lan Harrison 6G HoornCambridge International AS and A Level Vee ils) LET ola) G HODDER EDUCATION FVHAGHETTE UK CONANAcknowledgemers “Tho Publishers woul lik o thank the following for perission v9 repcduce copyright mats Phen cee .St © SIA KAMBOLIAFP/Geny Inages; p58 B maw - Fol: p91 © ter Howes / Alam 2.265 © Kaveh Kazem/Gety images p.269 © NAN Fotliscomy P29] © ParAnders Ptteosoa/ ‘Gery Tagen 336 © pb - Pol: 387 © Paynes Fo con p37 © Al gee Group Pe ad /aluny: pa © tere - Foto, (Questions rm the Carlee International AS an A Level Accuting piper ae sepreuced by Lit! perminice of Cambridge Iterations! Eaminatons (Camllge nerastonal Examinations bears no rnponsbiliy ee the example anowers 0 qutisns taken from ts past quesion papers which are contained inthis book/CD. 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Cover photo © Jasin Gundaia‘Cobis stairs by Inga Sofware Services Pvt Le, Porcher, lea “Typetet by Tange Software Services PT, Panchen, fia ‘Primed a Duta A catlogue cord for thistle s sble om the Bash Ube ISHN 97% 1454 181 432Contents Introduction. w PVR) Deu eer) 1 Chapter 1 The double-entry system.. Chapt 2 The books of prime entry, Chapter 3 The ledger accounts in detall.. Chapter 4 The cash book... Chapter 5 Discounts... Chapter 6 Preparing simple financial statements Chapter 7 Accounting principles, concepts and conventions Chapter 8 Closing down the double-entry system. Chapter 9 Accruals and prepayments suns Chapter 10 Control systems — the trial balance... Chapter 11 Suspense accounts.. Chapt 12 Control systems ~ bank reconciliations Chapter 13 Control systems — ledger control accounts. Chapter 14 Statements of financial position, Chapter 15 Profits. 7 Chapter 16 The trading account. N22 131 Chapter 17 The profit and loss account. Chapter 18 Ircoverable debts and provision for doubtful debts Chapt Chapt 19 Depreciation of non-current assets... 20 The valuation of inventories. Chapter 21 Financial statements... 167 Chapter 22 incomplete records 77 Chapter 23 Partnership accounting . 190 201 Chapter 24 Partnership accounting ~ structural changesContents Chapter 25 The financial statements of limited companies ...nn:unnninnnnnsnninnnneninnnsnnens 23S Chapter 26 Company financing .. wo 262 Chapter 27 Interpretation and analysis of financial data 267 Pere ener sutietecl ie 281 Chapter 28 Absorption (total) costing. 281 Chapter 29 Marginal costing 1301 Chapter 30 Unit, job and batch costing 322 Chapter 31 Business planning. e327 AS Level examination-style questions 330 rR) 1 Financial accounting 336 ‘Chapter 32 Manufacturing accounts. 13386 Chapter 33 Clubs and societies sit passe somceninnssniae SL Chapter 34 Published financial statements of limited companies Chapter 35 IAS 7 Statements of cash flows... an. Chapter 36 International accounting standards, 38S Chapter 37 The role of the auditor and directors. wnt Chapter 38 Business purchase and merger Chapter 39 Consignment accounts. Chapter 40 Joint venture accounts. Chapter 41 Computerised accounting systems. Chapter 42 Investment and other ratios... 2 Cost and management accounting 442 Chapter 43 Activity based costing.. Chapter 44 Budgeting and budgetary contra. Chapter 45 Standard costing. Chapter 46 Capital investment appraisal. A Level examination-style questions 503 Index 509Contents Student's CD contents @ ‘Additional questions Interactive tests Revision checklists Examination structure Glossary of command words Planning your revision ‘Answers to Additional questions ‘Appendix 1: Ratios ‘Appendix 2: Layouts of financial statementsIntroduction The textbook ‘This book has been writen with the needs of students in mind, and 1 have tried to maximise, as far as is possible, the Achievement of postive leaming. Also, the book has been developed based on my many yess of expericnce as both an ‘examiner and a teacher ofthe subject to Advanced Level students both in the UK and overseas ‘The book has been endorsed by Cambridge International Examinations, lsted as an endorsed textbook for students who study the Cambridge International Examinations syllabus 9706. The text covers the whole ofthe syllabus, organised and split in accordance with the examination papers in the syllabus, an follows as fa asi possible the order in which topics appee in the published syllabus. The serions covered by each chapter ar listed, Fach area ofthe syllabus is given asa reference point, Syllabus coverage “The frst 31 chapters cover the AS syllabus i is entirety. At the end of the AS Level syllabus chapters there ae examination style questions. Some of the questions are from past exam papets. Where appropriate the crignal questions have been modied to reflect recent changes in accounting teeminology and practice. Readers are advised that all tpice in the AS section ofthe eyllabus ‘may also be examined at Advanced Level ‘Chapters 32 to 46 deal with topics that may be examined at Advanced Level. The examination style questions at the end of the A Level chapters are wniten to rellect recent changes ip accounting exam papers Features of the book ach chapter stats with the eleyant syllabus statement. Throughout the chapters there are Examples and Worked examples, with answers, to dusrate the invodueed concepts. They are followed by a few ‘Now ty .” quests leading students to adelitional questions in the CD as well as some self-test questions, which allow students to further explore the concept and test themselves, Meanwhile, impottant terms are explained and sometimes tips are given to help students to better understand the elated concepts. Each chapter ends witha summary, which covers all the key points How the syllabus points are covered in the 46 chapters im Chapters 1—Tand 14 | 1.1.4 Chapter 32 12 Chapters 6 and 19 EF Chapter 38 13 Chapters 10 12 13) (Chapters 34 and 35 1ay Chapters and 18-70 [44 Chapter 36 1az Chapters 15—17and2z [15 Chapter 37 143 Chapters 23 ond 24 [4.2 Chopter 38 14a Chapter 25 and 26 13 Chapters 39 and 15 Chapter 27 14 Chapter 24 Chapters 20 and 28 ‘(45 | chapter a2 224 chapier 28 24 Chapter a3 222 Chapter 29 22 Chapter a 223 Chapters 29 and 30 [23 Chapter as 23 Chapter 31 24 ChaptersIntroduction Key concepts ‘The 9706 sylabus is built around five fundzmental concepts that should be applied to all accounting taasactions. They are: A true and fair view ‘The concept of tue and fair view ensures that financial statements accurately and truthfully reflect the transactions ofthe business. Duality (double entry) ‘The method of systematically recowding tansactions to show the giving and receiving of value Consistency, ‘The treatment of similar transtctions and items in dhe sume way each year so thatthe results of business activity can be compared with previous results Business eatisy ‘The separition of the ownership ofa business from the actual busines itself. Only buriness assets and transactions are recorded! fn the business books of account Money measurement “The business financial records only deal with transactions that can be measured ip monetary terms. ‘These key concepts will dictate the way that you suey accounting, They underpin the work that you will study during your course. You should find that they provide themes that mun through al the accounting topies that you study. The above icons appear in the txt, indicating where each Koy concept is covered, ‘When you are snidying a topic, relate one or more of these lee concepts to that topic. The Student's CD-ROM ‘There isa stidents CD-ROM accompanying the book to help students further their study ia accouating. It includes © Addltional questions ~ they are seferred to in the book as Now ty.” questions which Ulasate more about the concept where introxuced and tes if you have grasped the knowledge: « Inveratve tess these ae cilereat types of questions such as tue oF false and mukiple choice, designed 1 improve the understanding of accounting. f Revision checklist to check if you have understood every silabus point covered inthe chapter. Answers to adkltional questions. © Materials to help you prepare forthe examinations in Accounting. Tn accounting, there are certain layouts that you must learn so itis important that you practise questions based on each topic aren ‘on a regular basis, Use each piace of work in the book and the CD to build up a baak of knowlege and sls that you may be able to apply to subsequent pieces of work, AS 2 subject, accounting is rather like a detective solving a erime; the pieces of Information collected some weeks ago might help to solve today’s problem. Most mporanily, you must learn the concepts for each topic. This is usualy easier that you might fist chinks the dificult past is applying the appropriate knowledge to the questions. Thope you enjoy exploring in accounting snd may you have good performance in your AS/A Level examinations. lan HarizonThis page intentionally left blankS Level 1 Financial accounting 1 The double-entry system By the end of this chapter you should be able to: ‘8 use double-entry book-keeping to record financial transactions «enter financial transactions into ledger using debit and credit entries Saar se ka eta eee ener «understand and explain the purpose of using a ledger f understand and explain why 2 ledgers generally divided into three parts @ 1.1 Debit and credit entries in the double-entry system ‘There are two main ways in which the managers of businesses record thei nancial tranmctions. They use ether (¢ 2 double-entry system of recording transactions (9 single entry systom of recering transactions. “his chapter looks at the doubleentry system, which provides the accountant with ‘An Income statement 2 statement the information needed in onder to produce the data required to prepare an income that cscuates the proftthat a busress statement that will show whether or not the business has been profitable. You will has made fora period of time(usualy 2 asec ope cael a Aa 2 geareel ee [As the name implies, doubleenty bookkeeping recognises that there are twa sles or aspects to every business transaction. See, for example, the two sides of each of the following transictons: [ill my eae with $20 of Fel (9 Treceive the fuel (© The filing station anendant puts the fuel into my vehicle I buy a pair of soccer boots cesting $13. (9 Teeceive the honts ‘© The sports shop ‘gives’ me the boots. @ Tse bre mor apes to ach of these tenmatione ‘When T give the fling station arendant xy $20 18 she raceives the cash 9 Tigive the cash, Like all areas of study, accounting has its own jargon. Whenever a new word or term is introduced, an explanation or defrtion will begiven, Make sure When I give the shop assistant my $13, you read and understand what these terms mean and how they are used in accounting ‘he receives the cash (9 Ligive the cash ‘This way of reconing both sides of any transaction is known as the dual aspect principle of accounting.[EB tee coubte-cntry system iar scion icing ilar ect oem ik Aldger acount san ent a a anne (eet ine user deen cate pe gente edger Ine re esis decom Deana anes can ane cee ay ee Sere | Selene Ter mene one nk i ila Es wel smaller books. You can imagine tat large businesses like the Toyota Mowe ‘Aledger'sthe book where all accounts Ceeporaton or McDonalds could not possibly keep all thei financial records in ekert mana Initially, to make our task a litle simples, we shall keep all our records together. When the other books are introduced, you will see that it does make sense to split the ledger into several different pacts Do oot worry ifall this seems a litle strange. You will soon be famiiar with it but it does requive practice. The key to success in accounting is practice. ‘An account looks like aT shape, like this: ‘ledger account contains the detaied ach account has two sides (9 The lef side is known as the debit side (9 The right side is known as the credit side ‘An account Debit Crd ‘he debt sie ofan accounts avays the |The credits of an accounts aveys the recehing ideorthesdethatshows gains | gung er lesng sl the side that shows insole ‘ale given Debits often abbreviated to Dr Cra is often abbreviated tor : [An account Receives ‘ches Gane loses An account inthe ledgor would be headed thus: ct ecount Note ‘There should alvanys be a heading; ithe account shown is not a personal account, the heading should include the wor ‘accoure. “The golden ale of the game of double entry” is that everytime you enter something on the debit side (eft side) of an account you aust enter an equivalent amount on the credit sid (right side) of another account. ‘This all ily straghfceward, but it does require practice1.1 Debit and credit entries in the double-entry system Cee Bola owns a business selling meat, During one week the following financial ‘eansictions take placer | Bola purchases meat $210 from Seragg, a meat wholesaler. She will pay for the ‘meat in a couple of weeks! time 2 Boks cash sales for the week amount to $742, 13 Bola supplies meat tothe Grand Hote $217, They will pay forthe meat atthe end of die month, 4 Bola pays the reat for her shop 875 5 sho pays hor telephone bill (43. Required [Enter the transactions in Bolas ledges, ‘chases ae anyitns thatare pursed | ANSWET ‘withthe tention of sling them #0, 1 Bola receives meat... and Seragg ‘loses the meat loners Dr Purchases account cr be seragp « s s aa re sald nthe ‘ermal cues of busines to curtomers au a 2 Bola loses (ell) some meat. and she gains cash Dr ___Sales account br cash account a s 3 ma mm +3 Bola loses’ meat. and the Grand Hove gains the meat Dr ___Salesaccount cr Grand Hotel o 5 s a7 2 4 Bola gains the use of her premises... and she loses (pays) cash Dr Rentaccount cr or cath account o s s 5 18 + This is can be a confusing entry because we are sed to talking about ‘paving rent + Bola pays money to a landlord fer the use of his building. + Bola receives/gains the use of the premises +n caves like this, thnk ofthe cash entry frst and dhen put in the second entry, 5 Bola gains the use of her telephone .. apd she loses cash Dr___ Telephone account Grr Cash account © $ $ 43 a + Another confusing entry. Hola coceives/gains the use of the telephone. + Bola gives the telephone company cash for the sevice they provide to her.