Association of Accounting Technicians

Transcription

1 Association of Accounting Technicians Accounts Preparation Level 3 Book 1

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3 Published by: Home Learning College 1 Hammersmith Broadway London W6 9DL Home Learning College Ltd 2013 Version 3.0 aat3_acpr_book1_v2_master_ All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, transmitted or utilised in any form or by any other means, electronic, mechanical, photocopying, recording or otherwise without the written permission of the publisher. All product names and services identified throughout this book are trademarks and registered trademarks of their respective owners. They are used throughout this book in editorial fashion only and are for the benefit of such companies. No such usage, or the uses of any trade names, is intended to convey endorsement or other affiliation with the book. Home Learning College course materials are made available in electronic format for use by students of the College. All rights, including copyright and related rights and database rights, in electronic course materials and their contents are owned by or licensed to Home Learning College. In using electronic course materials and their contents you agree that your use will be solely for the purposes of completing a Home Learning College course. Except as permitted above you undertake not to copy, store in any medium (including electronic storage or use in a website), distribute, transmit or retransmit, broadcast, modify or show in public such electronic materials in whole or in part without the prior written consent of Home Learning College or in accordance with the Copyright, Designs and Patents Act 1988.

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5 Contents Lesson1 - Introduction to Double Entry Processing Introduction 4 The accounting function 4 Keeping financial records 5 Source data 6 The confidentiality and security of information 7 Double entry principles 8 Accounting terms 11 The accounting equation - Calculating the missing term 13 Double entry processing 14 Balancing off ledger accounts 25 Lesson 2 - Value Added Tax (VAT) Introduction 44 Administration of the VAT scheme 44 Registering for VAT 44 Rates of VAT Items not covered by the VAT scheme How the VAT scheme works 46 Calculating VAT 47 Rounding VAT 49 Vat and settlement discounts 49 Accounting for VAT 50 The VAT return (VAT 100) 56

6 Lesson 3 - Use a Sub-divided Accounting System Introduction 60 Processing techniques (real time and batch processing) 60 Sub-dividing the accounting system 61 Main books of account 62 Subsidiary books 63 The books of prime entry 63 Day books 65 The use of control accounts 68 Maintaining the cash book 81 Checking the accuracy of postings to the cash book 98 Posting from the cash book to the control accounts 100 Lesson 4 Prepare a Trial Balance and Correct Errors Introduction 104 Preparing a trial balance 104 Using a suspense account 116 Lesson 5 Prepare Reconciliations Introduction 128 Bank reconciliation 128 Control account reconciliations 141 Drawing up the control accounts 143 Correcting errors discovered by preparing control accounts 147

7 Accounts Preparation Book 1 Introduction The AAT Level 3 Diploma in Accounting consists of six separate units which should be completed in the following order: 1. Accounts Preparation (ACPR) 2. Prepare final accounts for sole traders and partnerships (FSTP) 3. Costs and revenues (CSTR) 4. Indirect tax (ITAX) 5. Spreadsheet software (SDST) 6. Professional ethics (PETH) The Accounts Preparation unit is divided into two books, with Lessons 1 5 in Book 1 and Lessons 6 13 in Book 2. It is written to AAT s AQ2013 syllabus specifications and is designed to be used in conjunction with Home Learning College s Virtual Learning Community (VLC). The Accounts Preparation unit covers the required skills and knowledge to prepare ledger accounts to trial balance stage according to current financial standards, including making any necessary adjustments. You will also learn how to account for the purchase and disposal of non-current assets. Throughout the book you will find the icons shown below. These highlight important items, reinforce essential points and provide helpful exam tips. Example this is an illustration of a learning point in the context of a real-life scenario. Key Learning Points the main items to learn and understand in a particular lesson. Exam Tip these call attention to information about potential pitfalls and essential information regarding the AAT assessment. 1

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9 Accounts Preparation Book 1 LESSON 1 Introduction to Double Entry Processing On completing this lesson you should be able to: Explain the purpose of keeping financial records and identify the nature of the information taken from the accounting system and the sources from which transactions are processed Identify and explain the accounting concepts which underpin the double entry system of processing business transactions Identify and define the terms which make up the accounting equation Process transactions through ledger accounts applying the principles of double entry processing Balance off ledger accounts, and prepare a trial balance Classify ledger account balances 3

10 Home Learning College Introduction The accounting units studied at Level 2 concentrated on the processing of financial transactions, which included the preparation and use of business documents, recording transactions in a sub-divided accounting system applying double entry bookkeeping principles, and the use of devices to check the accuracy of transactions processed. At this level of the qualification (Level 3 Diploma in Accounting) the emphasis is on financial accounting activities associated with accounts preparation (the making of accounting adjustments at the financial year end) and the preparation of final accounts for sole trader and partnership type business entities. The assumption at this level is that learners already have a sound knowledge and understanding of the principles of double entry bookkeeping. For those students who have graduated to this level having completed Level 2, a light refresher in double entry principles is probably worthwhile. However, for those students who are entering the qualification at Level 3 as direct entry students a more in-depth study of double entry processing may be required. This introductory lesson is based on material taken from the Level 2 study text (Processing bookkeeping transactions) and is designed to give you the opportunity to study and practise the system of processing business transactions known as double entry. The accounting function Accounting is made up of two main functions - financial accounting and management accounting. These can be described as follows: Financial accounting The activities we associate with financial accounting are those of financial record keeping and the use of information from within the financial records to prepare financial statements. All business organisations, regardless of their size and type, are legally required to keep financial records and prepare financial statements. We also find in practice that financial records and financial statements form the basis of proving the creditworthiness of a business and are usually required by suppliers when making decisions about giving credit to 4

