Chapter 5 Transaction analysis for double-entry · PDF fileFocus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST ... Debits = Credits Record the

Chapter 5 Transaction analysis for double-entry accounting (with GST) �

Working through this chapter will assist you to:• classify accounts to prepare financial records• apply accounting principles to record transactions.

Information Procedures IP 4.3 and 5.3

Chapter 5Transaction analysis for double-entry accounting (with GST)

Chapter 1 Nature of

information

Chapter 2

Managing

information

Chapter 3 Source

documents

Chapter 4 Accounting

fundamentals

Chapter 5Transaction analysis

Key topics:

Double-entry accounting

Goods and Services Tax

Transaction analysis

Chapter 6 The double-

entry

process

Chapter 7 Specialised

journals

Chapter 8 Other

accounting

systems

Chapter 9 End-of-

period

reports

Chapter 10 Control

procedures

INFORMATION PROCEDURES

� Focus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST) �

Double-entry accountingIn the previous chapters we’ve discussed accounting systems in a general way and the rules that these systems follow. In this chapter we will begin to look at an actual accounting system that businesses use. We’ll see how the rules for accounts and the accounting equation are applied to transactions in this system.

The system we are examining is known as double entry.

✦ The double-entry system of accounting states that for every transaction there is a debit (DR) entry and a corresponding credit (CR) entry of equal value.

The double-entry system allows businesses to build safeguards into their accounting system and to prepare detailed and varied financial reports. It also ensures that the accounting equation remains equal.

Assets = Liabilities + Owner’s equity DR = CR

Figure [5.1] illustrates the flow of information in a double-entry system of accounting. In this chapter we are focusing on the thinking process involved in recording information into the accounting system of a business. In later chapters we’ll look at the other steps in the double-entry system.

[5.1] Double-entry accounting process

Goods and Services Tax (GST)Every time you buy a magazine or book or go to the movies, for example, you pay Goods and Services Tax (GST). Although businesses are also charged GST on goods and services they purchase, they are able to claim this back from the government. It is eventually only the final consumer who pays the GST.

The Commonwealth government introduced this tax on 1 July 2000. It applies to most goods and services and is calculated at the rate of 10% of the total price of the product or service. Only businesses that register with the Australian Taxation Office (ATO) are required to charge GST. They receive an Australian Business Number (ABN), which they must display on all their business documents.

Where a price includes the amount of GST to be paid, it is said to be GST-inclusive. When the GST component has not yet been added to the price for a product or service, the price is said to be GST-exclusive. Figure [5.2] shows prices in both formats.

✦ GST-inclusive indicates that the price given for a product includes the GST component.

✦ GST-exclusive indicates that the price given for a product has not had the GST component added.

[5.2] A document that shows both

GST-inclusive and GST-exclusive prices

The GST-inclusive price of a product is given as $165. In order to determine the value of GST, it is necessary to divide the price by 11 or multiply by .

Therefore, the GST component of the above product = × $165 = $15

Journal Ledger Trial balanceFinancial reports

Evaluation of reports

Thinking process:transaction analysis

Source documents

ExampleGST-inclusive calculations

The GST-exclusive price

The GST-inclusive price

� Focus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST) 5

Consider the following transaction:On 1 June 2007 Petra Pollack bought computer equipment for business purposes for

$22 000 cash (including GST). The GST included in the price paid is 1/11th of the total. So that is 22 000 divided by 11 = $2 000. That means that the value of the equipment is $20 000, but the business has to pay $22 000 to purchase the equipment. GST that is paid by businesses on its purchases is able to be reclaimed (paid back) from the government.

Equipment is an asset account, which has a debit nature. Because the computer equipment account is increasing (that is, the business has more invested in computer equipment than before this transaction), the computer equipment account would be debited. The GST included in the price is also debited as it is decreasing the amount the business has to pay to the government because this amount of GST can be reclaimed by Petra’s business. Remember that you have learnt that assets are debit in nature and that to increase an account you do the same as its nature. On the other hand, the bank account (an asset ) would decrease because Petra’s Peraphernalia has paid money out of this account. Because the bank account is an asset account decreasing, it is credited.

Analysing transactions involves the following questioning process:

1 Which accounts does the transaction affect? (names of individual accounts)

3 Is the value of the individual account going to increase or decrease as a result of the transaction?

2 What category does each of these accounts belong to? (Revenue, expense, asset, liability or owner’s equity?)

4 Will this increase or decrease lead to this account being debited or credited?

If you apply this process in the table format called a transactional analysis table (see [5.3]), you will have an invaluable tool for learning the rules of double-entry accounting.

[5.3] Transaction analysis table

Transaction Account involved

Account type Increase or decrease

Debit or credit Amount

A business activity with a financial value

Be concise and select the most obvious name or the common name used for that type of activity

Revenue,Expense,Asset,Liability orOwner’s equity

↑ or ↓ Apply the rules:debit or credit so thatDebits = Credits

Record the amount to be entered into each account

ExamplePurchase of an asset for cash

The GST-exclusive price of a product is given as $150. In order to determine the value of GST, the product selling price is simply multiplied by 10%:

GST = 10% × $150 = $15Therefore, the full selling price of the product would be $150 + $15 = $165.

It is important to distinguish between the terms GST inclusive and GST exclusive, because the calculation of the GST component will vary accordingly. In this chapter, GST will be recorded in a GST account, and this account is a liability as it represents the amount of GST owed to the government. When a business pays for goods and services it purchases, it has to pay out the total cost including GST. However, as long as a business has kept correct records, it can reclaim from the government the amount of GST it has had to pay to run its business. This then reduces the GST liability. When the business makes sales of its goods or services, it must collect GST. This is a liability as this amount is paid to the government.

GST is only involved in transactions that are based on the buying and selling of goods and services. If the transaction does not involve buying or selling, GST is not included. GST is also not included in financial transactions (e.g. transactions with a bank) and some food items (generally fresh food). The following is a list of transactions that will be included in this chapter that do not include GST:• capital contributions by the owner (cash and other assets)• drawings by the owner (cash only)• interest paid on a loan• interest received from a bank• a loan from a bank• a loan to another party• payment of wages to employees.

