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IABBookkeeping1 - page 1 of 1

IAB LEVEL 2 & 3

CERTIFICATE IN BOOKKEEPING

in a retrieval system or transmitted, in a form or by any means, electronic,

mechanical, photocopying, recording or otherwise, without the prior

written permission of AAS Training Limited.

Author: Mr. P R Baron ACCA, IFA, MIMI

Published by:

AAS Training Limited

609/611 Fishponds Road

Fishponds

Bristol

England

BS16 3AA

Introduction

This manual is based on a boarding school, the reason for this is that school

is a familiar environment to most students.

The headmaster of the school Mr. N Wisdom commences in business

initially with a few students, all income and expenditure being in cash.

As the school expends, Mr. Wisdom requires a more complicated

bookkeeping system involving bank reconciliation, VAT and books of prime

entry.

To introduce the concept of control accounts a ’Tuck Shop’ is included, run

by a Mr. G Cole and a ‘school clothes shop’ run by a Mrs. M Rutherford.

In order to produce balances bought forward and carried forward school

terms are used. Where applicable term 1 is the example in the manual, term

2 an example for the student to try and term 3 the assignment.

Please note the objective of this manual is to acquaint you with bookkeeping

principals. In order to practice these principals I would strongly

recommend that you apply to the IAB for past papers and answers.

A further service that we are introducing includes access to our web site at

http://www.skills-4-success.com/. Amongst the many features on the site

includes a multiple choice practice test. Please feel free to access the site,

should you not have a computer you can access via libraries etc and obtain a

hot mail address.

Finally might I take this opportunity of wishing you every success your

studies.

Contents: Sample Course

* first 3 chapters only

CHAPTER 1 ACCOUNTANCY BOOK-

KEEPING,

CONCEPTS AND CONVENTIONS

CHAPTER 2 BUSINESS DOCUMENTATION

AND

CASHFLOW

CHAPTER 3

DOUBLE ENTRY

CHAPTER 4

BANK RECONCILIATION

CHAPTER 5

CASH BOOK

CHAPTER 6

PETTY CASH BOOK

CHAPTER 7

CREDITORS AND DEBTORS

LEDGERS

CHAPTER 8

CONTROL ACCOUNTS

CHAPTER 9

VAT

CHAPTER 10

TRIAL BALANCE

APPENDIX

ANSWERS TO QUESTIONS

CHAPTER 1

ACCOUNTANCY AND BOOKKEEPING

CONCEPTS AND CONVENTIONS

Section 1 Accountancy and Bookkeeping

Section 2 Accounting concepts and conventions

Section 3 Overview of the Bookkeeping Process

Notes

Section 1 Accountancy and Bookkeeping

Introduction

I feel it would be easiest to try and differentiate clearly between

accountancy and bookkeeping, and show the limitations and advantages of

each. Bookkeeping has always been very important but more recently has

become of even greater importance due primarily to the new self-

assessment rules. Typically there is now up to a ?3000 penalty for not

keeping accurate records. The manual will enable you to reach a standard

not only to attain an internationally recognized qualification, but also

equally to be able to keep practical records. The manual has been written

in conjunction with a firm of Chartered Certified Accountants, affording

the student both the academic and practical advantages.

Bookkeeping is in essence recording business transactions on a day to day

basis in financial terms. Accountancy on the other hand uses the

information provided by the bookkeeper for statutory reporting, ie

preparing accounts that are acceptable for Companies House, Inland

Revenue etc, monitoring and performance forecasting.

1 Who has a vested interest to ensure the books are kept

accurately?

(a) H M Inspector of Taxes - H M Inspector of Taxes relies on the

business accounts to ensure that a true and fair assessment of the

tax due is paid to the Inspector of Taxes.

(b) The owners - Owners need to be aware of the financial position

of the company in order that they might determine if they could

possibly put their time to better use for instance being employed

as opposed to self-employed.

1.1

Notes

or a lender will invest money in the business they want to ensure

that the business is able to ie pay the original amount as well as

the interest.

(d) Shareholders - the directors of a limited company are merely

custodians of that company. The shareholders will want to ensure

the company represents a viable proposition when investing in the

company and effectively make sure the directors are doing their

job properly.

(e) H M Customs and Excise - similar to H M Inspector of Taxes

ensuring that the amount of VAT assessed is based on the

accounts presented to H M Customs and Excise, and that their

accounts give a true and fair view of that business.

(f) Suppliers - similar to bank managers and lenders, creditors will

equally need to ensure that the business will be able to pay the

credit given.

(g) Potential Investors - potential investors will need to ensure that

their investment is as safe as possible and indeed that the

proposition is viable; accounts prepared on a going-concern basis

are part of the information that would be needed.

(h) Trade Unions - accounts revealing profits are a boost to morale

and equally can be a good bargaining tool for pay increases.

While lower profit might reveal the necessity for action.

(i) Managers - as a tool to measure performance, company ratios

etc.