11 Accounts Preparation Book 1 the business, and financiers such as banks and other lending institutions from which the business may seek loan capital/finance. Management accounting - the activity of management accounting is concerned with the process of providing financial information for internal use. The preparation of management accounts is not a legal requirement and the purpose of management accounting is to provide financial information at a time and in a format that makes it suitable for the purpose of planning and controlling the business. Keeping financial records Financial record keeping is the mechanistic routine by which the financial transactions of a business are processed and recorded and is more commonly referred to as bookkeeping. The system used by a business entity as the basis of recording its business transactions, i.e. its bookkeeping system, will to a great extent depend on the volume and nature of the business transactions to be processed and the competence of the individual(s) responsible for the keeping of the financial records. However, the basic requirements of an accounting system are that it is effective, efficient and secure. Transactions need to be processed with speed and accuracy and the procedures used, and controls in place, must ensure that opportunities to commit acts of fraud by those operating the system are minimised, and that data contained within the system (much of which is confidential) is kept under safe and secure conditions. Smaller sole trader and partnership business organisations tend to use a bookkeeping system known as the single entry system. This system usually consists of a simple cash book or spread sheet where the receipts and payments of the business are recorded and analysed. Such systems are easy to operate and meet the requirements of the majority of small businesses. Medium size or large business organisations tend to use a system of processing and recording business transactions known as the double entry system. Certainly a business organisation with a high volume of transactions to process would need to operate such a system. Nowadays, we find the majority of accounting systems are double entry computer based systems. Software packages such as Sage are extremely popular 5

12 Home Learning College as they are inexpensive to install and, with appropriate training, fairly easy to operate. Many of the larger business organisations operate computerised accounting systems which are tailored to meet their own specific needs. Staff within the accounts department of an organisation using such a system will need initial and on-going training if they are to operate the system efficiently and effectively. The accounting system provides information for the purpose of the dayto-day running of the business as well as the preparation of financial statements. Information provided by an accounting system will include: The nature and value of the assets of the business (what it owns, what it is owed and the extent of its liquid funds, i.e. its cash in hand or in a bank account). The claim of the owner(s) on the assets of the business (the capital claim of a sole trader or partners, or the equity claim of the shareholders of a company). The amounts owed by a business to organisations or individuals other than its owner (the liabilities of the business). The income earned by the business from trading or non-trading activities. The costs and expenses incurred in the running and administration of the business. Source data The transactions processed and recorded within the bookkeeping system, whether it is a single entry or double entry bookkeeping system, need to be supported by appropriate source documents or records. Typical documents used as the basis of processing financial transactions include: Sales invoices and credit notes issued to credit based customers Purchase invoices and credit notes received from credit based suppliers 6

13 Accounts Preparation Book 1 Receipts issued to cash based customers, or till roll readings showing a summary of cash sales Receipts collected to support cash-based purchases Bills received from utility companies Vouchers - such as a petty cash voucher Statements of Account particularly the bank statement Cheque book stubs Other records from which data is extracted include: A register of payments by standing order or direct debit The payroll or wages book The journal You should note that it is a legal requirement that source documents and records from which financial information is processed be kept on file for a minimum period of six years. The confidentiality and security of information Those working within accounting need to recognise the importance of maintaining confidentiality in keeping financial records and preparing financial statements. The financial affairs of the business organisation should not be discussed with those outside the organisation and should never be discussed in a public place where the conversation could be overheard. Information of a confidential nature should be circulated only to authorised individuals within the organisation and should never be openly discussed. For example, it would be unacceptable for the payroll clerk to discuss the pay of specific employees with other colleagues outside the payroll section. Likewise, it would be a breach of confidentiality if the clerk(s) responsible for keeping customer and supplier accounts were to 7

14 Home Learning College openly discuss the account of one particular customer or supplier with other rival customers and suppliers. If working in private practice it is essential that client confidentiality be respected. A client s business should never be discussed with other clients or a client s family and friends without the express permission of the client themselves. Financial information should be kept secure and yet needs to be filed within a system that makes it easily accessible to those authorised to use it. Simple security measures such as keeping office doors locked when an office is unoccupied, locking filing cabinets or keeping information in a lockable drawer or safe should be encouraged. Computer files should be protected by the use of passwords and PIN s to restrict access. Confidential information should be stored on removable files (tapes, discs or CDs) and kept in secure locations. The Data Protection Act requires that personal data be kept under safe and secure conditions; this would require the use of firewalls to protect the information from contamination or hackers. Double entry principles Accounting concepts are principles and rules that those within the accounting profession observe in recording financial information and in the preparation and presentation of financial statements. The system of double entry bookkeeping is underpinned in particular by four accounting concepts. These are: The business entity concept The dual aspect concept The money measurement concept, and The historic cost concept The business entity concept This concept requires that those individuals who are responsible for keeping financial records and preparing financial statements treat the organisation for which they are doing so as though it were a living person. Therefore, each business is given an identity which is separate from that of its owner or owners. 8

