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Level II

Certificate in Bookkeeping

Lesson 1

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Lesson 1

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CONTENTS Page Introduction to the Course 5 Introduction to Bookkeeping and Accounting 7 Professional Code of Ethics 9 Business Transactions 11 The Purpose of Bookkeeping 13 The Accounting Equation 14 Progress Test 1 17 The Balance Sheet 19 The Double-Entry Principle 26 Progress Test 2 28 Recording Entries in the Cash Account 30 Balancing an Account 32 Progress Test 3 35 Basic Elements of a Contract 37 Cash Based Accounting System 38 Glossary 40 Answers to Progress Tests 42 Assignment 1 45

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INTRODUCTION TO THE COURSE Welcome Welcome to Ideal Schools' course in Basic Bookkeeping, which is a first-level bookkeeping course. This course has been written by experts in the bookkeeping and accounting field but it assumes that you may not have any prior knowledge of the subject, so those of you new to the field will have no difficulty in starting and proceeding through the lessons. Regular, conscientious study on your part is necessary in order to acquire a good knowledge of bookkeeping and to reach a high standard of competence. Therefore we expect you to follow the study timetables you plan at the start of the course. Approach your training with vigour, enthusiasm and a genuine desire to learn, and you will be well rewarded. The average completion time is around 40 hours. Throughout the course, prices and rates quoted will be for illustrative purposes only, in order to help you understand the principles and concepts of bookkeeping. These are not to be assumed to represent current prices.

Assignments Your course comprises five lessons, and at the end of each there is an assignment. In addition, there is a final assignment in the form of a mock examination paper. Please submit each assignment, completed to the best of your ability, to Ideal Schools for marking. For smooth running of your studies, it is important that you send only one assignment at a time. It is not necessary to send them by registered post; this will only cause you unnecessary expense. You may email your assignments, or any tutorial questions to your tutor, whose details are provided in the “How your course works” page at the start of this course and in these cases we will return your work via email. When submitting work using Excel Spreadsheets, please ensure that it is in a format that can be easily printed. When the marked assignment has been returned to you, please take very careful note of the tutor's comments and the printed Suggested Answers. These are all part of the tuition process. Sometimes there may be more than one possible way of presenting the information required in the answer, so your answer is not necessarily wrong because it differs from the suggested answer. Your tutor will tell you if your answer is wrong or if your method of presenting the information is unacceptable.

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Progress Tests In addition to the assignments, there is a series of progress tests throughout each lesson. These tests are a valuable part of your training. They will help you to practice applying the material you have studied and they will also help you to judge how well you have understood it. If you are really going to learn a subject, then regular practice is essential. Experience has shown that these tests both increase your memory and improve your understanding of your studies. Please do each test as you come to it, as part of your study programme. Do not be tempted to ignore these tests. They may seem like hard work, but you will certainly feel the benefit when you come to the assignment at the end of each lesson. The procedure to follow is this: first read the questions carefully and think about them. Next plan your answers and write them on the blank page if you wish. Then look again at your answers until you are satisfied they are the best you can do. Finally, when you have finished the test, check your answers with the answers included at the end of the lesson. Do not send your answers to the School, but keep them for your own future reference. If about three-quarters or more of your answers are correct, go on to the next part of the lesson. If you have less than three-quarters correct, we suggest that you restudy the material. This should ensure that you learn each lesson thoroughly. It does not matter how often you have to do each progress test; what really matters is that you learn everything thoroughly.

Examinations Finally, enclosed with this lesson is a leaflet called How to Study. This will help you to get the best results from your course. So now read How to Study, and then go straight on with your studies - and good luck with them. When you have completed your assignments, including the mock exam, and the online practice exam you are ready for the final ICB Examination, which is completed from home in an online format. On completion of your study simply book this via IDEAL Schools and we’ll pass the booking onto ICB and they'll email you the examination link. Don't start the examination until you are ready, relaxed and prepared as once you start it must be completed within two hours. IMPORTANT: we strongly advise that you complete all assignments and mock exam(s) before booking your final exam(s). This will give you the best opportunity to pass first time, with a high percentage mark.

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INTRODUCTION TO BOOKKEEPING AND ACCOUNTING

Introduction As individuals we all need to have some record of our personal finances. We require

to know our present financial position - how much cash we have available to spend -

and also to have some idea as to what our future financial position is likely to be, e.g.

whether we shall be able to go on holiday next year, or buy an item of furniture for

the house. To decide this we shall have to consider how much cash we have

available at present and what our income and expenditure are likely to be in the

foreseeable future. It is therefore necessary to keep some record of our money

transactions.

The financial records a private individual will need to keep for his own purposes will

obviously be much simpler than those a trader or business would require to maintain.

Moreover, other people may be interested in a trader's financial records: for instance,

a bank which has lent the trader money for his business purposes, or the tax

authorities, who will be interested in ensuring that the correct amount of tax is paid

on any profits the trader may make. Therefore, a business must keep an accurate

and detailed record of all the various transactions in which it is engaged.

Bookkeeping The traditional method of recording financial transactions was in books, and

therefore the process of such recording is known as bookkeeping. The same term is

still used even if the actual recording is done by means of a computer. Bookkeeping

can therefore be defined as the method of recording the financial aspects of all

business transactions so that the financial position of the business can be

ascertained.

Throughout this course we shall refer to all bookkeeping processes as if they were

being done by manually recording the details in books. We are, of course, aware that

even the smallest businesses now have access to the advantages of

computerisation. However, even if a computer is being used to do the actual

recording, the person responsible for the records needs to understand the principles

of the bookkeeping process, and these can be most clearly explained by reference to

a manual system.

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Accounting

Whereas bookkeeping consists of keeping accurate records of all financial

transactions, accounting goes beyond this: it refers to the use to which the records

are put, i.e. the analysis and interpretation of the records in such a way that they

reveal clearly how successfully or otherwise the business is operating. Just as an

individual needs some kind of guideline to his future financial situation, so a business

needs to be able to plan for the development of the business and to make decisions

on the various possible courses of action.

There are a number of basic rules to be learnt in bookkeeping to ensure that records

will be kept accurately and will be of maximum use to the business. Accounting, on

the other hand, calls for a greater understanding of the financial transactions and an

ability to make use of the information that has been collected as an aid to managing

the business as efficiently and effectively as possible.

Whilst the purpose of this course is to consider the main aspects of bookkeeping, it is

important to bear in mind that the information recorded will ultimately have wider and

more extensive uses in the management of the business.

