Financial Accounting:

LECTURER:AGIL AZIZOV
Incomplete records and missing
information: Internal control:
Learning outcomes
•deal with incomplete information such as missing sales, purchases, payables or receivables
figures
•deduce the missing figures from the available information.
•explain the nature and need for internal control in the preparation of financial accounts
•explain the purpose and computation of a bank reconciliation statement
•discuss the need for control accounts
•demonstrate how to reconcile differences between control account balances and a list of
receivables and payables balances
•resolve a suspense account and trial balance differences.
Incomplete information
In the kinds of situations you may meet in accounting, pieces of information which you
need to complete the financial statements may be missing.
Trading account      Mark-up Margi
n
  £ £ % %
Sales   200,000    
Less: Cost of sales        
Opening inventory 25,000      
Purchases 155,000      
Less: Closing inventory (30,000)      
    (150,00 100 (75)
0)
 Gross profit   50,000 33 25
Example
Example 1. Lucy Loo makes sales of £100,000 in a year at a mark-up of 25 per cent on
cost. Her opening stock at the beginning of the year was £15,000. Her closing stock at
the end of the year was £18,000. What are her purchases for the year?
Use Lucy Loo’s trading account as your working. The figures in bold are the ones that
you need to work out, and the numbers on the right-hand side are the order that you
should work them out in:

Example 2 . The next year, Lucy Loo makes sales of £120,000. However, because of
increased competition, she was only able to charge a mark-up of 20 per cent on cost. If
her closing inventory at the end of this year was £20,000, what are her purchases?
Solution 1
Lucy Loo trading account    Mark-    
up 
  £ £ % order
Sales   100,000 125   
Less: Cost of sales        
Opening inventory 15,000      
Purchases 83,000     2

Less: Closing inventory (18,000)    

(80,000
    ) (100)  1

 Gross profit   20,000 25  

Solution 2
Lucy Loo Trading Account     Mark-up
  £ £ %
Sales   120,000 120 
Less: Cost of sales      
Opening inventory 18,000    
Purchases 102,000    
Less: Closing inventory (20,000)    
(100,00
    (100)
0)
 Gross profit   20,000 20
Missing sales or receivables
Sometimes we are missing sales but we do not have the right information to use the trading account to find the missing figure.
T account will be one the best solution to find the missing figure

Receivables
  £   £
Bal b/f Cash received
Sales Bad debts
written off
    Bal c/f
   
Bal b/f    

Note that the doubtful debt provision does not appear in this working. The receivables b/f and c/f balances should be the gross figures,
after writing off bad debts, but before deducting the provision for doubtful debts .
Example
Lucy Loo makes sales to customers on credit. One year, her opening receivables were
£20,000, and her closing receivables were £24,000, before making any adjustments for
bad and doubtful debts. One of her customers had recently gone bankrupt owing her
£2,000 and this amount would have to be written off. She had never had this problem
before. However, every year she makes a provision for doubtful debts of five per cent. If
Lucy Loo received £95,000 cash from her customers during the year, what are her sales?
Solution

Receivables
  £   £
Bal b/f 20,000 Cash received 95,000
Bad debts
Sales  99,000 2,000
written off
    Bal c/f 22,000
  119,000   119,000
Bal b/f 22,000  
Missing purchases or creditors
We can apply a similar logic to missing purchases or payables figures. This time the
relevant ‘T’ account is the payables control account.
One year, Lucy Loo had opening payables of £12,000 and closing payables of £9,500.
During the year, she paid a total of £87,000 to her suppliers. What were her purchases?

Payables
  £   £
    Bal b/f 12,000
Cash paid 87,000 Purchases 84,500
  9,500     
  85,500   96,500
     Bal b/f 9,500 
Internal control

•explain the nature and need for internal control in the preparation of financial accounts
•explain the purpose and computation of a bank reconciliation statement
•discuss the need for control accounts
•demonstrate how to reconcile differences between control account balances and a list of
receivables and payables balances
•resolve a suspense account and trial balance differences.
Introduction
Internal controls are the systems and procedures that management put in place in order to secure
as far as possible the accuracy and reliability of the accounting records and to safeguard the
assets of the business.
The principal objectives of an internal control system in relation to financial accounting records
are to ensure that:

• the business receives all the income or revenue to which it is entitled, and this is accurately recorded in the appropriate
period
• all expenditure is properly authorized and accurately recorded in the appropriate period
• all assets are properly recorded and safeguarded
• all liabilities are properly recorded, and provision is made for known, or expected, losses
• the accounting records provide a reliable basis for the preparation of financial statements
• errors and fraud are detected and dealt with promptly.
Example
On 30 April, the closing balance on Joanne Brown’s receivables control account is £1,422. The total she is owed
according to the data for individual customers in her receivables ledger is £1,360. On further investigation, she discovers
the following errors:
1. An amount of £160 received from Blue plc was correctly recorded in the receivables ledger, but was recorded as
£116 in the cash book.
2. An invoice for the sale of £86 worth of goods to Yellow & Son was correctly recorded in the sales day book but
was recorded as £68 in the receivables ledger.
3. An invoice for the sale of £50 worth of goods to Green Ltd was recorded twice in both the sales day book and
receivables ledger.
4. A cash receipt from Yellow & Son was recorded in the receivables ledger against Blue plc.

Error 1 affects the control account via the incorrect entry in the cash book. It does not affect the receivables
ledger. Error 2 affects the receivables ledger but does not affect the control account because the sales day
book entry is correct. Error 3 affects both balances. Error 4 does not affect either total balance.
  

Correction
Sales ledger control £
Original balance per receivables control
account 1,422
Less: cash receipt under-recorded in cash book (44)
Less: invoice recorded twice in sales day book (50)
Corrected balance 1,328

List of sales ledger balances  

Original total from receivables ledger balances 1,360
Add: sale under-recorded in receivables ledger 18
Less: invoice recorded twice in sales day book (50)
Corrected list of balances 1,328
 Example
On 30 April, the closing balance on Joanne Brown’s payables control account is £290. The total that she owes,
according to the data for individual suppliers in her payables ledger, is £279. On further investigation, she
discovers the following errors:
1.An invoice for £60 goods purchased from First Supplies plc was not recorded in the payables ledger.
2.A cash payment of £40 to Second Ltd was not recorded in the payables ledger.
3.A cash payment of £56 to First Supplies was correctly recorded in the payables ledger, but was added as £65 in
the cash book payments total. 
4.An invoice for £25 goods purchased from Second Ltd was not recorded in either the purchases day book or,
therefore, in the payables ledger.
What is the amount that should appear as trade payables in Joanne’s S of FP on 30 April?
Solution
Purchase Ledger Control   Dr Cr
per Q     290

(3) Cash payments total overstated      

(4) Invoice omitted from PD Book     25

    – 324
Revised balance     324
       
List of balances      
Per Q     279
(1) Purchase invoice omitted     60
(2) Cash payment omitted   40  

(4) Invoice omitted from PD Book cash payment     25

not posted in ledger

    40 364
Revised balance     324

£324 would be the figure for payables appearing in Joanne's S of FP on 30 April.

 
Bank reconciliations
Bank reconciliations are an example of an important control that should be operated by
all businesses.
For example:
1. An entry appears on the bank statement but has not been recorded in the cash book.
2. Transactions undertaken at the end of the month such as cheques drawn.

The bank is therefore not aware of these transactions and they will appear in the ‘bank
reconciliation’ in which the corrected cash book balance is reconciled to the bank
statement final balance.
 Example
The following is a summary from the cash book of a company for July 20X5: opening balance 2920, Receipts 26382, Payments 26245 and closing
balance 3057
On investigation you discover that:
1.
Bank charges of £40 shown on the bank statement have not been entered in the cash book.
2.
A cheque drawn by the company for £125 to pay a supplier has been entered in the cash book as a receipt.
3.
A cheque from a customer for £180, which was banked (and included above in receipts), has been returned by the bank as ‘unpaid:
4.
funds not available’, but this has not been adjusted in the company’s books.
5.
An error of transposition has occurred in that the opening balance in the cash book should have been recorded as £2,290. (You can see that the
figures have been written in the wrong order.)
6.
Cheques totalling £285 have been sent by post to suppliers but were not presented to the company’s bank until August 20X5.
7.
The last page of the bank account paying-in book shows a deposit of £1,260 which was not credited to the account by the bank until 1 August 20X5.
8.
The company’s bank statement at 31 July 20X5 shows a balance of £982.
 Solution
The cash book balance should be: Bank reconciliation statement as at 31 July 20X5
Balance, as it appears at present: £ 3,057 Balance as per bank statement £
Payment entered as a receipt now (125) Add: receipts not yet cleared into account 982
cancelled
Payment omitted (125)   1,260
Bank charges not yet entered (40)   2,242
Returned (’bounced) cheque (180)    
Error in opening cash book balance Less: payments drawn but not yet  
(630)
(2290-2920)
presented to bank (285)
Corrected dosing cash book balance 1,957
Balance as per cash book (after
1,957
correction)
Suspense accounts
A suspense account arises in one of two circumstances.
1. if the trial balance does not agree, a new T-account is created to make the trial balance
agree.
This is a temporary measure since, if the trial balance does not agree, some error has
occurred. In due course, the error will be corrected and the suspense account will
disappear.
2. a transaction might arise where the debit (or the credit) entry is entered but the
bookkeeper does not know the corresponding entry.
Since, of course, every debit must have a credit, for the time being the unknown entry
will be posted to Suspense until the correct T-account to post that entry is established
Trial balance differences