[EB tee coubte-cntry system > Now try Question 1 > Now try Question 2. If you are uncertain about the telephone account ask whether Bola has gained cash ‘or Tos cash, You knows that Bola has paid cash fo the telephone company 0 the cash has fo be a eredit entry (right side) the osher entry has tobe a debic entry Cleft side) according to the rules of double ent: @ 1.2 Treatment of similar transactions 1 there are a number of similar transactions that need to be recorded, we enter thoes all in one account Cs Greta Teer owns and runs a store selling newspapers, magazines and candies. The following transactions took place over the past Few days 1 Cash sales of newspapers amounted to $68. 2 Cash sales of chocolate and candies amounted to $151 3 Greta purchased candies, potato chips and soft drinks $135, paying cash to her wwholesiler 4 She paid #160 cash for local taxes 5 Greta sold four boxes of potato chips toa local club for cash $30. Required Enter the transactions in Greta's ledger. Answer be Sales account @ br ash acount a 5 5 3 cy os 135 151 151 160 a 20 Dr Purchaser account Dr__tocaltanes acount Gr 5 5 135 1 Note All the transactions involving cash have been entered in one cash account, All he sales transactions have also been entered in one account {should be obvious tha as well as keeping money in the business, the owners of businesses will bank money snd will pay many bills by means of cheques. So, a3 well as having a cash account in the ledger, the business would also keep a bank account to record transactions using the business bank account. Worked example Sven Drax owns and runs a hotel, He supplies the following information 1 Sven purchases a deep freeze uni $415, paying by cheque. 2 He purchases for eash $127 fru and vegetables forthe hotel reseaurant. 3 Sven purchases petrol 445 forthe hotel mint-bus using cash.Drawings isthe tem used 0 deserbe the ‘withdrawal of resources each or gases) from the business by the owner fr private ‘gs outside the business 1.3 The division of the ledger 4 He pays for a family holiday $1500 paying with a business cheque 15 He pays $2178 cash takings into the bank account, Requived Enter the transactions inthe hotel ledget Answer Dr Freezer account c o 5 s a5 ms 1500) Dr___Purchases account cr br Cash account Cr 3 i 2 a 4 Dr__Motorexpensesaccount__ Cr o 5 45 De © 3 2078 Note “The freezer nit is not purchases itis capital expenditure. There was not already ‘an account, 80 when in doubt pn an account The cheque paid Out to the holiday ‘company is drawings —i s nota business expense GEE 1 fvey____needs a corresponding debit entry. 2 Define the tem ‘account In which account would goods purchased for resale be entered? Denzil pays the rent on his factory with $300 cash, The entries to record this ‘wansaction ate debit rent account $300; edit cash account $300. TrueFatse? Bradley pays the telephone bil $120 cash. The entries to record this transaction are debit cash account $120; credit telephone account $120. TuelFalse? ‘Which side of an account is the ‘eceiving’ side? ‘Which side of an account i the ‘giving’ side? @ 1.3 The division of the ledger ‘Aacomereanees wane neanamenanenemnemnmane et secur could ran to many uecheda a ter connie oath eer to iran eramsantan[EB tee coubte-cntry system Gan you think of how you might split the ledger to make it more manageable? We eerie make it mote manageable by gouping together similar accounts, We put: businesses) that we sll goods te; they wll pay or thoi goods at some te in the ‘8 credit customers’ acoounts together in one ledger {future The goods ar sold on cre 1 create supplier” accumsan on eer (all other accounts in another ledger Until adit stores have paid forthe All wansactions involving credit customers wil be found in the sles ledger (also goed: thathave boon purchased, thay known athe debtors ledger), Beeler Fees | Me enmncrs nth ct pple wil be und nthe purchase ear lo = ‘known as the creditors’ ledger), a All other transactions wil be found ia the general ledger. (For those of you ‘credit suppliers are peopla(erbusinesas) familiar with computerised accounts, the general ledger & often called the nominal thatwe purchase goods from: we wil see ledger in accounting packages.) the debt that we owe at some future date ee toe ays are te Inkially you will male missles whea asked which accounts would appese in x ‘which ledger; do not worry abour this— we have all made similar misakes in aa— the past ‘Apersonor busines spphing goo on The deut ones ae a follows Hee eee eee ease @ The sales account, which is stat found inthe sales ledger, is reserved for the creditors ae coleivly own as wade personal accounts of ur cri customers, The sees account would be found ia payebles the general ledger. {6 The purchases account will ot be found in the purchases lege. I is reverve for the personal accounts of credit supplicrs only. The purchases account would be found inthe general ledger. Personal accounts ae accounts that record ansactcns with cre customers apd credit supers ‘We only record credit transactions in the sales ledger and the purchases ledger (Ifa sale is made for cash it is not entered inthe sles ledger. ‘Nominal accounts real accounts and | @ Hf something is purchascel for cash cs not entered in the purchases ledge. liability accounts wl all be found in the Sor ‘These transactions appear in the general ledger. Cee ea 1 Nad purchases goods for resale $73; he pays cat 2 He salls goods $19 for cash —————— wired Real accounts econ she acqueton ond" Gapomlcfnoncarentacsctike ied, Uist the tWo entries in Nadim’ ledger for each transacsion. buidings, eguipment and vides, Answer Purchases account [cash account ach account Sales account ‘ability accounts record the aqustion and repayment of leans and overdrais. sosvesoeesesensereonesonennsnsaneeseerees_ When You gO 10 takeaway food store and you order your mea, the proprietor does > Now try Question 3. ‘not open an account for you: he simply takes your money and gives you your meal ee debits ~ cash acconnt (the sale of your meal would be included! in his total cash sales for the day), "re eredts ~ sales account (using the foal sales Figure for the day), Remember that each account would be ina diferent ledger according to the classfcation we have discussed, Each account would be shown on « separate page in the ledger. There is not ‘enough space in this book to aford suc a luxury. We will write the accounts on the same page,> Now try Question 4. 1.3 The division of the ledger Cee Siobhan Murphy provides the fllowing information for the past Few days: 4 Siobhan purchases a non-cureent asst $1450 fom Adil on ere 2 She sells goods $77 to Fiona, who pays by cheque. 3 She purchases poods for resale $510 fom Zainab on credit. 4 She purchases poods for resale $65 from Joan for cash Required Enter the transactions in Siobhan’ ledges Indicate in which ledger eaeh account ‘would be found.) Answer Dr__Non-currantastetsaccount (GL) __¢r_—_Dr_Al(PL) o s s so | 1450 br Sales account (G1) br __ Bank account e 5 5 n n Dr Purchases account (GL) Br Zainab OL & 5 s 510 510 | Dr_Cash account (GL) cE 65 Note 1 Customers’ accounts and supplies’ accounts appear in the sales ledger (SD) and in the purchases ledger (PL) respectively — but only if the transactions are con credit ‘@ Accounts that are not personal accounts are found in the general ledger (GL) ‘9 All debit cates have a corresponding eredit cna. (All credit entries have a comesponding debit enuy. Readers who have bank accounts will have observed that when they receive a bank statement from the hank, money paid cut of the account is enterad in te lft columa (Geb) of the bank statement, while moneys received into the account are entered in the right column (credit). This causes problems initially. ‘Alice what has been said above, this might seem to be the wrong way round, So ‘who is righ? Well, both the bank statement and this book are correct. You necel 9 remember tha the bank statement ia written from the polat of view of the bank, not from your point of view: More details on this are given in Chapter 12[EB tee coubte-cntry system ST # Every ‘eed: 3 corresponding credit entry ‘9 Name the book in which all business transactions are entered, 10 List the three divisions of the ledge 111 Eplain the meaning ofthe term ‘personal account 112 Name two ‘eal accounts found in the ledger. 13 Name two ‘nominal accounts found in the ledger. 14 Name two “iabilty’ accounts found in the ledger ene ere eer Ee erase oa erect ee eemiieescrmpnity inp ec ered pe teersAS Level 1 Financial accounting 2 The books of prime entry By the end of this chapter you should be able to: «@ identify the five books of prime entry that deal with credit transactions ‘9 use a cash book as a book of prime entry «© identify the source documents used to make erties in the books ‘# make entries in the six books to record financial transactions «© post entries from the books of prime entry to the ledgers ‘6 understand the effect that rade discount has on entresin the books of prime erty. Se a TSeon Poesy ‘The books of prime entry are also known as subsidiary books and books of original entry. Thete are ax books of prime entry and they ace 1 the purchases journal 2 the sales journal 3 the purchases returns journal 44 the sales returns journal 5 the general journal 6 the cash book. Purchases Sols Cenc jut Panta Figure 2.1 The sicaooks of prime enty All sansaetions are fist entered in @ book of prime entry. Each book of prime entry is made up of a lst of sina types of transaction. The tems are lite in the book until ic is worthwhile to pos the sto the ledger. Some ofthis may sound confusing; but when you have seen how the books werk, things will become clea. All wansactions must be entered io one of the books of prime entey before they cam be entexed inthe ledger. So the cash book is used to get into the ground and it will also play its part in the same of double entry.[Bil tre boos of prime entry ‘# The books of prime entry are used as a convenient way of entering transactions lato the double-entry system. 