Something to remember is that GST only involves sales and purchases of goods and services and that when a sale is concerned, GST is always credited because the liability is increasing. When purchases are made, GST is always debited because the liability is decreasing.

Transaction analysisWe discussed the first step in the accounting process, the preparation of source documents, in chapter 3. These source documents contain the details of transactions. The next step is to record the information about the transactions into the journals of a business.

First, however, you need to practise the thinking process that will help you apply the rules for accounts to transactions and ensure you enter the information correctly into the business’s financial records. This process is called transaction analysis.

✦ Transaction analysis is a process used to break down a transaction into its debit and credit parts. It is the ‘thinking process’ involved in taking information from the source document/transaction and applying the rules of debit and credit so that you can enter the details into the accounting records.

ExampleGST-exclusive calculations

� Focus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST) �

activity

Analysing and evaluatingApplyingCommunicatingKnowing and understanding

We will use this table format to show how the following transactions are analysed:

• contributions of cash or other assets by the owner (no GST)

• withdrawals of cash by the owner (no GST)

• purchases of assets for cash (GST) • purchases of assets on credit (GST)• sales of assets (other than

inventories) for cash (GST)• sales of assets (other than

inventories) on credit (GST)• sales of inventories for cash (GST) • sales of inventories on credit (GST)• sales of services for cash (GST) • sales of services on credit (GST)• return of inventories purchased

for cash (GST)• return of inventories purchased on

credit (GST)• return of inventories sold for cash

(GST)• return of inventories sold on credit

(GST)• cash paid to accounts payable

(not a sale or a purchase—no GST)• purchase of supplies and services for

cash (GST)

• purchase of supplies and services on credit (GST)

• cash received from accounts receivable (not a sale or a purchase—no GST)

• other cash received (may involve GST e.g. commission or may not involve GST, e.g. interest).

Contributions of cash or other assets by the ownerBusiness owners usually make an investment of cash and/or other assets to start a business. They do this so that the business can begin purchasing the items and services needed to begin the business. When the owner makes an investment, the name of the account used to record these contributions is called ‘capital’ and is grouped with the owner’s equity accounts.

✦ Capital is the name of the account used to record the owner’s contributions to a business.

When an owner contributes cash or other assets to the business, we always represent (and record) the transaction from the business’s point of view. As the transaction analysis table [5.4] shows, the assets (for example, Bank or Computer equipment) are said to be increasing and therefore they are debited. At the same time, the amount invested by the owner is increasing and the Capital account is therefore credited.

[5.4] Transaction analysis of contributions by the owner

Type of transaction Example Accountsinvolved

Type of account

Increase ordecrease

Debit or credit

Amount

Investment of cash by owner

Petra Pollack invested $20 000 cash

BankCapital

AssetOwner’s equity

IncreaseIncrease

DRCR

$20 000$20 000

Investment of assets other than cash by owner

Petra contributed computer equipment for business use

Computer equipmentCapital

AssetOwner’s equity

IncreaseIncrease

DRCR

$25 000$25 000

RULE Asset (e.g. Bank, Vehicle, Equipment) Increase DR

Owner’s equity (Capital) Increase CR

KNOWING AND DOING 5.1� What is transaction analysis?

� Explain the double-entry system of accounting. Illustrate your answer.

� What are the steps involved in analysing transactions?

� Draw a flow diagram to illustrate the steps involved in analysing transactions.

5 What are the benefits of preparing a transaction analysis table?

� Distinguish between GST exclusive and GST inclusive.

� List some items on which you pay GST.

8 Find out which everyday items GST is not charged on.

9 Calculate the GST amount for each of the following.

a $700 (GST exclusive) b $440 (GST exclusive)

c $165 (GST inclusive) d $720 (GST exclusive)

e $1 210 (GST inclusive) f $66 (GST exclusive)

�0 What is the purpose of the capital account?

�� Why do we always represent transactions from the point of view of the business?

�� Identify the accounts involved in each of the following transactions.

a J Smith invested $40 000 cash into a business.

b B Clancy contributed $20 000 cash and a vehicle worth $40 000 into his new business.

�� What type of account is each of the following?

a Capital b Bank c Motor vehicle d Equipment e Furniture f Buildings

�� Complete a transaction analysis table for the following transactions.

• Jenny Wong invested $100 000 cash into her new business.

• Nicky’s Nautical Wear received a $60 000 contribution in cash from the owner.

• Jan Lowe commenced business with a vehicle valued at $25 000, equipment worth $10 000 and $40 000 cash.

8 Focus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST) 9

activity

Analysing and evaluatingApplyingKnowing and understanding

Purchase of assets—cashJust as we buy furniture or equipment (for example, washing machines or toasters) to use in our homes to make our lives comfortable, businesses buy assets such as vehicles, furniture or equipment (for example, computers or fax machines). A trading business purchases goods and these goods are called inventories. Inventories are owned by the business (until they are sold) so they are also assets. GST is paid on all purchases of assets but the business can reclaim this amount of GST from the government at a later date.

When a business buys an asset, the value of the assets (what the business owns) increases. You therefore debit the asset account (for example, the Motor vehicle, Inventories, Furniture or Equipment account), as [5.6] illustrates. GST is debited because it represents a decrease in the liability of GST owed to the government because GST paid on purchases can be reclaimed by a business. If the business uses cash to buy the asset, then the Bank account will decrease because there will be less money in the account. Decreases in assets are credited.

[5.6] Transaction analysis of the purchase of an asset for cash

Type of transaction

Example Accountsinvolved

Type of account

Increase ordecrease

Debit or credit

Amount

Purchase of asset for cash

Bought equipment for $4 400 cash

EquipmentGST clearingBank

AssetLiabilityAsset

IncreaseDecreaseDecrease

DRDRCR

$4 000$400

$4 400

RULE Asset (e.g. Furniture, Inventories, Motor vehicle) Increase DR

Liability (GST) Decrease DR

Asset (Bank) Decrease CR

Withdrawal of cash by the ownerA business owner may want to take out cash to use for their personal needs outside the business. When a business owner withdraws cash, a negative owner’s equity account called ‘drawings’ is used to record this transaction. GST is not involved in this type of transaction.