There are five different reasons a trial balance would not agree, some of them involving a
suspense account. In every instance, the correct approach to correcting the error is as
follows:
Step 1: What double entry has been completed?
Step 2: What double entry should have been completed?
Step 3: What entries need to be input in order to arrive at the correct position?
Error of omission
a sum of £100 was paid directly into the bank account by an unknown customer.
Dr: Cash 100  
Cr: Suspense account    100

Once it is established the sum was paid to the company by customer/ receivable D Ltd, clearly
the double entry should have been:
Dr: Cash 100  
Cr: Receivables: D Ltd   100
So, the correction is:    
Dr: Suspense account 100  
Cr: Receivables: D Ltd   100
Error of transportation
a payment of rent of £890 was posted to the rent T-account as £980.The double entry in the first
instance was:
Dr: Rent 980  
Cr: Cash   890

This difference in the trial balance will result in the creation of a suspense account with a credit balance of £90.

Once it is established that the rent account has been overdebited with £90, the correction is:
Dr: Suspense account 90  
Cr: Rent   90
Compensating error
this is two unrelated errors, which together cancel each other out. Perhaps the cash
account has been overcast (casting is a term accountants often use for adding up figures)
by £50 while the electricity account has been undercast by £50. In this instance, the trial
balance will agree but it is nonetheless wrong. The correction required is:

Dr: Electricity
Cr: Cash
Error of commission:
this is where the correct sum has been posted but to the wrong T-account.
Here the trial balance will still agree but if, say, an electricity invoice of £200 was
debited to rent instead, the correction is:

Dr: Electricity 200  

Cr: Rent   200
Error of direction
where a debit balance or debit entry is entered as a credit balance (or vice versa).
◦ If this occurs, the trial balance totals will differ by twice the error. If a payment of £600 for
administration expenses has been credited by mistake, the trial balance credit total will exceed
the debit total by £1,200 and therefore a suspense account debit balance £1,200 will be
introduced. To correct this error:

Dr: Administration expenses 1,200  

1,20
Cr: Suspense account  
0
Example
At 31 December 20X1, the trial balance of Hay Limited has total balances as follows: Dr: 102,450; Cr: 98,400

As a result, until the errors are identified and corrections are posted, a suspense account is introduced.

The investigation establishes the following:

A cheque received from a customer of £3,640 was posted to receivables as £3,460.

A sales invoice of £3,000 was omitted from the sales account.

A rent invoice of £1,100 was posted as £110.

Motor repairs of £8,000 was posted to Motor vehicles: cost. Depreciation is charged on Motor vehicles at 25 per cent on cost
on a straight line basis.

Discounts received of £930 were debited to Discounts allowed.

Complete the Suspense account and show the effect of all these corrections to the company’s profit.
Solution
Affect on profit
Dr Cr
TB difference, excess debits   4,050  
Cr: Receivables 180    
Cr: Sales 3,000   3,000
Dr: Rent (1,100-110)   990 (990)
Dr: Repair, Cr: motor vehicles     (8,000)
Cr: Depn expense     2,000
Cr: Discounts allowed 930   930
Cr: Discounts received 930   930
Debits now equal credits 5,040 5,040  
Net reduction in the reported
    (2,130)
profits