INTRODUCTION
The purpose of book-keeping and account is to find out if the business is making a profit and determine the true value of the business assets and liabilities.
Assets – things owned by the business or to the business. There are two (2) types of assets.
(i) Fixed Assets – assets that has long life and usually last for more than one (1) year. E.g. Premises, building, land, equipment, motor vehicle, fixtures and fittings, equipment etc.
(ii) Current Assets – short term assets that are done away with in less than one year. E.g. Closing stock, debtors, cash at bank, cash in hand, prepaid expenses.
Liabilities – things owed by (debts) the business. There are two (2) types of liabilities.
(iii) Long Term Liabilities - debts of the business that is payable over a time longer than one (1) year. E.g. Mortgages and debentures.
(iv) Current Assets – short term debts that are paid within one year. E.g. Creditors, bank overdraft and accrued expenses.
Capital – amount of resources invested into the business by the owner.
Turnover (net sales) = Sales – Sales Returns (returns inwards). When there is no returns, the sales figure is known as turnover.
Debit – the left side of an account.
Credit – the right side of an account.
Account – a written record of a group of transaction of a similar nature.
Accounting – the process of identifying, measuring, and communicating economic information.
Book-keeping – refer to the actual recording to the actual recording in the books of accounts.
Profit – the result when goods are sold for more than they cost
Loss – when goods are sold for less than they cost.
ACCOUNTING CONCEPTS AND CONVENTIONS
Separate Entity/Business Entity Concept – the affairs of the business must be kept different from the personal affairs of the owner.
Historical Cost – assets are normally shown or recorded at cost price.
Money Measurement Concept – concerned with transaction being measured in money and that people will agree to the “monetary” value of the transaction.
Dual aspect concept – recording a transaction using double entry; i.e. for every debit entry there must be a corresponding credit entry.
Going concern/Continuity concept – the business will continue to operate for the foreseeable future or a long period of time.
Consistency – when a business has a fixed method for recording transactions, it will enter all similar items in exactly the same way in the following years.
Realization – Profits is normally said to be earned when goods or services are provided for the buyer and the buyer accepts liability to pay for goods or services.
Recognition- when you can be reasonably certain as to how much will be received that you can recognize profits or gains.
Study Guide
Subjectivity – using one’s own judgment or method of valuation.
Prudence – accountants will take caution or record the figure that will understate and not overstate profit.
Accruals Concept/Matching Concept - accounting practice whereby expenses are recognized in the same accounting period when the related revenues are recognized.
Materiality – recording items of significant or material value.
Capital Expenditure – when a business spends money to buy fixed assets or increase the value of an existing fixed asset. Capital expenditure also includes legal costs of buying buildings. Carriage inwards or delivery inwards on fixed asset bought or any other cost needed to get the fixed asset ready for use.
Capital expenditure is recorded in the balance sheet. If capital expenditure is incorrectly recorded it can cause profits to be understated and the balance sheet figures to be
overstated.
Revenue Expenditure - expenditure on the day to day running of the business. For example rent, salaries, insurance etc.
Revenue Expenditures are recorded in the Profit and Loss Accounts. If revenue expenditure is incorrectly recorded it can cause profits to be understated or overstated.
Double Entry System – there must be a debit and a credit entry for each transaction to two (2) separate accounts. Learn the double entry rules or the rules of “PEARLS”.
Depreciation – reducing the value of a fixed asset. Depreciation allows the cost of an asset to be spread over its useful life.
Methods of Depreciation
(i) Straight Line Method – same amount of depreciation every year. Also known as the fixed installment method.
Calculations for straight line method
(a) Cost x % OR
(b) Cost – Scrap (residual or estimated) Value ÷ number of years
(ii) Reducing/Diminishing Balance Method – lower depreciation amounts every year.
Calculations for reducing/diminishing balance
Cost – provision for depreciation x %
Stock Valuation – gives closing stock a different value. There are three (3) methods of stock namely: FIFO (first in first out), LIFO (last in first out) AVCO (average cost method).
THE BALANCE SHEET EQUATION
Balance sheet Equation – the accounting equation that is based on the resources
supplied by the owner (capital) will always equal to the resources in the business (assets).
