INTRODUTION TO ACCOUNTING
a) NATURE OF ACCOUNTING
Accounting is defined as the process of identifying, measuring and reporting economic information to the users of this information to permit informed judgment
Many businesses carry out transactions. Some of these transactions have a financial implication i.e. either cash is received or paid out. Examples of these transactions include selling goods, buying goods, paying employees and so many others.
Accounting is involved with identifying these transactions measuring (attaching a value) and reporting on these transactions. If a firm employs a new staff member then this may not be an accounting transaction. However when the firm pays the employee salary, then this is related to accounting as cash involved. This has an economic impact on the organization and will be recorded for accounting purposes. A process is put in place to collect and record this information; it is then classified and summarized so that it can be reported to the interested parties.
b) USERS OF ACCOUNTING INFORMATION
Accounting information is produced in form of financial statement. These financial statements provide information about an entity financial position, performance and changes in financial position.
Financial position of a firm is what the resources the business has and how much belongs to the owners and others.
The financial performance reflects how the business has performed, whether it has made profits or losses. Changes in financial positions determine whether the resources have increased or reduced.
The users of accounting information have an interest in the existence of the firm. Therefore the information contained in the financial statements will affect the decision making process.
The following are the users of accounting information:
- Owners:
They have invested in the business and examples of such owners include sole traders, partners (partnerships) and shareholders (company). They would like to have information on the financial performance, financial position and changes in financial position.
This information will enable them to assess how the managers of the business are performing whether the business is profitable or not and whether to make drawings or put in additional capital.
- Customers
Customers rely on the business for goods and services. They would like to know how the business is performing and its financial position.
This information would enable them to assess whether they can rely on the firm for future supplies.
Suppliers
They supply goods or services to the firm. The supplies are either for cash or credit. The suppliers would like to have information on the financial performance and position so as to assess whether the business would be able to pay up for the goods and services provided as and when the payments falls due.
- Managers
The managers are involved in the day-to-day activities of the business. They would like to have information on the financial position, performance and changes in financial position so as to determine whether the business is operating as per the plans.
In case the plan is not achieved then the managers come up with appropriate measures (controls) to ensure that the set plans are met.
- The Lenders
They have provided loans and others sources of capital to the business. Such lenders include banks and other financial institutions. They would like to have information on the financial performance and position of the business to assess whether the business is profitable enough to pay the interest on loans and whether it has enough resources to pay back the principal amount when it is due.
- The Government and its agencies
The Government is interested in the financial performance of the business to be able to assess the tax to be collected in the case there are any profits made by the business.
The other government agencies are interested with the financial position and performance of the business to be able to come with National Statistics. This statistics measure the average performance of the economy.
- The Financial Analyst and Advisors
Financial analyst and advisors interpret the financial information. Examples include stockbrokers who advise investors on shares to buy in the stock market and other professional consultants like accountants. They are interested with the financial position and performance of the firm so that they can advise their clients on how much is the value their investment i.e. whether it is profitable or not and what is the value.
Others advisors would include the press who will then pass the information to other relevant users.
- The Employees
They work for the business/entity. They would like to have information on the financial position and performance so as to make decisions on their terms of employment. This information would be important as they can use it to negotiate for better terms including salaries, training and other benefits.
They can also use it to assess whether the firm is financially sound and therefore their jobs are secure.
- The Public
Institutions and other welfare associations and groups represent the public. They are interested with the financial performance of the firm. This information will be important for them to assess how socially responsible is the firm.
This responsibility is in form the employment opportunities the firm offers, charitable activities and the effect of firm’s activities on the environment.
c) THE ACCOUNTING EQUATION
A business owns properties. These properties are called assets. The assets are the business resources that enable it to trade and carry out trading. They are financed or funded by the owners of the business who put in funds.
These funds, including assets that the owner may put is called capital. Other persons who are not owners of the firm may also finance assets. Funds from these sources are called liabilities.
The total assets must be equal to the total funding i.e. both from owners and non-owners. This is expressed inform of accounting equation which is stated as follows:
ASSETS = LIABILITIES + CAPITAL
Each item in this equation is briefly explained below.
Assets:
An asset is a resource controlled by a business entity/firm as a result of past events for which economic benefits are expected to flow to the firm.
An example is if a business sells goods on credit then it has an asset called a debtor. The past event is the sale on credit and the resource is a debtor. This debtor is expected to pay so that economic benefits will flow towards the firm i.e. in form of cash once the customers pays.
Assets are classified into two main types:
i) Non current assets (formerly called fixed assets).
ii) Current assets.
Non current assets are acquired by the business to assist in earning revenues and not for resale. They are normally expected to be in business for a period of more than one year.
Major examples include:
§ Land and buildings
§ Plant and machinery
§ Fixtures, furniture, fittings and equipment
§ Motor vehicles
Current assets are not expected to last for more than one year. They are in most cases directly related to the trading activities of the firm. Examples include:
§ Stock of goods – for purpose of selling.
§ Trade debtors/accounts receivables – owe the business amounts as a resort of trading.
§ Other debtors – owe the firm amounts other than for trading.
§ Cash at bank.
§ Cash in hand.
Liabilities:
These are obligations of a business as a result of past events settlement of which is expected to result to an economic outflow of amounts from the firm. An example is when a business buys goods on credit, then the firm has a liability called creditor. The past event is the credit purchase and the liability being the creditor the firm will pay cash to the creditor and therefore there is an out flow of cash from the business.
Liabilities are also classified into two main classes.
i) Non-current liabilities (or long term liabilities)
ii) Current liabilities.
Non-current liabilities are expected to last or be paid after one year. This includes long-term loans from banks or other financial institutions. Current liabilities last for a period of less than one year and therefore will be paid within one year. Major examples:
§ Trade creditors/
or accounts payable – owed amounts as a result of
business buying goods on credit.
§ Other creditors - owed amounts for services supplied to the firm
other than goods.
§ Bank overdraft - amounts advanced by the bank for a short-term
period.
Capital:
This is the residual amount on the owner’s interest in the firm after deducting liabilities from the assets.
