Accounts

Introduction to Accounting

Concept of Accounting

Accounting is the process of identifying, recording, measuring and communicating financial

information which allows balanced judgement and sound financial management decisions.
Account systems have been used throughout history as long as there was need to make financial
decisions.

Accounting:
-Identifies, records, measures and communicates information on the finances of a business.

-Focuses or communicates information about entities in monetary terms.

-Provides general financial information which may be used for specific functions by relevant
entities in need of financial information.

-Has the intended effect of assisting the organization in reaching its objectives.

-Illuminates what is being measured, as well as providing summarized information for general
management decision making.

Users of accounting information

Internal users
-Owners of the business to assess the results of their investment in the business.
-Managers to plan, control, analyse, and evaluate activities and performance in order to
strengthen policies.
-Employees to look at the stability of the business, job security and adequacy of salary.

External users
-Government to ensure that legal conformity and tax obligations are met by businesses; to
assess impact of business activities on the economy.
-Competitors to make performance comparisons and strengthen weak areas.
-Suppliers to determine the credit history of potential customers before committing to supply.
-Customers To provide after-sales support.

Types of Business Organizations

A business is an economic entity that engages in activities for financial gain or profit. The
structure of a business in terms of the ownership and management is one of the important tasks
of the entrepreneur. Therefore, the form of organization must be chosen with careful thought.
Factors to be considered are:

The Nature of the activities of the Business

The selection of a particular type of organizational structure is dependent upon the type of
business activity. A partnership or Sole Proprietorship is ideal for a service oriented business, but
a Company or partnership would be better for a manufacturing concern.

Scale of Operation

If the scale of operation is small, a sole proprietorship or partnership form is ideal. But a
company would be better if the scale of operation was very large.

Area of Operation

If the operation of entity is spread over a wide geographic area, the company structure is better,
but if it is confined to a specific region, other forms may be ideal.

Finance

If the initial capital outlay and daily operational costs are very large, a company structure may be
the best option.

Ownership and Control

One should go for a sole proprietorship or partnership when direct control over the business is
ideal, instead of company or co-operative Structure.

Liability

An individual who does not wish for unlimited liability, he may opt for a company but if he can
bear the unlimited liability of business can go for sole proprietorship or partnership.

Sole Trader

Sole proprietorship is a basically a one person owned business. It is a form of business

organization in which an individual invest his own resources, uses his own organizing abilities in
management and decision making some small business start out as sole traders. Sole Traders
sometimes are small or micro- enterprises which need little capital to start up and may therefore
be easy to establish and operate.

Advantages
-Easier establish and manage than a company

-Decision making is speedy due to its solo nature

-Customers receive special attention due to economies of scale

-Profits are not shared but goes to the sole owner

Disadvantages

-Unlimited liability by the owner

-Problem in raising capital when needed sometimes due to scale of operation and capital outlay

-Sometimes limited managerial skills due to lack of team management

-Lack of competitiveness

-Lack of continuity when owner dies

-Long working hours due to economies of scale

Partnership

A partnership is a form of organization where two to twenty persons are associated to operate a
business entity with a view to earn profit. Each member of such a group is individually known as
partner and collectively the members are known as a partnership firm.

In order to avoid misunderstandings about how profits/losses are shared, the responsibilities of
each partner, and other ownership, management, and operating decisions the partners usually
have a formal legal partnership agreement which sets out the rights and obligations of each
partner.

Some factors to consider in a partnership deed

-The number of partners needed

-Capital invested by each partner

-Interest on capital paid to each partner

-Profit or loss sharing ratio between or among partners

-Salaries paid to partners

-Admission of a new partner

-Dismissal or withdrawal of a partner

Advantages of Partnerships

-Easily formed

-More people to contribute capital than sole trader

-Greater continuity than sole trader

-Expenses and management of the business are shared

Disadvantages of Partnerships

-Generally unlimited liability of partners

-Possible disagreement among partners

-Each partner is liable for the debt of the business

-Membership limit of twenty partners may sometimes restrict the capital resources of the
business depending on the nature and scale of operations

Co-Operative Society

The co-operatives are formed primarily to render services to its members. Generally it also
provides some service to the society. When the purpose of business is to provide service than to
earn profit and to promote common economic interest, the co-operative society is the only
alternative.

The main objectives of co-operative societies are:

-rendering service rather than earning profit

-mutual help instead of competition

-self help in place of dependence

On the basis of these objectives, various types of co-operatives can be formed with the objective
of providing different benefits to their members. Some types of co-operatives are outlined below.

Types of Cooperatives
Consumer co-operatives

These are formed to protect and strengthen the specific interests of ordinary consumers of society
by making consumer goods available at a fair price.

Producer co-operatives

These societies are set up to strengthen producers who operate on a small scale who face
challenges related to resources for raw material and available markets for finished goods.

Marketing co-operatives

These are formed by producers and manufactures. Marketing co-operatives eliminate

exploitation of the middlemen when marketing their product.

Credit Co-operatives

These societies are formed to provide financial help to its members.

Farming Co-operatives

These are formed by small farmers who carry on work together to operate on a larger scale and
thereby share the benefits of large scale farming.

Besides these types, other co-operatives can be formed with the objective of providing different
benefits to its members, like the construction co-operatives, transport co-operatives, co-
operatives to provide education etc.

Characteristics of Co-operatives

Members Voluntary Association

Individuals with common interest may come together to form a co-operative society. Any person
can become a member of such a co-operative.

Membership

The minimum number of individuals required to form a co-operative society is ten and the
maximum number is unlimited.

Body Corporate

Registration of a society under the Co-operative Societies Act is a must. Once it is registered, it
becomes a body corporate and enjoys certain privileges just like a joint stock company.

Some of the privileges are:

-It can sue others in court of law.

-It can enter into contract with others

-It has its own common seal.

-It can own property in its name.

-It can enter into contract with others.

-The society enjoys perpetual succession

-It has its own common seal.

-It can own property in its name.

Service Motive

The main motive of any co-operative organization is to provide specific services to its members
in particular and to the society in general.

Democratic Set Up

Every member has a right to take part in the management of the society. Each member has one
vote. The Executive Committee, who is elected and responsible to members, look after the daily
operations of the organization.

Sources of Finances

Co-operative organizations have units of investments called shares which are contributed by
members It can also raise loans and obtain grants from the government.

Return on capital

The profit earnings on capital subscribed by the members is in the form of a fixed rate of
dividend after deduction from the profit of the co-operative.

Advantages of Co-operative Society

Easy Formation

Formation of a co-operative society is relatively easy as compared to a company. Any 10 persons

can form an association and get the entity registered.

Limited Liability
The liability of the members is only limited to the extent of capital contributed by them.

Open Membership

Any member of society may become a member of a co-operative.

State Assistance

Co-operatives may have the advantage of patronage in the form of exemptions and tax
concessions and financial assistance from the governments.

Middlemans Profit Eliminated

Consumers benefit and the profit is maximized. Through the co-operative the consumer members
control their own supplies and by this means the middlemans profit is eliminated.

Management

Decision making by members on specific terms are democratized.. Each member has only one
vote.

Winding up

A co-operative has a fairly stable life. The dissolution of a co-operative firm is quite difficult. It
does not cease to exist in the case of the death, or insolvency or resignation of any member.

Disadvantages of Co-operatives

Limited Capital

Due to the specificity of co-operatives the amount of capital that can be generated may
sometimes be limited. This is because of the membership remaining confined to a geographic
area or a particular group of people.

Lack of Motivation

Co-operatives are basically service oriented more than profit motivated. There might not be
sufficient motivation to manage the co-operatives effectively.

Corporations

A corporation is an organization that is made up of many owners who normally are not active in
the decision making and operations of the business. The capital of a limited liability company is
divided into shares which are certificates of ownership (stock) issued by the corporation. The
owners of these shares are called shareholders and the capital of the company referred to as share
capital. Corporations must have at least one shareholder. Corporations are incorporated
businesses, are considered as a separate entity, and this often provide a measure of legal and
financial protection for the shareholders. The shareholders of corporations have limited liability
protection, and corporations have full discretion over the amount of profits Suitability of Joint
Stock Company:

A Limited Liability Company may be suitable where the volume of business is quite large, the
area of operation is widespread, the risk involved is heavy and there is a need for huge financial
resources and manpower. It is also preferred when there is need for professional management
and flexibility of operations.

Characteristics of Limited Liability Companies

Artificial Person

A Joint Stock Company is an artificial person in the sense that it is created by law and does not
possess physical attributes of a natural person. However, it has a legal status.

Separate Legal Entity

Being an artificial person, a company has an existence independent of its members. It can own
property, enter into contract and conduct any lawful business in its own name. It can sue and can
be sued in the court of law. A shareholder cannot be held responsible for the acts of the
company.

Common Seal

Every company has a common seal by which it is represented while dealing with outsiders. Any
document with the common seal and duly signed by an officer of the company is binding on the
company.

Perpetual Existence

A company once formed continues to exist as long as it fullfils the requirements of law. It is not
affected by the death, lunacy, insolvency or retirement of any of its members.

Limited Liability

The liability of a member of a Joint Stock Company is limited by guarantee or the shares he
owns. In other words, in case of payment of debts by the company, a shareholder is held liable
only to the extent of his share.

Transferability of Shares

The members of a company are free to transfer the shares held by them to anyone else.
Formation

A Jamaican company for example, comes into existence only when it has been registered, after
completing the formalities prescribed by The Registrar of Companies of Jamaica.

Membership

A company having a minimum membership of two persons and maximum fifty is known as a
Private Limited Company. In the case of a Public Limited Company, the minimum is seven and
the maximum membership is unlimited.

Management

Limited Liability Companies have democratic management and control. Even though the
shareholders are the owners of the company, all of them cannot participate in the management
process. The company is managed by the elected representatives of shareholders known as
Directors.

Capital

A Limited Liability Company generally raises a large amount of capital through issue of shares.

Advantages of Limited liability Companies

Limited Liability

In a Joint Stock Company the liability of its members is limited to the extent of shares held by
them. This attracts a large number of small investors to invest in the company. It helps the
company to raise huge capital. Because of limited liability, a company is also able to take larger
risks.

Continuity of existence

A company is an artificial person created by law and possesses independent legal status. It is not
affected by the death, insolvency etc. of its members. Thus it has a perpetual existence.

Benefits of large scale operation

It is only the company form of organization which can provide capital for large scale operations.
It results in large scale production consequently leading to increase in efficiency and reduction in
the cost of operation. It further opens the scope for expansion.

Professional Management
Companies, because of complex nature of activities and operations and large volume of business,
require professional managers at every level of organization. And because of their financial
strength they can afford to appoint such managers. This leads to efficiency.

Social Benefit

Corporations offer employment to a large number of people. It facilitates promotion of various

ancillary industries, trade and auxiliaries to trade. Sometimes it also donates money for
education, health, community service and renders help to charitable and social institutions.

Research and Development

A company generally invests a lot of money on research and development for improved
processes of production, designing and innovating new products, improving quality of product,
new ways of training its staff, etc.

Disadvantages of Limited liability Companies

Formation is not easy

The formation of a company involves compliance with a number of legal formalities under the
companies Act and compliance with several other Laws.

Control by a Group

Companies are controlled by a group of persons known as the Board of Directors. This may be
due to lack of interest on the part of the shareholders who are widely dispersed; ignorance,
indifference and lack of proper and timely information. Thus, the democratic virtues of a
company do not really exist in practice.

Speculation and Manipulation

The shares of a company are purchased and sold in the stock exchanges. The value or price of a
share is determined in terms of the dividend expected and the reputation of the company. These
can be manipulated.

Excessive government control

A company is expected to comply with the provisions of several Acts. Non-compliance of these
invites heavy penalty. This affects the smooth functioning of the companies.

