Copy _2_ of Principles of Accounting Note Year 1

8/3/2019 Copy _2_ of Principles of Accounting Note Year 1

1/213

[email protected] Tutorial | DEFINITION AND NATURE OF ACCOUNTING 1

FINANCIAL ACCOUNTING

DEFINITION AND NATURE OF ACCOUNTING

Introduction:

Any organized group or business, regardless of its size has certain resources and obligations which areinfluenced by a number of business transactions undertaken by it for the accomplishment of itsobjectives. It is not possible for a person or a group of persons to remember the occurrence of theseevents and their impact on business. Therefore these transactions are recorded in certain books known asbooks of accounts. Not only this, they are also analyzed, interpreted and communicated to the interestedparties who use the information as basis for their decision. The person responsible for these processes iscalled accountant and the system incorporating these processes is known as accounting Many business decisions were taken without reference to any data. Most firms were closed down

because of poor methods of recording data. With the introduction of book-keeping, this problem tosome extent has been overcome.

What is book-keeping?

It is the art of recording business transactions in terms of money or moneys worth in a regular andsystematic manner so that information in regard to them may be readily or quickly obtained. A personwho does the work of book-keeping is called a book-keeper; that is he/she keeps the books of accounts.

What is accounting?

There are various ways in which accounting may be defined. Some of them are given below: The American Institute of Accountants defined accounting in 1941 as the art of recording,

classifying and summarizing in a significant manner and in terms of money, transactions and eventswhich are, in part at least, of a financial character, and interpreting the results thereof.

The American Accounting Association defined accounting as the process of identifying, measuringand communicating economic information to permit informed judgments and decisions by users ofthe information

The rather broad definition is appealing because it highlights the fact that accounting exists for aparticular purpose. That purpose is to help users of accounting information to make more informeddecisions. If accounting information is not capable of helping to make better decisions then it is awaste of time and money to produce. Sometimes, the impression is given that the purpose of

accounting is simply to prepare financial reports on a regular basis. Whilst it is true that accountantsundertake this kind of work, it does not represent an end in itself. The ultimate purpose of theaccountants work is to influence the decisions of users of the information produced.


2/213

[email protected] Tutorial | BRANCHES OF ACCOUNTING 2

BRANCHES OF ACCOUNTINGAccounting as a discipline is constantly developing and expanding. There are several branches ofaccounting, the major branches of accounting are:

Financial Accounting

Cost and Management Accounting Tax Accounting Auditing Public Sector Accounting

Financial Accounting

Financial Accounting focuses on the stewardship function of management by generating reports thatexplain how financial resources made available by lenders and owners have been applied for thebusiness of the enterprise. Financial Accounting deals mainly with the recording of historical data andthe preparation of reports on past events.

Cost and Management Accounting

Cost and Management Accounting focuses on providing information to management to be used for theplanning, control and decision making purposes. The emphasis is on making estimates about the costand benefits of future events so as to ensure that the enterprise achieves its objectives.

Tax Accounting

Tax Accounting is concerned with arranging the tax issues of individuals and organizations. It involvesthe computation of tax obligations as well as advising on various ways of carrying on business so as tominimize the tax obligation of organizations. Tax Accountants also provide service to governmentinstitutions in charge of revenue mobilization for the state. They help in the assessment of taxes.

Auditing

This branch of accounting provides assurance to various users of financial statements that the financialstatements are true and fair and that users can reasonably rely on the statements for planning, control anddecision making purposes.

Public Sector Accounting

Public Sector Accounting is the branch of accounting that concentrates on public sector organizationssuch as central government, local government, non-governmental organizations etc. It encompasses

financial accounting, cost and management practices in public sector organizations.


3/213

[email protected] Tutorial | USERS OF ACCOUNTING INFORMATION AND THEIR

INFORMATION NEEDS

3

USERS OF ACCOUNTING INFORMATION AND THEIR INFORMATION

NEEDSFor accounting information to be useful, the accountant must be clear about for whom the informationis being prepared and for what purpose the information will be used. There are likely to be various user

groups with interest in a particular organization. The most common users are shown inMAIN USERS OF FINANCIAL INFORMATION RELATING TO A BUSINESS

Table

User Group UseCustomers To assess the ability of the business to

continue in business and to supply the needs of the customers

Employees To assess the ability of the business tocontinue to provide employment and to reward employees for theirlabour

Government To assess how much tax the business should pay, whether it complieswith agreed pricing policies, etc

Investment/Financial

analysts

to assess the likely risks and returns associated with the business in

order to determine its investments potential and to advise clientsaccordingly

Suppliers To assess the ability of the business to pay for the goods and servicessupplied (liquidity and solvency)

Lenders (Banks) To assess the ability of the business tomeet its obligations and to pay interest and to repay the principal

Customers Competitors

BusinessEmployees and

their representatives

Government

Owners

Managers

Lenders

Suppliers Investment

analysts

Community

representative


4/213

[email protected] Tutorial | CHARACTERISTICS (DESIRABLE QUALITIES) OF GOOD

ACCOUNTING INFORMATION

4

Managers To help them to make decisions and plans for the business and toexercise control to try to ensure that plans come to fruition.

Owners To assess how effectively the managers are running the business andto make judgments about likely levels of risks and returns in the future

CHARACTERISTICS (DESIRABLE QUALITIES) OF GOOD ACCOUNTING

INFORMATIONGood accounting information must have the following qualities:

Relevance

Accounting information must have the ability to influence decisions. Unless this characteristic ispresent, there really is not any point producing the information. The information may be relevant to the

prediction of future events or relevant in helping confirm past events. Relevant implies the following: Timeliness Completeness Appropriateness and suitability to user objective

Timeliness

Since information has an objective, there are usually periods within which these objectives operate.

Good information neither is produced too frequently nor is it compiled after it is needed most. For

instance, information that reaches a decision-maker after the decision is of limited use in the context of

the decision-making process.

Completeness

Good accounting information is complete. This means that it provides intended users with all the

information that is necessary to fulfil their information needs and requirements. Completeness also

suggests that all necessary information is included in any report that the organisation produces. The

assumption is that there would be no error of omission in the information.

Reliability

Accounting information is reliable if it is free from material errors or bias, it is complete and faithfullyrepresents what it purports to represent. Reliability implies reasonable accuracy.

Accuracy

It is almost self-evident that accounting information should be accurate. This does not suggest that you

must always state figures and facts down to the last penny or detail. What it means is that information

should be accurate enough for its intended purpose (or user), without being unnecessarily detailed.


5/213

[email protected] Tutorial | The Characteristics Which Influence the Usefulness of

Accounting Information

5

Inaccurate information cannot provide a valid representation of reality and can limit the effectiveness or

worth of decisions based on it.

Comparability

Accounting information should permit meaningful comparison between one period and another as well

as between one company and another. Comparability requires that items which are basically the sameshould be treated in the same manner for measurement and presentation purposes.

Understandability

Accounting reports should be expressed as clearly as possible and should be understood by those forwhom the information is aimed. In other words, information must be understandable before it can beuseful.

Cost-efficient

Valuable information should not cost more to produce than it is worth. This is the reason whyinformation that is produced more regularly than required is less useful/ valuable than information that is

produced to satisfy a specific need or requirement.

The Characteristics Which Influence the Usefulness of Accounting Information

Can produce

Which will be limited by

The lack of

Relevance Reliability

Useful accounting information

Comparability Understandability

Timelinessess

Cost/benefit


6/213

[email protected] Tutorial | ACCOUNTING STANDARDS 6

Constraints/Problems on Relevant and Reliable Information

In theory, financial information should be produced only if the cost of providing that piece ofinformation is less than the benefit, or value, to be derived from its use. Some of the constraints areindicated below. Figure 1.2 above illustrates further. Timeliness Balance between benefit and cost(cost/benefit analysis)

ACCOUNTING STANDARDS Accounting Standards are pronouncements made by the standard setters which are expected to be

used in the preparation of financial statements.

The standard setters include Ghana national Accounting Standards Board (GNASB), AccountingStandards Board (ASB) in the U.K, Financial Accounting Standards Board (FASB)in the U.S.

The international Accounting Standards Board (IASB) constituting the professional accountingbodies which are members of international Federation of Accountants (IFAC) such as ICA(Ghana), ACCA, ICA(Eng &Wales), AICPA, ICA(Scotland), etc.

Standards are not static; but are revised continuously to suit changing business environment .

THE ROLE OF THE ACCOUNTANT IN AN ORGANIZATION

Who is a professional accountant?The term accountant has been used loosely in the literature to refer to different grades of accountingpersonnel. We need to distinguish between the qualified self-disciplined, ethically motivatedprofessional chartered accountant from the self-proclaimed accountant.

