FET FIRST NATED Series Financial Accounting N4 Student s Book R. Eyssen
FET FIRST NATED Series Financial Accounting Student s Book R. Eyssen, 2012 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, photocopying, recording, or otherwise, without the prior written permission of the copyright holder or in accordance with the provisions of the Copyright Act, 1978 [as amended]. Any person who does any unauthorised act in relation to this publication may be liable for criminal prosecution and civil claims for damages. First published 2012 by Troupant Publishers [Pty] Ltd P. O. Box 4532 Northcliff 2115 Distributed by Macmillan South Africa [Pty] Ltd ISBN: 978-1-920334-99-4, eisbn: 978-1-430802-28-0 It is illegal to photocopy any page of this book without written permission from the publishers. While every effort has been made to ensure the information published in this work is accurate, the authors, editors, publishers and printers take no responsibility for any loss or damage suffered by any person as a result of reliance upon the information contained therein. The publishers respectfully advise readers to obtain professional advice concerning the content. To order any of these books contact Macmillan Customer Services at: Tel: (011) 731 3300 Fax: (011) 731 3535 e-mail: customerservices@macmillan.co.za
Contents Syllabus Grid: Financial Accounting N4.... v Module 1 Introduction (revision of components of previous syllabi)...1 Part 1: Accounting theory, principles and concepts...1. Unit 1.1: Accounting theory, principles and concepts.... 1 Unit 1.2: Types of commercial organisation... 3 Unit 1.3: Activities of organisations... 5 Unit 1.4: The accounting transactions of service and trading activities.... 6 Part 2: Recording transactions from source documents according to the continuous (perpetual) stock system... 14 Unit 1.5: Accounting cycle... 14 Unit 1.6: Source documents... 15 Unit 1.7: Books of original entry... 16 Unit 1.8: Posting to the general and subsidiary ledgers.... 21 Unit 1.9: Drawing up a Trial Balance.... 28 Part 3: Bank reconciliations.... 30 Unit 1.10: Aims of a bank reconciliation.... 30 Unit 1.11: Aims and uses of a bank statement... 30 Unit 1.12: Comparing the bank statement with the Cash Journals... 31 Unit 1.13: Reconciling a bank statement with the previous month s reconciliation statement.... 34 Unit 1.14: Steps to reconcile the bank statement.... 36 Unit 1.15: Dealing with stop payment cheques.... 41 Unit 1.16: How to record postdated cheques... 42 Part 4: Control accounts.... 50 Unit 1.17: Aim of control accounts... 50 Unit 1.18: Adjustment of books of original entry.................................................50 Unit 1.19: Debtors and creditors control accounts.... 53 Unit 1.20: Reconciliation of the balance of the control accounts and the totals of the lists of debtors and creditors.... 59 Unit 1.21: Transfers between debtors and creditors ledgers.... 61 Part 5: Results of sole traders.... 63 Unit 1.22: Additional transactions.... 63 Unit 1.23: Accounting adjustments... 76 Unit 1.24: Post-adjustment Trial Balance... 96 Unit 1.25: Closing transfers.... 109 Unit 1.26: Final accounts.... 109 Unit 1.27: Income Statement.... 119 Unit 1.28: Balance Sheet.... 120 Module 2 accounting entries for a trading organisation according to the periodic stock system.... 129. Unit 2.1: Recording transactions for stock movements using the periodic stock system.... 130 Unit 2.2: Adjusting books of first entry to accommodate the periodic stock system... 137
Unit 2.3: Calculating the cost of sales value... 140 Unit 2.4: The end-of-year adjustment for trading stock.... 142 Unit 2.5: Year-end closing transfers for stock... 143 Unit 2.6: Dealing with stock in the Income Statement.... 144 Module 3 Departmental accounts according to the periodic stock system... 150. Unit 3.1: Aim of departmental accounts... 150 Unit 3.2: Adaptation of source documents for departmental purposes... 151 Unit 3.3: Adaptation of books of original entry for departmental purposes... 151 Unit 3.4: Adaptation of General Ledger accounts for departmental purposes... 152 Unit 3.5: Drawing up a Departmental Trading Statement... 154 Unit 3.6: Drawing up a Departmental Income Statement........................................157 MODULE 4 Non-trading organisations (organisations without a profit motive)... 164.. Unit 4.1: The aim of a non-trading organisation... 164 Unit 4.2: Special items (ledger accounts).... 165 Unit 4.3: Special funds... 168 Unit 4.4: Accounting concepts for non-profit organisations... 170 Unit 4.5: Analysis Cash Book... 172 Unit 4.6: Operating (Trading) account per activity... 173 Unit 4.7: Statement of Income and Expenditure.... 175 Unit 4.8: Balance Sheet for an NPO... 184 MODULE 5 The Cash Flow Statement for a sole trader... 191. Unit 5.1: The aim of a Cash Flow Statement (CFS).... 191 Unit 5.2: Users of a Cash Flow Statement... 192 Unit 5.3: Explanations and concepts of a Cash Flow Statement... 192 Unit 5.4: Dealing with non-cash items... 197 Unit 5.5: Procedure for drawing up a Cash Flow Statement... 197 Unit 5.6: Dealing with special items... 212 Glossary... 218 Abbreviations/acronyms.... 221
SYLLABUS GRID: Financial accounting Page in SB Learning Content MODULE 1: INTRODUCTION (REVISION COMPONENTS OF PREVIOUS SYLLABI) 1 13 1.1 ACCOUNTING THEORY, PRINCIPLES AND CONCEPTS Revision components i.r.o. accounting principles of the sole trader (service and trading enterprise) 1.1.1 Accounting theory, principles and concepts 1.1.2 Types of organisations Sole trader Partnership Close Corporation Company with limited liability Public company Organisations with no profit motive 1.1.3 Activities of organisations Service activities Trading activities Manufacturing activities Activities with no profit motive 1.1.4 The accounting transactions of service and trading activities with relation to the usage of source documents, the double entry principle and influence of the double entry transactions on the accounting equation Learning Objectives On completion of this module the student must be able to: 1.1.1 briefly describe the basic accounting concepts, principles and policy 1.1.2 identify the different forms of organisations by explaining the similarities and differences between each 1.1.3 identify the business activities of the organisations