Delay in Policy Decisions

A company has to fulfill certain procedural formalities before making a policy decision. These
formalities are time consuming and, therefore, policy decisions may be delayed.
NonProfit

Nonprofit Organizations are corporations formed for a charitable, civic, or artistic purpose.
Nonprofits are generally exempt taxation on their income, and so they are often called exempt
organizations. Nonprofits have substantial responsibilities for reporting their activities, income,
and assets to ensure that they are in compliance with government laws governing charities.

Financial Statements

What is a financial statement? What does it tell us? Why should we care? These are good
questions and they deserve an answer.

Financial Statements are summary accounting reports prepared periodically to inform the owner,
creditors, and other interested parties as to the financial condition and operating results of the
business. The purpose of financial statements is to communicate the Groups financial
information to its stakeholders, especially shareholders, investors and lenders. Financial
Statements uses the summarized data contained in the Trial Balance to prepare the businesss
financial reports.

Financial Statements provide relevant financial information in a format that is useful in making
important business decisions. Each financial statement tells its own story. Together they serve
many purposes. They form a comprehensive financial picture of the company, the results of its
operations, its financial condition, and the sources and uses of its money. They also allow
comparison of different companies with each other, or to evaluate different years performance
within the same company. Evaluating past performance helps managers identify successful
strategies, eliminate wasteful spending and budget appropriately for the future. It can also help a
bank or creditor evaluate the company for a loan or charge account. And the Government will be
interested in collecting the appropriate amount of income tax. Armed with this information,
business managers will be able to make necessary business decisions in a timely manner.

Financial statements have generally agreed-upon formats. There are three main financial
statements:

-Trading and Profit and Loss Account

-Balance Sheet

-Statement of Cash Flows

The Income Statement

At the end of a financial period, all expense and revenue accounts are closed to a summarizing
account usually called an Income Statement. This is the financial statement that summarizes
revenues and expenses for a specific period of time, usually a month or a year. This statement is
also called a Profit and Loss Statement. For this reason, all income statement accounts are
considered to be temporary or nominal.

-The Profit and Loss Account reflects a Period of Time month, quarter and year. It shows
financial the activity of a business during that period and indicates any profit or loss earned.
-Revenue - the value of your goods and services which have been delivered to customers
-Expenses - costs incurred in earning these revenues.

-Net Profit - the excess of Revenue over Expenses, on the Profit and Loss Account.
-Net Loss - the excess of Expenses over Revenue, on the Income Statement.

The Balance Sheet

The statement of financial position of a business sums up its economic resources, obligations
(debts and other non-current liabilities) and owners capital at a particular point of time. It also
shows how the economic resources contributed by lenders and shareholders are used in the
business.

Balance sheet items are classified as assets, liabilities, or capital, and the amount and nature of
these items are shown at a specific date in time.

-Assets Something the company owns that has value

-Liability Money the company owes to creditors
-Capital This is the portion that remains after liabilities are subtracted from assets. Capital
includes profit or Loss from the business.
-Drawings Represent assets taken out by owners of the business

The Balance sheet:

-Reflects a Moment in Time.

It indicates Assets, Liabilities and Equity of business as of a specific date.

-Shows Financial Position of Business as of specific date:

Financial Position what you have/what you owe/what your stockholders have

Have Owe = Value to Owner

-Value of Business to Owners.

Assets Liabilities = Capital

Statement of Cash Flows

The Statement of Cash Flows is the third financial statement. The Cash Flow statement shows
the inflows and outflows of Cash over a period of time, usually one year. The time period will
coincide with the Income Statement. The accounts are analyzed to determine the Sources
(inflows) and Uses (outflows) of cash over a period of time The Statement of Cash Flows
removes all accruals, deferrals and other non-cash adjustments,. An Income Statement might
show a Profit or a Loss, but that says nothing about how the companys Management managed
the companys money.

Cash Flow Statement:

-Reflects a Period of Time Month, Quarter, Year
-Shows cash inflows and outflows during period

-Indicates solvency of company during period

The Accounting Cycle

The Accounting Cycle is a sequence of procedures used to record, classify and summarize and
processing accounting information to generate financial statements, on a regular basis. The
accounting cycle during each period starts from recording individual transactions in the books of
accounting and ends at the preparation of financial statements and closing processes.

Steps in the Accounting Cycle

-Capture and Record business activities.

Identify and analyze transactions that need to be recorded, journalize (record) the transactions in
the proper journal.

-Classify transactions into appropriate Accounts.

Post from the journals to the General Ledger and Subsidiary Ledgers.

-Prepare an unadjusted Trial Balance

Enter Trial Balance Information from General Ledger

-Make adjusting entries at the end of the period

Review accounts and other information to determine if any Adjusting Entries are necessary

-Prepare an Adjusted Trial Balance.

This is a Trial Balance after adjusting entries have been made.

-Prepare final accounts

Summarize and Report the balances of Ledger Accounts in financial statements.

-Journalize and post closingentries

Record our closing Entries in our General Journal Post our entries from our General Journal to
our General Ledger.

-Prepare a Closing Trial Balance

The Accounting Cycle

Accounting Concepts and Conventions

Accounting concepts and conventions as used in accountancy are the rules and guidelines by
which the accountant lives. All accounts and accounting statements should be created, preserved
and presented according to the concepts and conventions.

-These generally accepted accounting principles are a set of rules and practices that are
recognized as a general guide for financial reporting purposes.
-Generally accepted means that these principles must have substantial authoritative support.

Accruals Concept

The Accruals concept assumes that revenue and expenses are taken account of when they occur
and not when the cash is received or paid out. The purpose of this concept is to make sure that all
revenues and costs are recorded in the appropriate statement at the appropriate time. The accrual
concept under accounting assumes that revenue is realised at the time of sale of goods or services
irrespective of the fact when the cash is received. Similarly, expenses are recognised at the time
of services provided, irrespective of when cash is paid.

In brief, accrual concept requires that revenue is recognised when realized, and expenses are
recognised when they become due and payable without regard to the time of cash receipt or cash
payment. Thus, when a profit statement is compiled, the cost of goods sold relevant to those
sales should be recorded accurately and in full in that statement. Costs concerning a future period
must be carried forward as a prepayment for that period and not charged in the current profit
statement. For example, payments made in advance such as the prepayment of rent would be
treated in this way. Similarly, expenses paid in arrears must, although paid after the period to that
they relate, also be shown in the current periods profit statement: by means of an accruals
adjustment.

Matching concept states that the revenue and the expenses incurred to earn the revenue must
belong to the same accounting period. Therefore, the matching concept implies that all revenues
earned during an accounting year, whether received/not received during that year and all cost
incurred, whether paid/not paid during the year should be taken into account while ascertaining
profit or loss for that year. It guides how the expenses should be matched with revenue for
determining exact profit or loss for a particular period.

Accruals Concept
Revenue should be recognized in the accounting period in which it is earned.

Matching Concept
Expenses should be matched with revenues in the period in which the revenues are earned. (i.e.
the need for prepaid expenses)

Significance:

-It helps in knowing actual expenses and actual income during a particular time period.

-It helps in calculating the net profit of the business.

Prudence Concept or Concept of Conservatism

It is this concept more than any other that has given rise to the idea that accountants are
pessimistic boring people!! Basically the concept says that whenever there are alternative
procedures or values, the accountant will choose the one that results in a lower profit, a lower
asset value and a higher liability value. The concept is summarised by the well known phrase
anticipate no profit and provide for all possible losses.

Revenue and profits are included in the balance sheet only when they are realized (or there is
reasonable certainty of realizing them) but liabilities are included when there is a reasonable
possibility of incurring them.

The Prudence Concept assumes:

-Assets should not be overvalued

-Liabilities should not be undervalued

-The financial statements does not reflect overstatement or understatement of gains or losses but
neutral

-Profit or revenue only recorded when they are realized.

Consistency Concept

Because the methods employed in treating certain items within the accounting records may be
varied from time to time, the concept of consistency has come to be applied more and more
rigidly. Because of these sorts of effects, it is now accepted practice that when an entity chooses
to treat items such as depreciation in a particular way in the accounts it should continue to use
that method year after year. If it is NECESSARY to change the accounting method being
employed then an explanation of the change and the effects it is having on the results must be
shown as a note to the accounts being presented.

Separate Entity Concept

The business entity concept states that a business and the owner(s) are two separate Legal
Entities.

Being an artificial person, a company has an existence independent of its members. It can own
property, enter into contract and conduct any lawful business in its own name. It can sue and can
be sued in the court of law. A shareholder cannot be held responsible for the acts of the
company.

The best example here concerns that of the sole trader or one man business: in this situation you
may have the sole trader taking money by way of drawings: money for his own personal use.
Despite it being his business and apparently his money, there are still two aspects to the
transaction: the business is giving money and the individual is receiving money. So, the
affairs of the individuals behind a business must be kept separate from the affairs of the business
itself.

This concept restrains accountants from recording of owners private/ personal transactions. It
also facilitates the recording and reporting of business transactions from the business point of
view.

Conclusions
These, then, are some basic concepts and conventions on which the accountant bases all of his
accounting work. We can see evidence of such work in the published annual reports and
accounts that all publicly quoted companies are required to prepare and publish. The concepts
and conventions also apply to the millions of businesses world wide that do not publish their
accounts.

Accounting Processes

All accounting information historically has been done manually. In modern society we now have
access to computers that actually performs the same tasks with much improvement.

Computerised accounting systems may be obtained in modular packages or be fully integrated.

Modules include Stock control, sales order processing, purchases order processing, pay roll,
fixed assets, Sales Ledger, Purchases Ledger, debtors and creditors schedule, and general
ledger. These accounting systems follow the basic rules of double entry.

Most accounting software has these common modules which can be used each by themselves or
combined with other modules in the same packages.

Accounts receivable where the business enters money receivable from activities

Accounts payable - business records and discharges its financial obligations

General ledger the companys books

Billing where the company creates invoices to customers

Stock/Inventory - the business maintains inventory management

Purchase Order Goods are order as required

Sales Order the business records customer orders for stock items they need

Cash Book the business records money collected and paid out.
Accounting Softwares

As technology improves, software vendors have been able to offer increasingly advanced
software at lower prices.

Different Types of Accounting Software Packages

There are different types of Accounting Software Packages that are designed to cater the
different needs of different businesses. Below are some of the popular and general types of
accounting software.

Accounting Software for Personal Use

This kind of private software is meant for home use. The applications here are adequate and
simple and are meant to meet with all the basic accounting requirements such as, budget planner,
accounting spreadsheets, diagrams, bookkeeping, etc.

Accounting Software for Small Business

These accounting softwares fulfill the accounting needs of small businesses, such as, creating
invoices, financial reporting, merging accounts and payrolls.

Accounting Software for Big Business

These expensive software allow have a large number of applications which can be that can be
accessed from anywhere. These softwares can be very complex and extremely functional.

List of Accounting Softwares

There are a wide range of accounting software for different needs. Below is a list of softwares
used.

-Vision Point

-QuickBooks Pro

-Peachtree Complete Accounting

-MYOB

-Account Edge

-Dac Easy

-CYMA Accounting for Windows

-Netsuite Small Business

-Cougar Mountain

-Accpac from Sage

-Syspro 6.1

Advantages of using computers in accounting

(1) Faster and efficient in processing of information.