According to the Institute of Chartered Accountants Ghana code of professional conduct, the termprofessional accountant refers to those individuals, whether they be in public practice, industry,commerce, the public sector or education who are members of an IFAC member body.

According to the Chartered Accountants Act 1963, Act 170, the term Chartered Accountant refers tothose individuals who have been admitted into membership of the Institute of Chartered Accountants(Ghana) as having successfully completed the qualifying examinations of the institute. The termexcludes individuals who have been admitted into membership of the Institute as PracticingAccountant.

In accordance with section 13 of the Chartered Accountants Act 1963, Act 170, any person, not being achartered accountant, who hold any of the qualifications prescribed by the council, shall be eligible for


7/213

[email protected] Tutorial | THE ROLE OF THE ACCOUNTANT IN AN ORGANIZATION 7

registration as an accountant. any person who is registered as such shall be called Practicing Accountant,and shall be entitled to use the expression P.A.: after his name to indicate that he is so registered.

The role of the accountant

In a global economy such as we are experiencing in recent times, which is characterized by changing

technology and complex production systems, it is logical that there will continue to be significantchanges in the systems of production, commerce and the management of private and public enterprises.In such an environment, the role of the accountant cannot be overemphasized. The role of the accountantcan be summarized below:

To collect and process financial data and communicate the resultant information for the purpose ofdecision making and control. Decision making is essentially about making choices. The rate ofsuccess in any venture depends on the soundness of decisions impacting on the venture and theeffectiveness and efficiency in the implementation of such decisions.

The professional accountant is best placed by virtue of his training to provide reliable information

for the making of good decisions as well as the effective monitoring of the execution of the decisionsto ensure that decisions are well executed.

There are five areas that the professional accountant could be identified with. These areas of practiceare: Accountants in public practice, Accountants in industry, Accountants in governmentalinstitutions, Accountants in Non-Governmental institutions and Accountants in education.

Accountants in public practice

Public accountants (or the Chartered Accountants or auditors as they are popularly called) areindependent professional persons comparable to attorneys or physicians who offer accounting servicesto clients for a fee. The main areas of accounting covered by public accountants include: auditing, tax

services and management advisory services.

Accountants in industry

These are accountants employed by private enterprises in industry. The work of accountants in industrymay include the following: designing accounting and internal control systems, performing financialaccounting duties; such as managing accounts payable, managing accounts receivable, preparingfinancial statements etc. Their work also includes performing cost accounting and managementaccounting functions.

Accountants in government and non-governmental institutions

Central and local government departments and agencies rely on financial information to help them directthe affairs of their departments and agencies. There is therefore the need for these institutions to employprofessional accountants to carry out these responsibilities. The case is the same for non-governmentalinstitutions.


8/213

[email protected] Tutorial | INTRODUCTION TO DOUBLE ENTRY 8

Accountants in education

Research to develop accounting principles and practices which keep pace with changes in the economicand political environment should be a major activity of professional accountants and accountingeducators. Accounting is not a closed system but a constantly evolving body of knowledge, a criticalexamination and review of accounting principles and practices clearly reveal that there are severalproblems and conflicts in accounting for which fully satisfactory solutions have not been developed. Theresponsibility for teaching and encouraging research in accountancy and securing the well being andadvancement of the accounting profession lies on university accounting lecturers, accountingpractitioners and professional accounting organizations. It is thus important to have professionalaccountants in education to promote research in accountancy.

INTRODUCTION TO DOUBLE ENTRY

The Accounting Equation

The whole of financial accounting is based on a very simple idea. This is called the accounting equation.

Resources In The Business=Resource Supplied By The OwnerThis implies that the resources supplied by the owner to set up a firm are all the resources the businesshas. Again, this confirms the saying that A business owns nothing and therefore does not owe. What itowns it owes.

In accounting the amount of resources supplied by the owner is called CAPITAL.The actual resources that are then in the business are called ASSETS.Therefore the accounting equation can be related as

ASSETS = CAPITALUsually, however, people other than the owner e.g. Banks, lenders etc. have supplied some of the assets.Liabilities are the name given to the amount owing to the people for these assets. The equation has nowchanged to: ASSETS = CAPITAL + LIABILITIESIt can be seen that the two sides of the equation will have the same total. This is because we are dealingwith the same thing from two viewpoints. It is:Resources: which are (Assets) = Resources: who supply them (Capital + Liabilities)It is fact that the totals of each side will always equal one another, and that this will always be true no

matter the number of transactions there may be. The actual assets, Capital and liabilities may change,but the total of the assets will always equal the total of the capital + liabilities.

ILLUSTRATION

The following information relates to Ashili Enterprise for the month of January, 2008.

a) Started business with GH25,000cash.


9/213


b) Deposited GH15,000 in a newly opened bank account.

c) Bought goods costing GH5,500, on credit from Jalal.

d) Purchase machinery GH10,000 paying GH7,000 immediately by cheque.

e) Sold goods costing GH2500 to Zidan on credit for GH3, 000.

f) Borrowed GH4,000 cash from Sham.

g) Cash purchases of goods GH5,300,

h) Zidan paidGH2,200, cash in partial settlement of his debt.

i) Goods withdrawn for personal use GH500.

You are required to show the effect of each transaction on the accounting equation and prepare a balance

sheet as at 31st

January, 2008.

ANALYSIS OF ILLUSTRATION

a) Started business with GH25,000cashASSETS = LIABILITIES + CAPITAL

Cash = 0 + Capital

25,000 = 0 + 25,000

b) Deposited GH15,000 in a newly opened bank account.

Cash + Bank = Capital

Old bal. 25,000 + 0 = 25,000

Effects (15,000) + 15,000 = 0

10,000 + 15,000 = 25,000

c) Bought goods costing GH5,500, on credit from Jalal.

Cash + Bank + Stock = Creditors + Capital

Old bal. 10,000 + 15,000 + 0 = 0 + 25,000

Effect 0 + 0 + 5,500 = 5,500 + 0

New 10,000 + 15,000 5,500 = 5,500 25,000


10/213


d) Purchase machinery GH10,000 paying GH7,000 immediately by cheque.

Cash + Bank + Stock + Machinery= Creditors + Capital

Old bal. 10,000 + 15,000 + 5,500 + 0 = 5,500 + 25,000

Effects 0 + (7,000) + 0 + 10,000 = 3,000 + 3,000

New 10,000 + 8,000 +5,500 + 10,000 = 8,500 + 25,000

e) Sold goods costing GH2500 to Zidan on credit for GH3, 000.

Cash + Bank + Stock + Machinery + Debtors = Creditors+ Capital

Old bal. 10,000 + 8,000 + 5,500 + 10,000 + 0 = 8,500 + 25,000

Effects 0 + 0 + (2,500) + 0 + 3,000 = + 0 + 500

10,000 8,000 3,000 10,000 3,000 8,500 25,500

f) Borrowed GH4,000 cash from Sham.

Cash + Bank + Stock + Machinery + Debtors= Creditors + Loan+ Capital

Old bal.10,000 + 8,000 + 3000 + 10,000 + 3,000 = 8,500 + 0 + 25,500

Effects 4,000 + 0 + 0 + 0 + 0 = 0 + 4,000 + 0

New 14,000 8,000 3,000 10,000 3,000 = 8,500 4,000 25.500

g) Cash purchases of goods GH5,300,


Old bal.14,000 + 8,000 + 3000 + 10,000 + 3,000 = 8,500 + 0 + 25,500

Effects (5,300) + 0 + 5,300 + 0 + 0 = 0 + 4,000 + 0

New 8,700 8,000 8,300 10,000 3,000 = 8,500 4,000 25.500


11/213


h) Zidan paidGH2,200, cash in partial settlement of his debt


Old bal. 8,700 + 8,000 + 3000 + 10,000 + 3,000 = 8,500 + 0 + 25,500

Effects 2,200 + 0 + 5,300 + 0 + (2,200) = 0 + 4,000 + 0

New 10,900 8,000 8,300 10,000 800 = 8,500 4,000 25.500

i) Goods withdrawn for personal use GH500.