mentioned in par 1.1.2 and to indicate the difference between each in respect of generating profit 1.1.4 identify the source document and the accounts involved with each transaction, and to determine which account must be debited or credited, as well as explaining the influence of the relevant transaction on the accounting equation DIDACTIC DIRECTIVES With reference to learning objectives 1.1.1 to 1.1.3: 1. Topics in this section must be discussed briefly to serve as revision of students background knowledge. Illustrate with good examples. Additional literature, such as published annual statements of listed companies, as well as accounting statements can be consulted. With reference to learning objective 1.1.4: 2. Students should be able to handle each transaction on the basis of the following structure: source document for the transaction ledger account debited and ledger account credited the influence of the double entry on the accounting equation. 3. Topics dealt with in this module, must be emphasised continuously in all other modules. Use practical examples to illustrate the accounting practice visually. Evaluation With reference to learning objectives 1.1.1 to 1.1.3: 1. Theory questions can be asked in class tests. In examination papers the emphasis should rather be on practical than on theoretical questions as students should already have mastered the theory concepts. With reference to learning objectives 1.1.1 to 1.1.4: 2. Students must be evaluated on a daily basis to determine whether the student has grasped the double entry principle, including all other elements involved (also refer in this regard to the evaluation guidelines (par 4) at the beginning of the syllabus). MODULE 1: (Cont.) 14 29 1.2 THE RECORDING OF TRANSACTIONS FROM SOURCE DOCUMENTS ACCORDING TO THE CONTINUOUS (PERPETUAL) STOCK SYSTEM 1.2.1 The accounting cycle 1.2.1 identify and describe briefly the steps in the accounting cycle v
Page in SB Learning Content 1.2.2 Source documents 1.2.3 Books of original entry: Cash receipts journal Cash payments journal Debtors journal Creditors journal Debtors allowances journal Creditors allowances journal Petty cash journal General journal Wages journal Salaries journal Cash book with analysis columns 1.2.4 Posting to the general and subsidiary ledgers 1.2.5 Drafting of a trial balance Learning Objectives On completion of this module the student must be able to: 1.2.2 define a source document, describe the necessity of it as a source of information and to distinguish between the original and duplicate as well as source and supporting documents and also external and internal documents 1.2.3 do the recording of transactions in the subsidiary books of organisations from source documents 1.2.4 do the posting of all the transactions in columns from the books of original entry to the general and subsidiary ledgers, as well as the grouping of ledger accounts, T-form and three column accounts 1.2.5 test the correctness of the double entries with the aid of the trial balance, and to trace the errors if it does not balance DIDACTIC DIRECTIVES With reference to the learning objectives 1.2.1 and 1.2.2: 1. Topics can only be discussed briefly to serve as revision for background knowledge of the students. With reference to the learning objectives 1.2.2 to 1.2.4: 2. Students should at all times be able to do exercises directly from sets of source documents. 3. Students should be able to do all cash and credit transactions of a service and trading organisation which are usually recorded in the journals mentioned and which have been dealt with in the N3/NSC and std 10 HG/SG syllabi. With reference to learning objective 1.2.3: 4. Both methods of dealing with employer s contribution must be dealt with. 5. Students must be informed that different names for the same subsidiary journals are in use, e.g. debtors journal/sales journal/sales book. 6. Columns and the position of columns can also vary in the subsidiary journals of the different enterprises. With reference to learning objective 1.2.5: 7. It must be emphasised that the trial balance only indicates that for every debit entry a corresponding credit entry was made. Evaluation With reference to learning objective 1.2.1 to 1.2.5: 1. Theory questions can be asked in class tests. In examination papers the emphasis should rather be on practical than on theoretical questions as students should already have mastered the theory concepts. With reference to learning objectives 1.2.2 to 1.2.5: 2. Examination questions will be set from actual source documents with the exception of the salaries and wages journals. 3. Students should reach a high competency level in regard to these topics. 4. To increase the competency level of the students, short assignments and exercises must be evaluated on a regular basis. 5. Students can be evaluated on all transactions that are recorded in the subsidiary journals mentioned and which were dealt with in the N3/NSC and std 10 HG/SG syllabi. vi
Page in SB Learning Content MODULE 1: (Cont.) 30 49 1.3 BANK RECONCILIATION 1.3.1 Aim of bank reconciliation 1.3.2 Bank statement: aim and uses 1.3.3 Reasons for the differences between the balances as in the bank statement and the bank account 1.3.3.1 Items in the cash journals/cash book, but not on the bank statement Outstanding deposits Outstanding cheques 1.3.3.2 Items on the bank statement, but not in the journals/cash book Bank charges Interest on overdraft Stop and debit orders Dishonoured (R/D) cheques Deposits by debtors Interest on current account (favourable balance) 1.3.3.3 Errors in the cash journals/cash book 1.3.3.4 Errors on the bank statement Deposits credited in error on the bank statement Cheques debited in error on the bank statement 1.3.4 Steps to reconcile the bank statement and the cash journals/cash books Learning Objectives On completion of this module the student must be able to: 1.3.1 describe the aim of bank reconciliation 1.3.2 name the aim and functions of the bank statement 1.3.3 compare the bank statement with the cash journals/cash book and identify and record the differences 1.3.4 record the supplementary entries in the cash journals/cash book 1.3.4.1 Recording of outstanding transactions in the cash journals/cash book 1.3.4.2 Drafting of the bank reconciliation statement where