1.2

Notes

2 Benefits to the business of keeping accurate records

Apart from those mentioned above, there are far more practical reasons for

keeping accurate records as indicated below:-

1 Amounts owed to the business can be identified.

Details of who owes the business money.

Amounts owed to other companies by the business.

Details of whom the business owes money.

What money has been received by the business.

How the money that has been received has been spent.

To help prevent fines especially with the introduction of self-

assessment.

If all the above information has been recorded accurately it can be used in

many ways to assist the business i.e :-

1 To enhance performance.

To increase control over the business.

To look after the interest of the business (as indicated above, to

provide confirmation of how the business is performing).

1.3

Notes

3 Limitations of Accountancy and Bookkeeping

Accounts and Bookkeeping are prepared on a historical basis. This

means that the event is only recorded in the book when the event has

happened. By the time the accounts are prepared several months

may have elapsed.

As the information is historical: -

! There is no guarantee that what happened in the past will repeat

itself in the future.

! The events have been recorded in the past at past prices, an

adjustment might be necessary to interpret them at today's prices.

! The information is recorded in strict monetary terms, non-

financial information is often not available, including:-

competition in the local area, management structure, financial

arrangements of the company, pending court action against the

business etc.

However, this is not to say an accurate recording of information as

indicated above is not of the greatest importance; what we are

pointing out is that there are limitations, especially when looking to

the future.

Very often, important financial decisions are made on the basis of

the accounts, and the core elements of the accounts are the Profit and

Loss and the Balance Sheet. However, the Profit and Loss and

Balance Sheet are prepared from the bookkeeping process, and

should the bookkeeping process itself be inaccurate, ultimately

inaccurate decisions will follow.

It is for this reason that bookkeeping is most important.

Bookkeeping is the accurate recording of information while

accountancy is concerned more with interpreting the data.

1.4

Notes

There are four accounting concepts (Principles that accountants adhere to

when preparing accounts) at this level that need to be understood. These

are as follows:-

Historical cost

Business entity

Duality

Money measurement

Taking each of these in turn

1 Historical Cost – items are recorded at the price at which they were

originally purchased. A property often appreciates in value, let us

assume that the school was originally purchased for ?100,000

although 10 years later it is worth ?200,000 unless re -valued it will

still be shown in the books as ?100,000 ie the historical cost.

2 Business entity – the business is separate to the owners. This is

clear with a Limited company, as a company is a separate legal

entity. It can do everything in law except marry. It can sue, be sued,

own land and sign documents with its seal. A business with a sole

proprietor or partnership is exactly the same.

ie the owners personal affairs are separate to the Business affairs.

3 Duality – This in essence is double entry, for every credit entry there

is a debit entry and visa versa. This will become clearer as you

proceed through the manual.

1.5

Notes

4 Money measurement – The transactions will need to be recorded in

a common unit, this unit of measurement is money i.e. ?15. Please

note that a limitation of this is that the accounts do not reflect non -

money facts such as potential orders, good management structure etc.

1.6

Notes

Please note this process will be explained in greater detail later in the

manual.

Referring to our diagram, source, prime or original documents.

Source, Prime or original documents are usually documents that need to be

furnished to or by a third party in order to record a transaction i.e sales

invoice or purchase invoice. The documentation needs to be collated then

recorded into books, these books being called: -

Source, Prime or original books of prime entry

Please refer to the diagram for the different types of books. Typical

examples of these books are as follows: -

1.7

Sales Day Book

Purchase Day Book

Sales Return Book

Purchase Returns Book

Notes

After the invoices have been entered into the day books or credit note in the

returns book. There are two further stages to the process:-

1 Each individual transaction is posted to the customer or suppliers

account.

2 Total of all the transactions in the books are posted to the appropriate

ledger account i.e either sales or debtors and suppliers or creditors

ledger.

It is important to realise that as the two main ledger accounts are a

summary of the individual accounts. The total sales figure in the ledger

accounts should amount to the total of sales as per the individual accounts.

As can be seen a sales invoice is entered in the sales day book which is

then entered on the left hand side of the debtors ledger. Customers credit

notes are entered in the sales return book and entered on the right hand side

of each individual ledger, and then again in total in the debtors ledger

account (vice versa for purchases)

Please refer to the diagram below.

1.8

Notes

Purchase Day Book (PDB)

Purchase Ledger

Date Narrative

5/4/9X Returns

Folio

P110

? Date Narrative Folio

20 5/1/9X Purchases P100

180

1.9

1.10

CHAPTER 2

BUSINESS DOCUMENTATION AND

CASHFLOW

Section 1

Business Documentation

Section 2

Monies Paid and Monies Received

Section 3

Other Facets of the Bank Process

Section 4

The Bank and the Clearing System

Notes

In business it is essential that records are maintained accurately, however

there are many different forms of business documentation and these can

include the following: -

Purchase order

Acknowledgement of order

Advice note

Delivery note

Invoice

Credit note

Debit note

Statement of Account

Remittance advice

Please remember failure to keep proper records can now result in a fine of

up to ?3,000.