Simple Balance Sheet
Calculation of Capital
(i) Assets – Liabilities = Capital
(ii) Beginning Capital + Net profit – Drawings = Ending Capital
(iii) Beginning Capital + Additional Capital + NP – Drawings = Ending Capital (iv) Beginning Capital – Net loss – Drawings = Ending Capital
Calculation of Working Capital
Current Asset – Current Liabilities = Working Capital
Working capital shows how well a company can pay it short terms debts. If working capital is negative (more current liabilities than current assets), that business can become bankrupt.
THE LEDGER
The ledgers are the books of double entry. The ledger is divided in three main sections: 1. The sales ledger containing the accounts of debtors.
2. The purchases ledger containing the accounts of creditors. 3. The general ledger containing the nominal and real accounts.
Example: Bought goods on credit. This transaction is recorded in the ledger by: Debit to: Purchases account in the General Ledger and
Credit to: Creditors account in the Purchases Ledger Recording transactions
Double entry transactions are recorded in ‘t’ accounts or in three column ledgers. (Memorize’ PEARLS’ and practice double entry transactions).
Ledger Balances
Balance is the difference between the debit and credit entries in an account.
The balance c/d is recorded above the total on the smallest side of the account usually on the last day in the month and the balance b/d is recorded below the total on the opposite side of the balance c/d on the 1st day of the following month (unless the question specifies
another date).
The balance b/d of an account at the end of a period becomes the opening balance at the beginning or the next period.
Opening balance b/d on the debit side are referred to as debit balances and the opening balance on the credit side are referred to as credit balances.
Study Guide
Interpret Entries in Accounts
Example: The account of P. Fox appears in the books of Royal Vase Company. Examine Fox’s Account below as it appears below in those books:
Date Details Folio Debit Credit Balance
2004
April 1 $2 550 dr
3 Bank CB $2 500
3 Discount CB $50
10 Goods SJ $700
10 Returns RIJ $120
(a) Complete BALANCE column of this account in the spaces provided. (b) In which Ledger should this account be found?
(c) Based on each detail recorded, describe the transaction that took place between P. Fox and Royal Vase Company.
April 1: _________________________________________________________________ April 3: _________________________________________________________________ April 3: _________________________________________________________________ April 10: ________________________________________________________________ April 12: ________________________________________________________________
(d) What is the relationship between P. Fox and Royal Vase Company?
Folio Columns – columns used for entering references to page numbers in ledgers and daybooks.
Control Accounts
Control account is an account the checks the arithmetical accuracy of the personal ledgers (debtors/sales ledger or creditors/purchases ledgers).
Information from control accounts are gathered from the sales and purchases ledger.
Steps in preparing control accounts
Step 1: Prepare or correct individual personal accounts
Step 2: Add all of the beginning balance b/d in each personal account (1st of the month)
to get one (1) balance b/d figure
Step 3: Add all the credit sales or credit purchases to get one (1) credit sales figure
Step 4: Add all the other items that would increase the balance (interest, return cheques, discount disallowed etc) to get one (1) figure for each item
Step 5: Add all the other items that would decrease the balance return, cash and bank payments , discounts, contras, etc) to get one (1) figure for each item.
Step 6: Balance the control account to get the balance on the control account.
* It is also possible to have debit balance on a creditor’s account. If the creditor has been overpaid, or if the goods were returned to him after they had been paid for.
ASSET OF STOCK
The accounts used to record the movement of stock are:
(1) Sales – refer to goods (stock) sold in the normal course of the business.
Double entry for Sales
Credit Sales – Debit ‘Debtor Account’ and Credit ‘Sales Account’
Cash Sales – Debit ‘Cash Account’ and Credit ‘Sales Account’
(2) Purchases - refer to goods (stock) bought for resale.
Double entry for Purchases
Credit Purchases – Debit ‘Purchases Account’ and Credit ‘Creditors Account’
Cash Purchases - Debit ‘Purchases account’ and Credit ‘Cash Account’
(3) Returns Inwards – Goods returned by customers. (This account is debited)
(4) Returns Outwards – Goods returned to suppliers. (This account is credited)
THE TRIAL BALANCE
The trial balance is a list of account titles and their closing balances. The purpose of the trial balance is to test the arithmetical accuracy of double entry postings in the ledgers.