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PROFESSIONAL CODE OF ETHICS

Many professions that are trusted by the public to apply expert knowledge (doctors, engineers, surveyors, accountants and the like) have a Code of Ethics which sets out their expectations of a member’s behavior and the boundaries within which members have to operate. A Code of Ethics helps to clarify the profession’s values, provides a reference point for decision making, and can be used as a framework for discipline. Most Codes of Ethics are principles based, providing guidance as to the principles on which professional judgement and decisions should be based, rather than a rigid system of rules. There tend to be some common themes which members must apply: Integrity, objectivity, professional competence and due care, confidentiality and professional behavior. Law v Ethics Behaviour can be unethical without being illegal, and professional ethics covers a wider area than the law. For example tax evasion (the deliberate misrepresentation of personal or corporate affairs to the tax authorities) is illegal and not something that most people would wish to condone. However the comedian Jimmy Carr used a legal tax avoidance scheme to significantly reduce the tax on his earnings which gave rise to widespread criticism by the media and politicians (including the Prime Minister) who questioned the morality of his actions. Although not illegal there is an ethical issue concerning tax avoidance and the payment of what is fair/just by the wealthy. An Attitude of Mind Thus professional ethics is not just about complying with the letter of the law but also about applying the spirit of principles, rules and guidelines. Really it is about cultivating the right attitude of mind. Ethical issues are not always clear cut. Claiming expenses for amounts that have not been incurred or were for personal rather than business use might be considered unethical by most (the MPs expenses scandal is an obvious example) but what about the taking home of office stationery, pens, paper etc? A useful test is to consider what a reasonable person who is well informed, well intentioned and unbiased would do in a similar situation. Conflicts of interest Many professional ethics issues are about conflict and in particular the conflict between professional duties and personal interest. In order to act ethically a professional expert must be sure they are protecting the interests of others rather than themselves. At the start of 2012 the Chairman of the Swiss National Bank, Phillip Hildebrand, resigned after he was unable to prove that he was unaware of the currency trade made by his wife just before the Swiss National Bank intervened in the currency markets and capped the Swiss Franc against the Euro. His wife made around £45,000 on the transaction but was later quoted as saying that she had failed her husband by not even considering the perception of a conflict of interest…a conflict which cost him his job.

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In situations of possible conflict, professionals need to balance the commercial pressures of the business environment with the need to treat people fairly and act with integrity. So with the Facebook flotation there were concerns about the ethics of how Facebook’s professional advisors disclosed information, when estimates of revenue growth were revised downward a few days before the company went to the market, but this information was only provided to selected investors. The unequal dissemination of information meant that individual investors were left buying shares at prices that the institutional investors already knew were overvalued. Ethical Dilemmas The difficult economic environment has increased pressure on businesses to evidence liquidity, e.g. by reporting appropriate cash balances to the stock exchange, or to achieve profitability, e.g. by ensuring certain contracts are won. In such circumstances the pressure to act unethically increases. Britain’s banks have been heavily criticised for aggressively selling ineffective but highly profitable payment protection insurance during the course of the last decade alongside their mortgages, credit cards and loans – either mis-selling to customers who already had insurance, putting inappropriate pressure on customers to buy PPI, or in some cases adding insurance to loans without the customer’s knowledge. In the famous case of Lehma Brothers, sale and repurchase agreements that were in reality loans were treated as sales, after a well-known UK legal firm advised Lehmans that such treatment was acceptable under UK accounting regulations. Lehmans was the largest bankruptcy in US history and its collapse triggered the panic that led to the global economic crisis. Many questioned the ethics of Lehman’s professional advisors in conspiring to manipulate the balance sheet. In such cases the conflict between the duty to the client and the duty to the wider public interest is clear. Professional ethics help individuals faced with such ethical dilemmas to make the right decision, by setting out a framework which informs members about the issues to consider and the steps to go through in resolving difficult situations, whether a solicitor who has been asked to act for both parties in a dispute, or a finance director under pressure from a Board of Directors to take an aggressive approach to reporting earnings. Conclusion In conclusion the main thing that distinguishes members of a profession is a commitment to the highest standards of professional practice reflected in the high level of ethical standards expected of its members.

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BUSINESS TRANSACTIONS

There are many different sorts of businesses. One way of classifying them is according to how they are owned. A very common type of business is the sole trader, also known as sole proprietor or sole owner. Here one person owns the business. This person may employ people to help in the running of the business, but the proprietor is the sole owner, is entitled to all the profits and is responsible for all the debts of the business. Other types of business include the partnership, where the business is owned jointly by more than one person, and the limited company, where the business is owned by shareholders, who appoint a director or directors to run the business. For our present studies we shall deal with an individual running his own business as a sole trader. Whenever he enters into dealings with a view to financial gain, we refer to this as a business transaction. Note that all the roles referred to in this course may be filled by men or women, but we have avoided the clumsy he/she formula by choosing at random a gender for each participant.

Examples A simple example of a business transaction is if we consider an individual buying a packet of nuts from a shop. To the buyer this is merely the satisfaction of a personal desire. To the trader selling the nuts, however, this is a business transaction. He has sold a packet of nuts, which is one of the types of transactions by which he performs his business and earns his living. The number of transactions in any period will vary from one business to another. A manufacturer of hand-built, luxury sports cars, for instance, may make only one or two sales a week, whereas a large department store will have thousands of sales daily.

Every transaction will bring about a change in the business The trader selling nuts, for instance, had a packet of nuts before the transaction, whereas after it he has a certain sum of money, say, £1.30. He has exchanged the packet of nuts for £1.30. Not only has there been a change in what he physically has in the shop, but it is likely that there has been a change of values. It is not likely that the shopkeeper will have paid £1.30 for the packet of nuts; he could not pay his expenses and earn a living if he sold goods for what he paid for them. Let us suppose that he bought the nuts for £0.70 from his supplier. He therefore has an extra 60p above what he paid, and this is his profit on the transaction. The price he sells the nuts for will be based on how much he has to pay for the goods plus how much he needs to run his shop and meet his personal needs. The price will also depend on how much other traders in the area are charging for a packet of the same size and brand.

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The trader must know the true financial value

A variety of factors, therefore, will determine what a shopkeeper will charge for the goods he sells every day. He must, however, be in a position to know whether the price he is charging is of benefit to him, or he will not be in business very long. Obviously it would not be in his interests to buy an item for £0.90 and sell it for £ 0.89. But he may not really be able to afford to sell it for £1.00 either, since, if he sells all his goods at such a small profit he may not cover the expenses of running his shop, let alone make any money for him to live on. The trader must therefore know the true financial value, to him, of the business transactions he is entering into. Business transactions should not be entered into in a haphazard way. The shopkeeper must know what type of goods to hold in stock; what is the best time to buy, especially if goods are likely to sell best at particular times of the year (e.g. Christmas cards); from whom to buy and at what price; and how much to sell the goods for. He will need to know how much it is costing him to run his business and how much he can afford to spend on developing or improving it. He will be able to acquire such knowledge from the bookkeeping techniques we shall be discussing in this course.

A transfer of money All business transactions result in a transfer of money (or of money's worth) between two parties: the giver of value and the receiver of value. Where, for instance, a restaurant takes delivery of food from a supplier, the giver of value is the supplier and the receiver of value is the restaurant. When the restaurant pays for the food (whether this is in advance of receiving the delivery or afterwards) the restaurant is the giver of value and the supplier is the receiver of value. When a meal is served to a customer, the restaurant is the giver and the customer the receiver of value. When the customer pays for the meal, she becomes the giver of value and the restaurant becomes the receiver. An important fact to remember at this stage is that every business transaction has two aspects, the giving of value or benefit and the receiving of that value or benefit. It is impossible in bookkeeping terms to think of one without the other.

