UNIT 10 Unit Code

FINANCIAL ACCOUNTING A/508/0496

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 WHAT IS ACCOUNTING?

 Accounting af fects people in their personal lives as much as it

af fects businesses. We are constantly planning what to do
with our money in our everyday lives. We plan how much to
spend or save.
 In the world of business, accounting is a process of recording
transactions, to calculate, among other things, profits or
losses and how much can be invested in the business.
 It is the art of controlling a business , by keeping accurate
bookkeping records in order to indicate in which direction the
company is going.
 It is known as the “ language of business”.

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 WHAT IS BOOKKEEPING?

 Bookkeeping or financial reporting is a way of recording,

analysing and summarising financial data.
 Financial data is actual transactions carried out by the
business, e.g sales or purchases of goods.
 This financial data is inputted into a set of financial
statements, which shows the key information about the
business.
 There are two key documents making up the financial
statements of a business. These are:
 the Income Statement; and
 the Statement of Financial Position .

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 OBJECTIVES OF BOOKKEEPING

There are many dif ferent objectives of bookkeeping, such as:

o To have a record of all business transactions;
o To keep track of income and expenses in such a way that the
profit or loss of the business may be calculated;
o To keep track of expenses in order to find a way how to
increase profits;
o To keep record of assets and liabilities in a way that the
financial position of the business may be assessed;
o To know the names of customers and amounts due from them;
o To know names of suppliers and amounts due to them;
o To extract information for legal and tax purposes.

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 USERS OF ACCOUNTING INFORMATION

 Owners of the business – to be able to see whether the

business has made a profit or not;
 A prospective buyer – to see how much the business is worth;
 The bank – should the owner wish to borrow a bank loan;
 Tax inspectors – to calculate tax payable;
 A prospective partner – should someone wish to invest in the
business;
 Existing or potential investors – should they wish to invest
more money in the business.
 Without properly recorded accounting data, a business would
have dif ficulty providing the information to its various users,
often referred to as stakeholers.

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 CATEGORIES OF TRANSACTIONS

 Income generally relates to revenue generated by making sales

to a customer but also includes other sources of income such as
interest received.
 Expenses are operating costs incurred by the business such as
purchases, electricity and water.
 Assets are things owned by the business such as equipment and
premises.
 Liabilities are things owed by the business to third parties such
as bank loans or trade payables.
 Capital is the amount of money that the owner invested into the
business.
 Drawings are amounts of money withdrawn or goods taken from
the business by the owner to settle his personal expenses.

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 FURTHER DEFINITIONS

 Sales is income received from selling goods or services to

suppliers.
 Purchases are items bought by the business in order to produce
goods or services to sell.
 Returns In or Sales Returns are when customers returns goods
which were sold to them back to the business.
 Returns out or Purchases Returns are when the business returns
goods bought back to its suppliers
 Trade Receivables or Debtors refer to customers or other parties
who owe money to the business, generally these are made up of
customers of the business.
 Trade payables or Creditors refer to the suppliers or other parties
who are owed money by the business.

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 THE ACCOUNTING EQUATION

 By adding up what the accounting records say what the

business owns (i.e. its Assets) and what the business
owes (i.e. its Liabilities), you can identify what the
business is worth.
Resources supplied by the owner = Resources in the
business
 Therefore, the financial position of a business is
measured by the following items:
- Assets (what the business owns);
- Liabilities (what the business owes);
- Capital or Owner’s equity (the dif ference between
assets & liabilites).

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 THE ACCOUNTING EQUATION

 The accounting equation of fers a simple way of how to

understand how these ite ms relate to each other:
ASSETS – LIABILITIES = CAPITAL
 No matter how the accounting equation is presented, the total
of both sides must always be equal. This is always true no
matter how many transactions there are in the period.
 The balance in the equation is maintained because every
business transaction af fects at least two items – the double
entry accounting system.

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 DOUBLE ENTRY

 The double entry system of accounting suggests that each

transaction impacts upon at least two balances in our
accounts. Therefore each transaction has a dual ef fect.
 For example;
 A cash sale to a customer will have the following dual effect:
– the balance of the cash will increase;
– the balance of the sales will increase.

 A credit purchase from a supplier will have the following dual

effect:
– the balance of the purchases will increase;
– the balance owed to the supplier will increase

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 DOUBLE ENTRY

 We must ensure that when recording data, only the ite ms

af fected by the transaction have changed.
 The double entry is a system of debit (DR) and credit (CR)
entries that describe the dual ef fect of a financial
transaction.
 Every double entry must balance with equal values on the
debit and credit sides.
 Therefore:
Debit entry = Credit entry

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 DEAD CLIC

 A useful acronym to help you remember the basics of double

entry is DEAD CLIC.

Debit increases Credit increases

Expenses Liabilities
Assets Income
Drawings Capital
o Therefore, for a cash sale to a customer:
- the increase in the balance of the cash, will require a
debit entry;
- the increase in the balance of the sales, will require a
credit entry.
This gives a balancing double entry of DR cash and CR sales.

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SUMMARY OF DOUBLE ENTRY RULES

Accounts To record Entry in the account

Assets An increase Debit
Assets A decrease Credit
Expenses An increase Debit
Expenses A decrease Credit
Liabilities An increase Credit
Liabilities A decrease Debit
Capital An increase Credit
Capital A decrease Debit
Income An increase Credit
Income A decrease Debit

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 EXAMPLES

o A credit sale of €2,000.

 DR Trade Receivables €2,000
 CR Sales €2,000
o A credit purchase of €600.
 DR Purchases €600
 CR Trade Payables €600
o Receiving €500 from a credit customer.
 DR Cash €500
 CR Trade Receivables €500
o Buying a laptop for €800.
 DR Laptop Asset Account €800
 CR Cash €800
o Taking out a loan of €8,000 from the bank .
 DR Bank €8,000
 CR Bank Loan (Liability) €8,000
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