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Maintaining Financial RecordsFA2FIA

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FA2 Maintaining Financial Records1. Financial statements, accounting principles and accounting standards 3

2. Recording business transactions within the accounting and double entry system 15

3. Sales Tax, The day books and Control Accounts 37

4. Cash 49

5. More on sales and receivables 63

6. Accruals and Prepayments 75

7. Accounting for Inventory 79

8. Non-Current Assets 89

9. Trial balances and correcting errors 97

10. Incomplete Records 111

11. Partnerships 119

Answers To Tests 127

Answers To Examples 139

FA2 Maintaining Financial Records (2019 Exams) 1


Chapter 1FINANCIAL STATEMENTS, ACCOUNTING PRINCIPLES AND ACCOUNTING STANDARDS

1. Introduction

The income statement and the statement of financial position are the key documents in the financial statements of any business.

You need to know how these are usually set out and the terminology that is used.

2. Types of business transaction

An organisation can be defined as:

A social arrangement which pursues collective goals, which controls its own performance and which has a boundary separating it from its environment.

Organisations can include businesses such as companies and partnerships, clubs, charities, government departments, hospitals and schools.

Even if not strictly a ‘business’ all organisations will have business transactions. Typically these will include:

๏ Purchasing goods and materials. Purchases can be for cash or credit. Cash purchases are paid for immediately and are fairly rare in most businesses. Credit purchases are paid for after some time, typically a month or so

๏ Purchasing services, for example, repair s to equipment, advertising, printing costs.๏ Sales. Cash sales, for example in shops, are paid for immediately. Credit sales are paid for after

some time.

๏ Paying wages and salaries.๏ Purchase of non-current assets.๏ Raising finance and paying rewards to the suppliers of finance. For example, owners putting in

capital or loans being raised form banks. Owners of the business expect rewards based on a share of the profit; banks usually expect interest to be paid.

๏ Accounting for and paying tax.๏ Movements of cash and money in the bank account. These movements usually arise from the

transactions above.



3. Types of business documentation

Each type of business transaction has its own set of documentation. The documentation is needed to:

๏ Control the progress of the transaction๏ Record the transaction๏ Provide a history of how the transaction proceeded. This is sometimes known as an ‘audit trail’Sometimes the documentation is purely internal; sometimes it arises externally or is sent outside the business. Nowadays, the term ‘documentation’ is not confined to paper documents only as many business transactions are mostly handled using computerised records.

Typical documentation is as follows:

Purchase of goods and materials: this will usually be initiated by someone in the warehouse or factory who can see that more materials will soon be needed. Often this person raises a purchase requisition which goes the buyers’ department. Buyers will then raise a purchase order to order goods from the most suitable supplier. Goods, accompanied by the supplier’s delivery note, will be received in the warehouse, where a goods received note will be raised. These must be checked back to the order to ensure that the correct goods are being received. Invoices from suppliers will be received and recorded by the accounting department first in a purchases day book (just a list of invoices received) and then in the payables ledger. Usually suppliers will send statements of account setting out the amounts still owed. Statements act as reminders and also they can be used to check that buyers agree with suppliers’ versions of events. Later the invoices will be paid and a remittance advice sent by the customer to indicate which invoices have been settled.

If goods are returned to suppliers (for example their quality was poor) then buyers will ask for a credit note. This acts like a negative invoice.

Purchasing services: often, these will be recurring items such as rent, electricity, telephone and insurance, and an invoice will be received Sometimes they will be once-off like paying for an advertisement in a newspaper or for the repair of a piece of equipment. These services should have a purchase order. The invoices will be processed by the accounting department who will make sure that the expenses look reasonable compared to previous amounts or who will ensure that the services have been properly ordered and received.

Sales: in a retail organisation sales will be initiated by customers either in a shop or through the internet. Payment will usually take place immediately and the customer given a till (cash register) receipt; a copy of the sales is also recorded by the cash register system. In businesses selling to other businesses, the sales representatives (sales men and sales women) will be responsible for encouraging customers to place sales orders. Once received, orders should result in goods despatch notes being raised and these act as authorisation to despatch the goods from the warehouse and for also sales invoices being created and sent to the customers by the accounting department. The accounting department will also record each invoice in a sales day book (just a list of invoices) and will then record what each customer owes in the receivables ledger.

Most businesses will send customers statements of account which set out the amounts still owed by customers. Statements act as reminders to customers about what needs to be paid and they also allow customers to check that they agree with the seller’s version of events. Payments by credit customers should be accompanied by remittance advices which detail what is being paid.

If goods are returned by customers (for example their quality was poor) then customers will ask for a credit note. This acts like a negative invoice.



Paying employees: large organisations will have a wages and salaries department which is responsible for calculating amounts owing, and dealing with employees who leave and with new joiners. Sometimes the payments are the same every week or month; sometimes they depend on time records (such as clock cards). In both cases employees will receive a wage or salary slip showing their pay and any deductions for tax etc. The amounts to be paid will usually be passed to the accounting department which will look after the cash transfers to employees.

Purchase of non-current assets: The purchase of these assets will often begin with en employee raising a purchase requisition, for example for a new printer, which is then authorised by a manager or by the company accountant. When the invoice is received, someone needs to ensure that the asset has been received and that it is working properly. These payments are handled in a similar way to purchases of goods and raw materials.

Finance. In companies, shares can be issued in exchange for new share capital. Loans will usually be accompanied by a loan agreement setting out the terms of the loan.

Tax will be paid in response to an assessment by the tax authorities.

Movements in cash and bank account amounts require careful documentation. Cash payments are usually small and usually made through the petty cash system where payments will be supported by petty cash vouchers. Payments from bank accounts will be by cheque or credit transfer. Credit transfers can be:

๏ Specially initiated by the company๏ Automatic constant amounts (standing orders)๏ Initiated by the person receiving the money (direct debits). In all cases there should be documentation to back up the payments.

All to these transactions are recorded in the books of account (described in detail in a later chapter). The information is summarised at the end of accounting periods into two statements:

๏ Income statement ๏ Statement of financial position



4. Income statement

This shows the sales made and the costs incurred in a period. Sales less costs will show the profit made in the period (or if costs are greater than sales, the loss for the period). You might sometimes still hear this document referred to as the ‘Profit and loss account’, but that is no longer official terminology and you should try not to use it.

If the income statement is for a limited company its presentation is usually defined by statute, because limited companies are closely regulated. If it is for a sole trader or a partnership, then there can be more flexibility.

The typical layout is:

Notes1 ABC LimitedABC LimitedABC Limited2 Income statement for the year ended 31 December 2014Income statement for the year ended 31 December 2014Income statement for the year ended 31 December 2014

$ $3 Sales X4 Less: cost of sales (X)5 Gross profit X6 Selling costs X6 Distribution costs X6 Administration costs X

X7 Net profit X

Notes

1. The name of the entity must be stated.

2. Income statements are for periods. Typically they show income, expenses and profits for a period of a year. However, other periods are also possible.

3. Sales, or revenue, is what is sold in the period. This will exclude any sales tax that customers are charged because that is a tax passed onto the government, not a sale.