15 Accounts Preparation Book 1 In the eyes of the law, however, only limited companies have their own legal identity. As unincorporated businesses the law does not distinguish between the identity of the sole trader, or those in partnership, and their business. For those keeping records and preparing financial statements however, each business is treated as though it were an independent unit or person. As a result of applying the business entity concept we restrict the records we keep to giving an account of transactions which relate specifically to the business entity. We are not keeping records for the owner(s) of the business but for the business itself. The only circumstances in which we record the activities of the owner(s) in the records we keep are when their activities have a direct impact on the financial affairs of the business. For example, when the owner(s) of the business invest capital in their business, we record the fact that the business is in debt to its owner(s). Should the owner(s) take goods, or funds, from the business in the form of drawings, this too would be recorded in the books as we need to account for the fact that the claim of the owner(s) on the resources of the business has decreased. You should also note that as a result of applying the business entity concept, the financial records we keep, and the financial statements we prepare, must be headed-up in the name in which the business trades. The dual aspect concept This concept is the very essence of the double entry system of bookkeeping. The dual aspect concept, or duality as it is often referred to, requires that we recognise that there are two aspects to accounting. We need to recognise that as a living person the business is itself capable of owning resources and these resources are known as its assets. We must also recognise that the business entity is really a fictitious person, with no means of personally financing the assets it has acquired. The business entity must therefore be financed either by its owner(s) or other financiers. The claim of the owner(s) of the business on its assets is known as capital (or equity in the case of a limited company), whilst the claims on assets of other financiers are known as liabilities. The dual aspect concept determines that the two aspects must always be equal. In other words, what the business entity owns (its assets) must be equal to what it owes (its capital and liability claims). This relationship is expressed by the accounting equation: 9

16 Home Learning College 10 Assets = Capital + Liabilities The above equation reflects the assumption that for each business transaction there is a giver and a receiver. The double entry system of bookkeeping is an expansion of this assumption which results in each transaction being recorded twice in the financial records. One entry is made to the left-hand side of an account (debit side) with a corresponding entry of equal monetary value being made to the right-hand side of an account (credit side). If we start our bookkeeping system with accounts showing that Assets = Capital + Liabilities, i.e. that debits (DR s) equal credits (CR s) and for every transaction we process, we process a debit posting and credit posting of equal monetary value, then debit entries should always be equal in value to credit entries. The transactions processed once the opening position is established will have an impact on the factors within the accounting equation. For example, if the proprietor of a business introduced further capital of 10,000 into the business by transferring this amount from his private account into the business bank current account, then the value of the assets of the business would increase by 10,000, likewise the owners claim on the assets of the business (capital) would increase by 10,000. However, overall the equation would be maintained i.e. assets would be equal to capital plus liabilities. The money measurement concept In keeping financial records we are classifying, categorising and recording business events (transactions), to which a monetary value can be attached. There are, however, some aspects of business which we cannot value in monetary terms. For example, it is impossible to put a monetary value on the flair, skill, and motivation of the owner(s) and workforce of a business, and yet these aspects of business life are essential to its wellbeing and survival. The money measurement concept requires that we confine ourselves to only recording those transactions to which we can attach a monetary value. The historic cost concept The information recorded in the books of account is capable of being influenced by the person recording it, or by what it is required for. As a result, the historic cost concept has been adopted. This concept requires

17 Accounts Preparation Book 1 that assets are recorded in the books at their original cost to the business. Transactions recorded in the books of account are in the main documented by the invoice as proof of the amount paid to acquire an asset, in payment of an expense, or of the amount received when goods are sold. The books of account are history books providing a detailed account of the value at which goods and services are bought and sold. Accounting terms The dual aspect concept referred to above made the point that the system of double entry processing has its foundations in what is known as the accounting equation i.e. Assets = Capital + Liabilities Before you explore further the principles of double entry bookkeeping, it is important that you have an understanding of each of terms within the equation. Assets - these are defined as resources controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. Whilst the above definition of the term assets should be quoted at this level of your studies in layman s terms, assets can be described as resources owned by a business or monies owed to it. Assets can be further classified as being either non-current assets or current assets. Non-current assets These are items of value acquired and owned by the business for the specific purpose of being used within the business over a number of accounting periods (years). Non-current assets form the framework of the business and make a long-term contribution to the business in terms of the profits it generates. Examples of non-current assets include: Business premises (land and buildings) Plant and machinery Fixtures and fittings 11

