accounting danial

7/23/2019 Accounting Danial

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Diference between book-keeping and accounting

What is accounting?

We haveseen in the introduction that accounting is about 3 main things:

i) Recording of financial information

This part is known as book-keeping. It involves recording transactions involvingmoney accurately and systematically. It includes recording the receipts andpayments of cash, the buying and selling of goods inventory!, the buying ofassets that will be used in business! and the paying for e"penses like rent andrates, electricity, salaries and wages etc.

ii) Organise information in a systematic and methodical way

This involves classifying financial information so as to ease the process ofpreparing financial statements. #imply recording transactions does notnecessarily mean such records will be useful. $ecords are useful only wheninformation can be e"tracted rapidly and accurately. This is only possible wheninformation is well organised. %or instance, using the double entry system ofrecording financial transactions allows information to be e"tracted timely andaccurately.

iii) Analyse information for decision making

&oing business involves a lot of decisions to be taken. &ecisions are taken outof available information. 'owever, different decision re(uires different types ofinformation. %or instance, deciding on a wage increase may re(uire an analysisof profit trends as well as li(uidity situation. Therefore, accounting involves thepreparation of financial statements like income statement to calculate profit, thebalance sheet to show financial position of the business and any such statementsthat would help management of a business make good decision.

So what is the difference between book-keeping and accounting?

)s discussed above, book-keeping is the accurate and systematic recording ofbusiness transactions. It is part of accounting. 'owever, accounting is book-keeping plus the organising, interpreting and reporting of financial informationand preparing of financial statements that enable decisions to be taken.The role o accounting

Accounting is the systematic recording of nancial transactions and the reporting of

such transactions for decision making purposes.

As such, it can be seen that the main role of accounting is to assist in better


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decision making. The type of decision varies from business to business in terms of

nature, size, form and location. Below is a list of someof the role of accounting in

the decision making process

!. "t allows the entrepreneur to know how much is earned. This can be compared

with other alternatives to doing business. #or e$ample, an entrepreneur who isearning %! &&& a month from business but would otherwise earn %! '&& as an

employee may prefer to close down business and take up a (ob.

). Accounting allows the entrepreneur to have a follow up of trade payables and

trade receivables and as such make better decisions about cash management.

*. Accounting makes information readily available to banks and nancial institutions

to allow them approve or disapprove a loan re+uest.

. By calculating ratios from accounting data, owners and investors may compare

the results of the business with its past performances as well as with other

businesses.

'. Accounting information allows the government to assess the reasonableness of

the amount of ta$ being paid by the business.

-. mployees and trade unions may use accounting records to (ustify their demand

for wage increase and changes in working conditions.

the benets o ICT (Inormation and CommunicationsTechnology) in book-keeping and accounting

)dvancement in technology has affected the way things are done in various domains.)ccounting is no e"ception. The traditional books are being replaced by computers. )ccountingstaff are re(uired to be computer literate and spend more time in front of a computer screen thanwriting on papers and in books. This is because information and communications technologybrings lots of benefits to accounting, among which are:

Accuracy

*omputers perform calculations without errors irrespective of such calculations being simple ore"tremely comple". 'owever, care should be observed to input the right information. +lse,garbage in will result in garbage out.

Speed of processing information

)part from being accurate, computers have the ability to process huge volumes of data veryrapidly. $eports such as account balances, control accounts, trial balance, income statement and


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balance sheet can be obtained at few clicks. )lso, reports can be processed in different formats tosuit the needs of the users.

Ability to process high volumes of information

*omputers have the ability to do the obs that would re(uire several workers had a manual

system been used. +"amples include preparation of control accounts, financial statements andpreparing payroll. It only re(uires the right software to be used.

erforming reconciliations

)ccounting software allows reconciliations to be performed automatically and rapidly. Theseinclude reconciling cash book balance with balance on bank statement and reconciling controlaccount balances with balances from sales ledger and purchases ledger.

!ase and capacity of information storage

*omputers provide virtually unlimited space for storing data on discs hard disks, servers,

removable disks and even on the internet!. These re(uire very little space and may retaininformation for years. esides, information can be safeguarded by making backups keepingsame information on different disks!. sing computers reduces considerably the use of filingcabinets.

Security

Information on computers are considered to be safe. This is because access to information can berestricted by using passwords. )lso, in some accounting software which allows multi-users, it iseasy to trace which user has performed what transaction. This reduces the risk of fraud.

Drawbacks o ICT in book-keeping and accounting

The advantages of using I*T in book-keeping and accounting are undisputedly considerable. /et,it contains few drawbacks which include the following:

"ost of installation

*omputer hardware and software are costly. They also involve high maintenance andreplacement costs. 'owever, such costs may well be recovered over few years in terms ofsavings in payroll cost among others.

#ependence on computers and power supply

*omputers may not be operated without power supply. In case of power failures, the accountingdepartment may not be operational. esides, power failures may cause damages to computersand related devices resulting in loss of information.

"ost of training staff

sing a computerised system implies employing (ualified labour who re(uires higher pay. Inaddition, the business may also need to incur cost in training e"isting staff so that they do notbecome redundant.


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$uman errors

*omputers may be accurate in performing calculations and producing reports. 'uman beings arenot. Inputting the wrong information will result in incorrect reports to be produced garbage in,garbage out!.

%iruses

*omputer programs are prone to viruses. 0iruses can damage hardware and software andtherefore cause loss of information.

Security

*omputer systems are not foolproof. 'ackers may enter computer systems to collect or modifyfinancial information.

Accounting !&uation

The accounting e(uation can be considered as the foundationof financial accounting. It shows ,on one hand, the resourcesowned by the business and, on the other hand, claims over theassets how the assets are financed or who supplied the assets!.

What the business has = how they are financed

Assets = Owners Equity +Liabilities

Assetsrefer to all that a business possesses and that havemoney value. 1bviously, these assets have been obtained fromthe owner or were bought later.

+"amples of assets are:

uilding, 0ehicles, %urniture, +(uipment, Inventory #tock of2oods!, Trade $eceivables debtors or amount owed by credit


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customers!, 1ther $eceivables prepayment of e"penses!, cashe(uivalents money at bank! and cash in hand.

)t the very beginning of most businesses, all assets aresupplied by the owner as his initial investment. In most cases,

the initial investment is in the form of cash though in othercases it can be in form of other items like building, furniture orvehicles etc!.

Capitalrepresents the claim that the owner has over the assets of the business. The owner has a claim over what he investedin his business. /hould he stop doing business one day, he e$pects to get back what the amount he invested together with theprot.

Therefore, it can be said that the business owes its owner the amount the latter invested in the business.

iabilitiesrefer to the amount that the business owes to other persons other than the owner. /uch persons include creditsuppliers and banking institutions. They have a claim on the assets of the business to the amount they have given credit facilities orthey have lent.Let us consider the following case:

Bill started business on 1st January as a computer reseller. He invested $100 000 cash which he too from his past

savings.

0ow, remember that, as from this point, Bill and his business are considered as two di1erent persons 2see business entity concept3.Therefore, now the %!&& &&& belongs to the business, though Bill has a claim over it.

4ence

5e have seen above that what the business has is called an asset. Therefore, the asset of Bill6s business is cash of %!&& &&&.

The claim that an owner has over its business is called capital or owner7s e+uity

This gives us the following e+uation

On 2nd January, Bill bouht co!"uters for resale #oods in this case$ oncredit fro! %a! for &2' ((()

1n one hand the business is receiving goods. ow, anyone would agree thatwhatever you buy, whether for cash or on credit, belongs to you. In the sameway, the business has bought computers for resale. #o, the computers belongto the business.

Therefore, assets of the business now include inventory costing 456 777.

*ote oods for resale are ter!ed as -n.entory)


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1n the other hand, given that goods were bought on credit, the business owes#am, a credit supplier, 456 777. #am being an outsider to the business, theamount owed is a liability.

Therefore, the liabilities of the business now include trade payablesamounting to 456 777.

*ote A!ount owed to a credit su""lier is ter!ed as /rade 0ayables)

'ence:

This gives us the following e+uation

The validity of the Accounting +uation can be tested with any transaction. "t shall always hold. Besides, the accounting e+uation isapplied in theBalance /heet.

edger

The ledger is a special book in which transactions are recorded. In other words, a bookin which accounts are kept.