Old bal.10, 900 + 8,000 + 8300 + 10,000 + 800 = 8,500 + 0 + 25,500

Effects 0 + 0 + (500) + 0 + 0 = 0 + 4,000 + (500)

New 10,900 8,000 7,800 10,000 800 = 8,500 4,000 25.000

Ashili Enterprise

Balance Sheet as at 31 January 2008

GH

Capital 25,000

Long term Liabilities:

Loan 4,000

Current Liabilities:

Creditors 8,500

37,500

GH GH

Fixed Assets

Machinery 10,000

Current Assets:

Stock 7,800

Debtors 800

Bank 8,000

Cash 10,900

27,500

37,500

The balance sheet attempts to show the financial position of a business at a point in time. There is

currently one professional way of setting out the balance sheet vertical as illustrated below;


12/213


Kofi Wayo

Balance sheet as at 31December 2009

Fixed Assets/Non-Current Assets: Cost Dep. NBV

Land and building *** - ***Plant and Machinery *** (***) ***Motor Vehicles *** (***) ***Furniture and Fittings *** (***) ***Fixtures *** (***) ***

**** (****) ****Current Assets:Stock/Inventory ***Debtors/ Receivables ***Less provision for bad debts (***) ***Prepayments ***

Bank ***Cash *******

Less Current Liabilities:Creditors/Payables ***Accruals/Owings ***Bank overdraft *** (****)WORKING CAPITAL *****NET ASSETS ****Financed by:Capital ***Add net Profit ***

****Less Drawings (***)

***Long Term Liability:Loan ***

.****

Quiz.

Dr. Commando started a business on 31st December 20x1. Before he actually starts to sell anything, he

has bought fixtures 200,000 Motor vehicle 500,000 and stock of goods 350,000. Although he has

paid in full for the fixtures and the motor vehicle, he still owes 140,000 for some of the goods. Mr.

John had lent him 300,000. Dr. Commando, after the above, has 280,000 in the business bank account

and 100,000 cash in hand.

You are required to calculate his capital and draft his balance sheet.


13/213


THE RECORDING PROCESS

Most companies employing more than a handful of staff use the system of recording called doubleentry bookkeeping.

This system records both cash and credit transactions as they occur at their different times. The name double entry derives from the fact that each individual transaction is entered twice,

recognizing two aspects. These two aspects are referred to by accountants as debits and credits.

THE DOUBLE ENTRY SYSTEM

We have seen in our previous studies that every transaction affects two items. For example if a businesspurchases stock worth 200,000 and issues cheque, the transaction affects stock of goods i.e. Stocksincrease by 200,000 and cash at bank decrease by 200,000. In this case for each transactionbookkeeping entry will have to be made to show an increase in stock and decrease in cash at bank. Thisis double entry system.Double entry system of bookkeeping is good because drawing up balance sheet after every transactionwill not give enough information about the business. It does not for instance tell who the debtors are andhow each one of them owes. Lets recall the double entry rules

DOUBLE ENTRY RULES ARE:

ACCOUNTS TO RECORD ENTRY IN THEACCOUNT

Assets An increase Debit

A decrease Credit

Liabilities An increase Credit

A decrease Debit

Capital An increase Credit

A decrease Debit

Expenses An increase Debit

A decrease Credit

Revenue/Income An increase Credit

A decrease Debit


14/213


ELEMENTS OF BALANCE SHEET STATEMENTS

1. Assets2. Liabilities3. Equity/Capital

The these three elements are directly related to the measurement of financial position.

Assets

Resources controlled by the enterprise as a result of past events and from which future economicbenefits are expected to flow to the enterprise.

Assets are classified as current and noncurrent.

Noncurrent AssetsAre expected to be in the business for more than one year (12 calendar months) are referred tononcurrent assets. E.g. Equipment, plant, Land and buildings, Investment property etc.

Current Assets are expected to be realized or intended for sale or consumption in the entitys normal operating

cycle Assets held primarily for trading Assets expected to be realized within 12 months after balance sheet date. Cash or cash equivalents

Liabilities

An entitys indebtedness to third parties. Claims against the assets of the business by outsiders Liabilities can be current or noncurrent

Current Liabilities are

liabilities expected to be settled in the entitys normal operating cycle liabilities held primarily for trading Liabilities due to be settled within 12 months after the balance sheet date.

Noncurrent Liabilities

Liabilities due to be settled more than 12 months after the balance sheet date Long-term interest-bearing liabilities to be settled within 12 months after the balance sheet date can

be classified as noncurrent if the original term is greater than 12 months it is the intention to refinance or reschedule the obligationThe agreement to refinance or reschedule is completed on or before the balance sheet date.


15/213

[email protected] Tutorial | AN ACCOUNT 15

AN ACCOUNT

An account is a statement, which records all the transactions of a specific class, which have takenplace during a given period.

Account in its simplest form, has three elements: (1) a title consisting of a particular assets, liability or owners equity; (2) a left side, which is called debit side; and (3) a right side, which is called the credit side

This form of account, illustrated below, is called a T account because of its resemblance to theletter T.

Account Title

Left Side (Debit) Right side (Credit)

Date Details Folio Amount Date Details Folio Amount

CLASSIFICATION OF ACCOUNT

Personal and Impersonal Account (divided into Real and Nominal Accounts) Ledger accounts which bear the names of individuals, partnerships or companies are called Personal

Accounts; All other accounts are calledImpersonal Accounts. Impersonal accounts may be further sub-divided into two classes: Real Accounts Recording transactions in property and material objects. (E.g. motor van, Land and

Building, stock, cash etc) Nominal Accounts records expenses, losses, revenue, incomes or gains. (E.g. sales, purchases, rent

and rates, interest paid and receive, etc)

A diagram of the types of accounts commonly used

Accounts

Im ersonal AccountsPersonal Accounts

Real

Accounts for

Possessions

Nominal Accounts

for Expenses, Income

Creditors

Account

Debtors

Accounts


16/213

[email protected] Tutorial | BALANCING OFF ACCOUNTS 16

LEDGER

A ledger is the principal book of account. It is a collection of accounts, maintained by transfers fromthe books of original entry. The ledger may be sub divided as follows:

Sales ledger (Debtors ledger)- this ledger contains the personal account of all customers Purchases ledger (creditors ledger) - this ledger contains the personal account of all suppliers. General ledger (nominal ledger) this ledger contains all other accounts relating to assets,

liabilities, expenses, income, capital and drawings.

ACCOUNTING CYCLE (PROCESS)

1. The process of recording, classifying and summarizing which is repeated in the same order eachaccounting period is referred to as theACCOUNTING CYCLE.

2. Several steps are involved from recording of transactions, analysis of those transactions to the

generation of financial statements.These steps are collectively called the Accounting Cycle.

Analyse the transactions in terms of its effects on the accounting equation Pass the entry in the journal Post the entry to the ledger Balance accounts and extract trial balance Pass and post adjusting entries Prepare financial statements (Income statement, Balance sheet and Cash flow statement)

BALANCING OFF ACCOUNTS

Before a trial balance can be drawn up the ledger must be balanced. At the end of each accountingperiod the firm will wish to balance its accounts off. An accounting period is normally one year but mostfirms will wish to balance off their accounts on a more frequent basis - usually every month. The morefrequently a firm balances its accounts off, the less likely it is to make mistakes.

The process of balancing accounts off should not be rushed. It is, in effect, the final part of the doubleentry system of bookkeeping. Once accounts have been balanced off then the firm can begin to assesswhether it has made a profit and if so how much profit has been generated.

The balance on each account is simply the difference in the totals of the debit side of the account and thecredit side of the account. For example, if the debit side of an account added up to GH190 but thecredit side of the account added up to GH330, then we would say that the account had a credit balanceof GH330 - GH190 = GH140.

Some things to remember when balancing off accounts are:


17/213

[email protected] Tutorial | THE TRIAL BALANCE 17

1. The totals for each column should always be on the same level on the page - never at split-levels.2. The balance brought down must always be on the opposite side to the balancing figure of the balance

to be carried down.3. The actual balance on the account is the balance brought down not the balance carried down.4. An account is not really finished until the balance has been brought down to the next period.

Note: Balance carried down (c/d) is known as closing balance, the balance brought down (b/d) is openbalance.

THE TRIAL BALANCE

When entering transactions in the double entry accounts we see that for every entry made on the debitside of the account there will always be a credit entry made in another account for the same amount ofmoney. When we balance off the individual accounts in the ledgers, we should therefore find that the

total of all the debit balances should be exactly equal to the total of credit balances. If the totals are notthe same then a mistake must have been made in the bookkeeping.

To see if the two totals are equal we draw up a trial balance at the end of an accounting period. Whenthe totals of the trial balance are equal we say that the trial balance totalsagree.

The uses of the trial balance as follows:

It provides a check on the accuracy of the ledger account balances - ensuring that entries have beenmade correctly.

It makes preparation of the final accounts easier - we can simply use the balances from the trialbalance, rather than having to refer to all the individual accounts.

Certain errors will be highlighted or avoided as outlined below.