2.1

Notes

Taking each of these in turn: -

Purchase Order

Normally a supplier will initially furnish a quotation, if the customer is

satisfied he will place an order with the supplier using a purchase order.

Let us assume that Mrs. Rutherford, owner of the School clothes shop,

received a quotation from Hall and Son for blouses and accepted the

quotation, Mrs. Rutherford would then use an official purchase order as

follows: -

2.2

Notes

Please note usually shown on the purchase order are the following: -

An order number or reference number.

A delivery address and indication of time for delivery.

Details of goods and services required with any corresponding

stock or catalogue number.

An agreed price with associated discounts.

Carriage costs if appropriate.

Acknowledgement of order

Upon receipt of the purchase order Hall and Sons would acknowledge

receipt of the official purchase order and confirm in written details of

delivery etc.

Advice Note

An advice note will be sent to the customer prior to delivery advising the

customer when they can expect the goods, the place they are to be

delivered and by what means of transport.

Please find overleaf an advice note from Hall and Sons to Mrs. Rutherford.

2.3

Notes

Delivery Note

The delivery note is very similar to the advice note above. It is enclosed

with the goods. The purpose of the delivery note is for the customer to

check that all goods have been delivered undamaged. The carrier will

usually request the customer to sign a copy of the delivery note confirming

that all goods did arrive in good condition.

Invoices

An invoice forms part of the source documents necessary for recording

transactions and is usually the first notification that the customer receives

with reference to payment for the goods or services. Please find below a

typical invoice.

2.4

Notes

Credit notes

This is raised by the supplier and sent to the customer. It is the opposite of

an invoice, and consequently reduces the debt of the customer to the

supplier. Reasons for credit notes include, faulty goods having been sent

back and overcharging on the invoice.

Debit note

This is similar to a credit note except the customer raises this, and issued to

the supplier, a reason should be given i.e. given faulty goods. In the case of

Mrs. Rutherford this could be due to the fact that some blouses were torn.

2.5

Notes

Statement of Account

Statement of accounts are issued by the supplier on a regular basis, often

monthly, indicating the transactions that have taken place since the last

statement. This is very important as not only does it provide third party

confirmation but equally allows reconciliation’s on a regular basis.

Please find below a typical statement of account.

2.6

Notes

Remittance Advice

This is usually accompanied with the statement and the customer will

usually return the remittance advice with payment. The advantage to the

supplier is that the payment is matched to specific invoices, credit notes,

debit notes etc.

2.7

Notes

Introduction

For the remainder of this chapter we will concentrate on the methods of

payment, receipt of money and the banking system with respect to

businesses, the services that banks offer and the varying types of account

they provide.

Cash

Often small businesses do not require a complicated system for keeping

their records, as the majority of income and expenditure is in cash.

Take a taxi driver for example, the majority of his income and expenditure

being in cash. Quite often the taxi driver will commence a new day with a

float, similar to a Balance brought down on a cash account. Money will be

taken through the day and payments made in cash for expenses.

To reconcile the cash with the days activities a ‘cashing up’ process should

be conducted. How exactly this is accomplished is not important, however

the principles are, and for instance can follow the cash account ie float plus

the income less the expenditure should be the exact amount remaining after

counting the cash at the end of the day.

2.9

Notes

Bank Accounts

When going into business it is always advisable to operate a separate

business bank account, after all this is in compliance with the business

entity concept.

Fundamentally there are two types of business account: -

Deposit or Savings Account

The Current Account

Deposit or Savings Accounts

Often interest will be paid on the balance of these accounts, however if

notice is not given and withdrawals made on demand this might jeopardise

the interest received.

To operate the account a paying-in slip is available, no cheques are needed.

To withdraw money transfers can be made between accounts or the sum

could be withdrawn in cash.

Often in business large regular payments are required, ie income tax twice

a year, VAT four times a year.

In order to ‘soften the blow’ of such payments it might be advisable to

establish a deposit or savings account. Every month transfer an amount in

order to cover these payments, earn interest on the balance, and at the end

of the period i.e. every three months, transfer sufficient back to the current

account to pay for the liability, i.e. VAT, and twice a year transfer

sufficient back to cover the tax liability.

2.10

Notes

Current Accounts

The facilities associated with a current account are as follows: -

Cheque book and paying in book

Cheque guarantee cards

Debit card

Direct debits/standing orders

Frequent bank statements

Cheques

Cheques are a very popular method of paying bills when compared with

cash, it is a safer method and the sum can be varied. The definition of a

cheque is as follows: -

‘A cheque is a document signed by the drawer authorising the

bank to make payment of a specified amount to the payee’

When a cheque is received by a business it is good practice to make checks

for certain errors: -

Do the words and figures agree?