4. Cost of sales. The cost of sales is the direct costs of buying or making whatever is sold. Cost of sales is not generally the same as what was purchased because there can be opening and closing inventory.

Cost of sales = Opening inventory + Purchases – Closing inventory

The inventory adjustment ensures that sales are properly matched with the cost off the goods sold:

Opening inventory + Purchases equal all the items that were available for sale.

Closing inventory is what was not sold.

5. The gross profit is sales less cost of sales. Think of this as the main-spring of the business. If gross profit is poor, very poor profits will be made overall.

6. In a company’s income statement, typically other expenses are grouped and summarised as shown into selling, distribution and administration costs. This keeps the income statement relatively uncluttered. More details can be provided as notes to the financial statements.



7. The net profit is what’s left after all expenses. Out of this, companies will pay their corporation tax (for example a simple percentage of the new profit). Anything left can be kept in the business or paid out as dividends to reward shareholders) or taken as drawings in an unincorporated business).

The income statement of an unincorporated business (a sole trader for example) could look identical, but often the expenses will be listed in greater detail.

5. The statement of financial position

As the name of this document suggests the statement of financial position (“SOFP”) shows the financial position of a business at a point in time. You might sometimes hear this document referred to as a ‘balance sheet’, but this is old terminology and you should try to avoid it.

It shows:

๏ Assets (non-current assets and current assets)๏ Liabilities (non-current liabilities and current liabilities)๏ CapitalThe typical layout is:

Notes1 ABC LimitedABC LimitedABC Limited2 Statement of financial position as at 31 December 2014Statement of financial position as at 31 December 2014Statement of financial position as at 31 December 2014

$ $3 Non current assets:

Land and buildings Machinery Vehicles

XXX

X4 Current assets

Inventory Receivables Cash at bank and in hand

XXX

X

XX

5 Capital Capital introduced Retained profits

XX

XNon-current liabilities Bank loan XCurrent liabilities Payables Overdraft

XX

XX



Notes

1. The name of the entity must be stated.

Statements of financial position are drafted for a point in time.

Non-current assets are used by the business to make profits and have a life of longer than one accounting period. They are not regularly bought and sold as trading goods are.

Current assets are either cash or expected to become cash within one year. They are presented in increasing order of liquidity. So, inventory has to be first sold and then the sales proceeds have to be collected. That could all take many months. Customers (receivables) are usually expected to pay within a month or so. Cash is already cash. So, the ‘bad news’ comes first because some inventory might never sell and might never become cash.

Capital arises from capital introduced by the owners of the business and from retained profits. Any withdrawal of profits by the owners will reduce the retained profit and therefore will reduce the capital of the business.

Non-current liabilities are liabilities that have to be settled after more than 12 months. For example, a bank loan being repaid over five years.

Current liabilities have to be settled in less than 12 months. Note that overdrafts are repayable on demand.

The figures marked by the arrows should be equal:

Assets = Liabilities + Capital (amounts owed to the owners)

In essence, the statement of financial position sets out the accounting equation covered in more detail in a later chapter).

6. The conceptual framework of accounting

There are certain principles which underpin accounting and accounts preparation. You need to know what these are:

1. Going concern: the assumption that the business will continue functioning in the foreseeable future. This can affect the valuation of many assets because if the business closes, assets might have to be disposed of at their scrap values.

2. Accruals: income and expenses should be matched on a time basis, not just when cash is received or paid.

3. Consistency: financial statements should be drawn up using the same approaches each year. If, for example, the way an amount is measured is altered, then profits could be affected or manipulated.

4. Double entry: every transaction has matching Debit and Credit entries in the bookkeeping system.

5. Business entity: accounting records record the transactions of the business entity, not the transactions of its owners.

6. Materiality: an item is material if its misstatement could alter the economic decisions of user of the financial statements. Immaterial items do not have to be disclosed – indeed too much information can be confusing.



7. Historical cost: transactions are recorded at their historical cost.

There are also certain qualitative characteristics of accounting, which you also need to know. These are:

1. Relevance: financial information is regarded as relevant if it is capable of influencing the decisions of users. Therefore, all relevant information should be included in financial statements.

2. Faithful representation: financial information must be complete, neutral and free from error otherwise it will mislead users of the financial statements.

3. Comparability: financial information should be capable of being compared over time and with similar information about other entities. If it is not comparable, then interpretation and understanding is difficult.

4. Verifiability: the accounting information should be capable of being verified through auditing procedures. This allows users to place more trust in the information.

5. Timeliness: information should be provided quickly enough to be of use in decision-making.

6. Understandability: information should be presented in a way that makes it understandable to users. This can be done, for example, by good layout, accurate descriptions and, where necessary, notes explaining the information.

7. Accounting standards

At one time accountants had an enormous amount of discretion when it came to producing financial statements. For example:

๏ There are many way in which inventory can be valued.๏ There are different views on how money spent on research should be treated (is it an expense or

an investment)

๏ How should profits be take on large construction contracts which last several years? Spread in some way or all taken at the very end of the contract?

Different accounting policies meant that it was hard to compare different entities because they might use different approaches to accounting. Also it meant that some financial statements were drawn up using approaches which might not be sufficiently prudent.

To bring consistency and prudence to the preparation of financial statements, there are now potentially three sources of rules for many accounting issues:

๏ National laws๏ Local accounting standards๏ International accounting standards (IAS) or International Financial Reporting Standards IFRS).National laws take precedence, then local standards, then international standards, though many countries are adopting international standards.

IASs and IFRSs are developed by the International Accounting Standards Board in liaison with users of financial statements, academics, auditors, accounting bodies and industry.



You need to be aware of the main points covered by the following IASs:

๏ IAS 1 Presentation of financial statements๏ IAS 2 Inventories๏ IAS16 Property, plant and equipment๏ IAS18 Revenue๏ IAS 37 Provisions, contingent liabilities and contingent assets.IAS 1 ! Presentation of financial statements

The objective of IAS 1 (2007) is to set out the basis for presentation of how general purpose financial statements should be presented to ensure comparability with both the entity's financial statements of previous periods and with the financial statements of other entities. IAS 1 sets out the overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content.

IAS 2!Inventories

The fundamental principle of IAS 2 is that inventories (or stock) are must be stated at the lower of cost and net realisable value.

Cost should include all:

๏ Costs of purchase (including taxes, transport, and handling) net of trade discounts received. ๏ Costs of conversion (including fixed and variable manufacturing overheads) ๏ Other costs incurred in bringing the inventories to their present location and condition.Net realisable value is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale.

IAS16! Property, plant and equipment

Items of property, plant, and equipment should be recognised as assets when:

๏ It is probable that the future economic benefits associated with the asset will flow to the entity, and

๏ The cost of the asset can be measured reliably. An item of property, plant and equipment should initially be recorded at cost. Cost includes all costs necessary to bring the asset to working condition for its intended use. This would include not only its original purchase price but also costs of site preparation, delivery and handling, installation, related professional fees for architects and engineers, and the estimated cost of dismantling and removing the asset and restoring the site.