The Accounting equation can be expressed in a simple report called the Balance Sheet. The basic format is as follows:
Name
Balance sheet as at 31.12. Sh Sh Sh Sh
Capital xx Non Current Assets
Land & Buildings xx
Non Current Liabilities Plant & Machinery xx
Loan xx Fixtures, furniture & fittings xx
Motor vehicles xx
Current liabilities xx
Overdraft xx Current Assets
Creditors xx xx Stocks xx
Debtor’s xx
Capital and Liabilities Cash at bank xx
Cash in hand xx xx
xx Total assets xx
The above format of the balance sheet is the horizontal format however currently the practice is to present the Balance Sheet using the vertical format which is shown below.
Name
Balance sheet as at 31.12.
Non Current Assets Sh Sh Sh
Land & Buildings xx
Plant & Machinery xx
Fixtures, furniture & fittings xx
Motors vehicles xx
xx
Current Assets
Stocks/inventories xx
Debtors/ trade receivables xx
Cash at bank xx
Cash in hand xx
Current Liabilities
Bank Overdraft xx
Creditors/trade payables xx (xx)
Net Current Assets xx
Net assets xx
Capital xx
Non Current Liabilities
Loan (from bank or other sources) xx
xx
Please pay attention to the format. The Non Current assets are listed in order of permanence as shown i.e. from Land and Buildings to motor vehicles. The Current Assets are listed in order of liquidity i.e. which asset is far from being converted into cash. Example ,stock is not yet sold, (i.e. not yet realised yet) then when it is sold we either get cash or a debtor (if sold on credit). When the debtor pays then the debtor may pay by cheque (cash has to be banked) or cash.
The Current Liabilities are listed in order of payment i.e. which is due for payment first. Bank overdraft is payable on demand by the bank, then followed by creditors.
Note that in the vertical format, current liabilities are deducted from current assets to give net current assets. This is added to Non Current assets, which give us net assets.
Net assets should be the same as the total of Capital and Non Current Liabilities.
Example 1.1
B Kelly has a business that has been trading for some time. You are given the following information as at 31.12.2002
£
Buildings 11,000
Furniture & Fittings 5,500
Motor Vehicles 5,800
Stocks 8,500
Debtor 5,600
Cash a bank 1,500
Cash in hand 400
Creditors 2,500
Capital 30,800
Loan 5,000
You are required to prepare a Balance Sheet as at 31 December 2001
B Kelly
Balance Sheet as at 31 December 2001
Non Current Assets £ £ £
Buildings 11,000
Furniture & Fittings 5,500
Motor Vehicles 5,800
22,300
Current Assets
Stock 8,500
Debtors 5,600
Cash at bank 1,500
Cash in hand 400
16,000
Creditors (2,500)
Net Current Assets 13,500
Net Assets 35,800
Capital 30,800
Non-Current Liabilities
Loan 5,000
35,800
Example 1.2
L Stokes sets up a new business. Before he actually sells anything he has bought motor vehicles of ₤3,000, premises of ₤7,000, stock of goods ₤2,000. He still owes ₤800 in respect of them. He had borrowed ₤4,000 from D Evans. After the events just described and before trading starts, he had ₤300 cash in hand and ₤600 cash at bank.
You are required to calculate the amount of his capital.
Solution:
Assets: ₤ ₤
Motor Vehicle 3,000
Premises 7,000
Stock 2,000
Cash at bank 600
Cash in hand 300
12,900
Liabilities:
Creditors 800
Loan - D Evans 4,000 (4,800)
8,100
Capital 8,100
Remember the Accounting equation:
Assets = Liabilities + Capital.
To get capital we rearrange the equation as follows:
Capital = Assets - Liabilities
Total Assets = ₤12,900
Total Liabilities = ₤4,800
Capital = ₤ 12,900 - 4,800
= ₤ 8,100
Example 1.3
C Kings has the following items in his balance sheet as on 30 June 2002.
Capital £41,800, Creditors £3,200, Fixtures £7,000, Motor Vehicles £8,400, Stock of goods £9,900, Debtors £6,500, Cash at bank £12,900 and Cash in hand £240.
During the first week of July 2002:
a. He bought extra stock of goods £1,540 on credit.
b. One of the debtors paid him £560 in cash.
c. He bought extra fixture by cheque £2,000.
You are to draw up a balance sheet as on 7 July 2002 after the above transactions have been completed.
First we need to look at the effect of the above transactions on the assets and liabilities of C Kings.
For
(a) Buying extra stock increases the level of stock by £1,540 and because this is bought on credit the creditors increase by £1,540 also.
(b) Amount received from the debtor means that the level of debtors reduces and cash increases by £560.
(c) Extra fixtures bought by cheque, will increase the fixtures and reduce the cash at bank by £2,000.
This can be summarized as follows:
Opening Increase/(Decrease) Closing
Balances Balances
£ £
Capital 41,800 - 41,800
Creditors 3,200 1,540 4,740
Fixtures 7,000 2,000 9,000
Motor Vehicles 8,400 - 8,400
Stock 9,900 1,540 11,440
Debtors 6,560 (560) 6,000
Cash at bank 12,900 (2000) 10,900
Cash in hand 240 560 800
Given these closing balances then the balance sheet can be drawn as follows:
C Kings
Balance sheet as at 7 July 2002.
Non Current Assets £ £
Fixtures 9,000
Motor Vehicles 8,400
17,400
Current Assets
Stock 11,440
Debtors 6,000
Cash at bank 10,900
Cash at hand 800
29,140
Current Liabilities
Creditors (4,740)
Net Current Assets 24,400
Net Assets 41,800
Capital 41,800
From the illustration remember that any change in the items of the balance sheet will have a double effect on the accounting equation has a double effect and therefore the equation will always balance.
Example 1.4
D Moody has the following assets and liabilities as on 31 April 2002:
£
Creditors 15,800
Equipment 46,000
Motor Vehicle 25,160
Stock 24,600
Debtors 23,080
Cash at bank 29,120
Cash in hand 160
During the first week of May 2002 Moody:
a. Bought extra equipment on credit for £5,520.
b. Bought extra stock by cheque £2,280.
c. Paid creditors by cheque £3,160.
d. Debtors paid £3,360 by cheque and £240 by cash.
e. Moody put in extra £1,000 cash as capital.
Required:
a. Determine the capital as at 1st May 2002.
b. Draw up a balance sheet after the above transactions have been completed.
