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20 02
22 1
Recording Financial
Transactions
(FA1)
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1
FA1 Recording Financial Transactions
1.
Types of Business Transactions and Documentation
3
2.
Recording business transactions within the accounting and double entry system
21
3.
The day books and the Journal
43
4.
Cash Transactions
53
5.
More on sales and receivables
67
6.
More on purchases and payables
79
7.
Trial balances and correcting errors
85
8.
Labour Costs and Remuneration Methods
95
Answers To Examples
101
Answers To Tests
109
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2
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3
Chapter 1
TYPES OF BUSINESS TRANSACTIONS
AND DOCUMENTATION
1.
Introduction
This chapter gives a brief introduction to organisations, accounting documentation, and computerbased accounting systems.
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 from 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.
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All to these transactions are summarised at the end of accounting periods into two statements:
Statement of financial position Assets (amounts owned) and Liabilities (amounts owed).
Income statement
Income (such as sales) less expenses (such as rent, wages,
electricity, raw materials). If income is greater than expenses, a
profit will result.
In the statement of financial position, assets are divided into:
Non-current assets
such as equipment, premises, motor vehicles. These are kept longterm in the business.
Current assets
such as inventory (stock) receivables or cash. These either are cash
or will become cash within 12 months.
Liabilities are divided into:
Current liabilities
such as amounts that have to be paid to suppliers (trade payables).
These liabilities have to be settled within 12 months.
Long-term liabilities
These don’t have to be settled until at least 12 months time
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 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.
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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.
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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.
Example 1
What are the two main documents produced at the end of accounting periods and what
appears on each?
Question 1
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 2
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
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4.
7
Coding systems
It is universal practice in accounting systems to use coding systems to refer to customers, suppliers,
accounts and employees. Codes are used because they are concise and precise, and can be subject to
computer checking
Concise:
Instead of referring to a product as a “50cm high resolution LED
monitor”, the product is given a code such as 50HRL. This is much
quicker to write or type.
Precise:
There might be several makes of 50cm high resolution LED
monitors and information might be confusing and ambiguous if the
manufacturer (Sony, Panasonic, Samsung LG etc) wasn’t specified. A
code number can therefore be used to ensure that products and
people are referred to uniquely eg 50HRLLG.
Automatic processing.
Codes can also help in processing transactions. For example if all
income-related accounts have the structure 1xxxx, all expenserelated accounts have the structure 2xxxx, all asset-related accounts
3xxxx and all liability accounts 4xxxx, then this will help the
production of the income statement (all 1xxxx amounts less all
2xxxx amounts) and the statement of financial position (3xxxx as
asset amounts and 4xxxx amounts as liabilities). This is particularly
needed in computerised accounting systems because the
computer cannot understand that, say, rent is an expense, but
doesn’t need this understanding so long as rent is coded, say
21892. Because it starts with ‘2’ it will be treated as an expense.
Checking:
If all inventory codes are 7 digits long then forms and input screens
can be designed for this. Computers can check that all 7 digits are
present, and sometime more sophisticated checks can be carried
out on the structure off the code. This reduces the chance of errors.
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5.
8
Different methods of coding
There are several methods of coding. Codes should be:
๏
Simple to use
๏
Understandable
๏
Concise
๏
Precise
๏
Expandable
Sequential codes
In this method products or customer are simply allocated numbers in sequence:
0001
0002
0003
.
.
.
Abrahams
Adkins
Ahmad
This is simple and concise, but as constructed might have some faults:
(1)
There is no relationship at all between the code and the item/person being encoded.
(2)
Expansion might be difficult once you have over 9999 customer if documents and computer
files can hold only four digits. Additionally, if someone called Affleck becomes a customer, he
will have to be tagged onto the end of the sequence ie not reflecting alphabetical order. To
avoid this problem, often sequence codes proceed as 0010, 0020, 0030…etc so that gaps are
built in for future use.
Hierarchical or significant digit codes
In a business, hierarchical codes could be used to code the accounts in the general ledger. For
example a code such as 3112 could be interpreted as the Machinery Cost Account, using the following
system.
3
1
1
1 = expenses
2 = income
3 = assets
4 = liabilities
1 = non-current
assets
2 = current assets
1 = cost
2 = accumulated
depreciation
2
1 = property
2 = machinery
3 = office
equipment
4 = motor vehicles
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The great advantage of this type of code is that its structure provides information both to human
users and to computers. For example, it would be easy to program the compute to work out the total
cost of all fixed assets: simply add up all accounts starting 311.
Block codes
These lie somewhere between simple sequence codes and the full, detailed hierarchical code. They
start off giving some information but then lose enthusiasm. So for general ledger codes you might
have
1xxx = expenses
2xxx = income
3xxx = assets
4xxx = liabilities
You will see in the next chapter that accounting systems rely on double entry bookkeeping. There it is
essential that the accounting entries made are precise and before transactions are recorded in the
system it would be normal to attach codes to the transactions.
Illustration
When a purchase invoice is received from a supplier, three codes would normally be
needed:
• The code number of the supplier
• The code number of the account which describes the purchase net of sales tax
• The code number of the input sales tax.
These codes will allow all the required information to be recorded in the ledger system
Question 3
A company uses the following hierarchical system:
1 = expenses
2 = income
3 = assets
4 = liabilities
1 = non-current assets
2 = current assets
1 = cost
2 = accumulated
depreciation
1 = property
2 = machinery
3 = office equipment
4 = motor vehicles
Which of the following correctly codes for the accumulated depreciation on cars? [Note: cars are
non-current assets]
A
1212
B
4124
C
3124
D
2133
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Question 4
A company uses a block code with the following structure:
1xxx = expenses
2xxx = income
3xxx = assets
4xxx = liabilities
Which on of the following accounts should not appear in the statement of financial position?
A
4321
B
3214
C
2234
D
3123
Question 5
What is the name given to a code in which the level of detail increases in a logical way as you
work through the code?
A
Sequence
B
Hierarchical or significant digit
C
Faceted
D
Block
Example 2
List three advantages of using coding systems
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6.
11
Examples of business documentation
6.1. Sales invoice
Invoice
XYZ Supplies Ltd
32 Low Road
Daventry
To:
Account Number 12938
Invoice number 2293
ABC Company
12 High Street
Greenfield
GR12 45H
Date 28 February 2013
Your order 12346
Part
number
Description
Quantity
Unit price
Value
$
3531
3m iron
3
20.00
60.00
6840
9.5m copper
5
50.00
250.00
Total Net
Sales tax
310.00
20%
Total Gross
62.00
372.00
Terms = 30 days from invoice date
Sales tax registration number 48480132
The invoice shows:
๏
Who it is from (XYZ Supplies Ltd)
๏
A unique invoice number (2293)
๏
Who the customer is (ABC Company)
๏
Customer’s account number (12938)
๏
Date of the invoice (28 February 2013)
๏
The customer’s order number (12346 – so that the customer can link it to goods ordered)
๏
Details about goods ordered and now invoiced on this document
๏
Net total, sales tax (VAT) and gross amount due
๏
Terms setting out when the invoice has to be paid by.
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6.2. Credit note
Credit note
XYZ Supplies Ltd
32 Low Road
Daventry
To:
Account Number 12938
Credit note number 159
ABC Company
12 High Street
Greenfield
GR12 45H
Date 15 March 2013
Against invoice 12346
Part
number
3531
Description
3m iron
Quantity
1
Unit price
20.00
Total Net
Sales tax
Total Gross
Value
$
20.00
20.00
20%
4.00
24.00
Sales tax registration number 48480132
A credit note is like a negative invoice. Credit notes can be issued to correct errors (for example if a
previous invoice had used a price that was too high) or to reduce the value of the goods invoiced
previously (for example, if were faulty).
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6.3. Statement of account
Statement of account
XYZ Supplies Ltd
32 Low Road
Daventry
To:
Account Number 12938
ABC Company
12 High Street
Greenfield
GR12 45H
Date 31 March 2013
Date
Reference
Debit
Credit
B/f
Balance
0.00
28/2/2013
Inv 12346
6840
CN 159
372.00
372.00
24.00
c/f
348.00
348.00
Sales tax registration number 48480132
When ABC Company pays the amount owing to XYZ Supplies, it will prepare a remittance advice
showing that is paying Invoice 12346 less the amount given in credit. This allows XYZ to keep track of
exactly what has been paid and what hasn’t.
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6.4. Petty cash voucher
Petty cash voucher
XYZ Supplies Ltd
32 Low Road
Daventry
Voucher number 11234
Date 15 February 2013
Description of expenditure
Light bulbs
12.00
Gross amount
12.00
Sales tax @ 20%
2.00
Net amount
10.00
Claimed by
A Smith
---------------------------------------------
7.
Amount
Authorised by
B Boss
---------------------------------------
Discounts
There are two types of discount that can be offered to customers:
A trade discount (also known as a quantity or bulk discount). This is a simple reduction n the price
of the goods. For example, 10% might be offered if at least 10 units are ordered and 20% if at least 100
units are ordered.
A cash (or settlement) discount. This is offered on the condition that payment is received quickly
enough. For example, terms might state that a 5% discount is given provided payment is received in
less than 30 days. This discount encourages prompt payment.
8.
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).
The 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 that is charged
by the supplier.
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.
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Illustration
If sales tax is at 20%, then the cost structure would be:
Net amount
100
+
sales tax
20
= Gross amount
120
Once that is established then you can easily move between any of the sales figures using
proportions
1)
Net amount = 280: therefore
Net amount
100
+
280
sales tax
20
= Gross amount
120
?
?
sales tax = 280 x 20/100 = 56, and
gross amount = 280 x 120/100 = 336
2)
Tax = 40: therefore
Net amount
100
+
?
sales tax
20
= Gross amount
120
40
?
net amount = 40 x100/20 = 200, and
gross amount = 40x 120/20 = 240
3)
Gross amount = 840: therefore
Net amount
100
+
sales tax
20
= Gross amount
120
?
40
?
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 from the government.
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Question 6
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 7
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 8
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
3,400 to be received from the government
D
3,600 to be paid to the government
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9.