✦ The drawings account is the name of the account where businesses record that the owner has withdrawn cash from the business, for personal use.

As the transaction analysis table [5.5] shows, the drawings account is a ‘negative’ owner’s equity account and has a debit nature because it decreases the value of the owner’s investment. At the same time, the asset account from which the withdrawal is made is also decreasing and is therefore credited.

[5.5] Transaction analysis of cash withdrawn by the owner


Type of account Increase ordecrease

Debit or credit

Amount

Drawings of cash by owner

Petra withdrew $200 cash for personal use

Drawings

Bank

Negative owner’s equityAsset

Increase

Decrease

DR

CR

$200

$200

RULE Negative owner’s equity (Drawings) Increase DR


KNOWING AND DOING 5.2 � What is the purpose of the Drawings account?

� Why do we debit the Drawings account when the owner takes out cash for personal use?

� Why is the Drawings account called a ‘negative’ owner’s equity?

� Analyse the following transactions:

a Benny Koutsis withdrew $200 to pay for personal expenses.

b The owner paid for her $365 home electricity bill from her business’s bank account.

c Johnny Liu (owner) took cash of $150 for his own use.

5 Analyse the following transactions for Linda Young:

a Linda contributed a motor vehicle valued at $40 000.

b Linda withdrew $50 for personal use.

c Linda invested an additional $10 000 into the business.

d Linda paid a $400 account for her daughter’s school fees from the business’s bank account.

‘Goods’ are also called ‘inventories, stock or merchandise’.

Note to teachers:This section of Chapter 5 Transaction analysis for double-entry accounting (with GST) differs slightly from Chapter 5 in the textbook. Drawings of cash only will be considered in this chapter as it does not involve GST. This chapter only considers drawings of cash, not other assets. GST as it applies to the withdrawal of inventories and other assets (other than cash) is outside the scope of this junior course.

�0 Focus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST) ��

activity


Purchase of assets—creditIf the business buys an asset on credit (that is, the business will pay for the asset at a later date), then a record of the business or person to whom the business owes money is necessary. The individual account used to record the amount owed to an individual or other business is called an ‘Accounts Payable’. This account is classified as a liability. Therefore, because the amount that the business owes has increased, it is necessary to credit the Accounts Payable account (see [5.7]). The GST involved in this transaction is recorded when the purchase is made. The cash owing is recorded at a different time.

[5.7] Transaction analysis of the purchase of assets on credit

Type of transaction


Type of account

Increase ordecrease

Debit or credit

Amount

Purchase of asset on credit

Bought $2 200 worth of inventories from Mandy Taylor

InventoriesGST clearingAccounts payable—Mandy Taylor

AssetLiabilityLiability

IncreaseDecreaseIncrease

DRDRCR

$2 000$200

$2 200

Sale of assets (other than inventories)—cashSometimes a business may find it has no further use for a particular asset, or the item now uses technology that has become out of date (for example, a computer). When a business sells its assets, the value of the business’s assets decreases. Therefore, we credit the individual asset account (for example, computer equipment or furniture) as [5.8] shows. If the business sells the asset for cash, then the bank account will increase because there will be more money in this account. Increases in assets are debited. When a business sells any of its assets it must charge GST on the sale. GST is a liability and it is remitted to the government at a later date; and as the amount owing is increasing it is credit.

[5.8] Transaction analysis of the sale of an asset (other than inventories) for cash


Type of account

Increase ordecrease

Debit or credit

Amount

Sale of asset for cash(not inventories)

Sold equipment for $770 cash

BankEquipmentGST clearing

AssetAssetLiability


DRCRCR

$770$700

$70

RULE Asset (Bank) Increase DR

Asset (e.g. Furniture, Equipment) Decrease CR

Liability (GST clearing) Increase CR

Sale of assets (other than inventories)—creditIf the business sells an asset on credit (that is, it will receive the money for the asset at a later date), then it needs to keep a record of the person or business owing the money. The account used to record the amount that another business or an individual owes is called an ‘accounts receivable’. We classify this account as an asset. Therefore, because the value of the business’s assets is increasing, we debit the accounts receivable account (see [5.9]).

[5.9] Transaction analysis of the sale of an asset (other than inventories) on credit

Type of transaction


Type of account

Increase ordecrease

Debit or credit

Amount

Sale of asset on credit

Sold motor vehicle to H Nolls for $16 500 on credit

Accounts receivable—H NollsMotor vehicleGST clearing

AssetAssetLiability


DRCRCR

$16 500$15 000$1 500

RULE Asset (Accounts receivable—name) Increase DR

Asset (e.g. Furniture, Equipment) Decrease CR


RULE Asset (e.g. Furniture, Inventories, Motor vehicle) Increase DR

Liability (GST clearing) Decrease DR

Liability (Accounts payable—name) Increase CR

KNOWING AND DOING 5.3 � Explain the difference between a cash purchase and a credit purchase.

� What is the rule for the purchase of an asset on credit?

� What is the rule for the purchase of inventories on credit?

� What are three other names used to identify the inventories of a business?

5 Why are inventories an asset to a business?

� What is the rule to record the purchase of goods on credit?

� What is the rule to record the purchase of inventories for cash?

8 Analyse the following transactions:

a Bought goods for $1 100 cash.

b Purchased stock valued at $5 500 for cash.

c Inventories worth $2 200 were bought on credit from Wholly Suppliers.

d Bought stock from Tickle Co. for $11 000 on credit.

e Georgia Parks purchased a new delivery van for $66 000 cash.

f Hao Van Nguyen bought furniture for the business for $2 200. He paid by cheque.

g Chris Chester bought a new computer from Computer World for $3 300 on credit.

h Tommy Chan bought a new vehicle from Westside Motors for $33 000 on credit. He paid a $5 000 deposit.