18 Home Learning College Office machinery and equipment Vehicles. Current assets These are items of value which are held by the business in the form of liquid funds (cash in hand or cash in a bank current account), or which are held in a form that facilitates them being converted by the business into liquid funds (cash) at short notice. Examples of current assets include: Inventories (stock of raw materials, work in progress or finished goods held for resale) Trade receivables (amounts owed to the business by credit customers for goods or services supplied to them on credit) Short-term investments (money in a bank deposit account) Cash in hand Liabilities - these are defined as a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources. Liabilities represent the claims on the assets of a business, i.e. its financial obligations. In theory, all claims on the assets of a business represent a liability, however, we tend to make a distinction between the claim on assets of the owner(s), which is referred to as capital, and the claims of other providers of funds, which are normally referred to as liabilities. Liability claims are classified as being either non-current liabilities or current liabilities. Non-current liabilities are the financial obligations of the business which the business is not expected to meet within the next twelve months and include: A bank loan over several years Debentures a method of raising funds used by limited companies Current liabilities these are the financial obligations that are repayable in the short-term (within the next twelve months). Examples of current liabilities include: 12

19 Accounts Preparation Book 1 Trade payables (suppliers who are owed money for goods and services supplied to the business on credit). An overdrawn balance on the business bank current account (a bank overdraft is meant to be a short-term arrangement with the bank and in theory is repayable on demand). Capital this is the term used in accounting for sole traders and partnerships to describe the claim of the owner(s) on the assets a business has after the liabilities have been deducted from the value of its assets. The term equity is used in accounting for limited companies to describe the claim of the owner(s) on the assets of a business. The accounting equation calculating the missing term Wherever we know two of the terms within the accounting equation (Assets = Capital + Liabilities), we can calculate the missing term. For example: If we are told that the assets of a business have a value of 200,000, and its liabilities are 60,000, we can calculate that the capital claim of the owner of the business must be 140,000. Assets 200,000 less Liabilities 60,000 = Capital 140,000 If we are told that the assets of a business have a value of 500,000 and the capital contribution of the owner to the business is 400,000, we can calculate that the obligation of the business to providers of funds other than its owner(s), i.e. its liabilities, must be 100,000. Assets 500,000 less Capital 400,000 = Liabilities 100,000 Given the information that the capital contribution of the owner to the business is 300,000 and that its liabilities are 50,000, we can calculate that its assets must have a value of 350,000. Capital 300,000 + Liabilities 50,000 = Assets 350,000 13

20 Home Learning College Double entry processing The processing of business transactions on a double entry basis requires that the giver and receiver element of each transaction (the dual aspect concept) be identified and applied. Each business transaction is posted with a left-hand or Debit (DR) entry to a suitable account with a corresponding posting of equal monetary value then being made to the right-hand side or Credit (CR) side of another suitable account. Suitable accounts are those accounts which categorise transactions so that account balances provide us with information from which, at the financial year end, the final accounts (Statement of Profit or Loss and Statement of Financial Position) are prepared. The system starts by opening accounts in the books that reflect the accounting equation (Assets = Capital + Liabilities). The accounts we keep are known as ledger accounts and the books are known as the ledgers. Assets are recorded as debit balances within accounts, with capital and liabilities being recorded as credit balances; as a result debit balances will be equal in value to credit balances. If all transactions which follow are then posted with a debit entry and corresponding credit entry then arithmetic accuracy, in terms of debit values being equal in value to credit values, will always be maintained. In bookkeeping terms the accounting equation can be shown as follows: Debit balances Credit balances Capital Assets and Liabilities 14

21 Accounts Preparation Book 1 Each transaction which follows will then be analysed, the giver and receiver aspect identified and appropriate debit and corresponding credit postings made. The following postings are necessary to increase or decrease debit and credit balances: To increase a debit balance a debit entry is made in an appropriate ledger account. To decrease a debit balance a credit entry is made in an appropriate ledger account. To increase a credit balance a credit entry is made in an appropriate ledger account. To decrease a credit balance a debit entry is made in an appropriate ledger account. The following information will also help in processing business transactions: Assets acquired for use in the business, such as fixtures and fittings, vehicles and plant and machinery are posted (debited) to an account opened in the name of the type of asset concerned, e.g. Fixtures and Fittings account. Goods bought for resale are posted (debited) to a purchases account. Goods originally bought on credit and later returned to the supplier are posted (credited) to a purchase returns account. Goods sold from inventory (stock) are posted (credited) to a sales account. Goods originally sold on credit and later returned by the customer are posted (debited) to a sales returns account. Where goods are bought on credit from a supplier, an account is opened in the name of the supplier. The amount owed to the supplier in respect of goods purchased from them is credited to the 15

22 Home Learning College supplier account. The value of any goods returned to the supplier is debited to the supplier account. Payments are made to a supplier and any settlement discounts received are also debited to the supplier account. Where goods are sold on credit to a customer, an account is opened in the name of the customer. The amount owed by the customer in respect of goods sold to them is debited to the account. The value of any goods returned by the customer is credited to the customer account. Payments received from a customer, and any settlement discounts given, are also credited to the customer account. Although a detailed analysis of transactions is recommended, some transactions may be grouped together under one account title. For example, road tax, vehicle insurance, petrol, diesel and vehicle repairs are usually posted (debited) to a vehicle expenses account. Cash taken from a cash box or from the business bank account by the owner for private purposes, or goods taken by the owner from inventory by the owner for private use, must be recorded in the books and posted (debited) to a drawings account. The ledger account In its simplest form a ledger account will take the following format. This is commonly known as the T account format: Example Ledger T account DR Account Title CR Date Details Date Details 16