The ledger differs from other books in the way columns are drawn to record transactionsas follows:

Dr The Ledger Cr
http://www.olevelprinciplesofaccounts.com/balance-sheet.htmlhttp://www.olevelprinciplesofaccounts.com/balance-sheet.htmlhttp://www.olevelprinciplesofaccounts.com/balance-sheet.html


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Date

Details FolioAmoun

tDate Details Folio Amount

$ $

Types of ledger:

In a real business, there are so many accounts to keepand each account may need lots of space to record

transactions for the whole accounting year. For thisreason, a business usually keeps, not one, but severalledgers. These ledgers are classified into three types:

Sales Ledger

The book (or set of books) in which the personal accounts of creditcustomers are kept.

credit customer is also called a debtor.

The balance of a customer!s account shows the amount that the

customer owes the business. Therefore, the total of balances in thesales ledger is the total amount the business is owed by its creditcustomers. This amount is called trade receivables or accountsreceivables.

Trade receivables is shown as a current asset in the balance sheet.

Purchases Ledger


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The book (or set of books) in which the personal accounts of creditsuppliers are kept.

credit supplier is also called a creditor.

The balance of a supplier!s account shows the amount that the business

owes the supplier. Therefore, the total of balances in the purchasesledger is the total amount the business owes by its credit suppliers. Thisamount is called trade payables or accounts payables.

Trade payables is shown as a current liability in the balance sheet.

General Ledger

The book (or set of books) in which all other accounts are kept.

Types o !ccounts

n account records changes to a specific item.For e"ample:

# The cash account records changes in the amount of cash available in hand.# The bank account records changes in the amount of cash held at the bank.# Furniture account records changes in the values of furniture owned by the

business etc.

$ust as the ledger has been classified into different types, accounts also are classifiedinto different types as below:


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0ersonal accounts

s the name says, personal accounts are accounts ofpersons. They, therefore, bear the names of persons.

%uch persons can be credit customers or credit

suppliers. Therefore, personal accounts are kept ineither:

# %ales ledger, or# &urchases ledger

'ote that in accounting, persons refer not only toindividuals but also to companies, partnerships or anyform of organisation with whom there may betransactions.

-!"ersonal accountss seen in the above diagram, impersonal accountsare of two types:

# eal accounts# 'ominal accounts

ll impersonal accounts are kept in the general ledger.

1eal accounts

eal accounts record property assets of the

business. *"amples of real accounts are:furniture account, building account, vehiclesaccount etc

*o!inal accounts

'ominal accounts record liabilities, e"penses,revenues, capital and drawing. *"amples ofnominal accounts are loan account, salesaccount, commission received account,salaries account, rent account, capital account,

drawings account etc.

Relationship between types o ledger and types o accounts


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The Double "ystem o #ook-keeping

The double entry system is one where transactions are recordedtwice in the ledger: 1ne on the debit of an account and the otheron the credit side if another account. The rules for recordingtransactions using double entry system are:

8. +very transaction affects two accounts in the ledger: 1neaccount is debited and the other is credited.

5. )mount for debit entry is e(ual to amount for creditentry.

3. &etails in one account is the name of the other accountaffected by the transaction.

The accounting e$uation and the recording otransactions in the ledger

2enerally, accounts can be classified under one of the following:

i. )ssetsii. 9iabilitiesiii. +(uityiv. $evenuesv. +"penses

We have seen that assets, liabilities and e(uity capital! form partof the accounting e(uation as follows:

)ssets 9iabilities ; +(uity

ow, given that e(uity increases when the business earns profitand it decreases when the business makes losses, we can derivethe following e"tended accounting e(uation:


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)ssets 9iabilities ; +(uity ; loss by the formula ?revenue = e"penses@ in theabove e"tended accounting e(uation gives us the following newe(uation:

)ssets 9iabilities ; +(uity ; $evenue = +"penses

Aaking all items positive:

)ssets ; +"penses 9iabilities ; +(uity ; $evenue

ow remember the format of the ledger:

&r 9edger *r

&ate &etails )mount &ate &etails )mount

It can be seen that if the e(uation ?)ssets ; +"penses 9iabilities ; +(uity ; $evenue@ iscompared with ledger with the double line at the center of the ledger representing the e(ual signof the e(uation, assets and e"penses represent the debit &r! side while liabilities, e(uity andrevenue represent the credit *r! side.


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0ote from the table above that we record an increase in an account on the same side as it7s balance is. A decrease is recorded onthe opposite side.

Double ntry "ystem continues below*

The Double "ystem o #ook-keeping

%ecording o Transactions in the ledger

efore recording transactions, we shall follow few steps that will help us know which account isdebited and which account is credited.


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%ebruary 8 #usan started business with cash at bank 456 777

8. This means #usan is the owner of the business and she is investing 456 777. #o, this

456 777 represents ownerDs e(uity capital!. #o, this has to be recorded in the e(uityaccount. )t the same time, the cash at bank belongs the possession of the business.

This is an asset and is recorded in the bank account.5. )s already said above, bank account is categorised under assets while e(uity issimply e(uity.

3. oth, the amount of cash at bank and e(uity are increased. They both now have abalance of 456 777.

B. sing the table of balances, we can see that when e(uity increases, e(uity account iscredited and when an asset increases the account for that asset is debited.

Accounts Affected +(uity ank

"ategory +(uity )sset

ncrease or #ecrease Increase Increase#ebit or "redit *redit &ebit

6. %rom the above table, we can see that there is one debit entry in the bank account and

one credit entry in the e(uity account. #o we can record the transactions.

n the ledger of Susan

&r +(uity account *r


/eb 0 *ank 12 333

&r ank account *r


/eb 0 !&uity 12 333

%rom the two accounts above, the following can be noted:

i. 1n top of all account, the name of the person #usan! owning the business is

mentioned as follows: ?In the 9edger of #[email protected]. The name of the account is written at the top centre of the account. The first

account drawn above is the e(uity account and the second is the bank account.iii. +(uity account has been credited. )n entry has been made on its credit side.

&etail in e(uity account is ?ank@ which is also the name of the other accountaffected for the transaction.


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iv. ank account has been debited. )n entry has been made on its debit side.&etail in e(uity account is ?+(uity@ which is also the name of the otheraccount affected for the transaction.

9et us see another transaction:

Aarch 8 #am started business with cash at bank 487 777 andcash in hand 46 777

The above transaction can be interpreted as two different transactions as follows:

4i) Aarch 8 #am started business with cash at bank 487 7774ii) Aarch 8 #am started business with 46 777 cash in hand

sing same procedures as above, we can conclude as follows:

4i) 4ii)

!&uity *ank Accounts Affected !&uity "ash

!&uity Asset "ategory !&uity Asset

ncrease ncrease ncrease or #ecrease ncrease ncrease

"redit #ebit #ebit or "redit "redit #ebit

The entries will be as follows:



5ar 0 *ank 03 333 5ar 0 "ash 2 333

&r ank account *r


5ar 0 !&uity 03 333

!+%ecording e$uity*onsider the following transaction:%ebruary 8 #usan started business with cash at bank 456 777

8. This means #usan is the owner of the business and she is investing 456 777. #o, this

456 777 represents ownerDs e(uity capital!. #o, this has to be recorded in the e(uityaccount. )t the same time, the cash at bank belongs the possession of the business.This is an asset and is recorded in the bank account.


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5. )s already said above, bank account is categorised under assets while e(uity issimply e(uity.

3. oth, the amount of cash at bank and e(uity are increased. They both now have abalance of 456 777.

B. sing the table of balances, we can see that when e(uity increases, e(uity account is

credited and when an asset increases the account for that asset is debited.

Accounts Affected +(uity ank

"ategory +(uity )sset

ncrease or #ecrease Increase Increase

#ebit or "redit *redit &ebit

6. %rom the above table, we can see that there is one debit entry in the bank account and

one credit entry in the e(uity account. #o we can record the transactions.

n the ledger of Susan



/eb 0 *ank 12 333

&r ank account *r


/eb 0 !&uity 12 333

%rom the two accounts above, the following can be noted:

i. 1n top of all account, the name of the person #usan! owning the business is

mentioned as follows: ?In the 9edger of #[email protected]. The name of the account is written at the top centre of the account. The first

account drawn above is the e(uity account and the second is the bank account.iii. +(uity account has been credited. )n entry has been made on its credit side.

&etail in e(uity account is ?ank@ which is also the name of the other accountaffected for the transaction.

iv. ank account has been debited. )n entry has been made on its debit side.&etail in e(uity account is ?+(uity@ which is also the name of the otheraccount affected for the transaction.