�� Focus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST) ��

activity


KNOWING AND DOING 5.4 � What is the rule to record the sale of assets (other than inventories) for cash?

� What is the rule to record the sale of assets (other than inventories) on credit?

� Explain the term ‘accounts receivable’.

� Why is an accounts receivable an asset?

5 Complete the following transaction analysis table:

Transaction Accounts involved Type of account

Increase ordecrease

Debit or credit

Amount

Sold vehicle for $22 000 cash

BankVehicleGST

BankFurnitureGST

AssetAssetLiability


$550$500

$50

Accounts receivable— T AntonioMachineryGST clearing

Asset

AssetLiability

Increase DecreaseIncrease

$1 100

$1 000$100

Sold equipment to V Collins for $990

C Papadopoulos sold furniture worth $1 100 to B Henry on credit. Received a $200 deposit

D Coulter sold P Fleming a computer for $2 200

Accounts receivable— O ReddingBankEquipmentGST clearing

$4 500

$1 000$5 000

$500

Sales of inventories—cashPetra’s Paraphernalia, the business we’ve been using as an example in this book, is a trading enterprise, that is, Petra buys goods and resells them at a higher price. The price Petra buys goods for is called the cost price. When she sells the goods, they are sold at a different price, the selling price, which is the cost price plus a mark-up and with GST added on as well.

✦ Cost price includes the cost of the goods bought and any costs of getting the goods ready for sale.

✦ Selling price is the price for which the business sells the product(s) and GST is added to this price.

✦ Mark-up is an amount added to the cost price to work out the selling price before GST is added.

Businesses use both sets of prices when recording a sale of inventories. The cost price is the value of the goods recorded in the inventories account.

The selling price is the value used when the business records the revenue earned from the sale.

Therefore, when a sale of inventories occurs, a business makes two distinct entries in the records of the business—a selling price entry (with GST) and a cost price entry (no GST).

Recording the selling priceIf a business sells goods for cash, the bank account will increase by the full amount received from the customer, that is, the selling price and GST (as shown in [5.10]). Increases in assets are debited. The income earned by the business (that is, revenue) also increases and the GST liability also increases. We call the individual account used to record this type of income a ‘sales revenue’ account or just ‘sales’. Increases in revenue are credited.

Recording the cost priceThe business also needs to record the cost price effect of the entry. The value of inventories is decreasing; therefore, the asset account, inventories, is credited (see [5.10]). An expense account called ‘cost of goods sold’ is debited as this reflects the costs directly associated with selling the products.

�� Focus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST) �5

[5.10] Transaction analysis of sale of inventories for cash


Type of account

Increase ordecrease

Debit or credit

Amount

Sale of inventories for cash

Sold goods for $660 cash (cost price $300)

BankSalesGST clearing

AssetRevenueLiability

IncreaseIncreaseIncrease

DRCRCR

$660$600$60

Cost of goods soldInventories

ExpenseAsset

IncreaseDecrease

DRCR

$300$300


Selling price Revenue (Sales) Increase CR


Expense (Cost of goods sold) Increase DR Cost price

Asset (Inventories) Decrease CR

Sales of inventories—creditSimilarly, when a business sells inventories on credit, it must record both the selling price (plus GST) and cost price part of the transaction. In a credit sale, however, the business has not yet received the cash, so it needs to record the name of the person or business who now owes it money. The account name given is ‘Accounts receivable—name of business or person’. As shown in [5.11], we debit Accounts receivable (name) because this represents an increase in the business’s assets. All the other accounts involved remain the same as the ones used for cash sales of inventories.

[5.11] Transaction analysis of sale of inventories on credit

Type of transaction


Type of account

Increase ordecrease

Debit or credit

Amount

Sale of inventories on credit

Sold stock to Party Planners Ltd on credit for $880 (cost price $400)

Accounts receivable— Party Planners LtdSalesGST clearing



DRCRCR

$880$800$80

Cost of goods soldInventories

ExpenseAsset

IncreaseDecrease

DRCR

$400$400


Selling price Revenue (Sales) Increase CR


Expense (Cost of goods sold) Increase DR Cost price Asset (Inventories) Decrease CR

activityKNOWING AND DOING 5.5 � Why do businesses need two prices to record the sale of inventories?

� What is the rule to record the cost price of goods sold for cash?

� What is the rule to record the selling price of goods sold for cash?

� What is the rule to record the cost price of goods sold on credit?

5 What is the rule to record the selling price of goods sold on credit?


a Sold inventories for $1 100 cash (cost price $600).

b Sold stock for $1 650 cash (cost price $700).

c Inventories worth $2 200 were sold on credit to P Chester (cost price $1 400).

d Y Polti was sold goods on credit for $3 300 (cost price $2 000).

e N Wiseman was sold goods on credit for $880 (cost price 50% of selling price).

f Inventories worth $990 were sold to B Vandermeer for cash (cost price 40% of selling price).

g Cash sales $3 300 (cost price $1 600).

Sale of services—cashWhen service enterprises (that is, businesses such as an auto-repair centre or an accountancy firm), sell their services, they increase their revenue. Service enterprises record this type of revenue in a ‘Service Fees Revenue’ account. GST is charged on the sale of services and remitted to the government. If the business provides a service for cash then the asset account, Bank, will increase and, therefore, will be debited (see [5.12]). The service fees revenue earned by the business will increase and therefore be credited. As this type of transaction represents a sale, the GST owing (liability) is increasing and is credited.

[5.12] Transaction analysis of the sale of services for cash


Type of account

Increase ordecrease

Debit or credit

Amount

Sale of service for cash

Serviced vehicle for a cash customer $330

BankService fees revenueGST clearing



DRCRCR

$330$300$30


Revenue (Service fees revenue) Increase CR




activity


Sale of services—creditIf a business sells its services on credit to a customer, then (as shown in [5.13]) it debits the Accounts receivable account for the customer because the customer now owes the business money and this results in an increase in assets. The Service fees revenue account will still be credited because the revenues for the business have increased, and as GST is charged it is therefore credited.