Solution:
(i) Using the accounting equation of Assets = Liabilities + Capital, then assets and liabilities can be listed as follows.
Assets £ Liabilities £
Equipment 46,000 Creditors 15,800
Motor Vehicle 25,160
Stock 24,600
Debtors 23,080
Cash at bank 29,120
Cash in hand 160
148,120
Capital = Assets – Liabilities
= £148,120 - £15,800 = £132,320
(ii) To draw up the balance sheet, we consider the effect of the above transactions on the relevant balances:
a. Buying extra equipment means that the equipment balance will increase by £5,520 and the creditors will also increase by the same amount.
b. Buying extra stock by cheque means that the level of stock goes up by £2,280 and the balance at bank reduces by the same.
c. Paying creditors by cheque reduces the balance on the creditors account and also reduce the amount at the bank.
d. Debtor paying the firm reduces the debtors balance by £3,600 and increases the cash at bank and cash in hand by £3,360 and £240 respectively.
e. Additional cash of £1,000 increases the cash in hand balance by £1,000 and the capital balances.
This is also summarized as follows:
Opening Adjustment Closing
Balance Increase/Decrease Balance
Assets/Liabilities £ £ £
Equipment 46,000 +5,520 51,520
Motor Vehicle 25,160 25,160
Stock 24,600 +2,280 26,880
Debtors 23,080 -3,600 19,480
Cash at bank 29,120 (-2,280 – 3,160 + 3,360) 27,040
Cash in hand 160 (+240 + 1000) 1,400
Creditors 15,800 (+5,520 – 3,160) 18,160
Capital 132,320 +1,000 133,320
The balance sheet will therefore be prepared as follows:
D Moody
Balance sheet as at 7 May 2002
Non Current Assets £ £
Equipment 51,520
Motor vehicle 25,160
76,680
Current Assets
Stock 26,880
Debtors 19,480
Cash at bank 27,040
Cash in hand 1,400
74,800
Current Liabilities
Creditors (18,160)
Net Current Assets 56,640
Net Assets 133,320
Capital 133,320
Double Entry Aspects
The Accounting equation forms the basis of double entry and therefore it should always be maintained. Any change in assets, liabilities or capital will have a double effect such that assets will always be equal to liabilities plus capital. If the owners put in additional capital then this will increase the cash at bank and the capital amount therefore the equation is still maintained.
Name Debit Credit
| Date | Detail | Folio | Amount | Date | | Detail | Folio | Amount |
| | | | | | | | | |
In this account the date will show the opening period of the asset ,liability or capital i.e. the balance brought forward. It will also show the date when a transaction took place (i.e. either an asset was bought or liability incurred).
The detail column (also called the particulars column) shows the nature of the transaction and reference to the corresponding account. The Folio Column for purposes of detailed recording shows the reference number of the corresponding account. The amount column shows the amount of the asset, liability or capital.
The left side of the account is called the debit side and the right side is called the credit side. All assets are shown or recorded on the debit side while all the liabilities and capital are recorded on the credit side. Each type of asset or liability must have its own account whereby all transactions affecting them are recorded in this account. Therefore there should be an account for Premises, Plant and Machinery, Stock, Debtors, Creditors etc.
Under the accounting equation if all assets are represented by liabilities and capital therefore all debits should be the same as credits.
For the double entry to be reflected in the accounts, every debit entry must have a corresponding credit entry. The transactions affecting these accounts are posted in the account as debit entry and credit entry to complete the double entry.
When we make a debit entry we are either:
i. Increasing the value of an asset.
ii. Reducing the value of a liability.
iii. Reducing the value of capital.
When we make a credit entry we are either:
i. Reducing the value of an asset.
ii. Increasing the value of a liability.
iii. Increasing the value of capital.
Example 1.5
H Jumps has the following assets and liabilities as on 30 November 2002:
Creditors £39,500; Equipment £115,000; Motor vehicle £62,900; Stock £61,500; Debtors £57,700;Cash at bank £72,800 and Cash in hand £400.
Compute the balance on the capital account as at 30 November 2002.
During the first week of December 2002, Jump:
a. Bought extra equipment on credit for £13,800.
b. Bought extra stock by cheque £5,700.
c. Paid creditors by cheque £7,900.
d. Received from debtors £8,400 by cheque and £600 by cash.
e. Put in an extra £2,500 cash as capital.
You are to draw up a balance sheet as on 7 December 2002 after the above transactions have been completed.
Answer:
Capital = Assets – Liabilities
| Assets | £ | Liabilities | £ |
| Equipment | 115,000 | Creditors | 39,500 |
| Motor vehicle | 62,900 | | |
| Stock | 61,500 | | |
| Debtors | 57,700 | | |
| Cash at bank | 72,800 | | |
| Cash in hand | 400 | | |
| | 371,300 | | |
Capital = £371,300 - £39,500 = £330,800
Creditors A/C Motor Vehicles a/c 2002 £ B 2002 £ 2002 £ 2002 £
Bank 7900 1.12 Bal b/d 39,500 1.12 Bal b/d 62,900 1.12 Bal c/d 62,900
1.12 Bal c/d 31,600
62,900 62,900
39,500 39,500
Equipment a/c
| 2002 £ | 2002 £ |
| 1.12 Bal b\d 115,000 | |
| Creditors 13,800 | 7.12 Bal c\d 128,800 |
| 128,800 | 128,800 |
Stock a/c
| 2002 £ | 2002 £ |
| 1.12 Bal b\d 61,500 | |
| Bank 5700 | 7.12 Bal c\d 67,200 |
| 67,200 | 67,200 |
| | |
Debtors a/c
| 2002 £ | 2002 £ |
| 1.12 Bal b\d 57,700 | Bank 8,400 |
| Bank 570 | Cash 600 7.12 Bal c\d 48,700 |
| 57,700 | 57,700 |
Cash at Bank a/c
| 2002 £ | 2002 £ |
| 1.12 Bal b\d 72,800 | Stock 5,700 |
| | Creditors 7,900 |
| Debtors 8,400 | 7.12 Bal c\d 67,600 |
| 81,200 | 81,200 |
Cash in hand a/c
| 2002 £ | 2002 £ |
| 1.12 Bal b\d 400 | |
| Debtors 600 | |
| Capital 2500 | 7.12 Bal c\d 3500 |
| 3500 | 3500 |
Capital
| 2002 £ | 2002 £ |
| | 1.12 Bal b\d 330800 |
| 7.12 Bal b\d 333300 | Cash 2500 |
| 128,800 | 128,800 |
Creditors Of Equipment
| 2002 £ | 2002 £ |
| | |
| 7.12 Bal b\d 13800 | Equipment 13800 |
| 13,800 | 13,800 |
H Jump
Balance sheet as at 7 December 2002
Non Current Assets £ £ £
Equipment 128,800
Motor vehicles 62,900
191,700
Current Assets
Stock 61,200
Debtors 48,700
Cash at Bank 67,600
Cash in Hand 3,500
187,000
Current Liabilities
Creditors of equipment 13,800
Creditors 31,000 (45,400)
Net Current Assets 141,000
Net Assets 333,300
Capital 333,300
Example 1.6
Write up the asset, capital and liability accounts in the books of M Crash to record the following transactions:
2002
June 1 Started business with £50,000 in the bank.
