debit J. Walker & Sons a/c £60 Date Effect Action 15/07/05 Decreases Asset (Bank) Credit Bank a/c £750 Decreases Liability (Creditor) Debit Planers Ltd a/c £750 Date Effect Action 23/07/05 Increases Asset (Cash Box) Debit Cash Box a/c £60 Decreases Asset (Debtor) Credit J. Walker & Sons a/c £60 Date Effect Action 31/07/05 Increases Asset (Machinery) Debit Machinery a/c £280 Decreases Asset (Bank) Credit Bank a/c £280

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Dr BANK Cr


01/07/2005 Capital 2500 02/07/2005 Office Furniture 150

05/07/2005 Vehicle 600 15/07/2005 Planers Ltd 750 31/07/2005 Machinery 280

Dr CASH BOX Cr


23/07/2005 J. Walker & Sons 60

Dr CAPITAL Cr


01/07/2005 Bank 2500

Dr OFFICE FURNITURE Cr


02/07/2005 Bank 150 08/07/2005 J. Walker & Sons 60

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Dr MACHINERY Cr


03/07/2005 Planers Ltd 750 31/07/2005 Bank 280

Dr PLANERS LTD. Cr


03/07/2005 Machinery 75015/07/2005 Bank 750

Dr VEHICLE Cr


05/07/2005 Bank 600

Dr J. WALKER & SONS Cr


08/07/2005 Office Furniture 60 23/07/2005 Cash Box 60

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Date Effect Action 01/06/05 Increase Asset (Cash Box) Debit Cash Box a/c £2000 Increase Capital of Owner Credit Capital a/c £2000 Date Effect Action 02/06/05 Increase Asset (Bank) Debit Bank a/c £1800 Decrease Asset (Cash Box) Credit Cash Box £1800 Date Effect Action 05/06/05 Increase Asset (Office Furniture) Debit Office Furniture a/c £120 Increase Liability (Creditor) Credit Betta-Built Ltd a/c £120 Date Effect Action 08/06/05 Increase Asset (Vehicle) Debit Vehicle a/c £950 Decrease Asset (Bank) Credit Bank a/c £950 Date Effect Action 12/06/05 Increase Asset (Machinery) Debit Machinery a/c £560 Increase Liability (Creditor) Credit Evans & Son a/c £560 Date Effect Action 18/06/05 Decrease Asset (Office Furniture) Credit Office Furniture a/c £62 Decrease Liability (Creditor) Debit Betta-Bulit Ltd £62 Date Effect Action 25/06/05 Decrease Asset (Machinery) Credit Machinery a/c £75 Increase Asset (Cash Box) Debit Cash Box a/c £75 Date Effect Action 26/06/05 Decrease Liability (Creditor) Debit Betta-Built Ltd a/c £58 Decrease Asset (Bank) Credit Bank a/c £58 Date Effect Action 28/06/05 Decrease Asset (Bank) Credit Bank a/c £100 Decrease Capital of Owner Debit Capital a/c £100 Date Effect Action 30/06/05 Increase Asset (Bank) Debit Bank a/c £500 Increase Liability (Creditor) Credit J. Smith a/c £500

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Dr BANK Cr


02/06/2005 Cash Box 1800 08/06/2005 Vehicle 950 26/06/2005 Betta-Built Ltd 58 28/06/2005 Capital 100

30/06/2005 J. Smith 500

Dr CASH BOX Cr


01/06/2005 Capital 2000 02/06/2005 Bank 1800

25/06/2005 Machinery 75

Dr CAPITAL Cr


01/06/2005 Cash Box 200028/06/2005 Bank 100



05/06/2005 Betta-Built Ltd 120 18/06/2005 Betta-Built Ltd 62

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Dr BETTA-BUILT LTD. Cr


05/06/2005 Office Furniture 12018/06/2005 Office Furniture 62 26/06/2005 Bank 58

Dr VEHICLE Cr


08/06/2005 Bank 950

Dr MACHINERY Cr


12/06/2005 Evans & Son 560 25/06/2005 Cash Box 75

Dr EVANS & SON Cr


12/06/2005 Machinery 560

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Dr J. SMITH Cr


30/06/2005 Bank 500

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Account to be Debited Account to be Credited a Vehicle (asset) Cash (asset) b T. Lake (creditor - liability) Bank (asset) c P. Logan (creditor - liability) Cash (asset) d Cash (asset) Vehicle (asset) e Office Machinery (asset) Ultra Ltd (creditor - liability) f Cash (asset) A. Hill (debtor) g Bank (asset) J.Cross (debtor) h Bank (asset) Capital i Cash (asset) L. Lowe (creditor - liability) j D. Lord (creditor - liability) Cash (asset)