[5.13] Transaction analysis of the sale of services on credit

Type of transaction


Type of account

Increase ordecrease

Debit or credit

Amount

Sale of service on credit

Serviced E Winters’s vehicle for $220 on credit

Accounts receivable—E WintersService fees revenueGST clearing



DRCRCR

$220$200

$20


Revenue (Service fees revenue) Increase CR


KNOWING AND DOING 5.6 � What is ‘service fees revenue’?

� List five types of businesses in your local area that would use a Service fees revenue account.

� What is the rule to record the sale of services for cash?

� What is the rule to record the sale of services on credit?

5 Analyse the following transactions.

a Received $660 cash for services provided.

b $440 cash was received for accounting services provided.

c Bookkeeping fees of $220 were provided to DH Chu on account.

d Security services were provided on credit to Nick’s Nightclub for $165.

e Design consultancy fees of $330 each were charged to G Kingley and W Quentin.

Return of inventories purchased for cashSometimes when a business purchases inventories, it may find that the goods are faulty, the wrong size or unsuitable in some other way. The business may decide to return the goods or keep them if the supplier provides an adjustment to the price of the goods. This is called an ‘allowance’. Whether the goods are returned or an allowance is given, the effects on the accounts are the same. If the business originally bought the goods for cash, then it will receive a refund for the full value

of the returned goods. This means (as shown in [5.14]) that the bank account will increase and, therefore, be debited. On the other hand, the inventories will decrease because the value of business’s assets is less—decreases in assets are credited. The GST clearing account is also affected and will be credited (opposite to when goods were purchased).

[5.14] Transaction analysis of the return of inventories that a business had purchased for cash


Type of account

Increase ordecrease

Debit or credit

Amount

Return of goods purchased for cash

Returned damaged inventories for $55 refund

BankInventoriesGST clearing

AssetAssetLiability


DRCRCR

$55$50

$5




Return of inventories purchased on creditIf the business originally purchased the goods on credit, the amount that the business now owes to the supplier is reduced. This will result in a decrease in a liability account—Accounts payable—and this account will be debited (see [5.15]). Again, the value of inventories owned by the business has decreased and will be credited because the asset has decreased and GST clearing, a liability, will be increased—credited.

[5.15] Transaction analysis of the return of inventories that a business had purchased on credit

Type of transaction


Type of account

Increase ordecrease

Debit or credit

Amount

Return of goods purchased on credit

Returned goods worth $77 originally bought on credit from Parties Galore

Accounts payable— Parties GaloreInventoriesGST clearing

LiabilityAssetLiability

DecreaseDecreaseIncrease

DRCRCR

$77$70

$7

RULE Liability (Accounts payable—name) Decrease DR



�8 Focus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST) �9

activityKNOWING AND DOING 5.7 � What is the rule to record the return of inventories purchased for cash?

� What is the rule to record the return of inventories purchased on credit?

� Why is a cash refund not received when inventories originally bought on credit are returned?

� Why might a business return inventories?


a Inventories worth $330 were returned to the supplier for a cash refund.

b $110 worth of goods was sent back to the supplier because they were the wrong colour.

c The business received an adjustment note for $55 from T Hallam on goods purchased on credit.

d The business returned $88 worth of goods to S Dimitriou.

Returns of inventories sold for cashWhen a customer returns goods sold for cash because they prove to be incorrect for some reason, or are more than what the customer needs, the customer is entitled to receive a cash refund from the business for the full price paid. Remember that the sale of the goods involved a selling price and a cost price component. Similarly, when the goods are returned for a cash refund, the adjustments in the books of the business need to reflect the selling price and the cost price parts of the transaction and the reversal of the GST originally charged (as shown in [5.16]).

Recording the selling price of goods returnedWhen a business provides a refund, the Bank account will decrease and the revenue from the original sale will also decrease. The business records this decrease in sales in a ‘Sales returns’ account. This is a negative revenue account because there has been a decrease in the revenues earned by the business. The GST clearing account is also decreasing and will be debited.

Recording the cost price of goods returnedBecause the returned goods are now back in stock, the business’s Inventories account will now increase. The cost of goods sold (or the expense associated with the original sale) is also decreasing and therefore this account will be credited.

[5.16] Transaction analysis of the return of inventories originally sold for cash

Type of transaction

Example AccountsInvolved


Debit or credit

Amount

Return of goods sold for cash

$110 worth of goods were returned for a cash refund. Cost price $55

Sales returnsBankGST clearingInventoriesCost of goods sold

Negative revenueAssetLiabilityAssetExpense

IncreaseDecreaseDecreaseIncreaseDecrease

DRCRDRDRCR

$100$110

$10$55$55

RULE Negative revenue (Sales return) Increase DR

Selling price Asset (Bank) Decrease CR


Asset (Inventories) Increase DR Cost price Expense (Cost of goods sold) Decrease CR

Returns of inventories sold on creditIf the goods were originally sold on credit, then the records need to show a reduction in the amount owed to the business by the customer (that is, the amount of the original credit sale). A cash refund is not appropriate as the customer has not yet paid for the goods. Therefore, (as shown in [5.17]) a decrease in the asset account—Accounts receivable—is necessary to record the reduced amount that the customer now owes. Decreases in assets are credited. The other accounts involved are the same as in the cash example above.

[5.17] Transaction analysis of the return of inventories originally sold on credit

Type of transaction



Debit or credit

Amount

Return of goods sold on credit

Party Planners Ltd returned $220 worth of excess goods. Cost price $100

Sales returnsAccounts receivable— Party Planners LtdGST clearingInventoriesCost of goods sold

Negative revenue

AssetLiabilityAssetExpense

Increase

DecreaseDecreaseIncreaseDecrease

DR

CRDRDRCR

$200

$220$20

$100$100

RULE Negative revenue (Sales returns) Increase DR

Selling price Asset (Accounts receivable—name) Decrease CR


Asset (Inventories) Increase DR Cost price Expense (Cost of goods sold) Decrease CR



activity


activity [5.19] Transaction analysis of the payment to an accounts payable with a discount received


Type of account

Increase ordecrease

Debit or credit

Amount

Cash paid to accounts payable (with discount)

Paid Parties Galore $1 045 and received a $55 discount for prompt payment

Accounts payable—Parties GaloreBank

Accounts payable—Parties GaloreDiscount revenueGST clearing

LiabilityAsset

LiabilityRevenueLiability

DecreaseDecrease

DecreaseIncreaseIncrease

DRCR

DRCRCR

$1 045$1 045

$55$50

$5

RULE Liability (Accounts payable) Decrease DR

Revenue (Discount revenue) Increase CR



KNOWING AND DOING 5.9 � What is the rule to record cash paid to an accounts payable?