9et us see another transaction:


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Aarch 8 #am started business with cash at bank 487 777 andcash in hand 46 777

The above transaction can be interpreted as two different transactions as follows:

4i) Aarch 8 #am started business with cash at bank 487 7774ii) Aarch 8 #am started business with 46 777 cash in hand

sing same procedures as above, we can conclude as follows:

4i) 4ii)

!&uity *ank Accounts Affected !&uity "ash

!&uity Asset "ategory !&uity Asset

ncrease ncrease ncrease or #ecrease ncrease ncrease

"redit #ebit #ebit or "redit "redit #ebit

The entries will be as follows:



5ar 0 *ank 03 333 5ar 0 "ash 2 333

&r ank account *r


5ar 0 !&uity 03 333

&r *ash account *r


5ar 0 !&uity 2 333

#+%ecording the #uying o an asset

i6 'he buying of an asset for cash

9et us consider the following transaction:%eb 3 ought %urniture and fittings for cash 43 777.


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uying of furniture and fittings is recorded in the furniture and fittings account. Infact, any item bought to be used in business, that is not for resale, is recorded in thatitemDs account. )lso, whatever the business buys becomes the possession of thebusiness. 'ence, furniture and fittings here are assets.

Accounts Affected %urniture and fittings *ash"ategory )sset )sset

ncrease or #ecrease Increase &ecrease

#ebit or "redit &ebit *redit

The entries are as follows:

&r *ash account *r


/eb 7 /urniture and fittings 7 333

&r %urniture and fittings account *r


/eb 7 "ash 7 333

i6 'he buying of an asset paying by che&ue

*onsider the following transaction:%eb E ought Aotor vehicles for 437 777 paying by che(ue

ow, it should easily be deduced that motor vehicles and bank are both assets.

Accounts Affected Aotor vehicles ank

"ategory )sset )sset

ncrease or #ecrease Increase &ecrease

#ebit or "redit &ebit *redit


&r ank account *r


/eb 8 5otor vehicles 73 333


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&r Aotor vehicles account *r


/eb 8 *ank 73 333

iii6 'he buying of an asset on credit

*onsider the following transaction:)pril 8 ought office e(uipment for 48F 577 from est +(uip 9td.We all agree that office e(uipment is an asset which have been bought on credit.Though it has not been said above that this is a credit transaction, it is implied as

being a credit transaction as no mention has been made of payment and the name ofthe person> company with whom the transaction occurred is given.#ince the e(uipment was bought on credit, the amount of 48F 577 is owed to est+(uip 9td. )nd is therefore a liability.Whenever the business owes someone, an account is opened in the name of theperson owed. Therefore, here, est +(uip 9td is to be opened.

Accounts Affected est +(uip 9td 1ffice +(uipment

"ategory 9iability )sset

ncrease or #ecrease Increase Increase#ebit or "redit *redit &ebit


&r est +(uip 9td account *r


Apr 0 Office e&uipment 09 133

&r 1ffice e(uipment account *r


Apr 0 *est !&uip +td 09 133

!ocumentary "ecords #ource !ocuments%


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Transactions are recorded by accountants and theirsubordinates. 'owever, these persons are not those whoare directly involved in the transaction. esides, theaccounting departments work with factsG therefore, torecord a transaction, proof of such transactions are

re(uired. #uch proofs are in the form of documentswhich are received and>or issued by the business uponthe occurrence of a transaction.

elow is a list of the most common documents used assource documents for recording transactions.

nvoice

-

)n invoice is a document that the seller gives to the buyer to informthe latter the amount payable for goods or services supplied to him.The invoice contains details of the seller, the buyer, the goods sold -(uantity, price, discount, ta"es, net amount payable and terms of

payments.

%rom the point of view of a business, invoices can be differentiatedas Sales nvoiceand urchases nvoice.

) sales invoice is one which the business prepares in duplicate ortriplicate! and issues one copy! to its customers. The business here isthe seller. Total sales from sales invoice is entered in the Sales:ournal.

) purchases invoice is one which the business receives from itssuppliers when goods are bought from them. The business here is thebuyer. Total purchases from purchases invoice is entered inthe urchases :ournal.

#ebit

,ote -

) business may return goods bought to its suppliers. There are variousreasons for that such as goods received were of the wrongspecification, were damaged, were supplied in e"cess etc. In that casethe business may return the goods to the supplier. #uch returns aretermed as Returns Outwardsor urchases Returns.

When goods are returned to a supplier, it means the business

owes that supplier less that is original amount less amount of goodsreturned!. Therefore, the business will decrease the amount owed tothe supplier by a H&ebit +ntryH in the suppliers account.

)t the same time, the business will send with the goods returneda #ebit ,oteto inform the supplier that his> her account has beendecreased in this case debited! by the amount of goods returned.


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The amount on the debit note is recorded in the urchases Returns:ournal.

"redit

,ote -

)s said earlier, a business may return goods to its suppliers. It is alsotrue to say that customers may return goods to the business and that

too for similar reasons discussed above.

$eturns of goods by a customer to the business are termed as Returnsnwardsor Sales Returns. In such cases, the business has todecrease the amount owed by the customer - this is done by a H*redit+ntryH in the customers account.

)t the same, a "redit noteis issued to the customer to acknowledgethat goods were received as return from him and that his account hasbeen decreased in this case credited! by the amount of goodsreturned.

The amount on the credit note is entered in the Sales Returns:ournal.

-

"he&ue

-

) che(ue is an advice given to a person known as the payee! whomwe have to pay. 'e will present this document at a specific bankwhere we hold an account! in order to get paid. This is a safe way ofeffecting payments. We do not have to deal with large amount cashwhen we run the risk of being robbed.

) payment by che(ue decreases the balance of our bank account. It isrecorded as a H*redit +ntryH in the bank columnof the "ash *ook.

'owever, given that it is taken away by the payee, the che(ue itselfcannot be used as a source document. ut, while drawing a che(ue,information is recorded on the piece of paper that remains in theche(ue book after the che(ue is detached for payment. This piece ofpaper is called the cheque counterfoiland is used as source documentto record payment by che(ue.

Receipt - ) receipt is a document issued when money or any other form ofpayment! is received from someone. It is used as a proof of paymentby the person who pays. The counterfoil of the receipt book or theduplicate copy of the receipt held by the business is used as sourcedocument to record receipt of money.Receipt of cashis recorded onthe H&ebit #ideH of the "ash "olumnof the"ash*ookwhile receipt of che&ue is recorded on the H&ebit #ideH ofthe *ank "olumnof the"ash *ook .


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#imilarly, a business also receives a receipt when money> cash is paidto another person. This receipt is used a source document to recordcash payment which is recorded on the H*redit #ideH of the "ash"olumnof the"ash *ook.

Statement

of

Account -

)t the end of each month a #tatement of )ccount is sent to eachcredit customer who owes the business money. This document is, infact, a summary of the customers account from the books of thebusiness. Its purpose is to allow the customer to match our recordswith his records and if there is any discrepancy, deal with them assoon as possible.

#iscounts

What are discounts

2enerally speaking, a discount is any amount taken off the actual price of a commodity or theactual payable. ) person who benefits a discount pays less and therefore gains.

&iscounts involve 5 parties: The giver and the receiver.

The giver is usually the seller or the creditor who allows discounts.The receiver is usually the buyer or the debtor who receives discounts.

)s such, discounts can be eitherdiscount allowed or discountreceived. &iscount allowed isdiscount given to customers or

debtors and discount received isdiscount received from sellers orcreditors.

There are two types of discounts:

Trade discount*ash discount

The differences between trade discounts and cash discounts are as follows:

Trade discount Cash discount

8. ) reduction in the selling price of acommodity.5. )llowed or given for bulk purchase3. ot recorded in the books> accounts

8. ) reduction in the amount owed by adebtor.5. )llowed for prompt> (uick payment3. $ecorded in the books

&o better understand the di'erences between trade discount and cash discount see the lins below: &rade !iscount (ash !iscount
http://www.olevelprinciplesofaccounts.com/trade-discount.htmlhttp://www.olevelprinciplesofaccounts.com/cash-discount.htmlhttp://www.olevelprinciplesofaccounts.com/trade-discount.htmlhttp://www.olevelprinciplesofaccounts.com/cash-discount.html


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'rade discount

To have a better understanding of trade discount and cash discount, consider the story below:

%omy is a trader who sells goods on credit to ,ulie +

%rom the cartoon strip above, we canobserve the following:

$omy is the seller and Julie thebuyer.

Julie wants to buy bo"es of pencilsfrom $omy that she then sell in herown shop.

The price of one bo" of pencil is 4K.

Julie proposes to buy 67bo"es. $omy agrees to reduce theprice by 48 per bo". Thismeans $omyhas given a tradediscountof 467 48 " 67 bo"es! toJulie for buying a large (uantity ofpencil bo"es. Julie, therefore,owes $omy 4377.

The sales made by $omy is therefore 4377 4C " 67 bo"es!. This amount is recorded in the booksof $omy as follows:

)ssume the date of the transaction to be %ebruary 3.

