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1 Understanding and Managing Finance 3 This Presentation is in Self-Study Form To start the presentation: Press F5 (Top Row of Keyboard) Then use the navigation buttons at the foot of each page

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2 Understanding and Managing Finance Presentation 3 Self-Study Version

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3 Objectives for This week After studying this weeks work, you should: Understand the principles behind double entry bookkeeping Be able to record transactions in a simple system Begin to understand how these transactions can contribute to more formal financial statements such as Balance Sheets and profit & Loss Accounts.

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4 Menu 3a Bookkeeping: Terms & Principles 3b Bookkeeping Examples 3c Follow-Up Activity: CashBook

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5 Part 3a Bookkeeping Some Terms & Principles

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6 A Reminder of Essential Terminology What are Assets and Claims?

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7 A Reminder of Essential Terminology What are Assets and Claims? Assets are what the business owns. This can be anything: money in the bank, stock held, buildings, cars, land etc. and also any monies owed to the business. Claims are what the business owes. This can be bank loans extended to the business, unpaid bills, profits which can be claimed by the owner or shareholders

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8 The Wealth of a Company As we have seen, the main purpose of a Balance Sheet is to show the total wealth of a business at a single point in time We show the Assets and the Claims To work effectively, a Balance Sheet should Balance, that is what the business owns should exactly match what the business owes In other words, the net worth is zero.

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9 Balance Sheet Example Lemonade Stall (From Last Week) Assets: Cash: 65 Stock: 20 (100 x 20p) Total: 85 On Day 2 of the Lemonade Stall (Last week) we had: Total business assets:85 Total claims on the business:85 Net worth of business 0 Claims: Loan outstanding: 20 Retained profits: 65 Total: 85

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10 Double Entry Bookkeeping Double Entry Bookkeeping is an important underlying financial practice which has a long history, and has been used since the Middle Ages. A book or ledger consists of a number of pages in which are recorded all the business transactions with dates and amounts. Each page is divided into two halves: on the left is the debit side; one the right is the credit side.

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11 Double Entry Bookkeeping Here are two pages: CASH STOCK Here are two pages: CASH STOCK On each page we show Debits on the left; Credits on the right. On each page we show Debits on the left; Credits on the right.

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12 Double Entry Bookkeeping Principles Bookkeeping has two principles: The Balancing Principle The Duality Principle

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13 Double Entry - Duality The Duality principle says that every business transaction will be recorded on two different pages of the book: Once on the Debit Side Once on the Credit side.

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14 Double Entry Bookkeeping EXAMPLE: Stock is bought for a cash payment of 600 EXAMPLE: Stock is bought for a cash payment of 600 This is entered once as a credit and once as a debit: This is entered once as a credit and once as a debit:

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15 Double Entry - Balancing The Balancing Principle says that every business transaction has precisely two effects: One which serves to increase the wealth of the business One which serves to decrease the wealth of the business The Net result of these effects is zero.

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16 Double Entry: Example 1 Suppose in the lemonade stall we buy 200 cans of lemonade for 20p per can (40) We have increased our stock of lemonade by 40; We have reduced our cash by 40 Bookkeeping rules would require two entries, one which increases assets by 40 (credit stock) and one which reduces assets by 40 (debit cash) Net change is zero.

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17 Balance Sheet Example Lemonade Stall Assets: Cash: 25 Stock: 60 Total: 85 We still have Total business assets:85 Total claims on the business:85 Net worth of business 0 Claims: Loan outstanding: 20 Retained profits: 65 Total: 85 Decrease by 40 Increase by 40

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18 Double Entry: Example 2 Suppose in the lemonade stall we pay the outstanding loan of 20. We reduce our cash by 20; We reduce our loan by 20 Bookkeeping rules would require two entries, one which decreases assets by 20 (cash) and one which decreases claims by 20 (loan) Net change is zero.

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19 Balance Sheet Example Lemonade Stall Assets: Cash: 5 Stock: 60 Total: 65 We now have Total business assets:65 Total claims on the business:65 Net worth of business 0 Claims: Loan outstanding: 0 Retained profits: 65 Total: 65 Decrease by 20

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20 Activity 3.1 Increase Asset Decrease Asset Increase Claims Decrease Claims Increase Asset Decrease Asset Increase Claims Decrease Claims Which of the actions on the right can balance each of the actions on the left? Answer

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21 Financial Statements Some Terms Increase Asset Decrease Asset Increase Claims Decrease Claims Increase Asset Decrease Asset Increase Claims Decrease Claims Note that each action can be balanced in two different ways.

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22 Part 3b Bookkeeping Double Entry Examples

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23 Double Entry Recap In Double Entry each financial transaction is recorded twice, once as a debit and once as a credit. Debits are always put on the left hand side of a bookkeeping system. Credits are always put on the right hand side of a bookkeeping system The Balance is what is left after the debit total has been subtracted from the credit total.

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24 Accounts The following pages are typical of those found in a Double Entry Accounting system: Cash Stock Capital Trade Creditors Trade Debtors Cost of Sales Sales Can you explain what each of these Accounts are for? Answer

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25 Accounts Pages typically found in a Double Entry System: Cash Money available in bank & petty cash Stock Goods which can be sold for profit. Capital The owners investment in the business Trade Creditors The people we owe money to Trade Debtors The people who owe us money Sales How much we get for selling things Cost of Sales The amount we paid for the things we sell.