“ 2 Bought motor van paying by cheque £12,000.
“ 5 Bought Fixtures £4,000 on credit from Office Masters Ltd.
“ 8 Bought a van on credit from Motor Cars Ltd £8,000.
“ 12 Took £1,000 out of the bank and put it into the cash till.
“ 15 Bought Fixtures paying by cash £600.
“ 19 Paid Motor Cars Ltd by cheque £8000.
“ 21 A loan of £10,000 cash is received from J Marcus.
“ 25 Paid £8,000 of the cash in hand into the bank account.
“ 30 Bought more Fixtures paying by cheque £3,000.
Capital a/c Cash at bank a/c
 |  | ||
2002 £ 2002 £ 2002 £ 2002 £
30/6 Bal c/f 50,000 1/6 Bank 50,000 1/6 Capital 50,000 2/6 Van 12,000
12/6 Cash 8,000 12/6Cash 1,000
19/6Motor ltd 8,000 50,000 50,000 30/6 Fixtures 3,000
30/6 Bal c/f 34,000
58,000 58,000
Motor Van
| 2002 £ | £ |
| 2/6 Bank 12,000 | |
| 8/6 Super M 8,000 | 30/6 Bal c/f 20,000 |
| 20000 | 20000 |
Fixtures
| 2002 £ | 2002 £ |
| 5/6 young 4,000 | |
| 15/6 Cash 600 | |
| 30/6 Bank 3000 | Bal c/f 7,600 |
| 7,600 | 7,600 |
Motor Car Ltd – Creditors
| 2002 £ | 2002 £ |
| 19/6 Bank 8000 | 8/6 Van 8000 |
| 8000 | 8000 |
Office Masters Ltd - Creditor
| 2002 £ | 2002 £ |
| 30/6 B\f 4000 | 8/6 Fixtures 4000 |
| 4000 | 4000 |
Cash in hand
| 2002 £ | 2002 £ |
| 12/6 Cash 1,000 | 15/6 Cash 600 |
| | 25/6 Bank 800 |
| 21/6 J. Marcus 10000 | 30/6 Bal c/f 2400 |
| 11000 | 11000 |
J. Marcus - Loaner
| 2002 £ | 2002 £ |
| 30/6 c\f 10000 | 21/6 Cash 10000 |
Note that the difference between the debit side and the credit side is the balancing figure. Most assets will have a balance on the credit side and most liabilities and capital accounts will have a balance on the debit side.
A simple balance sheet from these balances will be as follows:
M Crash
Balance Sheet as at 30th June 2002
£ £
Non Current Assets
Fixtures 7,600
Motor vehicles 20,000
27,600
Current Assets
Cash at bank 34,000
Cash in hand 2,400
36,400
Current Liabilities
Creditors – others (4,000)
Net Current Assets 32,400
Net Assets 60,000
Capital 50,000
Non Current Liabilities
Loan – J Jarvis 10,000
60,000
Let us now consider other transactions that take place in a business and the accounting entries to be made.
Accounting for sales, purchases, incomes and expenses.
Sales:
This is the sell of goods that were bought by a firm (the goods must have been bought with the purpose of resale). Sales are divided into cash sales and credit sales. When a cash sale is made, the following entries are to be made.
i. Debit cash either at bank or in hand.
ii. Credit sales account.
For a credit sale:
i. Debit debtors/ Accounts receivable account.
ii. Credit sales account.
A new account for sales is opened and credited with cash or credit sales.
Purchases:
Buying of goods meant for resale. Purchases can also be for cash or on credit. For cash purchases:
i. Debit purchases.
ii. Credit cash at bank/cash in hand
For credit purchases, we:
i. Debit purchases.
ii. Credit creditors for goods.
A new account is also opened for purchases where both cash and credit purchases are posted. NOTE: NO ENTRY IS MADE INTO THE STOCKS ACCOUNT.
Incomes:
A firm may have other incomes apart from that generated from trading (sales). Such incomes include:
§ Rent
§ Bank interest
§ Discounts received.
When the firm receives cash, from these incomes, the following entries are made:
§ Debit cash in hand/at bank.
§ Credit income account.
Each type of income should have its own account e.g. rent income, interest income.
Incomes increase the value of capital and that is the reason why they are posted on the credit side of their respective accounts.
Expenses:
These are amounts paid out for services rendered other than those paid for purchases. Examples include:
· Postage and stationery
· Salaries and wages
· Telephone bills
· Motor vehicle running expenses.
· Bank charges.
When a firm pays for an expense, we:
i. Debit the expense account.
ii. Credit cash at bank/in hand.
Each expense should also have its own account where the corresponding entry will be posted. Expenses decrease the value of capital and thus the posting is made on the debit side of their accounts.
The following diagram is a simple summary of the entries made for incomes and expenses.
Debit cash book/bank/in hand
|
|
INCOMES/EXPENSES Debit Expense A/C
|
Credit cash book /bank/in hand
Returns Inwards and Returns Outwards.
Returns Inwards: These are goods that have been returned by customers due to various reasons e.g.
i. They may be defective/damaged,
ii. Being of the wrong type .
iii. Excess goods being delivered.
Goods returned may relate to cash sales or credit sales. For the goods returned in relation to cash sales and cash is refunded to the customer the following entries are made:
i. Debit returns – inwards
ii. Credit cashbook.