Is the date correct?

If changes have been made have they been initialled?

Is the cheque signed?

Please find overleaf reproduced for your convenience a copy of a cheque,

paying in slip and standing order form: -

2.11

Notes

Notes

N.B. cheques will be listed on the reverse of both the paying in stub and

slip.

Standing Order Authority

Bank

__________________ Branch Address

__________________

Signature(s) ______________________________ Date

________________________

Note : The Bank will not undertake to :

________________________________ (i) make any reference to Value Added Tax or

other indeterminate element

(ii) advise payers address to beneficiary

(iii) advise beneficiary of inability to pay

(iv) request beneficiary's banker to advise

beneficiary of receipt

|if the amount of the periodic payments vary they should be incorporated in a schedule overleaf

2.13

Account Number

Notes

Cards

Although not normally associated with a business, a cheque guarantee card

can support a cheque.

The card can guarantee cheques up to ?250 depending upon the type of

card used. Upon receipt of the card check if the cardholder, the signature

and account details and expiry dates are correct. After checking the card

number, this number should be written on the reverse of the cheque.

However a cheque guarantee card can also be used for other purposes, ie as

a: -

1 Cash Card

2 Debit Card

3 Credit Card

We will now explain these in further details: -

1 (ATM’s) or Automatic Teller Machines are very common not only

are these cash machines outside banks but also supermarkets

shopping malls and even in airports. These machines are very

useful, they are open 24 hours and also allow the withdrawal of cash,

order of cheque books, statements and even gain up to date balances.

2 Debit Cards the debit card acts in much the same way as a cheque.

The payment shows up straight away on the statement and is debited

to the customers account in the same way. It is however just as

important to carryout certain checks these will include checking the

customer signature, expiry date etc.

2.14

3 Credit Cards are very similar to debit cards except they offer the

cardholders credit. Goods or services can be purchased and the

transactions entered onto a statement. If paid within a specific time,

usually 1 month, there is no interest charge otherwise the interest

accrues on a monthly basis.

There is a facility for a minimum payment to be paid usually very

low however, if the balance exceeds the specified time then interest

will continue to accrue.

Automatic Payment

These are payments that are automatically processed. A service the banks

offer is to make regular payments on your behalf. The amounts can either

be fixed or variable and can either be for a varied or specific time period.

In order to enact this, the banks have developed a system called B.A.C.S.

(Bank Automated Credit System)

In order to be as flexible as possible there are three various methods of

payment: -

Autopay

Standing Orders

Direct Debits

We shall explain a little further about these in turn.

1 Auto pay – this system is used where regular payments are

needed possibly to several regular payees with variable

amounts. The system is ideal for employers. In order to make

the transfer, details of the payee’s bank is required. The

company then informs the bank of the payment to each payee

and thus payment is then made.

2 Standing Orders – This is a convenient way for customers to

pay regular fixed amounts. In order to enact this the customer

2.15

Notes

Notes

will need to complete a mandate form, which authorises the

bank to make the payment on their behalf. Typical examples

of payments made using this method are Loan repayments,

Mortgage repayments and inter account transfers.

Direct Debits – This is a convenient way for customers to pay

regular flexible amounts. In order to enact this and as the

amounts are variable and determined by the payee, ie mobile

phone bills the payee completes the mandate. Quite naturally

as the amounts per payment can vary the customer should

ensure accuracy.

2.16

Notes

Bills of Exchange

A Bill of Exchange in essence is a piece of paper indicating that by a fixed

future date a fixed sum will be paid to a particular individual.

A Bill of Exchange is a guarantee that payment will be made

The fixed future date could be for instance 3 months away. Often

individuals for cashflow reasons find it difficult to wait so long. The bill

can be discounted by the bank ie the bill could have a face value of

?100,000 the individual would negotiate with the bank to only pay for

instance ?95,000 immediately. Consequently when the bill matures and the

funds are due for release, the bank will receive the ?100,000 charging in

essence the ?5,000 for early payment.

The bank would only undertake such an exercise as it s a guaranteed form

of payment and the banks know they will receive their money.

Credit Sanctioning

It is very common for an individual or business to require an overdraft,

personal loan or business loan. This is known as working capital. St

Swithens when they commenced in business required an overdraft which

was used to help finance the day to day running of the school ie paying

bills, buying equipment, buying books, paying wages etc.

However to access the facilities, such as an overdraft, personal loan or

business loan are by no means automatic.

The bank has a set procedure and in order to obtain these facilities the bank

scores the clients. The banks introduced the scoring system, to ensure that

the manager became less personally involved. Quite simply if the customer

did not obtain a certain score the manager was duty bound not to release

the funds.

2.17

Notes

Although as individuals we are not privy to such a list and a scoring

scheme, we are aware of the various questions that are often asked.

These can include the following: -

1 What is the credit worthiness of the client how long has the bank

known the client. Has that client ever defaulted on any payments or

had any bounced cheques or exceeded an overdraft limit in the past.