23 Accounts Preparation Book 1 By using the layout above each transaction can be recorded in terms of: The date of each transaction. The details of each transaction (usually the title of the opposite account(s) used, or if we are posting a total, the name of the book of prime entry where the total came from). The amount (monetary value) of each transaction. Note: the majority of ledger accounts shown within this textbook will be presented in T account format. Example Double entry processing Laura recently decided to become self-employed. For a number of years she had worked in a local hairdressing salon, but had decided that she would work for herself as a mobile hairdresser and would trade in the name of Curl Up and Dye. The following is a list of the business transactions relevant to setting up her business and the first week of trading: Date Details 201X 1 May Laura transferred 10,000 from her private bank account into a bank current account opened in the name of the business with the National Bank. 1 May The business received a loan repayable over 5 years of 5,000 from the National Bank. The funds were transferred by the bank directly into the business bank current account. 2 May Laura made out a cheque for 250 drawn on the business bank current account payable to cash. The 250 was to be used as a cash float for the business. 2 May Laura purchased shampoos, conditioners, tints, perm solution, hairsprays and other haircare products for use in her business. The items she purchased cost 300 and were paid for by cheque drawn on the business bank current account. 17

24 Home Learning College 2 May Laura purchased a vehicle at a cost of 10,000 for use in the business. The vehicle was paid for by a cheque drawn on the business bank current account. 2 May Laura filled the business vehicle with petrol at a cost of 40, paying in cash. 2 May Laura paid 850 by cheque drawn on the business bank current account to tax and insure the business vehicle. 3 May Laura purchased some hairdressing equipment that she would use in the business. The equipment cost 500 and was paid for by cheque drawn on the business bank current account. 4 May Laura purchased stationery items for use in the business at a cost of 25. The items were paid for in cash. 5 May Laura purchased a supply of hairdressing products at a cost of 250 from Haircare Ltd. The company gave her 30 days in which to pay for the goods. 5 May Laura paid cash of 820 received from customers in the week directly into the business bank current account. 5 May Laura made out a cheque for 200 to self, drawn on the business bank current account as personal drawings: Ledger Curl Up and Dye DR Capital CR 201X Details 201X Details 1 May Bank (1) 10,000 18

25 Accounts Preparation Book 1 DR Bank (Current) CR 201X Details 201X Details 1 May Capital (1) 10,000 2 May Cash (3) May Bank loan (2) 5,000 2 May Purchases (4) May Sales (11) May Vehicle (5) 10,000 2 May Vehicle expenses (7) May Equipment (8) May Drawings (12) May Balance c/d 3,720 15,820 15,820 5 May Balance b/d 3,720 DR Bank loan CR 201X Details 201X Details 1 May Bank (2) 5,000 DR Cash CR 201X Details 201X Details 2 May Bank (3) May Vehicle expenses (6) 40 4 May Stationery (9) 25 5 May Balance c/d May Balance b/d

26 Home Learning College DR Purchases CR 201X Details 201X Details 2 May Bank (4) May Balance c/d May Haircare Ltd (10) May Balance b/d 550 DR Vehicle CR 201X Details 201X Details 2 May Bank (8) 10,000 DR Vehicle expenses CR 201X Details 201X Details 2 May Cash (6) 40 5 May Balance c/d May Bank (7) May Balance b/d 890 DR Equipment CR 201X Details 201X Details 3 May Bank (8)

27 Accounts Preparation Book 1 DR Stationery CR 201X Details 201X Details 4 May Cash (9) 25 DR Haircare Ltd CR 201X Details 201X Details 5 May Purchases (10) 250 DR Sales CR 201X Details 201X Details 5 May Bank (11) 820 DR Drawings CR 201X Details 201X Details 5 May Bank (12)

28 Home Learning College Summary of double entry postings Curl Up and Dye Trans. Number Account Debited (the Receiver of Value) Account Credited (the Giver of Value) (1) Bank (Current) Account 10,000 (2) Bank (Current) Account 5,000 Capital Account 10,000 Bank Loan Account 5,000 (3) Cash Account 250 Bank (Current) Account 250 (4) Purchases Account 300 Bank (Current Account) 300 (5) (6) (7) (8) (9) (10) (11) (12) Vehicle Account 10,000 Vehicle Expenses Account 40 Vehicle Expenses Account 850 Equipment Account 500 Stationery Account 25 Purchases Account 250 Bank (Current) Account 820 Drawings Account 200 Bank (Current) Account 10,000 Cash Account 40 Bank (Current) Account 850 Bank (Current) Account 500 Cash Account 25 Haircare Ltd 250 Sales Account 820 Bank (Current) Account 200 Having processed the transactions using double entry principles the individual responsible for the processing could now, if they wished to do so, check the accuracy of their processing. This would be done by extracting a trial balance. The trial balance is a periodic listing of all account balances within the double entry system. If the books of account were opened with debit balances being equal in value to credit balances, and the individual processing the transactions in the period 1 to 5 May 201X has processed the transactions correctly (with debit postings and credit postings of equal 22