For goods returned that relate to credit sales; no cash has been given to customer, the following entry is to be made.
i. Debit returns inwards.
ii. Credit debtors.
Returns Outwards: These are goods returned to suppliers/creditors. They may be for cash purchases or for credit purchases. For cash purchases a cash refund given to the firm by the supplier,
i. Debit the cashbook (cash at bank/hand).
ii. Credit returns outwards.
For credit purchases and no refund has been made:
i. Debit creditors.
ii. Credit returns outwards.
Diagrammatically shown as follows:
Debit returns inwards.
Cash Credit cashbook.
Inwards Debit returns inwards
Credit Credit debtors
Debit cash
Returns Cash
Outwards Credit returns outwards
Debit creditors
Credit Credit returns outwards
Now lets us take one example that includes most of the above transactions.
Example 1.8
You are to enter the following transactions, completing the double entry in the books for the month of May 2002.
2002
May 1 Started business with £2,000 in the bank.
“ 2 Purchased goods £175 on credit from M Rooks.
“ 3 Bought furniture and fittings £150 paying by cheque.
“ 5 Sold goods for cash £275.
“ 6 Bought goods on credit £114 from P Scot.
“ 10 Paid rent by cash £15.
“ 12 Bought stationery £27, paying in cash.
“ 18 Goods returned to M Rooks £23.
“ 21 Let off part of the premises receiving rent by cheque £5.
“ 23 Sold goods on credit to U Foot for £77.
“ 24 Bought a motor van paying by cheque £300.
“ 30 Paid the month’s wages by cash £117.
“ 31 The proprietor took cash for himself £44.
Example
Bank a/c
| 2002 £ | 2002 £ |
| 1/5 Capital 2,000 | 3/5Furn& fitting 150 |
| | 24/5 Motor vehicle 300 |
| 21/5 Rent 5 | 31/5 Bal c/f 1,555 |
| 2,005 | 2,005 |
Capital a/c
| 31/5 Bal c/f 2,000 | 1/5 Bank 2,000 |
| | |
Purchases a/c
| 2002 £ | 2002 £ |
| 2/5M Rooks 175 | |
| 6/5 P Scot 114 | 31/5 Bal c/f 289 |
| 289 | 289 |
| | |
| | |
Creditor – M Rooks a/c
| 2002 £ | 2002 £ |
| 18/5 Returns in 23 | 2/5 Purchases 175 |
| 31/5 Bal c/f 152 | |
| 175 | 175 |
| | |
Furniture & Fittings a/c
2002 £ 2002 £ Sales a/c
3/5 Bank 150 31/5 Bal c/f 150 
2002 £ 2002 £ 31/5 Bal c/f 352 5/5 Cash 275
150 150 23/5 U. Foot 77
352 352
Cash in hand a/c
2002 £ 2002 £ P Scot a/c5/5 Sales 275 10/5 Rent 15 2002 £ 2002 £
12/5 Stationery 27 31/5 Bal c/f 114 6/5Purchases 114
30/5 Wages 117
31/5 Bal c/f 116
275 275 114 114 Expenses – Rent a/c Expenses – Stationery a/c
2002 £ 2002 £ 2002 £ 2002 £
11/5 Bal c/f 15 10/5 Cash 15 12/5 Cash 27 31/5Bal c/f 27
27 27
Returns – Out a/c Income – Rent a/c
2002 £ 2002 £ 2002 £ 2002 £31/5 Bal c/f 23 18/5 M Rooks 23 21/5 Bal c/f 5 31/5 Bank 5
Debtors – U Foot a/c Motor vehicle a/c
2002 £ 2002 £ 2002 £ 2002 £23/5 Sales 77 31/5 Bal c/f 77 24/5 Bank 300 31/5 Bal c/f 300
Expenses – Wages a/c Drawings a/c
2002 £ 2002 £ 2002 £ 200 £30/5 Cash 117 31/5 Bal c/f 117 31/5 Cash 44 31/5 Bal c/f 44
Accounting for drawings, discounts allowed and discounts received.
Drawings
The owner makes drawings from the firm in various ways:
i) Cash or bank withdrawals
When the owner withdraws money from the business we debit drawings and credit cashbook (cash in hand or cash at bank).
ii) Taking goods for own use and
When the owner takes out some of the goods for his own use, we debit drawings and credit purchases.
iii) Personal expenses, paid by the business
Here we debit the drawings and credit expense account
Taking some of the other assets from the business e.g. motor vehicles or using part of the premises.
Sometimes the owner may take over some of the assets of the business e.g. vehicle or converting business premises into living quarters or not paying into the business cash collected personally from the customers. When this happens we debit drawings and credit the relevant asset e.g. motor vehicles, premises or some building or even debtors.
Discounts
Discounts received.
A discount received is an allowance by the creditors to the firm to encourage the firm to pay the amount dues within the agreed time. It is an amount deducted from the invoice price.
When a discount is given by the supplier then we debit creditor’s account and credit discounts received e.g. A. Ltd sells some goods on credit to B Ltd. ₤1,000 under the terms of sale, B Ltd, will receive a discount of 5% if they pay the amount due within one month. B decides to take up the offer and pays the amount within the given time. B will record the transaction as follows.
Debit: Creditor – A Ltd
Credit: Discounts Received
Creditor A. Ltd a/c Purchases a/c
2002 £ 2002 £ 2002 £ 2002 £
Bank 950 Purchases 1,000 A Ltd 1,000
Discount received 50 1000 1000
Discounts Received a/c Bank a/c200 £ 2002 £ 2002 £ 2002 £Bal c/f 50 A Ltd 50 A Ltd 950
Discounts Allowed
These are the allowances made by a firm on the amounts receivable from the customers to encourage prompt payment. The amounts deducted from the sales invoice. In the previous example when A Ltd issued the discount and was taken up by B the entries will be:
i. Debit - discount allowed
ii. Credit - debtors - B Ltd.