IAS 16 permits two accounting models:

๏ Cost model. The asset is carried at cost less accumulated depreciation and impairment. ๏ Revaluation model. The asset is carried at a revalued amount, being its fair value at the date of

revaluation less subsequent depreciation and impairment, provided that fair value can be measured reliably.



IAS 18 ! Revenue

Revenue should be measured at the fair value of the consideration received or receivable. An exchange for goods or services of a similar nature and value is not regarded as a transaction that generates revenue. However, exchanges for dissimilar items are regarded as generating revenue.

Recognition of revenue can occur when:

๏ It is probable that any future economic benefit associated with the item of revenue will flow to the entity, and

๏ The amount of revenue can be measured with reliability

IAS 37! Provisions, contingent liabilities and contingent assets.

๏ Provision: - a liability of uncertain timing or amount.๏ Liability: - present obligation as a result of past events

- settlement is expected to result in an outflow of resources (payment)

A contingent liability is a possible obligation arising from past events that depends on a future event. For example, damages that might have to be paid are contingent on the findings of a court.

Similarly, a contingent asset arises from past events but which is dependent on future events. For example, the amount of damages won can depend on the outcome of a court case.



Question 1 Which accounting principle says that income and expenditure should be matched on a time basis?

A Prudence

B Going concern

C Accruals

D Business entity

Question 2 IAS 2 states that inventories are must be stated at the lower of cost and net realisable value.

Which two accounting principles are in conflict if inventory is valued at net realisable value?

A Materiality and prudence

B Consistency and accruals

C Materiality and historical cost

D Prudence and accruals

Question 3 Going concern is the assumption that a business will:

A continue for the foreseeable future

B continue for the next 5 years

C be profitable in the future

D will shortly be closed down

Question 4 In its previous financial statements a business valued inventory using FIFO. In its current financial statements it has adopted the cumulative average approach.

Which accounting principle would this violate?

A Prudence

B Consistency

C Historical cost

D Understandability



Question 5

A business bought a machine for $10,000. Delivery cost $500 and installation cost $1,000.

What is the cost of the machine according to IAS 16?

A $10,000

B $10,500

C $11,000

D $11,500

Question 6

What do the following statements define according to IAS 37?

Present obligation as a result of past events

Settlement is expected to result in an outflow of resources (payment)

A A liability

B A contingent liability

C A provision

D A contingent asset.

Question 7 What is the purpose of a statement of account sent to a customer?

A It is a demand for payment

B It states to the customer what goods have been sent

C It tells the customer what is owed as a reminder and as a check

D It states the credit limit on the account.

Question 8 A remittance advice:

A Advises on what has to be paid

B Gives information about what is being paid

C Advises about goods being returned

D Gives information about wages being paid



Chapter 2RECORDING BUSINESS TRANSACTIONS WITHIN THE ACCOUNTING AND DOUBLE ENTRY SYSTEM

1. Introduction

This chapter gives a brief description of how transactions are recorded in accounting systems, including the use of codes to define information precisely.

2. Recording transactions.

Transactions are first recorded in the books of prime entry and then recorded on the ledger system.

A prime entry record (or book of prime entry) is where a transaction is first recorded.

These records consist of:

๏ The cash book: this records amounts paid into and out of the bank account๏ The petty cash book: this records small amounts of cash paid for day to day expenses, such as

buying postage stamps and teas or coffee for the office.

๏ The sales day book: sales invoices issued to credit customers๏ The purchases day book: purchase invoices received from suppliers๏ The journal: where adjustments, such as correcting errors, are first recorded.Some businesses also have sales returns and purchases returns day books.

The books of prime entry serve to ‘capture’ transactions as soon as possible so that they are not subsequently lost or forgotten about.

The cash book and the petty cash book are part of the double entry system and record cash coming in and going out.

The day books and journal are not part of the ledger (double entry) system, and entries are made from there to the ledgers.



The word ‘ledger’ means a book. In accounting systems there are usually three ledgers:

๏ The general or nominal ledger, which records amounts such as wages, sales, purchases, sales, electricity, travel, advertising, rent, insurance, repairs, receivables, payables and non-current assets. The cash and bank accounts are technically part of this ledger but are usually physically kept in a separate book because cash and bank transactions are so numerous.

๏ The payables ledger (also known as the creditors’ ledger and sometime the purchase ledger). Although the total amount owed to suppliers is recorded in the general ledger, details of exactly what is owed to whom are also recorded here. There is a separate account for each supplier. The sum of the amounts owing in this ledger should agree with the payables balance in the general ledger.

๏ The receivables ledger (also known as the debtors’ ledger and sometimes the sales ledger). Although the total amount owed by customers is recorded in the general ledger, details of exactly what is owed from whom are also recorded here. There is a separate account for each credit customer. The sum of the amounts owing in this ledger should agree with the receivables balance in the general ledger.



3. The accounting system in diagrammatic form

The accounting system can be depicted as follows:

Receivables ledgerHolds detail of what makes up the total receivables.

An account for each credit customer:

Abramson xAhmad xBerry xBurton xCheridjian x.........

Total x

Sales day book

Lists credit sales.

From this the general ledger sales and receivable control accounts are updated together with the detailed receivables accounts in the receivables ledger

Purchases day book

Lists credit purchases.

From this the general ledger purchases and payables control accounts are updated together with the detailed payables accounts in the payables ledgerJournal

Makes adjustments to accounts in the double entry system

Payables ledgerHolds detail of what makes up the total payables.

An account for each credit supplier:

Adams xBoulez xClarke xDalziel xChun x.........

Total x

The double entry system

General (nominal) ledger

Assets (things owned)

Liabilities(things owed)

Equipment Payables (control)Machinery Bank loansPremisesInventory Owner’s capitalReceivables (control)

Income ExpensesSales Purchases for resaleInterest earned Rent

ElectricityInterest paid......etc

Cash Book

Dr! CrReceipts Payments

Petty cash Book


To recap:

The double entry system consists of the general ledger, the cash book and the petty cash book.

The receivables and payables ledgers provide details of the total receivables and payables that are recorded in the nominal ledger.

The books of prime entry are the cash book, the petty cash book, the sales day book, the purchases day book and the journal.



4. The accounting equation and the principles and practice of double-entry book-keeping

Bookkeeping relies on a number of linked principles:

1. The transactions of the business are separate from those of its owners

2. Every transaction gives rise to two effects (or two entries). One entry is known as a credit entry and the other a debit entry.

3. Things owned by the business equals things owed by the business.

The double entries are often displayed in ‘T’ accounts:

Account nameAccount nameAccount nameAccount name

Debit (DR) side Credit (CR) side

Means: Means:Increase in an asset Decrease in an assetIncrease in an expense Decrease in an expenseDecrease in a liability Increase in a liability(an amount owed) (an amount owed)

Increase in income

The accounts are collected together into ledgers. Remember ‘ledger’ just means ‘’book’ and it used to be that each account had its own page in the books.

Here are some simple, common transactions: remember every transaction has two effects: one debit, one credit. The amounts of debits must equal the amounts of credits.