the bank account has a favourable balance where the bank account has an overdrawn balance 1.3.5 Reconciliation of the bank statement with a bank reconciliation statement of a previous month 1.3.6 Payment stopped due to lost cheque stale cheques disputes 1.3.7 Postdated cheques received issued 1.3.4.2 draw up a bank reconciliation statement and to compare the balance in the bank statement with the balance in the bank account/cash book 1.3.5 compare the bank statement with the cash journals/cash book of the current month and the reconciliation statement of the previous month and to do the necessary entries 1.3.6 briefly describe the procedure to stop the payment of a cheque, recording of the cancellation in the applicable cash journal/ cash book, and the issuing of a new cheque 1.3.7 the correct procedure and entries with regard to postdated cheques DIDACTIC DIRECTIVES With reference to learning objective 1.3.4: 1. Students should be able to do bank reconciliation from a given bank statement and actual source documents. vii
Page in SB Learning Content Learning Objectives On completion of this module the student must be able to: Evaluation With reference to learning objectives 1.3.1 to 1.3.7: 1. Theory questions can be asked in class tests. In examination papers the emphasis should rather be on practical than on theoretical questions as students should already have mastered the theory concepts. 2. Students should reach a high competency level in regard to this topic. MODULE 1: (Cont.) 50 62 1.4 CONTROL ACCOUNTS 1.4.1 Aim of control accounts 1.4.2 Adjustment of books of original entry 63 128 1.4.3 Debtors and creditors ledger 1.4.4 Debtors control account 1.4.5 Creditors control account 1.4.6 Transfers between debtors and creditors ledgers 1.5 RESULTS OF SOLE TRADERS: ACTIVITIES AND FINANCIAL STATUS 1.5.1 Additional transactions 1.5.1.1 Carriage on purchases 1.5.1.2 Bad debts recovered 1.5.1.3 Sale of fixed assets 1.4.1 briefly describe the aim of control accounts 1.4.2 provide additional columns required in the books of original entry 1.4.3 post from the books of original entry to the subsidiary ledgers 1.4.4 post from the books of original entry to the debtors control account in the general ledger draft a list of debtors at a given stage and reconcile it with the debtors control account 1.4.5 post from the books of original entry to the creditors control account in the general ledger draft a list of creditors at a given stage and reconcile it with the creditors control account 1.4.6 make transfers between the debtors and creditors by means of journal entries and post to the general and subsidiary ledgers 1.5.1.1 do the following in connection with transactions in par. 1.5.1.1 and 1.5.1.2 of the contents column: record the entries in the correct subsidiary journal post the entries to the correct accounts in the general ledger indicate the influence on the accounting equation 1.5.1.3 do the following in connection with transactions in par 1.5.1.3 of the contents column: complete or adjust the asset register do the recording procedure for the sale of fixed assets during and at the end of the financial period, namely journalise the applicable transactions and record the cash transactions in the cash journals post the entries to the relevant ledger accounts indicate the influence on the accounting equation viii
Page in SB Learning Content 1.5.2 Adjustments 1.5.2.1 Additional bad debts 1.5.2.2 Provision for bad debts 1.5.2.3 Provision for depreciation on fixed assets: 1.5.2.4 Provision for discount allowed 1.5.2.5 Provision for unforeseen expenses 1.5.2.6 Expenses payable/accrued expenses 1.5.2.7 Income receivable/accrued income 1.5.2.8 Prepaid expenses 1.5.2.9 Income received in advance 1.5.2.10 Consumable stores on hand 1.5.2.11 Trading stores on hand 1.5.2.12 Correction of errors and omissions Learning Objectives On completion of this module the student must be able to: 1.5.2 do the following in connection with transactions in par 1.5.2.1 to 1.5.2.12 in the contents column: briefly explain the aim of adjustments journalise the necessary adjustments post the adjustments to the correct ledger accounts indicate the influence on the accounting equation indicate how the relevant ledger accounts will be shown in the financial statements identify and journalise the amounts that must be written back at the beginning of the next financial period, and adjust the relevant ledger accounts 1.5.3 Post-adjustment trial balance 1.5.3 draft a post-adjustment trial balance after all adjustments have been journalised and transferred to the relevant accounts 1.5.4 Closing transfers 1.5.4 journalise the closing transfers and post to the relevant accounts 1.5.5 Final accounts 1.5.5 draft a trading account and profit and loss account as well as a post-closing trial balance 1.5.6 Income statement 1.5.6 draft an income statement in vertical form 1.5.7 Balance sheet 1.5.7 draft a balance sheet in vertical form with the necessary notes DIDACTIC DIRECTIVES With reference to learning objectives 1.5.1 to 1.5.7: 1. After the completion of module 1 the students should be able to draft a complete set of books for a sole trader (service and trading enterprise) from the subsidiary books up to the balance sheet. With reference to learning objective 1.5.2.3: 2. Refer to the requirements of the Receiver of Revenue i.r.o. the time-limit for writing off an asset. Evaluation With reference to all learning objectives in module 1: 1. This module will be examined in full. 2. Questions should be in the form of practical applications where students will be asked to do entries directly from source documents. MODULE 1: (Cont.) 120 1.6 DOCUMENT PROJECT (ACCORDING TO THE CONTINUOUS/PERPETUAL STOCK SYSTEM) 1.6.1 Complete document assignment on a combined service and trading organisation 1.6.1 complete a comprehensive assignment from source documents within a specified time DIDACTIC DIRECTIVES With reference to learning objective 1.6: 1. The lecturer can draw up a comprehensive assignment where students must use a set of source documents to complete the books of account for a combined service and trading organisation within a specified time. 2. This set of documents must be compiled in such a manner that it simulates the practice of accounting as faithfully as possible. 3. The following aspects must be dealt with in the assignment: 3.1 Grouping of documents in bundles. ix