Debtors B Ltd a/c Sales a/c
2002 £ 2002 £ 2002 £ 2002 £Sales 1,000 Bank 950
Discount 50 Debtor 1,000
1,000 1,000
Discount allowed a/c Bank a/c
2002 £ 2002 £ 2002 £ Debtor 50 Bal c/f 50 Debtor 950TRIAL BALANCE
The trial balance is a simple report that shows the list of account balances classified as per the debits and credits. The purpose of the trial balance is to show the accuracy of the double entriesmade and to facilitate the preparation of final accounts i.e. the trading, profit & loss account and a balance sheet.
The debits of the trial balance should be the same as the credits, if not then there is an error in one or more of the accounts.
The trial balance in example 1.8 would be extracted as follows:
Name
| Trial balance as at 31 May 2002 | ||
| | Debit | Credit |
| | £ | £ |
| Rent – income | | 5 |
| Debtor – U Foot | 7 | |
| Motor vehicle | 300 | |
| Bank | 1555 | |
| Purchases | 289 | |
| Wages | 117 | |
| Capital | | 2000 |
| Creditor – M Rooks | | 152 |
| Furniture & Fittings | 150 | |
| Sales | | 352 |
| Cash in hand | 72 | |
| Creditor – P Scot | | 114 |
| Expenses – Rent | 15 | |
| Expenses – Stationery | 27 | |
| Returns Outwards | | 23 |
| Drawings | 44 | . |
| | 2464 | 2464 |
From the trial balance please note that assets and expenses are on the debit side. Capital, liabilities and incomes are normally listed on the credit side.
The next example is a detailed one that shows extracting of trial balance once all the postings have been made in the relevant accounts.
Example 1.9
Write up the following transactions in the books of S Pink:
2003
March 1 Started business with cash £1,000.
“ 2 Bought goods on credit from A Cliks £296.
“ 3 Paid rent by cash £28.
“ 4 Paid £1,000 of the cash of the firm into a bank account.
“ 5 Sold goods on credit to J Simpson £54.
“ 7 Bought stationery £15 paying by cheque.
“ 11 Cash sales £49.
“ 14 Goods returned by us to A Cliks £17.
“ 17 Sold goods on credit to P Lutz £29.
“ 20 Paid for repairs to the building by cash £18.
“ 22 J Simpson returned goods to us £14.
“ 27 Paid A Cliks by cheque £279.
“ 28 Cash purchases £125.
“ 29 Bought a motor vehicle paying by cheque £395.
“ 30 Paid motor expenses in cash £15.
“ 31 Bought fixtures £120 on credit from R west.
Solutions
Capital a/c Cash in hand a/c
2003 £ 2003 £ 2003 £ 2003 £31/3 Bal c/d 1,500 1/3 Cash 1,500 1/3 Capital 1,500 3/3 Rent 28
11/3 Sales 49 4/3 Bank 1,000
20/3 Repairs 18
28/3 Purchases 125
30/3 Motor exp. 15
31/3 Bal c/d 363
1,549 1,549
Purchases a/c
2003 £ 2003 £
2/3 A Hanson 296 31/3 Bal c/d 421 Creditors – A Cliks ac
28/3 Cash 125 2003 £ 2003 £ 421 421 14/3 Returns out 17 2/3 Purchases 296
27/3 Bank 279
296 296
Rent –Expenses a/c Bank a/c
2003 £ 2003 £ 2003 £ 2003 £
3/3 Cash 28 31/3 Bal c/d 28 4/3 Cash 1,000 5/3 Stationery 15
27/3 A. Hanson 279
29/3 Motor van 395
31/3 Bal c/d 311 1,000 1,000
Debtor – J Simpson a/c Sales a/c
2003 £ 2003 £ 2003 ` £ 2002 £
3/3 Sales 54 22/3 Returns in 14 31/3 Bal c/d 132 5/3 JSimpson 54
31/3 Bal c/d 40 11/3 Sales 49 17/3 P Lutz 29
54 54 132 132
Stationery a/c 2003 £ 2003 £ Returns outwards a/c
7/3 Bank 15 31/3 Bal c/d 15 2003 £ 2003 £
31/3 Bal c/d 17 14/3 A Cliks 17
P Lutz – Debtor a Building repairs - expenses
2003 £ 2003 £ 2003 £ 2003 £
17/3 Sales 29 21/3 Bal c/d 29 20/3 Cash 18 31/3 Bal c/d 18
Returns - Inwards
Motor vehicle2003 £ 2003 £ 2003 £ 2003 £22/3 J Simpson 14 31/3 Bal c/d 14 29/3 Bank 395 31/3 Bal c/d 395
R West – Creditor (others) Motor expenses
2003 £ 2003 £ 2003 £ 2003 £
31/3 Bal c/d 120 31/3 Fixtures 120 30/3 Cash 15 31/3 Bal c/d 15
Fixtures2003 £ 2003 £
31/3 A. Webster 120 31/3 Bal c/d 120
S PINKS
TRIAL BALANCE AS AT 31 MARCH 2003
| | Debit (£) | Credit (£) |
| Capital | | 1500 |
| Purchases | 421 | |
| Cash in hand | 363 | |
| Bank | 311 | |
| Rent expense | 28 | |
| Sales | | 132 |
| Fixtures | 120 | |
| Debtor – J Simpson | 40 | |
| Debtor – P Lutz | 29 | |
| Motor vehicle | 395 | |
| Creditors | - | - |
| Motor expenses | 15 | |
| Returns inwards | 14 | |
| Creditors others – R West | | 120 |
| Stationery | 15 | |
| Returns outwards | | 17 |
| Building repairs | 18 | - |
| | 1769 | 1769 |
Example 1.10
The following transactions took place during the month of May:
2003
May 1 Started firm with capital in cash of £250.
“ 2 Bought goods on credit from the following persons: R Kelly £54; Pcombs £87;
J Role £25; D Mobile £76; I. Sims £64.
“ 4 Sold goods on credit to: C Blanes £43; B Long £62; F Skin £176.
“ 6 Paid rent by cash £12.
“ 9 C Blanes paid us his account by cheque £43.
“ 10 F Skin paid us £150 by cheque.
“ 12 We paid the following by cheque: J Role £25; R Kelley £54.
“ 15 Paid carriage by cash £23.
“ 18 Bought goods on credit from P Combs £43; Mobile £110.
“ 21 Sold goods on credit to B Long £67.
“ 31 Paid rent by cheque £18.