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Date Effect Action 1/7 Increases Asset (Bank) Debit Bank a/c £5000 Increases Capital of Owner Credit Capital a/c £5000 Date Effect Action 2/7 Increases Asset (Vehicle) Debit Vehicle a/c £1200 Decreases Asset (Bank) Credit Bank a/c £1200 Date Effect Action 5/7 Increases Asset (Office Fixtures) Debit Office Fixtures a/c £400 Increases Liability (Creditors) Credit Young Ltd a/c £400 Date Effect Action 8/7 Increases Asset (Vehicle) Debit Vehicle a/c £800 Increases Liability (Creditors) Credit Super Motors a/c £800 Date Effect Action 12/7 Decreases Asset (Bank) Credit Bank a/c £100 Increases Asset (Cash Till) Debit Cash Till a/c £100 Date Effect Action 15/7 Increases Asset (Office Fixtures) Debit Office Fixtures a/c £60 Decreases Asset (Cash Till) Credit Cash Till a/c £60 Date Effect Action 19/7 Decreases Liability (Creditors) Debit Super Motors a/c £800 Decreases Asset (Bank) Credit Bank a/c £800 Date Effect Action 21/7 Increases Asset (Bank) Debit Bank a/c £1000 Increases Liability (Creditor) Credit J. Jarvis a/c £1000 Date Effect Action 25/7 Decreases Asset (Cash Till) Credit Cash Till a/c £800 Increases Asset (Bank) Debit Bank a/c £800 Date Effect Action 30/7 Increases Asset (Office Fixtures) Debit Office Fixtures a/c £300 Decreases Asset (Bank) Credit Bank a/c £300

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Dr BANK Cr


01/07/2005 Capital 5000 02/07/2005 Vehicle 1200 12/07/2005 Cash Till 100 19/07/2005 Super Motors 800

21/07/2005 J. Jarvis 1000 25/07/2005 Cash Till 800

30/07/2005 Office Fixtures 300

Dr CAPITAL Cr


01/07/2005 Bank 5000

Dr VEHICLE Cr


02/07/2005 Bank 1200 08/07/2005 Super Motors 800

Dr OFFICE FIXTURES Cr


05/07/2005 Young Ltd 400 15/07/2005 Cash Till 60 30/07/2005 Bank 300

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Dr YOUNG LTD Cr


05/07/2005 Office Fixtures 400

Dr SUPER MOTORS Cr


08/07/2005 Vehicle 80019/07/2005 Bank 800

Dr CASH TILL Cr


12/07/2005 Cash Till 100 15/07/2005 Office Fixtures 60 25/07/2005 Bank 800

Dr J. JARVIS Cr


21/07/2005 Bank 1000

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Dr CASH TILL Cr


01/03/2005 Capital 1000 03/03/2005 Machinery 60

08/03/2005 Bank 300 24/03/2005 M. Chow 100

Dr CAPITAL Cr


01/03/2005 Cash Till 1000

Dr M. CHOW Cr


02/03/2005 Bank 500015/03/2005 Bank 800 24/03/2005 Cash Till 100

£500 by cheque.

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Dr BANK Cr


Amount £

02/03/2005 M. Chow 5000 08/03/2005 Cash Till 300 15/03/2005 M. Chow 800 17/03/2005 Betterview Machines 500

Dr MACHINERY Cr


Amount £

03/03/2005 Cash Till 60 31/03/2005 D. Smith 500

Dr DISPLAY EQUIPMENT Cr


Amount £

05/03/2005 Betterview Machines 500

Dr BETTERVIEW MACHINES Cr


Amount £

05/03/2005 Display Equipment 50017/03/2005 Bank 500

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Dr D. SMITH Cr


31/03/2005 Machinery 500

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The Asset of Stock Normally goods are sold at more than they cost with the difference being the PROFIT. When goods are sold at less than cost price this results in a LOSS.

Let’s think about the implications of double entry if sales were at cost price. It would be possible to have a stock account with goods purchased being DEBITED to the stock account, (as purchases represent an INCREASE in the asset of stock), and goods being sold being CREDITED to it, (as sales represent a DECREASE in the asset of stock).