&r $evenue #ales! account *r


/eb 7 :ulie 733

&r JulieDs account *r


/eb 7 Revenue 4Sales) 733

0ote The discount of %'& is not recorded in the books. 4owever, it is normalbusiness practice to show it on the invoice if the seller wants to.


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&he above story continues with Julie paying "omy and receives a cash discount on the following page: (ash !iscount

"ash discount

To have a better understanding of cash discount, consider the story of 1o!y and Juliethatcontinues below:

./ days ater buying goods& ,ulie'isits %omy again +

%rom the cartoon strip above, we can observe the following:

Julie visits $omy 86 days after she bought the 67 bo"es ofpencils from him.

)s agreed on the day of sales, if Julie pays within 57 days, she isentitled to a discount of 6L on the amount owed. #he owes 4377and therefore receives a reduction of 486 6L " 4377!. In other

words, Julie receives a cash discountof 486 for (uick> promptpayment.

Julie, therefore, pays only 45F6 to $omy.

It is to be note that the 6L discount on amount owed is givendespite trade discount was already given when sales took place.


24/69


/eb 09 :ulie 192

&r &iscount allowed account *r &ate &etails )mount &ate &etails )mount

/eb 09 :ulie 02

0ote*

The discount of %!' is deducted from


25/69

3redit %ide

In case the business has a bank overdraft at the start of amonth, this side starts with an opening bank overdraftbalance.

1n the credit side, "ay!entsof cash and che(ues arerecorded, that is, items thatdecrease the cash balance orthe ban7 balance)

+"amples are:


26/69

4iscount allowed

This is discount given to customers for prompt payment as e"plained in the page on cashdiscount!. %or e"ample, if a customer named #usan owes 4877 and is allowed a reduction of 6Lfor paying early, the customer finally pays 4E6. If he pays by che(ue, the bank column of thecash book is debited by 4E6. If a 3-column cash book is being used, the discount allowed of 46 isrecorded on the same line in the discount allowed column.

#ee e"ample below:

&r *ash ook *r

4ate 1ecei"ts4iscoun

tAllowed

3as

h

Ban

74ate 0ay!ents

4iscount

1ecei.ed

3as

h

Ban

7

& & & & & &5ay ; Susan 2 82

In the above 3-column cash book e"tract, the entry on the debit side shows that on Aay B, 4E6was received from #usan and she was given a cash discount discount allowed! of 46.

)dding the amount received 4E6! with the discount allowed 46! gives the amount settled by#usan 4877!. This may also represent the amount owed if the customer settles her full account.

1E3O14-* 4-%3O;*/ 1E3E-


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In the above 3-column cash book e"tract, the entry on the credit side shows that on Aay K, 4K5was paid to Tony and the latter gave a cash discount discount received! of 4F.

)dding the amount paid 4K5! with the discount received 4F! gives the amount settled by us4F7!.

edger !ccount or !ccruals and1repayments

(2ther payables and other recei'ables)

1art . --ntroduction

i6 !.pensesAt any "oint in ti!e, e"enses !ay be:

Accrued> 4ue>Outstandin>

Owin

0re"aid> 0aid inad.ance

+iability Asset

"redit balance #ebit balance

*alance b=d on credit

side of the ledger

*alance b=d on debit

side of the ledger

oint to remember> A balance b=d is first a balance c=d on

the opposite side of the ledger before the total6

ii6 ncomeAt any "oint in ti!e, inco!es !ay be:

Accrued> 4ue>Outstandin>

Owin

0re"aid>1ecei.ed in

ad.ance

Asset +iability

#ebit balance "redit balance

*alance b=d on debit

side of the ledger

*alance b=d on credit

side of the ledger


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)ccruals concept

"n calculating prot for a given period, revenue earned in that period is matched against e$penses incurred during that period,whether such revenues have been received or not and e$penses paid or not.

As such, when calculating prot or loss for a given period ad(ustments are made for accruals and prepayments of both e$penses andincome.

*oints to remember when preparing ledger accounts involving accruals and prepayments:

Account ofan e"ense

Account ofan inco!e

1pening alance = d! &r side *r side

1pening alance = &ue alance b>d! *r side &r side

)mount paid &r side

)mount received *r side

Transfer to Income #tatement *r side &r side

*losing alance = d! *r side &r side

*losing alance = &ue alance c>d! &r side *r side

Lins to other parts of this topic

;art ! "ntroduction

;art ) = >edger accounts for accruals and prepayment of e$penses

;art * = >edger accounts for accruals and prepayment of "ncomes

;art = 9alculating amount earned or incurred

1art 3 -Leder accounts for accruals and "re"ay!ent of e"enses

0lease note that for all the ea!"les i.en below, the accountin years are assu!ed to be the

"eriod fro! 8 January to 98 4ece!ber, ece"t where otherwise stated)

*o o"enin balances

Ea!"le 8) business pays rent at the rate of 48 777 per month. In a given year, amount actually paid byche(ue amounted to 483 777. #how the $ent account.

&r $ent )ccount *r


4 4

38 &ec ank 83 777 38 &ec Income #tatement 85 77738 &ec alance c>d - prepaid 8 777

83 777 83 777

8 Jan alance b>d - prepaid 8 777

$ent incurred remains at 48 777 per month, that is 485 777 for the year. The 48 777 483 777 -485 777! paid in e"cess is a prepayment.
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In balance sheet: 1ther receivables $ent prepaid! is 48 777 Mcurrent assetN

Ea!"le 2) business has incurred telephone e"penses amounting to 48 F67. 1nly an amount of 48 677 waspaid by che(ue at 38 &ecember. #how the Telephone +"penses account.

&r Telephone +"penses )ccount *r &ate &etails )mount &ate &etails )mount

4 4

38 &ec ank 8 677 38 &ec Income #tatement 8 F67

38 &ec alance c>d - due 367

83 777 83 777

8 Jan alance b>d - due 367

4367 was due. T amount incurred remains 48 F67 and is entered in the income statement as

telephone e"penses.

In balance sheet: 1ther payables telephone e"penses due! is 4367 Mcurrent liabilitiesN

With o"enin balances

Ea!"le 91n 8 January, a business had insurance prepaid of 4E7. &uring the year, insurance paid byche(ue amounted to 4E67. Insurance for the current year amounted to 4FB7. #how the Insuranceaccount.

&r Insurance )ccount *r

&ate &etails )mount &ate &etails )mount4 4

Jan 8 alance b>d - prepaid E7 &ec 38 Income #tatement FB7

&ec 38 ank E67 &ec 38 alance c>d - prepaid 577

8 7B7 8 7B7

Jan 8 alance b>d - prepaid 577

)t the start of the year, there was a prepayment of 4E7 and this is an asset. #o, it is shown as adebit balance in the insurance account. )mount paid during the year 4E67 is debited to theinsurance account. The amount incurred for the year of 4FB7 is transferred to the income

statement and is credited to insurance account. When the insurance account is balanced, itreveals there was a prepayment of insurance of 4577 at the end of the period.

In balance sheet at 38 &ec: 1ther receivables insurance prepaid! is 4577 Mcurrent assetN

Ea!"le ?


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1n 8 January, general e"penses prepaid amounted to 4B6. &uring the year, amount paid forgeneral e"penses were 46C7 by che(ue and 48B7 in cash. 2eneral e"penses incurred for the yearamounted to 4F77. #how the 2eneral +"penses account.

&r 2eneral +"penses )ccount *r


Jan 8 alance b>d - prepaid B6 &ec 38 Income statement F77

&ec 38 ank 6C7

&ec 38 *ash 8B7

&ec 38 alance c>d - due 66

F77 F77

Jan 8 alance b>d - due 66

ote from the above account that at the beginning of a period, there may be a prepayment for aparticular e"pense but there is an accrual at the end of the period.

There may also be an accrual at the start of a period and a prepayment at the end as in e.g 6below:

Ea!"le '1n 8 January, Aaintenance +"penses owing amounted to 4867. &uring the year, Aaintenance+"penses paid were 4C B77 by che(ue. Total Aaintenance +"penses that relate to the currentaccounting year amounted to 4C 757. #how the Aaintenance +"penses account.

&r Aaintenance +"penses )ccount *r


&ec 38 ank C B77 Jan 8 alance b>d - due 867

&ec 38 Income statement C 757

&ec 38 alance c>d - prepaid 537

C B77 C B77

Jan 8 alance b>d - prepaid 537

Ea!"le @1n 8 January, inventory of stationery amounted to 4C7. #tationery were bought as follows during

the year: 4577 in cash, 4867 by che(ue and 4C37 on credit from *oco. #tationery used during theyear amounted to 4F56. #how the stationery account.