16 1tis less efficient to make entries into the ledgers as they aise. It s too time ‘consuming and that means i s generally more costly {Its better to collec dhe entries and categorise them into buns of sina types and then t0 post from these books in balk: 2.1 Recording credit purchases and sales 2.1.1 The purchases journal ‘The purchases journal is also known as the purchases day book. “When a purchases invoice is received from a supplicr of goode i shows the _g00ds that have been purchased and the price charged. The detals are listed in the purchases joural ‘The purchases journal is list of credit purchases made, The source documents “he primary sounes of information weed 9 ace the purchase invoices received trot grigasin ta books of prin aty “When its convenient (this could be daily, weekly or monthly depending om the volume of purchases made by the business, the list of purchases is totalled and the tal is posted to the bi side of the purchases account i the general ledger because the goods have been received. ach individual suppliers ledger account in the purchases ledger is erated with the value of goods purchased (showing thatthe supplier has ‘given the goods). @ 6 slong as you remember the let side is debit and the right side is cresit, you can leave Dir aut when writing the ledges accounts. source socumens Bookeof rein ery P.Galy Tre system ‘Note Ts purchases ¥ s sou iis to 10 156220 Soa = 4 ‘te accoun Figure 2.2 The purchases aural 102.1 Recording credit purchases and sales 2.1.2 The sales journal ‘The sales journal is also known asthe sales day book. When goods are sold the supplicr semis sales invoice to the eastomcr. The sles favolee itemise the goods that have been sold and the peice of those goods {copy ofthis invoice is retained by te sll ‘The copy sales invoice i the source document from which the sles journal i “The copy sles invoices sect to customer are used to prepare a ist ofthe credit sales made ‘When i is convonicnt (this could he daily, weekly or menthiy depending on the ‘vohume of sales made by the business), the ist is rtalled and the total & posted to the cre sie ofthe sles account in the genera edger because the goods have been ‘given tothe customer, ach individual customers ledger account inthe sales leer is debited with the ng thatthe customer bas ‘gained dhe goods). Source ocomen Sales onal 5 Actor Bainesple $4700 Emily Smits 912.50, Book af Cat & See 1827 prime cay wan I Tee pie General edger ‘Sales accouat r,s fay edo ain friar eat ote accouts Figure 2.3 The sles journal[Bil tre boos of prime entry 2 Figure 2.4 The 2.2 Recording the return of goods 2.2.4 The purchases retums journal ‘The purchases returns journal also known asthe returns outwards journal or purchases returns book Sometimes, goods that have been purchase rn out be fay the wrong loathe wong sims or not efi eames oer way Teme wl be tured ib the nip he opp in dn Gate wil ode ul ote “Ta cet ces ae the wuica dunn Boe which the paca i jpomal is writen up The cee ei oul Wi all init ec ee supplice: When tis convenien thelist is added and te tol is povted to the credit of the purchases returns acount (he retums have been sent back t0 the apple). Note (The goods hat hare been stimed are not posted t the cet ide of the pitches acount «Each individual ens in the purchases rerum ura shen posted othe debit of the rempecvesippilers aon in the purchases ledge he sppion cee the goods). Credit aote ‘Source document tara om ook of Putas rum journal as, The gate Parciaws lode ‘Gene edger Bloges Purchases rts account 5 s Ps * chases tetas journalat 2.3 The general journal and its uses 2.2.2 The sales returns journal ‘The sales returns journal is also known asthe eeroras inwards journal Sales that are not acceptable ae retire! by the customer ala eel note is sent to the customer ‘A copy ofthe credit note will he retained and this isthe source document fem ‘which the sales stirs journal i writen up. ‘When convenient, the list is added and the tot is posted to the debit ofthe sales returns account (the goods have been received) Nore {The goods thar have been semamed are aot debited tn the sles account. (Bich individual en inthe sales returns joural is posted t the cet of the eu tomer who returned the goods (they have ‘given’ the goods buck to the supple) (Coy cro ots | Source documont a — Book ot Sales etamsjoaral os Thesystem ‘Geer edger ‘Sass acco Joos Figure 25 The salar jdt @ @ o ‘The general journal is usually referred to 35 ‘the journal 2.3 The general journal and its uses ‘The general journal i afin a source of confusion for students. Bur do not worry — ‘ts uses are very init and itis not as difficult as we often assume when we Fest contact it Its, however, a topic that you need to be familia with “The general journal is used when we cannot comfortably find another book of rime eniry 10 use, Its layout i cferent from the other books of prime entry described above, BBr books of prime entry e The oo columns at offen ome in amination questions 4 Genera journal Date Particulars Folio Debit Credit Thedate ofthe The acountto_Ledgerand page Amount io be cents be debited ebited The acount Amount tobe be ceded crates ‘Adascption of why the transaction was necessary the naratine) After the wo entries have been entered in the general journal, an explanation of why the tansuction was necessary is required. This is rfested to as the narrative “The general journal has six uses. Its sed to record: 1 the purchase of non current asses on credit 2 the sale of non-eurent assets on credit 3 the entries necessary to open ledger accounts when a business fst comes into 4 the entries required to record the closing of ledger accounts when a business finaly ceases to ade 5 the correction of eors 6 interlecger transfers ‘The source documents used to write up the general journal would include: «© purchase invoices for capital expenditure 1 sales invoices for sales of capital tems, ‘Other source documents will he encountered as we progress with ovr studies Cn ee) (On 23 April 2014, Tamara purchased on credit an st/397 machine from Destel and Co. for 812600, Required Propate the entry in Tamara’ general joumal 9 record the transaction. Answer General journal Date Particulars Folio Debit Credit s 5 23ApHI2014 Machine GL23* 600 Dells 126 12600 Purchase of Machine 397 on cet from Det Ltd * Page numbers in the lelgers ae for illustrative purposes Remember the use ofthe narrative explaining why entries in the ledgers are recess,2.3 The general journal and its uses (Omen (On 6 September 2014, Hussain sold vehicle PH41 FTX to Geeq’s garage for $230. Grea, vill sete the debt on 31 October 2014 Required Prepare the entry in Husstn's general journal to record the transaction, Answer General journal Date Particulars Folio Debit credit s s 6 September Grads guage SAD 220 2018 Vels aut 230 lsposl account Sale of vehicle P341 FTK 0 Greg garage OCS Marlene started in business on 1 January 2014 by paying $14000 into her business bank accomnt Required Prepare the enty in Marlene's general journal to recom the wansacton, Answer ‘General journal Date Particulars Folio Debit credit s s ‘anunry2014 Bankesecount GLI 14000 ° Capit =z 14000 Hf you find it efficut to prepare journal envies, ty drawing up accounts as you did in Chapter 1. Then from the accounts draw up the journal In realty, the journal should be donefirst The ther three uses are dealt with later asitis the book of prime entry. capt inroduced by Matlane (9 use 4 in Chapter 38 (closing the ledge accounts when a business ceases to wade) {@ use Sin Chapter 11 (correcting eros inthe double entry system) {9 use 6 in Chapter 13 (making eansfers from the sales leger (othe purchases ledge,[Bil tre boos of prime entry 16 Worked example On 2 August 2014, Jared purchases, on credit a new machine for his business costing $5400 fom Face Led, Required Prepare the enue in Jared general journal to record the transaction. Workings {Ifyou are unsure how to tackle this question, draw up the "T accounts. Jared gains a machine, Factre Ld loses’ the machine Machinery acount Foctre Ltd $ 4 5400 400 ‘Which account has been debited? Which account has becn credited? I you can do this, then you can draw up the general journal Answer General journal Date Particulars Folio Debit cred s s ZAugust 2014 — Machineryaccourt GLI 400 Factoid putt 5400 Purchace of new machin fram Facts Lid 2.4 The cash book used as a book of prime entry ‘The final book of prime eniy the eash book. The cash book is dealt with in more {etal in Chapters 4 und 5, Itissuficent to say at this stage that any cash Cor back teansactions will be entered ia the cash book (aad in another account in onder to complete the double eats) “The cath book is not only part of our doubieentry system, iis alo a book of prime enuy. The source documents used to write up the cash ook would include: 18 cheque book counteefols ( veceipts received from supplies who have dealt in cash {copy receipts given to customers ‘© cash register tl rll (Other source documents used to write up the cash bool: will be encountered i lace chapters.Trade discount ‘Trade discount is « reduction in the price charged to a customer who is also in business, [Exar ple sells 2 wooden kitchen cupboard to the general public for $300. Clyde is akitchen designer and fiter. He purchases a kitchen cupboard from Extrav ple, to ft ‘nto one of his customer’ kitchens for $240. (Gye gets trade discount of $60, This wade discount expressed as 4 percentage ‘would be 20 per cent ‘Trade discount isnot recorded in Extav ples ledger, nor is it recorded in Clyde's Ilse. In Clyde's purchases journal the entry would show s Extra pe 240 1p Fxteav ple’ sales joumal the enty would shows s hyde 20 Worked example “The falloming are the prices of some kitchen cupboards as charged to the general public by Beuay ple and the rates of tade discount allowed to other difeeat ret businesses, Hay Bee Lid ovis 1490 2 Sea Dee baa 600 30 Henn ple ji 670 70 Pes Queue Led bez 60 10 Required repate the entries in the sales journal of Easy ple, Answer Sales journal s Hay Beeed anv7so Sea Dee 2300.00 M.Henn ple 2034.00 Pea Queue Ltd 567.00 Boras0[Bil tre boos of prime entry Posting fe tha term weed by accountants for enteting wansactions into the ledger accounts of a busines > Now try Question 1. 8 Similarly, inthe purchases journal of the customers of Extrav ple the amounts would be shown net of tice discenne So in the purchases journal of Hay Bee Lid we would find an entry s earavele 11750 Postings t the respective ledgers would follow the lines shown earlier in this chapter Sgt es 1 Why is there a need to use books of prime entry? 2. Give an alternative name for the books of prime entry. 3 Give another name forthe sales journal 4 What is meant by the term ‘posting’? 5 Which book of prime entry s also part of the double-enty system? 6 Name the source document used to prepare the purchases journal 7. Name the source document used to prepare the sales returs journal '8 Which two accounts are prepared from the entries inthe sles journal? 9 Which two accounts are prepare from the enviesin the purchases returns journal? 10. Explain how postings are made from the returns journal to the general ledger ‘11 Nome one use of the genera journal 12. Hows trade dacount entered in the books of prime entry? ‘© All business transactions must be frst entered in a book of prime entry before they can be entered in the doubleetry system, ‘Five books of prime entry deal with credit transactions: * purchases journal + sales journal + purchases returns journal sales returns journal + general journal 1¢ The five books of prime entry are lists from which ledger accounts are comoiled. ‘© The sith book of prime enty is the cash book: ‘¢ The cash book deals with all cash and bank account transactions, tts also part of the doubleentry system "Trade discount i a reduction in price charged by a supplier to a customer who i in business.AS Level 1 Financial accounting 3 The ledger accounts in detail 3.1 Making detailed entries in ledger accounts ‘Upto now we have used P accounts to record the two sides of a transaction, This is ‘usefl and it wll give us the information that we requize. However, i would be more useful ifthe "T accounts gave us more details ofeach transaction, {It would be useful to know when the mnsaction took place. {Te would also be seul tn be able t follow the whole wansaction through to is completion, especially when a problem occur inthe system. “These problems are rectified by simple means, Exch entry should he preceded by (the date of the transaction 6 escription stating where the corresponding entry can be located the appropriate ledger and folio (page) number of the ‘thes’ entry. ‘An cotry na ledger account may lok ike this: Dr ‘An account o 5 Teel Saks LIT 27 ‘The transaction took place on 7 Apri. The ‘opposite’ entry (the credit entry is in the sales account and can be found on page 17 ofthe general ledger, Dr “Another account o s 12Sept Purchases G18 aie He the tansaction took place oa 12 Septomber. The debit entey isin the purchases saocount, which is on page 25 ofthe general ledger. 