29 Accounts Preparation Book 1 amounts for each transaction), then if the ledger accounts were now balanced off and the account balances listed, debit balances should be equal in value to credit balances. To check the arithmetic accuracy of the postings to the ledger of Curl Up and Dye for the period 1 to 5 May 201X, the ledger accounts were balanced off and a trial balance prepared as follows: Curl Up and Dye Trial Balance at 5 May 201X Account DR CR Capital 10,000 Bank (Current) 3,720 Bank loan 5,000 Cash Purchases Vehicle Vehicle expenses Equipment Stationery , Haircare Ltd Sales Drawings 200 Totals 16,070 16,070 As you will see by looking at the ledger accounts of Curl Up and Dye, the accounts were balanced off as at 5 May 201X for the purpose of preparing the above trial balance. By looking at the balances on the above trial balance we can now apply the following rules with regard to the classification of balances on ledger accounts. Whereas initially debit balances were assets and credit balances 23

30 Home Learning College were capital and liabilities, as the trading theme of a business develops we see that the balances on accounts can be classified as follows: Debits (DR) Credits (CR) Assets Costs Expenses Capital Liabilities Income Drawings You can use the following acronyms to identify debit and credit balances: Debits = ACED Credits = CLI You are already familiar with the terms Assets, Capital and Liabilities as these were defined for you earlier in this lesson. You now, however, need an awareness of the terms Costs, Expenses, Drawings and Income. These terms can be defined as follows. Costs This term is used to describe expenditure associated with making or buying goods for resale. Purchases (goods bought for resale) are a good example of a cost. Expenses This term is used to describe expenditure associated with the day-to-day running and administration of a business. There are many examples of expenses, including wages, salaries, vehicle running costs, postage, stationery, gas, electricity, telephone, rent, rates, etc. Drawings Sole traders, or those in partnership, are likely to take cash or goods from their business at regular intervals throughout the year. Taking cash, or goods for personal use, is known as drawings and must be recorded in the books of account. 24

31 Accounts Preparation Book 1 Income This is the term used to describe the activities from which a business earns profit. Sales, interest received on monies in a bank deposit account and rent received on property sub-let to a tenant, are typical examples of how businesses generate income. Balancing off ledger accounts Where ledger accounts are presented in T account format they need to be balanced off periodically to show the balance on the account. The balance on an account represents the amount by which the larger side of an account (in terms of content value) exceeds the smaller side (in terms of content value). It is possible for the value of postings to the debit side of an account to exceed the value of postings to the credit side of the account, in which case the account will carry a debit balance. Alternatively, the value of postings to the credit side of an account may exceed the value of the postings to the debit side of the account, in which case the account will carry a credit balance. Where, on balancing off an account, both sides carry postings of equal value, then the account does not carry a balance and we simply close off the account. There is no need to show a nil balance. Usually, where an account contains only one posting, to either the debit or credit side, there is no need to balance off the account as we can clearly see, without making any calculations, which is the biggest side (in terms of content value), of the account and we can leave the account open. Where, however, an account contains several postings to either the debit side, or credit side, and particularly where an account has postings to both sides, it has to be balanced off in the correct manner. The following process should be followed when balancing off each account: 1. Go to the side of account containing the highest number of postings. Miss a line or so after the last posting and rule an answer box. Rule an answer box also on the same line on the opposite side of the account. 2. Add up the side of the account which is the largest in terms of value content (has most money in it). Put the total in the answer boxes on 25

32 Home Learning College both sides of the account. 3. Add up the side of the account which is smallest in terms of value content (has least money in it) and deduct this amount from the total of the largest side, thereby calculating the balance (the amount which makes both sides equal). This process is usually carried out using a piece of scrap paper or workings paper. 4. Enter the balance in the smallest side of the account (in terms of value content) above the answer box; both sides of the account are now equal. 5. Bring the balance down (below the answer box) to the larger side of the account. Be sure to use the correct terminology, in balancing off an account, to describe the balances. The balance added to the account above the answer box is referred to as balance carried down (balance c/d), whereas the balance entered below the answer box is referred to as the balance brought down (balance b/d). The following is an example showing these steps applied when balancing off the Bank (Current) account of Curl Up and Dye: Example Balancing off accounts Step 1 Go to the side of the account with most entries, miss a line and rule an answer box. Rule also an answer box on the same line at the opposite side of the ledger account: DR Bank (Current) CR 201X Details 201X Details 1 May Capital (1) 10,000 2 May Cash (3) May Bank loan (2) 5,000 2 May Purchases(4) May Sales (11) May Vehicle (5) 10,000 2 May Vehicle expenses (7) May Equipment (8) May Drawings (12)