Uses of trial balance - to find out the net amount of errors, to check the book balance, and used to prepare final accounts (trading account, profit & loss account and balance sheet).
The trial balance does not reveal all errors. These Errors not affecting the trial balance
are:–
NAME OF ERROR DESCRIPTION
Error of commission Correct amount entered in the wrong person’s account. Error of principle Correct amount entered in the wrong type of account.
Error of Original Entry Incorrect amounts from invoices or daybooks posted to ledgers. Error of Omission Transaction completely omitted from the books.
Error of Transposition Numbers transposed in the accounts.
Compensating Errors Two errors on opposite sides of an account cancel out each other Complete Reversal of Entries Correct amount entered in the right accounts but on wrong side.
Practice these from your text books Errors affecting the trial balance
are:-NAME OF ERROR DESCRIPTION
Double Entry Errors A debit was posted but no credit or vice versa Two debits but no credits or vice versa
Posting two (2) different amounts to the accounts
Casting Errors Over casting or under casting an account
Study Guide
Suspense Account - A temporary account in which the difference in the trial balance is place until the errors causing the trial balance not to agree can be determined.
Practice these from your text books
TRADING ACCOUNT (you have to know both horizontal & vertical layouts) Trading Accounts records the buying and selling of stock. This is where the cost of goods sold and gross profit is calculated.
Cost of Goods Sold = Opening stock + Net Purchases – Closing stock
*Net Purchases = Purchases + Carriage Inwards – Returns Outwards(Purchases Returns) *Please note that opening stock is added and closing stock is subtracted
Gross Profit = Net Sales (or turnover) – Cost of Goods Sold
*Net Sales = Sales – Returns Inwards (Sales Returns)
* Net Sales is also known as turnover
The following must be added to gross profit before subtracting expenses:
Revenues (Discount received, interest received, commission received, rent received) Reduction in Bad Debts (also known as doubtful debts)
GROSS LOSS - When a company has more expenses than gross profit
PROFIT AND LOSS ACCOUNT (you have to know both layouts)
List all the expenses of the business. This is where net profit is calculated.
Net Profit = Gross profit + anything received – total expenses
BALANCE SHEET (you have to know both layouts)
The Balance Sheet is a snapshot of the owners’ financial position. Its show the assets (things owned), the liabilities (debts owed), and the capital (the worth of the owner).
Fixed assets – assets that have long life (last for more than one year) and usually bought with the intentions of not reselling. Examples: Land, Building, Premises, Equipment, Machinery, Fixtures and fittings, Motor vehicles etc.
Current assets – assets that are done away with in less than one year. Examples: closing stock, debtors, bank, cash, prepaid expenses.
Current liabilities – debts that are settled in less than one year. Examples: creditors, bank overdraft, accrued expenses, interest payable, small loans, etc.
Long Term Liabilities – debts that are not settled within one year. Examples: mortgages, debentures, large loans etc.
Order of Balance Sheet/Marshalling of assets and liabilities – there are two (2) systems of arranging the assets and liabilities in the balance sheet:
(1) Order of Permanency – assets which are not easily convertible to cash come first and those which are more readily convertible into cash comes next and so on. See Example of order of Permanency onPage 3
(2) Order of liquidity - the assets which are more readily convertible into cash come first and those which cannot be so readily converted come next and so on.
Liabilities Assets
Bank Overdraft
Outstanding Expenses Interest Payable Creditors
Long – terms Loans Capital
Cash in hand
Cash at Bank Prepaid Expenses Debtors
Closing Stock Furniture
Plant and Machinery Building
Land
Calculation of Working Capital
Current Asset – Current Liabilities = Working Capital
Working capital shows how well a company can pay it short terms debts. If working capital is negative (more current liabilities than current assets), that business can become bankrupt.
THE JOURNAL/SPECIAL JOURNALS LEDGERS ACCOUNTS
In a book-keeping system there are different types of account: a distinction is made between personal and impersonal accounts.
Personal accounts
Names of people and businesses; these are the accounts of debtors and creditors.
Impersonal accounts
These are the other accounts; they are usually divided between real accounts &nominal accounts.