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26 Examples of Bookkeeping Entries On these slides you will see the following: Bookkeeping pages: Left & Right Bookkeeping pages: Credit & Debit Example of Double Entry Activity 3.2

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27 Bookkeeping Pages: Left & Right On the Left is shown the money which has come into that account. Each page shows a separate Account On the Right is shown the money which has gone out of that account. IN OUT

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28 Bookkeeping Pages Transaction Examples 5000 comes into the Cash Account; its partner transaction will be found in the the Capital Account, which will be debited by 5000. These are shown as Debits and Credits 600 goes out of the Cash Account; its partner transaction will be found in the the Stock Account, which will be credited by 600.

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29 Bookkeeping Pages Example of Double Entry EXAMPLE: Stock is bought for a cash payment of 600 EXAMPLE: Stock is bought for a cash payment of 600 We reduce Cash by 600; this is shown on the right in the Cash Account, as it is money going out of the account. The money goes to Stock, so we Credit Stock by 600 We increase Stock by 600; this is shown on the left in the Stock Account, as it is money coming into the account. The money comes from Cash, so we Debit Cash by 600

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30 Activity 3.2 Examine the entry for 18-Jan. What exactly is the transaction? Where will its partner be found? Answer

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31 Activity 3.2 Solution Transaction: Receive 800 Cash from Trade Debtors Transaction: Receive 800 Cash from Trade Debtors Partner to 18-Jan entry on CASH Page: On the Trade Debtors page, we show that Cash has been credited with 800 Partner to 18-Jan entry on CASH Page: On the Trade Debtors page, we show that Cash has been credited with 800

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32 Selling for Cash A More Complex Example When we sell something for Cash, we have two different Double Entries to make. This is because we have two different amounts: The amount we sell for The amount we originally bought it for. Each of these requires two entries to balance it. Original Purchase Price This is entered in Cost of Sales and Stock Selling Price This is entered in Sales and Cash

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33 Sales Page: Sales of 800 goes out (right hand side) Reads as Credit Cash by 800 Sales Page: Sales of 800 goes out (right hand side) Reads as Credit Cash by 800 Sales Example : Recording the Selling price We sell goods for Cash to the value of 800, which we originally bought for 750. The entries are recorded as follows: Cash Page: Cash of 800 comes in (left hand side) Reads as Debit Sales by 800 Cash Page: Cash of 800 comes in (left hand side) Reads as Debit Sales by 800

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34 Stock: Stock of value 800 goes out (right hand side) Reads as Credit Cost of Sales by 750 Stock: Stock of value 800 goes out (right hand side) Reads as Credit Cost of Sales by 750 Sales Example : Recording the Purchase Price We sell goods for Cash to the value of 900, which we originally bought for 750. The entries are recorded as follows: Cost of Sales: Cost of Sales increased by 750 (left hand side) Reads as Debit Stock by 750 Cost of Sales: Cost of Sales increased by 750 (left hand side) Reads as Debit Stock by 750

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35 Activity 3.3 An antique dealer buys a table for 3750 and sells it on to retailer in a City Centre shop for 4500 on trade credit. 1.What pages will the dealer use to record this transaction, and why? 2.What are the amounts and on which sides will they be recorded? Answer

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36 Activity 3.3 Solution (1) An antique dealer buys a table for 3750 and sells it on to retailer in a City Centre shop for 4500 on credit. 1.The Pages used will be: Trade Debtors (the retailer will owe the dealer money), Sales (obvious something is being sold!) Cost of Sales (to account for the original purchase price) Stock (the table is part of the dealers stock)

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37 Activity 3.3 Solution (2) An antique dealer buys a table for 3750 and sells it on to retailer in a City Centre shop for 4500 on trade credit. 2. The Entries will be : Trade Debtors Page: (On Left) debit Sales by 4500 Sales Page: (On Right) credit Trade Debtors by 4500 Cost of Sales Page: (On left) debit Stock by 3750 Stock Page: (On right) credit Cost of Sales by 3750

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38 Part 3c Follow-Up Activities Cash Book

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39 Cash Book This activity practises and develops some of the skills necessary to understand the principles behind double entry bookkeeping. The material all comes from M & A Appendix A pp 546- 558, and you should begin by reading this. Next you should download the Word Document: CashBook Activity. This will take you through the Activity step-by-step. You may find that you will need to refer to M & A from time to time.

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40 Cash Book Next, from the Website, Download the CashBook spreadsheet. When you try to open this, you will normally get a message telling you that the spreadsheet contains Macros. Click on Enable Macros.

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41 CashBook Spreadsheet The details of how the Spreadsheet works are given in the CashBook Activity document. You will find that there are several features (buttons & lists) which will help you complete the activity

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42 Seminar Preparation Cash Book Activity takes you through the full set of tasks for preparing a balance sheet for January. For the next Seminar, you should come prepared with the full details of how you dealt with the February Transactions. These are given at the end of Cash Book Activity.