The Two Sides of the Stock Account The difference between the two sides of the Stock Account would represent the cost of goods unsold at that date. However, most sales are not sold at cost price and the sales figures will have elements of Profit and/or Loss. To address this we Sub-divide the Stock Accounts Firstly we must distinguish between the transactions that cause stock to Increase and those that cause stock to Decrease.

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Increase An Increase in stock has two causes:

• The purchase of additional goods. • The return of goods that were previously sold, e.g. faulty, wrong type,

etc.

Two accounts are opened:

1. A Purchase account for Purchases.

2. A Returns Inwards Account for returned goods, (also known as Sales Returns).

So for increases in stock we need to choose which of these to use to record DEBIT transactions.

Decrease A Decrease in stock has two causes:

• The sale of goods. • Goods previously bought now returned to the supplier.

Two accounts are opened:

1. A Sales Account for the Sales of goods. 2. A Returns Outwards Account for goods returned to suppliers, (also

known as Purchases Returns).

So for decreases in stock we need to choose which of these accounts to record the CREDIT side of the transaction.

* We have now divided the Stock Account into four parts:

1. Purchase Account – purchases – increase in stock asset - debit 2. Returns Inwards Account – returned goods from CUSTOMERS -

increase in stock asset – debit 3. Sales Account – sales – decrease in stock asset – credit 4. Returns Outwards Account – returned goods to SUPPLIERS -

decrease in stock asset – credit

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Sales and Purchases

• Purchases mean those goods which a business buys with the prime intention of selling, e.g. a Van would not be a purchase if it were for use in the business.

• Sales mean the sale of goods in which the business normally deals. The term ‘sales’ must not be given to the disposal of other items such as vans, buildings, etc.

Comparison of cash and credit transactions for purchases and sales

On the other hand the complete set of entries for the purchase of goods on credit can be broken down into two stages: first the purchase of goods and; second, the payment for them.

When goods are purchased for cash the entries are

DEBIT the PURCHASES account CREDIT the CASH account

The first part

Debit the Purchases account Credit the Suppliers account

The second part

Debit the Suppliers account Credit the Cash account

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Exercise Fred Flintstone opened a business in May 2005 and the following transactions took place: 2005 May 1 Bought goods on credit £68 from D. Small 2 Bought goods on credit £77 from A. Lyon & Son 5 Sold goods on credit to D. Hughes for £60 6 Sold goods on credit to M. Spencer for £50 10 Returned goods £15 to D. Small 12 M. Spencer returned £16 goods to us 19 Goods bought for cash £150 21 Goods sold for cash £150 22 Paid cash to D. Small £53 30 Bought goods on credit £64 from A. Lyon & Son Dr CASH BOX Cr


19/05/2005 Purchases 15021/05/2005 Sales 150

22/05/2005 D. Small 53

Dr PURCHASES Cr


01/05/2005 D. Small 68 02/05/2005 A. Lyon & Son 77 19/05/2005 Cash Box 150 30/05/2005 A. Lyon & Son 64

Dr SALES Cr


05/05/2005 D. Hughes 60 06/05/2005 M. Spencer 50 21/05/2005 Cash Box 150

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Dr RETURNS OUTWARDS Cr


10/05/2005 D. Small 15

Dr RETURNS INWARDS Cr


12/05/2005 M. Spencer 16

Dr D.SMALL Cr


01/05/2005 Purchases 6810/05/2005 Returns Outwards 15 22/05/2005 Cash Box 53

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Dr A. LYON & SON Cr


02/05/2005 Purchases 77 30/05/2005 Purchases 64

Dr M. SPENCER Cr


06/05/2005 Sales 50 12/05/2005 Returns Inwards 16

Dr D. HUGHES Cr


05/05/2005 Sales 60

Accounting Course

- 44 -

Exercise

Dr CASH BOX Cr


01/07/2005 Capital 500 03/07/2005 Purchases 85

10/07/2005 Sales 42 25/07/2005 E. Morgan 88

31/07/2005 A. Knight 55

Dr CAPITAL Cr


01/07/2005 Cash Box 500

Dr PURCHASES Cr


03/07/2005 Cash Box 85 07/07/2005 E. Morgan 116 18/07/2005 A. Moses 98

Accounting Course

- 45 -

Dr SALES Cr


10/07/2005 Cash Box 42 24/07/2005 A. Knight 55





14/07/2005 E. Morgan 28 21/07/2005 A. Moses 19

Accounting Course

- 46 -

Dr E. MORGAN Cr


07/07/2005 Purchases 11614/07/2005 Returns Outwards 28 25/07/2005 Cash Box

Dr A. MOSES Cr


18/07/2005 Purchases 9821/07/2005 Returns Outwards 19

Dr A. KNIGHT Cr


24/07/2005 Sales 55 31/07/2005 Cash Box 55

Accounting Course

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Review We have now learned that:

• That it is not appropriate to use a stock account to record increases and decreases in stock because stock is normally sold at a price greater than its cost.