2 For what purpose is the loan/overdraft required. If the loan is for

personal reasons, i.e. for double-glazing for their home, then a

different set of criteria will be used than if it was to be used for a

business.

3 Can the customer make the repayments? If for instance a personal

loan is being sought, and there has been no change in circumstances

and a repayment of say ?230 per calendar month is being replaced by

a loan of ?200 per calendar month. Then there should be every

reason to believe that the repayments will be made. However if the

individual is going into business, it is not quite so clear if the loan

repayments will be met and consequently the bank manager will

require further information.

When St Swithens went into business, it was very hard to predict

exactly how many pupils the school would receive and therefore in

order to gauge the viability of a business venture, often a bank

manager will require a cashflow.

(Although a cashflow is not part of this syllabus, it is in simplistic

terms a flow of cash split into time intervals. The bank manager

would require perhaps a 12 monthly cashflow looking at each month

in turn the actual receipts in cash and payments in cash going out for

each month. Quite naturally if there is a surplus at the end of the

period, taking in to account the overdraft facility, sufficient to not

only service the loan repayments but also the personal drawings of

the business man/women, this would act in favour of the customer)

2.18

Notes

4 The history of the client especially if the client is known to the bank,

the bank manager will look at any previous loans or overdraft

facilities to see that they have been serviced properly, final payments

have been made etc. If the client is new to the bank manager or

indeed to the bank he will often require 6 or even 12 months bank

statements from the previous bank to ascertain whether an agreed

overdraft limit has been exceeded or if cheques have bounced.

5 Collateral. The banks will not only look at serviceability although

that has become more important in recent years; the banks will also

look to the final repayment of the loan and will look at the worse

scenario.

Let us assume for instance that the businessman is unable to repay

the loan or indeed the individual is unable to repay their personal

loan. The bank will look to retrieve this money and indeed will look

for instance at how this loan could be repaid. If the loan is

substantial enough this could easily be repaid perhaps after selling an

asset of the clients.

The easiest asset to attach for an individual, sole trader or partnership

is on a fixed asset such as a house or land and property. This can

easily be done at the land registry office and the property is not

allowed to be sold until the proceeds have first been paid to the first

charge holder, that could be the bank.

For a limited company, which we will concentrate more in the

Intermediate level, there is security known as a floating charge. This

is a charge over the general assets of the company and consequently

the banks could quite easily appoint a receiver ie a person who could

go into the business and sell certain assets of that business such as

cars, stock etc in order to repay the loan. Alternatively, the bank

would look to a personal guarantee, this is someone who has

sufficient assets and is able to repay the loan, to guarantee that

should any thing go wrong, the individual who is acquiring the loan,

will in the worse sinario pay the outstanding balance.

2.19

Notes

Referees and references. Quite naturally if a loan or overdraft facility

was required then it would be reassuring to the lender if they could contact

either referees or references from previous lenders.

Despite the fact that this is the banks system, any businessman who extends

credit to its customers should carry out similar checks. There is a cost in

the time taken in order to achieve this, consequently if the customer is only

requiring a very small amount of credit and it is more or less a one off then

it might not be expedient in time resources to conduct such a thorough

check. However certainly there should be a facility in place for customers

requiring credit over a certain amount and should in essence be credit

sanctioned.

ACTIVITIES 2.3

Explain a bill of exchange.

List the points a bank manager might need to

consider when offering a loan.

2.20

From you own personal experience you might appreciate that although you

write a cheque today it does take some time for it to appear on your bank

statement. This is commonly caused by the clearing system.

The clearing system is the method of payment from one bank to another

You might equally have heard of the term clearing banks. These constitute

your four main high street banks, that is Lloyds Bank, Barclays Bank,

HSBC (formally Midland Bank) and National Westminster Bank.

However this is not to say that other banks do not use their clearing system,

due now to the greater freedom of the banks and also the recent trend of

building societies forming as banks. Typical examples of other such

organisations that use the clearing system can include Abbey National and

Halifax of the building societies, and other less well known banks such as

Williams and Glin, Coutts and RBS.

Why is clearing essential?

One great advantage of using a bank ie cheques or standing orders as

oppose to cash, is the great flexibility that cheques or standing orders allow

the individual in making or receiving payments. In order to meet all the

demands of cheques or standing orders a tremendous sum in cash would

need to be carried around. Also a tremendous amount of travelling would

need to be undertaken.

Today for instance I have written a cheque to my brother in London, if it

were not for the banks and the clearing system, I would in essence have to

take this cash to London. Not only would there be safety implications but

2.21

Notes

Notes

equally a consideration to the time element. Quite naturally although fairly

flexible there will inevitably be a time delay in me writing a cheque today

and my brother receiving the funds in his bank in London. In order to help

facilitate this process a centralised system is used. I indicated to my brother

that it would take several working days for the cheque to clear. This is

because there is a set procedure in the centralised banking system.