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THE PURPOSE OF BOOKKEEPING

The purpose of bookkeeping is to measure, in money terms, the way in which a business has been run. This constant measuring process, together with the use of accounting principles, enables the owner, manager or people running a business to guide it towards its objectives. As the rules of bookkeeping are universal, it forms a common business language. This enables all people interested in a business's affairs, such as owners, managers, bankers, lawyers, accountants, customers, suppliers, the government, to look at a business's affairs in the same fundamental way, although they may have different reasons for doing so and have different priorities. There are two basic factors the managers or owners of a business will consider when looking at the bookkeeping records: The first is whether they are operating at a profit and, if so, whether that profit is satisfactory. The second is whether they will be able to pay their bills when they become due; that is, whether they will have sufficient ready cash when required to keep the business operating. Both of these factors should be highlighted by the proper use of the bookkeeping system, in recording the business transactions, and the proper use of accounting techniques in interpreting that information.

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THE ACCOUNTING EQUATION

The accounting equation is the most fundamental rule of business bookkeeping and helps to explain the dual concept of giving and receiving of value referred to earlier. It can be stated in simple terms. For a business to exist it will need resources, and these resources will have to be supplied to the business by someone. These resources are known as assets and some of them, or perhaps all of them, will have been supplied by the owner of the business. The total amount of resources supplied by the owner of a business is known as capital. If we assume that all the resources have been supplied by the owner, then the following will represent the business's situation:

ASSETS = CAPITAL For example, Mr Brown takes early retirement at the age of fifty and receives a lump- sum payment. He then sells his house, which he owns, and uses £220,000 of the money he now has to buy a grocery business, with all the goods in stock at the time, all the fittings included, and a flat above the shop. The capital he has put in the business is £220,000. The assets which he has are worth £220,000 (the shop, flat, goods and fittings). His capital therefore equals his assets. Suppose, however, that the resources are contributed partly by someone else. The amount which the business owes to that someone else is known as a liability. It is clear that the assets have now been paid for partly by his own capital and partly by incurring liabilities. The equation will now be:

ASSETS = CAPITAL + LIABILITIES For example, if Mr Brown is only able to raise £210,000 and has to borrow £10,000 from a bank to make up the difference, the business will owe the bank £10,000, which is a liability. The equation will now be:

ASSETS £220,000 = CAPITAL £210,000 + LIABILITY £10,000 The totals of the two sides of the equation equal each other. On the one side are the resources possessed, the assets, whilst on the other side are the sources from which these resources are obtained. Both sides must always be equal. It will not matter how many transactions the business enters into, or how long the business exists, the two sides will always be the same. In Mr Brown's example the sources of finance available (capital + liability to the bank) equal the purchase price of the business. We have defined assets as the resources which a business has available to it. We can now simplify this definition to read:

ASSETS = anything of value owned by the business

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Assets Assets could be buildings, shop fittings, machinery, motor vehicles, office furniture and equipment, stocks of goods, cash, and money in the bank. These are all assets of a business. Another asset is money owed to the business. For instance, if a business sells goods to its customers on credit, i.e. they take the goods and agree to pay later, then until the customers pay they are in debt to the business. In other words they are debtors of the business, which is a value owned by the business.

Liabilities Similarly, if a business buys goods on credit, i.e. it receives the goods and is allowed time to pay for them, then this is a debt which the firm owes to its suppliers, or in other words the suppliers are creditors of the business, which is a value owed by the business. The creditors are therefore a further liability of the business because they represent money which the business owes and which it must repay at some future date. We have now considered what capital is, what assets and liabilities are, and what debtors and creditors are. Let us look again at our earlier equation of assets equal capital plus liabilities. We have defined assets as anything of value owned by the business, but we must now consider these assets further.

Current Assets A business may at any one time own goods and cash and be owed payment from its credit customers, all of which are representative of its normal trading activities. These items which the business owns are termed current assets - current because they are likely to be turned into cash in the near future. For example, a hotel with a quantity of food to sell would expect to sell that food quickly and therefore convert it into cash within a very short period. Broadly speaking, any assets which a business would expect to sell or convert into cash in the next 12 months are called current assets.

Fixed Assets In addition to such assets, many businesses own items of a more permanent nature, such as motor vehicles, buildings, machinery, etc. These are owned so that the business can conduct its affairs and are not for resale within a normal trading period. The business needs such resources to enable it to manufacture, produce and sell its products. Such permanent items are called fixed assets, because they are assets not intended for resale, but instead they are used in the production and sale of the business's products or services. Suppose an individual with £200 cash buys a motor-bike. He has exchanged an asset of £200, his cash, for an asset of £200, the motor-bike. His wealth, or total value of assets, remains the same. He is merely now holding his asset in a different form. The accounting equation of capital = assets is represented by £200 capital on one side and a motor-bike worth £200 on the other. If he sells the bike for £250 on a

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month's credit, then he has further exchanged his asset - the motor-bike - for another asset, the debtor of £250. As we have now increased one side of the equation the other side must also be increased. His capital must also have increased by £50, which is the amount of profit on the sale of the motor-bike. The profit on this business transaction is, therefore, reflected in the change on the capital side of the accounting equation: the original capital of £200 plus the profit of £50 equals the new asset of £250.

Capital is represented in a variety of forms It should be apparent by now that capital can be represented not merely in cash, but in a variety of forms and a variety of mixes of those forms. In fact, the capital of a business can be regarded as its net worth, i.e. the total value of those items which the business owns (current assets plus fixed assets) less the total value of the outstanding debts of the business to its credit suppliers. These debts are called its current liabilities, because they should be paid within the next 12 months, as opposed to the capital and external loans which would not be expected to be repaid in such a short time. This time distinction as regards liabilities is similar to that considered earlier for assets. Current liabilities would generally take the nature of creditors of the business, as defined earlier, just as current assets include debtors of the business. Our original equation of:

ASSETS = CAPITAL

can therefore be broken down into:

ASSETS = CAPITAL + LIABILITIES

and from there into:

FIXED ASSETS + CURRENT ASSETS = CAPITAL + LIABILITIES or

FIXED ASSETS + CURRENT ASSETS - LIABILITIES = CAPITAL

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PROGRESS TEST 1

1. Define Bookkeeping.

2. What are the two main aspects of every business transaction?

3. A business buys a dining table and four chairs from a furniture manufacturer at a cost of £600 and sells the items to a customer for £850. The customer pays cash at the time of the sale.

a) How many business transactions have occurred here from the business’s point of view?

b) Where has the value been given and received? c) How would you describe the difference of £250 between what the

business paid for the goods and what it sold them for?