The trial balance will ensure that the following errors are avoided or highlighted:

Only entering one half of the transaction (e.g. a debit but no credit entry)

Entering different figures for the two halves of the transaction

Entering two debits or two credits for a transaction

If any of the above errors have been made then the trial balance totals will not agree and investigativework can begin to see where the mistakes are. Technically, it could be possible for these errors to bemade and the trial balance would appear as if the mistakes had not taken place. For example, if wemissed out an entry of GH50 on the debit side of an account and then later we missed out on anothertransaction a credit entry of GH50, the trial balance totals would still agree. However as far asexamination questions go, you will know when you are dealing with errors - it will be indicated in thequestion itself.


18/213

[email protected] Tutorial | THE TRIAL BALANCE 18

Even if the trial balance totals do agree this does not mean that the books are completely correct. Theseerrors outlined here could have been made:

Entering correct figures in the wrong account (but on the correct side) Reversing entries so that both entries are made on the incorrect side of the each account Entering the incorrect total on both sides of the account.

We would need to know how to identify these errors, how to correct them and also how to recalculatethe firm's profits if they have been affected.

A lot of students believe that the profit or loss account, and the balance sheet could not be constructedwithout a trial balance. This is not true. We would, if we wished, use the balances from each account.However this approach would take a lot longer and we would not have the check on the accuracy thatthe trial balance provides. As a rule the entries for the trial balance will be as follows:

Type of account Entry

Assets, expenses & drawings Debit

Liabilities, revenues & capital Credit

The following is a trial balance for S Halls, which was extracted from the books on 31 December 2010

S Halls - trial balance as on 31 December 2010

Dr (GH) Cr (GH)

Capital 1000

Cash 210

Bank 270

S Knight (Accounts Payable) 66

Purchases 118

Office supplies 24

Sales 216

K Curnock (Accounts receivable) 87A Hynam (Accounts receivable) 95

Returns out 12

Wages 140

Office fixtures 350

1294 1294


19/213

[email protected] Tutorial | DAY BOOKS AND LEDGERS 19

Thetitle of any financial statement is very important. It should always contain the following three piecesof information:

Who it is for. In this case it is for S Halls.

What it is. In this case it is a trial balance.

When it is for. In this case it is as at 31 December 2010.

Remember! Who? What? When?

In this trial balance we have the balances from three personal accounts. S Knight is a creditor of the firm(it is in the credit column - indicating that it is a liability). A Hynam and K Curnock are both debtors (inthe debit column - indicating that they are an asset). Normally, debtors and creditors are listed in a trialbalance as just 'debtors' or 'creditors', rather than as their individual names.

Also, if a firm has unsold stocks of goods left at the end of a period, these will be listed underneath thetrial balance. This is because the account for closing stock is not part of the double entry system.However, any stock that was in the firm at the start of a period will be listed in the debit balances of thetrial balance.

DAY BOOKS AND LEDGERS

When a business is very small, all the double entry accounts can be kept in one book, which we wouldcall a 'ledger'. As the business grows it would be impossible just to use one book, as the large number ofpages needed for a lot of transactions would mean that the book would be too big to handle. Also,suppose the firm has several bookkeepers. They could not all do their work properly if there were onlyone ledger.

The answer to this problem is for us to use more books- more ledgers. When we do this, we put similartypes of transactions together and have a book for each type. In each book, we will not mix togethertransactions, which are different from each other.

DAYBOOKS - BOOKS OF ORIGINAL ENTRY

When a transaction takes place, we need to record as much as possible of the details of the transaction.For example, if we sold goods to A Smith on credit. We would also want to record the address andcontact information of A Smith and the date of the transaction. Some businesses would also recordinformation like the identity of the person who sold them to A Smith and the time of the sale. Ledgeraccounts cannot give us all this information so, as a further system of keeping records, firms will alsokeepbooks of original entry.


20/213


Books of original entry are the books in which we first record transactions. These are not accounts; theyare simply books that records the details of a transactions, almost like a diary. The firm will have aseparate book for each kind of transaction. The type of the transaction will affect which book it, isentered into. Sales will be entered in one book, purchases in another book, cash in another book, and soon. The books of original entry are used to record the following:

The date on which each transaction took place - the transactions should be shown in date order; Details relating to the sale are entered in a 'details' column; A folio column entry is made cross-referencing back to the original 'source document', e.g. the

invoice; The monetary amounts are entered in columns included in the books of original entry for that

purpose. An Example of a Day Book/Books of Prime Entry

Date Particulars L/F Amounts

GH

ADVANTAGES OF KEEPING BOOKS OF ORIGINAL ENTRY

1. Accounts can be found more easily by the use of the cross referencing nature of the books of originalentry being kept.

2. If records are lost then the ledgers and the books of original entry act as a backup for each other.3. Acts as a 'listing device' for posting totals to various accounts, thereby saving labour

TYPES OF BOOKS OF ORIGINAL ENTRY

Books of original entry are also known as either 'journals' or 'daybooks'. The term 'day book' is,perhaps, more commonly used, as it more clearly indicates the nature of these books of original entry -entries are made to them every day.

The commonly used books of original entry are:

1. Purchases Day Book/JOURNAL: to record purchases of merchandise on credit. The total of thepurchases book is posted to the debit of purchases account. Names of the suppliers appear in thepurchases book. These parties have supplied the goods. They are, therefore, credited with the amountappearing against their respective names. The double entry will thus be completed.


21/213


2. Purchases Returns Day Book: to record returns of goods to supplier or grant of allowances by thesupplier due to defects or some other reasons. The source document for making entries into thepurchases returns day book is either the debit note issued by the business to its credit suppliers or thecredit note issued by the supplier to the business. The total of the purchases returns or returns

outwards book is credited to returns outward account or purchases return account (being the goodssent out). Individual suppliers to whom goods are returned are debited (because they receive thegoods).

3. Sales Day Book/JOURNAL: to record sales of merchandise on credit. The total of the sales book iscredited to sales account. Customers whose names appear in the sales book are debited with theamount appearing against their names. Double entry is thus completed.

4. Sales Returns Day Book / JOURNAL: to record the return of goods by customers due to defects or

other reason. The source document used for recording into the sales returns day book is the creditnote issued by the business to the customer or the debit note issued by the customer to the business.The returns inwards book or sales returns book is debited to returns inwards account or sales returnsaccount. The customers who have returned the goods are credited with the amount shown againsttheir names.

SOURCE DOCUMENTS

All the daybooks are constructed on the basis of transfers from original source documents. These areitems of business use that contain financial data related to business transactions. The main sourcedocuments a firm is likely to use are as follows:

Purchase invoice: Received by the firm from suppliers when buying goods on credit Sales invoice: Sent by the firm when selling goods on credit Debit notes: Received by the firm from suppliers when goods purchased are returned to the

original supplier Credit notes: Sent by the firm to customers who have returned the goods Cheque counterfoils: From the chequebook to show cheques paid out

Paying slip; Evidence of money paid into bank accounts Till rolls: Evidence of cash being received Petty cash vouchers: Slips to indicate small amounts of cash being paid Bank statements: A summary of the bank account from the banks point of view.

The following daybooks are constructed by the use of each of the following source documents:


22/213

[email protected] Tutorial | CASH BOOKS AND PETTY CASHBOOKS 22

Daybook Source document(s)

Sales daybook Sales invoice

Purchases daybook Purchases invoice

Returns inwards daybook Credit notes

Returns outwards daybook Debit notesCashbook Cheque counterfoils, paying in slips, till rolls, etc.

The journal Everything else not covered by above

THE USE OF FOLIO COLUMNS

Each double entry account will contain the name of the other account in which the other half othertransaction is contained. Apart from very small firms, this does not necessarily make it any easier tolocate the other account - there may be hundreds of separate accounts.

A method of speeding up the ability to find an account is the use of folio columns. These are found inboth accounts and also in daybooks. An extra column, usually quite small is placed besides the details ofeach transaction. In this folio column is placed an abbreviated reference to which ledger or daybook thetransaction can be located in, and on what page of the relevant book. For example, if a credit sale wasrecord in the sales daybook with the folio reference SL54, then this would tell us that the customer'saccount could be found on page fifty-four of the sales ledger. If we actually looked at this relevantaccount then we would see that it also had a folio reference sending us back to the sales daybook itself.Common abbreviations are as follows:

SL Sales ledgerPL Purchases ledgerGL General ledgerCB Cashbook

If the entry 'C' appears in the folio column then this refers to a contra entry. This means that both halvesof the transaction are contained in the same account. An example of this is dealt with in the section oncashbooks.