(2) Automatic generation of accounting documents like invoices, cheques and statement of
account;
(3) With the larger reductions in the cost of hardware and software and availability of user-
friendly accounting software package, it becomes relatively cheaper;
(4) More timely information can be produced;
(5) Many types of useful reports can be generated for management to make decisions
(6) Increased accuracy of information

(7) Improved reporting and analysis

(8) Greater flexibility of use of information

(9) Internal control system of increased productivity

(10) Easy back up and restoration of records

Disadvantages of using computers in accounting

(1) Power failure, computer viruses and hackers are the inherent problems of using
computerized systems;
(2) Some accounting system may not be properly set up to meet the requirement of the business
due to badly programmed or inappropriate software or hardware or personnel problems can
caused more havoc.
(3) There is the constant threat of computer fraud or computer damage due to virus. It means
that appropriate types of monitoring and control and security features need to be constantly in
place.

Quiz

1. Fill in the Blanks:

a. A partnership firm normally requires a maximum of persons.

b. Owners of a Partnership are liable to for all liabilities of the firm.

d. Partners have a relationship between them.

e. The individuals who own the partnership business are called collectively referred to as
.

Answers

(a) 20 persons

(b) Pay

(c) Legal

(d) Partnership

2. Which of the following statements are TRUE or FALSE?

a. A partner may sometimes not work in a partnership that he part owns.

b. The interests of partners may not be used as future capital in the business.

c. A partnership firm has separate legal entity from its owners.

Answers

(a) True

(b) False

(c) False

3. Which of the following statement are TRUE or FALSE ?

(a) The members of a co-operative get a fixed rate of dividend from profit.

(b) A co-operative society can not enter into any contract.

(c) The liability of the members of a co-operative is unlimited.

(d) A co-operative society needs not be registered.

(e) A member of a co-operative society may have voting power based the amount of shares
owned.

Answers
(a) True

(b) True

(c) False

(d) False

(e) False

4. Fill in the blanks:

(a) A co-operative society may not cease to exist with the of a member.

(b) New members of a co-operative are obtained .

(c) is the primary motive of a co-operative.

(d) The maximum membership to get a co-operative registered is .

(e) Most co-operative society are restricted by .

Answers

(a) death

(b) Voluntarily

(c) Service

(d) Unlimlited

(e) Capital

5. Which of the following statements are TRUE or FALSE ?

(a) The minimum membership for a public limited company is 50.

(b) A company is dissolved with the entry of a new member.

(c) The members of a company may transfer their shares through on the stock market.

(d) The liability of the members of a Joint Stock Company is limited.

Answer
(a) False

(b) False
(c) True

(d) True

6. Fill in the blanks:

(a) A company has existence.

(b) A company may enjoy the benefits of operation.

(c) A partnership may be managed by .

(d) When the scale of operation of the business is a sole proprietorship form is preferred.

(e) The capital of a sole trader may not be in the stock market.

Answer

(a) Perpetual

(b) Large Scale

(c) Partners

(d) Small

(e) not

7. Fill in the blanks with suitable word/words:

(a) Accrual concept relates to the determination of ____________.

(b) Goods of Rs.50000 are sold on 25th March 2006 but payment is received on 10th April
2007. It will be a revenue

for the year ending _____________.

(c) Accrual concept requires revenue is recognised when ____________.

(d) Expenses are matched with ____________ generated during a period.

(e) Income is the excess of revenues over ____________.

Answers

(a) Revenue

(b) 2006

(c) Service is rendered or goods are delivered

(d) Revenues

(e) Expenses

Balance Sheet

Assets, Liabilities & Capital

Assets

Assets are things that a company owns and are sometimes referred to as the resources of the
company.

The properties used in the operation or investment activities of a business.

Assets include tangible and intangible items. Tangible items can be physically seen and touched
such as vehicles, equipment and buildings. Intangible items are like pieces of paper (sales
invoices) representing loans to your customers where they promise to pay you later for your
services or product. Some examples of business type assets are cash, debtors, stock of goods,
land, and equipment.

Liabilities

Liabilities are obligations of the company; they are amounts the business owes to others as of the
balance sheet date.

Another liability is money received in advance of actually earning the money.

Usually one of a businesss biggest liabilities is to suppliers where a business has bought goods
and services and charged them. Some examples of business liabilities are outstanding expense
accounts, creditors, and mortgages.

Capital
It represents the owners rights to the property (assets) of the business. Capital is the monetary
value of the part of the business which belongs to the proprietor. In other words what the
business owes the owner, that is the amount left for the owner after all liabilities (amounts owed)
have been paid.

Definition & Purpose of Balance Sheet

The Balance Sheet is a statement of financial position of a business at a specific point in time
usually at the end of the month or year. By analyzing and reviewing this financial statement the
current financial health of a business can be determined.

The Balance Sheet sums up the economic resources (assets), obligations (debts and other long-
term liabilities) and the owners Capital at a particular point of time. It also shows how the
economic resources contributed by lenders and shareholders are used in the business. This
statement is called a balance sheet because at any given time, Assets must equal Liabilities
plus Capital, in other words, be in balance.

Balance Sheet Equation

There are three main sections of a Balance Sheet: Assets, Liabilities, and Capital just like the
accounting equation. The balance sheet is derived from our accounting equation and is a formal
representation of our equation.

Items are listed in the Balance Sheet just as in the accounting equation:

Assets = Liabilities + Capital

Assets are normally listed on the left hand side.

Capital is entered on the right hand side.

Liabilities are entered on the left hand side.

Preparation of the Balance Sheet

The balance sheet heading contains the name of the company, the title of the statement, and the
date of the statement.

Entries in the balance sheet are made from transfers from the trial balance. A debit balance in the
trial balance must be transferred to the debit side in the balance sheet; similarly a credit balance
in the trial balance must appear only on the credit side of the Balance Sheet.

There are two basic formats for balance sheet presentation:

-The Horizontal Form

In this form the major categories are presented side by side.

-The Vertical Form

In this form the major categories are stacked on top of each other.
Balance Sheet Headings

Fixed Assets

These are items bought in the business not for resale but to be used over a period of several
years. These assets are of a long term nature. Examples of Fixed Assets would include
machinery, building and furniture.

Current Assets

These are items in the business which are used up and change daily in the normal operation of
the business. These are the revenue generating assets and they are of a temporary nature.
Examples of Current assets would include stock of goods for sale, debtors and business cash.

Liability Accounts

Liability Accounts are usually classified (put into distinct groupings, categories, or
classifications) on the balance sheet. The liability classifications and their order of appearance on
the balance sheet are:

-Current Liabilities

These represent money which the business owes and is obligated to settle within one year.
Examples of current liabilities would include Creditors for goods purchases, and unpaid utility
expenses

-Long Term Liabilities

These represent money which the business owes and is obligated to settle within one year.
Examples of long term liabilities would include Loan to buy motor vehicle, Mortgage.

Capital

Lets illustrate this statement with a simple equation.

Capital at End = Capital at Beginning + Additional Capital Contributed + Profit or ( Loss )
Draws

Capital is increased by money or property contributed and any profits the business earns from
operation.

Capital is decreased by withdrawals made by the owner or loss by the business.

Drawings represent amounts the owner withdraws from his business for personal use.
Arrangement of Assets and Liabilities

Assets may be listed based on how quickly they can be converted into cash which is called the
order of liquidity. In other words, theyre ranked. The asset most easily converted into cash is
listed first followed by the next easiest and so on. Of course since cash is already cash its the
first asset listed.
Assets may be listed based on the difficulty with which they can be converted into cash, called
the order of permanence. These assets are ranked in the opposite order of liquidity; they are
ranked from most difficult to convert to cash, to least difficult to convert to cash.

Effect of Transactions on the Balance Sheet

Every transaction affects two accounts or items. One account is always debited and the other
account credited.

This means that a balance is always maintained in the records. This is also reflected in the
Balance Sheet where every transaction may affect two items, and a balance is always maintained.

Illustration of how transactions affect the balance sheet

(A)Owner puts $5,000 in the business bank account.

(B)Borrowed $ 4000 cash from E. Dennis.

(C)Bought Motor van for $459 cash

(D)Received cash of $150 from debtor V. Ryan.

(E)Bought Fixtures by cheque of $257.

Quiz
Question
Answer

Books of Original Entry

Uses of Books of Original Entry

A Journal is an accounting record that is used to record the different types of transactions in
chronological order or date order. Journals are often called or referred to as the books of original
entry. The reason is that this is the first place that business transactions are formally
recorded. You can think of a Journal as a Financial Diary.

Specialized Journals are journals used to initially record special types of transactions such as
sales and purchases. All these journals are designed to record special types of business
transactions and post the totals accumulated in these journals to the General Ledger periodically
(usually once a month).

The General Journal

The Journal is a textual record of events (Debit and Credit) that is characterized by the fact that
all the records it contains are in a sequential chronological order. The General Journal is used to
record unusual or infrequent types of transactions. Type of entries normally made in the general
journal include depreciation entries, correcting entries, and adjusting and closing entries.

The Cash Book

The Cash Book is used to record the receipt and payment of money by the business in the form
of cash, or through the business bank account. It contains the cash and bank accounts.

Sales Journal

The Sales Journal is a special journal where Credit sales to customers are recorded. Another
name for this journal is the Sales Book or Sales Day Book.

Purchases Journal

The Purchases Journal is a special journal where Credit purchases from customers are recorded.
Another name for this journal is the Purchases Book or Purchases Day Book.

Returns Inwards Journal

The Returns Inwards Journal is a special journal that is used to record the returns from debtors
and allowances of goods sold on credit. Another name for this journal is the Sales Returns Book.

Returns Outwards Journal

The Returns Outwards Journal is a special journal that is used to record the returns to creditors
and allowances of goods purchased on credit. Another names for this journal is the Purchases
Returns Book.

The Petty Cash Book

This is just a fancy name that describes a special fund that is set up and used for minor and
unanticipated cash expenses where a cheque cant be written or the amount is so small that you
dont want to write a cheque. The petty cash account is based on the Imprest System which is a
system of cash disbursement, cash expenditure and reimbursement of that expenditure.

Cash & Credit Transactions

Cheques

A Chequeis a document/instrument (usually a piece of paper) that orders a payment of money

from a bank account. Technically, a cheque is a negotiable instrument instructing a financial
institution to pay a specific amount of a specific currency from a specified transactional account
held in the drawers name with that institution. Both the drawer and payee may be natural
persons or legal entities.

The person writing the cheque, the drawer, usually has a current account where their money was
previously deposited. The drawer writes the various details including the money amount, date,
and a payee on the cheque, and signs it, ordering their bank, known as the drawee, to pay that
person or company the amount of money stated. Cheques are a type of bill of exchange and were
developed as a way to make payments without the need to carry large amounts of gold and silver

Credit Cards

Think of credit as borrowed money. This money is made available to you, but it must be repaid
within an agreed amount of time. Credit cards provide a line of revolving credit. Credit cards
eliminate the need for carrying cash or checks. A typical plastic card includes the customers
name and a series of numbers that represent the applicable network, bank and account. The
numbers in aggregate are referred to as the account number or card number. The front also
features the cards expiration date and the issuers logo.

The back of the card has a horizontal magnetic strip and a signature box that must be signed by
the card holder. The account number and a three- to four-digit card identification number or
security number are often listed as well.

Credit cards enable you to reserve a hotel room, airline tickets and concert tickets, replace lost or
stolen items in person, over the phone or through email. They offer convenience and some
special perks for using them, such as travel insurance and gift certificates. They can be used
almost everywhere.

Types Of Credit Cards

Credit card products come in a wide assortment these days. Some credit card programs will ease
their terms and conditions and offer perks for people with stellar credit, such as travel insurance,
concierge service and free entertainment. Other credit card program may help a person re-
establish their credit.

Not all cards are for everyone. The ability to get a credit card will depend on whether you
qualify. This is determined by whether you have a history of establishing credit and your ability
to pay bills on time.

Here are the most common types of credit cards:

-Standard Credit Cards

-Reward Cards

-Secured Credit Cards

Credit Cards: Pros and Cons

Pros

-You can use them practically everywhere, especially overseas.