4. What are a business’s assets and its liabilities?

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This page is left blank for your Progress Test workings

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THE BALANCE SHEET

We have defined those items a business owns as its assets, and we have considered these further as fixed assets (those held for use in the business year after year) and current assets (those which are converted into cash in the short term). We have also described the items a business owes as its liabilities and have distinguished these in a similar manner to assets. The debts a business must pay to its suppliers and short- term loans are current liabilities and the amount invested in the business is capital. There may also be long-term loans which the business will use to finance its operations and which are not expected to be paid back within the current trading period. Some students find it difficult, at first, to associate capital with liabilities, since these are what the business owes. In this it is important to separate in your mind the business itself from the owner of the business as a person. This distinction needs to be made even if the business is a person operating as a sole trader, using entirely his own capital.

Think of the business as separate from the owner Then it is easy to see that the capital which the owner invests in the business is really loaned by him personally to the business, so it is owed to him by the business. Like other liabilities, it is therefore shown as part of what the business owes, on the liabilities side of the equation. When a business starts, a statement should be drawn up showing its financial position. If Jean Jones uses £10,000 of her own money to start a business on 1 January, the business will have an asset of £10,000 (cash) and a liability (amount owed to Jean Jones, the person) of £10,000. We could summarise this position in the form of our accounting equation, or we could show it in the form of a statement

Assets Liabilities Cash £10,000 Capital £10,000

This statement represents our accounting equation

Because, as we have seen, the accounting equation must always balance, this statement is known as a balance sheet. We may define a balance sheet as a list of all the assets and liabilities of a business at a particular point in time. In the case of Jean Jones, this will be the balance sheet as at 1 January. This is not the only way of displaying such information, but it is the traditional method, showing the two sides of the accounting equation.

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(Until relatively recently the standard UK practice was to show liabilities on the left and assets on the right, and you may well still come across this layout in older textbooks. However, where the two-sided balance sheet is used, the preferred method is now to show liabilities on the right, and there are some situations where this is now obligatory by law. If you keep to this method, you cannot be wrong.) The main advantage of the two-sided style of presentation is that it makes very clear the relationship between sources of finance and assets. In any business the value of capital and liabilities which make up the sources of finance will always equal the value of assets. As we have stated, the balance sheet portrays the equation at a particular point in time. The title of the balance sheet would show the date when this was. Important: In this lesson we use the “horizontal” balance sheet format to help with the understanding of the Accounting Equation. However, the most widely used format, and the format you will be expected to use in assignments and examinations, is the “Vertical” format, an example of which you’ll see on Page 25 of this lesson.

Jean Jones Balance Sheet as at 1 January xxxx (year)

Assets Liabilities Cash £10,000 Capital £10,000

The Changing Balance Sheet As soon as Ms Jones begins to do business, the above balance sheet will no longer show the business's true position. The balance sheet is, therefore, always a historical document reflecting the position at one particular time. Over the next few pages we are going to show how Ms Jones's balance sheet is built up and how her various business transactions affect the balance sheet. These transactions are explained to you and after each one a new balance sheet is laid out for you. However, we have not explained each small step of arithmetic; we expect you to check this for yourself from the explanations in the text.

Asset Changes We want you to work carefully through each explanation and write down how each transaction affects the balance sheet. You can then compare this with the balance sheets we have laid out. By working in this way you will increase your understanding and get valuable practice at compiling a balance sheet. To keep things simple, we have kept to round figures, which are not necessarily meant to represent realistic prices. At this stage it is the principles illustrated that are important. Suppose that on 6 January Ms Jones buys an electronic knitting machine (she intends to make and sell high-quality sweaters) for £1,600 and £1,200 worth of

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assorted wools and threads. This wool and thread is the raw material with which she will manufacture sweaters and will be described as stock of raw materials. Stock, in an accounting sense, means finished goods ready to be sold, partially finished goods in some stage of production, and raw materials used to manufacture the product. We shall return to the question of stock later in the course. Ms Jones has therefore exchanged £2,800 of her cash asset for a fixed asset of £1,600 (the machine which will be used to produce the saleable product) and a current asset of £1,200 (raw material to be used in the making of the saleable product). Assuming that there are no other transactions, a balance sheet drawn up on 6 January would look like this:

Jean Jones Balance Sheet as at 6th January XXXX

Assets Liabilities

Fixed Assets Capital £10,000 Knitting Machine £1,600 Current Assets Stock of Raw Materials £1,200 Cash 7,200 8,400 _ £10,000 £10,000 All that has happened is that Ms Jones has altered the mix of her assets, her capital remaining unaltered. Note how the assets have been arranged. It is usual to show the fixed assets first, with the current assets beneath, and you should always do so. You can see how the current assets of stock and cash are shown as separate items. The figure of £8,400 is the total of these current assets. Suppose that in the following week Ms Jones uses £600 worth of the wool and thread to produce sweaters ready to sell. At the same time she buys a further £1,000 worth of wool and thread from I. Sew Ltd, who allow her four weeks' credit; i.e. she does not need to pay for the goods for four weeks. These transactions mean that Ms Jones has reduced her raw materials stock and created a stock of finished goods worth £600. She has also increased her stock of raw materials by £1,000 and created a liability to pay for these goods. As we have stated earlier, a person to whom we owe money is a creditor. The balance sheet will now show: Fixed Assets Capital £10,000 Knitting Machine £1,600 Current Assets Current Liabilities Stock of finished goods £600 Creditor 1,000 Stock of Raw Materials 1,600 2,200 Cash 7,200 9,400 £11,000 £11,000

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Notice here that we have dropped the two headings, Assets and Liabilities, as they are not really necessary. We have created a sub-total within our current assets of £2,200, which is the total stock cost and on the other side we have distinguished the creditor from capital by call ing it a current l iabil ity. In the normal course of business the creditor would be paid within the four-week period of credit. This must, therefore, be distinguished from capital as the owner would not expect to get her capital back from the business in so short a t ime, if indeed she expected it back at all. The capital remains available for use in the business as long as the owner wishes to continue, but the creditor will remain available for only four weeks. More Transactions Suppose now that on 20 January Ms Jones sells £100 worth of her sweaters to her family charging them only the cost of the materials used; i.e. she makes no profit and takes no account of the labour expended in producing the sweaters. At the same time she allows them four weeks to pay for the goods. She now has switched £100 of her stock of finished goods into a debtor of £100. There is therefore a reduction of one asset and the creation of another, the rest of the balance sheet remaining as before. On 31 January Ms Jones pays the £1,000 she owes I. Sew Ltd. The balance sheet would now show: Fixed Assets Capital £10,000 Knitting Machine £1,600 Current Assets Stock of finished goods £500 Stock of Raw Materials 1,600 2,100 Debtors 100 Cash 6,200 8,400 _ £10,000 £10,000 Here, stock has decreased by the amount of the debtor, while cash has decreased because the creditor has been paid. Notice also that this creditor no longer appears in the balance sheet. The only liability now is the original capital and the assets have also returned to their original value of £10,000. So far in all Ms Jones's transactions her capital has remained unchanged. It has merely been represented at different times by a different mix of assets. The changes have occurred within the current assets, this being the group of assets most l ikely to change, which is another reason why they are referred to as current.