(a) Real accounts records asset accounts such as cash, bank, equipment, cars, fixtures, etc.
Study Guide DIVISION OF THE LEDGER
The ledger is divided into separate e sections:
1. The sales ledger containing the accounts of debtors
2. The purchases ledger, containing the accounts of creditors
3. The general ledger, containing the nominal accounts and the real accounts.
Example: Bought goods on credit.
Debit: Purchases Account in the General Ledger
Credit: The personal account of the creditor in the Purchases Ledger THE BOOKS OF ORIGINAL ENTRY
These books are also known as Subsidiary books, Books of First Entry or Books of Prime Entry. These books are used to record transactions for the first time, before entering them in their respective ledger. The main books of original entry are: 1. Sales day book
2. Purchases day book
3. Returns Inwards day book or Sales Returns Day Book 4. Returns Outwards day book or Purchases Returns Day Book 5. Cash Book
6. Petty Cash Book 7. The General Journal
SOURCE DOCUMENTS
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/stubs: 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 SUMMARY OF DAY BOOKS AND SOURCE DOCUMENTS
Day
Book/Journal What is recorded Source Document Which Ledger Recorded in Which Account in
General Ledger Sales Day Book/
Journal Credit Sales/Debtors Sales Invoice Debtors/Sales Ledger Sales Account
Purchases Day Book /Journal
Credit
Purchases/Creditors
Purchases Invoice Creditors/Purchases
Ledger Purchases Account Returns Inwards Day Book/Journal
Goods returned by
customers Credit Note Debtors/Sales Ledger Returns Inwards
Account Returns
Outwards Day Book/Journal
Goods returned to suppliers
Debit Notes Creditors/Purchases
Ledger
Returns Outwards Account
Cash Book Cash receipts and
payments Pay-in slips, counterfoils, till
rolls, bank statements, receipts, cash requisitions
Personal accounts Impersonal
accounts
Petty Cash Book Small cash payments &
reimbursements Petty cash vouchers Impersonal accounts
The General
Journal Correction of errors, Sale or purchases of fixed assets on credit, writing of bad debts, opening and closing entries
There are two (2) types of discounts:
(1) Trade Discounts – a reduction given to a customer when calculating the selling prices of goods. Trade discounts are automatic discounts given to customers to
encourage bulk buying and as an incentive for customers to return. Trade discounts are never recorded in the books of double entry or in the sales daybook.
(2) Cash Discounts – there are two (2) types of cash discounts. Cash discounts are recorded in the books of double entry. These optional discounts are:
(a) Discounts allowed – a reduction in an invoice amount given to customers as an incentive for prompt payment. Discounts allowed are expenses.
(b) Discounts received - a reduction in an invoice amount from suppliers as an incentive for prompt payment. Discounts received are revenues.
Trade discounts and Cash discounts are never added together and then calculated. Trade discount is calculated first and cash discount is calculated on the balance of the invoice.
THE TWO AND THREE COLUMN CASH BOOKS
The cashbook consists of the cash account and the bank account put together in one book. The cash book records all money received and paid during a period on the same page. See page 8 for source documents used in the cash book.
The cash book is debited when a business receives cash or cheques and credited when it makes payments by cash or cheque.
The difference between a two and three column cash books are the discount
columns. Discount allowed is on the debit side (because it is an expense) of the cash book and discount received is on the credit side of the cash book. (because it is a revenue).
The cashbook is balanced like any other ledger account. The discount columns are never
balanced they are only totaled.
The cash book is the only book of original entry the forms a part of the double entry system.
Contra Entry - the debit and the credit entry has been made and completed in one book. It is identified by putting a ‘c’ in the folio column of the cash book for the transaction.
Posting from the cash book to the ledger
When posting from the cash book to a ledger account the corresponding entry must be made opposite to that in the cash book. For example: if sales are debited in the
cashbook then the sales account in the general ledger will be credited. This is true for all other entries except discounts (is is no double entry for discounts allowed and
received) and contra (because the debit & credit has already been made in the cash book).
THE BANKING SYSTEM Banking terms
(a) Overdraft – a facility offered by banks allowing customers to withdraw more money out of their current accounts than they have deposited.
(b) Interest -
(c) Bank charges -