-They can boost your purchasing power because they can be used to buy goods and services over
the phone, through the mail and online.

-They provide financial backup in the event of an emergency, such as an unexpected healthcare
cost, job loss or auto repair.

-They allow you to purchase items and pay them off in monthly installments. They offer
discounts at stores and rewards. For instance, when you make purchases using the credit card
you can collect points; these points accumulate and can be used to get free items, such as airline
tickets.

-Some cards may offer cash back as an incentive to use the card.

-They can help build your credit history.

-They keep a record of your expenses, helping you to monitor your financial activities.

-They help raise your credit score, when you pay balances down by the due date. This improved
credit history paves the way for lower rates borrowing rates on other loans, including a
mortgage.

-Credit cards allow you the right to dispute billing errors and defective merchandise.

-They allow you withhold payments.

Cons

-Credit cards can have their disadvantages, though, especially when theyre used in an unwise
manner.

-Some consumers feel compelled to spend more money than they have.

-Consumers may continuously roll over a balance for several months.

-When you default on credit card payments, you are charged with late fees and interest,
increasing your debt load.
-Carrying a large amount of credit cards also isnt too favorable in the eyes of lenders.

-Acquiring too much credit card debt can ruin your credit score.

-Studies have indicated credit card debt as a significant factor in consumer bankruptcies.

-Credit card fraud is a possibility.

Debit Cards

A debit card is a plastic card that provides the cardholder electronic access to his or her bank
account/s at a financial institution. Some cards have a stored value with which a payment is
made, while most relay a message to the cardholders bank to withdraw funds from a designated
account in favor of the payees designated bank account. The card can be used as an alternative
payment method to cash when making purchases

In many countries the use of debit cards has become so widespread that their volume of use has
overtaken the cheque and, in some instances, cash transactions. Like credit cards, debit cards are
used widely for telephone and Internet purchases.

However, unlike credit cards, the funds paid using a debit card are transferred immediately from
the bearers bank account, instead of having the bearer pay back the money at a later date.

Debit cards usually also allow for instant withdrawal of cash, acting as the ATM card for
withdrawing cash and as a check guarantee card. Merchants may also offer cashback facilities to
customers, where a customer can withdraw cash along with their purchase.

The widespread use of debit and check cards have revealed numerous advantages and
disadvantages to the consumer and retailer alike.

Advantages of debit cards

-A consumer who is not credit worthy and may find it difficult or impossible to obtain a credit
card can more easily obtain a debit card, allowing him/her to make plastic transactions. For
example, legislation often prevents minors from taking out debt, which includes the use of a
credit card, but not online debit card transactions.

-For most transactions, a check card can be used to avoid check writing altogether. Check cards
debit funds from the users account on the spot, thereby finalizing the transaction at the time of
purchase, and bypassing the requirement to pay a credit card bill at a later date, or to write an
insecure check containing the account holders personal information.

-Like credit cards, debit cards are accepted by merchants with less identification and scrutiny
than personal checks, thereby making transactions quicker and less intrusive. Unlike personal
checks, merchants generally do not believe that a payment via a debit card may be later
dishonored.
-Unlike a credit card, which charges higher fees and interest rates when a cash advance is
obtained, a debit card may be used to obtain cash from an ATM or a PIN-based transaction at no
extra charge, other than a foreign ATM fee.

Disadvantages of debit cards

-Use of a debit card is not usually limited to the existing funds in the account to which it is
linked, most banks allow a certain threshold over the available bank balance which can cause
overdraft fees if the users transaction does not reflect available balance.

-Many banks are now charging over-limit fees or non-sufficient funds fees based upon pre-
authorizations, and even attempted but refused transactions by the merchant (some of which may
be unknown until later discovery by account holder).

-Many merchants mistakenly believe that amounts owed can be taken from a customers
account after a debit card (or number) has been presented, without agreement as to date, payee
name, amount and currency, thus causing penalty fees for overdrafts, over-the-limit, amounts not
available causing further rejections or overdrafts, and rejected transactions by some banks.

Source Documents

Source Documents are the original sources of information that provide documentation (proof)
that a transaction has occurred such as sales invoices (tickets), invoices from suppliers, contracts,
checks written and checks received , promissory notes, and various other types of business
documents. These documents provide us with the information needed to record our financial
transactions in our bookkeeping records. If you recall, a transaction is any event or condition that
must be recorded in the books of a business because of its effect on the financial condition of the
business, such as buying and selling.

Source documents detail the particulars of transactions that include the date, name, address,
terms, and product description among other relevant pieces of information. Types of source
documents include cash receipts, canceled checks and invoices. Source documents may be paper-
based business forms or electronic documents.

-They are used for initial input to the accounting system. The transactions they record can be
entered into the first of the accounting records the journals.

-They assist internal control of the resources of the business making sure that there is
documentary evidence that a transaction took place such as the purchase or sale of items and the
receipt and payment of money (that is, it makes it more difficult for people to misappropriate or
steal cash or other items).

-They are part of the audit trail for as long as those documents are required to be kept by law or
policy. Of such, they are a part of the record keeping process.
Here is a summary of some types of sources documents and their uses:

Sales Invoice

This document is sent to request payment for monies owed, for goods that were delivered, or
services that were rendered.

Features of invoice
Invoices are numbered to keep track of sent invoices

Invoice usually includes the following information:

-Name, address of seller and purchaser

-Date of sale

-Description of sale (goods or services)

-Quantity and unit price of what has been sold

-Details discount if it is provided

-Total amount of invoice plus sales tax if applicable

-Other (date of payment, terms of sale)

Purchases Invoice
This document is received in request payment for monies owed, for goods that were delivered,
or services that were rendered. It is identical to The Sales Invoice but is called a Purchases
Invoice when the purchaser receives it.

Credit Note

This document is sent by a supplier to a customer to reduce the liability of the customer. In
essence it is a negative invoice that is issued when goods are returned, when there was an
overpayment, or when some other event has occurred that has the effect of reducing the amount
that the customer owes to the supplier.

Debit Note

This document is sent from a customer to a supplier to request a credit note in respect to an
overpayment or return of goods.
Receipt

This is a written document that confirms that money has been received as a down payment,
account settlement or installment.

Petty Cash Voucher

This Document records in numeric order the specific amounts paid out in petty cash, to whom
the payments are made and for what purpose.

Recording Transactions from Source Documents

Journals use the information from the source documents to create a chronological listing of all
business transactions and detailed information about each transaction.

Journals are preliminary records where business transactions are first entered into the accounting
system. The journal is commonly referred to as the book of original entry. Specialized Journals-
are journals used to initially record special types of transactions such as sales and purchases in
their own journal

Why Use Special Journals

-Groups and records transactions of a like nature. A familiar example is recording all cash
received by a business in one place.

-Saves time with summary and less frequent postings to the General Ledger.
-Allows a business to have different individuals responsible for different journals thereby
increasing internal controls and allocating the record keeping workload.

General Journal

The Journal is a textual record of events (Debit and Credit) that is characterized by the fact that
all the records it contains are in a sequential chronological order.

Debit and Credit

Journals can be viewed as pages of a book. Each page has lines and columns. A journal page has
columns for the date, account name, and two columns for dollar amounts, referred to as the Debit
and Credit columns.

Entries are transferred (Posted) from the journal to the ledger pages on a regular basis.

When do we use Debit or Credit?

When to use a debit or credit to record a journal entry is one of the biggest problems for
beginning accounting students. It doesnt have to be difficult, if you remember a few simple
rules.

All journal entries follow the rules of debit and credit. Remember the Accounting Equation?

-Increase in assets is reported on the debit side of a journal entry.

-Decrease in assets is reported on the credit side of a journal entry.

Functions of the General Journal

-Buying and selling of fixed assets on credit

2009 June 1, Bought furniture on credit from Kull dunne for $1 000.
-Return of Fixed Assets

2009 June 5, $1,000 Furniture returned to Kull Dunne.

-Transfer of Creditors

We owed Bee Bobby $500. On June 10 2009 Bee Bobbys business is taken over by Rune
Crumbe who we will know owe the $500.

-Settlement of Debt

2009 June 15 We receive machinery valued $250 from Carl reeves in settlement of his debt of
$500.

-Opening Entries

On July 1 2009 V. Nemhard Opens his books of accounting to start business. At that date His
records reflect:

Assets:

Premises $2 000

Fixtures and Fittings $1 000

Machinery $600

Motor Vehicle $400

Stock of goods $200

Debtors:Vanne Style $100

Pryce Goonie $60

Bank $40

Cash $50

Liabilities:

Creditors: Evelyn Dianne $250

Devlin Cole $200

Capital:
$4 000

The Above transactions are journalized by date order below.

Sales Journal

The Sales Journal is a special journal where Credit sales from customers are recorded.

Steps in journalising Credit sales

The following credit sales transactions are Journalised below:

2009

July 3 Sold goods on credit to Yule Terry for $!00

July 10 Credit sales to jerry Hulle $200

July 20 Sold stock for credit $300 to Larry Hadman

Purchases Journal

The Purchases Journal is a special journal where Credit purchases from suppliers are recorded.

Steps in journalising Credit Purchases

The following credit purchases transactions are Journalised below:

2009

July 5 Credit purchases from Karnot Webb $400

July 7 Goods purchased on credit $500 from Harlot Mcqueen

July 15 Bought goods on credit 4600 from Clement Rhoden.

Returns Inwards Journal

The Sales Return & Allowances Journal is a special journal that is used to record the returns and
allowances of goods sold on credit.

Steps in Journalizing Returns Inwards

The following Returns Inwards transactions are Journalised below:

2009

July 6 Goods returned from Yule Terry $ 10

July 13 Returned goods from Jerry Hulle $20

July 26 Returns Inwards from Larry Hadman $30

Returns Outwards Journal

The Purchase Returns and Allowances Journal is a special journal that is used to record the
returns and allowances of merchandise purchased on account.

Steps in journalising Rturns Outwards

The following Returns Outwards transactions are Journalised below:

2009

July 9 Goods returned to Karnot Webb $40

July 14 Returned goods to Harlot Mcqueen $50

July 31 Returns Outwards to Clement Rhoden $60

Cashbook

The Cash Book is used to record the receipt and payment of money by the business in the form
of cash, or through the business bank account. It contains the cash and bank accounts.

Columns are set up for:

-The Date

-Details

Entries are made for the other account to enter to complete double entry

-Folio

The reference is entered for the book and page number for the other account to complete double
entry

-Discount Allowed

This is an incentive for speedy settlement of credit sales. All Discount Allowed merely listed
here.

-Discount Received

This is an incentive for speedy settlement of credit Purchases. All Discount Received merely
listed here.

-Cash and Bank Receipts

Types of Transactions Recorded:

Cash product sales / fees

Cash collected on customer accounts

Any other receipt (source) of cash

-Cash and Bank Payments

Types of Transactions Recorded:

Cash paid for expenses

Cash payments to our suppliers on account or cash purchases

Cash purchase of supplies

Any other cash payment

The following Cash Book transactions are entered below:

2009

May 1 Balances brought forward for Cash $100 and Bank $2 000

May 2 Cash sales $250. paid directly into the bank

May 3 Bought motor van for cash $200

May 5 Cash sales $ 250

May 8 Paid rent by cheque $150

May 10 Paid wages by cheque $120

May 18 Received cheque of $90 from debtor B.Butler, Discount Allowed $10

May 19 Paid cheque $200 to creditor C. Bare. Discount Received $20

May 22 Received cheque of $50 from debtor S.Combs, Discount Allowed $5

May 24 Paid cheque $30 to creditor V. Bryan, Discount allowed $30

May 24 Withdrew cash from the bank $20 for personal use
May 28 Cash of $20 was deposited to the bank account

Petty Cashbook

Another name that is sometimes used to refer to Petty Cash is an imprest fund. This is just a
fancy name that describes a special fund that is set up and used for minor and unanticipated cash
expenses where a cheque cant be written or the amount is so small that you dont want to write a
cheque. Some examples include buying pizza for the staff, postage stamps, minor office supplies,
paper towels, and cleaning supplies. A pre-numbered voucher or ticket should be filled out and
approved for each expenditure. When the balance in the fund becomes low a check from your
regular bank account should be issued and cashed to replenish the fund and the expenses
recorded in your accounting records. Surprise counts of petty cash should occasionally be done
to make sure that employees are not borrowing from this source of cash. Counting the fund is
very easy. The total amount of the tickets and the cash on hand should equal to the funds
established balance.