� What is the rule to record the discount received from an accounts payable?

� Why is a discount given by an accounts payable?

� Why is the Accounts payable account debited when recording a discount received?


a Sent a cheque to C Knight for $500 in full settlement of amount owing.

b Paid P Xavier $900 in settlement of account.

c Paid B Engles $400 and received a $44 discount for prompt payment (including GST).

d P Calder was paid $900 in full settlement of a $999 account.

e We owed W Wilson $880. He gave us a discount of 5% for prompt payment.

f The amount owing to C H Lai was $2 200. The account was settled in full after deducting a 2% discount for prompt payment.

KNOWING AND DOING 5.8 � What is the rule to record the cost price of the return of inventories sold for cash?

� What is the rule to record the cost price of the return of inventories sold on credit?

� What is the rule to record the selling price of the return of inventories sold for cash?

� What is the rule to record the selling price of the return of inventories sold on credit?

5 What is the nature of the Sales returns account? Why?


a A customer has returned inventories worth $440 (cost price $150) for a cash refund.

b Customers returned stock to the value of $99 (cost price $30).

c H Major returned $220 worth of goods (cost price $110). The business issued an adjustment note.

d G Fernando returned inventories to the value of $132 (cost price 40% of selling price).

e A Huang returned goods worth $990 (cost price 60% of selling price).

Cash paid to accounts payableYou will recall from our earlier examples that, when a business purchases an asset or goods on credit, it records this credit purchase in a liability account—accounts payable. This records the fact that the business owes someone money and that the amount owed includes the GST that was recorded when the purchase was recorded. The amount of GST owed is included in the amount paid but is not recorded again as this transaction is not a sale or purchase – just a subsequent payment of cash owing.

[5.18] Transaction analysis of a payment to accounts payable


Type of account

Increase ordecrease

Debit or credit

Amount

Cash paid to accounts payable (no discount)

Paid Parties Galore $1 100

Accounts payable— Parties GaloreBank

LiabilityAsset

DecreaseDecrease

DRCR

$1 100$1 100

RULE Liability (Accounts payable—name) Decrease DR


Discount receivedA discount has the effect of reducing the original transaction amount and as this included GST, an adjustment must also be made for GST in this transaction. Due to the GST, it may be easier to understand this transaction if done as two entries. The first entry is the amount actually paid. The second entry is the amount not paid which includes a component of GST in the discount.


See chapter 3, page 84, for a discussion of terms of trade such as discount for prompt payment.


activity

Purchases of supplies and services—cashIn the previous sections we have been discussing the purchase of assets such as equipment and inventories. Businesses also need to pay for other supplies, such as stationery, and for services such as electricity, advertising and rent to keep operating and to carry out their main activities. These costs are called expenses because they must be incurred in order to earn the revenue. Expenses will reduce the overall profit made by the business at the end of the accounting period. If the business pays for the expense by cash (that is, with a cheque), then the expense account will increase and therefore be debited (see [5.20]). The amount paid for these expenses will generally include GST but because the amount can be reclaimed by the business from the government at a later date, the GST liability is decreasing. The bank account will decrease as there will be less cash available in this account—so the asset, Bank, is credited because it is decreasing. Wages and interest paid to a bank do not attract GST.

[5.20] Transaction analysis of the purchase of a supply or service for cash


Type of account

Increase ordecrease

Debit or credit

Amount

Purchase of supply or service for cash

Paid $220 telephone bill TelephoneBankGST clearing

ExpenseAssetLiability


DRCRDR

$200$220

$20

RULE Expense (e.g. Electricity, stationery) Increase DR



Purchases of supplies and services—creditWhen the business buys the supply or service on credit, the expense account will increase and, therefore, be debited (see [5.21]). The amount that the business owes will also increase; therefore, the business’s liabilities will increase—and so liabilities will be credited. GST will be included in the amount paid and represents an amount that can be reclaimed from the government at a later date and is therefore decreasing the overall GST liability account.

[5.21] Transaction analysis of the purchase of a supply or service on credit


Type of account

Increase ordecrease

Debit or credit

Amount

Purchase of supply or service on credit

Bought $770 worth of advertising from SunQuest News on account

AdvertisingAccounts payable—SunQuest NewsGST clearing

Expense

LiabilityLiability

Increase

IncreaseDecrease

DR

CRDR

$700

$770$70

RULE Expense (e.g. Electricity, stationery) Increase DR

Liability (Accounts payable) Increase CR


KNOWING AND DOING 5.10 � What is the rule to record the purchase of a supply for cash?

� What is the rule to record the purchase of a supply on credit?

� Explain why an expense account is debited when a supply or service is purchased.


a Paid $440 for a telephone account.

b Sent a cheque for $220 to Energex for electricity supplied.

c Purchased advertising on account from Questfair Newspapers $990.

d Received a tax invoice from Busy Bookkeepers for $880 accounting fees.

e Paid $1 200 wages. (There is no GST in wages.)

f Auto Repairs Ltd charged our account $550 for repairs to the delivery van.

Cash received from accounts receivableYou will remember from our earlier examples that the sale of an asset or goods on credit meant that the customer now owes the business money. The business records the amount of money owing in an Accounts receivable account. This account is an asset. When the customer settles the account, that is, pays the business the full amount owing or part of the amount owing, the Accounts receivable (asset) decreases and therefore is credited (see [5.22]). GST is not included in this transaction as it has already been recorded at the time of the sale. At the same time the Bank account will increase and therefore be debited.