Answer
| Capital | | Cash in Hand | |||||||||||||||||||||||||||||||
| 2003 | | £ | 2003 | | £ | | 2003 | | £ | 2003 | | £ | |||||||||||||||||||||
| 31/5 | Bal c/d | 250 | 1/5 | Cash | 250 | | 1/5 | Capital | 250 | 6/5 | Rent | 12 | |||||||||||||||||||||
| | | | | | | | | | | 15/5 | Carriage | 23 | |||||||||||||||||||||
| | | | | | | | | | . | 31/5 | Bal c/d | 215 | |||||||||||||||||||||
| | | | | | | | | | 250 | | | 250 | |||||||||||||||||||||
| Creditor R Kelly | | Creditor P Combs | |||||||||||||||||||||||||||||||
| 2003 | | £ | 2003 | | £ | | 2003 | | £ | 2003 | | £ | |||||||||||||||||||||
| 12/5 | Bank | 54 | 2/5 | Purchases | 54 | | 31/5 | Bal c/d | 130 | 2/5 | Purchases | 87 | |||||||||||||||||||||
| | | | | | | | | | . | 18/5 | Purchases | 43 | |||||||||||||||||||||
| | | | | | | | | | 130 | | | 130 | |||||||||||||||||||||
| | | | | | | | | | | | | | |||||||||||||||||||||
| Creditor – J Role | | Creditor – D Mobile | |||||||||||||||||||||||||||||||
| 2003 | | £ | | | £ | | 2003 | | £ | 2003 | | £ | |||||||||||||||||||||
| 12/5 | Bank | 25 | 2/5 | Purchases | 25 | | 31/5 | Bal c/d | 186 | 2/5 | Purchases | 76 | |||||||||||||||||||||
| | | | | | | | | | . | 18/5 | Purchases | 110 | |||||||||||||||||||||
| | | | | | | | | | 186 | | | 186 | |||||||||||||||||||||
| | | | | | | | | | | | | | |||||||||||||||||||||
| Creditor I Sims | | Debtor C. Blares | |||||||||||||||||||||||||||||||
| 2003 | | £ | 2003 | | £ | | 2003 | | £ | 2003 | | £ | |||||||||||||||||||||
| 31/5 | Bal c/d | 64 | 2/5 | Purchases | 64 | | 4/5 | Sales | 43 | 4/5 | Bank | 43 | |||||||||||||||||||||
| | | | | | | | | | | | | | |||||||||||||||||||||
| Debtor B Long | | Debtor F Smith | |||||||||||||||||||||||||||||||
| 2003 | | £ | 2003 | | £ | | 2003 | | £ | 2003 | | £ | |||||||||||||||||||||
| 4/5 | Sales | 62 | 31/5 | Bal c/d | 129 | | 4/5 | Sales | 176 | 10/5 | Bank | 150 | |||||||||||||||||||||
| 21/5 | Sales | 67 | | | . | | | | . | 31/5 | Bal c/d | 26 | |||||||||||||||||||||
| | | 129 | | | 129 | | | | 176 | | | 176 | |||||||||||||||||||||
| | | | | | | | | | | | | | |||||||||||||||||||||
| Purchases | | Sales | |||||||||||||||||||||||||||||||
| 2003 | | £ | 2003 | | £ | | 2003 | | £ | 2003 | | £ | |||||||||||||||||||||
| 2/5 | R Kelly | 54 | 31/5 | Bal c/d | 459 | | 31/5 | Bal c/f | 348 | 4/5 | C Blanes | 43 | |||||||||||||||||||||
| 2/5 | P Combs | 87 | | | | | | | | 4/5 | F Long | 62 | |||||||||||||||||||||
| 2/5 | J Role | 25 | | | | | | | | 4/5 | F Skin | 176 | |||||||||||||||||||||
| 2/5 | D Mobile | 76 | | | | | | | | 4/5 | B Long | 67 | |||||||||||||||||||||
| 2/5 | L Sims | 64 | | | | | | | | | | . | |||||||||||||||||||||
| 18/5 | P Combs | 43 | | | | | | | | | | 348 | |||||||||||||||||||||
| 18/5 | D. Mobile | 100 | | | . | | | | | | | | |||||||||||||||||||||
| | | 459 | | | 459 | | | | | | | | |||||||||||||||||||||
| Bank | | Carriage Expenses | |||||||||||||||||||||||||||||||
| 2003 | | £ | 2003 | | £ | | 2003 | | £ | 2003 | | £ | |||||||||||||||||||||
| 9/5 | C Blanes | 43 | 12/5 | J Role | 25 | | 15/5 | Cash | 23 | 31/5 | Bal c/d | 23 | |||||||||||||||||||||
| 10/5 | H F Skin | 150 | 12/5 | R Kelly | 54 | | | | | | | | |||||||||||||||||||||
| | | | 31/5 | Rent | 18 | | | | | | | | |||||||||||||||||||||
| | | . | 31/5 | Bal c/d | 96 | | | | | | | | |||||||||||||||||||||
| | | 193 | | | 193 | | | | | | | | |||||||||||||||||||||
| | | | | | | | | | | | | | |||||||||||||||||||||
| Rent | | | | | | | | |||||
| 19x6 | | £ | 19x6 | | £ | | | | | | | |
| 6/5 | Cash | 12 | 31/5 | Bal c/d | 30 | | | | | | | |
| 31/5 | Bank | 18 | | | . | | | | | | | |
| | | 30 | | | 30 | | | | | | | |
Trial Balance as at 31/5/2003
Debit Credit
Capital - 250
Cash 215 -
Creditor – R Kelly - -
Creditor – P Combs - 130
Creditor – J Role - -
Creditor – D Mobile - 186
Creditor – L. Simms - 64
Debtor – C. Blanes - -
Purchases 459 -
Sales - 348
Debtor- B. Long 129 -
Debtor- F Skin 26 -
Bank 96 -
Carriage -
Rent 30 -
978 978
REINFORCEMENT QUESTIONS
Question One
Spark has been trading for a number of years as an electrical appliance retailer and repairer in premises which he rents at an annual rate of $1,500 payable in arrears. Balances appearing in his books at 1 January 19X1 were as follows:
| | $ | $ |
| Capital account | | 1,808 |
| Motor van | | 1,200 |
| Fixtures and fittings | | 806 |
| Provision for depreciation on motor van (credit) | | 720 |
| Provisions for depreciation on fixtures& fittings (credit) | | 250 |
| Inventory at cost | | 366 |
| Receivables for credit sales: | | |
| Brown | 160 | |
| Blue | 40 | |
| Stripe | 20 | |
| | | 220 |
| Cash at bank | | 672 |
| Cash in hand | | 5 |
| Payables for supplies: | | |
| Live | 143 | |
| Negative | 80 | |
| Earth | 73 | |
| | | 296 |
| Amount owing for electricity | | 45 |
| Local taxes paid in advance | | 100 |
Although Sparks has three credit customers the majority of his sales and services are for cash, out of which he pays various expenses before banking the balance.