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Capital Changes Suppose, however, that on 10 February Ms Jones does the following:

1. Sells her entire stock of finished goods for £1,100 on credit, allowing her customers 4 weeks to pay

2. Uses £1,000 worth of her raw materials to make more finished goods 3. Buys a further £2,000 of wools and threads on 4 week credit from I. Sew Ltd 4. Receives the cash her family owe her.

The balance sheet showing the effect of all these transactions would now look like this. Fixed Assets Capital £10,000 Knitting Machine £1,600 Profit 600 Current Assets Stock of finished goods £1,000 Current Liabilities Stock of Raw Materials 2,600 Creditor 2,000 3,600 Debtors 1,100 Cash 6,300 11,000 _ £12,600 £12,600 The first transaction here means that Jones has sold goods costing her £500 for £1,100. She has therefore made a profit of £600. On the assets side the stock figure of £500 disappears and we have a new debtor of £1,100. The assets side of the balance sheet has therefore increased by a net £600, the amount of profit. In order to balance both sides the profit is shown below the capital figure, since it is the profit of Jean Jones, the owner, and therefore represents part of the overall liability the business owes to her. In the same way, if the stock had been sold for less than it had cost, i.e. at a loss, this would have reduced Jean Jones's capital, since she must bear the losses as well as having the benefit of profits. As we have stated, capital represents the value of the investment in the business. Clearly, if the business makes a profit this value will increase; if it makes a loss this value will decrease. Whatever other liabilities there are, profit or loss should always be shown immediately below capital. The other three transactions are relatively straightforward. £1,000 worth of the raw material stock is converted into finished goods; raw material stock is therefore temporarily decreased to £600, but it is then increased by the £2,000 purchase of new stock. The increase in stock is balanced by the creation of a creditor for £2,000. Finally, cash is increased by £100 as the original debtor disappears when this is paid. We could continue producing a balance sheet to show the effect of every business transaction in which Jean Jones is involved, but this would be a laborious way of recording them and would be quite unpractical for a business with many transactions every day.

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The Double-Entry System This problem is overcome by the double-entry bookkeeping system which we shall consider next. Each class of asset and liability is given a separate account so that after each transaction we merely adjust the balance of the two accounts that are affected by that transaction. This makes it comparatively simple to produce a balance sheet, whenever desired, by merely listing the balances of each account. One important point you should have noticed from the transactions so far is that each one affects at least two items in the balance sheet. Sometimes it has changed two assets by increasing one and decreasing the other. Other transactions may change two liabilities, increasing one and decreasing the other. Others may affect both assets and liabilities, increasing or decreasing both by the same amount. In the case of the sale of finished goods, three items were affected: one asset (stock) was reduced by £500 and an asset (debtor) of £1,100 was created, making a net increase of £600, which was balanced by the creation of a profit figure on the liability side. In each case, however, for every item there must be an equal and compensating effect elsewhere in the balance sheet so that it will continue to balance. This is a fundamental accounting rule. If one item in a balance sheet is changed there must be a corresponding change elsewhere within the balance sheet. As we noted earlier, every business transaction must have two aspects to it, that of the giving of value and that of the receiving of value. The above balance sheet was presented in what is generally referred to as horizontal layout. We chose this as the clearest way of explaining to a beginner what was happening, but this layout, though not wrong, is now considered rather old- fashioned. Accountants now almost universally use the vertical style. The following shows the above balance sheet laid out in vertical form. You are advised to use this format from now on.

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Jean Jones

Balance Sheet as at 10th February XXXX Fixed Assets Knitting Machine £1,600

Current Assets Stock of finished goods £1,000 Stock of raw materials 2,600 3,600 Debtors 1,100 Cash 6,300 11,000

Current Liabilities Creditor (2,000) Net Current Assets 9,000 £10,600

Represented By: Capital £10,000 Profit 600 £10,600

You will see that we have deducted the current liabilities from the current assets, instead of adding them to the capital. Because we have deducted the £2,000 from one section instead of adding it to the other, the two totals (the ones double-underlined) still balance. A conventional way in bookkeeping of showing that a figure is a negative one, or one to be deducted, is to put it in brackets, as we have done here. The creditor is, of course, owed £2,000 as a positive amount but as against the assets the figure has to be deducted, so we have put it in brackets. The figure of current assets less current liabilities is known as net current assets, and gives a clearer picture of the resources available to the business, since we know that the £2,000 owed to creditors has to be paid soon and is not available for anything else.

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THE DOUBLE-ENTRY PRINCIPLE

As we have seen, every business transaction affects at least two items in a balance sheet, be they capital, assets or liabilities. We have also seen that to draft a balance sheet after every transaction would be both inefficient and unpractical when there are many transactions. We must therefore look to a better way of recording a business's daily transactions, and this we do by double-entry bookkeeping. We have mentioned the term bookkeeping before. It means simply recording the business transactions in a book or, nowadays, in a computer file. Double-entry bookkeeping means that there are two entries (hence the name double-entry) for every transaction in the books of the business. Each transaction appears twice in order to show the two aspects that every transaction has - the giving of value and the receiving of value.

The Ledger The main book in which business transactions are entered is called the ledger. There are other subsidiary books, which we shall return to later, but the ledger is the most important of any business's books as it contains details of all the items which appear in the balance sheet. At one time all ledgers were bound books, but nowadays loose-leaf files, paper cards and computer-based systems are often used. Whatever the format of the ledger, however, the principles and methods used to record business transactions in it are always the same. Sometimes in a computer-based system, the operator only has to make one entry for a transaction, the rest being done automatically by the computer. It is important to realise, however, that the double-entry has to be made, even if one entry is by the operator and one automatically by the computer. And it is important for the bookkeeper to understand what these entries are, even if he does not physically have to make them. That is why the following description of a manual-based system is essential study even for book-keepers who intend to use a computer. The double-entry system divides each page in the ledger down the middle. The left- hand side is called the debit side and the right-hand side is called the credit side. These terms are often abbreviated to Dr and Cr, respectively. You must not confuse the term credit here with its other usage of someone being allowed time to pay a bill. In terms of double-entry bookkeeping, the words debit and credit mean simply the left-hand side and the right-hand side, respectively.

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Accounts For every asset and liability of the business an account is opened in the ledger. The word account, usually abbreviated to a/c, means a history or record of. Thus a shop premises account is a record of the business transactions affecting the shop premises. A cash account is a record of all the business cash transactions, and similarly there is an account for every asset and liability of the business.

A separate page in the ledger should be used for each account, the title of the account being written across the account at the centre.

Below is an example of the layout of the cash account before any transactions have been recorded.

DR CASH ACCOUNT CR Date Particulars Folio Amount Date Particulars Folio Amount

The account is laid out in the form of a letter: Cash Account

The left-hand side of the T is the debit side and the right-hand side is the credit side.