Purchase of office stationery for cash:

Debit Office stationery (increase in an expense)

Credit Cash (decrease in an asset)

A cash sale:

Debit Cash (increase in an asset)

Credit Sales (increase in income)

A credit sale:

Debit Receivables (increase in an asset)

Credit Sales (increase in income)



Payment by a customer of an amount owing:

Debit Cash (increase in an asset)

Credit Receivables (decrease in an asset)

Purchase, on credit, of goods for resale:

Debit Purchases (increase in an expense. ‘Purchases’ is the name given to purchases for resale)

Credit Payables (increase in a liability).

You should understand that if the double entry as been carried out properly, then the sum of the debit entries should always equal the sum of the credit entries. This should be regularly checked by compiling a trial balance, which is simply all the accounts listed in debit and credit columns and the lists added up. The totals should always agree.

Question 1 What would be the double entry for the payment of wages to employees?

A Dr Employees Cr Wages

B Dr Wages Cr Cash

C Dr Cash Cr Wages

D Dr Cash Cr Employees

Question 2 What would be the double entry for the purchase of a car on credit?

A Dr Garage Cr Cars

B Dr Cars Cr Cash

C Dr Cars Cr Garage

D Dr Garage Cr Cash

Question 3 What would be the double entry for payment of an amount owing to a supplier?

A Dr Purchases Cr Cash

B Dr Supplier Cr Purchases

C Dr Purchases Cr Supplier

D Dr Supplier Cr Cash



5. Starting a business and its initial transactions

Transaction 1

The owner starts up the business in 1/1/2013 by putting $10,000 of cash in as capital.

From the business’s point of view, its cash has increased by $10,000 and its capital has increased by $10,000. Cash is an asset (something owned) and the capital is the amount owed by the business back to its owner.

The double entry would be:

Dr CashCashCashCash Cr1/1/2013 Capital 10,000

Dr CapitalCapitalCapitalCapital Cr1/1/2013 Cash 10,000

Notice the cross-referencing between the accounts. The entry in the Cash account is described as ‘Capital’, which is where the cash came from; the entry in the Capital account is described as ‘Cash’, the nature of the capital injected.

Accounting equation:

Things owned, cash $10,000 = Things owed, capital 10,000



Transaction 2

The business buys some equipment for $2,000 cash on 3/1/2013.

Cash has decreased $2,000 and the cost of equipment has increased by $2,000

Dr CashCashCashCash Cr1/1/2013 Capital 10,000 3/1/2013 Equipment 2,000

Note the balance on this account is Dr 8,000, the net of the Dr and Cr sides

Dr EquipmentEquipmentEquipmentEquipment Cr3/1/2013 Cash 2,000

The asset of cash decreases and that of equipment increases



Things owned, cash $8,000 + equipment $2,000 = Things owed, capital $10,000



Transaction 3

On 10/1/2013, the business purchases goods for resale for $5,000 on credit.

Dr Cash Cash Cash Cash Cr1/1/2013 Capital 10,000 3/1/2013 Equipment 2,000



Dr InventoryInventoryInventoryInventory Cr10/1/2013 Suppliers 5,000

Dr SuppliersSuppliersSuppliersSuppliers Cr10/1/2013 Inventory 5,000

The asset of inventory increases and the liability to suppliers increases


Things owned, cash $8,000 + equipment $2,000 + inventory $5,000

= Things owed, capital $10,000 + suppliers $5,000



Transaction 4

On 15/1/2013, sells half the goods for $4,000 credit.

This will create a profit of 4,000 – 5,000/2 = $1,500. The profit is owed to the owners and is a liability of the business to its owners.

We can look at the sale in two parts: earning $4,000 for a cost of 5,000/2 = 2,500.




Dr InventoryInventoryInventoryInventory Cr10/1/2013 Suppliers 5,000 15/1/2013 Cost of goods sold 2,500

Dr SuppliersSuppliersSuppliersSuppliers Cr10/1/2013 Inventory 5,000

Dr CustomersCustomersCustomersCustomers Cr15/1/2013 Profit 4,000

Dr SalesSalesSalesSales Cr10/1/2013 Customers 4,000

Dr Cost of goods soldCost of goods soldCost of goods soldCost of goods sold Cr10/1/2013 Inventory 2,500




Things owned, cash $8,000 + equipment $2,000 + inventory $2,500 + due from customers $4,000 = $16,500

= Things owed, suppliers $5,000 capital $10,000 + profit [4,000 – 2,500] = $16,500

Transaction 5

On 31/1/2013, the suppliers are paid what they are owed and $100 is paid for rent.

The rent is an expense and decreases the profit. Paying suppliers what is owed to them has no effect on profits.


31/1/2013 Suppliers 5,000

31/1/2013 Rent 100



Dr InventoryInventoryInventoryInventory Cr10/1/2013 Suppliers 5,000 15/1/2013 Cost of goods sold 2,500

Dr SuppliersSuppliersSuppliersSuppliers Cr

31/1/2013 Cash 5,000 10/1/2013 Inventory 5,000

Dr CustomersCustomersCustomersCustomers Cr

15/1/2013 Profit 4,000



Dr SalesSalesSalesSales Cr

10/1/2013 Customers 4,000

Dr Cost of goods soldCost of goods soldCost of goods soldCost of goods sold Cr

10/1/2013 Inventory 2,500

Dr RentRentRentRent Cr

31/1/2013 Cash 100


Things owned, cash $2,900 + equipment $2,000 + inventory $2,500 + due from customers $4,000 = $11,400

= Things owed, capital $10,000 + profit [4,000- 2,500 – 100 (rent)] = $11,400

6. Trial balances

At any stage, the sums of debit balances and credit balances should be the same. This is because we were strict to always have equal debit and credit entries.

These totals are the trial balance

Example 1

Produce a trial balance for the above accounts: Dr balances Cr balances

Totals



7. Statements of financial position and statement of comprehensive income (income statement)

The accounts can also be used to produce a statement of financial position and an income statement.

๏ Statement of financial position: the assets and liabilities (things owned and things owed) at a point in time

๏ Income statements: income and expenses for the period.Note that capital put in or taken out by the owners is neither income or expense. It is simply the owner changing his or her investment in the business.

The trial balance amounts can be marked up with SOFP or IS to show which document they form part of:

Dr CR

Cash 2,900 Asset: SOFP

Equipment 2,000 Asset: SOFP

Capital 10,000 Liability: SOFP

Inventory 2,500 Asset: SOFP

Suppliers – – Liability: SOFP

Customers 4,000 Asset: SOFP

Sales 4,000 Income: IS

Cost of goods sold 2,500 Expense: IS

Rent 100 Expense: IS

Total 14,000 14,000



Income statement for January 2013Sales 4,000

Cost of goods sold (2,500)

Gross profit 1,500

Rent (100)

Net profit 1,400

Statement of financial position as at 31 January 2013Assets

Equipment 2,000

Inventory 2,500

Cash 2,900

Due from customers 4,000

11,400

Liabilities

Capital introduced 10,000

Profit 1,400

11,400

Note that the profit made by the business is added to the liabilities in the SOFP. This is because profit is owed to the owners and becomes part of the capital of the business.