The stages of the process are as follows: -

I pay a cheque to my brother in London he then banks this cheque in his

local account in London.

The local branch upon receiving this cheque enters this into my

payees account as an uncleared item. (They will do this as at this

stage they are not satisfied that there are sufficient funds in my

account to actually pay this amount)

The cheque is then sent to the head office, which will be a clearing

bank.

The clearing bank will then process the cheque and send it to the

head office of my account.

The head office of my bank will then process the cheque and pass it

onto the branch to ensure there are sufficient funds in that account.

My account is then reduced by this amount,

Once the funds have been transferred to my brother’s account the

funds are no longer uncleared.

2.22

CHAPTER 3

DOUBLE ENTRY

Section 1

Introduction to Double Entry

Section 2

Completing the Double Entry

Section 3

Ledger or T Accounts in more Detail

Section 4

The Accounting Equation

Section 5

Columnar Accounts

Notes

Book-keeping is recorded by using T accounts or ledger accounts. The

accounts are known as T accounts as this is what the account looks like.

Please refer below:

The reason why we refer to Bookkeeping as double entry is because every

entry is entered twice, once on the left - hand side and a corresponding

entry on the right hand side i.e. the concept of duality.

It is often easier to refer to the left hand side as the 'in' side and the right

hand side as the 'out' side i.e.,

OUT

Let us assume for simplicity that a business operated only in cash, the

business did not owe money, and money was not owed by the business. If

this business operated a till the following T account could represent the till.

The T account is called a Cash Account - all income being recorded on the

left (IN) side and all expenses on the right (OUT) side.

3.1

Notes

Please find below cash transactions for the first term: Mr N Wisdom being

the tutor with two pupils initially.

Our aim is now to draw up a simple profit and loss account. However, what

should be included in a profit and loss account?

All items of business income including income from fees.

All items of business expenditure. Business expenditure

incorporates such items that are wholly and exclusively for the

use of business. In essence, any item of expenditure that is

incurred in order to derive the business income.

Please note, initially we will produce a Profit and Loss account using single

entry from the Cash Account and then show how these figures are derived

using double entry

We are now, with this business, able to prepare a simple Profit and Loss

account.

3.2

Notes

A Profit and Loss Account summarises all the income and expenditure of a

business for a certain period under appropriate headings as follows:

Please note:

Personal drawings are items of expenditure that do not relate to the

business. i.e. if a carpet was purchased by Mr. Wisdom for his home,

this would be entered as 'drawings'. They are not shown in the Profit

and Loss account because personal drawings are not a business

expense but relate to private expenditure.

The figures in the cash book are only single entry; the same figures

are not entered anywhere else.

3.3

Notes

3 The figures on the Profit and Loss account have been reversed. On

the cashbook the ?4000 was on the left (i.e coming into the business)

while on the Profit and Loss it is on the right and equally with the

expenses the entry for the cash book was on the right i.e going out of

the cash book yet being entered on the left of the Profit and Loss (i.e.

an expense).

4 The parentheses around the Total Expenses indicate that it is a

negative value. This is the standard way by which we denote

negative values.

3.4

Notes

Please refer to the original cash book. Remember for each left hand entry

there must be a right hand entry and vice versa

N.B. The dates by each entry represent the order in which the entries are

made i.e. 1/9/XX entry would be entered before 31/12/XX.

3.5

Notes

3.6

Notes

3.7

Notes

3.8

Notes

Points to note about the example:

1 For each entry there is a corresponding entry on the opposite side.

2 Both the Profit and Loss and Balance Sheet have initially been drawn up

as T accounts.

3 The Profit and Loss Account relates to a period i.e. all the transactions

for a period of time are summarised in the Profit and Loss (i.e. all the

income and costs). The period usually relates to one year.

4 The Capital Account represents the owner's view of the business.

5 The Balance Sheet is at a certain point in time (i.e a snap shot of the

business).

6 If the business is not subject to credit (i.e a time delay between the

invoice and the payment) the process regarding expenses is as follows:

a) Entry on the 'out' side of the cash account payment for

each item (i.e 'out' side of cash account for food 9/9/XX

?500, 10/9/XX ?95, 1/11/XX ?55).

b) Corresponding entry on the 'in' side of the appropriate

expense account (i.e 'in' side of food T account 9/9/XX

?500, 10/9/XX ?95, 1/11/XX ?55).

c) Add all of these individual expense entries on that

account (i.e Food = ?500+?95+?55 = ?650) together

relating to the profit and loss period and enter on the

'out' side of that expense account, this total i.e. ?650.

d) Enter on the 'in' side of the Profit and Loss Account this

entry i.e total cost for the period equals ?650.

e) Vice versa for income.

f) As all the entries have been entered in the T accounts,

totaled and transferred to the Profit and Loss account

for

3.9

Notes

that period there should be no balance at the beginning

the next period for these profit and loss accounts

Please note all the accounting concepts already discussed have

been implemented ie:-

1 Historical -

Food of ?500 was recorded when purchased as

at 9/9/XX not at the period end price.