Such layouts are often, in fact, referred to as T Accounts.

Look again at the detailed layout of the cash account and note the items included. The left-hand side of the account is headed Dr for debit and the right-hand side Cr for credit. The name of the account is written at the top of the page, which will probably be numbered for reference purposes. Some accounts will require more pages than others, depending on the number of transactions that need to be entered, and this is where loose-leaf books are useful.

The detail columns on the debit side are the same as on the credit side. There is a space to record the date of each transaction. Then under Particulars you must give a brief explanation of what the transaction is about. The amount of the transaction in money value (pounds and pence) is recorded and there is a Folio column which is used to give a convenient cross-reference to the other account in the double entry which is affected by the transaction. The crucial point to bear in mind is that every business transaction has a giving and receiving aspect. In double-entry bookkeeping every transaction is recorded in at least two accounts in the ledger, one account receiving the value and one account giving the value.

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Progress Test 2

1. What is double entry bookkeeping? 2. Which side of an account is a) the debit side and b) the credit side?

3. What, in bookkeeping terms, is an account?

4. Draft a Balance Sheet from the following figures which appear in a

business’s books:

Capital £60,000 Creditors £30,000 Debtors £15,000 Stock £10,000 Factory £40,000 Fittings & Equipment £25,000

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RECORDING ENTRIES IN THE CASH ACCOUNT

The cash account will record all cash received by the business and all cash paid out by it. Often these transactions will be carried out using the firm's bank account, issuing and receiving cheques instead of cash, but for the moment we shall think of these transactions only from the cash point of view. Any cash that the business receives will be shown on the debit side of the cash account; any cash that it pays out will be shown on the credit side. Suppose that a business has the following cash transactions in a month. July 1 Cash sales £1,200 3 Bought tools and equipment 600 10 Cash sales 900 12 Paid staff wages 1,000 14 Cash sales 2,400 15 Bought goods for resale 2,000 17 Cash sales 1,000 18 Cash sales 600 These transactions would appear in the cash account as follows:

Dr Cash Account Cr

Date Particulars Amount Date Particulars Amount July 1

10 14 17 18

Cash Sales Cash Sales Cash Sales Cash Sales Cash Sales

£1,200 900

2,400 1,000

600

July 3 12 15

Tool & Equipment Wages Purchases

£ 600 1,000 2,000

Note that, for the sake of simplicity, the folio column has been omitted from this account. The entries for cash sales on the debit side represent cash which the business has taken in for sales. The word cash could be omitted from the description in the particulars column, the word sales being sufficient, since the items would not appear in the cash account if they were not cash sales. The entries on the credit side represent cash the business has paid out for tools and equipment, wages and purchases of goods bought for resale. We have paid out these cash amounts and, as the cash account has given these amounts, it must be credited with them.

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This receiving and giving by the cash account may be easier to understand if you think of the cash account as a cash box in which money is kept. When we make cash sales we put money into the box. When we pay out for tools and equipment, wages and purchases we take money out of the box. The box is debited when we put money into it and credited when we take money out. We described goods bought for resale as purchases. This is an important point which we shall discuss at greater length later, but it is worth noting at this stage that only goods bought for resale are called purchases. Obviously the nature of purchases will vary from one business to another. A car bought by a car dealer for resale in the course of his business is classed as purchases, but a car bought by a greengrocer to collect and deliver supplies in the course of his business will not be described as purchases, because the trader has not bought it for the purpose of reselling it. Instead, his purchases would be the fruit and vegetables he buys to resell in his shop. Note the layout of the cash account. Each transaction is recorded immediately beneath the previous one, and the f igures are written neatly in columns in chronological order. The particulars entered are brief. There is no need, for instance, to write paid wages opposite this transaction because we know that, as this entry is on the credit side of the cash account, a payment has been made. The layout of all accounts in a business's ledger will be in the same format as that used here.

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BALANCING AN ACCOUNT

When all the debits on the cash accounts are totalled and all the credits are totalled, the difference between the two totals will be the balance which, if entered on the smaller side, will make both sides the same. To understand this concept of balancing an account, think of our cash T account as a set of scales like this:

The left hand tray on our scales represents the debit side of an account and the right- hand tray represents the credit side. If, instead of pounds sterling (£) as in our account, we think of kilogram weights on our scales, and we put 3 kg in the left-hand tray and 2.5 kg in the right-hand tray, then the left-hand tray will drop and pull up the right- hand tray. In order to balance the scales, we should have to put 0.5 kg more in the right-hand tray. We apply exactly the same principle when we balance our ledger accounts. At any point in t ime we can square off an account by calculating the balance on it and inserting the balance on the side which is lighter in order to make both sides the same.

If we look again at our cash account shown earlier, we shall see that the debits total £6,100 and the credits total £3,600. Our balance at the close of business on 18 July is therefore £2,500. In order to balance the account we should have to include £2,500 on the credit side.

What, though, does this £2,500 represent? If we think again of our cash account being a cash box, we have put £6,100 in the cash box and only taken £3,600 out. Clearly, the £2,500 is the cash we have in hand. We could also describe this as being a balance of cash in over cash out. Where the debit total exceeds the credit total on an account this is described as a debit balance and it is shown by balancing the account in the following manner:

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Dr Cash Account Cr

Date Particulars Amount Date Particulars Amount July 1

10 14 17 18

July 19

Cash Sales Cash Sales Cash Sales Cash Sales Cash Sales Balance b/d

£1,200 900

2,400 1,000

600 £6,100 £2,500

July 3 12 15 18

Tool & Equipment Wages Purchases Balance c/d

£ 600 1,000 2,000

£2,500 _ £6,100

What we have done here is balance the cash account at the close of business on 18 July by inserting the amount needed on the smaller side of the account to make the two sides the same. The £2,500 is a debit balance because debits exceed credits. We have shown this balance on the debit side of the account on the opening of the business on the next day. This shows that we start business on 19 July with cash in hand of £2,500. It is not necessary to look any further up the account to find the cash position of the business at that point in time. This closing off of accounts and carrying the balance forward is normally done at the end of the month. Note the manner in which the account has been balanced. We have entered the total of £2,500 on the credit side to balance both sides, then totalled both sides to £6,100 and double underlined the totals, to emphasise that both totals balance.

Carried Down and Brought Down

The abbreviations c/d and b/d mean carried down and brought down, respectively.

If we had used a folio column they would have been entered there, indicating that no other account is affected, the cross-reference being within the cash account itself. This balance is merely a summary of the position on the cash account to date. We have carried the debit balance down from 18 July to 19 July. As we have said, the accounts in the ledger are normally balanced monthly, so that the business has a regular check on how it is doing. However, the owner may want to know how things are at some intermediate time and may therefore sometimes balance his accounts at mid-month, as we have done here. Note that the cash account will always have a debit balance, as it is impossible to take more cash out of the cash box than we have put in it. Other accounts, however, may have debit or credit balances. The bank account, for instance, might have a credit balance if the business has issued cheques for a greater amount than it has deposited in the bank. This is assuming that the bank has agreed to overdraft facilities; that is an arrangement to borrow money up to a certain limit simply by issuing cheques which the bank agrees to honour, even though there is not enough in the account to cover them. We shall return to the matter of bank overdrafts later.