CASH BOOKS AND PETTY CASHBOOKSCash Book / JOURNAL is used to record transactions relating to receipts and payments of cash. It

serves a dual purpose- as a book of prime entry for all cash transactions as well as the ledger account for

the cash and bank account Types of cash books are the one column, the two column and the three

column cash books. For Every entry made in the cash book there must be a proper voucher. Vouchers


23/213


are documents containing evidence of payment and receipts. When money is received generally a

printed receipt is issued to the payer but counterfoil or the carbon copy of it is preserved by the cashier.

The copy receipts are called debit vouchers, and they support the entries appearing on the debit side of

the cash book. Similarly when payment is made a receipt is obtained from the payee. These receipts are

known as credit vouchers. All the debit and credit vouchers are consecutively numbered. For ready

reference the numbers of the vouchers are noted against the respective entries. A column is provided on

either side of the cash book for this purpose.

SINGLE COLUMN CASH BOOK

A cashbook is the cash account and the bank account combined into one single account. We alreadyknow how to maintain a separate cash account and bank account. The two accounts below are juststraightforward examples of double-entry accounts:

BANK

Date

2011

Details F Amount

GH

Date

2011

Details F Amount

GH

1 Jan Capital CB 2,500 2 Jan Office furniture GL 7505 Jan Sales GL 150 8 Jan T McClure PL 14012 Jan W Green SL 320 15 Jan Purchases GL 25018 Jan Rent GL 85 31 Jan Balance c/d 1,915

3,055 3,0551 Feb Balance b/d 1,915

CASH

Date

2011

Details Folio Amount

GH

Date

2011

Details Folio Amount

GH

2 Jan B Griffin SL 250 2 Jan Office expenses GL 507 Jan H Spence SL 430 11 Jan Insurance GL 55

14 Jan Motor expenses GL 12021 Jan P Yarrow PL 320

31 Jan Balance c/d 135680 680

1 Feb Balance b/d 135

However the cashbook combines the two separate accounts into one joint account. The example below isjust the two separate examples from above combined into a cashbook format:


24/213


DOUBLE COLUMN CASHBOOK

Date Details Folio Cash Bank Date Details Folio Cash Bank

Jan GH GH Jan GH GH1 Capital CB 2,500 2 Office expenses GL 502 B Griffin SL 250 2 Office furniture GL 7505 Sales GL 150 8 T McClure PL 1407 H Spence SL 430 11 Insurance GL 5512 W Green SL 320 14 Motor expenses GL 12018 Rent GL 85 15 Purchases GL 250

21 P Yarrow PL 32031 Balances c/d 135 1,915

680 3,055 680 3,0551/2 Balances b/d 135 1,915

Notice that the accounts have not altered at all. They are still balanced off separately at the end of themonth and the balances will obviously be the same as before. The above example is known as a two- column cashbook - the two columns being bank and cash columns. It is possible to have a closingbalance which is a debit balance for the cash account but a credit balance for the bank account. Theaccount should simply have balances drawn in for both sides. It is impossible for the cash account to bea credit balance, this would mean that the firm had a negative amount of cash. This cannot be the case -one can have either some cash or no cash but not a negative amount. The bank account can be a credit

balance and this means that the firm is overdrawn on the account - the firm has drawn more from thebank account than is actually there and the firm now owes the bank money.

Cash paid into the bank

Frequently, firms will pay cash into the firm's bank account and also, draw money out of the bank foruse elsewhere. The double entry required to record this sort of transaction is unusual because both'halves' of the transaction are now going to be found in the same account - the cashbook.

Cash discounts

Although firms will offer terms of credit to their customers, the firm would prefer it if customers settledtheir account as quickly as possible (i.e. paid what they owed) fairly quickly because the cash flow willbe important to most firms. Many firms will offer discounts in return for prompt payments. These areknown ascash discounts (also known as settlement discounts) and are usually given as a percentage ofthe overall invoice total (e.g. 5% off the sales value).


25/213


The term cash discount does not mean that the amount has to be paid in cash - cash or cheques wouldboth qualify if they were paid within the given time limit. The term cash discount is used to distinguishit fromtrade discounts. The cash discount offered and the terms and conditions will normally be foundon the invoice. There are two types of cash discounts that are recorded in the ledger accounts:

Discounts allowed

Cash discounts allowed by a firm to its customers when they pay their accounts quickly.

Discounts received

Received by a firm from its suppliers when it pays their accounts quickly.

Discounts columns in cashbook

Both discount accounts are kept in the general ledger. There is the danger that, with frequent purchasesand sales, these accounts will quickly become cluttered with many small entries. An alternativeapproach, which avoids this clutter, is to make use of athree-column cashbook.

The three-column cashbook incorporates the cash discounts for each relevant entry into a third column.At the end of each month (or other relevant period) when the cashbook is balanced off, the totals formthese discount column would then be transferred to the discount accounts in the general ledger.Discounts received are entered in the discounts column on the credit side of the cashbook, and discountsallowed in the discounts column on the debit side of the cashbook.

The cashbook, if completed for the two examples so far dealt with, would appear as follows:

THREE COLUMN CASHBOOK

Date Details Folio DisAll

Cash Bank Date Details Folio DisRec

Cash Bank

Nov GH GH GH Nov GH GH GH

5 /11 D Jackson SL 7 273 3/11 J O'Neill PL 23 437

There is no alteration to the method of showing discounts in the personal accounts. When balancing theaccounts off at the end of the period, you must take care to note that the discounts columns are notbalanced off against each other. The discounts columns are simply totalled up and then transferred tothe relevant discount account. Therefore the totals are likely to be different for the discount columns.


26/213


QUIZ:

2010

October 1 Balances brought forward: Cash GH 215, Bank 190 (Cr.)

October 3 Paid creditors by cheque; G Dawes GH440 L Lewes GH120 (before discount)and received a 5% discount on invoice totals.

October 9 Paid GH100 cash into bank account

October 13 Received cheques from suppliers for accounts totals as follows: R Kirk GH360and C Watson GH120, in each case allowing a 2.5% discount.

October 19 Cash purchases GH78

October 20 Paid rent by cheque 56

October 22 Received cheque ofGH90 from H Knight in settlement of sales worth GH95.

October 25 Cash withdrawn from bank for personal use GH50

October 30 Received commission by cash GH46

PETTY CASH BOOK

Some firms actually keep a separate cashbook anda petty cash book. The petty cash book is for dealingwith small items of money. Some firms will have lots of transactions which involve relatively smallamounts of money (e.g. petrol costs, postage costs and so on). If these were entered in the cashbook thenit would quickly become cluttered up with entries for small amounts of money.

To stop this happening some firms will keep a petty cashbook, which deals with these items. At the endof each month the monthly totals can then be transferred to the main cashbook. This has the otheradvantage of allowing another member of staff (usually a junior) the responsibility of dealing with pettycashbook alone and this frees up time for the main cashier of the firm to deal with the main cashbook.

Some very large firms may actually use the petty cashbook for dealing with all cash items ofexpenditure. The main cashbook would then only be used for bank transactions.

Imprest system

The most common system used to maintain the petty cash book is known as the imprest system. Thisinvolves co-ordination between the cashier responsible for the cashbook and the cashier responsible forthe petty cash book.

The cashier will give the petty book cashier just enough money to cover the petty cash transactions of aperiod of time - usually one month. At the end of the month, the amount actually spent will be totalledup and the amount will be refunded from the main cashbook as follows:


27/213


Entries needed to refund amount spent on petty cash

Debit Credit

Petty cashbook Cashbook

In this way, the balance on the petty cashbook will always be the same at the start of each period. Thisopening balance is known as the float or imprest. The float can be changed if it is observed that the pettycash is either being spent too quickly, or is not being spent at all. The idea is that the float should coverthe periods' expenses.

Most firms who maintain petty cashbooks will do so in a format which categorises different types ofpetty cash expenditure. This is known as an analytical petty cashbook because it analyses the different

types of expenditure.

The petty cashbook still follows the rules of any double entry account. However, the credit side of thisaccount will be split into the various categories of expenditure.

The following are details of petty cash transactions for the month of February 2011. The businesstransactions that occur are as follows:

Feb 1 The chief cashier debits the petty cashbook with GH 70 to restore the float

GH

Feb 4 Petrol costs 10

Feb 5 Stationery 4

Feb 9 Coffee for office 3

Feb 8 Bus fares 6

Feb 15 Milk and tea 2

Feb 16 Rail fares 17

Feb 21 New paper for printer 9Feb 24 Folders for office 4

Feb 28 The chief cashier debits the petty cashbook with GH 55 to restore the float


28/213


The GH55 received on February 28 is exactly the amount that was spent during February on petty cashtransactions.