Page in SB Learning Content Learning Objectives On completion of this module the student must be able to: 3.2 Arranging in date order. 3.3 Drafting of all subsidiary journals revised in module 1: Cash receipts journal Cash payments journal Debtors journal Creditors journal Debtors allowance journal Creditors allowance journal Petty cash journal General journal Wages journal/salaries journal 3.4 Posting to the debtors and creditors ledger. 3.5 Posting to the general ledger. 3.6 Drafting of a bank reconciliation statement. 3.7 Drafting of a debtors list and reconciliation with the debtors control account. 3.8 Drafting of a creditors list and reconciliation with the creditors control account. 3.9 Drafting of a pre-adjustment trial balance. 3.10 All the additional transactions and adjustments dealt with. 3.11 Drafting of a post-adjustment trial balance. 3.12 Drafting of the annual financial statements. Evaluation 1. The assignment can be evaluated as part of the semester work. 2. The following methods of evaluation can be followed: 2.1 Students can complete the assignment in the prescribed time under test conditions after which the complete assignment is handed in to be marked. 2.2 Students can complete sections of the assignment in their own time while other sections are done under test conditions. Marks are then allocated for those sections completed under test conditions. MODULE 2: ACCOUNTING ENTRIES FOR A TRADING ORGANISATION ACCORDING TO THE PERIODIC STOCK SYSTEM 129 149 2.1 Recording of the following transactions in the ledger accounts: 2.1.1 Purchasing of stock 2.1.2 Sales of stock 2.1.3 Returns of stock bought by the organisation 2.1.4 Returns of stock bought by clients 2.1.5 Withdrawal of stock by the owner 2.1.6 Carriage on purchases (carriage in) 2.1.7 Other purchasing costs that increase the purchase price 2.1.8 Carriage on sales (carriage out) 2.2 Adjusting of books of first entry to accommodate the periodic stock system 2.1 enter the transactions mentioned in general ledger accounts 2.2 adjust the columns of the respective books of first entry, properly closing off and posting them to the general ledger 2.3 Calculation of cost of sales 2.3 identify the accounts involved in the calculation of the cost of sales and to do the calculation 2.4 Trading stock as year-end adjustment 2.4 record the adjustment of the trading stock amount in the general journal and post it to the general ledger 2.5 Closing transfers 2.5 do the closing transfers to the trading account, profit and loss account and capital account x
Page in SB Learning Content Learning Objectives On completion of this module the student must be able to: 2.6 Financial statement 2.6 do the trading section (calculation of the gross profit) in the income statement DIDACTIC DIRECTIVES With reference to learning objective 2.1 to 2.6: 1. After completion of this module the students should be able to compile the books of an organisation according to the continuous (perpetual) as well as the periodic stock system. Evaluation 1. During evaluation there should only be concentrated on the learning objectives as set out above. It should therefore not be necessary to evaluate a complete set of books according to the periodic stock system. MODULE 3: DEPARTMENTAL ACCOUNTS ACCORDING TO THE PERIODIC STOCK SYSTEM 150 163 3.1 Aim of departmental accounts 3.1 explain the aim of departmental accounts and explain how to control the departmental profits by making use of departmental accounts 3.2 Adaptation of source documents 3.2 interpret source documents or departmental codes on source documents and enter them in the books of original entry 3.3 Adaptation of books of original entry 3.3 adapt the books of original entry mentioned Columnar creditors journal in the contents column by providing Columnar creditors allowances journal additional columns, recording the Columnar debtors journal transactions, and closing them off Columnar debtors allowances journal Cash journals/cash book Columnar inter-departmental transfers journal General journal 3.4 Adaptation of relevant accounts in the general ledger 3.4 adapt the accounts mentioned in the contents column by providing additional Departmental purchases account columns, recording the relevant journal Departmental sales account totals in them, and closing them off 3.5 Departmental trading statement 3.5 draw up the departmental trading statement at the end of the accounting period 3.6 Departmental income statement 3.6 draw up the departmental income statement at the end of the accounting period. DIDACTIC DIRECTIVES With reference to learning objective 3.1 to 3.6: 1. Departmental sets of accounts with two departments will be sufficient. 2. Practical contact with departmental organisations is of the utmost importance for students to gain knowledge of departmental stock recording and especially stock control. 3. Students must complete some exercises from source documents that are based on departmental stock codes. Evaluation 1. Evaluation must be based on practical orientated exercises and questions. 2. Theory questions can be asked in class tests. MODULE 4: ORGANISATIONS WITHOUT A PROFIT MOTIVE (NON-TRADING ORGANISATIONS) 164 190 4.1 Aim of non-trading organisations 4.1.1 Terminology 4.1.2 Administration 4.1.3 Characteristics 4.1 explain the difference between organisations with and without a profit motive, as well as give a brief explanation of the general and accounting administration of a non-trading organisation xi