17
The functions and benefits of a computerised accounting
system
Most accounting systems are now computerises and these systems should offer the following
advantages over manual systems:
๏
faster provision of information
๏
provision of information that would not be easily available without a computerised accounting
system
๏
once the system is set up, cheaper information
๏
more accurate information because arithmetic and certain other errors will be eliminated.
Of course sometimes things go wrong and systems break down or incorrect information is produced.
IN particular, if incorrect data is entered, incorrect information will be produced (garbage-in, garbageout, GIGO).
A computerised accounting system can be represented as:
Input of
data
Processing
data
Output of
information
Computer files
For example:
Input:
Orders are input over the internet
Processing:
Prices are accessed on a product file and the order value worked out.
The customers’ account in the receivables ledger (now held on a computer file) is debited.
Inventory records (now on a computer file) are updated.
Output:
An invoice is printed for the customer.
Despatch information is displayed on a screen in the warehouse to show the goods that
have to be sent.
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In general there are two types of processing that can be carried out: batch processing and real-time
on-line processing.
Batch processing:
transactions are accumulated into batches and then all processed
together. Because transactions have to be accumulated it means
that there is a delay in processing them so the information held in
the accounting system is generally out-of-date. For example, if sales
transactions were accumulated during the week and processed to
the receivables file on the last day of the week, for most of the time
the balances shown owing from each customer would be
understated. The balances would be correct only just after
processing. Batch processing is not so common now.
Real-time, on-line processing: ‘real-time’ means that files are updated as transaction happen; ‘online’ means that the files are permanently accessible to be updated.
For example, when you withdraw cash from a cash machine, the
machine can access your bank account record (it is on-line) to see if
you have the funds. When you take the money out your bank
account is immediately updated (real-time).
10. Accounting documents and management reports
produced.
Many accounting documents and reports will be routine: invoices, statements, sales analyses,
monthly sets of financial statements. However, computerised accounting systems excel at producing
exception reports.
Exception reporting is the concept of directing managers’ attention to areas of operations which
seem to be performing either exceptionally badly or exceptionally well.
If operations are going more or less as planned, then it is assumed that not much management care is
needed there. Managers should concentrate their efforts where operations seem to be diverging from
what is expected. Exception reports include:
๏
Slow-paying customers
๏
Slow-moving stock
๏
Expenses much greater than expected
๏
Failed password attempts at accessing data.
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Question 9
Because computers are machines, the information they produce will always be correct.
Is the above statement true or false?
A
True
B
False
Question 10
What is exception reporting?
A
Expected results are investigated
B
All results except are investigated without exception
C
Unexpected results are investigated
D
Unexceptional results are investigated
11. Risks to data
In large organisations, which typically can have thousands of transactions, it is very easy for
๏
errors to be made
๏
unauthorised transactions to take place
๏
fraud to be carried out.
Additionally, after data has been successfully recorded it can be lost and this is perhaps an acute
danger in computer-based accounting systems where it is very easy to overwrite or erase information.
Good control of all transactions is therefore necessary. ‘Internal control’ is the name given to the
system used to control transactions. All transactions should be:
๏
authorised
๏
completely recorded
๏
accurately recorded
๏
safeguarded
An important part of internal control is known as the segregation of duties. This means that
transactions are broken down into different stages with a different person being responsible for each
stage. So in a purchase transaction, one person should order the goods, another receive and check
them, and a third person should pay for them. Because several people are involved in the transaction
it will be more difficult for unauthorised transaction to slip through and also each person to some
extent checks up on what the previous one has done. For a fraudulent transaction to be processed
would probably require collusion (co-operation) between all the parties, and this can be dangerous
for the fraudster to organise.
Other types of controls include: signatures to authorise amounts, control totals to ensure all
transactions have been processed and the use of sequential documents so check if any go astray.
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Accounting data needs to be safeguarded:
๏
If ledgers are maintained manually, then they should be locked each night in a fireproof safe.
๏
If ledgers are computer-based then back-up copies should be taken regularly, ideally daily.
Additionally, passwords should be used to prevent improper access to data and all systems
should be equipped with virus checkers and firewalls to prevent improper access to data over
the internet.
12. Document and record retention policies.
Documents and records should be kept for some time in order to:
๏
Answer queries (for example, what were the sales over the last 4 years to a certain customer?).
๏
Defend legal actions (for example, a customer alleges some years later that faulty goods had
been supplied)
๏
Comply with legislation (for example tax legislation in case an enquiry is launched by the tax
authorities).
Typically documents have to be retained for around 5 – 10 years depending on local rules.
The documents do not have to be kept on the business premises and it is now becoming more
common to scan the documents and keep computerised images rather than the originals - which can
be very bulky and expensive to store.
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Chapter 2
RECORDING 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.
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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 in the payables ledger. 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 in the receivables ledger. 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.
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23
The accounting system in diagrammatic form
The accounting system can be depicted as follows:
Receivables ledger
Holds detail of what
makes up the total
receivables.
General (nominal) ledger
Assets
Liabilities
x
x
x
x
x
(things owned)
Equipment
Machinery
Premises
Inventory
Receivables (control)
(things owed)
Payables (control)
Bank loans
x
Income
Sales
Interest earned
Expenses
Purchases for resale
Rent
Electricity
An account for each
credit customer:
Abramson
Ahmad
Berry
Burton
Cheridjian
...
...
...
Total
The double entry system
Owner’s capital
Interest paid
...
...
etc
Sales day book
An account for each
credit supplier:
Adams
Boulez
Clarke
Dalziel
Chun
...
...
...
Total
x
x
x
x
x
x
Purchases day book
Lists credit purchases.
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
Payables ledger
Holds detail of what
makes up the total
payables.
Cash Book
Petty cash Book
Dr!
Cr
Receipts Payments
Dr!
Cr
Receipts Payments
Journal
Makes adjustments to accounts in
the double entry system
From this the general
ledger purchases and
payables control
accounts are updated
together with the
detailed payables
accounts in the payables
ledger
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.
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4.
24
The accounting equation and the principles and practice
of double-entry book-keeping
Bookkeeping relies on a number of linked principles:
The transactions of the business are separate from those of its owners
Every transaction gives rise to two effects (or two entries). One entry is known as a credit entry and
the other a debit entry.
Things owned by the business equals things owed by the business.
The double entries are often displayed in ‘T’ accounts:
Account name
Debit (DR) side
Credit (CR) side
Means:
Means:
Increase in an asset
Decrease in an asset
Increase in an expense
Decrease in an expense
Decrease 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)
Debit
Cash
(increase in an asset)
Credit
Sales
(increase in income)
Debit
Receivables
(increase in an asset)
Credit
Sales
(increase in income)
A cash sale:
A credit sale:
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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
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26
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:
Cash
Dr
1/1/2013
Capital
Dr
Cr
10,000
Capital
1/1/2013
Cr
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
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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
Cash
Dr
1/1/2013
Capital
10,000 3/1/2013
Cr
Equipment
2,000
Note the balance on this account is Dr 8,000, the net of the Dr and Cr sides
Equipment
Dr
3/1/2013
Cash
Cr
2,000
The asset of cash decreases and that of equipment increases
Dr
Capital
1/1/2013
Cr
Cash
10,000
Accounting equation:
Things owned, cash $8,000 + equipment $2,000 = Things owed, capital $10,000
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Transaction 3
On 10/1/2013, the business purchases goods for resale for $5,000 on credit.
Cash
Dr
1/1/2013
Capital
Cash
2,000
1/1/2013
Cr
Cash
Inventory
Dr
Suppliers
Dr
2,000
Cr
Capital
Dr
10/1/2013
Equipment
Equipment
Dr
3/1/2013
10,000 3/1/2013
Cr
10,000
Cr
5,000
Suppliers
10/1/2013
Cr
Inventory
5,000
The asset of inventory increases and the liability to suppliers increases
Accounting equation:
Things owned, cash $8,000 + equipment $2,000 + inventory $5,000
= Things owed, capital $10,000 + suppliers $5,000
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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.
Cash
Dr
1/1/2013
Capital
Cash
2,000
1/1/2013
Suppliers
Cash
5,000 15/1/2013
10/1/2013
Customers
Dr
Profit
10,000
Cr
Cost of goods sold
Suppliers
Dr
15/1/2013
Cr
Inventory
Dr
2,000
Cr
Capital
Dr
10/1/2013
Equipment
Equipment
Dr
3/1/2013
10,000 3/1/2013
Cr
2,500
Cr
Inventory
5,000
Cr
4,000
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Sales
Dr
10/1/2013
Customers
Cost of goods sold
Dr
10/1/2013
Cr
Inventory
4,000
Cr
2,500
Accounting equation:
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
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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.
Cash
Dr
1/1/2013
Capital
Equipment
2,000
31/1/2013
Suppliers
5,000
31/1/2013
Rent
Equipment
Dr
3/1/2013
10,000 3/1/2013
Cash
2,000
1/1/2013
Suppliers
Cash
Profit
5,000 10/1/2013
Cash
10,000
Cr
Cost of goods sold
2,500
Cr
Inventory
5,000
Cr
4,000
Rent
Dr
31/1/2013
5,000 15/1/2013
Customers
Dr
15/1/2013
Cash
Suppliers
Dr
31/1/2013
Cr
Inventory
Dr
100
Cr
Capital
Dr
10/1/2013
Cr
Cr
100
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Sales
Dr
10/1/2013
Cr
Customers
Cost of goods sold
Dr
10/1/2013
Inventory
4,000
Cr
2,500
Accounting equation:
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
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33
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
Inventory
2,500
Suppliers
Customers
–
4,000
Sales
Cost of goods sold
Rent
Total
Liability: SOFP
Asset: SOFP
–
4,000
Liability: SOFP
Asset: SOFP
Income: IS
2,500
Expense: IS
100
Expense: IS
14,000
14,000
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Income statement for January 2013
Sales
4,000
(2,500)
Cost of goods sold
Gross profit
1,500
Rent
(100)
Net profit
1,400
Statement of financial position as at 31 January 2013
Assets
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
Profit
Drawings
10,000
1,400
(1,000)
10,400
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35
Carrying down balances
Look at this account:
Cash
Capital introduced
2,000 Wages
Sales
3,000 Purchases
Sales
100 Rent
Heating
200
1,400
200
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.