The analysis columns that are to be used in this example are:

Travel expenses Stationery Miscellaneous

There are no strict rules on what columns should be used or how many of them there should be. It makessense not to have too many because it may become confusing when filling in the petty cashbook.

Advantages of maintaining a petty cashbook

1. It stops the main cashbook being cluttered up with small items of expenditure.

2. It allows the firm to delegate these small times to a junior member of staff, which frees up thetime of the main cashier to concentrate on other areas.

3. As the petty cashier cannot draw as and when he likes, it prevents unnecessary accumulation ofcash in his hand thus the chances of defalcation of cash are minimised.

. FORMAT OF THE PETTY CASH BOOK:

Receipt F Date Details Voucher

No

Total Payment Analysis E.g.

MotorExps

Cleaning SundryExp

LedgerFolio

LedgerAccount

PROCESS illustration;

Step I: The cashier gives the petty cashier. The petty cashier pays out in the period. The pettycash now in hand. The cashier now gives the petty cashier the amount spent. Petty cash inhand at the end of period 1.

Step II: The petty cashier pays out in the period. Petty cash now in hand. The cashier now givesthe petty cashier the amount spent. Petty cash in hand at the end of period 2


29/213

[email protected] Tutorial | JOURNAL PROPER/GENERAL JOURNAL 29

A DIAGRAM OF THE BOOKS COMMONLY USED

JOURNAL PROPER/GENERAL JOURNAL

Definition and Explanation:

Journal proper is book of original entry (simple journal) in which miscellaneous credit transactions

which do not fit in any other books are recorded. It is also called miscellaneous journal. The form andprocedure for maintaining this journal is the same that of simple journal.

USES OF JOURNAL PROPER/ GENERAL

1. The recording of Opening and Closing entries2. Correction of Errors3. Recording purchases and Sales of Fixed Assets on credits

All Business Transactions

Classify put same types of transactions together

Credit

sales

Credit

purchase

s

Returns

inwardsReturns

outwar

Cash

receipts /

payments

Other

types

Enter in

sales day

book

Enter in

purchase

s Day

Book

Enter in

Returns

Inwards

Day Book

Enter in

Returns

Outwar

ds Da

Enter inCash

Book

Enterin

Journal

Enter in double entry accounts in the various ledgers

Sales Ledger

Purchases Ledger General Ledger


30/213


4. Recording the issues (sales) of shares by companies, etc.5. Writing off bad debts.

Opening Entries:

When a businessman wants to open the book for a new year, it is necessary to journalise the variousassets and liabilities before the new accounts are opened in the ledger. The journal entries so passed arecalled "opening entries". Suppose a businessman opens a new set of books on January 1, 2010 with cashin hand GH100, debtors GH200, stock in trade GH320, machinery GH700, furniture GH 150,bank loan GH 300, capital GH1,070 the respective opening entry in the journal will be:

GH GH

CashSundry debtors

Stock in tradeMachineryFurniture & fitting

100200

320700200

To Sundry creditorsTo Bank loanTo Capital

150300

1,070

(Being the opening balance of assets, liabilities and capital at this date)

Closing Entries:

When the books are balanced at the close of the accounting period with a view to prepare final accounts,it is necessary that balance of all the income and expenses accounts must be transferred to trading andprofit and loss account. The process of transferring balances to the trading and profit and loss account atthe end of year is called closing the books and entries passed at that time are called closing entries. Forexample on 31st December, 2010 the balance in expenses accounts are: Salary GH500; rent GH 200;Stationary GH50; legal charges GH100; and income accounts are: commission received GH 50.These balances will be recorded in profit and loss account though the following closing entries:

GH GH

Profit and loss accountTo SalaryTo RentTo Stationary

850500200

50


31/213


To Legal charges

(Being the closing entry)

100

Commission received accountTo Profit and loss account

(Being the closing entry)

5050

Transfer Entries:

When accounts are transferred from one account to another for combination of allied items, it isnecessary to pass transfer entry. For example, Drawings GH500 is transferred from the drawings

account to the capital account to find out the net capital. The transfer entry will be passed as follows:

Capital AccountTo Drawings account

(Being the transfer entry)

500500

Adjusting Entries:

Modification of the accounts at the end of an accounting period is called adjustments. If there be anyevent affecting the related period of accounts but left out of the books, the same should be incorporatedin the books before the preparation of the final accounts. This is done by means of adjusting entriesthrough the journal proper. For example at the end of the year it is found that rent GH50 is outstanding.It is not recorded in the books. It will be taken into account by means of adjusting entry which is asfollows:

Rent accountTo Outstanding rent account

(Being outstanding rent recorded)

5050

Rectification Entries:

When an error is detected in the books, the same is rectified through an entry in the journal proper; thusis called rectification entry. For example, it was detected that an expenditure of GH100 on repair tobuilding was charged to building account. It is corrected through the following entry in the journalproper:


32/213


Building repair accountTo Building account

100100

Entries of which there is No Special Journal:

When a trader cannot record the entries in the above mentioned sub-journals, the same are entered in thejournal proper. The common transactions which cannot be recorded in any of the book of original entryare:

Distribution of goods as free sample. Distribution of goods as charity. Goods destroyed by fire. Goods stolen away by employees. Exchange of one asset for another asset etc.

Entries for Rare Transactions:

In a business it may happen sometimes that transactions are usually rare. Journal proper is usedfor such rare

This book is used for all other transactions that cannot be captured by any of the books of original entryalready discussed.

A Table showing the formation of a Journal/General Journal

Date Details L/F DR CR

In the date column, the date of the transaction is entered.

In the particulars column, the name of account to be debited or credited is recorded.The account to be debited is listed first beginning at the left margin of the column. The word Dr. iswritten against these accounts at the extreme right of this column. The accounts to be credited appear

below the debit entries and are indicated. The names of these accounts are preceded by the word To:beneath this should be written a brief explanation of the above entry containing all information essentialfor better understanding of the transaction. This is called the narration of the entry.

In the LF (Ledger Folio) column, we enter the page number of the ledger account where the entry ismade at the time of posting. This indicates that entries have been posted to the relevant ledger account.


33/213


An entry in the general journal is entered only when an analysis of the transaction is made and theaccounts to be debited or credited determined. This takes into effect principles of double entry.

Illustration

The following transactions took place in the books of B. Hanan Enterprise for the month of July,2008

July 1. Started business with GH4,230 cash3. Bought goods for cash GH1,7558. Bought goods on credit GH2,000 from Lincoln10. Sold goods for cash GH3,00014. Deposited GH1,800 in a newly opened bank Account15. Bought motor van by cheque GH82016. Sold goods on credit to Saani GH8,000

17. Received cheque GH6,000 from Saani as part-payment of his account20. Paid for stationary GH1,150 by cash22. Paid GH1,200 cheque to Lincon as part payment of his account25. Paid Wages and salaries by cheque GH3,500

27. Cash withdrawn by the proprietor for his personal use GH25031. Paid the following expenses by cash; electricity GH25 and insurance GH30

Requirement:

Journalise the above transactions and post in a ledger account, balance off the accounts and extract atrial balance.

GENERAL JOURNAL EXAMPLE

Date Description Post

Ref

Dr. Cr.

1/7/08Cash a/c

Capital a/c

(Being cash invested by the owner)

4,230

4,230

3/7/08Purchases a/c

Cash a/c

(Being cash purchase of goods)

1,755

1,755


34/213


8/7/08 Purchases a/c

Creditor (Lincoln ) a/c

(Being goods bought on credit from

Lincoln)

2,000

2,000

Date Description Post

Ref.

Dr. Cr.

10/7/08 Cash a/c

Sales a/c

(Being goods sold for cash)

3,000

3,000

14/7/08 Bank a/c

Cash a/c

(Being cash deposited in a newly openbank) a/c

1,800

1,800

15/7/08

Motor van a/C

Bank a/c

(Being motor van bought by cash)

820

820

16/7/08 Debtor (Saani) a/c

Sales a/c

(Being credit sales of goods to saani)

8,000

8,000

17/7/08 Bank a/c

Debtor (Saani) a/c

(Being part payments of goods sold toSaani)

6,000

6,000

Date Description PostRef.

Dr. Cr.