9| 3 | The ledger accounts in detail & © 3.2 Using the books of prime entry Ifyou are asked to prepare a ledger “The information shown in ledger accounts is derived fiom one of the books of ‘account, then your answer must have prime entry. al the detalls. However, when you are working things out you may use Coes accounts because thi is faster and just as am {he loving nosso ok plc ing the wes Ostbe Noy acoumarwand eacherue'T? | 1Osthe munis gndterca cnet on hoe pc HD SUeoemnapeea Pee ee a eewrera ile general workings, 3 2.0cwher: purchased vehicle on eredit from Pooley Motors ple $17400 fe ee sat Sa op nan pagar ee @ 6 ea cias widuionpuminauly AV ink Oana “T accounts. When you gain confidence 8 7 October retuned damaged goods $38 to Arkimed ple in their use you wil find that you cen use 8 7 Ocwober: purchased goods For resale on credit from Charlene $320, them asareviion tol and forsovng, aired ables E identify the source document that has been used in each case to write up the book of prime entey bb Write up the appropriate books of prime entry «Show the entries in each ledger account, Answer 1 Purchase invoices; Transactions 1,3, 5, 6,9 ‘Copy sales invoices: Transactions 2,4, 7 Geet note: “Transaction & b Purchases journal Soles journal s s Oct Adkimedple —PL1_-- 120.1 0k Markco, L100 40a Hono. 2 ASD. 40m None «= S121 40d DathaSon P3170 70k Owais 8 Tost Chalere pla 220 Teo Purchases returns journal s Toct—Aikimed a 2 General journal oo sos 20 Vehices su 17400 Pooley Musple GL wr400 Parchate of vehicle fem Peley Mater ple Pr3.2 Using the books of prime entry c Purchases ledger or ‘ukimed pe o $ s Oct Purchases returns PRI 38 |) Om chases Put 120 br Bjorn & Co. ce | s A0ct Purchases PIN 450 Dearth Som ee s AQct Purchases PIN 170 br Cherlene $ 70s Purchases PI 320 Sales ledger or Mortis & Co. o $ tot Slee oo 5 40a Saks SH a5 olivia 3 Tot Saks SH 1340 General ledger br Purchases account o s Oct sundry payables Pi 1060 Sales account o = 0c — Sundry sn 2255 recevabes ns account « 5 70ct Sundry payables Sit 28 be Vehicles account o s 20a PookyMowrs Git 17400 le Pooley Motors ple c ’ 2ot — Vehides cn 17400 “The cash book is a book of prime entry: It contains the business cash account and the business bank account. We consider the cash book in much more detail in Chapter 4, a| 3 | The ledger accounts in detail 2 “The following example uses the cash book: as « book of prime entry: co mo “The fellowing transactions took place dhising December: 1 December: paid rent using cash 8250 2 December: paid local axes by cheque 110 6 December: paid wages using cas $1782 1 December: paid wages sing ash $1780 17 December: paid insurance premium by cheque 8240 20 December pad wages using ea $1780 27 December: paid wages using cash $1781 31 December: paid reat by cheque $250. Required 2 Rater the transactions in an appropdate book of prime ent. bb Show the necessary ledger accounts Answer a Cath book br Cash 1Dec Rent = GT De Wages, GLA 13Dec Wages lt 20Dec Wages GLA 27Dec Wages GLA br Bank account 2Dec Local taxes GI2 ¥7 Dec Insurance GL 21Dee Rent GLI b se Cah a 2)Dec tank ar 2Dec bank ar or 17 De Bank cr or Wages account s 6c Cash cer 17 yada Cash cer 1780 pode Cah cer 1780 Bde Cah cr 781 vee 170 1780 1781 110 20 250> Now try Question 1 3.2 Using the books of prime entry [Entering transactions inthe bools of prime entry and then the ledgers isnot & lficul task; jst takes patience and the ability to enter transactions twice — once ‘on the debit side of an account and once on the credit side of anexher account, Remember, practice makes perfect. SEES 1 Identity the four pieces of information you would expect to find on the debit side of a ledger account, 2 deny the four pieces of information you would expect to find on the crest, side of a ledger account. 3 When would you use ' accounts? 4 Which source document would you use to write up the purchases returns journal? 5. Which type of account would you expect to find in the sales ledger? 6 Name a personal ledger Grit «Ledger accounts must show date, details of a ‘corresponding’ entry, flio detals and ‘the amount of the transaction, ‘accounts must only be used for revision purposes or as part of workings. ‘© Alltransactions must be entered in a book of prime entty before being posted to ledgerAS Level Mali Merl merece tie 4 The cash book Gen ils Sirois ee Ong ‘Money can bein the form of cash, chogus, ced and debit ard rarsactons m4 By the end of this chapter you should be able to: (record cash and cheque payments ‘record receipts of cash and cheques identify the source documents used to write up @ cash book ‘balance the cash and bank colurnns ofa cash book ‘@ make conta entries in a cash book, 4.1 The cash book “We have looked in some detall atthe five books of prime entry sed to access the doublentry system. The sixth and final bool is Ue cash book. The eash book records ail transactions concerning money. ‘You will have noticed in the section on double entry that the cash and bank accounts were used very frequently and asa result became very full with entries Generlly, in business these accounts are used moce frequently than any other sccounts. This means that i is sensible to remove these two accounts from the ‘general ledger and keep them apart fem the oder accounts, ‘The cash and bank accounts are kept separately in one book ~ the cash book. [Because it is such an important and sensitive area of the business all cash and cheque transactions are usully the responsbiliy of one senior or well-qualified person ~ the cashier 4.2 Recording cash and cheque payments in a cash book ‘The accounts inthe cash book: work on doubleentry principles like all other The debit (or receiving) side is found on the left The credit (or giving) side ison the tight. “The only differences inthe layout of the cash book are that the debit entries are distanced from the credit entries by extra columns and information; and tha the debit catros, generally, tke up the whole of the let page while the credit ents take up the wile of the sight page.4.2 Recording cash and cheque payments in a cash book ‘The layout is the same on both sides ofthe eash book: “The debit side ofthe cash book looks like thse ash book rticulars Folio Cash Bank ‘The credit side ofthe cash book looks ike this cash book Date Particulars Folio Cash “The whole cash book looks ike this Dr Cash book o Date Particulars Folio Cash ank | Date Particulars Folio Cach Bank 0 @ eo #» » |e o @ @ ao + Columns (1) and (6) give the date on which the transaction occurred, + Columns (2) and (7) identiy the aocount where the corresporsting entry ean be found, + Colurnns (3) and (8) show the page ofthe ledger where the comrespending entry can be found +All cash received is entered in Column + All monies pad into the business bank account are recorded in Column (5). «all cash payments made are recorded in Columnn (9) «all payments made by cheque are recorded in Colurnn (10). Worked exampl ‘The following transactions took place inthe fee week of September: 1 September paid R. Serth §34 cash 2 September: paid T. Horse $167 cash 3 September pak V. Dole $78 cash Required Ente the transactions in cash book. Answer Date Particilare Folio Cash Bank [Date Particulars Folio Cash Bank s VSopt Rseth FLO 34 2sept Those I 16r Sept VOole 278 6[El tte cash book 6 rere a ane nes Jens pata ene teatime Answer Partciars Folio Cash Banke s 2h Rent Gl ‘400 The Gay FD a Fe) Wages GIS 832 4.3 Recording the receipt of cash and cheques in a cash book Fig tlt ct ln dyin eae oe, many nel Answer or Cath book @ ‘Date Particulars Folio Cash Bank] Date Particulars Folio Cash Bonk 4May Ned SLI 213 SMoy Henry = SIT 92 OMay Hoy = SiR 729 (anes ‘The following transactions took place during January: 2 January: cheque received from Steve $249 3 January: eash sales banked $851 11 January: cheque received from Masta §29. Required Enter the transactions in a eath book,4.3 Recording the receipt of cash and cheques in a cash book Answer Dr Cash book & ‘Date Particulars Folio Cath iiclara Fella Cash Banke Din Steve SS 9 Blan Cashesles GL22 51 Mian Murtst Si 29 ‘Once you have mastered the method of recording debit enirles and credit entries it should be fay straightforward to combine the two. Worked example “The following transactions took place during April 2 Apstl eash received from Xavier, customer, $455 4 Ape: motor repairs $530 paid using cash G Apel eash received From Milly, a customer, $77 7 Apel ont §210 paid using cash 9 Apel insurance premium $156 paid using cash 12 April: cash sales $763, Required Enver the transactions in cash book, Answer br ash book. cr Worked exampl “The following transactions took place in October 3 October: paid Price, a supplier, $350 by cheque 6 October a cheaue For $150 received, an overpayment of rent 9 October kings paid into bank $2187 M1 Ocwber Bi, & customer, paid by cheque $639 12 October cheque received from Bax §95 pald into the banke 17 October: local taxes $219 paid by cheque. Required Enter the transactions in @ cash book, 2> Now try Question 1. or Cath book ce Date Particulars Folio Gash ank| Date Particulars Folio Cash Bank s s 6Oct Ret lS 450] 30c Pike 14 350 Oct Sales GLI 2187/17 Oct Localtares GUT 219 Nos alte sa eas 1208 fox mua, 2 It is now simply a matter of putting cash payments and cash receipts in the same book as cheque payments and monies paid into the bank, Steric ie je Taare ie fi pia ecient ree paler ba ae Scone Siocon eereacays Sena tam ss 30 November: cash sales $5630, paid directly into bank, ee ani ea Answer be ‘Dats Particulars Folio Cash icles Follo Cash Bank sos sos Nov Norman Sl 288 | 2Nov Motorexpense: LIZ at 1DNov Sales G9 2390 Stor Drawings G23 150 21Nor nurance LIT 273 |15Nov Motoraxpenses LIZ 2 20Now Sales cla 5620 | 29.Nev Wages 71300 Source documents used to write up a cash book “The source documents used to waite up a cash book are: Cony receipts Recepts Ti ls Cheque book counters Bank paying Book counted A further source of information to be used to waite up the cash book isa copy af the details (gecoeded by the bunk) of transactions made using the business bank account but mowe of this source laterSEC 1 Draw out the headings used ina cash book. 2 On which site of a cash book would you enter a cheque received? 3 On which side of a cash book would a cheque payment be entered? 4 In which column would a cash sale be entered? 5 Inwhich column would a cheque for the payment of rent be entered? @ 45 ‘Balancing’ a cash book ‘At the end of an appropriate length of time, a cash book should be balanced. (The time when balancing takes place will generally depend on the sizeof the business And the number of trinsactions that are ncikéed in the cash books) ‘Cosh in hand the tm used to deccibe ‘Roth of the blac in cath boa howd were Shennan st chy abuses tg How could yo ven the a ance rough dow? ny one tne. The cash nhandn 93 ec Hopecall you lance that you brought down? ‘would be found in the tills. In 2 larger Hyco sone thes, har eee: inert bewee bss it might foundin a ste “The balance bnovaht down in the cash columa should sgpce with the cash in hand st that date “The bank balance inthe cash ook can he verified! by reference to the bank statement ‘A balancing figure is an amount that ‘The balances are brought down to start the ‘new’ time period. reeds tobe nducedinshedebtsidece | gemember the cash balance wil always be Lrought down a a debit. The bank eee eee TERE SP akance boughe down could be ether a debit ora eet balance. ‘sad tDbalance a ash book column & then ‘ed tsar the next ime period CO “The cash book of Grey is shown: De Cash book © ‘Date Particulars Folio Cash Bank [Date a8 sos Nov fed U6 1439 | aNov Wage Glt 428 Nov Sale 191270, Nov Hunt = PBT BNov Gong 8123 451 | 11 Nov Rent GLB 600 Va Nor Pots Lia 310 | 16 no Tig pus 38 Required [Balance the cash and bank columns of the cash book em 16 November and carry any balances down, Answer be Cath booke c ° Ay em de important, co make are you getin the practice of doing so. Ge o In ledger accounts, use ‘Balance ot (carted down) for the balances above the total, Use "Balance bid (brought down) for the balance below the total. a> Now try Question 2, ' transaction that appeats on both the dhbic and creat ele ofthe doubleenty system fe calad a contra entry, Conte fetes have no afacon the wel-beng of the busines. 