Cash
Capital introduced
2,000 Wages
Sales
3,000 Purchases
Sales
100 Rent
Heating
5,100
2.
200
1,400
200
100
5,100
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’).
Cash
Capital introduced
2,000 Wages
Sales
3,000 Purchases
Sales
100 Rent
Heating
Balance c/d
5,100
200
1,400
200
100
3,200
5,100
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36
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.
Cash
Capital introduced
2,000 Wages
Sales
3,000 Purchases
Sales
200
1,400
100 Rent
200
Heating
100
Balance c/d
3,200
5,100
5,100
3,200
Balance b/d
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:
Sales
21/6/2013
Returns
550 1/6/2013
25/6/2013
Returns
32 3/6/2013
29/6/2013
Cash
Credit sales
Cash
250
1,395
49
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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.
Cash
Capital
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Inventory
Sales
Cost of goods sold
V V Gogh
L D Vinci
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Electricity
Rent
Repairs
Repair company
Computer
Drawings
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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
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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
Question 5
On 1 January 2013 a business had net assets of $15,000
On 31 January 2013, net assets amounted to £19,000.
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
Question 6
On 1 January 2013 a business had net assets of $25,000
On 31 January 2013, net assets amounted to £23,000.
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
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Question 7
On 1 January 2013 and 31 January 2013 a business had the following assets and liabilities:
1 January
31 January
$
$
Cash
Owed to suppliers
Owed from customers
Equipment
Bank loan
10,000
3,000
2,000
6,000
12,000
4,000
1,000
10,000
2,000
5,000
No additional capital had been introduced, but the owner withdrew $800 to live on.
What profits were made in January?
A
$1,000
B
$5,800
C
$200
D
$1,800
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Chapter 3
THE DAY BOOKS AND THE JOURNAL
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.
The accounting system
For convenience, the diagram of the accounting system is produced again:
Receivables ledger
Holds detail of what
makes up the total
receivables.
General (nominal) ledger
Assets
Liabilities
x
x
x
x
x
(things owned)
Equipment
Machinery
Premises
Inventory
Receivables (control)
(things owed)
Payables (control)
Bank loans
x
Income
Sales
Interest earned
Expenses
Purchases for resale
Rent
Electricity
Interest paid
...
...
etc
An account for each
credit customer:
Abramson
Ahmad
Berry
Burton
Cheridjian
...
...
...
Total
The double entry system
Sales day book
Owner’s capital
An account for each
credit supplier:
Adams
Boulez
Clarke
Dalziel
Chun
...
...
...
Total
x
x
x
x
x
x
Purchases day book
Lists credit purchases.
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
Payables ledger
Holds detail of what
makes up the total
payables.
Cash Book
Petty cash Book
Dr!
Cr
Receipts Payments
Dr!
Cr
Receipts Payments
Journal
Makes adjustments to accounts in
the double entry system
From this the general
ledger purchases and
payables control
accounts are updated
together with the
detailed payables
accounts in the payables
ledger
We will look first at what day books are used for.
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44
The purchases 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 from here to the
ledgers and eventual payment.
The PDB is just a list. A simple PDB would be as follows:
Date
4/2/2013
8/2/2013
8/2/2013
9/2/2013
Details
ABC Ltd
CDE Ltd
FGH Ltd
IJK Ltd
Supplier’s
account
number
123
234
332
346
TOTALS
Net
amount
Sales tax
amount
1000
400
1200
150
2750
200
80
240
30
550
Gross
amount
1200
480
1440
180
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, an error has 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 postings that would be made to account for these purchases transactions are:
In the general ledger
Credit:
Payables control account (total payables)
Debit:
Purchases account
Debit:
Sales tax account
3,300
2,750
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.
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In addition, in the Payables Ledger, each of the suppliers is credited with the gross amount of their
invoices
Supplier’s account
number
123
Details
ABC Ltd
Gross
amount
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.
4.
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
4/2/2013
8/2/2013
8/2/2013
9/2/2013
Details
PQR Ltd
STU Ltd
VWX Ltd
YZA Ltd
Customer’s
account number
378
388
587
775
TOTALS
Net
Sales tax
Gross
amount
amount amount
400
80
480
300
60
360
200
40
240
120
24
144
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, an error has 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 pre-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:
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In the general ledger
Debit
Sales control account (total receivables)
Credit
Sales account
Credit
Sales tax account
1,224
1,020
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
PQR Ltd
STU Ltd
VWX Ltd
YZA Ltd
Gross amount
480
360
240
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.
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47
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.
Illustration 1
A receivables control account balance is $3,825.
The three receivable account balances in the receivables ledger are as follows:
Customer name Amount owing
A 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 undercast (ie added up by too little) by $400
Solution
List 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
300
Corrected list
4,225
Control account balance
3,825
3
Undercasting error
400
4,225
It is vital to understand which entries come from 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.
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Question 1
The total columns in a purchases day book are as follows:
Date
Details
Supplier’s
account
number
Net amount
Sales tax
amount
Gross amount
..
..
..
..
..
..
4,000
800
4,800
TOTALS
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 2
The total columns in a sales day book are as follows:
Date
Details
Customer’s
account
number
Net amount
Sales tax
amount
Gross amount
..
..
..
..
..
..
6,000
1,200
7,200
TOTALS
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 3
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
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Question 4
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 5
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 6
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?
A
B
C
D
Control account AGS’s account in the
receivables ledger
Dr 900
Dr 900
Dr 900
No effect
Cr 900
Cr 900
Dr 900
Dr 900
Sales account in the
general ledger
Cr 900
Cr 900
Dr 900
No effect
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50
Returns day books
In addition to sales and purchases day books, some businesses have 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
6.
The journal
The journal is used as the book of prime entry for transactions or adjustments that are not initiated
anywhere else. Examples include:
๏
Correction of errors
๏
Off-set of amounts owed and owing. For example $1,400 is owed from ABC Ltd in the
receivables ledger and $1,600 is owed to ABC Ltd in the payables ledger (ABC Ltd is both a
customer and a supplier). The two amounts can be offset and only $200 needs to be paid.
๏
Dealing irrecoverable debts
The traditional way of setting out a journal is:
Journal number 1411
Dr ABC Ltd in the payables ledger
Dr
1,400
Cr
Cr ABC Ltd in the receivables ledger
Being the offset of amounts payable and receivable
1,400
1,400 1,400
Authorised by
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Example 1
An amount of $350 paid for the repair of a machine was incorrectly treated as the purchase of a new
machine.
What is the correcting journal?
Journal number
Dr
Cr
Authorised by
Example 2
An amount of $1789 received from XYZ in settlement of an invoice was incorrectly treated as a new
sale.
What is the correcting journal?
Journal number
Dr
Cr
Authorised by
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Chapter 4
CASH TRANSACTIONS
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.
Receivables ledger
Holds detail of what
makes up the total
receivables.
General (nominal) ledger
Assets
Liabilities
x
x
x
x
x
(things owned)
Equipment
Machinery
Premises
Inventory
Receivables (control)
(things owed)
Payables (control)
Bank loans
x
Income
Sales
Interest earned
Expenses
Purchases for resale
Rent
Electricity
Interest paid
...
...
etc
An account for each
credit customer:
Abramson
Ahmad
Berry
Burton
Cheridjian
...
...
...
Total
The double entry system
Sales day book
Owner’s capital
An account for each
credit supplier:
Adams
Boulez
Clarke
Dalziel
Chun
...
...
...
Total
x
x
x
x
x
x
Purchases day book
Lists credit purchases.
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
Payables ledger
Holds detail of what
makes up the total
payables.
Cash Book
Petty cash Book
Dr!
Cr
Receipts Payments
Dr!
Cr
Receipts Payments
Journal
Makes adjustments to accounts in
the double entry system
From this the general
ledger purchases and
payables control
accounts are updated
together with the
detailed payables
accounts in the payables
ledger
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Types of payment from the bank
Payments can be made from a bank account in four main ways:
๏
Cheque: see later
๏
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.
Cheques and the clearing system
Cheques 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).
Here is a typical UK cheque
Counterfoil
Cheque
HSBC is the bank (the drawee ie the institution on whom the cheque is drawn and the order to pay
given).
Mr J Tar is the drawer (the person paying the money)
40-07-05 and 21745175 are numbers that identify the bank branch and the bank account
202546 is the cheque number (for identification)
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The numbers printed at the top right are reproduced in special machine-readable characters at the
bottom of the cheque and these allow automatic processing of the cheque.
The cheque can be torn out of the cheque book leaving a counterfoil onto which details should also
be entered.
When completed, the cheque would look like:
15 /1/2013
ABC Co Ltd
1500.00
15 January 2013
ABC Company Ltd-------------One thousand five hundred
pounds only
1,500 - 00
The ABC Company Ltd is the payee (the person who will receive the funds)
Cheque books must be kept securely as the signature of the authorised person (J Tar) could be forged
(falsified) and cheques made out improperly to steal funds.
Note that the payee is written as “ABC Company Ltd-------------------“ and the amount as “One thousand
five hundred pounds only”. The line after Ltd and the word ‘only’ are to prevent changes being made.
All cheques should be accounted for, even those which are made out incorrectly and scrapped: the
cheque should be marked “VOID” in large letters and kept in the cheque book.
When ABC Ltd receives the cheque it is important to pay the cheque into the bank promptly. Delay
increases the risk of the cheque being lost, stolen or of J Tar not having the funds to pay.
When ABC Company receives the cheque it must be paid into the company’s bank. This is done using
a Paying-in slip.
ABC will list cheque details on the reverse of the slip, and the total on the front.
The total will appear in ABC’s bank account at the end of the day, but that does not mean that funds
have been safely transferred: the amount is only provisional. The cheque from J Tar has to be sent
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back to his bank to see if there is enough money in the account. If there is, then Tar’s bank will send
the money to ABC’s bank and the funds are transferred at that point.
This process is known as ‘clearing the cheque’ and it takes around three days (Internet transfers are
usually completed in a couple of hours).