Profits taken out of the business are know as ‘Drawings’ (derived from ‘withdrawals’). If the owner removed $1,000 profits then cash would go down $1,000 and drawings up by $1,000. The liability side of the SOFP would then look like:

Liabilities Capital introduced 10,000

Profit 1,400

Drawings (1,000)

10,400



8. Carrying down balances

Look at this account:

CashCashCashCashCapital introduced 2,000 Wages 200

Sales 3,000 Purchases 1,400

Sales 100 Rent 200

Heating 100

To find out how much cash there is now, you have to find the balance on the account ie the net debit or credit amount.

Debits = 2,000 + 3,000 + 100 = 5,100

Credits = 200 + 1,400 + 200 + 100 = 1,900

Therefore balance = Dr 5,100 – Cr 1,900 = = Dr 3,200

This means that there is $3,200 cash i.e. and asset of $3,200.

In bookkeeping finding the balance is done in a very formal way:1. At the bottom of the Dr and Cr sides, enter the larger of the two totals. Here that would be 5,100.



Sales 100 Rent 200

Heating 100

5,100 5,100

2. To make the smaller column add up to that you have to enter the ‘balancing figure’. Here 3,200 needs to be entered on the credit side. This is marked with ‘Balance c/d’ (‘c/d’ meaning ‘carried down’).



Sales 100 Rent 200

Heating 100

Balance c/d 3,200

5,100 5,100



3. This figure is brought down below the totals on the other side. Here $3,200 would be brought down (b/d) on the debit side.



Sales 100 Rent 200

Heating 100

Balance c/d 3,200

5,100 5,100

Balance b/d 3,200

A balance brought down on the debit side of the cash account means that there is an asset of cash.

Example 2

Show how the balance would be carried down on this account:SalesSalesSalesSales

21/6/2013 Returns 550 1/6/2013 Cash 250

25/6/2013 Returns 32 3/6/2013 Credit sales 1,395

29/6/2013 Cash 49



Example 3

James started business as an art dealer in 1 January 2013. His transactions in January 2013 were:

1. Introduced $6,000 capital

2. Bought Picture A for $1,000 cash

3. Bought three identical prints for $1,500 in total, on credit, from V V Gogh

4. Sold Picture A for $1,900 cash [Hint: deal with the sale for $1,900 cash and also transfer the cost of the sale from inventory to the Cost of Goods Sold Account]

5. Sold one of the prints for $850 on credit to L D Vinci

6. Paid rent of $1,000

7. Paid electricity bill of $250

8. Paid V V Gogh half of what was owed.

9. Received the full amount owing from L D Vinci

10. Withdrew $500 from the business for personal living expenses

11. Received a bill for $300 for repairs, but didn’t pay it yet.

12. Bought a computer for $750.

You are required to

(a) write up the required ledger accounts for those transactions (there are accounts on the next page),

(b) calculate the balances on each account(c) produce a trial balance for the end of the period (d) state for each account on the trial balance whether it is an asset, liability, item of income or

item of expense.CashCashCashCash

CapitalCapitalCapitalCapital



InventoryInventoryInventoryInventory

SalesSalesSalesSales

Cost of goods soldCost of goods soldCost of goods soldCost of goods sold

V V GoghV V GoghV V GoghV V Gogh

L D VinciL D VinciL D VinciL D Vinci



ElectricityElectricityElectricityElectricity

RentRentRentRent

RepairsRepairsRepairsRepairs

Repair companyRepair companyRepair companyRepair company

ComputerComputerComputerComputer

DrawingsDrawingsDrawingsDrawings



13. The accounting equation and profit

You have seen how the accounting equation should always hold true:

Things owed = Things owned

If $10,000 cash in introduced as capital, then the equation is:

(1) Things owed $10,000 (Capital) = Things owned $10,000 (Cash)

If the business trades and makes profits of, say $6,000, then the business has become ‘richer’ by £6,000 and the owner’s stake in the business (capital) will have increased by $6,000.

(2) Things owed [$10,000 + $6,000] (Capital) = Things owned $16,000

If the business borrows $2,000, then cash will increase by that amount, but the business will also owe money to the bank:

(3) Things owed [$10,000 + $6,000] (Capital) + $2,000 = Things owned $18,000

or

(4) [$10,000 + $6,000] (Capital) = $18,000 – $2,000 [Loan] = Net assets $16,000

Comparing equations 1 and 4, Capital has increased by $6,000 because a profit has been made and this is reflected in the increase in net assets from $10,000 to $16,000.

Profit makes businesses richer.

However, profit and capital can be withdrawn from a business and this will reduce the net assets of the business. So, if the owner withdrew money to live on (made drawings) of $2,000, the assets would reduce by $2,000 and the equation would be:

(5) [$10,000 + $6,000 – 2,000] (Capital) = $16,000 –$2,000[Loan] = Net assets $14,000

So, comparing equations 1 and 5, we can say that:

Increase in net assets between two dates $(14,000 – 10,000) =

Capital introduced in the period ($Nil) + Profit ($6,000) – Drawings ($2,000) = $4,000.

Remember:

Increase in net assets = capital introduced + profit - drawings



Question 4 On 1 January 2013 a business had net assets of $15,000

On 31 January 2013, net assets amounted to £19,000.

No capital had been introduced in January, but the owner had made drawings of $750.

What profits were made in January?

A $4,000

B $4,750

C $3,250



Additional capital of $1,000 had been introduced in January, but the owner had made drawings of $400

What profits were made in January?

A $3,400

B $4,000

C $4,600

D $5,400



A loss of $7,000 had been made and the owner withdrew $1,000 to live on.

What additional capital was introduced to the business in January?

A $8,000

B $6,000

C $7,000

D $10,000



Question 7

On 1 January 2013 and 31 January 2013 a business had the following assets and liabilities:

1 January 31 January$ $

Cash 10,000 12,000Owed to suppliers 3,000 4,000Owed from customers 2,000 1,000Equipment 8,000 10,000Bank loan 2,000 5,000

No additional capital had been introduced, but the owner withdrew $800 to live on.

What profit or loss was made in January?

A $1,000 loss

B $5,800

C $200 loss

D $1,800



Chapter 3SALES TAX, THE DAY BOOKS AND CONTROL ACCOUNTS

1. Introduction

This chapter shows how the day books and journal are used to feed information into the double-entry system and into the receivables and payables ledgers.

2. Sales tax

Many countries have a sales tax where an amount is added to goods sold and this amount must later be paid over to the Government. In the UK, the sales tax is called VAT (value added tax). Usually businesses are required to register for sales tax once their turnover (sales) reaches a certain amount. Once registered, they have to charge sales tax to their customers on any taxable supplies they make.

The rates at which tax is charges can be complicated and varies from country to country. For example, in the UK there are:

๏ Exempt supplies. No tax is charged at any rate. Supplies include insurance and healthcare.๏ Zero-rated supplies. Tax is levied at 0%. Supplies include most food (but not hot or restaurant

food), books and newspapers, most travel.

๏ Standard-rated. Most goods have tax added at this rate. For example, hotel and restaurant bills, adult clothing, petrol etc.

๏ Reduced rate. For example, domestic electricity, gas and heating oilThe amount of the sales before the tax is added is called the net amount, and after tax is added is called the gross amount. Similarly, most purchases will include an amount of sales tax.