20/7/08 Stationery a/c 1,150


35/213


Cash a/c

(Being stationery bought in cash)

1,150

22/7/08 Creditor (Lincoln) a/c

Bank a/c

(Being part payment of goods bought oncredit)

1,200

1,200

25/7/08 Wages and salaries a/c

Bank a/c

(Being wages paid by cheque)

3,500

3,500

27/7/08 Drawings a/c

Cash a/c

(Being cash withdrawn by the businessowner)

250

250

31/7/08 Electricity a/c

Insurance a/c

Cash a/c

(Being electricity and insurance paid bycash)

25

30

55

POSTING ENTRIES TO THE LEDGER

Posting refers to transferring accounting entries from the journal on to the ledger. As a matter of fact, every debit entry has a corresponding credit entry and vice versa. Account titles take name of the corresponding entry.


36/213


The General Ledger

Capital Account

GH

31/7/08 Balance c/d 4,230

4,230

GH1/7/08 Cash 4,230

4,320

1/8/08 Balance b/d 4,320

Cash A/c

GH

1/7/08 Capital 4,230

10/7/08 Sales 3,000

7,2301/8/08 Balance b/d 2,220

GH

3/7/08 Purchases 1,755

14/7/08 Bank 1,800

20/7/08 Stationery 1,150

7/7/08 Drawings 250

31/7/08 Electricity 25

31/7/08 Insurance 30

31/7/08 Balance c/d 2,220

7,230

Purchases Account

GH

3/7/08 Cash 1,755

8/7/08Lincoln(creditor) 2,000

3,755

1/8/08 Balance b/d 3,755

GH

31/7/08 Balance c/d 3,755

3,755


37/213


Lincoln (Creditor) Account

GH

22/7/08 Bank 1,200

31/7/08 Balance c/d 8002,000

GH

8/7/08 Purchases 2,000

2,000

1/8/08 Balance b/d 800

Sales Account

GH

31/7/08 Balance c/d 11,000

11,000

GH

10/7/08 Cash 3,000

16/7/08 Saani (Debtor) 8,000

11000

1/8/08 Balance b/d 11,000

Bank Account

GH

14/7/08 Cash 1,800

17/7/08 Saani 6,000

7,800

1/8/08 Balance b/d 2,280

GH

15/7/08 Motor Van 820

22/7/08 Lincoln (creditor) 1,200

25/7/08 Wages and Salary 3,500

31/7/08 Balance c/d 2,280

7,800

Motor Van Account

GH

15/7/08 Bank 820

820


GH

31/7/08 Balance c/d 820

820


38/213


Saanis (debtor) Account

GH

16/7/08 Sales 8,000

8,000

1/8/08 Balance b/d 2,000

GH

17/7/08 Bank 6,000

31/7/08 Bal. c/d 2,000

8,000

Stationery AccountGH

20/7/08 Cash 1,150

1,150

1/8/08 Balance b/d 1,150

GH

31/7/08 Balance c/d 1,150

1,150

Stationery AccountGH

20/7/08 Cash 1,150

1,150

1/8/08 Balance b/d 1,150

GH

31/7/08 Balance c/d 1,150

1,150

Drawings Account

GH

27/7/08 Cash 250

250


GH

31/7/08 Balance c/d 250

250


39/213


Electricity Account

GH

31/7/08 Cash 25

251/8/08 Balance b/d 25

GH

31/7/08 Balance c/d 25

25

Insurance Account

GH

31/7/08 Cash 30

30


GH

31/7/08 Balance c/d 30

30

B. HANAN ENTERPRISE TRIAL BALANCE AT 31st July, 2008

PARTICULARS DEBIT

GH

CREDIT

GH

Capital

Cash

Purchases

Creditor Lincoln

Sales

Bank

Motor Van

Debtor Saani

Stationery

Wages and Salaries

Drawings

Electricity

Insurance

2,220

3,755

2,280

820

2,000

1,150

3,500

250

25

3016,030

4,230

800

11,000

16,030


40/213

[email protected] Tutorial | VALUE ADDED TAX 40

VALUE ADDED TAXThis is general tax on consumption expenditure. It is a type of indirect tax which a person may pay solong as the person has the ability to consume or venture into any economic activity. It is a charged onthe final consumer and an addition to the price of supplies at all stages in the chain of production anddistribution.

However, because firms are dealing with other firms in the buying and selling of inputs (materials andproducts to be used in the production process) which are subject to VAT, the firms are allowed to 'claim'back VAT paid when purchasing inputs. Rather than having to collect VAT on any sales and also payVAT on any purchases, firms can use the amount paid on purchases to offset (or reduce) the amountpaid on any sales made. The final consumer of the product has no one to sell the product on to the finalconsumer will pay the full 15% VAT.

VAT on invoice = 0.115 x Net invoice total Gross total for invoice = 1.115 x Net invoice total

The gross total will include the original net invoice amount plus the VAT due on that invoice. If you aregiven the net total for any invoice then the VAT on that invoice can be calculated by multiplying it bythe following:

It is collected by registered persons on value added that is created at the various stages in the productionand distribution of the product. Value Added created is the addition made by the persons or firmsthrough their own activities, to the value of inputs procured from other persons or firms to turn out theoutput. It is the difference between the sale value of the output and the costs of inputs relating to theoutput. It will be wrong to think that value added is created through manufacturing or conversion of rawmaterials (inputs) to goods (output). This will limit the incidence of value added. In a broader sense,

value added tax according to Act 546, is chargeable on value added at;

a. Importationb. Manufacturingc. Wholesale and Retail levels (Distribution)d. Provision of serviceThe following is an illustration of the system of VAT;

A wholesaler sells a product to a retailer for GH 5000.00 plus VAT of GH 400.00.

The retailer will pay the wholesaler GH 5400.00 (5000 + 400) for the product.

The VAT on that sale will be paid to the VAT Service by the wholesaler. Assume that the retailer sells the product for GH 6000.00 plus VAT of GH 550.00 to a customer.

The customer will pay GH 6550.00 (6000+550) to the retailer for the product.

The amount of VAT paid for the product by the retailer from the customer (GH 550.00) and thedifference of GH 150.00 is then sent to the VAT service at the end of the month.

To this end, the overall VAT of GH 550.00 is paid by the customer as tax on consumption.


41/213


CHARACTERISTICS OF VAT

i. It is a tax on consumption expenditure. Thus VAT is a tax on consumable products consumerswho buy such products pay the VAT on them.

ii. It is a tax on the final consumer. VAT is ultimately paid by the final consumer of the product.The producer, wholesaler and retailer pass the VAT on the product to the final consumer of thatproduct.

iii. It is a multi stage tax. VAT is paid by the wholesaler when he or she buys goods from themanufacturer, the retailer pays VAT on goods he buys from the wholesaler and ultimate VAT ispassed to the final consumer when he or she buys from the retailer.

iv. It is collected by the registered persons. A business that is registered for VAT is essentially acollection agent for the government.

v. VAT returns are paid monthly to the government. In Ghana, the VAT returns are submitted notlater than the last working day of the month immediately following the month to which it relates.

vi. It is an indirect tax. Hence, it is not levied on personal income but rather on goods and services.Thus the consumer pays for tax when he or she buys goods and services.

CALCULATION OF VALUE ADDED TAX

OUTPUT VAT; it is a category of VAT paid on goods sold and for services rendered by a firm. Fromthe illustration above, GH 550.00 VAT paid by the consumer to the retailer is an output VAT to theretailer.

INPUT VAT; It is a category VAT on goods purchased by a business. Input VAT is also levied onservices received. From the example above, GH 400.00 VAT paid by the retailer to the wholesaler istermed as input VAT to the retailer.

Example 1

A wholesaler buys goods from a manufacturer at GH 550.00 plus VAT at 155. Calculate the inputVAT;

Solution 1

Input VAT = 15% * GH 550.00 = GH 82.50

Example 2

The wholesaler sells goods to a retailer at GH 1050.00 plus VAT at 15%. Compute the output VAT.

Solution 2

Output VAT = 15/115 * 1050 = GH 137.00


42/213


VAT AND THE DOUBLE ENTRY SYSTEM

So far, all our double entry transactions have assumed that there is no VAT to be accounted for.However, we now need to adjust our adjustments to take VAT into account. When we buy or sell goodswe know part of the selling price will include VAT (assuming that the firm is registered for VAT). This

amount will need to be separated out from the actual net invoice total on both purchases and sales totals.VAT usually changes the accounting entries for purchases and sales. The following are the accountingentry for VAT;

i. Where VAT is paid on purchases (input tax);Debit Purchases account, with cost excluding VAT

Debit VAT account, with VAT on purchases.

Credit creditors/Cash book, with cost including VAT.

ii. Where VAT is change on sales (output VAT).

Debit Debtor/Cash book, with sales price including VAT

Credit VAT with the VAT.