If J Tar did not have enough funds to pay the money, then the cheque is sent back to ABC’s bank and
from there to ABC marked ‘Refer to Drawer’. This means that the cheque has been dishonoured or
‘bounced’. ABC then has to pursue the matter with Tar and the funds that had provisionally appeared
in ABC’s account are removed.
5.
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 Book
Dr (Receipts)
Balance b/d
Cash sales
Received from A Smith
Cash sales
Received from B Bodkin
1,200
240
360
120
600
Paid to C Clark
Paid to D Drake
Wages
Cash purchases
Tax
Balance c/d
Cr (Payments)
404
172
1200
72
300
372
2,520
Balance b/d
2,520
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:
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Dr (Receipts)
Total
Balance b/
d
Cash sales
1,200
Received
from A
Smith
Cash sales
360
Received
from B
Bodkin
600
240
120
Cash
sales
240
120
57
Cash Book
Cr (Payments)
Receivables
Total
Paid to
C Clark
Paid to
D Drake
360 Wages
Balance b/
d
360
Payables
404
404
172
172
1200
Wages Sundry
1200
72
Cash
purchases
600 Tax
72
300
300
Tax
372
2,520
Balance c/d
2,520
Cash
purchases
960
72
576
1200
300
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
Dr
Payables ledger control account
Dr
Wages
Dr
Tax
72
576
1200
300
In addition, the memoranda accounts of C Clark and D Drake in the Payables ledger would have to be
updated.
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58
Cash book with sales tax
Dr (Receipts)
Balance b/d
Cash Book
Cr (Payments)
Total
Sales Cash Receivables
Total Sales
Cash
Payables Wages Sundry
tax sales
tax purchases
Paid to
1,200
404
404
C Clark
Cash sales
240
Received
from A Smith
360
Cash sales
120
Received
from B
Bodkin
600
40
Paid to
D Drake
200
360 Wages
20
Cash
purchases
100
600 Tax
Balance c/d
Balance b/d
2520
372
60
300
960
172
172
1200
72
1200
12
60
300
Tax
300
372
2520
12
60
576
1200
300
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.
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6.
59
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)
Balance b/d 1 May 2013
Paid in 31 May 2013
Cash Book
1,900 CN 1200
200
CN 1201
150
360 CN 1202
388
CN1203
290
Balance c/d 31 May 2013
2,260
Balance b/d 1 June 2013
Cr
(Payments)
1,232
2,260
1,232
[CN = cheque number]
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Note CN = cheque number; DD = direct debit; SO = standing order.
Dr
1201
DD
Bank charges
1202
Balance c/d 31 May 2013
Bank Statement - Safe Bank Inc
200 Balance b/d 1 May 2013
Cr
1,900
50
5
290
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.
Dr
(Receipts)
Balance b/d 1 May 2013
Paid in 31 May 2013
Cash Book
√ 1,900 CN 1200
√ 200
CN 1201
150
360 CN 1202
388
CN1203
√ 290
Balance c/d 31 May 2013
1,232
2,260
Balance b/d 1 June 2013
Dr
1201
DD
Bank charges
Cr
(Payments)
2,260
1,232
Bank Statement - Safe Bank Inc
√ 200 Balance b/d 1 May 2013
50
Cr
√ 1,900
5
1202
√ 290
Balance c/d 31 May 2013
1,355
1,900
1,900
Balance b/d 1 June 2013
1,355
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Then bring each document up to date for the reconciling items
Bank statement
Opening balance
1,355
Less: 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
1,177
Up-to-date balance
Dr
(Receipts)
Balance b/d 1 June 2013
360
Cash Book
Cr
(Payments)
1,232
Direct debit
50
Bank charges
Correct bal c/d 1 June 2013
1,232 Balance b/d 1 June 2013
5
1,177
1,355
You will see that the two balances now agree.
Example 1
On 31 July 2013, the cash book of Pizazz Ltd showed a debit balance (ie cash at the bank) of $200. The
bank statement showed a credit balance of (ie Pizazz had cash in the account) of $339.
The following errors and differences were found;
1.
Cheques in the cash book of $500 had not been presented for payment (ie had this amount had
not yet left the bank account).
2.
An amount of $250 paid in had not yet been credited to the bank account.
3.
The credit side of the cash book had been undercast by $70 (ie under-added) by $70 when
working out the closing balance of $200
4.
A payment of $40 by a customer had been sent directly to the bank and was not in the cash
book.
5.
Bank charges of $31 had been taken by the bank but were not in the cash book.
6.
The bank had taken $50 out of the bank account because a cheque from a customer that had
been credited to the bank account later ‘bounced’ ie was dishonoured. This was not reflected in
the Cash Book
Reconcile the bank account and the cash book, adjusting each as appropriate:
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Dr
(Receipts)
62
Cr
(Payments)
Cash Book
Balance b/d 31 July 2013
200
Bank statement
Opening balance
339
Up-to-date balance
7.
Petty cash
The petty cash book will look similar to the main cash book and will usually have analysis columns.
Usually the only source of funds will be when the petty cash is topped up by cash from the main bank
account, though occasionally there will be small amounts received from staff as payment for personal
photocopying, use of the firm’s postage and so on.
Debit
Date
Narrative
Credit
Total
$
Date
Narrative
Total Refreshments
$
Post
Fares
Stationery
Petty cash is usually kept in a small locking box, the petty cash box.
As payments of cash are made, a petty cash voucher will be filled in showing the amount and purpose
of the payment. Ideally, any receipts for the purchase will be stapled to the petty cash voucher and
the voucher approved by a manager or supervisor.
Petty cash is usually kept on the imprest system as this prevents too much cash accumulating in the
petty cash box. Under this system, on the presentation of the vouchers the balance is topped-up, back
to an agreed amount (the petty cash float). The amount of the top-up should equal the sum of the
vouchers and the vouchers are filed away.
At any stage, the total of the cash and the vouchers in the box should add back to the agreed
maximum balance.
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Illustration
Petty cash float = $100. During the week of 12 July, petty cash amounts paid out amounted to $68 and all
amounts were supported by petty cash vouchers and receipts.
Just prior to reimbursement:
Cash in the box should be = 100 – 68 = $32; vouchers amount to $68
Cash + Vouchers = $100 (the agreed float)
The reimbursement process is:
Petty cash float
=
Less: authorised expenditure
100
(68)
32
Petty cash reimbursement
Re-established float
68
100
Question 1
A bank reconciliation can be best described as:
A
Part of the double entry system
B
Part of the books of prime entry
C
A way of checking that the opening balance in the cash account can be reconciled to the closing
balance on the bank statement
D
An essential part of an organisation’s internal control system
Question 2
In the credit side of an analysed cash book there is a column headed Payables.
What double entries are made from this column?
A
Dr Purchases with the total of the column; Cr Creditors control account with the total; Cr
individual creditors with each entry in the column
B
Dr Creditors control account with the total; Dr individual creditors with each entry in the column
C
Cr Creditors control account with the total; Cr individual creditors with each entry in the column
D
Dr Purchases with the total of the column
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Question 3
The following information is to be used to prepare a bank reconciliation:
Balance per cash book 31/3/2013
5,700
Amounts paid in not yet appearing on the bank statement
(uncredited lodgements)
1,367
Unpresented cheques
3,880
Bank charges not in cash book
Receipt from a customer sent to bank but not in cash book
Dr
70
403
What is the balance shown on the bank statement as at 31/3/2013?
A
8,213
B
6,033
C
3,520
D
8,546
Question 4
A bank a statement shows a balance of $750 overdrawn
The statement shows bank charges of $75 that have not been credited to the cash book.
There are also unpresented cheques totalling $800 and uncredited lodgements of $330
The bank overdraft on the balance sheet should be:
A
1,145
B
1,295
C
1,220
D
750
Question 5
The receivables column in debit side of a cash book has been added up by $100 too much.
When the list of receivables balances is being reconciled with the receivables ledger control
account, what correction(s) will be needed?
A
No correction is needed
B
The receivables control account balance needs to be increased by $100
C
The receivables control account balance needs to be decreased by $100
D
The sum of the list of balances needs to be increased by $100
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Question 6
Walton Ltd operates a petty cash imprest system. During the month an amount of $5 was received
from a member of staff for private photocopying and petty cash vouchers amounting to $45 were
approved.
If the agreed float is $100, how much will the petty cash need to be topped up by at the end of
the month?
A
$45
B
$40
C
$60
D
$35
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Chapter 5
MORE ON SALES AND RECEIVABLES
1.
Introduction
This chapter looks in a little more detail at sales transactions and the receivables ledger
2.
Recap of the receivables ledger system
Entries in the receivables ledger arise from two main sources:
๏
The sales day book (SDB), where new credit sales are first recorded.
๏
The cash book(CB) where receipts from credit customers are first recorded (in the receivables
ledger column, on the debit side)
Additionally there will be occasional postings made from:
๏
The journal (eg the offset of debts to an account in the payables ledger)
The entries made from the sales day book will be:
๏
Dr
Receivables control account with the total of the SDB gross amount column
๏
Cr
Sales Account with the total of the SDB net amount column
๏
Cr
Sales Tax Account with the total of the SDB sales tax amount column.
In addition, each line in the gross column of the SDB will be used to Debit individual accounts in the
Receivables Ledger so as to record exactly who owes what.
The entries made from the cash book will be:
๏
Cr
Receivables control account with the total of the Receivables Ledger column
In addition, each line in the Receivables column of the Cash Book will be used to Credit individual
accounts in the Receivables Ledger so as to record exactly who has paid.
The accounting documents used are:
1.
When sales are made, invoices will be issued to customers
2.
Statements will be sent regularly to customers, setting out what is owed and what has been
paid.
3.
Remittance advices will be received from customers when they pay to explain which invoices
are being settled.
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68
Credit control
Credit control is the name given to the process of trying to ensure that cash is eventually received for
all credit sales.
The process starts with a new customer applying for credit and this should initiate some investigation,
such as:
๏
Asking for the applicant’s recent financial statements.
๏
Enquiries to a credit reference agency to see if the applicant has any history of poor payments.
Based on these investigations, the applicant will be accepted or rejected. A credit limit should be set
for all customers.