• That stock increases either because some stock has been purchased or because stock that was sold has been returned by the buyer.

• That stock decreases either because some stock has been sold or because stock previously purchased has been returned to the supplier.

• That a purchase account is used to record purchases of stock, (as debit entries in the account), and that a returns inward account is used to record stock returned by customers, (as debit entries in the account).

• That a sales account is used to record sales of stock, (as credit entries in the account), and that a returns outwards account is used to record stock returned to suppliers, (as credit entries in the account).

• How to record increases and decreases of stock in the appropriate accounts.

• That in accounting, the term purchases refers to purchases of stocks. Acquisitions of any other assets, such as a van, are never described as purchases.

• That in accounting, the term sales refers to stocks. Disposals of any other assets such as equipment are never described as sales.

• That purchases for cash are never entered in the supplier’s account. • That purchases on credit are always entered in the suppliers,

(creditor’s), account. • That sales for cash are never entered in the customer’s account. • That sales on credit are always entered in the customers, (debtor’s),

account. Facts

• Luca Pacioli invented double entry book keeping. • The names of the 3 ledgers are the Sales, Purchase and the Nominal. • An Invoice is a record of a transaction given to a customer or client

when requesting payment for services or goods delivered. • Invoices can be sent from a supplier for purchases made from them. • Invoices can be sent to a customer for sales made to them.

Accounting Course

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Exercise

Dr BANK Cr


01/07/05 Capital 10,000 06/07/05 Cash 250

25/07/05 F. Jones 1,070 29/07/05 Manchester Motors 2,600

Dr CAPITAL Cr


01/07/05 Bank 10000 28/07/05 Cash 500

Accounting Course

- 49 -

Dr CASH Cr


02/07/05 T. Cooper 400 04/07/05 Sales 200

06/07/05 Bank 250 20/07/05 Purchases 220

24/07/05 Sales 70 28/07/05 Capital 500

31/07/05 Office Furniture 100

Dr T. COOPER Cr


02/07/05 Cash 400

Dr PURCHASES Cr


03/07/05 F. Jones 840 03/07/05 S. Charles 3600 11/07/05 F. Jones 370 20/07/05 Cash 220



12/07/05 C. Moody 40 26/07/05 H. Morgan 30

Accounting Course

- 50 -

Dr SALES Cr


04/07/05 Cash 200 08/07/05 C. Moody 180 10/07/05 J. Newman 220 14/07/05 H. Morgan 190 14/07/05 J. Peat 320 24/07/05 Cash 70



15/07/05 F. Jones 140 19/07/05 S. Charles 110

Dr F. JONES Cr


03/07/05 Purchases 840 11/07/05 Purchases 370

15/07/05 Returns Outwards 140 25/07/05 Bank 1070

Dr S. CHARLES Cr


03/07/05 Purchases 360019/07/05 Returns Outwards 110

Accounting Course

- 51 -

Dr C. MOODY Cr



Dr J. NEWMAN Cr


10/07/05 Sales 220

Dr H. MORGAN Cr



Dr J. PEAT Cr


14/07/05 Sales 320

Accounting Course

- 52 -

Dr MANCHESTER MOTORS Cr


17/07/05 Vehicle 260029/07/05 Bank 2600

Dr FASTER SUPPLIES LTD Cr


18/07/05 Office Furniture 60027/07/05 Office Furniture 160



18/07/05 Faster Supplies Ltd 600 31/07/05 Cash 100

27/07/05 Faster Supplies Ltd 160

Dr VEHICLES Cr


17/07/05 Manchester Motors 2600

Accounting Course

- 53 -

The Effect of Profit or Loss on Capital The Nature of Profit or Loss PROFIT

• To an accountant PROFIT means the amount by which revenues are greater than expenses for a set of transactions.

• The term REVENUES means sales value of goods and services to customers.

• The term EXPENSES means the cost value of all assets that have been used up to obtain the revenues.