Page in SB Learning Content 4.2 Special items (ledger accounts) 4.2.1 Entrance fees 4.2.2 Subscriptions 4.2.3 Affiliation fees 4.2.4 Honorarium 4.2.5 Legacies and donations 4.3 Special funds 4.3.1 Creation and expansion of funds and fund investments 4.3.2 Interest on funds 4.3.3 Capitalisation of interest to funds 4.3.4 Interest to cover current expenses 4.3.5 Allocation of prizes from interest 4.4 Concepts i.r.o. incomes and expenses as well as receipts and payments 4.4.1 Receipts and incomes 4.4.2 Payments and expenses 4.4.3 Capital expenses and current expenses 4.4.4 Capital receipts and current receipts Learning Objectives On completion of this module the student must be able to: 4.2 explain the aim of the different ledger accounts typical to a non-trading organisation, interpret and record the entries allocated to them 4.3 explain the aim of special funds and record the entries i.r.o. the creation of the fund as well as the employment of the income from the special fund 4.4 define the concepts in the contents column and explain the difference between the respective concepts 4.5 Analysis cash book 4.5 draw up an analysis cash book with relevant entries and post to the correct ledger accounts 4.6 Trading account per activity 4.6 draw up a trading account for the different activities of a non-trading organisation 4.7 Statement of incomes and expenses (income and expenditure statement) 4.8 Adjustments of the set of accounts to provide for a profit section 4.7 indicate the surplus or deficit by means of an income statement 4.8 do the necessary adjustments to accommodate a section with a profit motive within the books of a non-trading organisation 4.9 Balance sheet 4.9 draw up the balance sheet of the nontrading organisation in vertical form DIDACTIC DIRECTIVES With reference to learning objective 4.3: 1. The operation of only one special fund is sufficient. With reference to learning objective 4.9: 2. For the placement of the special fund in the balance sheet of the non-trading organisation see annexure 2. Evaluation 1. Evaluation must be based on practical orientated exercises and questions. 2. Theory question can be asked during class tests. 3. Questions should include all types of non-trading organisations and not only clubs. MODULE 5: CASH FLOW STATEMENT OF A SOLE TRADER 191 5.1 The aim of a cash flow statement 5.1 explain the aim of a cash flow statement 217 5.2 Users of the cash flow statement 5.2 name the users of the cash flow statement Entrepreneur/owner of an organisation and indicate why they are Credit providers interested in the cash flow statement Cash flow planning 5.3 Explanations and concepts 5.3 define the different cash flow items and explain the important principles i.r.o. the setting out of the cash flow statement xii
Page in SB Learning Content Learning Objectives On completion of this module the student must be able to: 5.4 Non-cash flow items 5.4 name and explain the different non-cash flow items 5.5 Procedure for the drafting of a cash flow statement 5.5.1 Cash retained from operating activities 5.5.2 Cash utilised in investment activities 5.5.3 Cash goods from financing activities 5.6 Special items 5.6.1 Depreciation 5.6.2 Profit/loss on sale/scrapping of fixed assets DIDACTIC DIRECTIVES With reference to learning objectives 5.1 to 5.6: See annexure 1 for the form of the cash flow statement. 5.5 follow the correct procedure for the drafting of the cash flow statement 5.6 explain special items i.r.o. the cash flow and record these in the cash flow statement Evaluation Students can be requested to draft a complete cash flow statement from given cash flow information applicable to a sole trader. xiii
Part 1: Accounting theory, principles and concepts Overview Module 1 Introduction (revision of components of previous syllabi) When you have completed Part 1 of this module, you should be able to: Briefly describe the basic accounting concepts, principles and policy. Identify the different forms of organisations by explaining the similarities and differences between each. Identify the business activities of the organisations mentioned above and indicate the difference between each in respect of generating profit. Identify the source document and the accounts involved with each transaction and determine which account must be debited and credited, as well as explaining the influence of the relevant transaction on the accounting equation. Unit 1.1: Accounting theory, principles and concepts Accounting is the process of transaction recording in order to have a permanent record of those transactions. From these records an enterprise can determine whether a profit was made or a loss was suffered for a financial period. This profit or loss will have an effect on the owner s equity or the wealth of the owner. It is also important for an enterprise to report on its assets and liabilities, indicating whether there was an increase or decrease in these accounts. The main objective of all enterprises is to make a profit at the end of a financial period. A profit is recorded when the income exceeds the expenses of that enterprise, while a loss is suffered when the expenditure exceeds the income of the enterprise. The accounting equation defines the relationship between assets, owner s equity and liabilities. This relationship defines assets as being equal to the owner s equity and liabilities, or A = O + L. Assets Assets can be defined as the possessions owned by an enterprise, like a vehicle. All assets can be divided into two groups (types): Non-current (fixed) assets These assets are bought to be used (not for resale) in the enterprise. Therefore these assets have a long life span and assets: Are the possessions owned by an enterprise, for example a vehicle. All assets can be divided into two groups (types): non-current (fixed) assets and current assets. All asset accounts increase on the debit side of the account and decrease on the credit side of the account. 1
will be used for periods longer than 12 months. However, these assets can be resold close to the end of their life span and be replaced with new assets for the same purpose or to expand current operations. Examples of fixed assets are land and buildings, vehicles and equipment. Current assets These assets include the cash in the enterprise s current bank account or any other asset that can be converted into cash within a year. Examples of current assets are the cash in the current account or any other forms of cash, like petty cash or cash float, trading stock and debtors. All asset accounts increase on the debit side of the account and decrease on the credit side of the account. Owner s equity Owner s equity refers to the wealth of the business owner or the interest the owner has in his or her enterprise. There are two owner-related accounts that have an effect on the owner s equity. These accounts are capital and drawings. Any contribution that an owner makes towards his or her business is called his or her capital contribution and will increase the owner s equity. If the owner withdraws