&r #tationery )ccount *r


4 4

Jan 8 alance b>d C7 &ec 38 Income statement F56


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&ec 38 *ash 577 &ec 38 alance c>d 586

&ec 38 ank 867

&ec 38 *oco C37

8 7B7 8 7B7

Jan 8 alance b>d 586

The above e"ample shows #tationery account. nlike, the previous accounts, the &r balances donot really represent prepayments for stationery but rather unused stock of stationery. The openingbalance of 4C7 shows that 4C7 worth of stationery were unused from the previous period andhave been transferred to the current period. The closing balance represents unused stocktransferred to the ne"t accounting period.

1art 4 -Leder accounts for accruals and "re"ay!ent of -nco!es

Ea!"le 8

1n 8 January, commission receivable was outstanding by 4567. &uring the year, 48 F67 wasreceived by che(ue for commission. )ctual commission earned for the year amounted to 48 EK6.#how the *ommission $eceivable account.

&r *ommission $eceivable )ccount *r


4 4

8 Jan alance b>d = due 567 38 &ec ank 8 F67

38 &ec Income #tatement 8 EK6 38 &ec alance c>d - due 3K6

5 556 5 556

8 Jan alance b>d = due 3K6

*ommission receivable is an income. Income due is an asset and is shown as a debit balance of4567. )mount received 48 F67! is credited to the *ommission $eceivable account. The amountearned 48 EK6! is entered on the debit side and credited to income statement.

Ea!"le 2) business sublets part of its building at an annual rent of 48 F77. )t 8 January, rent received inadvance was 4577. &uring the year, rent was received as follows: 4F77 in cash on 38 Aarch and48 877 by che(ue on 38 1ctober. d = advance 577

38 &ec alance c>d = advance 377 38 Aar *ash F77

38 1ct ank 8 877

5 877 5 877


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8 Jan alance b>d = advance 377

1art 5 -3alculatin a!ount earned or incurred

Ea!"le 8The following balances are available:

$ent due at 8 %eb 5788 4B67$ent due at 38 Jan 5785 4557$ent paid by che(ue during the year were 4B 6F7.

d = &ue B67

38 Jan 85 alance c>d = &ue 557 70 :an 01 ncome Statement ; 723

B F77 B F77

8 %eb 85 alance b>d = &ue 557

nlike previous e.amples@ the above e.ample provides figures for opening and closing

balances and amount paid6 $owever@ amount incurred is not provided6 'his is calculated as

the balancing figure in the account6 Also note that@ had the balance c=d been a prepayment

and therefore@ on the credit side@ the detail income statementB would have been insertedwithout its amount before the balance c=d6 After plugging in all available figures@ the

amount to be transferred is then calculated as the balancing figure6 'his is because balance

c=d is always the last item in a ledger account before calculating the totals6 Similarly@

balance b=d is always the first item in a ledger account6

Ea!"le 2The following information is available: Wages due at 8 )pril 5787 4KF7 Wages prepaid at 38 Aarch 5788 4857 Wages paid during the year were as follows: In cash 48 6C7

y che(ue 4B BB7


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38 Aar 88 *ash 8 6C7 8 )pr 87 alance b>d = &ue KF7

38 Aar 88 ank B BB7 70 5ar 00 ncome Statement 2 033

38 Aar 88 alance c>d - d =


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years. A building may be used for over )& years.

#or the above reasons, capital e$penditure are entered as non=current

assets in the balance sheet. The cost of non=current assets is charged

against prot over the years the assets can used and benets derived.

/uch process is called ?provision for depreciation@.

"evenue +,penditure:

These are e$penditure incurred for the day to day running of the

business. Though they do not increase the earning capacity of the

business but they are essential in maintaining it.

8evenue e$penditure benets the business only in the period to which

they relate. #or e$ample, rent is paid monthly, so the rent paid in


35/69

vi. Compensating errors

vii. Error of duplication

viii. Error of transposition

/he followin are errors affectin trial balance

In subsidiary books:i. Error in total

In ledger:

ii. Omission of one entry

iii. osting to the !rong side of the ledger for one entryiv. Enter in amount for one entry

v. Error in calculation

In trial balance:

vi. Error in amountvii. Omission of a balance

3orrectin errors

*orrecting errors are normal accounting tasks and are carried out using the double entry system.

The basic steps to follow are:

#tep 8: Identify the transaction and state the entries that should have been made. #tep 5: #tate the entries actually made #tep 3: #tate the entries to be made to cancel wrong entries #tep B: #tate the entries to complete missing entries #tep 6: *omplete double entry through suspense account, if needed #tep C: *ombine entries in steps 3, B and 6

Errors not affectin trial balance

%or these errors, at least 5 accounts are affected. *ombined, total of debit entries should be e(ualto total of credit entries.

Errors affectin trial balance

These errors are corrected through the sus"ense account.

%us"ense Account

The suspense account is a temporary account opened when the trial balance does not agree. Its

balance represents the difference between the &r total and the *r total of the trial balance.If the &r total of the trial balance is greater than the *r total, then the suspense account will havea &r balance and vice versa.

)fter all errors have been corrected, the suspense account will no longer have a balance.

&ypes of +rrors


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Correction o rrors

Errors not affectin trial balance

Wor7ed ea!"les

8. 2oods sold on credit to John, 4537, was not recorded in

the books.'ype of !rror +rror of omission

Step 0+ntries that should have

been made&r John 4537*r #ales 4537

Step 1 )ctual entries made none

Step 7 *ancelling wrong entries none

Step ;*ompleting missing

entries&r John 4537*r #ales 4537

Step 2 #uspense account none

Step C*ombined correction

re(uired#r :ohn D173

"r Sales D173

5. 2oods bought from Jane 4677 was credited to JennyDsaccount.

'ype of !rror +rror of commission


37/69


been made&r


38/69

6. 2oods returned by #am 46C7 was debited to #amDs account and credited to returnsinwards account.

'ype of !rror *omplete reversal of entries


been made

&r $eturns Inwards account 46C7

*r #amDs account 46C7Step 1 )ctual entries made

&r #amDs account 46C7*r $eturns Inwards account 46C7

Step 7 *ancelling wrong entries&r $eturns Inwards account 46C7

*r #amDs account 46C7


entries&r $eturns Inwards account 46C7

*r #amDs account 46C7

Step 2 #uspense account one


re(uired&r $eturns Inwards account 48 857

*r #amDs account 48 857

C.


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re(uired&r #tationery account 4E

*r *ash account 4E

F. *he(ue of 4E77 received from Jerry was posted twice in the books.

'ype of !rror +rror of duplication


been made&r ank account 4E77*r Jerry account 4E77

Step 1 )ctual entries made&r ank account 48 F77 5"4E77!*r Jerry account 48 F77 5"4E77!

Step 7 *ancelling wrong entries&r Jerry account E77*r ank account E77


entriesone

Step 2 #uspense account one


re(uired&r Jerry account E77*r ank account E77

Correction o rrors

Errors affectin trial balance

Wor7ed ea!"les

8. #ales day book was overcast by 4877. Individual entrieswere correctly posted to personal accounts in the sales

ledger.

'ype of !rror +rror in calculation in subsidiary book


been made

Step 1 )ctual entries made

Step 7 *ancelling wrong entries &r #ales account 4877

Step ; *ompleting missing entries

Step 2 #uspense account *r #uspense account 4877


re(uired#r Sales account D033

"r Suspense account D033

5. +lectricity paid by che(ue 4577 was credited to account.o other entries were made in the ledger.


40/69

'ype of !rror +rror of omission of one entry


been made&r +lectricity account 4577

*r ank account 4577

Step 1 )ctual entries made *r ank account 4577

Step 7 *ancelling wrong entries one


entries&r +lectricity account 4577



re(uired#r !lectricity account D133


3. &iscount received 4377 was debited to discount allowed account.

'ype of !rror +rror in posting to the wrong side of the ledger


been made*r &iscount received 4377

Step 1 )ctual entries made &r &iscount allowed 4377

Step 7 *ancelling wrong entries *r &iscount allowed 4377


entries*r &iscount received 4377

Step 2 #uspense account &r #uspense account 4C77

Step C *ombined correctionre(uired

#r Suspense account DC33

"r #iscount allowed D733

"r #iscount received D733

B. %urniture bought on credit from James, 46K6, was correctly debited to furniture accountbut credited to James account at 4KK6.

'ype of !rror +rror in amount for one entry


been made&r %urniture account 46K6

*r James account 46K6

Step 1 )ctual entries made&r %urniture account 46K6

*r James account 4KK6

Step 7 *ancelling wrong entries &r James account 4KK6


entries*r James account 4KK6



re(uired#r :ames account D133



41/69

6. $eturns inwards account was overcast by 4887.