For example

• Revenues: goods /services supplied for the sum of £100,000 • Less Expenses: value of assets used to enable us to supply the

goods/services (£70,000) • Profit is therefore: £30,000

LOSS On the other hand expenses sometimes exceed revenues for a set of transactions and this would result in a loss. For example

• Revenues: what we have charged customers for goods £60,000 • Less Expenses: value of assets used to enable us to supply the

goods/services (£80,000) • Loss is therefore: £20,000

The Effect of Profit or Loss Businesses exist to make a PROFIT and so increase their CAPITAL. For example On 01/01/05 the assets and liabilities are: ASSETS: Fixtures £10,000 Stock £7,000 Cash at bank £3,000 LIABILITIES: Creditors £2,000 CAPITAL = ASSETS ― LIABILITIES CAPITAL = £18,000

Accounting Course

- 54 -

With Profit? During January the whole of the £7,000 stock is sold for £11,000 cash. On 31/01/05 the assets and liabilities have become: ASSETS: Fixtures £10,000 Stock £NIL Cash at bank £14,000 LIABILITIES: Creditors £2,000 Capital is now OLD CAPITAL + PROFIT = NEW CAPITAL CAPITAL = £18,000 + £4,000 = £22,000 What about a Loss? A loss on the other hand would reduce capital Capital would be OLD CAPITAL ― LOSS = NEW CAPITAL Profit will be made when goods or services are sold at more than cost price. Loss will be made when goods or services are sold at less than cost price.

Accounting Course

- 55 -

Profit or Loss and Expenses Once profit/loss has been calculated, businesses can alter the capital account. This may be done once a year or more frequently – usually the bigger the business the more often they calculate profits, e.g. the Arcadia group. In order to calculate profits and losses, revenues and expenses must be entered into appropriate accounts. All the expenses could be charged to one Expenses Account, but you would be able to understand the calculations of profit better if full details of each type of expense were shown in the profit calculations. The same applies to each type of revenue. For this reason, a separate account is opened for each type of expense and each type of revenue. For example, accounts in use may include:

• Commissions Account Revenues • Bank Interest Account Expenses • Royalties Receivable Account Revenues • Rent Receivable Account Revenues • Overdraft Interest Account Expenses • Subscriptions Account Expenses • Motor Expenses Account Expenses • Telephone Account Expenses • General Expenses Account Expenses • Audit Fees Account Expenses • Rent Account Expenses • Postages Account Expenses • Stationery Account Expenses • Wages Account Expenses • Insurance Account Expenses

The titles of the accounts are simply a matter of choice. Most organisations make it obvious which are expense accounts and which are revenue accounts. When in doubt there are two obvious indicators. The first is which side most of the entries are appearing. If it is the debit side, then the account is almost certainly an expense account.

Accounting Course

- 56 -

Debit or Credit? You need to know whether expense accounts should be debited or credited with amounts involved. You know that assets involve expenditure by the business and are shown as debit entries. Expenses also involve expenditure by the business and should, therefore, also be debit entries. WHY? Well because assets and expenses must ultimately be paid for. This payment involves a CREDIT to the bank account, (or cash account), so the original entry in the asset account or in the expense account must be a DEBIT. Even where an expense is incurred on credit, the creditor must eventually be paid. The first entry will be to credit the supplier’s, (i.e. creditors), account and DEBIT the expense account. When payment is made to the supplier, the bank account is credited and the supplier’s account is debited. For example, if you pay £500 rent in cash, the asset cash is decreased by £500. The accounting equation tells you that this means that the capital is reduced by each expense — if assets decrease, so does capital; if liabilities increase, capital decreases, (otherwise the equation won’t balance). Expense accounts contain debit entries for expenses. The second part of the entry will be either a credit against an asset account, such as cash or a credit against a liability account, e.g. a creditor. Worked Example

a) A business spends £30 in cash hiring a van for the day b) A business hires a van for the day at a cost of £30 and is given one

month to pay the bill For both cases: Assets of £200, Liabilities £80, Capital £120

a) • The asset of cash is reduced by £30 and this is posted as a credit to the cash

account. • The expenditure account, ‘Van Hire’, is debited by £30. • Capital will decrease because expenditure decreases the asset (and so

Capital will decrease). • Capital will be £90. b) • The suppliers account, (creditor), will be posted £30 as a credit because the

liability is increasing. • The expenditure account, ‘Van Hire’, is debited by £30. • When we pay the invoice the bank account is credited by £30 and the

suppliers account is debited by £30. • Capital will decrease because the asset ‘bank account’ is decreasing. • Capital will be £90.