33 Accounts Preparation Book 1 Step 2 Add up the bigger side of the account in terms of content value and put this amount in the answer boxes at both sides of the account (the DR side is the biggest side of the account in terms of value content, the entries posted total 15,820): DR Bank (Current) CR 201X Details 201X Details 1 May Capital (1) 10,000 2 May Cash (3) May Bank loan (2) 5,000 2 May Purchases(4) May Sales (11) May Vehicle (5) 10,000 2 May Vehicle expenses (7) May Equipment (8) May Drawings (12) ,820 15,820 Step 3 Calculate the account balance. Add up the side of the account which is smallest in terms of value content and deduct this amount from the total of the largest side of the account, this will give you the account balance (the CR side of account is the smallest side, the entries posted total 12,100. Deduct this amount from the DR side total of 15,820 and the balance is 3,720). Steps 4 and 5 Add the balance (3,720) above the answer box in the smaller side of the account (in terms of value content), thereby making both sides of the account equal in terms of value content. Describe the balance added on the smaller side as balance c/d. Also use the balance (3,720) on the larger side of the account (in terms of value content) by bringing down the balance beneath the answer box and describing it as balance b/d. 27

34 Home Learning College DR Bank (Current) CR 201X Details 201X Details 1 May Capital (1) 10,000 2 May Cash (3) May Bank loan (2) 5,000 2 May Purchases(4) May Sales (11) May Vehicle (5) 10,000 2 May Vehicle expenses (7) May Equipment (8) May Drawings (12) May Balance c/d 3,720 15,820 15,820 5 May Balance b/d 3,720 Note: The Bank Account carries a debit balance of 3,720. This balance represents an asset to the business. In addition to being able to process transactions using double entry principles, you also need to be able to balance off ledger accounts in the correct manner. 28

35 Accounts Preparation Book 1 Example Classifying balances The trial balance of Curl Up and Dye as at 5 May 201X has now been reproduced and each of the balances have been classified for you: Curl Up and Dye Trial Balance at 5 May 201X Account DR CR Classification of Balances Capital 10,000 Capital Bank (Current) 3,720 Asset Bank loan 5,000 Liability Cash Purchases Vehicle Vehicle expenses Equipment Stationery , Asset Cost Asset Expense Expense Expense Haircare Ltd Sales Liability Income Drawings 200 Drawings Totals 16,070 16,070 The following is a detailed example of a double entry exercise. The transactions whilst varied are, as yet, fairly straightforward. Follow the exercise through and then practise the exercises given in the Learning Check Questions. 29

36 Home Learning College Detailed example Double entry processing Amir commenced trading in the name of Cozee Carpets on 1 July 201X. Amir has made arrangements to purchase carpets from several suppliers on a credit basis and also to carry out carpet contract work for several customers on a credit basis. The following business transactions took place during the month of July 201X: Date 201X 1 July Amir transferred 30,000 from his personal bank account into a bank current account opened on behalf of the business with the Midwest Bank. 1 July Purchased goods for resale costing 2,600, paying by cheque. 1 July Purchased fixtures and fittings, paying by cheque 2, July Paid three months rent and rates on warehouse unit, paying by cheque 4, July Purchased van for use in the business 15,000, paying by cheque. 2 July Paid road tax and insurance on van 800, paying by cheque. 3 July Withdrew cash from bank to use as cash float for business July Arranged a loan from the bank for investment in the business. The amount of 8,000 was transferred by the bank to the business Bank Current Account and is repayable over 5 years. 5 July Purchased office furniture and equipment for use in the business for 4,000, paying by cheque. 30

37 Accounts Preparation Book 1 6 July Purchased goods for resale on credit from Carpet Imports Ltd 4, July Cash sales 3, July Paid wages in cash July Purchased goods for resale on credit from Saxon Carpets 3, July Purchased stationery 80, paying in cash. 9 July Paid cash into bank 2, July Purchased cleaning materials 60, paying in cash. 14 July Returned goods to Carpet Imports Ltd 600, not as ordered 14 July Cash sales 2, July Paid wages in cash July Paid cash into bank 2, July Sold goods on credit to Swan Homes, 2, July Paid insurance for year 600, paying by cheque. 20 July Purchased goods for resale on credit from Saxon Carpets 2, July Goods returned by Swan Homes, not as ordered July Cash sales 2, July Paid wages in cash July Paid cash into bank 1, July Paid Carpet Imports Ltd 4,200 by cheque. 25 July Paid office cleaner 100, paying in cash. 28 July Cash sales 2, July Paid wages in cash July Paid cash into bank 2,

38 Home Learning College 30 July Received cheque from Swan Homes 1, July Purchased goods for resale on credit from Carpet Imports Ltd 4, July Paid petrol bill for month 250, paying by cheque. 31 July Amir withdrew 1,500 from the business bank as personal drawings. The following is a summary of the postings of the transactions which took place during July 201X: 201X Transaction Account to be Debited Account to be Credited 1 July Capital paid into bank 30,000 1 July Purchased goods for resale 2,600 by cheque 1 July Purchased fixtures and fittings by cheque 2,000 2 July Paid rent and rates on warehouse by cheque 4,500 2 July Purchased van by cheque 15,000 2 July Paid road tax and insurance by cheque 800 Bank 30,000 Purchases 2,600 Fixtures and fittings 2,000 Rent and rates 4,500 Vehicle 15,000 Vehicle expenses 800 Capital 30,000 Bank 2,600 Bank2,000 Bank 4,500 Bank 15,000 Bank July Withdrew cash float for business from bank 300 Cash 300 Bank July Loan from bank 8,000 Bank 8,000 Bank Loan 8,000 5 July Purchased office furniture and equipment by cheque 4,000 Furniture and equipment 4,000 Bank 4,000 32