30 Note Make size that all fone totals are on the same line. Balance the cash cokusnns frst thea balance the bank columns. Do not uy t do them both atthe same time, 4.6 Contra entries in a cash book ‘Clearly, iis unsafe to keep large amounts of cash and cheques ca the business ‘Premises fbr prolonged periods oF time. The cashier will aange for the monies received fo be taken w a bank and deposited when the amount i the dill o safe ‘warrants i ‘The fllowing isan extract from the eash book of Grant or ash book c ‘Date Particulars Folio Cath Bank Date Particulars Folio Cash Bank s s Al Cashsoks G2 4397 Siu Purchases GU? 48 nl Bader S51 74 Grant has more than $4000 cash on his premises ~ this represents a security risk. He avs $4000 into the business bank account on 5 July ‘Talk yourself through this ansacton, Grant takes $4000 from the til. the cash column loses’ $4000, Date Particulars Folio Cath Bank s Sul pink = 4000 so ib ion + the paling whet ecrespndg ety so be ound the bk wae «Caron homing shat rant ns er baer ner won ff rexeurertcioneet + Ho inthe al cele sows at eh has ben Yost Gt ake mney tthe bk andthe bk ete the mony Date Particulars Folio Cath Banke s SM Cah 4000 Note «the date of the transaction * the particulars telling where the ‘coresponding’ entry isto be found (inthe cash column “C's for ‘conta’ showing that Grants business is nether better nce worse off because of the trananction + $4000 inthe bank column shows that money has bean recived into the baak account ‘The effect. ca the business isthe same as the effect on your finances that woud occur \Fyou removed a five-dollar bil from one pocket and put it into another pocket.> Now try Question 3. 4.6 Contra entries in a cash book “Anctlier common contra entry in the cash book isthe withdrawal of cash from the bank for use in the business. This transaction aften occurs when cash wages need to be pad and the business has insoficient cash in the safe fo make up the necessary swage packets In fay, for secrity reasons, many larger businesses none pay wages And salasiesdireciy ito sa bank accounts so that lage amosnts of cash do not need to be transported from the bank and then kept on the business's premises, ‘The following isan extract from the eash book of Diegor Dr Cash hook co Date Particulars Folio Cash Bank [Date Particulars Folio Cash Bonk s s 12Aug Rabin 5132 4574 | 11.Aug Machinery Glé 2380 16Aug Nkemo 79 5490 ‘Wages amounting to $4529 have to be paid in cash on 18 August. Diego wahdeaws this sum from the bank oa 17 August Tw ilk ourselves through the process, the entries become clear Diego goes 0 the bank and withdraws $4529, Date Particulars Folie Cash Banke 3 VAug cash © a9 ie reruns to his business peemisos and pots the cash inthe sae Date Particulars Folio Cash Bank 17.8uq Banke casa “Many larger businesses now lcep a cheque payments book and a cash receipts and lodgement book, This is certainly the ease where the bui of transactions are ‘condhcted through the bank account Sarees 6 What does the word ‘contra’ mean? 7 The cash book isnot only 8 book of prime entry itis also part ofthe —___ system 8 Fillin the gaps with ‘debited’ or ‘credited 18 Money taken from the safe and deposited in the bank would be inthe cash column of the cash book and be the bank column. bb Money withdrawn from the bank for use in the business would be in the cash column of the cash book and bein the bank column, 9 Which book of prime entry would you use to record a sale of goods on credit? 110. Name two source documents used to write up a cash book 11 Ist possible to have a credit balance in the cash column of a cash book? 12 \s it possible to have a cect balance in the bank column of a cash book? 13 Under what circumstances do we write ‘C' for contra against transactions in the cash book? anGrice? ‘© The cash book is both a book of prime entry and itis part of the doubleentry ‘system, ‘© All ransactions that involve cash and cheques are entered inthe cash book. ‘© Allcash transactions are entered inthe cash columns, ‘© Al transactions involving cheques are entesed in the bank. columns. '¢ Allenties in cash book need ‘corresponding’ ents in other ledger accounts to complete the double entry. ‘¢ Contra items have no effect on the worth of the busines. '# Any balance shown in the cash column must be a debit balance. ‘8 Balances shown in the bank column could be either a debit ora credit balanceS Level 1 Financial accounting 5 Discounts By the end of this chapter you should be able to: ‘distinguish between trade discount and cash discount ‘ cakuate both kinds of discount ‘record cath discount allowed and cash discount received in ledger accounts ‘9 use discount columns in a cash book as memorandum entries @ 5.1 Types of discount “There are wo types of court avaiable to business: trade discount snc cash discount [As we siw cali, tade discount isa seduction in the pice of goode charged by a _auavfacturer of distibutor to another business, Tride discount i aot cecorced in the double-eniry books of account ‘Cash discount Is 2 reduction in the price charged for goods when a credit customer setes thele debt within atime given by the supplier. Cash discounts are available 10 encourage tale receivables to sete debes prompt. Accustomer owes $100, [A teaile may indicate that if the debt fs sete before the month end, a ash discount of five per cent will be allowed, ‘The debior pays before the month end, so only $95 nceds to be pald ~ $100 less $5 cash discount Both the receipt oF the money and the cash discount are recorded by the retailer and the customer. 5.2 Recording cash discounts allowed ‘The ledger accounts necessary to cecord cash discount allowed to credit customers are shown below: Worked exam (On 1 Augnst Yong has thrce dabtors. Her seement terms allow a cash discount of five per cent to customers who sete their debts before the end, of August. (For illustrative purposes only, Yung does not keep a cash book.) Georgi $2000 | 23 august ‘Ahmed $90___ | 17 septenbe tims $360 [20 August 3Required ‘Prepare the ledger accounts to record the setling of the debes due Answer Sale ledger eee Aug Balanced 2800.00] 23.Aug Bank Gu 2660.00 22Aug Discount alowed G12 140.00 be ‘Ahmed a s 5 Aug Balanced ‘a200|17 Sept Bank cu BoD VAuy Balance bd 360,00 | 29.Aug Bank cu 342.00 2B Aug Dicountalowed cL2 18.00, General ledger or Bank account @ s 23a Georgi SL 2660.00 29ANg Fatma S13 342.00 W7sept_ Ahmed S12 0.00 nt all $ 230ug Georgi St 140.00 290ug Fatma S83 18.00 ‘You can see that discount allowed is credited tothe customer's account, thus reducing the amount wo be paid in setdement. tis debited to the discount allowed account in the general ledger. Ahined did not qualify fora discount ~ he did no pay before the ‘cod of August 5.3. Recording cash discount received a ‘Yung hus three creditors on 1 Augus (for illustrative purposes only, Yung does not keep a cash book), mpl Hameed & Co. 00 2 TQple 7400 5 Cart 200 a ‘Yung, sted the amounts she owed by cheque on 26 August, Required ‘The ledger accounts in Vung’ hooks of account rceoeding the payments made by het.5.4 Entering cash discounts in the general ledger Answer Purchases ledger De Hameed & Co. a s s 26 Aug Bani Gia 39200 |1Auy Balance ve ———400000, 26 Aug —Oiscountrecewed GLA 800 De ce 5 26 Aug Banke 6a Balance bd 740000 26 Aug Discounerecehed GLA De s 5 26g Bank ia rago0 |1/Auj lance bid 20000 26 Aug Decouncrecewed GLA 6.00 bs cr . 26Aug Hameod aco. LI 392.00, 26Aug BTQ ple p2 7020.00 26Aug Cott —FLA_—=194.00, De Discount received account a s 26 Av Hameed &.Co. PLL 800 26Aug 8TQ ple P2370 260g Cette = PLS 6.00 ‘You can see that discount received is debited to he suppliers account, thus reducing the amount that Yung has to pay in settlement. The diseonts are credited to the acount received account in the general ledger. ‘To summarise: (Discount allowed is debited to the discount allowed account in the general ledger And is credited to the customer's account in the sales ledger. «© Discount received is creed fo the discount received account in the general ledger and is debited to the supplie’s account in the purchases ledger. 5.4 Entering cash discounts in the general ledger ‘To waite up the discount accounts inthe general ledger in the way outlined above means that all the accounts in the sales leer must be scrutinised and all he aocounis i the porchases ledger must also be examined and lists must be made of ll the discounts allowed and discounts received in onder to post them to the general ledger. This could be a huge task. We simplify our work by adding an extra column to those already found in the eash book. We have already ted a "two-column’ cash book (cash columns are bank columns). The principles used sill hold good, We introduce a third column on the debit and credit sides for clsccunts, so that we now havea three-color cash ook, cy“The three-column cash book headings look like this: Date Particulars Folio Discount _Cash_Bank __Date_Partiulars __Follo Discount _ Cash _Bank ‘The discount columns are memorandum columns only; they record the discownts ‘Memorandum columns record but are not yet part ofthe double-entry system. This is 2 much more efficient way of information thats not partef the double collecting the informaiton necessary to write up the discount accounts in the general Siren, ledger rather than examining every account in the sales ledger and every account in the purchases ledger Note that we will now cspense with te follo columns in most examples and questions. Yu will not usually need to include them in sour answers to questions ‘The enties to record the previous transactions in Yun cash book would look Hike this be cash book o Date ticular Discount Cash Banke [Date Particulars Discount Gash ‘Bank s s s 5 23x Geoah 140.00 2660.00 |26Aug Hameed Co, 800 392.00 2945 Fatima 13.00 342.00 |264ug TO ple 37000 7030.00 17 sept Ahmed e000 |26Aug Carotid 500 94.00 17 sept Balance od 4534.00 Tsao 7616.00] aor aE 1B Sept Salarce bid 4534.00 “The cash and bunk columns in the cash book are balanced as they were in the cash book of Grey in Chapter 4 Note 1 ILs important to note that the discount cohumas ate totalled. They are mot ‘compured and balanced sioce there ino connection berween the entries in che wo columns. One column refers to customers’ accounts, the other column refers to supplies! accounts {9 The discount columns are memoranda columns only they are not part of the ddowble-entry system ‘The totls of the discouee columns are then posted to the respective discount allowed snd discount received accounts in the general ledger, “The purchases ledger accounts and the sales ledger accounts are the sume as previously shown. However, the discount accounts would loos like this. General ledger br Discount allowed account Cr Dr __ Discount received account cr s $ U7 Sept Sundrydebtos = 158, 17 Sept Sundry creditors 324.00 Note 19 The was are used the individual dscounss are net shown, 1¢ Notice also that wo separate accounts are used, 36> Now try Question 1 5.4 Entering cash discounts in the general ledger ST 1 Explain the term ‘cash discount. 2. Explain the term “trade discount 3 Dscount_____isdebited to the discount ___ account in the general ledger Discount iscredted to the discount accountin the general ledger (On which side of the cash book would you find the discount allowed column? On which se of the cash book would you find the discount received column? ‘Which columns ofthe cash book are balanced regulary? ‘Which columns ofthe cash book are not balanced? What is meant by the term ‘memorandum column’? Geen «© Trade diccount is not recorded in the books of account ‘© Cash discount is a reward for prompt payment. ‘© Cash discount allowed is credited in the debtor's account and debited to the discount allowed account in the general ledger ‘© Cash discount received is debited to the cteditors account and credited tothe scount received account inthe general ledger. {© To save ime, both types of cash discount ae listed in the cash book. The totals of the two columns ae posted separately tothe two discount accounts inthe general ledger ‘¢ The discount columns in the cash book are memorandum columns only — they are rot part of the double-enty system, aAS Level Mali Merl merece tie 6 Preparing simple financial statements By the end of this chapter you should be able to: ‘© prepare a simple income statement to reveal the profit or loss earned by a eee eee business ‘© prepare a simple statement of financial position. + Understand the need for and purpose “The managers and owners of all businesses wish that their business will survive and flourish. In order that this might happen, the business must generate positive cash flows as these should ensure ks short term survival. All cash and bank wansactions se recorded in a cash book. Balancing the cash and bank columns enable cash and bank surpluses and deficits to be recognised quickly. Short-term decisions regarding these surpluses and deficits can be then be made to benefit the business. Profs should ensure survival ofthe business inthe