The tax on sales is called output tax.

The tax on purchases is called input tax.

Once registered, tax has to be charged on taxable supplies and this is periodically paid over the government. However, once registered, traders can reclaim input tax from the government. Only the net amount of input and output tax is paid to, or reclaimed from, the government.



Sales tax is accounted for in a sales tax account:

Sales TaxSales TaxSales TaxSales TaxInput tax X Output tax XCash – payment of net amount to government

X

It is vital to realise that for a registered trader, tax charged on sales is not part of sales or income and that tax charged on purchases is not part of expenses. The sales tax account shows the liability to or from the government.

Example 1

Sales tax is charged at 20%. In a period a business makes cash sales of $6,000 (net) on which sales tax is $1,200 and $7,200 is the gross amount.

In the same period cash purchases of $2,000 (net) were made on which sales tax was $400 and $2,400 is the gross amount.

At the end of the period the appropriate amount of tax was paid to the government.

Write up the following accounts:

SalesSalesSalesSales

PurchasesPurchasesPurchasesPurchases

Sales tax accountSales tax accountSales tax accountSales tax account



Cash accountCash accountCash accountCash account

3. Sales tax calculations

It is important to be able to work out gross and net amounts and the amount of tax, and this can best be done by a cost structure.

If sales tax is at 20%, then the cost structure would be:

Net amount + sales tax = Gross amount

100 20 120

Once that is established then you can easily move between any of the sales figures using proportions.

1 Net amount = 280: therefore


100 20 120

280 ? ?

sales tax = 280 x 20/100 = 56, and

gross amount = 280 x 120/100 = 336

2 Tax = 40: therefore


100 20 120

? 40 ?

net amount = 40 x100/20 = 200, and

gross amount = 40x 120/20 = 240

3 Gross amount = 840: therefore


100 20 120

sales tax = 840 x 20/120 = 140, and

net amount = 840 x 100/120 = 700



Note that this type of calculation was necessary in the petty cash voucher, above. $12 was charged, of which $2 was the VAT and $10 the net cost

If there are bulk or quantity discounts, the VAT is calculated on the amount after the discount.

The amount of sales tax charged on sales is known as output tax (a tax on goods leaving the business). Business suffer sales tax on their purchases as suppliers have to charge sales tax on their sales; that tax is known as input tax (it is the tax on goods coming into the business).

At the end of each tax accounting period, the net of the sales output and input taxes has is paid to or received form the government.

Question 1

Sales tax rate = 15%. Gross sales are $690.

What are the net sales and the sales tax?

A Net = $586.50. Sales tax = $103.5

B Net = $600. Sales tax = $90

C Net = $600. Sales tax = $103.5

D Net = $586.50. Sales tax = $90

Question 2

Sales tax rate = 16%. Full net price before any bulk discount = $3,000.

Bulk discount = 20%.

What are the gross sales and the sales tax?

A Gross = $2,784. Sales tax = $480

B Gross = $2,400 Sales tax = $384

C Gross = $3,480. Sales tax = $480

D Gross = $2,784. Sales tax = $384

Question 3

In a period a company charges $4,600 sales tax on its sales. Its purchases from its suppliers cost $6,000 including sales tax at 20%.

What payment/receipt will be made to/received from the government at the end of the period?

A 1,400 received from the government

B 1,400 to be paid to the government

C 3,600 to be paid to the government

D 3,600 to be received from the government



4. The day books

For convenience, the diagram of the accounting system is produced again:




Total x

Sales day book

Lists credit sales.


Purchases day book







Total x








Cash Book


Petty cash Book




The purchase day book (PDB)

This book records of all the invoices received by a business from its credit suppliers.

Before invoices are listed here, they should be approved for payment as the invoices will progress form here to the ledgers and eventual payment.

The PDB is simply a list. A simple PDB would be as follows:

Date Details Supplier’s account number

Net amount Sales tax amount

Gross amount

4/2/2013 ABC Ltd 123 1000 200 1200

8/2/2013 CDE Ltd 234 400 80 480

8/2/2013 FGH Ltd 332 1200 240 1440

9/2/2013 IJK Ltd 346 150 30 180

TOTALS 2750 550 3300

Notes

1. Despite its name the purchases day book does not have to be totalled every day.

2. The total of the net amount, sales tax amount and gross amount columns should add across (known as cross casting). If they don’t and error have been made somewhere.

3. The total of the gross amount column is how much extra we owe suppliers because of these invoices.

4. The total of the net amount column is the cost of how much extra has been purchased.

5. The total of the sales tax amount is simply the total of the sales tax relating to these invoices. This can be recovered from the government.

The posting that would be made to account for these purchases transactions are:

In the general ledger

Credit: Payables control account (total payables) 3,300Debit: Purchases account 2,750Debit: Sales tax account 550

3,300 3,300

These entries reflect that $3,300 is owed to suppliers for goods of $2,750 and sales tax of $550.

In addition, in the Payables Ledger, each of the suppliers is credited with the gross amount of their invoices



Supplier account number Supplier name Gross amount123 ABC Ltd 1200

234 CDE Ltd 480

332 FGH Ltd 1440

346 IJK Ltd 180

Note: the Payables Ledger is not part of the double entry system: it is a memorandum entry. If everything has been done properly, the sum of the detailed accounts in the payables ledger will agree with the payables Control Account in the general ledger.

This system fulfils the following functions:

1. The control account provides an instant answer as to what is owed to suppliers in total

2. The detailed ledger accounts in the Payables Ledger give information about exactly what is owed to whom

3. Ensuring the control account and the sum of the ledger balances agree will reduce the chance of an error having occurred in the postings.

The sales day book (SDB)

This book records of all the invoices issued by a business to its credit customers before they are sent out to customers.

The SDB is simply a list. A simple SDB would be as follows:

Date Details Customer’s account number


Gross amount

4/2/2013 PQR Ltd 378 400 80 480

8/2/2013 STU Ltd 388 300 60 360

8/2/2013 VWX Ltd 587 200 40 240

9/2/2013 YZA Ltd 775 120 24 144

TOTALS 1020 204 1224

Notes

1. Despite its name the sales day book does not have to be totalled every day.

2. The total of the net amount, sales tax amount and gross amount columns should add across (known as cross casting). If they don’t and error have been made somewhere.

3. The total of the gross amount column is how much extra we are owed by customers because of these invoices.

4. The total of the net amount column is the ore-tax sales value of the extra sales.

5. The total of the sales tax amount is simply the total of the sales tax relating to these invoices. This will be paid to the government (after off-setting any input sales tax).



The posting that would be made to account for these sales transactions are:

In the general ledger

Debit: Sales control account (total receivables) 1,224 3,300Credit: Sales account 1,020Credit: Sales tax account 204

1,224 1,224

These entries reflect that $1,224 is owed by customers for goods of $1,020 and sales tax of $204.

In addition, in the Receivables Ledger, each of the customers is debited with the gross amount of their invoices

Details Gross amountPQR Ltd 480

STU Ltd 360

VWX Ltd 240

YZA Ltd 144

Note: the Receivables Ledger is not part of the double entry system: it is a memorandum entry. If everything has been done properly, the sum of the detailed accounts in the receivables ledger will agree with the receivables Control Account in the general ledger.