2 Business Entity - The capital account represents the owners

interaction with the business. Profit earned by the

business is credited to the Capital Account,

drawings is in effect a debit entry, a reduction of

the profit owed.

Duality -

Double entry.

4 Money Measurement -All recorded in sterling

Well Done!! You have just completed your first Profit and Loss and

Balance Sheet through Double Entry.

3.10

Notes

Name of the account:- This should identify the account. If it is a

stationery account it should be headed "Stationery".

Date: - This should be the date of the transaction.

Detail: - Comments included in the ledger usually relate to corresponding

entry (i.e. the opposite account).

Fo: - Short for folio number - acts primarily as an audit trail i.e if the

account is numbered the number of the corresponding account will be

entered in the folio column. Can also be used to note page numbers. An

audit trail is a numbered list corresponding to each transaction.

?: - Amount in money terms of the transaction.

3.11

Notes

Terminology

Balance c/d - is short for balance carried down. To calculate the balance

c/d this is done by adding both 'in' and 'out' columns. The largest is placed

at the bottom (double underlined) on each side and the other side is

subtracted from this to find the difference.

i.e.

Balance b/f - is short for balance brought forward i.e. we are bringing down

the balance that has been carried down from a previous period. Please

note this is always on the opposite side to the carried down figure.

Referring to the example above, the larger monetary transactions were on

the right side; the right side totaled ?190 while the left side totaled ?140,

consequently the Balance c/d (carried down) is equal to ?190 minus ?140

on the left side = ?50. This balance is carried forward on the opposite side

(right hand side in this case) when we open the account next period.

Left hand side (or in) - this is known as the debit side

Right hand side (or out) - this is known as the credit side.

3.12

3.13

The left hand side of the T account usually represents:-

An asset.

An expense.

Reducing a liability.

The right hand side of the T account usually represents:-

A liability.

Revenue (such as sales).

Reducing an asset.

3.15

Notes

If you refer to the earlier Balance Sheet you will see Assets of ?2830 =

Capital of ?2830.

i.e.

Assets = Capital

Resources of the business = Owners interaction with the business

Please also note the equation can be written as

Assets – Liabilities = Capital

If we were to reproduce a Balance Sheet (please refer to the pro-forma) it

could look as follows:-

3.16

Notes

For definitions of Fixed Assets, Current Assets, Current Liabilities, Long-

term Liabilities and the Capital Account please refer to the glossary of

terms.

3.17

Notes

3.18

Notes

There are accounting equations, for example

Assets = Capital

Assets are resources of the business.

Capital is money or other items such as computers invested in the business

by the owner.

If the owner borrows money, this is a liability, the equation then becomes

Assets = Capital + Liabilities

Or as often presented in Accounts

Assets – Liabilities = Capital

If the owner invested a computer in the business worth ?5,000 and also

borrowed ?3,000 deposited in a bank account, the business would have as

assets ?5,000 computer and ?3,000 in a deposit account. ?5,000 as capital

introduction and ?3,000 as loans.

Assets

= Capital + Liabilities

?5,000 + ?3,000

= ?5,000 + ?3,000

?8,000

= ?8,000

Continuing with our school by term two it was felt wise that a Bank

account be opened. There was also one extra student.

In reality there is one extra account, that of the Bank. Again treat this

account as we did the cash account - entries on the Debit (left side) for

deposits into the account, and entries on the Credit (right side) for

payments out of the account.

3.19

Notes

Please find below an example. Please attempt this and then look at the

answer. This will probably be your first attempt at double entry; it is very

confusing so please do not hesitate to contact your tutor should you require

assistance.

Deposit into Bank account 3/1/XX

?6000

Paid cheque for cash

3/1/XX

?500

Paid cheque for food

3/1/XX

?250

Paid cheque for telephone 21/1/XX

?120

Paid cash for stationery 21/1/XX

?55

Paid cash for petrol

28/1/XX

?15

Paid cheque for food

8/2/XX

?450

Paid cash for food

15/2/XX

?35

Paid cheque for drawings 15/2/XX

?850

10.

Paid cheque for books 28/2/XX

?1150

11.

Paid cash for drawings 15/3/XX

?2500

12.

Paid cash for car repairs 15/3/XX

?125

13.

Paid cheque for electricity 20/3/XX

?625

N.B. when opening your ledger account, if applicable please be sure to

bring the balances forward on the correct side.

i.e Debit side cash account 2830

Credit side capital account 2830

3.20

Notes

3.21

Notes

3.22

Notes

3.23

Notes

3.24

Notes

Bank Account

Date

Detail

Fo ? Date

Detail

31/3/XX Balance b/f

2055

Capital Account

Date

Detail

Fo ? Date

Detail

31/3/XX

Balance b/f

2655

Please note: after all the transfers have been made, these are the accounts

that have a balance remaining on the left hand side or right hand side, not

only will the total of the left hand side amounts equal the right hand

amounts i.e. ?600 + ?2055 = ?2655, the balances will also form the

opening balances of the next period.