long term, “We have seen how all ransactions are recorded in detail inthe ledgers of business, but the recording of cash and credit transactions in the ledaer does not immediately ceveal whether or not a business is profitable, @ 6.1 Balancing a ledger account “We have soca that every tone we make a debit entry into our double-setey system we rust also make a credit ene. If we fellow this cule, then the teal ofall debit enties ‘Abslancng figure isan amount that in the system must equal the sum ofall ere entries. needs tobe eden the debits ot Atwial balance is a summary of all the enties i the double entry system. I SDeshaleinemcarade TPS" checks thar each transaction has been entered once on the debit side ofan account nd cace on the rect side of another asin 386.1 Balancing a ledger account © €=D ‘The cash and bank columns of the cash book are balanced inthe same way that ledger accounts are balanced. An account co s s 2 4 a 16 ‘The debit side ofthe account adds to $80. ‘The credit side adds o $45, “Tor make the account bake we need to insert $35 into the crit sie. “The account now looks like this or An account © s s 2 ra a a 6 20 ‘The account balances. This process makes it look as though the debit eneis were exactly the same amounts as the erdit entries ~ not tue! ‘The debit side tolled $35 moce than dhe credit side, We need to rele this when we start the account again, We cay the balance down. ‘We sart anew with an opening balance of $35 on the debi side or [An account © s s 2 as a as 16 2 o 35 ‘The mules of our double-eniry game say that every time we include a debit entry in the system we mus also include a credit entry, We have done jut that. We inserted a credit catry to make the account balance. ur debit entry starts us off aging CE ‘The following accounts are given: Dr og Grr Meleyn Dr Tan 5 5 s 5 $ s 2 a 2 By a %0 3 4“ 2s 7 a 22 8 a a Required [Balance the accounts and cary down any balances. 3[Gi Peeparing simple financial statements Answer br z cr cer 3 s 3 s 3 4 2 33 2 a4 n 0 a a 2 27 2 38 6s 8 a 20 3 st 02 io2 10 10 19 189 cs 39 o When a balance is described as a debit balance or a credit balance, we are desexibing the balance requited to stat the account in the next time period the balance that has been brought down. In the example above: (6 Zog's account has a credit balance of $66 {¢ Melvyn's account has a debit balance of $39 ‘¢ Tan's account has a debit balance of $61 6.2 The trial balance We prepare alist ofall the balances that we extracted from the lexigers by balancing, all the ledger accounts and carrying domn any ottstanding balances on each account. ‘We list all the debit balances under a caluma headed debit and we list each cxedit balance in « columa headed cre, “The debit column is totalled; the credit is totalled. The two columns should have the same tot This Hist s called a tal balance. Ti we extract tial balance, and the two sides tral ro the sime figure, we can say ‘with some certainty that every debit has a corresponding credit If the teal balance totals do not agree, thea we can say with some certainty that there are some exors in the double-enty system. ere ace a couple of simple double-enry examples using “P account, followed by a very simple tial balance, CEs ‘The following transactions are fr Geraint busines 1 Geraint purchased goods for resale $153 from Buveu on credit. 2 He sold goods $29 r0 Sangita on crit. 3 Geraint sold goods far cash $296, 4 He paid motor expenses $68 paying cash. Required Enter the transactions in Geraint ledger. Camry down any balances and check the accuracy ofthe entries by extracting 4 wil balance. Answer Dr___ Purchases acount___Cr_—=_Dr Buveu cr 5 $ 1s 1533 br Sales account cbr Sangita cr s s 29 2s] 266.2 The trial balance or ath account ce co 5 s 296 e “ial balance Debit Credit s s Purchase 1593 ‘The account shows a debit balance the rial balance show a debit balance ave 153. The account shows a credit balance th wal balance shows ace balance Sales 325 Sales have cel ants tating $325; the tt balance shows this balance, Sangits 2 The account shows a debit balance the tril balance shove a debit balance cosh De The debit ste is greater the a balance shows the debi balsa figure. Motor expanses 6 ‘The account shows a debit lance the til balance shone 2 debt balance ae we “The trial balance has shown that we have entered our transactions accurtely. ‘Worked examp! ‘The following aecounts have been extracted from a ledgers br ath account ce Bank account co s 5 5 s a 100 365 sua 534 458 912 14 2 @ br Rent account cr Wages acount & 5 5 10 258 or Sales account Ge _Dr__Purchases account ce s 5 2 ms 265 a on 2 Requived Balance the ledger accounts. Carry down any balances and extract wal balance © check the accuracy of the erties i the ledger Answer br cosh secount cr Bank account ce 3 s $ 3 a 100 35 saa 534 458 ow va 2 @ 6 523 Te, a6 1a 7 © 53 at[Gi Peeparing simple financial statements br Rent account ce s 100 br Sales acount Ct _Dr__ Purchases aceount cr s s a 35 1319, 12 1319 Be 1319 ‘ial balance Dr o s s cae 6 ak 5a ont 100 Wages 458 sales 139 Purchases 2 79 Ey 6.3 Calculating profit “We sow in Chapter 1 that accounts in a general ledger can be divided into nominal accounts, real accounts and lability accounts, Information in the form of balances exticted rer nominal accounts in a ledger can be used to calculate business profits, If the total of all revenues eared is compared tothe total of ail expenses incurred, the difference will veal whether fr not the business has made a profit or los in the time poriod covered by the information Coe Balances taken from the nominal acoounts ia the ledger of Ong show the Following {nformtioa for a financial year + rent and local taxes paid $870; wages paid $56000; payments for other expenses $8900 + purchase of goods for resale $121 500; sales for the year $193000. Required Calculate whether or not Ong's business has been profitable over the year Answer Prof For the year $5730 (= Sales $193000 ~ Expenses 8187 270) (sxpenses = Purchases $121500 + $870 + $56000 + $3900), aeG 6 An income statement shows how the business has performed over a period of ‘hme whereas the statement of financial position shows the financial postion of the business on a particular date This point is identified in the headings ~ make sure that you use them as they are important. @ ° In income statement, we use ‘revenue’ instead of ‘sale’ 6.3 Calculating profit ‘The following information has been extracted from the nominal accounts in the ledger of Jethro ater one year of trading: « sales of goods: $116000 + expenses incurred during the year ~ purchases of goods for resale: §59600 «payments made ~ rent and local tues: $2760; power: $8930: wages: 41270, motor expenses: $2950; other expenses: 86840. Required Calculate whether or not Jethro’ business has been profitable during the year Answer Jethrols business has not been profitable. I has made a los of $7850 {4116000 — Payments $123850). Sales $116000 less Payments macle during the year $123850. “The calculation thar we have just done can be shown moe formally in an fncome ‘Ubertus provides the following information which is list of the nominal ledger balances he extracted from his ledger on 31 July 204 after one yea’ trading. + sales: $279988 + Purchases of goods for resale: §201 760 + Payments made ~ wages: §41.215; motor expenses: §8960; local taxes: $1800; advertising: $2430; insurances: $1540; other expenses: $9610, UUbestus ipcome statement for the year endes! 31 July 2014 wil include the {information above: Ubertus Income statement for the year ended 31 July 2014 or s s Revenue 270088 ess expenses Purchases 201760 wages 41215 Meror expences 060 os tes 100 Adhering 2430 Insurances 1540 Other erperses 610 Total expenses 261315 raft forthe yar 12673 3[GB Pccparng simple financial statements > Now try Question 1. ‘his a very simple income statement. ‘The difference between the sales revenue generated and the cost ofthe goods old ‘called gross profit. ‘We shall develop the layout in furure chapters whore we will consider adjustments to make the statement more accurate an reveal mote information 6.4 Statements to show financial position ‘Thore are other types of account in a general ledger. Some accounts inthe ledger record the purchase of assets; some record lables Incurred by the business. Accounts inthe purchases ledger show credit transactions with suppliers wile accounts inthe sales ledger show credit transactions with customers, Balances from these accounts will be used to prepare a statement of financial position A statement of financial postion lists the assets owned by a business and lablities cowed by a business, The total vale of assets held must equal the total value of abies External Habilites are amounts owed to people or business that are not the ‘owners: The difference between the amounts awed to extemal creditors and the assets held by a business is known as capital or act assets. It cepresents the amount of the owner's investment in their business. Worked example Heidi provides the following balances extracted from her general ledger: Premises $5000; mortgage ca premises §35000; vehicle §12000; aout owing 19 hank for vehicle purchase $4000; hank balance §1200. Required 1 Clasify the information given into assecs and labile bb Calculate the value of Heid’ capital Answer «Assets: Premises, vehicle and bank: balance ($65000 + $12000 + $1200 = $78200) Liabilities: Moctgage on premises andl amcunt owing to bank for vehicle purchase (435000 + $4000 = $3900) bb Capital= Value of asscts less value of lisilites ‘Once again we can show the information in a more formal layout. Co TD ‘Kamil provides the following information that he has extracted from his ledgers at 31 July 2014 or o s s Bank vera 220 ong tem bark loan 000 Machinesy 10000 -Meongege on premises 25000 Premises 40000 Vehicle 8500 Trade payables 200 ‘rade recehables 1500Inventories are goods thathave been purchased fr resalebuthave, 2 yet, not been old, > Now try Question 2. ‘6.4 Statements to show financial position Additional information ‘The inventory held at 31 July 2014 was valued at $2000, Required Prepare a statement of financial postion at 31 July 2014, Answer Kamit Statement oF financial postion at 31 July 2018 s s ASSETS ‘CAPITAL AND UABILITES Inventory 2000 Liabilities Machinary ——-10000——_—Bank overdraft 2200 ries 40000 Longtembsnklean 8000 ‘Vehides 8500 Mortgage on premises 25000 Traderecesablee 1500 Trade payables 800 36000 Capita ret ass ~iference between the 26000 sole of sets and external hates) ‘otol assets 62000 Total capital and labilites 62000 “The information detailed in business books of accounts can be used to show the profitability of the business and also to show is finaneial positions. A more formal and structured layout ofa satement of financial postion will be considered in greater deal in Chapter 14 (Section 14.3). [Nonaki provides the following lst of balances extracted from his ledgers at 30 [November 2014, ater his Best year of tading Dr o s s Bank overdo 1700 Sales 167880 Purchases 7500 Wages 53710 esting ape ighting 1000 fant and local tvee 4090 abies 9000 Motor expanses 2540 Emuipment 6700 General expenses v7e0 ‘rade recenablee 2900 ‘rade payables 2340 Additional information: lunventores held were valued at $4370 at 30 November 2014, Requived Prepare: {2 an income statement forthe year ended 30 November 2014 bya statement of financial postion at 30 November 2014. 