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If we were balancing the bank account in the ledger in these circumstances, the procedure would be exactly the same as we have shown for the cash account, except that the balance would be added to the debit side of the account to square it off and then brought down as a credit balance with which to begin the next period.

Avoid confusion over these terms of debit and credit. When more money has been paid into an account than has been taken out, then that account is holding the balance of money on behalf of the business; therefore it owes the money to the business and is in debit. When more money has been paid out from an account than has been paid in, then the account is in credit. Where there is only one entry in an account, as may be the case, for example, with the shop premises account , it may seem unnecessary to go through the process of balancing the account. However, this is normally done because it shows that all the accounts have been looked at and brought up to date at the same time.

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Progress Test 3

1. In recording a transaction under the rules of double entry bookkeeping which account is debited and which is credited?

2. How is an account balanced at any given point in time? What does the

balance represent?

3. Open a Cash Account and record the following transactions in it, balancing the account at the end of each month:

March 1st Sold goods for cash £3,200

4th Bought goods for resale, paying cash 1,400

7th Paid wages in cash 350

10th Bought second-hand motor van for cash 1,120

12th Sold goods for cash 4,150





April 4th Paid electricity bill by cash 420


10th Paid business rates by cash 755





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BASIC ELEMENTS OF A CONTRACT

Contract – A Definition A contract is an agreement giving rise to obligations which are enforced and/or recognised in law.

The Basic Elements Of A Contract In common law there are three basic essentials to the formation of a contract:

1. Agreement 2. Contractual intention 3. Consideration

An agreement is reached when one party makes an offer which is accepted by another party. An offer is an expression of willingness to contract on specific items made with the intention that it is to be binding once accepted by the party to whom it is addressed. An acceptance by the person or party to whom the offer is made is a final expression of agreement to the offer, i.e. the parties have an agreement. But this in itself is not yet sufficient to create a legal obligation. For an agreement to become a binding contract there must be considerations, i.e. ‘something of value’. For example a buyer is paying for goods in consideration for the seller’s promise to supply the goods. An agreement which is based on an informal gratuitous promise is not a contract. An agreement, even supported by consideration but without an intention to create legal obligations, is not a contract which can be legally enforced. In the case of ordinary commercial transactions, there is a presumption that both parties are intending to create legal relations and hence a contract enforceable by law. In summary, when an agreement is reached with contractual obligations and including the consideration (payment for goods or services) a legally binding contract exists.

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CASH BASED ACCOUNTING SYSTEM

1. Introduction Cash based (or Cash Basis) accounting is a simple way of working out the income and expenses for a business in order to determine the tax due. One can use the cash basis if the small business is a sole trader or a partnership (Limited companies cannot use it), and has an income below the VAT threshold. One can start using cash basis from the 2013/2014 tax year.

2. How Cash Based Accounting works One can choose to record the business income and expenses over the tax year in one of the following ways:

a) Using cash basis: record money when it actually comes in and goes out of the business (all money counts – cash, card payments, cheque and any other method of payment)

b) Using traditional accounting (accrual basis): record income and expenses when you invoice your customers or receive a bill.

Cash basis might suit smaller businesses because at the end of the tax year they won’t have to pay Income Tax on money they did not receive during the accounting period.

3. Who can use Cash Based Accounting? One can start to use the cash basis if the total business income is below the VAT threshold (currently £79,000 but can change). Existing businesses using traditional accounting (accruals basis) might have to make some adjustments when they switch to the cash basis. If one uses the cash basis remember: All payment count (cash, debit card, cheque etc) and you can choose how to record when money is received or paid (e.g. the date the money enters or leaves the account or the date a cheque is written) but you must use the same method each tax year.

4. When might cash basis not be suitable? Cash basis probably won’t suit your business if you:

Have losses that could be set against other taxable income (‘sideways tax relief’ for existing businesses)

Want to deduct interest of more than £500

Run a business that is more complex, e.g. you are VAT registered, you have higher levels of stock, or you produce detailed accounts for other business reasons.

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5. Who cannot use the scheme? Limited companies and limited liability partnerships cannot use the cash basis scheme. There are also some specific types of business that cannot use the scheme:

Lloyd’s underwriters

Farming businesses with a current herd basis election

Farming and creative businesses with a Section 221 ITTOIA profit averaging election

Businesses that have claimed business premises renovation allowance

Businesses that carry on a mineral extraction trade

Business that have claimed research and development allowance

Dealers in securities

Relief for mineral royalties

Lease premiums

Ministers of religion

Pool betting duty

Intermediaries treated as making employment payments

Managed service companies

Waste disposal

Cemeteries and crematoria

6. Summary Income With cash basis accounting one only counts the money actually received in a tax year. Any money owed is not counted until it is received. All payments – cash, card, cheque, payment in kind – count. Expenses Expenses are business costs deducted from income to calculate taxable profit. In practice this means allowable expenses reduce the Income Tax due. Cash basis doesn’t change the types of expenses one can claim, only when to claim them. Only count the expenses actually paid. Money owed is not counted until it is paid. Examples of allowable business expenses are:

Day to day running costs, e.g. electricity, water, fuel

Admin costs, e.g. stationery

Things you buy to sell on, e.g. stock

Things used by the business, e.g. machinery, computers, motor vehicles

Interest and charges up to £500, e.g. interest on bank overdrafts

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GLOSSARY

The following are the main terms introduced in this lesson: Account A record of a particular type of business transaction Assets A business’s resources. Anything of value owned by a business Balance The amount by which one side of a ledger account exceeds the

other side at any given point in time Balance Sheet A list of all assets and liabilities of a business at a particular

point in time Bookkeeping The method of recording the financial aspects of all business

transactions so that the total financial position of the business unit can be ascertained

Business Employment, trade, profession, occupation or industrial activity Business Entity The business is a separate entity from the owner(s) Business Rates In the UK, a form of property tax which is charged on business

premises. They are considered a general business expense and you may see the term used in examination papers, where they may sometimes be called simply rates. Rates were at one time also charged on domestic properties for financing local government but this has now been replaced by Council Tax.

Business Unit Whatever engages in business transactions Capital The amount of resources supplied by the owner or owners of a

business Credit The right-hand side of an account, recording the giving of value Creditors People to whom the business owes money for goods purchased

on credit. The value of creditors in the balance sheet refers to the total amount owed by the business to these creditors

Current Assets Assets which the business expects to turn into cash within a

twelve month period Current Liabilities Amounts due and payable with a twelve month period Debit The left-hand side of an account recording the receiving of value

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Debtors People who owe the business money for goods sold on credit. The value of debtors in the balance sheet refers to the total amount owed to the business by such debtors

Double-Entry Recording every transaction in the books of a business by

making a double-entry for each transaction, to reflect the dual aspect of every transaction (also known as the duality concept)

Fixed Assets Assets not intended for resale in the normal course of the

business’s activities Gross Profit Sales revenue less cost of the goods sold Ledger The main book used for recording a business’s transactions.