The following transactions took place during the first four months of 19X1
| | January | February | March | April | |
| | $ | $ | $ | $ | |
| Suppliers’ invoices: | | | | | |
| Live | 468 | 570 | 390 | 602 | |
| Negative | - | 87 | 103 | 64 | |
| Earth | 692 | - | 187 | - | |
| Capital introduced | | 500 | | | |
| Bankings of cash (from cash sales) | 908 | 940 | 766 | 1,031 | |
| Expenditure out of cash sales before banking: | | | | | |
| Withdrawals on account | 130 | 120 | 160 | 150 | |
| Stationery | 12 | 14 | 26 | 21 | |
| Travelling | 6 | 10 | 11 | 13 | |
| Petrol and van repairs | 19 | 22 | 37 | 26 | |
| Sundry expenses | 5 | 4 | 7 | 3 | |
| Postage | 12 | 10 | 15 | 19 | |
| Cleaner’s wages | 60 | 60 | 65 | 75 | |
| Goods invoiced to credit customers: | | | | | |
| Brown | 66 | 22 | 10 | 12 | |
| Blue | 120 | 140 | 130 | 180 | |
| Stripe | 44 | 38 | 20 | 48 | |
| Cheque payments (other than those to suppliers): | | | | | |
| Telephone | 40 | 49 | 59 | 66 | |
| Electricity | 62 | 47 | 20 | 106 | |
| Local taxes | - | - | 220 | - | |
| Motor van (1 February 19X1) | - | 800 | - | - | |
| Unbanked at the end of April | - | - | - | 12 | |
Spark pays for goods by cheque one month after receipt of invoice, and receives a settlement discount of 15% from each supplier.
Credit customers also pay by cheque one month after receipt of invoice, and are given a settlement discount of 10% of the invoice price.
Required:
Write up the ledger accounts of Spark for the four months to 30 April 19X1, and extract a list of account balances after balancing off the accounts.
Question Two
Mary
Balance Sheet as at 31 December 2000
| Non Current Assets | £ | £ |
| Premises | | 25,000.00 |
| Plant | | 12,000.00 |
| | | 37,000.00 |
| Current Assets: | | |
| Stock | 11,000.00 | |
| Debtors | 10,000.00 | |
| Cash at bank | 5,000.00 | |
| Cash in hand | 3,000.00 | |
| | 29,000.00 | |
| Current liabilities: | | |
| Creditors | (12,000.00) | 17,000.00 |
| | | 54,000.00 |
| Capital | | 34,000.00 |
| Non Current Liabilities: | | |
| Loan from bank | | 20,000.00 |
54,000.00
During the year to 31 December 2001 the following total transactions occurred:
a) Mary withdrew a total of £10,000.00 in cash
b) Stock in trade was bought, all on credit, for £34,000.00
c) Sales were made totaling 60,000.00 of stock in trade which had cost £37,000.00. Of these sales £51,000.00 were on credit and £9,000.00 for cash.
d) A total of £16,000.00 was drawn from the bank in cash to the cash till.
e) Electricity for the year paid by cheque totaled £2,000.00
f) Rates for the year paid by cheque totaled £1,000.00
g) Wages for the year all paid cash totaled £10,000.00
h) Sundry expenses all paid in cash totaled £2,000.00
i) Creditors were paid a total of £36,000.00 all by cheque
j) Debtors paid a total of £54,000.00 all in cheques.
k) The bank charged interest on the loan deducting £3,000.00.
Required:
Prepare a revised balance sheet. (20 marks)
Question Three
a) Explain the nature of accounting and the accounting equation (8 marks)
b) Calculate the profit for the year ended 31 December 2001 from the following information
(12 marks)
| Non Current Assets | 01.01.2001 | 31.12.2001 |
| | £ | £ |
| Property | 20,000.00 | 20,000.00 |
| Machinery | 6,000.00 | 9,000.00 |
| | 26,000.00 | 29,000.00 |
| Current Assets: | | |
| Debtors | 4,000.00 | 8,000.00 |
| Cash | 1,000.00 | 1,500.00 |
| | 5,000.00 | 9,500.00 |
| Current Liabilities: | | |
| Creditors | 5,000.00 | 3,000.00 |
| Overdraft | 6,000.00 | 9,000.00 |
| | 11,000.00 | 12,000.00 |
| Net Current Liabilities | (6,000.00) | (2,500.00) |
| Net Assets | 20,000.00 | 26,500.00 |
Drawings during the year amounted to £4,500.00
Additional capital introduced by the owner £5,000.00
Question Four
Brian Barmouth is a sole trader. At 30 June 2000 the following balances have been
extracted from his books:
| | £ |
| Sales | 47,600.00 |
| Purchases | 22,850.00 |
| Office expenses | 1,900.00 |
| Insurance | 700.00 |
| Wages | 7,900.00 |
| Rates | 2,800.00 |
| Heating and Lighting | 1,200.00 |
| Telephone | 650.00 |
| Discounts allowed | 1,150.00 |
| Opening stock | 500.00 |
| Returns inwards | 200.00 |
| Returns outwards | 150.00 |
| Premises | 40,000.00 |
| Plant and Machinery | 5,000.00 |
| Motor Vehicles | 12,000.00 |
| Debtors | 12,500.00 |
| Bank balance | 7,800.00 |
| Creditors | 3,400.00 |
| Loan-long term loan | 10,000.00 |
| Capital | 60,000.00 |
| Drawings for the year | 4,000.00 |
| Closing stock | 550.00 |
Required:
Construct a trial balance, from the above list of balances.
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