The petty cash (actual cash and all the supporting vouchers and receipts) is normally kept in a
locked drawer or box and one individual is assigned or designated as the custodian of the fund.
The custodian is responsible for all the petty cash activity. Individuals should also be designated
who have the authority to approve payments using petty cash. This could also be the custodian of
the fund.

How do you set up a Petty Cash Fund?

Determine the balance or amount of cash needed during a month to handle cash payments for
such items as stamps, COD shipments, office supplies, or any other types of payments where
writing a check is not practical. This balance is referred to as a float.

Designate an individual or petty Cashier to handle the petty cash book.

Payment is made to the Petty cashier for the amount determined to be needed (The Cash Float),
who then places the funds in a locked drawer or box. The accounting records would be to
debiting Petty Cash and crediting Cash in the Cash Book.

How do you operate the Petty Cash Fund?

All petty cash disbursements are made from this fund. A book or worksheet is maintained that
records all the payments made and why and what for they were made. Your chart of accounts is
used to determine what account(s) to charge the payment to.

A pre-numbered ticket or voucher is approved, signed by the person receiving the cash, and
prepared for each expenditure made from the fund and any supporting documents such as an
invoice or receipt is attached when the voucher is settled for.

The total of the cash in the fund plus the total of all the tickets and vouchers should always equal
the balance established for the fund. In other words if your petty cash fund amount is $500, the
total of the tickets paid and the currency on hand should equal $500.

Surprise counts of petty cash should occasionally be performed in order to make sure that
employees are not borrowing this cash.

How do you replenish the Petty Cash Fund when it runs out of cash?

At the end of a month or whenever the amount of currency (actual cash) in the fund becomes low
a summary is prepared of all the settled vouchers assigning the payments made to the appropriate
expense or other categories (accounts) which is used to record the debits to the expense and other
accounts and the total credit to the cash account in the Cash Disbursements Journal.

The current balance of the fund should also be checked by adding up all the currency still on
hand and the total of all the vouchers and tickets. This total should agree with the balance
assigned to the fund. In other words, if the funds assigned balance is $500 the total of all the
tickets and vouches and currency should equal to $500.

A cheque is then prepared and made payable to the Petty Cash Custodian and recorded in the
Cash book.

How do you increase or decrease the Float?

To increase the Petty Cash fund balance, you simply prepare a check made out to the Petty Cash
Custodian for the amount of the increase to the Petty Cash Fund. For example, if your current
fund balance is $100.00 and you want to increase the Petty Cash fund to a balance of $200.00,
you would issue a check for $100.00 and record the cheque in your Cash Disbursements Journal
as a debit to your Petty Cash Account and a credit to your Cash In Bank Account.

The following Petty Cash Book transactions are entered below:

2010

November 1 Cash of $5 000 deposited to Petty Cash account from cash book

November 2 Wages of $100 paid to casual Labourer

November 3 Stamps were bought for $300.

November 5 Floor Polish bought for $50

November 6 Office Worker paid Taxi Fare to travel to special meeting

November 7 Painter paid wages for repainting wall in kitchen

November 10 Office Worker paid Bus Fare to travel to special meeting

November 12 Paper bought for general office purpose

November 19 Bought brushes $60 to clean canteen and office floors

November 21 Ink bought for office use

November 22 Paid a creditor Paul Freddy $400 out of Petty Cash

November 30 Cash of $1 700 deposited to Petty Cash account from cashbook as reimbursed of
cash used throughout the month of November Petty Cash Float balance remains $5 000
Quiz

Question 1

On December 31, 2010, John Henry found that the debit side of his trial Balance exceeded the
credit side by $492. The difference was put to a suspense account. February 11 of 2011 the
following errors were discovered in the books:

1. $165 paid for the purchase of Fixtures had been entered to Purchases account.

2. Commissions received of $112 was debited to the Commissions received account.

3. The Returns Inwards Book was overcast by $57 and the wrong amount was entered to the
Returns Inwards account.

4. $ 217 cash paid to Mike Collester was debited to his account as $271.

5. $15 goods sold to Lee Gray was debited to Lee Mays account.
6. A cheque for $157 received from M. Ruddock was not entered to his account.

Required:

(a) State one purpose of the Trial Balance.

(b) Prepare the necessary Journal entries to correct the above mistakes.

(c) Enter up the Suspense Account.

(d) Identify from the above, ONE error of principle and ONE error of commission.

Solution

(a) The Trial Balance acts as a statement which arithmetically proves that proper double entry is
observed in making accounting entries. There are several errors which will not be revealed by the
Trial Balance.

(b)
(c)
(d)(i) Error of Principle occurred in error # 1 where $165 paid for the purchase of Fixtures had
been entered to Purchases account.

(ii) Error of Commission occurred in error # 5 where $15 goods sold to Lee Gray was debited to
Lee Mays

account.

Question 2

R. Guberman keeps a three column Cash Book. All cheques received are banked immediately.
All small payments of $20 or less are paid out of a petty cash float of $50 and recorded in a Petty
Cash Book with four analysis columns: Postage, Travelling, Sundry Expenses, and small
purchases of stock.

Using the following information, you are required to:

1. Write up his Cash Book and balance it.

2. Write up the Petty Cash Book and balance it.

October 16 Balances: Bank 574

Cash 126

Petty Cash 19

17 Reimbursed petty Cash Float

17 E Winters settled his debt of $580 by cash

less 5% discount.

19 Received cheque from A. Adam 675

19 Paid for stock by cheque. 473

20 Bank charges for services. 3

21 Cash sales for the week 720

21 Purchased postage stamps 12

21 Purchased small items of stock 17

22 Banked cash 500

22 Paid for stock by cheque 650

23 Drew cheques for wages. 300

23 Paid taxi fare for errands 7.65

24 Sent R. Boone a cheque to settle a debt

of $750 , less 4% cash discount.

26 Reimbursed petty cash float

26 Paid for postage of package. 18

28 Cash sales for the week 1,275

28 Banked cash 1,553.35

30 A. Adams cheque for $675 marked

Dishonoured was returned.

31 Paid for cleaning and painting. 15

Solution

1.
2.
Question 3

The following were transactions for Green Food Enterprises for the month of June 2007.

September 1 Sold Goods to V. Bentley 4,500

September 6 V. Bentley returned goods to us 1,200

September 9 Bought goods on credit from M. Mickey 8,400

September 11 Sold goods on credit to C. Ryan 2,400

September 17 Credit purchases from Discount Wholesalers 3,000

September 22 Returned goods to M. Mickey 400

September 24 Bought Fixtures from Best Furnishings for use in the business 4,900
September 28 Sold goods on credit to B. Gumby 1,350
Required:

(A) Make Entries in the books of original entry (subsidiary books) for Green Food Enterprises.

(B) Post the books of original entry to the ledger at the end of the month.

Solution

(A)
(B)
Ledgers and the Trial Balance

The Accounting Equation

We have often heard the expression the books are in balance in reference to the accounting
records of a business. This relates to the use of the double-entry system of accounting, which
says that every transaction will affect two accounts. Because the monetary values are equal we
say the transaction is in balance. Accounting is based on a simple rule, called the accounting
equation.

Using a two pan scale as illustration, the Accounting Equation is really:

The accounting Equation describes items owned by the business on one hand, and the financing
of these items on the other hand.

Assets are the items owned by the business and are represented on the left side of the equation.

Capital and Liabilities represent the financing activities of the business and are represented on
the right side of the equation

Assets may include land and buildings, machinery, motor vehicles, fixtures, cash on hand and
money in the bank, as well as debts owed by customers.

Liabilities represent money owed by the business due to borrowings and credit arrangements
including amounts owed by the business for goods and services supplied and unpaid expenses
incurred by the business.

Capital is the amount of resources supplied by the owner. This includes investments by the
owner as well as retained profits from ongoing business operations.

The accounting equation uses simple math and involves only addition and subtraction.
Regardless of the number of transactions, the Accounting Equation will always balance. The
respective values of assets, capital and liabilities may change but total assets will always be equal
to the total of capital and liabilities. This is because:

Assets = Capital and Liabilities

any item owned by the business must come from some source of financing

Types of Ledgers

Accounting entries are made in books called Ledgers. Most businesses use the following ledgers:

-Sales Ledger: This book contains the personal accounts for customers or debtors.

-Purchases Ledger : This book contains the personal accounts for suppliers or creditors.

-General Ledger: The remaining double-entry accounts such as those related to capital, fixed
assets, expenses and revenues ( except for cash account and bank account ) are entered in the
general ledger.

Classification of Accounts

All accounts may be grouped in two broad categories or classifications. These are personal and
impersonal.

Personal Accounts: These are the accounts that have the names of debtors (customers) or
creditors (suppliers). They are therefore personal to this extent.

Impersonal Accounts: These non-personal accounts may be divided into Real Accounts and
Nominal Accounts.

-Real Accounts - These accounts are tangible in nature and represent accounts that records
possession such as machinery, furniture, premises and stock.

-Nominal Accounts These accounts are intangible in nature and represent accounts that in
which expenses, revenues and capital are recorded.

CLASSIFICATION OF ACCOUNTS
Rules of Entry for general Accounts

An account is divided into two sides, a left side called the debit side and a right side called the
credit side. The title of the account is written in the center at the top of each account.

Accounts Rules for Double Entry

-When increasing an asset account we make a debit entry.

-When decreasing an asset account we make a credit entry.

-When increasing a capital/liability account we make a credit entry.

-When decreasing a capital/liability account we make a debit entry.

Illustration of basic accounting entries

2009

June 1 Owner started business ToyWare with $5,000 cash in hand.

June 5 The business borrowed $10,000 cash from C.Wuggot.

Asset of Stock

Stock refers to all items that a business normally engages in buying or selling to make a profit.
Stock is an asset because it represents goods owned by the business .In accounting certain terms
have specific or restricted meaning but these terms may have a different meaning outside the
context of accounting. In Accounting the term Purchases refers to buying of stock only. Sales
refer to selling of stock only. There are items which may occasionally be bought and sold by a
business which are not stock. These items are fixed assets which are bought not for resale but to
be used in the business for a long time.

Goods may be bought and sold for cash or on a credit basis. When goods are sold on credit the
customer becomes indebted to the business and is called debtors. Debtors are a form of asset and
represents customers who owe the business money usually for items sold on credit. When goods
are bought on credit the business becomes indebted to the supplier and is called creditors.
Creditors are a form of liability and represents suppliers to whom the business owes money
usually for items bought on credit.

There are four basic movements of stock, two representing increases in the asset of stock and
two representing decreases in stock; Each movement requiring its own accounting entry. These
movements are:
Increase of Stock

-Purchases of stock: The Purchase Account will be debited because purchases represent
increases in the asset of stock.

-Returns Inwards of stock: Returns Inwards represent goods returned to the business by
customers. These goods were previously sold so they are also referred to as sales returns. The
asset of stock will increase by the goods returned in, therefore the Returns Inwards (or Sales
Returns) Account will be debited. Goods are sometimes returned due to excess amount received
by customers, wrong type, damaged goods, or inferior quality.