cash or trading stock from his or her business this is referred to as drawings and will decrease the owner s equity. All income and expenditure accounts will also have an effect on the owner s equity. Income will increase the owner s equity, while expenditure will decrease the owner s equity. The capital and all income accounts increase on the credit side of the account and decrease on the debit side of the account. The drawings and all expenditure accounts increase on the debit side of the account and decrease on the credit side of the account. Liabilities Any amount owed by an enterprise to entities or enterprises is called a liability. These entities or enterprises are referred to as creditors. current assets: Include the cash in the enterprise s current bank account or any other asset that can be converted into cash within a year. Examples of current assets are the cash in the current account, trading stock and debtors. liability: Any amount owed by an enterprise to entities or enterprises is called a liability. These entities or enterprises are referred to as creditors. Liabilities can also be divided into two groups: non-current and current liabilities. Liability accounts increase on the credit side of the account and decrease on the debit side of the account. current liabilities: Are short-term liabilities like an overdrawn bank account and creditors. non-current liabilities: Include long-term loans, and are also known as interest-bearing liabilities. Liabilities can also be divided into two groups. These groups are non-current and current liabilities. Non-current liabilities, for example, long-term loans are also known as interest-bearing liabilities. Current liabilities are short-term liabilities like an overdrawn bank account and creditors. Liability accounts increase on the credit side of the account and decrease on the debit side of the account. 2
To summarise: dr assets, DRAWINGS OR EXPenses cr INCREASE DECREASE dr liabilities, CAPITAL OR INCOMe cr INCREASE DECREASE So far, we have talked about businesses and organisations. From an accounting point of view they have to keep similar records and the accounting process is the same for all entities. In the next unit, we are going to focus on the different types of business. Unit 1.2: Types of commercial organisation When you look around, you will easily identify many different organisations. These organisations all differ in size but each of these entities is also a different type of commercial organisation, because of the number of people who own all or part of the business. The different ways in which a business is set up depend on two basic elements, namely: The number of people who invest in or own the business. The level of risk that investors are willing to take. Therefore, business owners have to decide how to protect themselves and their businesses. One of the ways of doing this is through their choice of business structure. Table 1.1 shows how many investors can own a business and the advantages and disadvantages that need to be taken into account: Table 1.1 The advantages and disadvantages of the different types of business structure Business format Maximum no. of investors (owners) Advantages Disadvantages Sole trader 1 Legal business registration not required. Business can start to operate without registration delays. A sole proprietor receives all business profits. Business accounts do not have to be professionally prepared or audited. Partnership 2 20 Legal business registration not required. Business can start to operate without registration delays. Two or more owners share business responsibilities. The owner is self-reliant. A sole proprietor is personally liable for all business debts. The owner s personal assets can be sold to pay business debts. The business ceases on the death of the owner. The business name is not registered and protected. Partners are personally liable for all business debts. Partners personal assets can be sold to pay business debts. The business name is not registered and protected. 3
Business format Close corporation (CC) Limited liability company Public company Non-profit organisation (NPO) Maximum Advantages no. of investors (owners) Partners share profits between them. Business accounts do not have to be professionally prepared or audited. 1 10 Registration was easier than for a private limited company. Members liability is limited to the amounts invested in the business. Ownership can be easily transferred by selling a member s interest. A CC continues after the death of a member. In terms of the Companies Act, 2008, no new CCs may be established. However, existing CCs may continue or convert to other business formats. Max 50 Shareholders liability for business debts is limited to the amounts paid for shares. Shareholders can employ managers to run the company. Companies tend to be perceived as being more stable. Companies generally have easier access to loan capital. Min 7 Shares can be bought and sold easily on the Johannesburg Stock Exchange (JSE). There is no limit to the number of shareholders. Shareholders liability for business debts is limited to the amounts paid for shares. Shareholders employ managers to run the company. Companies are usually large and therefore perceived as being stable. Public companies generally have access to loan capital. Public companies can issue more shares in order to raise more capital. Various There are different forms of non-profit organisations that are governed by different rules. Small NPOs generally have to meet the same rules as private limited companies (see above). Large NPOs generally have to meet the same rules as public limited companies (see above). Disadvantages Ownership of a CC is limited to ten people. Dividends can only be paid if the business is solvent. Accounts have to be formally audited and presented to members. Limited liability results in creditors demanding more financial information. Companies must be formally registered. Business accounts must be professionally prepared and audited. Business information must be circulated to shareholders at specified times. A private limited company can have a maximum of 50 shareholders. Shares in a private limited company cannot generally be sold to the public. Companies must be formally registered with the JSE. Business accounts must be professionally prepared and audited. Formal business reports and information must be circulated to shareholders every year. Public companies must hold a public annual general meeting to report to shareholders. 4