Once credit sales have been made, each customer should be encouraged to pay according to the
terms of the contract. There are three ways of proceeding:
๏
Send statements. These often act as a gentle reminder about what’s due.
๏
Settlement discounts. For example, pay 5% less if paid within 30 days.
๏
Prepare aged receivables analyses and act accordingly on the information contained there.
5.
Settlement discounts
For example, an invoice is issued to DFH Ltd for $700 on 2nd January 2013 with terms offering a
settlement discount of 5% is settled within 30 days. The invoice was paid on 25th January 2013.
Therefore, because it was paid on time the amount due will be $700 x 95% = $665.
The discount of $35 is an expense of the business. The customer has been ‘let off’ $35 for prompt
payment.
The entries in the DFH’s account would be:
2/1/2013 Sales day book
DFH Ltd
700 25/1/2013 Cash book
Settlement discount
665
35
700
700
The settlement discount is debited to the Discounts Allowed account in the general ledger. This is an
expense account.
Occasionally there is a memorandum settlement discount column in the cash book so that, in the case
above, $665 would be the amount of cash received and $35 would be entered in the memorandum
column. The sum of the memorandum discount column would be debited to the Discounts Allowed
account.
It is important to realise that the receivables control account should always reflect in total whatever
happens the individual accounts. So, if a customer is given a settlement discount, this must also be
credited to the control account.
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For example, consider a company with just three customers:
Sales day book
ABC Ltd
700
Sales day book
DEF Ltd
400
Sales day book
GHI Ltd
200
B/f
Receivables control account
1,300
You will see that, the control account balance agrees with the sum of the individual balances in the
receivables ledger ($1,300 = $700 + $400 + $200)
Each is entitled to a settlement discount of 5% if the amounts are paid within 30 days. ABC Ltd and
DEF Ltd pay within this time limit; GHI does not and pays only $100 of what is owed.
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A cash book extract would be:
Cash book (Dr side)
Narrative
Total
Discount
ABC Ltd
665
35
Receivables
ledger
665
DEF Ltd
380
20
380
GHI Ltd
100
-
100
1,145
55
1,145
Dr Discounts allowed account $55
Cr Receivables control account $55
Sales day book
Sales day book
Sales day book
Bal b/d
B/f
Other….
Post to individual
accounts in the
receivables ledger.
Cr Receivables control account $1,145
ABC Ltd
700 Cash
Discount
665
35
700
700
DEF Ltd
400 Cash
Discount
380
20
400
400
GHI Ltd
200 Cash
Bal c/d
100
100
200
100
200
Receivables control account
1,300 Cash
Discounts allowed
Bal c/d
1,300
1145
55
100
1300
Note that the sun of the individual balances (now GHI Ltd only) still equals the balance on the control
account.
Note that a settlement discount is entirely different to a bulk or trade discount. The bulk or trade
discount is to all intents and purposes a straight reduction in the selling price and the only amounts
every invoiced or treated as a sale are after the discount has been removed.
With a settlement discount, the sales and the invoices are for the full amount (after the trade discount)
and the discount is contingent upon prompt payment.
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Question 1
A customer’s invoice and payment details are as follows:
Invoice date
5 May 2013
8 May 2013
12 May 2013
25 May 2013
Invoice amount
$1,200
$400
$500
$1,000
All the invoices offered a 2.5% discount for payment at or before 30 days and all were settled by a
payment on 9 June 2013.
How much should the payment be for and how much is the discount?
A
Payment = $3,100; discount = $37.50
B
Payment = $3,062.50; discount = $37.50
C
Payment = $3,052.50; discount = $47.50
D
Payment = $3,022.50; discount = $77.50
Question 2
The normal price of a purchase is $800, but a customer has negotiated a trade discount of 20%.
The invoice is dated 16 June 2013 and offers a 5% discount for payment within 45 days. Payment is
received on 25 July 2013.
What amounts should be posted to the Sales account and to the Discount Allowed account in
the general ledger?
(Ignore sales tax)
A
Credit Sales account $800; debit discounts allowed account $192
B
Credit Sales account $640; credit discounts allowed account $32
C
Credit Sales account $640; debit discounts allowed account $32
D
Credit Sales account $608; debit discounts allowed account $40
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72
Aged receivables analysis
This looks at all the invoices still owed by customers and displays them in age categories.
Typically the age categories are something like:
≤ 30 days
30 to ≤ 60 days
60 to ≤ 90 days
90 to ≤ 180 days
> 180 days
Usually, the older an unpaid debt becomes, the less likely to be paid. Also, as debts become older
more extreme action is likely to be taken to try to force payment. For example, final warnings, then
taking customers to court.
The layout of an aged analysis is usually something along the lines of:
Customer
Aardvark
Total
≤ 30 days
1,200
1,100
Benson
900
Chandos
100
100
Draghi
600
500
Ephram
500
Fahrook
800
800
:
:
94,560
100.0
:
:
85,382
90.3
:
:
Total
%
30 to ≤ 60
days
100
60 to ≤ 90 90 to ≤ 180
days
days
> 180 days
600
300
100
100
200
200
:
:
5,993
6.3
:
:
2,085
2.2
:
:
800
0.9
:
:
300
0.3
To be able to work out how old debts are, it is essential to know what exactly which invoices have
been paid. This is where remittance advices are important because they allow specific matched to be
carried out.
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For example, consider this customer’s account:
ABC Ltd
700
Invoice 125 3/1/2013
Invoice 135 23/1/2013
1,000
Invoice 178 5/2/2013
500
Invoice 201 4/3/2013
2,300
Invoice 233 12/3/2013
Invoice 278 2/3/2013
950
620 Bal c/d
6,070
6,070
6,070
The customer sends a cheque for $3,800, and this is accompanied by a remittance advice as follows:
ABC Ltd
49 High Street
REMITTANCE ADVICE
Date 31/3/2013
Invoices paid:
$
Invoice 135 23/1/2013
1,000
Invoice 178 5/2/2013
500
Invoice 201 4/3/2013
2,300
TOTAL REMITTANCE Cheque 585493
3,800
The payments set out on the remittance advice have to be matched as follows:
Invoice 125 3/1/2013
Invoice 135
Invoice 178
Invoice 201
Invoice 233
Invoice 278
23/1/2013
5/2/2013
4/3/2013
12/3/2013
2/3/2013
ABC Ltd
700
1,000
500
2,300
950
620
6,070
Invoice 135 31/3/2013
Invoice 178 31/3/2013
Invoice 201 31/3/2013
1,000
500
2,300
Bal c/d
2,270
6,070
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The matched items can be cleared out of the account to leave:
Invoice 125 3/1/2013
ABC Ltd
700
Invoice 233 12/3/2013
950
Invoice 278 2/3/2013
620 Bal c/d 31/3/2013
2,270
2,270
2,270
A valid aged analysis can be performed on the outstanding amounts.
7.
Irrecoverable (bad) debts
Sometimes, despite all efforts to sell only to credit-worthy customers and to follow up old amounts
carefully, it becomes clear that a debt is irrecoverable and no money will ever be received. Perhaps
the customer has gone into liquidation (or simply disappeared!)
There is then no point in continuing to record the debt as a receivable (an asset) when it is worthless:
the amount should be written off, ie reduced to zero. This is an expense to the business and will be
recorded in an irrecoverable debts account (sometimes called a bad debts account).
As always, whatever adjustment you make to an individual debtor you must make to the receivables
control account too. Writing off bad debts is one use of the journal.
Look at this example:
Bal b/d 1/1/2013
Total sales
Total receivables account (control account)
9,700 Total receipts
105,000
Bal c/d 31/12/2013
114,700
102,500
12,200
114,700
One of the receivables accounts in the receivables ledger is:
Bal b/d 1/1/2013
Badone Ltd
1,300
Sales 15/1/2013
2,500
Bal c/d 31/12/2013
3,800
3,800
3,800
It has been decided that none of the $3,800 due from Badone Ltd will be recovered and that this
amount should be written off.
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The journal to do this is:
Journal number 1411
Dr Irrecoverable debts account
Dr
3,800
Cr Receivables control account
Cr
3,800
Being the write-off of irrecoverable debts
Authorised by
3,800 3,800
The accounts would then be:
Bal b/d 1/1/2013
Total sales
Total receivables account (control account)
9,700 Total receipts
105,000 Irrecoverable debts
Bal c/d 31/12/2013
114,700
Bal b/d 31/12/2013
102,500
3,800
8,400
114,700
8,400
One of the receivables accounts in the receivables ledger is:
Bal b/d 1/1/2013
Sales 15/1/2013
Total receivables account
Badone Ltd
1,300 Written off
2,500
3,800
3,800
3,800
Irrecoverable debts
3,800 Bal c/d
3,800
8.
3,800
3,800
Irrecoverable (bad) debts and sales tax
Debts are not usually written off until all reasonable hope of recovery is gone and this usually takes
time. Sales tax will probably have been charged on the sales giving rise to the debt, and will have
been paid over to the government. Now it is clear that the sales tax will never be collected from the
defaulting customer.
Sellers can get relief for the sales tax on debts written off, provided the debt written off was at least six
months old.
So, if the $3,800 above contained sales tax at 20%, the sales tax content of that debt would be
$3,800/6 = $633.33 and the net amount of the sale would be 3,166.67 (check: 3,166.67 x 20% =
$633.33).
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Therefore, the cost of the irrecoverable debt is reduced by the sales tax amount as follows:
Total receivables account
Irrecoverable debts
3,800.00 Sales tax account
Bal c/d
3,800.00
633.33
3,166.67
3,800.67
The debit to the sales tax account will reduce what has to be paid to the government in the future, so
gives tax relief on the irrecoverable sales tax.
9.
Allowances for irrecoverable debts
Once a write-off occurs the debt is, in effect, forgotten about and will not be pursued. However,
before that stage is reached it will often begin to look unlikely that the debt will be recovered, but the
company does not yet want to give up all hope and does not want to write off the debt. Nevertheless,
to value the debt at its full amount would be over-optimistic.
In this case, an allowance can be made to reduce the value of the receivables. The allowance can be
calculated using a combination off approaches:
๏
A specific debt is identified as ‘doubtful’. This will be a specific allowance for irrecoverable
receivables.