45[GB Pccparng simple financial statements Workings “The phurchases shown inthe income satement isa measure of the goods hought and sed as sales. The igure of $57500 isthe value ofthe goods purchased for resale However, the additional information tells ss that not all ofthe goods were infact sold, Goods to the value of $4370 remain unsold at the end of the financial year, ©) the purchases ‘used! to generate profits was §83 130 (87500 fess $4370) Answer . Nonaki es eae eg ont Banat a a 2 ; ie ‘a poe om Grass profit 84750, ae tee is Gierepeon a0 favedage aa @ e° rs Temi apRmaneanernct ee ee Seon anameeets : : Sa Saas current liabilities. Vehicles: 9000 Liabilities: ae eee re eee a Seas a es a =a Se ee a Total capital and ibities 22970 Geta os The ‘et side’ of an account ads to $349. The right side adds to $421. What balance would be shown en the account? Would the account described above show a debit ora credit balance? ‘Explain the term ‘trial balance. Explain why a trial balance should ‘balance’ if there are no errs inthe books of ‘account Identity two statements that can be prepared using information shawn on a tral balance. Which ofthe two statements is used to calculate profits? ressvsonsnvaeanenes Explain the term ‘capital > Now try Question 3 ‘Give another name forthe term ‘capital.6.4 Statements to show financial position Giicennr ‘© A vial balance is a summary of all the balances remaining in the books of account (usually exracted atthe financial year end (9 The balances are arranged ina debit colurmn and a credit column, 19 The totals ofthe two colurmns should be the same, ‘If they ace equal, it generally indicates that every debit enty has a corresponding czedlt entry (see Chapter 10) 12 The information contained in a trial balance can be used to prepare two statements: ‘one calculating the profitability of the business and the other showing the assets and lables of the business a1AS Level Mali Merl merece tie 7 Accounting principles, concepts and conventions By the end of this chapter you should: ‘¢ understand the generally accepted principles, concepts and conventions of: business entity eek eer eee ain historic cost; money measurement; going concern; consistency, prudence; realisation; duality; materiality, matching (accruab), substance cover form, (Over the years accounting has evolved rules that all accountants use when preparing, the Financial statements of « business. These les are refered to as accouating, concepts or accounting principles. Some of these principles are enshrined ia Jaw and in International Accounting Standards (LAS) laid down by major accounting bodies (see Chapter 36). “The application of these rites by all accountants means thatthe users of the Finanelal statements can eely on the infeemation they contsin, safe ia the knowledge that a set of financial statemen's prepared in Kingston, Kuala Lumpur, Karachi oe Kalel for any type of business have been prepared using the same ground rules. “The concepts are an important topic: they underpin all ofthe work done by accountants, Make sure that you are famiae with ther, 7.1 The business entity concept ‘The concept of the business entity sates that only the expenses ankl revenues ‘relating to the business are recorded! in the business books of account, Transactions Involving the private affalrs of the owner are not pat ofthe business and should sot be included in the business books. “The owners private electricity bills or private food bills should not be included! as business expenditure Ifthe business cheque book is used to pay the proprietors peivate mortgage ‘payments the amount should he included in the deswsings account. 7.2 Historic cost ‘Traditionally financial statements have been prepared using historie cost. This means thar all sncome, expenditure, assets and ables ase recorded a the price paid for them atthe date ofthe transaction. Unfortunately, as time goes by, the value of assets Js understated and profits are overstated, especialy in times of inflation, Some of the advantages of using historic cost ate that i objective easly understood « caslly applied tothe double-eatry system {6 e1my for external svitors to verify all transitions «© recognised by tax authorities. 487.6 Prudence Some of the disidvantages of using hsteric cost inelude: © overstated profits cue to Failure to adjust for increased costs of replacing inventory (or replacement of non-current asses ‘© understatement of noe-curront asset values, hence understatement of capital employed (this can be overcome by revaluing the asset) Proper, plant and equipment should be value a cos in a statement of financial ‘postion, Cost includes the actual purchase price pus all ther costs involved in binging the asset ta the location where i i to be used together with costs of making sure that the asset can pesform its intended use. The asst is shown at historical cost Jes accumulated deprecistion. Non-current assets may be shown on a stitement of financial postion ata revalued amount if the fir value can be measured reliably. The ‘company must revalue all assets in a particular elas Ifa company has seven different ‘aeories,t cannot revalue ust one of those factovies. Future depreciation is ealeulated and provided on the evalued amount. 7.3 Money measurement ‘Only transactions that can be measured in monctary terms shoul be included i the business books of account. I is extremely dificult to put a value on: (© mumigeril efficiency and expense (the skill and efficiency ofthe workforce 1 good customer relations 1 Boad afice-sales sorvice 7.4 The going concern concept less we have knowledge tothe contrary, we assume thatthe business wall continue to ‘sade ints prescat form forthe foresceable firure. This means that we value all business assets at cost, not at what they would fetch if sold (but sce 1AS 16 in Chapter 36) IF the busines is going to contin, the ass will noc be sok so sale value is ielewant. Intemational Accounting Standard 1 (IAS 1) names the going concern concept as «fundamental accounting concept (sce Chapter 36) 7.5 The concept of consistency ‘The concept of consistency requites that once a method of treating information thas been eablished the method should continue to he used in subsequent years financial statements “The application of this concept can be seen in Chapter 19 when methods of providing for depreciation of non-curcent asets are considered, Tf information is weated differently each year then inter-yeareesults cannot be compared. Trends cannot be determined 7.6 Prudence Prudence requies that revenues and profs are only included in the accounts when, they are realised or their realisation is reasonably certain. Tls prevents profits from. being overstated. If year end gross profit overstated, then the profit for the year will also be overstated, If profs are overstated, a trader may withdraw more resonnces (money and goods) from the business than is wise, This conld lead to a pastion where assets could not be replaced when necessary for that trade payables could not be pald when due. However, the concept of ‘prudence allons provision to be made Fo ll known expenses of losses when they become known. For example if damages were awarded! against the business in a court case, the business could make a provision on the estimated amount that i might Ihave to pay out in compensation. 49PEM e Now try Questions 1-3 Grins ‘© Accounting concepts and principles are the basic rules of accounting. They should be applied to the recording of all transactons and the preparation of al accounting statements, 2AS Level 1 Financial accounting 3 Closing down the double-entry system by the end ofthis chapter you shouldbe able to: oe poet acenuni ot gentle S tansteromouns fm De nome! ccounts nthe genera oesbarmentrieereree a Seren eee eanaer aa transfer balance fom on came latent othe pale als proprietor’s capital account ‘8 show detads of changes to capital as a caleulation and in ‘account format ‘© prepare an inventory account in the general ledger eee Gas flue inventory by using castor net realisable value ee eae a «6 identify and caleulate the effect that a change in inventory et eeu valuation will have on reported profs. ‘We have seen how the douible-entry system works. The sytem selies on the basic principle: “Every debit must have @ corresponding credit ‘The following transactions took place during the year ended 31 August 2014 for ‘Ghoka all ransactions were paid by cheque + 26 September 2015: purchase of vehicle $17500 + 30 September 2013: payment of rent $700 + 11 October 2013: purchase of vehicle $16900 + 17 Ocsober 2013: payment for advertising $120, + November 2013: payment of wages $13200 © 23 November 2013: payment for advertising $2600 * 31 December 2013: payment of ren $700 +1 Rebeuary 2014 payment of wages $13700 31 March 2014: payment of rent $700, 31 March 2014: payment of local taxes $1300 +1 May 2014: payment of wages $12900 © 17 June 2014: payment for advertising $340 30 June 2014: payment of rent $700 91 August 2014: payment of wages $14 600, Required Prepare accounts for wages, rent local taxes, advertising and vehicles forthe year fended! 31 August 2014 53FE closing down the double-entsy system Answer or Vehicles account rr Rentaccount Gr s s 26Sep¢2013 Bank 17500 30Sept2013 sank — 700 v0a2013 ank 16900 310e2013 Bank — 700 31Mar2014° Bank 700, 30 une2014 Bank — 700 or ‘Advertsing account Grr Wages acount s 5 17042013 Bank — 120 WWov2013 Bank 13200, 22Now201 Bank 2600, Vfeb2014 dank 12700, V7lune 2014 tank 340 1May2014 gan 12900 Aug 2014 Bark 14600 be Local taxes account Cr s 31Mar2013 Bank 1300 ‘The credit entries corresponding to all the debit entries shown would appear in the bank account @ 8.1 Closing accounts in the general ledger pen i i ea i ie i Hon acoure wont fascia in euch ent ede Som ae Sega tarp a ree Ceca ican heen see ee Sure seca ei ca cepa ape ae eS ee ee, ‘Nominal accounts are gereal edger Real accounts a general edger aczouns in hich he purchase andsale How are the nominal accounts closed? {earoscore oe rected fea atcouris The nominal account are dosed by wansfeng the balances on each account to the ‘would inchude land, premices, plant, income statement, which should be found in the general ledger. tracery ofceequgment ec, ash ‘deally, the tncome staxement ought to be in the general ledger. In realty tt rarely kept inthe goncrl edges The isformation contained i of seniivenssee so i wll geacaly be kept separately ftom the rest of the general ledgc in a private ledger: peers nen A private ledger is kept apart from the general ledger for obvious reasons, Other ad che decttsralre latte accounts that he owner ofa business might wish m keepin a privat ledge ay Sune oration dos not eh oes lachide the capital account o an acount that shows loa transactions “The accounts shown in the books of account of Ghola, above, would be closed as Fallows ‘The nominal accounts are transferred tothe income statement, The toasters will, close the accounts fr the year in question and wil leave them clear to start 2 pew Aisne yea, “The accounts and the income statement areas follows: 54o Vides acount GDF « : 5 2oseph2019 Bank 17500 sept 2019 tk rroa2a9 nak 16000 31902019 tak BiMar2016 tak ze 30 e 2014 Bak 7300 o eros om cr 3 5 $ ozs sank 120 st aug 2014 weome 30601 Nor Z013. Bark 21am 2014 heone S440 23 Nov2013 tank 2600 sere 1b 2014 nk sare rim2014 tank 380 1 May2018 Bn 1Aug2014 are S000 | Sco. 00 eS cee a: ee « 3] . - 21Mar2014 tank 1300)21A192014 come 1300 assent2013vehide 17500 ‘statement |20 Sept 2013 Rent 700 = “30. 082013 vehde 16500 7082013 Adwrirg 120 ov20t3 Wags 13200 32013 dering 2600 sioe2013 tem 79 Febz014 ages 13700 StMar2014 octane 1300 Btyar2018 Ree 700 iay20%4 wages 12600 imz2014—Aderirg 310 oumzoia Rem m0 12014 ages 14600 Extract from income statement for the year ended 31 August 2018 s epenses ent 2800 acvertsing 3050 Wages 400 toca tes 1300 Notice tha et ents are made ning doblecnty pci cach red aa aa cei etched ya err nc eee he vehicles aco ard bak aceon ay ope since we wl te thee scant “The prchasy sales purchases rem an sles ous acount il be dosed using the me techie butte balances on howe acount we ansered tothe trading account ofthe icone eatement, No onl oe! the dosing of the oil coun provide ve wi fon co auble ust clare he profs mad by the buss also els uo have 55[Ei closing down the double: entry sytem Purchases ae any itn that ae purchased sth the imtantion ofesing them #0 ‘Inventory is goods held for resale tht hae not boon deposed of during the financial yea 56 a fresh startin the general ledger nominal accounts next year. Imagine if we did not tidy ox these accounts on an annual basis, some accounts would have hundreds of thousands of entries after 20 years! “The ru i that all accounts providing us with information that is relevant to one financial year ace closed dawa at the end ofthat year the ether accounts remain in the books of account as balances to str up the system again next year, All these remaining balances show the financial postion of the business ~in the statement of financial position on the final day of the nancial yeu 8.2 ‘Closing’ the income statement ‘The income statement is also closed dowin atthe end of each financial yene: We can then prepare the next income statement in a year's ime Work: mpl “The Following lis of balances has been extracted from the books of Pate, trader, afer his first year of trading Balances at 21 December 2014 $ s Purchases 1600 Sates 103110 {and and aulengs 50000 tres aed fttnge 7000 Vehicles 21000 Rent, local anes and neurance 5420 Lohting ana heating epancee 7980 Motor apes: 9750 Repairs and erewal 1780 Wages 14320 ate recehables v7a0 Tae payables 1490 Drawings 20 Capital 70000 cas a0 Bankbalonce 1800 V7as00 174600 laventory at 31 December 2014 was valued at $1020, Required 4 Identify the accounts that will be close down at the end of the Financial year by posting the amounts to an income statement. bb Prepare an income statement for the year ended 31 December 2014 « Prepare a statement of financial postion at 31 December 2014 Answer 4 The following accounts wil be closed Ghey are all nominal accounts purchases, sales ren, local taxes and insurance, lighting and heating, motor expenses, repats and renewals and wages.8.2 ‘Closing’ the income statement $ Patel Income statement for the year ended 31 December 2014 s s Revenue roanio Lees Cont of cles Purchases 1600 Les Inventory 1010 40590 Gros profit e220 ess pense or, local taxes and insurance 540 Lighting and heating 7980 Motor expenses 9200 Repairs and renova 1780 wages va220 2870 Profit forthe year 23750 +The income statement is closed! with the prot for the year calculation of $23750. + The profit for the yeae i entered on the credit side ofthe capital accou in the ‘ener ledger, thus increasing the amoune of eat invested inthe business by che Staterentf Nha peltion at 31 Deemer 2014 s s assets ieseciretaaed Land andbudings 0000 ie i 7000 Vebides 000. 