This system fulfils the following functions:

1. The control account provides an instant answer as to what is owed by customers in total

2. The detailed ledger accounts in the Receivables Ledger give information about exactly who owes what.

3. Ensuring the control account and the sum of the ledger balances agree will reduce the chance of an error having occurred in the postings.



5. Control account reconciliations

The receivables and payables control accounts should always agree with the sum of the balances on the receivables and payables ledgers respectively. If they don’t, then an error must haven been made and needs to be corrected.

Correcting control account and ledger errors is a common exam requirement.

For example, a receivables control account balance is $3,825. The three receivable account balances in the receivables ledger are as follows:

Customer name Amount owingA Ltd 1,800

B Ltd 1,500

C Ltd 652

Total 3,952

Something must have gone wrong because the control account balance does not agree with the total of the individual balances.

Investigation of the entries shows the following errors:

1. An invoice for $425 in the day book was posted to C Ltd’s account as $452.

2. An invoice for $500 in the day book was posted as $200 to B’s account

3. The sales day book was under cast (ie added up by too little) by $400

Solution

List of balances b/fList of balances b/f 3,952

1 $452 – 425 = $27 too much debited to C Ltd (27)2 $500 – $200 = $300 too little posted to B Ltd 300Corrected listCorrected list 4,225

Control account balanceControl account balance 3,8253 Under casting error 400

4,225

It is vital to understand which entries come form where.

Individual lines in the day book affect postings to the receivables (or payables) ledger

Totals in the day book affect postings to the receivables (or payables) control account.



Question 4

The total columns in a purchases day book are as follows:

Date Details Supplier’s account number


Gross amount

.. .. ..

.. .. ..TOTALS 4,000 800 4,800

To where are these figures posted in the ledgers?

A Debit Purchases 4,800 Credit Suppliers 4,800

B Debit Purchases 4,000, Credit Sales tax 800 Credit suppliers 4,800

C Credit Purchases 4,000, Credit sales tax 800 Debit suppliers 4,800

D Debit Purchases 4,000, Debit sales tax 800 Credit suppliers 4,800

Question 5

The total columns in a sales day book are as follows:

Date Details Customer’s account number


Gross amount

.. .. ..

.. .. ..

TOTALS 6,000 1,200 7,200

To where are these figures posted in the ledgers?

A Credit Sales 7,200, Debit Customers 7,200

B Credit Sales 6,000, Debit Sales tax 1,200, Debit Customers 7,200

C Credit Sales 6,000, Credit sales tax 1,200, Debit Customers 7,200

D Credit Sales 6,000, Debit sales tax 1,200, Credit Customers 7,200

Question 6

A debit balance of $100 on an individual’s ledger account in the payables ledger has been listed as a credit balance when adding up the list of balances.

To correct the reconciliation of the control account with the list of balances:

Control account List of balances

A Cr 200 Increase by 100

B Cr 100 Increase by 200

C No effect Decrease by 200

D No effect Decrease by 100



Question 7

For the last week of the accounting period, purchases net of sales tax totalled $70,000. The sales tax amounted to $15,000. $85,000 has been credited to the suppliers’ control account as: $83,000.

To correct the reconciliation of the control account with the list of balances:

Control account List of balances

A Cr 2,000 No effect

B Cr 2,000 Increase by $2,000

C Dr 13,000 No effect

D Dr 15,000 No effect

Question 8 The sales day book has been overcast by $1,000. The effect of this error is to:

A Overstate sales, overstate the control account, overstate the total of the accounts in the receivables ledger

B Overstate sales, understate the control account, no effect on the total of the accounts in the receivables ledger.

C Overstate sales, overstate the control account, no effect on the total of the accounts in the receivables ledger.

D Understate sales, overstate the control account, no effect on the total of the accounts in the receivables ledger.

Question 9 An invoice to AGS Ltd of value $4,300 was listed in the sales day book as $3,400. To correct this error, which corrections are needed?

Control account AGS’s account in Sales account

the receivables ledger in the general ledger

A Dr 900 Dr 900 Cr 900

B Dr 900 No effect Cr 900

C Cr 900 Cr 900 Dr 900

D Dr 900 Dr 900 No effect



6. Returns day books

In addition to sales and purchases day books, some businesses sales returns day books and purchases returns day books. Credit notes issued to customers or received from suppliers are listed there.

They act as ‘negative’ day books. Therefore the following postings are made:

Sales returns day book:

Total: Dr Sales, Cr Receivables control account

Individual lines: Cr individual customers’ accounts

Purchase returns day books

Total: Cr Purchases, Dr Payables control account

Individual lines: Dr individual suppliers’ accounts



Chapter 4CASH

1. Introduction

This chapter shows the use of the cash book and petty cash book.

2. The cash books in the accounting system

The cash book and the petty cash book are books of prime entry and are part of the double entry system. The cash book records the flows of money in the bank account of the business; the petty cash book records relatively small amounts of cash expenditure on items like paying for coffee for the office, reimbursing employees for taxi fares, buying some pens for cash from the local stationery shop.




Total x

Sales day book

Lists credit sales.


Purchases day book







Total x








Cash Book


Petty cash Book




3. Types of payment from the bank

Payments can be made from a bank account in four main ways:

๏ Cheque. These are unconditional orders in writing given to a bank (the drawee) by the person paying out of his or her bank account (the drawer of the cheque) to pay an amount to the payee (the person receiving the money). When cheques are received and paid in to a bank account, they are provisionally credited immediately by the bank. However, it takes about three days for the cheque ‘to clear’ which is when the funds are transferred. Until then there is always a possibility that the cheque ‘bounces’ because the payer/drawer has no funds. If that happens the bank debits the recipient’s bank account to reverse the earlier, provisional credit, and sends the cheque back to the recipient. The cheque will be marked ‘Refer to drawer’ meaning that the person who hopes to receive money has to take the matter up with the person who should pay it.

Cheque details are entered into the business’s cash book as they are made out. However, it can be some time before that cheque arrives with the payee and who might delay paying it in. Until the money is taken from payer’s bank account the cheque is described as ‘unpresented’.

๏ Internet transfer: now very common. It is vitally important that account log-on details are kept secure. In addition to user-known passwords, some banks now issue devices that generate unique use-once codes. Access to the bank account is then possible only by someone who both knows the password and who possesses the device.

๏ Direct debit. Here the person receiving the funds has the right to extract them from the bank account. This is often used by institutions like insurance companies to collect insurance premiums from clients. The process can be completely automated.

๏ Standing order. Here the person paying instructs their bank to pay a regular amount to the recipient. This is often used to pay regular amounts like rent. The process can be completely automated.

In addition, banks can remove funds from accounts for interest and bank charges.