๏
Our experience might show that, say 4%, of debts generally have to be written off, though we
do not know now which ones these will be. This might sometime be known as a general
allowance for irrecoverable receivables.
Example 1
On 31 December 2013, the total receivables are $125,000.
Of these:
1.
An amount of $6,000 is to be written off as it is clearly not recoverable.
2.
An amount of £12,000 is thought to be in danger of not being recoverable and a 100%
allowance is to be made for that.
3.
4% of remaining receivables are to have an allowance.
What value of receivables will appear on the statement of financial position as at 31 December
2013?
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Question 3
At the start of a period a customer owed $12,345 and sales for the year were $11,346. During the year
the customer paid $10,463 and was allowed discounts of $228.
It is though wise to make an allowance against irrecoverable debts in respect off this customer of 25%.
How much will the allowance against irrecoverable debts be?
A
$228
B
$3,307
C
$3,364
D
$3,250
Question 4
What does an aged receivables analysis show?
A
The age of invoices
B
The age of payments
C
The age of sales
D
The age of customers
Question 5
A debt of $34,615 has been written off. Sales tax is 15%.
What is the final cost of the write-off and how much sales tax can be recovered in respect to the
write-off?
A
Sales tax recoverable = $5,192.25; final cost of the write-off = $34,615
B
Sales tax recoverable = $4,515; final cost of the write-off = $34,615
C
Sales tax recoverable = $4,515; final cost of the write-off = $30,100
D
Sales tax recoverable = $5,192.25; final cost of the write-off = $30,100
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Chapter 6
MORE ON PURCHASES AND PAYABLES
1.
Introduction
This chapter looks in a little more detail at purchase transactions and the payables ledger
2.
Recap of the payables ledger system
Entries in the payables ledger arise from two main sources:
๏
The purchase day book (PDB), where new credit purchase invoices are first recorded.
๏
The cash book(CB) where payments to credit customers are first recorded (in the payables
ledger column, on the credit side)
Additionally there will be occasional postings made from:
๏
The journal (eg the offset of amounts to an account in the receivables ledger)
The entries made from the purchases day book will be:
๏
Cr
Payables control account with the total of the PDB gross amount column
๏
Dr
Purchases Account with the total of the PDB net amount column
๏
Dr
Sales Tax Account with the total of the PDB sales tax amount column.
In addition, each line in the gross column of the PDB will be used to Credit individual accounts in the
Payables Ledger so as to record exactly what is owed to whom.
The entries made from the cash book will be:
๏
Dr
Payables control account with the total of the Payables Ledger column
In addition, each line in the Payables column of the Cash Book will be used to Debit individual
accounts in the Payables Ledger so as to record exactly to whom payments have been made.
The accounting documents used are:
1.
When purchases are made, invoices will be received from suppliers
2.
Statements will be received regularly from suppliers, setting out what is still owed and what has
been paid.
3.
When payments are made Remittance advices should be sent to suppliers to explain which
invoices are being settled.
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80
Credit control
Suppliers should exercise credit control on their customers. The process starts with a new customer
applying for credit and this should initiate some investigation, such as:
๏
Asking for the applicant’s recent financial statements.
๏
Enquiries to a credit reference agency to see if the applicant has any history of poor payments in
the past,
Based on these investigations, the applicant will be accepted or rejected. A credit limit should be set
for all customers and it is important to ensure that when more goods are being ordered that the
credit limit will not be exceeded otherwise delivery is likely to be delayed.
To encourage payment, suppliers often:
๏
Send statements. These often act as a gentle reminder about what’s due.
๏
Offer settlement discounts. For example, pay 5% less if paid within 30 days.
5.
Settlement discounts
For example, an invoice is issued by RSQ Ltd for $900 on 5th June 2013 with terms offering a
settlement discount of 5% is settled within 30 days. The invoice was paid on 25th July 2013. Therefore,
because it was paid on time the amount due will be $900 x 95% = $855.
The discount of $45 is a reduction in the expense of the business buying the goods. The supplier has
‘let off’ the buyer $45 for prompt payment.
The entries in the RSQ’s account would be:
25/7/2013 Cash book
Settlement discount
RSJ Ltd
855 Purchases day book 5/6/2013
45
900
900
900
The settlement discount is credited to the Discounts Received account in the general ledger. This is an
income account.
Occasionally there is a memorandum settlement discount column in the cash book so that, in the case
above, $855 would be the amount of cash received and $55 would be entered in the memorandum
column. The sum of the memorandum discount column would be credited to the Discounts Received
account.
It is important to realise that the receivables control account should always reflect in total whatever
happens the individual accounts. So, if a customer is given a settlement discount, this must also be
credited to the control account.
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For example, consider a company with just three suppliers:
PQR Ltd
Purchases day book
650
RST Ltd
Purchases day book
800
UVW Ltd
Purchases day book
400
Payables control account
Balance B/f
1,850
You will see that, the control account balance agrees with the sum of the individual balances in the
payables ledger ($1,850 = $650 + $800 + $400)
Each customer offers a settlement discount of 4% if the amounts are paid within 30 days. PQR Ltd and
RST Ltd are paid within this time limit; UVW is not and is paid only $120 of what is owed.
A cash book extract would be:
Cash book (Cr side)
Narrative
Total
Discount
PQR Ltd
624
26
Payables
ledger
624
RST Ltd
768
32
768
UVW Ltd
120
-
120
1,512
58
1,512
Cr Discounts received account $58
Dr Payables control account $58
Other….
Post to individual
accounts in the payables
ledger.
Dr Payables control account $1,512
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For example, consider a company with just three suppliers:
Cash
Discount
Cash
Discount
Cash
Bal c/d
Cash
Discounts received
Bal c/d
PQR Ltd
624 Purchases day book
26
650
650
650
RST Ltd
768 Purchases day book
32
800
800
800
UVW Ltd
120 Purchases day book
280
400
400
400
Payables control account
1,512 B/f
58
1,850
280 Bal c/d
1,850
1.850
Note that the sun of the individual balances (now UVW Ltd only) still equals the balance on the
control account.
Note that a settlement discount is entirely different to a bulk or trade discount. The bulk or trade
discount is to all intents and purposes a straight reduction in the selling price and the only amounts
every invoiced or treated as a purchase are after the discount has been removed.
With a settlement discount, the purchases and the invoices are for the full amount (after trade
discount) and the discount is contingent upon prompt payment.
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Question 1
A supplier’s invoices and details of payments made are as follows:
Invoice date
5 June 2013
8 June 2013
15 June 2013
25 June 2013
Invoice amount
$2,400
$800
$1,000
$2,000
All the invoices offered a 5% discount for payment at or before 30 days and all were settled by a
payment on 10 July 2013.
How much should the payment be for and how much is the discount received?
A
Payment = $6,200; discount = $75
B
Payment = $6,125; discount = $150
C
Payment = $6,105; discount = $95
D
Payment = $6,050; discount = $150
Question 2
The normal price of a purchase is $2,800, but a trade discount of 25% has been negotiated
The invoice is dated 20 July 2013 and offers a 3% discount for payment within 30 days. Payment is
received by the supplier on 15 August 2013.
What amounts should be posted to the Purchases account and to the Discount Received
account in the general ledger?
(Ignore sales tax)
A
Credit Sales account $2,800; debit discounts received account $84
B
Credit Sales account $2,100; credit discounts received account $63
C
Credit Sales account $2,100; debit discounts received account $63
D
Credit Sales account $2,037; credit discounts received account $84
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Making payments to suppliers
Invoices should be paid when due otherwise:
๏
Valuable settlement discounts will be lost
๏
Suppliers might become reluctant to continue to give credit because they fear invoices will not
be paid.
Payments due lists can be prepared from the Payables ledger. This is rather like the Aged Receivables
Analysis. A senior official will then go through this list and mark which payments to make.
Payments can be made by internet transfer or by cheque, but before payments are made they have to
be carefully authorised to prevent incorrect amounts being paid - or defrauded from the company.
Often the person approving the payment will want to see the supplier’s invoice, the goods received
note and a copy of the authorised purchase order. Together, these three documents provide a good
standard of proof that the supplier should be paid.
All payments should be accompanied by a remittance advice that sets out what is being paid so that
the supplier can keep track of the account.
For example, consider this supplier’s account in the books of Azed Ltd:
Bal c/d
ABC Ltd
Invoice 2125 4/2/2013
1,700
Invoice 2135 3/2/2013
1,000
Invoice 2178 6/3/2013
1,500
Invoice 2201 5/4/2013
2,300
Invoice 2233 13/4/2013
950
8,070 Invoice 2278 23/4/2013
620
8,070
8,070
The supplier, ABC Ltd, is sent a cheque for $3,800, and this is accompanied by a remittance advice as
follows:
Azed Ltd
65 Low Road
REMITTANCE ADVICE
ABC Ltd
Date 30/4/2013
Invoices paid:
$
Invoice 2135 3/2/2013
1,000
Invoice 2178 6/3/2013
1,500
Invoice 2201 5/4/2013
2,300
TOTAL REMITTANCE Cheque 489013
US$4,800
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Chapter 7
TRIAL BALANCES AND CORRECTING
ERRORS
1.
Introduction
This chapter gives a brief revision of extracting trial balances and then investigates the errors that
could have occurred in a bookkeeping system.
2.
Recording transactions and the trial balance
The double entry system consists 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 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.
In addition there were two detailed memoranda ledgers
๏
The payables ledger which details of exactly what is owed to whom are also recorded here. The
sum of the amounts owing in this ledger should agree with the payables balance in the general
ledger.
๏
The receivables ledger which 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.