Even if the accounts are in fact held in a computer file rather than in a book this is still known as a ledger

Liabilities Amounts owed by a business Net Profit What is left of gross profit after all other expenses relevant to

the sale have been deducted At this stage you should revise carefully the whole of what you have studied so far before going on to your first assignment. Before you start the assignment, please read it through very carefully. Then attempt first those questions which appear to you easiest. You can refer back to the lesson notes at any time, though we assume that you have already revised thoroughly enough not to need to do so often. It is important that you read each question carefully, understand it and answer only the question asked. Also, make an attempt at every question. When you have completed your assignment, go over it carefully and check that each of the answers is the best you can produce. Then email it to Ideal Schools. Your tutor will mark your paper and return it to you with any personal comments and guidance that may be necessary. You will also receive printed advisory comments, which you should compare carefully with your own answers. Note that there may sometimes be more than one way of setting out a particular answer, and your attempt is not necessarily wrong because it differs from the one in the advisory comments. Your tutor will tell you whether your own approach is an acceptable one. Even if yours is an acceptable alternative to the given answer, however, it is still worth studying the latter as another way of approaching the question. While you are waiting for your assignment to be returned, you can carry on studying the next lesson in your possession. However, do not entirely forget this lesson; it contains many of the basic concepts on which the rest of the course is based, so you need to keep it constantly under review.

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ANSWERS TO PROGRESS TESTS

PROGRESS TEST 1

1. Bookkeeping is the method by which a business's financial transactions are recorded so that the financial position of the business can be ascertained.

2. The giving of value and the receiving of value.

3. (a) Two transactions. The buying of goods by the business and the subsequent

selling of them. (b) The furniture manufacturer gives value of £600 and the business receives it. When the business pays the £600 cash it gives value of £600 and the furniture manufacturer receives it.

When the business sells the furniture to the customer, who pays for it at the same time, the business gives value of £850 and the customer receives it, in the form of the furniture. At the same time the customer gives £850 in cash and the business receives it. (c) The difference of £250 represents a surplus or profit on the transaction.

4. Assets are everything of value owned by the business. Liabilities are amounts

owed by the business.

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PROGRESS TEST 2

1. The recording of the two aspects of every business transaction, i.e. the giving of value and the receiving of value in the business's books.

2. (a) The left-hand

side. (b) The right-hand side.

3. A record of a collection of business transactions of a particular type, i.e. for

every asset and liability of the business.

4.

Fixed Assets Factory £40,000 Fittings & Equipment 25,000 £65,000 Current Assets Stock 10,000 Debtors 15,000 25,000 Current Liabilities Creditors (30,000) Net Current Assets (5,000) £60,000 Represented By Capital £60,000

If you referred to net current assets simply as current assets less current liabilities this is perfectly correct. If you used the horizontal format, all assets would have been totalled on the left-hand side as £90,000 and the current liabilities would have been added to the capital, again making a total of £90,000. However, this balance sheet is a good illustration of one of the advantages of using the vertical format, since it highlights immediately the worrying fact that current liabilities exceed current assets, so if the business's creditors were to demand payment soon it would have to borrow money or sell some fixed assets to meet them. That is why the net current assets value is shown in brackets as a minus figure.

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PROGRESS TEST 3

1. The account receiving value is debited, while the account giving value is credited.

2. By inserting on that side of the account which is less, the amount which

is required to make both sides of the account equal. The balance is then carried down to the next trading period. The balance represents the value of the asset, liability, expense or income of which the account is a record at that particular point in time.

3.

CASH ACCOUNT DR CR March 1

st Sales £3,200 March 4

th Purchases £1,400

12th Sales 4,150 7

th Wages 350

18th Sales 1,120 10

th Motor Van 1,120

15th Wages 420

25th Wages 395

28th Purchases 2,650

_ 31st Balance c/d 2,135

£8,470 £8,470 April 1

st Balance b/d £2,135 April 4

th Electricity 420

16th Sales 4,000 7

th Wages 400

30th Sales 2,100 10

th Business Rates 755

25th Wages 430

28th Purchases 1,680

_ 30th Balance c/d 4,550

£8,235 £8,235 May 1

st Balance b/d £4,550

(Note: for the sake of simplicity we have omitted the headings date, particulars, etc)

ASSIGNMENT 1

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Submit your answers to the following questions for marking. Make sure that you clearly identify your paper with your name and student number and the number of the assignment (i.e. ICB 2014 Level II Certificate in Bookkeeping, Assignment 1). In the student area of our website, to help with the completion of your assignments, we have provided various Excel templates. It is not essential that you use these but they may save you some time Answer all questions. Question 1

From the balance sheet below, which accounts have been incorrectly posted and where should they have been posted?

Balance Sheet as at 1 January 20xx

Fixed Assets Motor Vehicles £50,000 Current Assets Stock £20,000 Cash at Bank 20,000 Bank Loan 15,000 Creditors 25,000 £80,000 Current Liabilities Debtors (40,000) Net Current Assets 40,000 Total Net Assets £90,000 Represented by Capital £90,000

Question 2

(a) What is the accounting equation on which the balance sheet is based?

(b) Why must a balance sheet balance?

(c) What does a balance sheet represent?

Question 3

Explain the difference between bookkeeping and accounting.

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Question 4 A business has capital of £18,000, fixed assets of £20,000 and current assets of £10,000. Its current liabilities will be:

a) £20,000 b) £28,000 c) £16,000 d) £12,000 e) £8,000

Question 5 If a business makes a profit it will be shown in the Balance Sheet...

a) As a fixed asset b) As a current liability c) As a current asset d) As a long term liability e) As an addition to Capital

Question 6 J Smith has cash in hand at 1st July of £600. During the month of July he spends £150 on office equipment, makes cash sales of £700, buys goods for resale for £300, receives cash sales of £150, takes £50 out of the petty cash tin for his own use and pays business bills in cash totaling £125. At the end of the month his cash balance will be:

a) £525 b) £825 c) £625 d) £325 e) £150

Cont…….

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Question 7 The following are items for inclusion on a company’s Balance Sheet. Using these figures calculate the amount of Capital. £ Motor Van 7,000 Cash 5,000 Creditors 30,000 Debtors 15,000 Stock 35,000 Furniture/Fittings 10,000 Machinery 20,000 Factory Premises 60,000

a) £125,000 b) £137,000 c) £122,000 d) £110,000 e) £115,000

Question 8 A business manufactures ball bearings. Which of the following are Current Assets?

a) Motor Van b) Stock of ball bearings c) Machinery for making ball bearings d) Debtors e) Factory building

level ii certificate in bookkeeping · the online practice exam you are ready for the final icb...

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