Accounting Course

- 57 -

Revenues

Revenue is the opposite of expenses and is, therefore, treated in the opposite way. Revenue entries appear on the CREDIT side of the revenue accounts. You’ve already seen this when you have entered sales figures as credits into the sales account. Therefore, revenue is collected together in appropriately named accounts, where it is shown as a credit until it is transferred to the profit calculations at the end of the period. Also, we must consider the use of funds to pay for expenses which are used up in the short term, or assets used up in the long term, both for the purpose of winning revenue. Both these forms of transactions are entered on the debit side of the appropriate accounts, (expense accounts or asset accounts respectively), while the revenue which has been won is shown on the credit side of the appropriate accounts. SUMMARY Profit belongs to the owners. Revenues increase profits, so they increase capital and that makes them Credits. Expenses decrease profits, so they reduce capital and that makes them Debits. The treatment of Expenses is the same as the treatment of assets. Increases result in debit entries to the appropriate expense accounts, while decreases, (such as a refund for overpayment of an electricity bill), result in credit entries to those same accounts. The treatment of Revenue is the same as the treatment of liabilities. Increases in revenue are credited to the appropriate revenue accounts, while decreases are debited to the same accounts.

Accounting Course

- 58 -

Examples for Revenues & Expenses

Dr BANK Cr


01/05/05 Capital 2000 03/05/05 Fixtures & Fittings 150

21/05/05 Lettings 5 24/05/05 Vehicle 300

Dr CAPITAL Cr


01/05/05 Bank 200031/05/05 44

Accounting Course

- 59 -

Dr PURCHASE Cr


02/05/05 M. Mills 175 06/05/05 S. Waites 114

Dr M. MILLS Cr


02/05/05 Purchase 17518/05/2005 Returns Outwards 23

Dr FIXTURES AND FITTINGS Cr


03/05/05 Bank 150

Dr SALES Cr


05/05/05 Cash 275 23/05/05 U. Henry 77

Accounting Course

- 60 -

Dr CASH Cr


05/05/05 Sales 10/05/05 Rent 15 12/05/05 Stationery 27 30/05/05 Wages 117 31/05/05 Capital 44

Dr S. WAITES Cr


06/05/05 Purchases 114

Dr RENT Cr


10/05/05 Cash 15

Dr STATIONERY Cr


12/05/2005 Cash 27

Accounting Course

- 61 -



18/05/05 M. Mills 23

Dr LETTINGS Cr


21/05/05 Bank 5

Dr U. HENRY Cr


23/05/05 Sales 77

Dr VEHICLE Cr


24/05/05 Bank 300

Accounting Course

- 62 -

Dr WAGES Cr


30/05/05 Cash 117

Accounting Course

- 63 -

Dr BANK Cr


04/03/05 Cash 1000 07/03/05 Stationery 15 27/03/05 Hanson 279 29/03/05 Vehicle 395

Dr CASH Cr


01/03/05 Capital 1500 03/03/05 Rent 50 04/03/05 Bank 1000

11/03/05 Sales 49 20/03/05 Building Repairs 18 28/03/05 Purchases 125 30/03/05 Motor Expenses 15

Accounting Course

- 64 -

Dr CAPITAL Cr


01/03/05 Cash 1500

Dr PURCHASES Cr


02/03/05 A. Hanson 296 28/03/05 Cash 125

Dr A. HANSON Cr


02/03/05 Purchases 29614/03/05 Returns Outwards 17 27/03/05 Bank 279

Dr RENT Cr


03/03/05 Cash 50

Accounting Course

- 65 -

Dr SALES Cr


05/03/05 E. Linton 54 11/03/05 Cash 49 17/03/05 S. Morgan 50

Dr E. LINTON Cr



Dr STATIONERY Cr


07/03/05 Bank 15



22/03/05 E. Linton 14

Accounting Course

- 66 -

Dr S. MORGAN Cr


17/03/05 Sales 50

Dr BUILDING REPAIRS Cr


20/03/05 Cash 18

Dr VEHICLE Cr


29/03/05 Bank 395

Dr MOTOR EXPENSES Cr


30/03/05 Cash 15

Accounting Course

- 67 -

Dr FIXTURES Cr


31/03/05 A. Webster 120

Dr A. WEBSTER Cr


31/03/05 Fixtures 120



14/03/05 A.Hanson 17

Documents

Accounting Course Book 1