Decrease of Stock

-Sale of stock: The Sales Account will be credited because sales represent decrease in the asset
of stock due to the leaving of stock.

-Returns Outwards of stock: Returns Outwards represent goods returned out to suppliers by the
business. These goods were previously purchased so they are also referred to as purchases
returns. The asset of stock will decrease by the goods returned out, therefore the Returns
Outwards (or Purchases Returns) Account will be credited.

Expense and Revenue Accounts

Expenses

These represent the daily cost to keep the business in effective operation. Expenses would
include light , water bills, telephone charges, wages and salaries, cleaning, transportation,
stationery used, and insurance. All expense accounts are debited.

Revenues

Revenues represent the monetary value of goods and services that have been delivered to
customers. Revenues would include rent received, commissioned received and discount received.
All revenue accounts are credited.

Profit

Profit is the excess of revenues over expenses for an accounting period. It is represented by
revenues minus expenses for the accounting period. Profits will have an increasing effect on
increase capital.

Loss

Loss is the excess of expenses over revenues for an accounting period. Loss will decrease
capital.

Drawings

Drawings represent the monetary of any asset which the owner takes out of the business for his
personal and private use. The drawings account is debited.

Capital and Revenue Expenditure

Capital Expenditure is directly related to fixed assets in that it is incurred when money is spent
by a business to either:

-Buy a fixed asset, or

-Increase the value of a fixed asset in existence.

Revenue Expenditure is not directly related to acquiring fixed assets, but relates to the everyday
cost to operate a business. Revenue expenditure is chargeable to the Trading and Profit and Loss
Account as an expense, while capital expenditure will reflect increase value for fixed assets in
the balance sheet. If the two classification are done incorrectly then the error will affect reported
profit, and the closing capital and value of assets in the balance sheet.

Basic Double Entry

2010

May 1 Owner started business Gummy Sweets with $5 000 cash in hand.

May 3 The business borrowed $10 000 from C. Wuggot which was put to the bank account.

May 4 Bought goods on credit for $400 from M. Dyall.

May 6 Goods returned to M. Dyall $50.

May 11 Rent Received by cheque $200

May 14 Paid wages by cheque $30

May 16 Owner took $ 250 cash from business for personal use

May 19 Sold goods on credit to H. Hannis for $200.

May 23 Goods returned from H. Hannis $20.

May 26 Paid M. Dyall $150 by cheque.

Posting Entries to the General and Subsidiary Ledgers

Balancing of Accounts

The respective accounts for most businesses are closed off at the last day of each month and
reopened for the first day of the following month. The steps by which this is done is referred to
as balancing off the accounts. An account balance is the difference between the totals on the
debit side, and the totals on the credit side of the account of the same account. The account
balance always belongs to the greater side.

The account balance is entered on the lesser side at the end of the month as a balance carried
down. This may be written as balance c/d. When the account is reopened the first day of the
following month the same balance is entered on the opposite side as a balance brought down.
This may be written as balance b/d.

If the debit side exceeds the credit side, the account is said to have a debit balance. If the credit
side exceeds the debit side, the account is said to have a credit balance.
The Trial Balance

The double entry system of accounting states that every transaction will affect two accounts. If
the first account is debited then the second one will be credited or vice versa. It means that every
value that is placed on the debit side of a first account must be placed on the opposite credit side
of a second account.

To ensure that a proper matching credit entry for every debit entry is being observed a Trial
Balance is prepared. A trial Balance is said to be a statement of arithmetic proof to ensure that
proper double entry is being done. This statement is made of a list of account balances arranged
according to whether they are debit balances or credit balances.

Steps to Trial Balance Entry

-The accounts should first be entered.

-The accounts should secondly be balanced off.

-The accounts balances should be entered in the Trial Balance on the same side as the balance
b/d in the accounts.

-Total both debit and credit columns.

If the totals of both columns are not equal then it means that there may be one or more
accounting errors. If both column totals are in agreement then it is assumed that proper double
entry was observed.

The Uses and limitations of the Trial Balance

-The Trial Balance assists in detecting accounting errors

-It provides closing balance figures for accounts to enter for Final Accounts

-It provides a summary of relevant accounts to assist management in making decisions.

The trial Balance will only detect some types of accounting errors. There are roughly seven
errors which will not be revealed by the trial balance. These errors will be looked at separately a
little later.
Quiz

Question

Garvey had the following transactions for the month of January 2007.

2007 $

January 1 Started business with cash 50,000.

January 1 Paid cash for rent 500

January 2 Paid cash for fixtures. 5,000

January 3 Purchased on credit goods from

E. John. 475

January 5 Cash Purchases 1599

January 13 Cash sales 300

January 18 Sold goods on credit to A. Goodman 742

January 27 Received cash from A. Goodman 500

January 31 Stock of goods sold for cash 520

Required:

(A)Record and balance transactions in the relevant accounts including a cash account in the
ledger of A. Garvey.

(B)Extract a Trial Balance.

Solution
Preparation and Analysis of Financial Statements

Financial Statements

Financial Statements are summary accounting reports prepared at stated time periods to inform
the owner, creditors, and other interested parties as to performance of the business. Financial
Statements uses summarized data to prepare the businesss financial reports.

Financial statements have generally agreed-upon formats. There are three main financial
statements:

-Trading and Profit and Loss Account

-Balance Sheet

-Statement of Cash Flows

Each financial statement provides a different perspective Combined the financial statements
provide a general overview of the company, the impact of its activities, its financial strength, and
an overview of its cash flow. Evaluating allows directors to formulate effective strategic policies,
and implement factors that will increase efficiency.

The Valuation of Stock

The closing stock figure at the end of the year may be valuated used several methods.

First in, First Out (FIFO) Method

This method of valuating closing stock assumes that stock of goods are sold in order of those
which were first purchased ( First In) being sold first (First Out).

Last In, First Out (LIFO) Method

This method of valuating closing stock assumes that stock of goods are sold in order of those
which were last purchased ( Last In) being sold first (First Out).

Average Cost (AVCO) Method

The average cost of each item of stock in hand is recalculated whenever there is a receival of
new stock of goods. The new average cost is calculated by adding the old average cost to the unit
cost of the new item of stock and divide by two.
Below is a fully worked example:

From the following figures calculate the closing stock value using the FIFO, LIFO and AVCO
method of stock valuation.
The Trading and Profit and Loss Account

One of the main aims of operating a business is to make profit. Profit is calculated in a Trading
and Profit and Loss Account. This is divided in a Trading Account which calculates the Gross
Profit for the period, and a Profit and Loss Account which calculates Net profit for the period.
The Trading Account calculates the profit made strictly from trading activities. Trading
involves buying and selling. In the trading account the cost of goods sold is subtracted from Net
Sales for the period to calculate Gross Profit.

Cost of Goods Sold the value of the goods sold at cost.

Net Sales the actual sales made after all adjustments have been made for goods returned.

Gross Profit this is the excess of Net Sales over Cost of Goods Sold.

Gross Loss this is the excess of Cost of goods sold over Net Sales.

At the end of a financial period, all expense and revenue accounts are closed to a summarizing
account usually called a Profit and Loss Account. This is the financial statement that summarizes
revenues and expenses for a specific period of time, usually a month or a year.

The Profit and Loss Account reflects a Period of Time Month, Quarter, Year. It shows financial
the activity of a business during that period and indicates any profit or loss earned.

Revenue is the value of goods and services which have been delivered to customers.

Expenses costs incurred in earning these revenues.

Net Profit is the excess of Revenue over Expenses, on the Profit and Loss Account.

Net Loss is the excess of Expenses over Revenue, on the Income Statement.
The Balance Sheet

The statement of financial position of a business sums up its economic resources, obligations
(debts and other non-current liabilities) and owners capital at a particular point of time. It also
shows how the economic resources contributed by lenders and shareholders are used in the
business.

Balance sheet items are classified as assets, liabilities, or capital, and the amount and nature of
these items are shown at a specific date in time.

Assets Something the company owns that has value.

Liability Money the company owes to creditors.

Capital This is the portion that remains after liabilities are subtracted from assets. Capital
includes profit or Loss from the business.

Drawings Represent assets taken out by owners of the business

The Balance Sheet:

Reflects a Moment in Time

It indicates Assets, Liabilities and Equity of business as of a specific date.

Shows Financial Position of Business as of specific date:

Financial Position what you have/what you owe/what your stockholders have Have Owe
= Value to Owner

Value of Business to Owners

Assets Liabilities = Capital

The effect of Net Profit or Net Loss on the Balance Sheet

In the balance sheet net profit is added to capital because profit increases capital. It also follows
that in net loss will be subtracted from capital because a loss will reduce the owners capital.

Working Capital
This is the excess of current (or short term) assets over current (or short term) liabilities. To
calculate working capital the total of Current liabilities is subtracted from the total of Current
assets.

Working Capital may be used as a tool for solvency. The calculation involves strictly short term
items and therefore working capital reveals the assets of the business that are most easily
converted to cash in the short term. This has significance for the liquidity or solvency of the
business or its ability to deal with short term payments. In the long run fixed assets may be sold
to offset immediate cash obligations.
The calculation of working capital
Accounting Ratios

A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values
taken from an enterprises financial statements. Often used in accounting, there are many
standard ratios used to try to evaluate the overall financial condition of a corporation or other
organization. Financial ratios may be used by managers within a firm, by current and potential
shareholders (owners) of a firm, and by a firms creditors. Security analysts use financial ratios
to compare the strengths and weaknesses in various companies.

Financial ratios quantify many aspects of a business and are an integral part of the financial
statement analysis. Financial ratios are categorized according to the financial aspect of the
business which the ratio measures.

Financial ratios allow for comparisons:

-between companies

-between industries

-between different time periods for one company

-between a single company and its industry average

Ratios generally hold no meaning unless they are benchmarked against something else, like past
performance or another company. Thus, the ratios of firms in different industries, which face
different risks, capital requirements, and competition, are usually hard to compare.

Profitability ratios

Profitability ratios measure the companys use of its assets and control of its expenses to
generate an acceptable rate of return. These are concerned with the return on investment for
shareholders, and with the relationship between return and the value of an investment in
companys shares.

Activity ratios (Efficiency Ratios)

Activity ratios measure the effectiveness of the firms use of resources. Activity ratios measure
how quickly a firm converts non-cash assets to cash assets.

Liquidity ratios

These measure the availability of cash to pay debt.

Debt ratios (leveraging ratios)

Debt ratios measure the firms ability to repay long-term debt. Debt ratios measure financial
leverage.

Market Ratios

If shares in a company are traded in a financial market, the market price of the shares is used in
certain financial ratios. Market ratios measure investor response to owning a companys stock
and also the cost of issuing stock. These are concerned with the return on investment for
shareholders, and with the relationship between return and the value of an investment in
companys shares.

If shares in a company are traded in a financial market, the market price of the shares is used in
certain financial ratios.

Mark-Up and Margin Ratios

Mark-up is profit expressed as a fraction or as a percentage of the cost of good.

Margin is profit expressed as a fraction or as a percentage of the sales price.

Stock Turn Ratio

Stock turn provides an indication as to how fast or slow stock is been sold. It also indicates the
efficiency of the business in terms of its control of stock levels. Assuming that gross profit
percentage remains constant, a faster sale of stock will mean increases in profits from sales;
likewise a slower sale of stock could mean decreases in profits.