38000 arent nse svenny 1010 alana a0 nach 1800 Gah 40 070 eee — = captraL np uasiumes capt Cindi 70020 dit 270 93750 sania 2170 1580 ret uta Tale pabls 1450 Total capital and ables = 37FE closing down the double-entsy system Draft an attempt io prepare a statement or document which may nad t b= amended before canbe said tobe 2 periect copy. 58 COs ‘The following draft ist of balances has been extracted from the books of accoust of Mischner on 30 June 2014 after her frst year of wading. There are three missing Figures, The accounts that wil provide the missing figures are shown below the list Draft ist of lances at 30 June 2014 s s Purchases 128360 Saks avrea0 Promos > Fires aa figs 17000 Vehicles 34000 Wages 119000 Bent and local taxes 14670 Metor expenses 21620 Repairs Z Lighting and heating expences a710 General expenses ? “ade rcehablee 2480 Tae payables 5400 Drawings 20300 Capital 150000 ankbalonce 3510 (Cath in hae 640 Inventory at 30 June 2014 was valued at $6490 or Repairs account Cr Dr General expenses account Cr st s 3Apr2014 Bank 348 7 Sept 2013 Cash 1467 19May2018 Cah 55 24Nov2013 Bank 1672 12kune 2014 dank 1219 fan 2014 dank 4281 27 hunw2014 Bank 737 17 feb 2014 Caoh 419) 9May 2014 Bank 2318 Tiune 2014 oank 2222 be Promises account Cr s 1 ily 2014 Balance 60000 Required 4 Complete the lis of balances and ensure that it balances bb Cloce the relevant accounts shown, « Prepare an income statement for the year ended 30 June 2014. dd Prepare a statement of financial postion at 30 Jane 2014 Answer 4 The balance totals aze $473.250. bb The repairs account is closed by a credit entry of $2460; the general expenses account is dosed by a credit entry of $13490. The premises account should not be closed down ~ the promises will be used by the business in subsequent years8.2 ‘Closing’ the income statement Income tatean forthe yor ended 20a 2014 s s fess 317830 te lato ln ches 1360 ti a 6480 121880 Gross profit OO 795950 oes ipnees Wages 10000 ere ero Mer eeies ie pats 2480 Uphing ard heating pores ono Gene epee 1380 180960 Profit forthe year — Ta ee Statement of fnacil poston at 20 June 2014 s s assets Ss ee sone Fates and figs 7000 vehi aoc 7000 Cartes entry 480 ee 2480 Bank balance 3510 Cah 10 13080 Tefal wens - “Yeaon0 CAPITAL AND UABILTES Capital Opening balance Add Pott tess Drawings Current abilities “ade payables Total capital and lables 9EE closing down the double-enty system © _Mesiners capital account inthe general leer would lok Hike this 2 quastion asks you to show acapital De optal account ‘account, it should bein account form =. } Tees spleen ay ap appear in 30 June 2014 Drawings 26300 | 1 July2013 Bank Semin of ee poin. 30,une2014 Balance ed 138690 | 30 June 2014 Prof far yea 168990 Inventories are the goods that renin unsold a the end ofa financial year Vhuy2014 Balanced ‘The profit for the year of $14990 is entered in Mischner's capital 1s sefol and ussal to show all the details contained in the capital account in the statement of financial postion, as we have done above and in previous examples 8.3 The inventory account in the general ledger Up to now the businesses that we have looked at have, in the main, bean in the frst year of wading. As part of our income statements and our statements of financial positon, we have had to consider inventories, Tventores are valued pysicaly atthe end of each financial year Even fa trader keeps manual or computerised inventory records, the figures produced are not used in the end-of-year nancial statements Despite what you might think, inventory records kept manually or on a ‘computerised syssem will be inaccurate! Why? Because goods get stolen, they get damaged, some goods deteriorate, and these occurrences sre not shown in our ‘manual or computer cecords “The most accurate way to value inventories is to count them manually and then value them ~ but more ofthat later Afier the trial balance is extracted from the ledgers, a value is placed en closing ‘nventories — hence ‘closing iaventory’ appears as an afterthought. ‘losing inventory is deducted from the goods available for sale to obtain the cost of goods that the business as sold, in ether words the cost of sales figure for the year Closing inventory is a current asset and must be shown in the statement oF financial postion atthe end ofthe financial year, “We have scen thatthe income statement is prepared using revenue incomes and cexpenclitires by closing the nominal accounts in the general lege. An inventory account appears in the general edger and is prepared as follows: {At the financial year endl inventories are valued andl recor! as a debit in the sccount since they age asits De Inventory acount $ 5 Endof Year 0 Deducted fram cost ofsles 1224 (oom) in income statement _Atthe end of the following yean8.4 Valuation of inventories De Inventory account 5 5 EndofYesrO Daductadfromcostof 1234 | Startof Addedto costo 1234 (oon) salesin income tateent. ——| Year 1 salesin income = — Endat Year! Deduct from cost of 2245) sales in income statement De Inventory account cr Endof Year Deducted fam costaf 1234) Start of Added tocostofsles 1234 © frow) sales inincomestatement | Year! inincomestatement Endof Deduct ram costof 2345) Storof Added tocostofsales 2345 Yer! sles inincemastatemert. ———| esr. inincamestatenert Endof Deduct from costo 3456. Yer2 sales inincomestatement ‘The closing inventory is dedicted from the current years cost of sales (since it has sot as yet een sold) and the balance inthe inventory account is shown to the statement of financial position as a current asst. 8.4 Valuation of inventories “he overriding principle used the ‘Av the end of the financial year tader will physically count dhe ems that remain Veluction of inventory sthetit sakvays 95 inventory (goods cemaining unsold) inthe busines. Ast is made ofall the items. valued atthe lower ef cost price ornet Each category of goods held has then to be valued. realizable value, lf closing inventory is rervulued, goss profit s overvalued 2 IF gross profits oxerealued, then the profit forthe year is ewrealue 2 If cosing inventory is amdervalued, then geoss profit is wdereaued. (9 IF gross profit is undereeiued, then the profit fr the year is undorvaled. ‘We can ches this with «simple example. ‘The following is the wading account of the income statement of Figaro: * Closing inventory should be valued at $15. « sales amount to $50. Inventory overvalued ‘Accurate inventory value Inventory undervalued s s s pening inventory 10 Opening inentony 10 Opening ventory 10 Purchases 25 Purchases 25 Purchases 2 35 3 35 L255 Clesing inventory 20. LessClesingleventony 15. Less Clesing inventory 8 ost of sales 15 Costofsakes 20 Costef sales 2 Gras profit 3 Grsproft 30 Grospoofit, 23 Sales 50 Sales SD Sales 50 Highest inventory valuation gives highest Lowest inventory valuation gives lowest rns profit. 27085 profi arRee ot rete vate caes poems or my dents ‘Make sure that you understand the Worked examp! ‘concept of net realisablev students throw away their ne sagt ‘The following information is available regarding iaventory held by John at 31 August chances 2014. success by being unable to calculate correctly the net realizable ‘of inventory. > iow ty Question 2. Show ty Question PANT 2 16 2 oni = a 798 8 18 15 ss9 2 10 2 Required Calculate the total value of the inventory of components held at 31 August 2014 Answer ‘Total value of inventory of components Workings s PX? ateost 385 (QR2183 atcost a2 ‘TN798C st realsble value (sling price) 120 595219 at ost 220 Nate ‘¢ Realisble value is slling price. 1 Net realisble value isthe relisable value net of (Jess) any expenses incutred in geting the goods ready for sale. Glgtares 1 Name the type of accounts that are closed down at the end of the financial yea. 2. Why do some traders keep a private ledger? 3 What entries are require to close the folowing accounts? Rent payable Discount rected Purchases 4 Insurance; purchases returns; carriage inviards; Orton, a debtor, wages. Identify the account that would not be closed at the end of a financial ear. 5 Axel, a creditor; bank; advertising: capital; vehicles. Identify the account that ‘would be cosed at the end ofa financial year. 6 Explain what is maant by the word draftin ‘draft income statement 7 What i the overriding principle used inthe valuation of inventory? '8 The application of this principle is an example of the concept. 9 closing inventoryis overvalued, ross profit will be. 10 Explain how closing inventory is dealt with in nancial statements8.4 Valuation of inventories Chapter summary ‘© At the end of each financial year the nominal accounts in the general ledger are dosed by transferring the balances to an income statement, ‘© Real accounts are nat dosed and are shown on the statement of financial positon 1 The profit forthe year is transferred to the capital account. « Inventories are valued atthe lower of cost or net realisable value «Net realisable value & the selling price ofthe ites held less any costs that might be Incurred in making the items ready forsale aAS Level Mali Merl merece tie ©) Accruals and prepayments Sere eee + Calculate the adjustments needed fora The accrusls concept recognises the ference between the actual payment of ash and the legal ciation te pay cath, Ito recognises the desncton beteen ‘the receipt of cash ad the legal ight receive ca ‘Arial halance is st ofthe total ofa ledger accounts a they oppest inal the ledger By the end of this chapter you should be able to: ‘¢ apply the accruals concept to relevant accounting information « account for expenses owed atthe end of a financial year ‘¢ account for expenditures pad in advance ofthe financial year {record amounis owed and prepaid in the appropriate ledger accounts © record revenues that ae outstanding and revenues that are paid in advance inthe books of account, 9.1 Accruals and prepayments So far we have assume! that money spent and money received exactly matches! the time period under review: For example, we have assumed tha: ‘8 ont paid in February was forthe use of premises in February «wages paid in July was payment for work done in July 6 the figures shown inthe trial balance prepared at 31 December 2014 showed all the incomes ane ll the expenses for the year ended! 31 Devember 2014, nothing more and nothing less ‘When calculating profit, accountants are interested in accounting forthe resources that che business has used during the nancial year to generate the cevenve ceceipts for that same yea ‘When preparing financial statements, a trader must include all items of| expenclture, paid and payable This sounds a litle strange at fst bur it will soon become close “When we prepare ser of nancial tatements we need 10 include al the items that apply fo the accounting period under consideration. Some expenses listed in a tral balance ate always pad in advance, For example: insurance has to be paid in advance «local axes are generally pad in advance, ‘Other expenses listed ina tral balance might aot be paid up to date: 6 part of rent payable may not yet have been paid # wages exmned for work already done may not be due to be paid uns the next mons, An accountant will ook at rent diferenily from the way a landlocd ora tenant soe i