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IF double entry had been carried out correctly then the values of all credits should equal the value of
all credits made and when balances on each account are worked out, the sum of the debit balances
should equal the sum of the credit balances. The document showing this is the trial balance. For
example:
Cash
Equipment
Capital
Inventory
Suppliers
Customers
Sales
Cost of goods sold
Rent
Total
Dr
2,900
2,000
CR
Type of account
Asset
Asset
Liability (to owners)
Asset
Liability
Asset
Income
Expense
Expense
10,000
2,500
–
4,000
–
4,000
2,500
100
14,000 14,000
Example 1
Produce a trial balance for the above accounts by listing each amount as appropriate in the Dr or Cr
columns, and label each asset, liability, income or expense:
Balance
Cash (in credit at
the bank)
Petty cash
Sales
24
123,758
84,758
Wages
15,893
Equipment
38,600
Electricity
Receivables
CR
8,175
Purchases
Rent
Dr
3,340
254
10,392
Payables
5,678
Bank loan
12,000
Capital
20,000
Totals
Trial balances should be taken out regularly (at least monthly) to see if something has gone wrong
with the maintenance of double entry. It is much easier finding an error in one month’s postings than
a whole year’s.
However, trial balances will not detect all errors: they only detect errors where the debit does not
equal the credit entry, or where the trial balance has been taken out incorrectly.
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Errors not found by trial balance can be categorised as:
๏
Errors of commission
Example: an expense of rent was incorrectly debited to the wages account.
Example: the purchases day book had been added up to be $8,900 when the correct total was
$9,800. Both purchases and the payables control account would then have $900 (ie $9,800 £8,900) too little posted to them, but the double entry would have been maintained.
๏
Errors of omission
Example: an invoice from a supplier is not entered into the purchases day book at all, so no entry
is made for that transaction.
๏
Compensating errors
Example: rent paid of $210 is debited to the rent account as £120 (error = $90 too little debited)
and cash sales of $540 are credited to the sales account as $450 (error = $90 too little credited).
๏
Errors of principle
Example: the expense of rent of £350 was incorrectly posted to a receivables account. This error
is worse than the error of commission above because it will affect the profit of the business.
Instead of adding to an expense, the value of an asset has increased.
A common cause of errors, rather than a type of error, is a transposition error, such as writing 1234
instead of 1324. A way to try to see if transposition might have been a cause of an error is to see if the
error is evenly divisible by 9. For example 1324 – 1234 = 90 which can obviously be divided by nine
without a remainder. A transposition error could therefore have been the cause of the error.
Any of the types errors described above will not cause a trial balance not to balance. The errors once
found are easy to correct by journal.
Example 2
What would be the correcting journals for the error of commission and the error of principle set
out above?
Journal number
Dr
Cr
Dr
Cr
Authorised by
Journal number
Authorised by
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If a trial balance does not balance then:
1.
A one sided error must have occurred (Such as Credit cash $120, Debit Purchases $100 and
forgetting about the sales tax of $20).
2.
The production of the trial balance is incorrect. For example, leaving out an account or listing it
on the wrong side of the trial balance.
Non-balancing trial balances often use a suspense account to indicate the amount by which the two
sides differ, and as errors are found, the suspense account can be brought back to zero, indicating
that the two columns of the trial balance agree.
For example: if the trial balance produced was this:
Dr
CR
Cash
2,700
Equipment
1,800
Capital
Inventory
Suppliers
Customers
10,000
2,500
–
4,000
Sales
Cost of goods sold
4,000
2,500
Rent
Wages
Total
2,700
100
2,456
16,056
16,700
Then a suspense account would be introduced to make it balance:
Dr
CR
Cash
2,700
Equipment
1,800
Capital
Inventory
Suppliers
Customers
10,000
2,500
–
4,000
Sales
Cost of goods sold
Rent
Wages
Suspense account
Total
2,700
4,000
2,500
100
2,456
644
16,700
16,700
This suspense account indicates that there was originally more on the credit side than on the debit
side so that more debits are needed.
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An investigation of the differences then needs to be carried out. Let’s say that the following errors
were found:
1.
Rent of £400 had been charged to wages.
2.
Cash received of £200 had been assumed to be from a customer paying an invoice in the
receivables ledger. In fact it was a new sale.
3.
Petty cash of $44 has been left out of the trial balance
4.
A sales day book total of $820 had been debited to receivables (customers) as $280, though had
been correctly posted to the sales account.
5.
Discounts allowed to customer of $30 had been credited to the sales account rather then
debited to the discounts allowed account.
Now look at each error and decide how to correct it. Also think carefully if it would have caused the
trial balance not to balance: if so, the suspense account will be affected.
Example 3
Errors 1 and 2 would not cause the trial balance to be out of balance. They are errors of commission
and principle.
Adjust the trial balance to correct these errors:
Adjustment
Dr
CR
Cash
2,700
Equipment
1,800
Capital
2,500
Suppliers
–
Rent
Wages
Suspense account
Total
Dr
CR
2,700
4,000
Sales
Cost of goods sold
CR
10,000
Inventory
Customers
Dr
4,000
2,500
100
2,456
644
16,700
16,700
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The trial balance with the adjustments so far will be as follows:
Adjustment
Dr
CR
Cash
2,700
Equipment
1,800
Capital
Dr
CR
CR
10,000
Inventory
2,500
Suppliers
–
Customers
2,700
4,000
Sales
200
4,000
Cost of goods sold
200
2,500
Rent
100
Wages
400
2,456
Suspense account
Total
Dr
400
644
16,700
16,700
600
600
The remaining errors are all of a one-sided nature, and as they are corrected, the suspense account
can be updated. [Note the suspense account is not a real ‘T’ account; it is just a way of tracking the
errors].
It is easy to make the wrong adjustments in the suspense account. The key is to think:
1.
How are the accounts or trial balance to be corrected? What side is to be adjusted and by how
much?
2.
Having worked that out, the suspense account entry is always on the other side.
Continuing with the example;
Error 3
$44 has been left out of the trial balance. $44 needs to be introduced on the debit side of the trial
balance so the suspense account will be credited $44.
Error 4
Receivables were debited by $280 when they should have been debited by $820. The size of the error
is therefore $540 and this needs to be an extra debit to receivables. Therefore, credit the suspense
account by $540.
Error 5
$30 had been credited to sales rather than debited to discounts allowed. The size of the error is $30 x
2 = $60. $30 has to be debited (ie come out of) to the sales account and $30 debited into the discount
account.
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The memorandum suspense account ‘T’ account would therefore be:
Balance b/f
Suspense account
644 Error 3 $44 petty cash put into the trial balance
Error 4 Extra $540 into receivables (customers)
Error 5 $30 out of sales and into discounts
44
540
60
644
644
The trial balance would be:
Adjustment
Dr
Cash
CR
Dr
CR
Dr
2,700
2,700
Petty cash
Equipment
44
1,800
10,000
Inventory
2,500
Suppliers
–
Customers
2,700
4,000
Discounts allowed
Rent
Suspense account
Total
–
200
540
30
200
4,170
30
2,500
2,500
400
500
2,456
400
644
644
16,900
2,700
4,740
30
100
Wages
10,000
2,500
4,000
Sales
Cost of goods sold
44
1,800
Capital
CR
16,900
1,244
1,244
2,056
16,870
16,870
Question 1
Which of the following errors would cause a trial balance not to balance?
1.
Debiting the purchase of a car to the Purchases account instead of the Motor Vehicles account.
2.
Debiting cash received to the cash book and crediting payables instead of Receivables
3.
Listing discounts allowed to customers as a credit balance
4.
Listing petty cash as a debit balance.
A
1, 2, 3 and 4
B
2, 3 and 4 only
C
3 only
D
3 and 4 only
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Question 2
A debit balance in the general ledger of £1123 was listed in the trial balance as $2123 credit.
By how much does this cause the trial balance not to balance?
A
3,246
B
1,000
C
3,266
D
1,633
Question 3
The trial balance of Mazar Ltd does not balance and a suspense account has been created. Cash paid
to a credit card account of $5,641 has been posted to the credit card account as $5,146.
Which of the following entries is the correct adjustment?
A
Dr Credit card company
990 Cr Suspense account 990
B
Dr Credit card company
495 Cr Suspense account 495
C
Dr Suspense account 495 Cr Credit card account 495
D
Dr Suspense account 990 Cr Credit card account 990
Question 4
A trial balance does not balance. One of the errors discovered was made in writing off a bad debt of
$500. The receivables ledger entry handled correctly, but the Irrecoverable Debts Account was
credited with $500.
The correcting entry would be to;
A
Dr Irrecoverable Debts 500 Cr Suspense Account 500
B
Dr Irrecoverable Debts 1,000 Cr Suspense Account 1,000
C
Dr Suspense Account 1,000 Cr Irrecoverable Debts 1,000
D
Dr Suspense Account
500 Cr Irrecoverable Debts 500
Question 5
A company made sales of $2,950 inclusive of sales tax at 18%.
The company debited the Receivables account $2,950, credited sales $2,950 and credited the Sales
Tax account $531.
What corrections are required?
A
Dr Receivables account $450;
Cr Suspense account $450
B
Dr Sales $531; Cr Suspense account $531
C
Cr Sales $531; Cr Sales tax $450;
Cr Suspense account
D
Dr Sales $450; Dr Sales tax
Cr Suspense account $531
$81;
$81
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Question 6
A sales order from a customer slips down the back of a desk before goods are despatched or invoiced.
Which of the following errors in the accounting system has been committed?
A
An error of omission
B
An error of commission
C
An error of principle
D
None of the above
Question 7
A company was owed $4,300 by a customer and there was to be a 5% settlement discount if the
amount was paid within 30 days.
The amount net of the discount was received after 25 days and this was debited to the cash book.
$4,300 was credited to the memorandum receivables account and to the receivables control account
to indicate that the debt had been fully settled in accordance with the terms offered.
When a trial balance is extracted, what will be the suspense account that is needed initially?
A
$4,085 Dr
B
$4,085 Cr
C
$215 Cr
D
$215 Dr
Question 8
An amount of $1,239 paid to a supplier to settle an invoice was treated as a new purchase.
What adjustment is needed to correct this error?
A
Dr Supplier $1,239
Cr Suspense account $1,239
B
Dr Supplier $1,239
Cr Purchases
C
Cr Suspense account $1,239
D
Dr Purchases
$1,239
$1,239
Dr Supplier $1,239
Cr Supplier $1,239
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Question 9
A company was owed $500 by ABC Ltd and owed $600 to ABC Ltd. It was decided to offset these
amounts to the fullest extent so as to leave a net balance of $100. The company debited Receivables
$500 and credited Payables $500.