�� Focus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST) �5

activity


[5.22] Transaction analysis of cash received from an accounts receivable customer


Type of account

Increase ordecrease

Debit or credit

Amount

Cash received from accounts receivable (no discount)

Party Planners Ltd paid us $300 for amount owing

BankAccounts receivable—Party Planners Ltd

Asset

Asset

Increase

Decrease

DR

CR

$300

$300


Asset (Accounts receivable—name) Decrease CR

Discount givenBecause the original sale to the accounts receivable included GST, if discount is now given it really means that the amount charged for the goods has decreased. This also means that the GST we originally recorded must also decrease. It is generally easier to do this transaction in two parts to make it more simple. The first part of the entry deals with the cash actually paid. The second part deals with the amount of cash not paid—the discount that has a GST component.

[5.23] Transaction analysis of the payment from an accounts receivable customer with a discount


Type of account

Increase ordecrease

Debit or credit

Amount

Cash received from accounts receivable (with discount)

Received $500 cheque from G Zammit. $55 discount was given for prompt payment

BankAccounts receivable—G Zammit

Discount expense GST clearingAccounts receivable—G Zammit

AssetAsset

ExpenseLiabilityAsset

IncreaseDecrease


DRCR

DRDRCR

$500$500

$50$5

$55


Expense (Discount expense) Increase DR

Asset (Accounts receivable—name) Decrease CR


Other cash receivedSometimes a business earns income from sources other than its main service or trading activity. For example, it may rent a building to other businesses, or it may earn interest from money invested. When the business receives cash for these other revenues, the Bank account will be debited as it is increasing, and an individual revenue account will be credited for the type of revenue received and GST clearing will be credited also (see [5.24]). Interest from a bank or some other type of investment does not attract GST.

[5.24] Transaction analysis of cash received from other revenue


Type of account

Increase ordecrease

Debit or credit

Amount

Receipt of revenue Received $88 commission

BankCommissionGST clearing



DRCRCR

$88$80$8


Revenue (e.g. Rent, commission) Increase CR


KNOWING AND DOING 5.11 � What is the rule to record cash received from an accounts receivable?

� What is the rule to record the discount given to an accounts receivable?

� Why is a discount sometimes given to an accounts receivable?

� Make a list of sources of revenue a business might earn other than sales or service fees revenue.

5 What is the rule to record cash received for other revenues?


a Received $900 from T Lee in full settlement of account.

b P Reed sent a cheque for $245 to pay the amount owing on his account.

c Received $1 400 from K Makris in full settlement of a $1 499 debt.

d L Jimmieson was given an $88 discount for prompt payment of a $988 account.

e M Briggs owed $1 650. She received a discount of 7 % for prompt payment.

f Received $200 interest on an investment. (There is no GST in this transaction.)

g Commission of $440 was received by cheque.

h J Nagy (a tenant) paid his monthly rent of $800.


Summary of business transactionsThe following table [5.25] provides an overview of the types of transactions we have analysed in this chapter.

[5.25] Summary of types of business transactions

Transaction Accounts involved (DR entry first CR entry indented)

Transaction Accounts involved (DR entry first CR entry indented)

Capital contributed—cash Bank Capital

Sale of services—cash Bank Service fees revenue GST clearing

Capital contributed —assets

Asset account Capital

Sale of services—credit Accounts receivable— name Service fees revenue GST clearing

Drawings of cash Drawings Bank

Goods returned—originally purchased for cash (cash refund received)

Bank Inventories GST clearing

Purchase of asset—cash Asset accountGST clearing Bank

Goods returned—originally purchased on credit

Accounts payable—name Inventories GST clearing

Purchase of asset—credit Asset accountGST clearing Accounts payable— name

Goods returned—originally sold for cash (cash refund paid)

Sales returnsGST clearing Selling price Bank

Inventories Cost price Cost of

goods soldSale of asset—cash Bank

Asset account GST clearing

Goods returned—originally sold on credit

Sales returnsGST clearing

Selling price Accounts receivable —name

Cost of goods sold Cost price Inventories

Sale of asset—credit Accounts receivable— name Asset account GST clearing

Payment to accounts payable

Accounts payable—name BankAccounts payable—name Discount revenue GST clearing

Purchase of inventories—cash

InventoriesGST clearing Bank

Purchase of supplies and services—cash

Expense accountGST clearing Bank

Purchase of inventories—credit

InventoriesGST clearing Accounts payable— name

Purchase of supplies and services—credit

Expense accountGST clearing Accounts payable— name

Sale of inventories—cash Bank Sales Selling price GST clearing


Payment from accounts receivable

Bank Accounts receivable— nameDiscount expenseGST clearing Accounts receivable— name

Sale of inventories—credit Accounts receivable —name Selling price Sales GST clearing


Revenue received Bank Revenue account GST clearing

�8 Focus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST) �9

activity

Goods and Services Tax and Business Activity Statements (BAS)

The business collects the GST on behalf of the ATO and pays GST when it purchases goods, supplies and assets for the operation of its own business. The GST collected is owed to the government. The GST paid by the business can be reclaimed from the government. Businesses must complete a Business Activity Statement (BAS) to determine the net GST payable to the ATO.

KNOWING AND DOING 5.12 � What is transaction analysis?

� Distinguish between GST exclusive and GST inclusive.

� List some items on which a business does not pay GST.

� Find out which everyday items GST is not charged on.

5 Using the form provided and the financial information listed below, prepare the quarterly Business Activity Statement (BAS) for Parties Galore at 119 Waterworks Road, Ashgrove, Qld 4060 and change dates to Quarter 1 April 2008 to 30 June 2008. Amounts are inclusive of GST.

a Calculate the total sales for the period and insert this figure at G1 in the BAS and tick the appropriate included/excluded box.

b Calculate the total purchases for the period and insert this figure at G11 in the BAS and tick the appropriate included/excluded box.

c Calculate total capital purchases for the period. Add 10% GST and insert this figure at G10 in the BAS and tick the appropriate included/excluded box.

d Then turn the page of the BAS and calculate either the GST owing to the ATO, or the amount owed back to the business by the ATO.