3.25

Notes

Remember the equation Assets = Capital

3.26

Notes

Above are in essence the accounts i.e. Profit and Loss Account and Balance

Sheet for the second term. Before we ask you to attempt a question I feel

certain points and terms require greater explanation. These are explained

below

1 Profit and Loss Account

(a)

Income - monies earned by the business from all sources, this

might include the main core business i.e fees from students and

other sources such as rental income etc.

(b)

Expenses - these relate to costs of obtaining the income and are

incurred in the day-to-day running of the business. These are

known as Revenue Expenditure and will include all those

items of expenditure as included in our Profit and Loss Account.

(c)

Please note a Profit and Loss Account relates to all the income

and expenditure relating to that period; these are added together

and summarised in the Profit and Loss for that period.

3.27

Notes

2 Balance Sheet

(a) Unlike the Profit and Loss Account it is important to remember

that a Balance Sheet is a 'snap shot' of the business at a moment

in time.

(b) Fixed assets - an asset (i.e. an item of value to the business) that

will be retained by the business. Fixed assets include motor

vehicles, fixtures and fittings i.e. retained for usually at least one

year.

that will not be retained by the business and will have changed

by the next Balance Sheet date (i.e. stock, cash in hand and

bank). Debtors, these usually change on a weekly basis and

therefore count as current

(d) Current liabilities - a liability (i.e. an item owed by the

business) that again will change frequently, definitely by the

next Balance Sheet date.

(e) Long term liabilities - a liability (i.e an item owed by the

business). This item will not normally change frequently - an

example is an interest-only loan.

(f) Capital Account - to understand the Capital Account, the

business should be viewed as separate from the owner, the

Capital Account being a record of what has happened between

the owner and the business.

The Capital Account usually has a credit (right hand) balance;

remember a credit can indicate a liability. The capital of the

business is a liability to the business as it is owned by the owner.

Similarly if a profit is earned this is not owned by the business

but by the owner, and again is a credit entry as it is a liability to

the business. Should the business make a loss then the opposite

applies.

3.28

Notes

Drawings are taken by the owner for personal use and therefore

reduce the capital owed to the owner. Hence, this is a debit entry

in the Capital Account

We have so far mainly concentrated on cash transactions. If the owner

introduced a motor vehicle at the start of the business how would this be

recorded? The owner has not sold the vehicle to the business for cash. The

vehicle is an asset. We therefore debit (enter on the left-hand side) the

vehicle in the motor vehicle account. Which account do we credit? We

can not credit cash as no cash has left the business - instead we credit the

Capital Account, by crediting the Capital Account we are acknowledging

that the owner has introduced these items into the business. These items

should be introduced at the current market value of the assets i.e. let us

assume for instance that the owner of the school introduced at the

beginning a motor vehicle ?2500 and a cash register for ?1200. The

appropriate entries would be as follows:-

3.29

Notes

(g)

Debtor - a debtor is an asset to the business as it is money due to

the business that is likely to change frequently e.g. if one of the

students parents suddenly became unemployed and could only

afford to pay ?1000 now and a further ?1000 next term the

?1000 remaining is a debtor (i.e. money owed). It is a current

asset as it will change by the next Balance Sheet date and is an

asset as it has value to the business.

(h)

Creditor - a creditor is a current liability to the business as it is

money owed by the business. It is likely to change frequently,

for instance, if not all the books could be paid for because not all

the fees were paid, and instead only ?500 was paid, for the

books the remaining ?650 at the term end would be considered

as a creditor under current liabilities.

(i)

Drawings - this is the amount drawn out of the business by the

owner, often in money, or in goods or services for personal use

(i.e. equivalent to an employee taking wages).

3.30

(g)

3.31

Notes

Notes

We have looked in detail at double entry, an alternative way of recording

transactions is using columnar accounts. You will notice that columnar

accounts are very similar to T accounts as indicated below:-

Account Name

As can be seen the columnar accounts record exactly the same as T

accounts except the format has changed. With T accounts it is obvious if

the balance is a debit or credit, with columnar accounts this will need to be

indicated.

To illustrate the columnar accounts as with the previous example, pay a

?265 telephone bill from the bank.

3.33

Notes

The main advantage of the column accounts is that you do not need to

balance off the accounts. A running balance is maintained in the balance

column. However due to the layout it will be important to indicate if the

balance is a debit or a credit.

Please note, the double entry principle still applies should you feel you

need practice with columnar accounts please attempt the previous question;

however, only do this after first ensuring that your answer was correct.

ACTIVITY 3.6

a. Please give an advantage of column accounts.

3.34