INTRODUCTION TO ACCOUNTING


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:
  1. 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.

  1. 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.

  1. 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.
  1. 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.
               
  1. 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.

  1. 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.

  1. 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.

  1. 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


Credit Income income
 
INCOME
 
                                                           
                                                                                               

INCOMES/EXPENSES                                                           Debit Expense A/C

EXPENCESGFSS
 
                                                      
                                                                                           

                                                                                                  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/c
5/5   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/c
200                £                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               950
                                                                                               

TRIAL 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 entries made 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 vehicle
2003                      £   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
                              
                          



                                  Fixtures
2003                             £     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.