39 Accounts Preparation Book 1 6 July Purchased goods on credit from Carpet Imports Ltd 4,800 Purchases 4,800 Carpet imports Ltd 4,800 7 July Cash sales 3,500 Cash 3,500 Sales 3,500 7 July Paid wages in cash 800 Wages 800 Cash July Purchased goods on credit from Saxon Carpets 3,000 8 July Purchased stationery 80 by cash Purchases 3,000 Stationery 80 Saxon Carpets 3,000 Cash 80 9 July Paid cash into bank 2,700 Bank 2,700 Cash 2, July Purchased cleaning materials by cash 60 Cleaning and maintenance 60 Cash July Returned goods to Carpet Imports Ltd 600 Carpet Imports Ltd 600 Purchase returns July Cash sales 2,800 Cash 2,800 Sales 2, July Paid wages in cash 800 Wages 800 Cash July Paid cash into bank 2,000 Bank 2,000 Cash 2, July Sold goods on credit to Swan Homes 2, July Paid insurance for year by cheque 600 Swan Homes 2,200 Insurance 600 Sales 2,200 Bank July Purchased goods on credit from Saxon Carpets 2, July Goods returned by Swan Homes 400 Purchases 2,750 Sales returns 400 Saxon Carpets 2,750 Swan Homes July Cash sales 2,750 Cash 2,750 Sales 2, July Paid wages in cash 800 Wages 800 Cash

40 Home Learning College 22 July Paid cash into bank 1,900 Bank 1,900 Cash 1, July Paid Carpet Imports Ltd 4,200 by cheque Carpet Imports Ltd 4,200 Bank 4, July Paid cleaner in cash 100 Cleaning and maintenance 100 Cash July Cash sales 2,950 Cash 2,950 Sales 2, July Paid wages in cash 800 Wages 800 Cash July Paid cash into bank 2,100 Bank 2,100 Cash 2, July Received cheque from Swan Homes 1, July Purchased goods on credit from Carpet imports Ltd 4, July Paid petrol bill for month by cheque July Personal drawings from bank 1,500 Bank 1,800 Purchases 4,500 Vehicle expenses 250 Drawings 1,500 Swan Homes 1,800 Carpet Imports Ltd 4,500 Bank 250 Bank 1,500 Provided below are the ledger accounts of Cozee Carpets showing the transactions for the month ended 31 July 201X posted. Note that a trial balance has also been prepared at 31 July 201X thereby confirming the arithmetic accuracy of the processing. Cozee Carpets - Ledger DR Capital CR 201X Details 201X Details 1 July Bank 30,000 34

41 Accounts Preparation Book 1 DR Bank CR 201X Details 201X Details 1 July Capital 30,000 1 July Purchases 2,600 3 July Bank loan 8,000 1 July Fixtures and fitt gs 2,000 9 July Cash 2,700 2 July Rent and rates 4, July Cash 2,000 2 July Vehicle 15, July Cash 1,900 2 July Vehicle expenses July Cash 2,100 3 July Cash July Swan Homes 1,800 5 July Furniture and eqp t 4, July Insurance July Carpet Imports Ltd 4, July Vehicle expenses July Drawings 1, July Balance c/d 12,750 48,500 48, July Balance b/d 12,750 DR Purchases CR 201X Details 201X Details 1 July Bank 2, July Balance c/d 17,650 6 July Carpet Imports Ltd 4,800 8 July Saxon Carpets 3, July Saxon Carpets 2, July Carpet Imports Ltd 4,500 17,650 17, July Balance b/d 17,650 35

42 Home Learning College DR Fixtures and Fittings CR 201X Details 201X Details 1 July Bank 2,000 DR Rent and Rates CR 201X Details 201X Details 2 July Bank 4,500 DR Vehicle CR 201X Details 201X Details 2 July Bank 15,000 DR Vehicle Expenses CR 201X Details 201X Details 2 July Bank July Balance c/d 1, July Bank 250 1,050 1, July Balance b/d 1,050 36

43 Accounts Preparation Book 1 DR Cash CR 201X Details 201X Details 3 July Bank July Wages July Sales 3,500 8 July Stationery July Sales 2,800 9 July Bank 2, July 28 July Sales Sales 2,750 2, July Cleaning & maintenance July Wages July Bank 2, July Wages July Bank 1, July Cleaning & maintenance July Wages July Bank 2, July Balance c/d ,300 12, July Balance b/d 160 DR Bank Loan CR 201X Details 201X Details 3 July Bank 8,000 37