The formula for stock turn is:

The Average stock is calculated as ( opening stock + closing stock ) 2

Gross Profit & Net Profit as a percentage of sales Ratios

Gross Profit as a percentage of sales

Sales revenue does not tell the total picture of performance. The sales revenue of a business may
significantly increase with only marginal increase in actual gross profit. Gross profit as a
percentage of sales provides information on the profitability of sales; that is the gross profit per
$100 of sales.
The formula is:

Net profit as a percentage of sales

Net profit as a percentage of sales provides information on the profitability of sales; that is the
net profit per $100 of sales.

The formula is:

Liquidity,Current & Acid Test Ratios

Liquidity Ratios

The ability of a business to meet current financial obligations such as loan repayments, expenses
and creditors is crucial to its continued existence. A business is said to be liquid when it is able
to pay its debts on time. It is equally important that the business collect from debtors their
outstanding amounts on time. Two ratios directly related to the liquidity or solvency of
businesses, are the Current Ratio and the Acid Test Ratio.

Current Ratio

This ratio provides indication of the business to meet its short term financial commitments. The
comparison is made with (current) assets which will become liquid within a year and (current)
liabilities which should be paid within the same period of one year. This will indicate if the
business has enough short term assets to meet its short term payments. The formula for current
ratio is:
Acid Test Ratio

Acid test ratio indicates the ability of the business to meet it short term payments given the
situation where all debtors settle and all creditors are paid at the same time. The formula for Acid
Test ratio is:

Return on Capital employed (ROCE)

Capital employed is basically the effective capital that is being used in the business. The average
of the capital account for the year i.e. (opening capital + closing capital) 2 may be used as
capital employed. Most people start a business with the hope to make satisfactory returns on their
capital employed. The formula for capital employed is:
This shows that effective use of capital is very crucial to the success of a business. Company A
has made a return of 30% net profit on its capital. Company B has only made a return of 10% net
profit on its capital although it has three times the value of capital.

Illustration of a Basic Financial Analysis of a Business

As seen from the table above, Adam Wesley is very liquid, enjoying a high liquidity ratio of 16.
This is augers well for the future.

The Gross Profit margin on sales is also attractive. A 35% profit margin on sales signals that
Adam Wesley should recoup his investment and then some.

The Current Ratio may be a bit too high, suggesting that some of the cash or bank can be
invested rather than resting in the bank or remaining as cash in hand. Cash or bank is best held in
such amounts as will be needed to fund the daily working of the business and no more. On a
positive note, it is better to have this ratio too high, as all Adam Wesley needs to do to regularize
this, is to invest some of the extra liquidity. If the converse is the case, the business may have to
take a loan or risk running into overdraft.

Notwithstanding the positive return on investment at the end of the day, the investor must,
however, look at the rate of return they desire on their investment because ultimately it makes
little sense to operate a business to achieve a rate of return which is lower than could have been
obtained had the money been invested in a money market instrument, for instance.

Quiz

Question 1

The records of R. Graham showed the following purchases and sales of stock for the months of
May and June 2006.

May 2 Purchased 12 boxes of wine at $40 per box

May 17 Purchased 20 boxes of sodas at $20 per box

June 8 Purchased 10 boxes of vinegar at $60 per box

June 25 Purchased 5 boxes of vinegar at $10 per box

June 30 Sold 32 boxes at $65 each.

Required:

Use the LIFO, FIFO and AVCO methods of stock valuation to calculate the value of closing
stock. Please show all workings clearly.

Solution
Question 2

The Following balances were extracted from the Trial balance of T. Brooks Wholesale at the end
of 2005.

Creditors 1400

Purchases 32,000

Returns Outwards 3,600

Opening Stock 4,800

Closing Stock 3,200

Rent owing 600

Debtors 2,000

Cash in hand 2,800

Required:

1. Calculate the following Ratios:

(a)Current Ratio

(b)Acid Test Ratio

(c)Rate of Stock Turnover

2. What is the purpose of each ratio?

3. Identify one limitation associated with the use of accounting ratios.

Solution

1.

2.
(a) Current Ratio provides indication of the business to meet its short term financial
commitments. The comparison is made with (current) assets which will become liquid within a
year and (current) liabilities which should be paid within the same period of one year. This will
indicate if the business has enough short term assets to meet its short term payments.

(b) Acid test ratio indicates the ability of the business to meet it short term payments given the
situation where all debtors settle and all creditors are paid at the same time.

(c) Stock turn provides an indication as to how fast or slow stock is been sold. It also indicates
the efficiency of the business in terms of its control of stock levels. Assuming that gross profit
percentage remains constant, a faster sale of stock will mean increases in profits from sales,
likewise a slower sale of stock could mean decreases in profits.

3. Ratios may become misleading if they are not used in proper context. The same ratios need to
be used as a means of comparison for different time periods of a business, or in comparison with
similar business entities.

End of Period Adjustments

Expenses and Revenues

Reasons for adjustments in revenue and expense accounts

The Accruals Concept of accounting states that in calculating net profit the expenses for the
period should be subtracted from the revenues generated in the same period. The process by
which the revenues and expenses for the period are ascertained is referred to as matching
expenses with revenues.

At the end of each accounting period some adjustments may be needed for some expense and
revenue accounts. This is due to some of these accounts having outstanding balances as well as
having prepayments and advanced revenues advance.

Entries for prepaid expenses and accrued expenses at the beginning and end of a period

Entries for advance revenues at the beginning and end of a period

Below is an example:

On January 1, 2010 the following balances among other balances stood in the books of T. Tyler.

(a)Light owing $100

(b)Rates prepaid $700

(c)Commissions Received outstanding $1000

During the financial year ending December 31, 2010 the following transactions were recorded:

1. Paid light by cheque $900

2. Paid rates by cash $1000

3. Received Commission by cheque $2500

At the end of the financial period December 31, 2010 the following accounts showed balances:

1. Light expense owing $200

2. Rates prepaid $$100

3. Commission received outstanding $500

You are required to write up the accounts including the correct amount to transfer to The Profit
and Loss Account ended December 31, 2010, and any balances to be carried forward to 2011.
Accruals and Prepayments in the Balance Sheet

Prepaid expenses represented assets of the business. The total of prepaid expenses will be listed
in the balance sheet immediately under debtors as a current asset.
Accrued expenses are a form of current liability and will be listed in the balance sheet under
current liabilities.

Distinction between Bad Debts and Doubtful Debts

When debtors fail to settle their accounts for items sold on credit a bad debt will occur. A bad
debt is an amount that is written off by the business as a loss to the business and classified as an
expense because the debt owed to the business is unable to be collected, and all reasonable
efforts have been exhausted to collect the amount owed. This usually occurs when the debtor has
declared bankruptcy or the cost of pursuing further action in an attempt to collect the debt
exceeds the debt itself.

The debt is immediately written off by crediting the debtors account and therefore eliminating
any balance remaining in that account. A bad debt represents money lost by a business which is
why it is regarded as an expense.

Doubtful debts are those debts which a business or individual is unlikely to be able to collect.
The reasons for potential non payment can include disputes over supply, delivery, and conditions
of goods or the appearance of financial stress within a customers operations. When such a
dispute occurs it is prudent to add this debt or portion thereof to the doubtful debt reserve. This is
done to avoid over-stating the assets of the business, as trade debtors are reported net of Doubtful
debt. When there is no longer any doubt that a debt is uncollectable the debt becomes bad. An
example of a debt becoming uncollectable would be: once final payments have been made
from the liquidation of a customers limited liability company, no further action can be taken.

To be considered as deductible, debts:

-must be a bona-fide debt, and

-worthless within the taxable year

An Ageing Debtors Schedule is set up where the debts are scheduled according to their age
starting with from youngest to the oldest debts. This will assist in the calculation of bad debts,
where the older debts are given a higher probability of bad debt, as well to determine those older
debts that may not be collectible.

Provision for Bad Debts

A provision for bad debts is an estimation for bad debts on the balance of debtors at the end of
the financial period.

-This bad debts provision expense attempts to allow as accurate as possible a calculation for bad
debts for the year in which the debt occurred.

-It also allows for as accurate a figure for debtors at the date of the balance sheet.

Accounting entries for Bad Debts and Provision for Bad Debts

Both Bad debts and Provision for bad Debts are expenses and are therefore entered to Profit and
Loss Account. However, only Provision for bad debts is entered to the balance sheet.
Below is an example

Enter up the Bad Debts account, Provision for Doubtful Debts Account, The Profit and Loss
Account extracts, and Balance Sheet extracts for the relevant years from the table below.
Provision for Depreciation

Depreciation refers to two very different but related concepts:

(1) The decrease in value of assets (fair value depreciation)

(2) The allocation of the cost of assets to periods in which the assets are used (depreciation with
the matching principle).

Causes of depreciation

The former affects values of businesses and entities. The latter affects net income. Generally the
cost is allocated, as depreciation expense, among the periods in which the asset is expected to be
used. Such expense is recognized by businesses for financial reporting and tax purposes.
Methods of computing depreciation may vary by asset for the same business. Methods and lives
may be specified in accounting and/or tax rules in a country. Several standard methods of
computing depreciation expense may be used, including straight line, and reducing balance
methods. Depreciation expense generally begins when the asset is placed in service.
Factors to consider when calculating depreciation

Depreciation is the gradual decrease in the economic value of the fixed assets of a business,
either through physical depreciation, obsolescence or changes in the demand for the services of
the asset in question.

While depreciation expense is recorded on the income statement of a business, its impact is
generally recorded in a separate account and disclosed on the balance sheet as accumulated
depreciation, under fixed assets, according to most accounting principles. Accumulated
depreciation is known as a contra account, because it separately shows a negative amount that is
directly associated with another account.

Depreciation expense is charged against accumulated depreciation. Showing accumulated

depreciation separately on the balance sheet has the effect of preserving the historical cost of
assets on the balance sheet. If there have been no investments or dispositions in fixed assets for
the year, then the values of the assets will be the same on the balance sheet for the current and
prior year.

Methods for calculating depreciation

There are several methods for calculating depreciation, generally based on either the passage of
time or the level of activity (or use) of the asset.

-Straight-line Method

Straight-line depreciation is the simplest and most-often-used technique, in which the company
estimates the disposal value of the asset at the end of the period during which it will be used to
generate revenues (useful life) and will expense a portion of original cost in equal increments
over that period. The disposal value is an estimate of the value of the asset at the time it will be
sold or disposed of; it may be zero or even negative. Disposal value is also known as scrap value
or residual value.

-Reducing Balance Method

Depreciation may be given as a fixed percentage annually and may be applied on cost in the first
year, but in subsequent years applied on the reduced balance or net book value of the previous
year. This method is called the reducing balance method.
Below is an Example

A motor van was bought on January 1, 2009 for $10 000. It has an estimated life of ten years
with an annual depreciation of 10% straight line method. Calculate the annual depreciation for
2009 to 2011 and make entries to Provision for Depreciation AccountMotor Van, and Balance
Sheet.
Quiz

Question 1

Sam Browns accounting period is from January 1 to December 31. The following provides
information for three periods.
Year Debtor Balances Provision for Doubtful Debts

2000 20,000 5%

2001 30,000 6%

2002 25,000 4%

Required:

Write up the Provision for Doubtful Debts Account for each of the three years ending December
31 2000 to 2002.

Solution

Question 2

Novelty Chemicals bought a Motor Vehicle for $110,000 on January 5, 2002. The estimated
useful life of the vehicle is ten years. The disposal value is estimated at $10,000. Annual
depreciation is on the straight line method.
Required for years 2002, 2003 and 2004:

(a)The accumulated Depreciation account- Motor Vehicle

(b)The Balance Sheet extracts for motor vehicle and its related depreciation.