Exercise In the following table, choose the term in Column A that matches the description in Column B: Column A Column B a) Non-profit organisations i) disallows new close corporations b) Close corporations ii) occurs when two friends start a new business without formal registration c) A sole trader iii) is the Johannesburg Stock Exchange d) Limited liability iv) may not have more than ten members e) A public company v) requires business assets to be worth more than liabilities f) JSE vi) generally have to comply with the rules for limited companies g) The 2011 Companies Act vii) allows people to start a business with minimum risk h) A partnership viii) is a one-person business with high personal risk i) Solvency ix) can trade its shares on the JSE j) A limited liability company x) means that the investor can only lose the value of his or her investment Having identified the different formats for organisations, we will now look at the activities of these organisations in more detail. Unit 1.3: Activities of organisations The activities of the different organisations listed in Unit 1.2 can be classified under the following headings: Service activities. Trading activities. Manufacturing activities. Activities with no profit motive. Service activities A service enterprise is a business that sells a service to the public to generate income, where this activity is its main source of income. Examples of service enterprises: Doctors. Garden services. Attorneys. Trading activities A trading enterprise is a business that buys and sells goods to generate income, where this activity is its main source of income. 5
Examples of trading enterprises: General dealers. Wholesalers. Manufacturing activities A manufacturing enterprise is a business that buys raw material and turns it into a product. Examples of manufacturing enterprises are factories that produce products through a manufacturing process, like a clothing factory. manufacturing enterprises: Are businesses that buy raw material and turn it into a product. Examples of manufacturing enterprises are factories that produce products through a manufacturing process, like a clothing factory. Activities with no profit motive In some cases an enterprise is incorporated not to make a profit, but rather to provide a service to a group of people with a common interest. These enterprises are called nonprofit enterprises and an example is a tennis club where people get together to play tennis. In Module 2, you will learn how to create and maintain accounting records, but we first need to find out where accounting information comes from and the type of systems used in the accounting process. Unit 1.4: The accounting transactions of service and trading activities In this unit we will look at the accounting transactions in relation to the use of source documents, the double-entry principle and the influence of double-entry transactions on the accounting equation. Accounting processes begin when you write out a piece of paper that shows details of a transaction relating to a product or service you are selling, or that specifies goods or services you have received from another business. These are called source documents. A source document is proof that a transaction has taken place and can be classified as an internal or external source document. Internal source documents are documents used internally, like petty cash vouchers, while external source documents are documents received from outside the enterprise, such as an invoice from a supplier. The most important source documents are the following: Receipts This source document will be issued for money received from the owner or debtor. Cash register roll This source document will be issued for money received from cash sales. Cheque counterfoil 6
This source document is left behind in the cheque book and will be applicable when payment is made by cheque. Invoice This source document will be issued to clients (debtor) for credit sales or will be issued by the supplier (creditor) for credit purchases. Petty cash voucher This source document will be issued when money is withdrawn from petty cash. Debit note This source document will be issued for returns on a credit purchase. Credit note This source document will be issued for returns on a credit sale. Journal voucher This source document will be issued for any entry in the General Journal. General Journal (GJ): This journal is used to capture all transactions for which no specific journal is opened. The source document applicable to this journal is the journal voucher (internal office memo). The first line of every journal entry is the debit entry, which will be posted to the debit side of the relevant account. The second line of every journal entry is the credit entry, which will be posted to the credit side of the relevant account. The control columns will be debited or credited to the relevant control account as journal debits or journal credits. For all transactions, at least two accounts are always applicable. Example: Purchase a vehicle per cheque, R150 000, from TSP Traders. For this example, we buy a vehicle and pay by cheque. The two accounts are vehicles and bank. One of these accounts will be debited and the other account will be credited. Or, for every account debited, there will be an account that will be credited. This principle is known as the double-entry principle. The vehicle account is an asset. When a vehicle is bought, this account will increase. Asset accounts increase on the debit side of the account and decrease on the credit side of the account. Therefore, the vehicle account will increase on the debit side of the account. So, the vehicle account is debited. The bank account is also an asset, given the fact that the bank is not in overdraft. When a cheque is issued, the cash in your bank account decreases. Therefore, the bank account will decrease on the credit side of the account. So, the bank account is credited. All transactions can be analysed on the basis of the accounting equation. 7