'ype of !rror +rror in calculation

Step 0+ntries that should have been

made

Step 1 )ctual entries made

Step 7 *ancelling wrong entries *r $eturns inwards account 4887

Step ; *ompleting missing entries

Step 2 #uspense account &r #uspense account 4887

Step C

Errors not re.ealed by the trial balance

i. Error of omission

This is an error where a transaction is completely omitted from the books. o entrieswere made at all for the transaction. It is as if the transaction has not e"isted.

ii. Error of commission

In this case, double entry was observed but the transaction was posted to a wrong

account of the same class. %or e"ample goods sold toJohnwas correctly credited to$evenue #ales! account but debited toJaneDs account.

iii. Error of principle

&ouble entry observed but an entry made in the wrong class of account. %or e"ample,payment by che(ue for .ehicle re"airscorrectly credited to bank account but debitedto .ehicleaccount instead. In this case, not only the account is wrong vehicle insteadof vehicle repairs! but also the class of account is different. 0ehicle account is a realaccount asset! whereas vehicle repairs account is a nominal account e"pense!.

iv. Error of original entry

The transaction was correctly according to the double entry system butwith thewrong amount. %or e"ample, payment of telephone e"penses in cash of 46C7 wascredited to cash account and debited to telephone e"penses account but by 4C77 inboth accounts.

v. Complete reversal of entries


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%or a given transaction, the account to be debited was credited and the account to becredited was debited. %or e"ample, goods sold to adia for 4677 was debited to$evenue #ales! account and credited to adiaDs account, both by 4677.

vi. Compensating errors

+rrors on the debit side of the ledger have been set off by errors on the credit side ofthe ledger. %or e"ample, vehicle account debit balance! and commission receivedaccount credit balance! were both understated by 4577.

vii. Error of duplication

) transaction was recorded twice in the ledger. &ouble entry was observed in eachcase.

viii. Error of transposition

%or a given transactions, double entry was correctly observed but the figures inamount were not written in the correct order. +"amples are: writing 4B67 instead of

46B7, 4K8 instead of 48K, 48 B56 instead of 48 B65, etc. %or e"ample, cash receivedfrom #am 48CB was debited to cash account and credited to #amDs account at 48BC.

Control !ccounts'rade Receivables "ontrol Account and 'rade ayables "ontrol Account

We have seen Types of 9edger that there are three types of ledger: #ales 9edger,


43/69

and trade payables. These figures are then compared with figures obtained fromthe list of balances from #ales 9edger and Opening inventory C 677


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Add urchases 85 777

"ost of goods available for sale 8F 677+ess "losing nventory K 677! 88 777

(ross rofit 88 777

Balance heetA Balance /heet is a statement that shows the nancial position of a business at a givendate.

A Balance /heet, unlike an "ncome /tatement is not prepared 8or a gi'en period8 but8ata gi'en date8+This is because the Balance /heet changes after each and everytransaction.

9inancial 1osition

What the business has = )sset 'ow are the assets financed : 8! y the owner = *apital > +(uity

5! y other persons Individuals, #uppliers, anks etc! =9iabilities

Therefore,)ssets +(uity ; 9iabilities

The above e(uation is called theaccounting e(uation. #o, the alance #heet applies theaccounting e(uation

)ssets

on(urrent )ssets
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45/69

To be classied as a non=current asset an item has to satisfy allof the following criteria

= Bought to be used in the business, therefore not for resale = "s used for a long period of time 2usually more than one year3 = 4as signicant value

$amples of 0on=9urrent Assets>and and building, #i$tures and #ittings, +uipment, Cotor Dehicles

(urrent )ssetsThese are the assets of a business that are easily convertible into cash within the normaloperating cycle, which is within the accounting year.

9urrent Assets are often referred to as >i+uid Assets and are listed in the Balance /heetaccording to their order of li+uidity = usually starting with the least li+uid and ending with themost li+uid.

Liabilities


46/69

on(urrent Liabilities

These are debtsE obligationsE amount owed by the business but that are repayable aftermore than one year.

An e$ample of non=current liabilities is loan.

(urrent LiabilitiesThese are short term debtsF that is debtsE obligations that will be paid within one nancialyear. "n other words, these will be paid before the ne$t balance sheet date.

$amples of current liabilities are bank overdraft, amount owed to suppliers 2trade payables3and amount owed for e$penses 2other payables3.

/wner2s +3uity also nown as (apitalwner6s +uity refers to the total value of the resources the owner invested in the business.

"t is also dened as the amount by which the owner is nancing the business.

"t is e$pected that, in case he wants to cease business, the owner will recover hisinvestment in addition to the prots earned by the business. Therefore, capitalE owner6se+uity is often considered as the amount that the business owes its owner.

4owever, owner6s e+uity does not remain $ed. "t changes.

0et 1rot

0et prot belongs to the owner. "t is the reason why the owner has started business.Therefore, it is added to the owner6s e+uity. n the other hand, a loss is deducted fromowner6s e+uity.

Drawings

This is the amount 2in cash and in kind3 that the owner has taken from the business for hisprivate use. "t is deducted from owner6s e+uity.

Format of Balance Sheet for a sole traderame of /wner or ame of Business#alance "heet at 4. December 3:;;


47/69

0on-current (9ied) assets Cost

!ggregate

Depreciation

0et#ookand and buildings )&& &&& )' &&& !G' &&i$tures and ttings )' &&& G '&& !G '&&

Hce e+uipment !) &&& ) && I -&&

Cotor vehicles ') &&& !& && ! -&&

)JI &&& ' *&& )* G&&

Current assets

"nventory 2/tock3 !J I&&

Trade receivables 2:ebtors3 G '&&

>ess ;rovision for doubtful debts )*- G )-

ther receivables 2;repayments3 ! )*-

ther receivables 2Accrued income3 !'&

9ash e+uivalents 2Bank3 ) ''&

9ash JI&

*& II&

ess* Current liabilities

Trade payables 29reditors3 ' I-&

ther payables 2Accruals3 )&

;repaid income )'& - '&

Net current assets (Working capital) ) '&

)-J )&ess* 0on-current liabilities (ong termliabilities)

>oan '& &&&

)!J )&

9inanced by

$uity (Capital)

pening balance )&& &&&

Add ;rot for the year 20et prot3E >ess >oss )) '&

))) '&>ess :rawings *&&

)!J )&

#alance "heets o other types o business organisations*Basically, balance sheets of all types of business organisations similar. They are prepared using the same principal. 5hat will di1er isthe nancing part.


48/69

9ompanies#inancing part for companies shows amount of share capital, reserves and retained prots.

;artnerships#or partnerships, the nancing part shows the closing balances of partners6 capital and current accounts

1artnership !ccounts

What is a "artnershi" business

) partnership is a form of business organisation. It is owned by twoor more persons but limited to twenty, e"cept for banks which islimited to ten!. These persons are called partners.


49/69

K. Working as a group allows brainstorming for new ideasto improve the business.

%isadvantages of artnership over #ole Trader:

8. enefits have to be shared among partners.

5. *ontrol over the business is diluted = shared with otherpartners.3.


50/69

!ccounts or 0on-Trading 2rganisations (Clubs and "ocieties)IntroductionThere are di1erent types of organisations and not all are meant to bebusinesses. There are also some organisations who are set up not to tradeand earn prot but rather to promote and cater for the interests 2cultural,

recreational, religious, sports among others3 of their members. /till, allorganisations need money for their smooth running. 4ence, whether anorganisation is a trading concern or a non=trading concern, accounts are kept= only the needs and the ways accounts are kept are di1erent.

Comparison between trading (businesses)and non-trading (clubs and societies) concerns

#usinesses Clubs and "ocieties

%et up to earn profit by selling goods andservices

%et up to promote activities of interest toits members (cultural, recreational,intellectual, sports etc.)