Credit sales account with sales price excluding VAT.

iii. Where payment of VAT is done (thus if output VAT exceeds input VAT);Debit VAT

Credit cash book, with the amount owing on VAT.

iv. Where VAT is received (thus if input VAT exceeds output VAT)

Debit cash bookCredit VAT with the amount received on VAT.

Example 3

Net VAT Total

GH GH GH

Purchases (All On Credit) 42,500.00 7,500.00 50,000.00

Sales (all on credit) 63,750.00 11,250.00 75,000.00

You are required to prepare the relevant ledger accounts to record the above transaction.

Solution


43/213


Sales Accounts

GH

Balance carried down 63,500.00

GH

Debtors 63,750.00

Purchases Account

GH

Creditors 42,500.00

GH


Debtors Accounts

GH

Sales 63,750.00

VAT 11,250.00

75,000.00

GH


75,000.00

Creditors Account

GH


50,000.00

GH

Purchases 42,500.00

VAT 7,500.00

50,000.00

VAT Accounts

GH

Creditors 7,500.00

Balance c/d 3.195.00

11,250.00

GH

Debtor 11,250.00

11,250.00

Balance b/d 3,195.00


44/213


As the VAT account has a credit balance, this will be shown on the B/S as a current liability. The VATaccount and the cash book will have been debited and credited respectively.

PREPARATION OF VALUE ADDED TAX RETURNS

A VAT registered person is required to file monthly returns showing details of VAT transaction for eachcalendar month. VAT returns mostly shows details of the sales and purchases made during the monthimmediately preceding that in which the returns are being filed and the related VAT on these values.

FORMAT OF VAT RETURNS

GH GH

Output VAT XXX 11,250.00

Less Input VAT (XX) (7,500.00)

Amount paid (received) XXX 3,195.00

EXERCISES WITH ANSWERS

1. Samuel Ltd sells the following goods;

i. To Enoch at a VAT inclusive of GH 1150.00ii. To Linda at a VAT exclusive of GH 1000.00

You are required to calculate the VAT to be collected by the government if the VAT rate is 15%.

Soln;

i. Enoch Sales = 15/115 * 1150 = GH 150.00ii. Linda Sales = 15/100 * 1000 = GH 100.00

Hence, total VAT collected = GH 150.00 + GH 100.00 = GH 250.00.

2. Tilly purchases goods for GH 2000.00 (VAT inclusive) and sells them for GH 2500.00 (VATinclusive).

Given the VAT rate at 15%, you are required to compute;

i. Input VAT ii. Output VAT and iii. VAT payable to the tax authority.Soln


45/213


i. Input VAT = 15/115 * 2000.00 = GH 260.87ii. Output VAT = 15/115 * 2500.00 = GH 326.09iii. Amount payable to tax authority = Output-Input = GH 65.22

VAT and fixed assets

VAT is payable on expenditure relating to fixed assets purchases as well as other expenses related to therunning of the business. Some firms will be able to reclaim the VAT paid on fixed asset purchases byoffsetting it against the VAT payable on sales, in the same way that VAT paid on purchases is used.

For example, if a firm buys a machine for GH5,000 and the VAT included amounted to GH750, thenthe firm would only enter the net value of the machine in the assets account (i.e. Debit machineryGH4,250) and the VAT would be entered in the account (Debit VAT GH750).

If a firm cannot reclaim VAT on these items that the full value of the purchase will be entered into theasset account.

Ex.

Construct VAT account from the following information:

1. Sales for the month were GH1,976 which included VAT of GH 296.25.2. Purchases for the month were GH1,666 that included VAT of GH 249.903. Returns inwards for the month were GH800 including VAT of GH120.4. Returns outwards for the month were GH588 including VAT of GH 88. 20

XYZ Ltd. Is a registered VAT organisation. During the month of August ending, it made the followingtransactions of which were subject to VAT of 15%; Use the information below to prepare a VATaccount to record the transactions.

SALES;

GH 200,000.00 excluding VAT

GH 149,500.00 including VAT


GH 264,500.00 including VATPURCHASES;

GH 140,000.00 excluding VAT


GH 172,500.00 including VAT GH 400,000.00 excluding VAT


46/213

[email protected] Tutorial | ACCOUNTING CONCEPTS AND CONVENTIONS 46

ACCOUNTING CONCEPTS AND CONVENTIONS

ACCOUNTING CONCEPTS

This may be defined as broad assumptions which underline the periodic financial accounts of business

concern. The concepts are axioms which have developed to become accepted by the accountancyprofession after a number of years of their application (use).

PURPOSE & IMPORTANCE

Accounts are prepared for internal and external use. Internally it forms the basis for an evaluation of pastperformance and is a guide for decision makers. External users include investors, taxation authoritiesetc. The task of regular measurement of position and profit of a firm is a difficult one and that there areconceptual as well as practical problems. It might be possible for each accountant to work out his ownsolution to those problems but this would clearly be unacceptable method of operating.

There is a need for a set of assumptions and rules which provide a conceptual framework to be used as aguide to preparing accounting information. It seems sensible that there should be some degree ofconsistency about the way in which accounting information is prepared. This makes it easier for thosepreparing and interpreting the information.

Also, it limits the area of discretion open to the accountant or to the firm to present information in abiased manner. The strength of this last comment depends of course on the sanctions provided againstnot working within the framework. Perhaps the most important reason for having a conceptualframework is that it is more likely to establish confidence in accounting information. This is verynecessary when it is remembered that users are expected to use it as a basis, for example, for investment

decisions, calculating taxation, or evaluating management performance or as a guide to governmentpolicy.

Fundamental accounting concepts are the assumptions that underline the preparation of financialstatements. These are usually not stated because their acceptance and use is assumed. If these are notfollowed, this fact and reasons for not following them must be given.

Going Concern Concept FAC:

This assumption implies that the business or entity will continue in operational existence for theforeseeable future. This means in particular that the income statement and the statement of financial

position assume no intention or necessity to liquidate or curtail significantly the scale of operation. Inline with this concept accounts are prepared in short; but regular intervals of equal lengths such as yearlyintervals.

The justification

i. If this assumption is accepted then depreciation and provision for bad debts are reasonableotherwise there will be no need for them.


47/213


ii. The distinction between fixed and current assets will be unfounded as both items will be writtenoff in the year of acquisition and are therefore current.

iii. Liquidation values would need to be substituted for historical cost based figure had it not beenhis concept.

Drawbacks

It may mislead, because some firms do cease trading shortly after the publication of accounts drawn upon the going concern basis.

Consequences

i. Fixed assets are shown at cost less depreciation.ii. Current assets are valued at cost or net realisable value (market price) in the course of the

business.iii. Liabilities that may arise in the event of liquidation are ignored e.g., redundancy pay.

iv. Information about the consequences of liquidation is not given.Accrual or the Matching Concept FAC:

The principle or concept states that in order to measure profit, the revenue for the period must bematched with the cost incurred in order to earn that revenue. This is to say that expenses, the benefitswhich have been used up in a given accounting year should be reported in the accounts of the periodwhether or not those expenses have been paid for. Also money paid in respect of expenses the benefitsof which have not yet been used, should not be included in the accounts as expenses because theexpenses do not relate to the given period.

The justification is that the profits of the period are revenue from transactions less associated costs for

the period. Any cost not connected with future revenue is written off as it occurs.

Drawbacks;

i. Difficulty in determining which costs are associated with particular revenue. The whole idea ofdepreciation, absorption cost, finished goods, work-in-progress (partly finished material)valuation are aspects of the matching concept.

ii. The use of different matching methods (e.g. depreciation methods) by different accountants lendto the results of enterprises not being comparable with another.

Consequences

i. Valuation of stock and work-in-progress on balance sheet which includes the related cost (e.g.rent) for expired periods.

ii. The inclusion on the balance sheet of assets with no tangible value, e.g., development costs.

Consistency Principle FAC:

It is the requirement that the same interpretation of accounting principle is applied from year to yearwithin the same firm. When a firm has once fixed a method of the accounting treatment of an item, it


48/213


will enter all similar items that follow in exactly the same way e.g. stock valuation and method ofproviding for depreciation. This does not mean changes should not be made in methods or procedures, ifthere is sufficient reason to change from one method to another. However, there should not be habitualand frequent changes.

This concept limits possibility of misinterpretation, since judgement and decision making depend

to a large extent upon validity of comparison

Prudence/Conservatism Concept FAC:

Anticipate no profit, provide for all possible losses. This principle states that accountant will tend tounderstate rather than overstate profit. Where alternative treatments are available, the treatment thatproduces the less favourable result should be preferred. Prudence however does not justify the creationof secret or hidden reserves.

The justification is that this

Documents

Copy _2_ of Principles of Accounting Note Year 1