Parties Galore financial information for quarter 1 April to 30 June 2008:

Sales for each month in the quarter including GST are as follows.

• Sales for April $33 000

• Sales for May $22 000

• Sales for June $44 000

Parties Galore purchased inventories during the period as follows.

• Purchases for April $16 500

• Purchases for May $11 000

• Purchases for June $13 200

Parties Galore also purchased the following assets. The prices given here are exclusive of GST.

• Computer in April $12 000

• Tailormade filing system $15 000


� Identify the accounts involved in each of the following transactions.

Transaction Accounts involved

Borrowed $40 000 from bank

Bought land for $100 000

Sold equipment for $4 400 cash

Paid electricity $440

Received rent of $1 100

Paid $500 wages

Received commission $330

Purchased building worth $90 000

Owner contributed delivery van worth $40 000 for business use

Paid telephone $330

A direct payment of $220 was made from our bank for rent

Sold motor vehicle to G Brandt for $16 500 on credit

� Categorise each of the following accounts into its correct group.

Account title Type of account

Capital

Bank

Accounts payable

Accounts receivable

Rent (received)

Wages

Interest (paid)

Advertising

Commission (received)

GST clearing

Commission (paid)

Building

Mortgage on land

Equipment

Loan from AGC Finance Co.

Loan to R Thore

<www.ato.gov.au>


8 State whether each account in the following transactions is increasing or decreasing.

Transaction Accounts involved Increase or decrease

Bought motor vehicle for $44 000 cash

Motor vehicleBankGST clearing

Bought equipment on credit from W Houston for $5 500

EquipmentW Houston (accounts payable)GST clearing

Paid wages $900WagesBank

Paid cleaning $440CleaningGST clearingBank

Sold equipment on credit to Eric Wise for $1 100

Eric Wise (accounts receivable)EquipmentGST clearing

Owner invested $10 000 cash

BankCapital

Owner contributed equipment worth $1 000

EquipmentCapital

Received interest of $40 on investment

BankInterest on investment

Received rent $440BankRentGST clearing

Received commission $220

BankCommissionGST clearing

9 Draw a transaction analysis table and analyse the following transactions (GST is included when applicable).

– Borrowed $40 000 from bank.

– Bought land for $100 000.

– Bought inventories $1 100 cash.

– Bought inventories from W Rent on credit $330.

– Sold equipment for $4 400 cash.

– Paid electricity $440.

– Received rent of $1 100.

– Paid $550 wages.

– Received commission $220

– Purchased building $90 000.

– Owner contributed delivery van worth $40 000 for business use.

– Paid telephone $330.

– A direct payment of $220 was made from our bank account for rent.

– Sold motor vehicle to G Brandt for $16 500 on credit.

– Sold inventories for cash $880 (cost price $400).

– Sold inventories to G Brennan on credit for $550 (cost price $250).


activityCulminating

Receipt no 78 12/03/07

Credit: PA ChesterDetails: Payment of accountCash received: $24.00Discount given:

Cash register summary 03/03/07

$600

Tax invoice no 258 09/03/07 Supplier: Mandy’s SuppliesSold to: Dom’s Doughnuts

The following goods:4 cartons cocoa powder $9.00/carton

Adjustment note no 698 03/03/07

Supplier: Fran Flour SuppliersDetails: Damaged goodsRe: Invoice 698

Return/allowance:2 bags self raising flour $5/bag7 boxes yeast $8/box

Terms of trade: 5/10; n/30

Tax invoice no 944 06/03/07

Supplier: MotorworldSold to: Dom’s Doughnuts

The following goods:Ford utility van $25 000

Cheque no 2358 11/03/07

Paid to: Dominic HaddadFor: Cash drawingsThis cheque: $300

Cheque no 2356 2/3/07

Paid to: EnergexFor: Electricity supplyThis cheque: $200


Supplier: Dom’s DoughnutsSold to: Tommy Tucker

The following goods:20 boxes mixed doughnuts $4.00/boxTerms of trade: 5/10; n/30


Supplier: Dom’s DoughnutsSold to: PA Chester

The following goods:6 boxes mixed doughnuts $4.00/box

Cheque no 2357 07/03/07

Paid to: Fran Flour SuppliesFor: Settlement of accountThis cheque: $71


Supplier: Fran Flour SuppliersSold to: Dom’s Doughnuts

The following goods:5 bags self-raising flour $5/bag

Receipt no 77 12/3/07

Credit: Tommy TuckerDetails: Payment of accountCash received: $76.00Discount given: $ 4.00

Analysing and evaluatingApplying

TRANSACTION ANALYSIS

Draw a transaction analysis table and analyse the following source documents on behalf of Dom’s Doughnuts owned by Dominic Haddad. The cost price of goods sold is 40% of the selling price in each case. Be sure to analyse the transactions in date order.

If Dom’s Doughnuts had registered to collect GST, which of the following statements would be considered true for the month of March?• All the transactions involving cheques would have had GST calculated. True/False• The cash register summary figure would not include GST. True/False• Mandy’s Supplies, Fran Flour Suppliers and Motorworld would have a GST figure

on each source document. True/False• Each of the transactions in the above source documents would include GST.

True/False

GLOSSARYCapitalname of the account used to record the owner’s contributions to a business

Cost pricethe cost of the goods bought and any costs of getting the goods ready for sale

Double-entry systemstates that for every transaction there is a debit (DR) entry and a corresponding credit (CR) entry of equal value

Drawings accountname of the account used to record the amount of assets that the owner withdraws from the business for personal use

GST-inclusivethe price given for a product includes the GST component

GST-exclusivethe price given for a product has not had the GST component added

Inventoriesgoods a business buys for resale to customers

Mark-upan amount added to the cost price to work out the selling price

Selling pricethe price for which the business sells the product(s)

Transaction analysisthe process used to break down a transaction into its debit and credit parts

Documents

Chapter 5 Transaction analysis for double-entry · PDF fileFocus on Business 1 Chapter 5 Transaction analysis for double-entry accounting (with GST ... Debits = Credits Record the