(c)The Profit and Loss accounts extracts for annual depreciation

Solution
Question 3

The Trial balance of Wholesome Groceries as at December 31, 2005 is shown below.
Notes:

Closing Stock $18,000

Rent paid in advance $4,000

Wages and Salaries owing $3,400

Insurance owing $600

Provision for doubtful debt to be created $600

Depreciation on machinery and equipment for the period $3,000

Prepare the Following for Wholesome Groceries:

1. The Trading and Profit and Loss account for the period ending December 32, 2005

2. The Balance Sheet as at December 31, 2005.

Solution

1.
2.
Control Systems

The Need for Control Systems

All accounting information systems have controls or checks in place to ensure accounting errors
and irregularities are minimized. Given the division of the accounting function carried out by
various persons these controls become very relevant to ensure the accounting system is working
in harmony.
Common control systems include:

-Suspense Accounts

-Control Accounts

-Bank Reconciliation Statements

Types of Accounting Errors

A Trial Balance is said to be a statement of proof done arithmetically to prove that proper double
was observed in making accounting entries. The assumption is that the Trial balance totals will
not agree whenever there is an accounting error. There are several errors in fact which will not
affect the agreement of the trial balance totals. This means that there are two basic types of
accounting errors:

-Errors which do not affect the Trial balance totals

-Errors which do affect the trial balance totals

The correction of all accounting errors must be journalized by way of the General Journal.

Accounting errors not detected by the trial balance are listed below:

Error of Omission this occurs when a transaction is completely left out or omitted from the
accounting entries.

-Accounting Error: Credit purchases of goods $100.from Al Binno omitted from the records.

The omitted entries will need to be entered.

The correction is journalized below:

Error of Commission This occurs where proper double entry is observed except an entry is
made to the wrong personal account.

-Accounting Error: Cash of $200 received from debtor V. Green entered correctly to cash but
incorrectly to W. Greens account.

The error will need to be corrected in W. Greens account and entered correctly to V. Greens
account.

The correction is journalized below:

Error of Principle This occurs where an entry is made to the wrong classification of account.

-Accounting Error: Cash of $400 paid for motor expenses correctly credited to cash account but
incorrectly debited to motor van account.

The incorrect entry will need to be subtracted from motor van account and correctly entered to
motor expense account.

The correction is journalized below:

Compensating Errors These occur where two or more accounting errors cancel out their effect
on the trial balance.

-Accounting Error: Purchases account is overcast or overstated by $500; while $500 is omitted
from the rent account.

An account is said to be overcast when its total is in excess of the correct amount, and under-cast
when the total is less than the correct amount.

$500 will need to be deducted from the purchases account and $500 added to the rent account.

The correction is journalized below:

Error of Original Entry With this type of error the accounts are entered correctly except with
the wrong figures.

-Accounting Error: Cash drawings of $1000 entered to both Cash and Drawings accounts as
$100.

$900 is needed to be added to both accounts to correct the errors.

The correction is journalized below:

Complete Reversal of Entries When accounting entries are mistakenly reversed the entries are
still debited to one account and credited to another.

-Accounting Error: Cash Payment for Furniture $77 debited to Cash account and credited to
Furniture account.

The values of the entries to make corrections will need to be doubled. This is because the first
entry is to correct the mistake and the second entry represents the actual entry.

The correction is journalized below:

Transposition Error A Transposition Error occurs when entries are made to the correct
account but the figures are not entered in the correct order.

-Accounting Error: Goods $25.returned inwards from W. Wugget entered to both accounts as
$52.

Both accounts will need to be decreased by $27 to make corrections

The correction is journalized below:

Suspense Accounts

When the trial balance totals do not agree and the errors cannot be found immediately the
difference is put to an interim account until the errors are located. Since the errors are put to
suspense the account is refereed to as a Suspense Account. The suspense account balance is
entered in the Trial Balance on the same side of the balance in the suspense account.

If the errors are not located by the end of the financial period, then the suspense account will be
entered in the Balance Sheet. Whenever the errors are located they are taken from the Suspense
Accounts and corrected in the account containing the error.

Below is an example:

The trial balance at December 31, 2009 for Wally West showed a difference reflecting a shortage
of $100 on the credit side. A suspense account is opened and the difference of $100 is put to the
credit side of the account. Net Profit was calculated to be $20,000.

March 5 of 2010 the following errors were found from the previous years errors.

(a) Credit purchases to K. Kenny $250 entered as $100 to both accounts.

(b) Cash sales $550 entered correctly to cash account but incorrectly entered to sales account as
$500.

(c) Drawings from bank $750 entered correctly to drawings account, but omitted from bank
account.

(d) Cash received from a debtor D. Marvin $1200 is correctly entered to cash account, but
credited to D. Marvins account as $1900.
The Effect of Accounting Errors on Final Accounts

Where accounting errors represent items normally entered for Final Accounts then the original
incorrect profit figure would need to be adjusted to calculate the correct figure for profit. A
statement of Corrected Net Profit would be prepared to calculate the correct profit.

A statement of corrected Net Profit for the above error is illustrated below
Control Accounts

A Trial Balance is said to be a statement of proof done arithmetically to prove that proper double
was observed in making accounting entries. The assumption is that the Trial balance totals will
not agree whenever there is an error. With the division of accounting records into different books
of entries it becomes difficult to identify a specific accounting error due to the number of books
to search. What is needed is a form of Trial balance for each ledger so that only those ledgers
with errors need searching. This simplifies the accounting work. This need is met by Control
Accounts.

A Control Account is a general ledger account that provides summarized information on the
detailed balances of the individual records maintained in a subsidiary ledger. Subsidiary Ledgers
provide the detail information about what makes up the balance in the control account.

Uses of Control accounts

-Assist in locating errors example in books like the sales ledger and purchases ledger.

-Minimizes fraud by assisting the scrutiny of records.

-Acts as an aid to management by providing summarized accounting information.

Sales Ledger Control Accounts and Purchases Ledger Control accounts

Two of the most common Control Accounts are Sales Ledger Control Accounts and Purchases
Ledger Control Accounts. After posting all transactions the balance of the Control Account and
the sum of the detailed records in the Subsidiary Ledger should always be the same. In other
words, a control account deals with summarized information while a subsidiary ledger deals with
detailed information. Because the control accounts contain summarized information they are
also called total accounts. Therefore a control account for a Sales Ledger can be called a Sales
ledger Control accounts or Total Debtors Account. A control account for a Purchases Ledger can
be called a Purchases Ledger Control account or a Total Creditors Account.

Sources of information for entries in Control Accounts

Significance of the balances on the control accounts

The closing balances on the sales ledger control accounts should be equal to the sum total of the
closing balances on the individual debtor accounts in the sales ledger. It follow as well that the
closing balances on the purchases ledger control accounts should be equal to the sum total of the
closing balances on the individual creditor accounts in the purchases ledger. If the respective
balances are not in agreement then it would suggest some form of irregularity in the records
which would need investigation.
Bank Reconciliation Statement

The bank columns of the cashbook records money paid out and received by the business bank
account. Both the bank and business concerned should have identical records of these
transactions since both records refer to the same transactions. The bank will regularly send to the
business concerned a copy of its related transactions. This is called a bank statement.

The business will check its cash book bank entries against the entries in the bank statement. The
differences found many times are due to:

-Genuine recording errors

-Fraud

-The difference in time when the entries to the cashbook of the business and the banks records
are made; most of the time it is due to this third factor.

Items which may cause a time difference in making entries to the cash book and the banks
records

Unpresented Cheques

These are cheques paid out and recorded by the business but have not been received by the bank
for payment. Unpresented cheques will therefore be found on the payment side of the cashbook
but not on the bank statement.

Late Lodgements

These are cheques received and recorded in the cashbook by the business which have not been
lodged, or were lodged late, so were not entered on the bank statement. Late Lodgements will be
found on the receipts side of the cashbook but not on the bank statement.

Standing Orders

A business may instruct its bank to make regular payments to stated entities on its behalf. These
would have been entered on the banks records first and would therefore be found on the
payment side of the bank statement but not in the cash book of the business.

Direct Debits

These represent payments where the creditor is given permission to withdraw the payments
directly from business bank account. These would first be recorded by the bank. Direct Debits
are found on the payment side of the bank statement but not in the cash book.
Bank Charges

These represent payments of the business for some services provided by the bank. These
payments would automatically be withdrawn from the business account by the bank so would
first be on the banks records. Bank Charges would be found on the payment side of the bank
statement but not in the cash book.

Credit Transfers

These represent funds transferred to the business bank account from another account through the
banking system. This would first be entered on the banks records. Credit Transfers are found on
the receipts side of the bank statement but not in the cash book.

Dishonoured Cheques

If a cheque is received by the business and lodged to the bank but later discovered by the bank to
have some irregularity, the bank will not accept the cheque. This dishonoured cheque would first
be recorded by the bank. Dishonoured cheques will be found on the payment side of the bank
statement but not in cashbook of the business.

Below is an example:

The bank columns in the cash book for May 2011 and the bank statement for the same month for
C. White are shown below.
You are required to:

(a) Update the cashbook with the correct balance as on May 31, 2011

(b) Draw up a bank reconciliation statement, reconciling the corrected cash book balance with
the bank statement balance.
Quiz

Question 1

The following errors were found in the books of Bell Traders:

-Credit sales $536 to V. Bennett was omitted from the books.

-$758 discount received was mistakenly debited to Discount Received Account.

-$530 discount allowed was entered in error as $503 in T. Wilsons account.

-There was a bank overdraft of $626 which was entered in error in the bank account as $662.

-A discount received of $474 was entered in the cash book but was not entered in S. Riddick
account who was a creditor.

-A credit sale of $2,000 to G. Jones had been omitted from the accounts.

-A machine bought for cash $1,000 as a fixed asset was entered to Purchases book.
Required:

1. Journalize the correction of the above errors.

2. Post the relevant entries to Suspense account.

3. Enter in Suspense account the figure which represented the original difference in the Trial
Balance.

Solution

1.
2.

3.The figure which represented the original difference in the Trial Balance is $1033.

Question 2

The following Details were extracted from the books of Angene Bisor;

2007

October 1 Debit balances for Sales Ledger 3,050

Credit balances for Sales Ledger 150

Credit balances for Purchases Ledger 12,500

Debited balances for Purchases Ledger 925

Totals for the month ending October 31, 2007

Credit sales 10,050

Cash and cheques received 7,100

Bad Debts written off 375

Discounts Allowed 250

Returns Inwards 500

Dishonoured cheques from customers 700

Purchases Journal 15,750

Cheques paid to suppliers 17,500

Discount Received 870

Returns Outwards 300

Required:

(A)Enter up the Sales Ledger Control accounts and The Purchases Ledger Control Accounts for
October 2007.

(B)From which books would the total of Credit Sales, Discount allowed, and Returns Inwards be
taken.

Solution

(A)
(B)

Items for entry in Control Account Source

Total Credit Sales The Sales Journal

Discounts Allowed The Cash Book

Returns Inwards The Returns Inwards Journal

Question 3

The Following is a summary of the bank account in the Cash Book of X. Wethernorth for the
month of April 2001.
You are informed that:

-Bank charges of $70 shown on the bank statement have not been entered in the cash book.

-Four cheques in the sums of $100, $150, $125 and $175 have not been presented to the bank

-A Standing Order for Utilities of $200 was paid by the bank but not entered to the cash book.

-A customers cheque for $400 was returned by the bank marked refer to drawer. No entry was
made in the cash book.

-The bank did not credit Wethernorths current account with a lodgement of $ 2,500 made on
April 30 2001.

-Two customers D. Mark and F. Garvey deposited $200 and $300 respectively directly into the
current account of Wethernorth.

Required:

(a)Show the adjustments you will make in Wethernorths Cash Book.

(b)Prepare a Bank Reconciliation Statement as at April 30, 2001 to show the Bank Statement
balance.

Solution
Mock Exam

Question 1
Solution
Question 4
Solution