%ell goods and services at more than

cost price to earn profit

'o value placed on the normal facilities

provided to members+usiness financed by owners! euity,most of which invested on setting upbusiness

Financed by monthly or yearlysubscriptions from members

-oney received and paid are recorded incash book

-oney received and paid are recorded inreceipts and payments account

Trading account (first part of incomestatement) to calculate gross profit orgross loss as%ales evenue /ost of %ales

If the club runs a restaurant, bar orcanteen, a trading account is prepared tocalculate profit from restaurant, bar orcanteen asTrading evenue Trading *"penses

-ain source of revenue is sales or feesreceived

-ain source of income is subscriptionsfrom members

&rofit and loss account (second part ofincome statement) prepared to calculatenet profit as 0ross profit 1 2ther Income# *"penses

Income and *"penditure accountprepared to calculate surplus or deficit asIncome # *"penditure

+alance %heet euation asssets 3 2wners *uity 1 4iabilities

+alance %heet euation asssets 3 ccumulated fund 1 4iabilities

Both need !oneyBoth ha.e sources of inco!e

Businesses/ale of

3lubs and %ocieties

/ubscriptions


51/69

goods8eceip

ts fromservices

8entreceived9ommissionreceived:iscount

received"nterestreceived;rotsondisposal

ntrance fees;rot from sale of

refreshments

;rot fromactivities"nterest received:onations

!i'erence between "eceipts and *ayments )ccount and -ncome +,penditure )ccount

1ecei"ts and 0ay!ents Account -nco!e and E"enditure Account


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- Is similar to a cash book - #ummary of cash and che(uesreceived and paid- Includes income and e"penditure ofboth, capital and revenue nature

- Includes all receipts and paymentsoccurring in the actual financial yearwhether relating to the year or not cashbasis!- alance shows amount of moneyavailable and is shown in balance sheetas a current asset. 'owever, amountmay also be a bank overdraft whichwould then be shown in the balancesheet as a current liability.

- Is similar to an Income #tatement- #ummary of income earned ande"penditure incurred for the actualaccounting period irrespective of whencash is received or paid accruals basis -

includes prepaid and due!- Includes only items of revenue naturetherefore items of capital nature do notenter this account!- alance shows a surplus or a deficitwhich is adusted to acculumated fundin the alance #heet- +"cess of income over e"pendituregives a surplus, else there is a deficit.

Why is there a Bar rading !ccount in "lubs and Societies#

ften, a club or society may have a specic corner where refreshments andsnacks are sold for the convenience of its members. This is not the mainactivity of the club, yet, is a small trading activity that genrates funds for theclub. Therefore, it is important to prepare a Bar Trading Account or a8efreshment Trading Account to claculate the prot or loss arising from suchan activity. Any prot is included among "ncome in the "ncome and$penditure Account whereas any loss is included among e$penditure.

Incomplete %ecordsIncomplete records arise in the following cases:

= $ecords loss due to theft, fire, flood, cyclone etc

= %ull double entry records not kept - single entryrecording or no records kept at all

'owever, whatever be the situation, profit or loss need to becalculated. The means by which profits will be calculateddepend on the information available.

1rot as the diference betweencapitals> e$uityTo note that profit increases e(uity. )s such, any e"cess ofe(uity at end over e(uity at start would mean the business hasearned a profit assume there is neither additional e(uitybrought in nor drawings!.

!.ample>

+(uity at start of the year 4877 777+(uity at end of the year 4856 777


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#tatement of profit and loss for the year ended 38 &ecember 5788

4+(uity at 38 &ecember 5788 83B 777+(uity at 38 &ecember 5787 85C 777

#tatement of profit and loss for the year ended 38 &ecember 5788

4+(uity at 38 &ecember 5788 C6B 777+(uity at 38 &ecember 5788 KBF 777

Lossfor the year EB 777!

ote: When closing e(uity is less than opening e(uity, a loss arises!


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!d?ustment or additional capital (e$uity) brought in anddrawingsAdditional equity brouht inincreases e(uity at end. )s such, it has to be deducted from e(uityat end so as to calculate profit.

4rawins made by a trader decreases e(uity at end. It is added to added to e(uity at end so as tocalculate profit.

These can be best understood by looking at the e(uity part of a sole traderDs balance sheet#tatement of financial position! which is as follows:

+(uity at start)&& )dditional e(uity brought in)&&


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+(uity at end 38 &ecember 5788! 8KF B77)dd &rawings 87 777

8FF B779ess )dditional e(uity brought in 57 777!9ess +(uity at start 38 &ecember 5787! 85K 677!

8. The following information is available for a business:

+(uity at 8 Aay 5788 4B35 677+(uity at 37 )pril 5785 4BC7 B77)dditional e(uity brought in 4F 777&rawing for the year 455 B77

*alculate profit or loss for the year ended 37 )pril 5785.

Answer>

#tatement of profit and loss for the year ended 37 )pril 5785

4 +(uity at 37 )pril 5785 BC7 B77)dd &rawings 55 B77

BF5 F779ess )dditional e(uity brought in F 777!9ess +(uity at 8 Aay 5788 B35 677!

#tatement of profit and loss for the year ended 38 Aarch 5785

4 +(uity at 38 Aarch 5785 6EB 677)dd &rawings 38 677

C5C 7779ess )dditional e(uity brought in 87 777!


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9ess +(uity at 8 )pril 5788 C35 777!

Loss for the year 8C 777!

&ayroll ccounting

Payroll

;ayroll refers to the costs associated with hiring employees by a business. The costsinclude salaries and wages payable and contributions to be made to such funds asre+uired by the legislation of the country in favour of employees 20ational pensionfund, national insurance etc3.

Payroll Accounting

;ayroll accounting refers to the process of collecting and processing data to

compute payroll. "t ensures that proper records and documentations are kept foreach employee and for the business, wages and salaries are calculated according tocurrent legislations, statutory and non statutory deductions are e1ected and toappropriate fundsE bodies and employees are paid timely and accurately.


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Tools for &ayroll ccountingA variety of toolsE worksheets are used for payrollaccounting. Among them are 9lock cards, timesheet, payslip. ;ayroll register and wages sheet.

Cloc! cards

This is a card or a sheet that each employee has. Thecard is inserted in a machine called the clock cardmachine. The machine punches in or prints the timethe employee attends work 2time in3 and leaves work2time out3 for each day. The clock card is an oHcialdocument and is used by the payroll department tocalculate hours worked 2including overtime3 by anemployee and gross pay.

Time sheet

This is a sheet that an employee lls in everydayabout details of hours worked. Therefore, the timesheet is used to calculate number of hours anemployee has worked for each day. The payrolldepartment uses the time sheet to calculate numberof overtime hours and gross pay.

Payslip

This is a document that the law re+uires allemployers to give to their employees on pay day. "t isused to inform the employee about his basic wagesEsalaries, overtime, gross pay, statutory and non=statutory deductions and net pay. "t also containsidentications of the employee like his name, nationalinsurance number etc.

Payroll register

9ontains a list of all employees and details likeemployee number, (ob title, national insurancenumber, ta$ account number, payment mode, bankaccount number, contact details 2address andtelephone number3 and date on which the employee

(oined the business.


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"ages sheet

;repared on each pay day. "t contains a list of allemployees and details about their respective payroll

wagesE salaries, overtime, gross pay, statutory andnon=statutory deductions and net pay.

-ethods of calculating &ayroll;ayroll can be calculated on a time basis or on a piecework basis depending, ofcourse, on the nature of the (ob.

Time basis

An employee paid on a time basis is one who7s wages is calculated according to thenumber of hours worked. #or e$ample, an employee may be paid at the rate of %!&per hour. "f he works J hours a day, he earns 2J hours $ %!&3 %J&.

4owever, this basis does not account for labour productivity. An employee whoworks hard is paid the same rate per hour as someone who is less productive.

Piecewor! basis

An employee paid on a piecework basis is one who is paid according to the unitsproduced. This basis is especially applicable to factory workers. "t also takes intoaccount labour productivity. #or e$ample, a factor pays its workers %' per unit

produced. mployee A produces !& units in an J hour working day. /o he earns 2Junits $ %'3 %&. 5hereas employee B makes only ' units and so earns only 2' units$ %'3 %)'.

#ertime

vertime refers to the e$cess of hours worked over and above normal or minimumhours per week. 5orking overtime implies the employee is sacricing his rest andleisure time for the benet of the business. Therefore, to compensate for workingunsocial hours, the employee is paid at higher rates for hour in e$cess of normalweekly hours. #or e$ample, an employee is paid at the rate of %!& per hour for a

normal & hours week. 4e is paid at the rate of time and a half for any e$cess hoursover and above the & hours. 4e works '& hours in a particular week. /o he earns

Basic hours 2%!& $ & hours3 K %&&

vertime 2%!& $ !& hours $ !L3 K %!'&

ross pay K %''&


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9inancial %atios

nancial analysis and interpretation oaccounts

- #how relationships between financial figures- *ompare performance of the business past accounting

years trend analysis!- *ompare performance of the business with other

similar businesses in the same industry! or with theindustry average.

Ratios can be classified under the following>

rofitability ratios

2ross profit margin

Aark up on cost

et profit margin

+"penses to sales

!fficiency ratios $ate of inventory turn

+i&uidity ratios

*urrent ratio Working capitalratio!

Ruick ratio )cid test ratio!