4. The cash book

The cash book is the cash account of the business and is where bank account receipts and payments are recorded. In a simple ‘T’ account it would look like;

Cash BookDr (Receipts) Cr (Payments)



Cash BookDr (Receipts) Cr (Payments)Balance b/d 1,200 Paid to C Clark 404Cash sales 240 Paid to D Drake 172Received from A Smith 360 Wages 1200Cash sales 120 Cash purchases 72Received from B Bodkin 600 Tax 300

Balance c/d 3722,520 2,520

Balance b/d 372



Notes:

1. At the start of the period there is cash of $1,200.

2. The receipts from Smith and Bodkin will be the settlement of sales invoices.

3. The payments to Clark and Drake will be the payment for purchases invoices.

4. At the end of the period there is cash of $372

Although the cash book would work perfectly well in this format, it does mean that every entry has to be posted individually to the other side of an account in the general ledger. A more efficient arrangement would be as follows:

Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments)

Total Cash sales

Receivables Total Cash purchases

Payables Wages Sundry

Balance b/d 1,200 Paid to C Clark

404 404

Cash sales 240 240 Paid to D Drake

172 172

Received from A Smith

360 360 Wages 1200 1200

Cash sales 120 120 Cash purchases

72 72

Received from B Bodkin

600 600 Tax 300 300Tax

Balance c/d 372

2,520 360 960 2,520 72 576 1200 300

Balance b/d 372

This is called an analysed cash book.

Remember, the cash book is part of the double entry, so the in debit entries in the cash book are debits in the double entry system. However, their corresponding credit entries for those items have not been. The entries required can be made from the total of each column:

Cr Sales 360

Cr Receivables ledger control account 960

In addition, the memoranda accounts of A Smith and B Bodkin in the Receivables ledger would have to be updated.

Similarly, the credit entries have been recorded in the double entry system, but the corresponding debit entries for those items have not been. The entries required can be made from the total of each column:

Dr Purchases 72

Dr Payables ledger control account 576

Dr Wages 1200

Dr Tax 300



In addition, the memoranda accounts of C Clark and D Drake in the Payables ledger would have to be updated.

5. Cash book with sales tax

Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments)

Total Sales tax

Cash sales

Receivables Total Sales tax

Cash purchases

Payables Wages Sundry

Balance b/d 1,200 Paid toC Clark

404 404

Cash sales 240 40 200 Paid toD Drake

172 172

Received from A Smith

360 360 Wages 1200 1200

Cash sales 120 20 100 Cash purchases 72 12 60Received from B Bodkin

600 600 Tax 300 300Tax

Balance c/d 3722520 60 300 960 2520 12 60 576 1200 300

Balance b/d 372

The introduction of sales tax alters the cells that are shaded.

Assume sales tax is at 20%

On the debit side, cash sales of $240 and $120 were made, but some of these amounts are the sales tax and some the net sales. These have to be accounted for separately.

Gross sales $240; net sales $200; sales tax $40

Gross sales $120; net sales $100; sales tax $20

Cash of $240 plus $120 was received and these amount are in the total column of the cash book.

$300, the total of the cash sale column would be credit to the Sales account

$60, the total of the sales tax column would be credited to the sales tax account.

There is no sales tax implication arising from the amounts received from A Smith and B Bodkin. These are not new sales and are merely these customers paying what they owe.

On the credit side, cash purchases of $72 were made and $72 was paid out. However, only $60 of this was the net purchases; the $12 was sales tax on these purchases.

$60 will be debited to the purchases account

$12 will be debited to the sales tax account

Wages and Tax are not subject to sales tax.

The payments to Clark and Drake are not new purchases so there is no sales tax implications. These payments are simply settling what is owed.



6. Bank reconciliations

The cash account (or cash book) records the movements of cash in the business’s bank account. Of course, there are usually many cash movements and it is easy for errors to be made. Fortunately, banks will normally send regular bank statements to their customers (or these can be downloaded or viewed over the Internet) and, by comparing the bank’s version with the cash book version, businesses have a very valuable way of checking that their bank account contains no errors.

However, often the cash book balance and the bank statement balance will differ because of timing and other differences. For example:

1. The bank might have made interest charges that have not yet been reflected in the cash book.

2. Cheques issued by the organisation and credited to their cash book, might not yet have reached the payee and not yet gone through the bank account (ie not yet cleared).

3. The organisation might have forgotten to enter standing orders or direct debits in its Cash Book, though these will have been paid by the bank.

4. Sometimes if an amount is paid at a different bank, it takes time to make its way to the bank account.

It is therefore necessary to carry out a bank reconciliation to ensure that any difference between the balance shown on the bank statement can be reconciled to (made to agree with) the balance in the cash book.

Bank reconciliations are in indispensable part of the internal control system of a business: cash has many movements and it is a very desirable asset so the accuracy of cash records has to be checked regularly

Here’s an example:

Dr(Receipts) Cash BookCash BookCash Book

Cr(Payments)

Balance b/d 1 May 2013Balance b/d 1 May 2013 1,900 CN 1200 200

CN 1201 150

Paid in 31 May 2013Paid in 31 May 2013 360 CN 1202 388

CN1203 290

Balance c/d 31 May 2013 1,232

2,260 2,260

Balance b/d 1 June 2013Balance b/d 1 June 2013 1,232

[CN = cheque number]

Note CN = cheque number; DD = direct debit; SO = standing order.



Dr Bank Statement - Safe Bank IncBank Statement - Safe Bank IncBank Statement - Safe Bank Inc Cr

12011201 200 Balance b/d 1 May 2013 1,900

DDDD 50

Bank chargesBank charges 5

12021202 290

Balance c/d 31 May 2013Balance c/d 31 May 2013 1,355

1,900 1,900

Balance b/d 1 June 2013 1,355

Note that things seem to be reversed on the bank statement. This is the bank’s document showing its relationship with its customers. If the customer has $1,900 cash in the bank on 1 May then on that date the bank owes its customer $1,900. The customer is therefore a creditor of the bank and this will show a credit balance on the bank statement.

As cash leaves the account then the bank owes the customer less and debits these amounts from the account.

You will see that the closing balances do not agree here: $1,232 compared to $1,355. We have to see if the difference can be explained logically by performing a bank reconciliation.

First compare the two documents and mark off each item which appears on both: they cannot be the cause of any difference.


Cr(Payments)

Balance b/d 1 May 2013Balance b/d 1 May 2013 √ 1,900 CN 1200 √ 200

CN 1201 150

Paid in 31 May 2013Paid in 31 May 2013 360 CN 1202 388

CN1203 √ 290

Balance c/d 31 May 2013 1,232

2,260 2,260


Dr Bank Statement - Safe Bank IncBank Statement - Safe Bank IncBank Statement - Safe Bank Inc Cr12011201 √ 200 Balance b/d 1 May 2013 √ 1,900DDDD 50Bank chargesBank charges 512021202 √ 290

Balance c/d 31 May 2013Balance c/d 31 May 2013 1,3551,900 1,900

Balance b/d 1 June 2013 1,355



Then bring each document up to date for the reconciling items

Bank statementBank statementBank statementBank statementOpening balance 1,355Less: cheques in cash book not yet on bank statement CN 1201 150

CN 1020 388(538)

Add: amount paid in but not yet on bank statement 360

Up-to-date balance 1,177


Cr(Payments)


Direct debit 50

Bank charges 5

Correct bal c/d 1 June 2013 1,177

1,232 Balance b/d 1 June 2013 1,355

You will see that the two balances now agree.


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