The accounting equation is: ASSETS = OWNER S EQUITY + LIABILITIES Or A = O + L In the previous example we indicated that: The vehicle account will increase on the debit side of the account by R150 000. The bank account will decrease on the credit side of the account by R150 000. Let s analyse this transaction on the basis of the accounting equation: For the vehicle account, the entry will be under ASSETS, because the vehicle account is classified as an asset account. If the vehicle account increases, the assets of the enterprise will also increase. ACCOUNTING EQUATION A O L + 150 000 This is only one entry and the bank account entry must also be indicated on this equation. For the bank account, the entry will be under ASSETS, because the bank account is classified as an asset account. If the cash in the bank account decreases, the assets of the enterprise will also decrease. ACCOUNTING EQUATION A O L + 150 000 150 000 No entries are made under O and L, because the applicable accounts are all assets. The net result under assets is zero, but it is worth noting that the accounting equation is balanced. The left of the equation, assets, is equal to the right of the equation, owner s equity plus liabilities. Let s consider the following transactions: Transaction 1 The owner, T Smit, increases his capital contribution by R50 000. Issue receipt 5. For this transaction, the enterprise receives money from T Smit, the owner. The enterprise will issue a receipt to T Smit as proof of the money received. The receipt is the source document and proof that a transaction took place. 8
All receipts will be recorded in the Cash Receipts Journal (CRJ). This journal will provide a summary of all monies received for a particular month. The two accounts for this transaction are Capital and Bank. Capital is an Owner s Equity account. Capital will increase on the credit side of this account with a bank entry of R50 000. Cash Receipts Journal (CRJ): In this journal, all cash receipts of the enterprise are captured. The source documents applicable to this journal are cash register roll slips (for cash sales) and receipts (for all other receipts). DR Capital cr Bank 50 000 00 This is the credit entry. Bank is the contra account in this case. Bank is an asset account. The cash in the bank will increase on the debit side of this account with a capital entry of R50 000. DR Bank cr Capital 50 000 00 This is the debit entry. Capital is the contra account in this case. On the accounting equation: For Capital account: Capital is an Owner s Equity account; therefore the entry under O. If capital increases, the owner s equity will also increase; therefore the +. ACCOUNTING EQUATION A O L + 50 000 For Bank account: Bank is an asset account; therefore the entry under A. If Bank increases, the assets will also increase; therefore the +. ACCOUNTING EQUATION A O L + 50 000 + 50 000 9
Transaction 2 Buy trading stock on credit from TRS Dealers, R10 000, and receive invoice 45. For this transaction, the enterprise receives trading stock from TRS Dealers. This is a credit purchase. TRS Dealers will issue an invoice to the enterprise as proof of the credit purchase. The invoice is the source document and the proof that a transaction took place. All invoices received will be recorded in the Creditors Journal (CJ). This journal will provide a summary of all credit purchases for a particular month. The two accounts for this transaction are Trading Stock and Creditors Control. Trading Stock is an asset account. Trading Stock will increase on the debit side of this account with a creditor control entry of R10 000. Creditors Journal (CJ): In this journal, all credit purchases of the enterprise are captured. The source document applicable to this journal is the credit invoice. The creditor control column will be credited to the Creditors Control account and all other columns or entries (like equipment and trading stock) will be debited to the relevant ledger account. dr trading Stock cr Creditors control 10 000 00 This is the debit entry. Creditors Control is the contra account in this case. Creditors Control is a liability account. The Creditors Control account will increase on the credit side of this account with a trading stock entry of R10 000. dr creditors Control cr Trading Stock 10 000 00 This is the credit entry. Trading Stock is the contra account in this case. On the accounting equation: For Trading Stock account: Trading Stock is an asset account; therefore the entry under A. If trading stock increases, the assets will also increase; therefore the +. ACCOUNTING EQUATION A O L + 10 000 10
For Creditor Control account: Creditors Control is a liability account; therefore the entry under L. If creditors control increases, the liabilities will also increase; therefore the +. ACCOUNTING EQUATION A O L + 10 000 + 10 000 Transaction 3 Pay the salary of K Nel per cheque, R8 500. Issue a cheque. For this transaction, the enterprise pays the salary of K Nel. This is a normal payment. The enterprise will issue a cheque to K Nel as proof of the payment. The cheque counterfoil is the source document and the proof that a transaction took place. All cheque counterfoils will be recorded in the Cash Payments Journal (CPJ). This journal will provide a summary of all cheque payments for a particular month. The two accounts for this transaction are Bank and Salary. Bank is an asset account. The cash in the bank will decrease on the credit side of this account with a salary entry of R8 500. Cash Payments Journal (CPJ): In this journal, all cash payments of the enterprise are captured. The source document applicable to this journal is the cheque counterfoil. Therefore, this journal will be posted to the credit side of the bank account in the General Ledger. Accounts like Trading Stock and Creditors Control will be debited in the General Ledger. DR Bank cr Salary 8 500 00 This is the credit entry. Salary is the contra account in this case. Salary is an expense and an Owner s Equity account. The Salary account will increase on the debit side of this account with a bank entry of R8 500. DR Salary cr Bank 8 500 00 This is the debit entry. Bank is the contra account in this case. On the accounting equation: For Bank account: Bank is an asset account; therefore the entry under A. If Bank decreases, the assets will also decrease; therefore the. 11