3lic7 on the lin7s below for other "arts of the cha"ter

*ro4tability ratios +5ciency ratios Li3uidity ratios

;rotability 8atios9onsider the following e$ample

ear

0 4D)

ear 1

4D)

Revenue 4Revenue) 877 867

"ost of sales K6 857

(ross profit 56 376ross prot to sales (6ross prot margin)/hows the amount of prot made on each dollar of sales. Also indicates the percentage of sales that is available to pay for e$pensesand to retain as prot.

6ross *ro4t, 100

"evenue

6ross prot margin
http://www.olevelprinciplesofaccounts.com/profitability-ratios.htmlhttp://www.olevelprinciplesofaccounts.com/efficiency-ratios.htmlhttp://www.olevelprinciplesofaccounts.com/liquidity-ratios.htmlhttp://www.olevelprinciplesofaccounts.com/profitability-ratios.htmlhttp://www.olevelprinciplesofaccounts.com/efficiency-ratios.htmlhttp://www.olevelprinciplesofaccounts.com/liquidity-ratios.html


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/ear 8 /ear 5

$78

,1009

78

$1

00

$;0, 100 9 ;0

$180

*an also bee"pressed as

56

877

*an also be e"pressed as73

E0

023 2

6ross prot to cost o sales (@ark up)#hows the gross profit as a percentage of cost of sales.)lso indicates how much profit is added to every dollarof the cost of goods sold.

6ross *ro4t, 100

(ost of sales

@arkup on cost/ear 8 /ear 5

$78, 100 9 ;; .;

$

Increase inmargin and markup

8. ) decrease in purchase price not passed on to customers5. Trade discount received for bulk purchase3. )n increase in selling priceB. The business no longer allows trade discount6. 1vervaluing closing inventoryC. ndervaluing opening inventory

%elationship between margin andmarkup*)s can be seen above, gross profit margin and markupare related. This is because they are calculated by the


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same figures. $emember that gross profit $evenue =cost of sales.Therefore,

2ross profit margin can be e"pressed as

"evenue = (ost of sales

, 100"evenue

and

Aarkup can be e"pressed as

"evenue = (ost of sales, 100

(ost of sales)s such, when one is given, the other can be easilycalculated.#imply apply one of the following rules:

.+ 6ross 1rot@argin A

>arup1 ?>aru

p

3+ @arkup A

6ross *ro4t>argin

1 = 6ross*ro4t >argin

The above rules apply for both fractions andpercentage.9et us try we use the e"ample given above!

0et prot to sales (0et prot margin)#hows the amount of net profit earned from each dollarof sales made, after all e"penses have been paid.

et *ro4t, 100

"evenue9ike other ratios, net profit margin also may increase ordecrease.

Increase inmargin and markup

8. Increase gross profit margin5. $educe e"penses

8. &ecrease gross profit ma5. Increase e"penses


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2iven net profit gross profit = e"penses, we can alsocalculate the

!.penses to sales ratio 4also known as e.penses to

turnover ratio)6

This shows the amount from each dollar of sales that is

used to pay for e"penses.+,penses

, 100"evenue

Hciency 8atio

%ate o In'entory turn

#hows on average the number of times inventory was sold off and replaced.

2iven holding inventory implies funds are tied up, it is important to calculate this ratio so as to

assess how efficient the business has been in managing both funds and inventory. ote that therate of inventory turn varies for different types of goods.


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76 "ash tied up in e.cessive inventory6 'herefore@ the business may have difficulties in

paying for e.penses and short term debts6

>i+uidity 8atios

9i(uidity refers to the ability of a business to satisfy its short term obligations.

#hort term obligations include payment to suppliers of goods, payment of e"penses for the day today running of the business and also repayment of short term borrowings. 1ne indication ofli(uidity is the net current asset, that is, current assets = current liabilities.


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comprise a significant amount representing inventory. There is no guarantee than inventory willalready be converted into cash when payments for e"penses and debts fall due.

Therefore, current ratio may not be enough as a measure of li(uidity. This is why acid test ratioalso known as (uick ratio is also calculated:

Buick ratio& also known as acid test ratio

This ratio shows the ability of the business to pay its short term obligations with its most li(uidassets. This ratio gives an indication of the li(uidity position of a business in a harsh situation,that is if short term debts are to be paid so soon that it may not be possible to convert inventoryinto cash.

Ruick ratio is also given asx:8

Implications o poor li$uidity position

8. *reditors may lose trust in the business and may stop giving credit facilities.5. )dditional cost may be incurred e.g interest on loans and overdrafts! to pay creditors

and e"penses.3. The business may be unable to pay for specific services resulting in suppliers of such

services to cease supply. This may disturb the normal running of the business.B. Inability to pay salaries may result in workersD strike and resignations.

ow to impro'e li$uidity position

8. $eschedule payment of e"penses5. *ut down prices to increase cash sales3. +ncourage credit customers to pay earlier by giving cash discountsB. &ebt factoring6. egotiate with credit suppliers to have credit facilities e"tendedC. #ell surplus non-current assetsK. ring additional capital in the form of cash

!ccounting Concepts

The preparation of "ncome /tatement and Balance /heet of a business is based on

certain assumptions. These assumptions are called Accounting 9oncepts.


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Accounting concepts are very helpful in applying commonly established procedures

in preparing nancial statements.

Below is a list of basic accounting concepts

6oing Concern Concept

Denition

"t is assumed that the business will continue to operate in the foreseeable future 2as

far as one can predict3. Therefore, there is no intention of closing down.

This concept may not be applied if there are evidences or conditions re+uiring the

ceasing of business for e$ample persistent losses or li+uidity problem.

Implication

Assets are valued at historical cost less aggregate depreciation and notat

disposable value since there is no intention to dispose of them.

istorical Cost Concept

Denition

Transactions are recorded in terms of the actual amount at which they occurred in

the past.

This concept has the advantage of being ob(ective. The amount at which a

transaction took place cannot be disputed over, which is also the amount found on

the document issued or received during the transaction.

This concept, therefore, eliminates sub(ectivity associated with valuation in

accounting records.

Implication

Assets and e$penses are recorded at the actual amount spent. 8evenues are

recorded at actual amount receivedE receivable. >iabilities are recorded at actual

amount borrowed, therefore, payable.


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#usiness ntity also known as !ccounting ntity Concept

Denition

The owner and the business are considered as two di1erent persons, distinct from

each other.

Transactions are recorded from the point of view of the business and not the owner.

As such, any amount invested by the owner in the business is considered as a

liability by the business.

Also, only those transactions that concern the business are recorded.

Implication

;ersonal transactions and private property of the owner are not recorded in the

books.

9apital and :rawings accounts are kept to record amounts the owner gives to or

takes from the business.

@oney @easurement Concept

Denition

nly those transactions that can be e$pressed in money terms 2nancial

transactions3 are recorded in the books.

0on=nancial transactions are therefore not recorded.

Implication

/ome strengths or benets of the business may not be reMected in the books since

they cannot be e$pressed in money terms e$amples are +uality of work force and

market share.

!ccounting 1eriod Concept

Denition

According to this concept, the lifespan of a business is divided into $ed period of

time 2months, +uarters, half=years or years3 for which accounts are prepared.


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"n most cases an accounting period is a year. 0ote that the accounting year need

not be the same as the calendar year. #or e$ample, the accounting year for

business N can be from !


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customers.

@ateriality Concept

Denition

According to this concept, when recording transactions, the accountant should

consider whether disclosure and non=disclosure of such transaction will a1ect the

decisions of persons reading the accounts. Also, the accountant should consider

whether the benets obtained from the particular treatment to a transaction is

worth the e1ort put to it.

A classical e$ample here would be the way an accountant will treat a stapler costing

%) in the accounts. Though this item is bought by a business and will be used for

several years, it does not have signicant value.

Implication

/ome items 2stapler, paper clips etc3 are not considered non=current assets though

they may be used by the business for a long period of time. 8ather, their costs are

written o1 at one against prot in the period they are bought.

Consistency Concept

Denition

All similar items need to be given the same accounting treatment in the sameaccounting period and from one period to another.

Onless there is a valid reason, no changes are allowed in the accounting policy

chosen. This concept especially prevents accountants from manipulating the results

of a business by simply changing the accounting policies

Implication

The same depreciation method is applied for similar items in the same period and

from one period to another.

Dual !spect Concept

Denition

This concept takes into account the two aspects of a accounting represented on one

side by the assets of the business and on the other by the claims against those


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assets.

This duality is also e$plained by the accounting e+uation as follows

Assets K 9apital P >iabilities

Implication

Transactions are recorded using the double entry system whereby each transaction

has a debit entry and a corresponding credit entry.

accounting danial

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