Which of the following statements is true?
A
These are the correct entries to carry out the offset.
B
This will cause the trial balance not to balance by $100
C
These are not the correct entries, but the trial balance will still balance.
D
This will cause the trial balance not to balance by $500
Question 10
Petty cash amounting to $56 was listed on the wrong side of the trial balance.
What adjustment is needed to correct this error?
A
Dr Trial balance petty cash line $56;
Cr suspense account $56
B
Cr Trial balance petty cash line $56
Dr suspense account $56
C
Dr Trial balance petty cash line $112;
Cr suspense account $112
D
Cr Trial balance petty cash line $112;
Dr suspense account $112
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Chapter 8
LABOUR COSTS AND REMUNERATION
METHODS
1.
Introduction
This chapter looks at how remuneration is calculated and accounted for.
2.
Remuneration methods and systems
Large organisations will have a wages and salaries department which is responsible for calculating
amounts owing, dealing with employees who leave and with new joiners. Sometimes the payments
to each employee are the same every week or month; sometimes they depend on time records (such
as clock cards), production records, or some other type of calculation. In all 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, the tax authorities and any other recipient, such as pension funds.
Employees can be paid by:
๏
Cash
๏
Cheque
๏
Credit transfer to their bank account
Cash payments are becoming much less common. They were labour intensive as envelopes had to be
filled with the correct cash for each employee. There were also considerable security issues as the cash
needed for a large workforce was very significant and an attractive target for robbery.
Additionally, as wages were being handed out, care was needed to ensure that the right people
received the cash and that they evidenced, by signing a register, that their wages had been received.
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Labour costs
Labour costs can arise from:
๏
Basic wage or salary
๏
Overtime premiums
๏
Bonuses
๏
Commission (for example so much per sale made)
๏
Holiday pay
๏
Sick Pay
๏
Payroll taxes
Many countries pay wages and salaries under a ‘pay as you earn scheme’ which means that the
employer deducts the employees’ income tax from the gross wage and pays that over directly to the
tax authority. Only the net amount after tax is then paid to the employee.
Employee remuneration can be based on the following approaches:
1.
A constant weekly or monthly amount
This is easy to calculate:
Labour cost = remuneration per period x number of periods
2.
An amount based on hours worked (basic plus overtime)
Illustration
52 hours are worked in a week. Basic week is 40 hours, the basic rate of pay = $10,
and overtime is paid at time and one half.
Basic pay: hours worked @ basic rate 52 x $10
Overtime premium :
520
(52 – 40) x $10 x 50%
60
Total pay
3.
US$580
An amount based on units produced: piecework
Often there is a guaranteed minimum amount of pay so as to comply with minimum wage rate
legislation.
Illustration
Minimum pay/week = $250
Piece rate = $3/unit
If 100 units are made in a week then the pay will be $3 x 100 = $300
If 80 units are made in a week then the pay will by $250 (because the piece rate
amount would be only $240
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An amount based on productivity
There are many different types of bonus scheme and any question would have to set out the
precise rules.
Illustration
Basic pay = $9/hour for a 40 hour week.
Normal production in that time = 120 units
Bonus = 50% of the time saved on production paid at time and a third
What will be the total wage in a week in which 150 units are made in 40 hours?
Answer:
$
Basic pay = 40 x $9
360
150 units should take 50 hours
150 units did take 40 hours
Hours saved 10 hours
Bonus = 50% x 10 x 9 x 1 ⅓
Total pay
5.
60
420
An initial amount plus a bonus
Here, for example, the bonus could be part of a profit share. Full instructions would have to be
supplied as to how to calculate the amounts.
Example 1
Employees are paid $7/hour for a standard 40 hour week. Overtime is paid at time and one half.
The employee is expected to make at least 120 units in a week, and to encourage productivity, each
unit in excess of 120 will generate an additional payment of $5 less any overtime premium that would
relate to the time the additional unit would normally take.
What is an employee’s wages in a week in which 135 units are made and the employee works 44
hours?
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Gross and net earnings
Gross pay:
the total amount earned by the employee
Net pay:
the amount paid to the employee after the employer makes
deductions for income tax and certain statutory amounts.
Total labour cost to employer: employees’ gross pay plus any additional payroll taxes and pension
contributions that the employer has to bear.
Example 2
An employee is paid at the rate of $10/hour.
Tax and other deductions amount to 25% for weekly income in excess of $120
Employer payroll taxes = 10% gross wages
If an employee works 46 hours in a week, what are the employee’s gross pay, net pay and the
total amounts that have to be paid by the employer to the tax authorities?
7.
Accounting for labour costs
Labour costs can be accounted for using a Salaries and Wages Control account
Dr
Step 1
Dr Wages and Salaries account with gross wages
Cr Wages Control account with gross wages
X
Step 2
Dr Wages and Salaries account with additional employer’s costs
Cr Wages Control account with additional employer’s costs
X
Step 3 (payment of net wages to employee)
Dr Wages Control account with net wages
Cr Cash with net wages
X
Step 4 (payment of deductions to government)
Dr Wages Control account with employee deductions
Cr Cash with employee deductions
X
Step 5 (payment of other amounts to government etc)
Dr Wages Control account with other amounts due
Cr Cash with other amounts due
X
Cr
X
X
X
X
X
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Example 3
Show the following transactions in Wages Control account and the Wages and Salaries account
31 March, gross wages calculated as $45,000; deductions for employees’ taxes = $8,000;
1.
deductions for employee pensions = £3,000.
2.
31 March, employer’s payroll tax calculated as $4,000
3.
31 March, employer’s pension contributions = $5,000
4.
1 April, employees paid amounts due
5.
15 April, tax authorities paid amounts due.
6.
20 April, pensions fund paid amounts due
Question 1
A company has the following components in its wages calculations:
Gross wages calculated as $76,000
Deductions for employees’ taxes = $20,000
Deductions for employee pensions = £12,000.
Employer’s payroll tax calculated as $15,000
Employer’s pension contributions = $16,000
Which of the following is correct?
A
Employees are paid $72,000 net; total employment cost to employer = $91,000
B
Employees are paid $76,000 net; total employment cost to employer = $107,000
C
Employees are paid $44,000 net; total employment cost to employer = $107,000
D
Employees are paid $60,000 net; total employment cost to employer = $77,000
Question 2
Under most systems of tax, what do employers pay to employees?
A
Gross wages
B
Gross wages less employees’ deductions less employers’ payroll tax
C
Gross wages less employees’ deductions
D
Gross wages less employers’ payroll tax
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ANSWERS TO EXAMPLES
Chapter 1
Example 1
Statement of financial position: shows assets and liabilities
Income statement: shows income and expenses
Example 2
Any three of:
๏
Concise
๏
Precise
๏
Enables automatic processing
๏
Enables checking
Chapter 2
Example 1
Dr
Cash
2,900
Equipment
2,000
Capital
10,000
Inventory
2,500
Suppliers
Customers
–
4,000
Sales
Cost of goods sold
Rent
Total
CR
–
4,000
2,500
100
14,000 14,000
Example 2
Sales
21/6/2103 Returns
25/6/2013 Returns
Balance carried down
550 1/6/2013 Cash
32 3/6/2013 Credit sales
1,112 29/6/2013 Cash
1,694
250
1,395
49
1,694
Balance brought down
1,112
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Example 3
1 Capital
4 Sales
9 LD Vinci
Cash
6,000 2 Inventory
1,900 6 Rent
850 7 Electricity
8 VV Gogh
10 Drawings
500
12 Cash
750
Balance c/d
8,750
4,500
Balance c/d
Capital
6,000 1 Cash
6,000
Balance b/d
Inventory
1,000 4 Cost of goods sold
1,500 5 Cost of goods sold
Balance c/d
2,500
Balance b/d
Balance c/d
5 Inventory
8 Cash
Balance c/d
6,000
1,000
500
1,000
1,000
Sales
4 Cash
1,900
2,750 5 L D Vinci
2,750
850
2,750
2,750
Cost of goods sold
1,000
500 Balance c/d
1,500
Balance b/d
6,000
6,000
2,500
Balance c/d
4 Inventory
4,500
8,750
Balance b/d
2 Cash
3 V V Gogh
1,000
1,000
250
750
1,500
1,500
1,500
V V Gogh
750 3 Inventory
750
1,500
1,500
1,500
Balance c/d
750
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5 Sales
L D Vinci
850 9 Cash
850
850
850
7 Cash
Electricity
250 Balance c/d
250
250
250
Balance b/d
250
6 Rent
Rent
1,000 Balance c/d
1,000
Balance b/d
1,000
11 Repair company
Repairs
300 Balance c/d
300
Balance b/d
300
Balance c/d
12 Computer
Balance b/d
10 Cash
Balance b/d
Repair company
300 11 Repairs
300
1,000
1,000
300
300
300
300
Balance b/d
300
Computer
750 Balance c/d
750
750
750
750
Drawings
500 Balance c/d
500
500
500
500
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Trial balance
Account
Cash
Dr
Cr
4,500
Capital
Asset
6,000
Inventory
1,000
Sales
Asset
2,750
Cost of goods sold
1,500
V V Gogh
L D Vinci
Electricity
Rent
Repairs
Liability
Expense
750
–
Income
Liability
–
250
Expense
1,000
Expense
300
Expense
Repair company
300
Liability
Computer
750
Asset
Drawings
500
Reduction in a liability
9,800
9,800
Chapter 3
Example 1
Journal number
Dr
Repairs
Dr
350
Cr Machinery cost account
Being the correction of the treatment of a repair invoice as an addition to
machinery
Authorised by
Cr
350
350
350
Dr
1789
Cr
Example 2
Journal number
Dr
Sales
Cr
XYZ Ltd
Being the correction of an amount treated as a new sale but which was the
settlement off a debt.
Authorised by
1789
1789
1789
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Chapter 4
Example 1
Dr
(Receipts)
Cr
(Payments)
Cash Book
Balance b/d 31 July 2013
4 Receipt not recorded
200
40 3 Undercast correction
70
5 Bank charges not recorded
31
6 Bounced cheque
50
Balance c/d 31 July 2013
89
240
240
Balance b/d 1 August 2013
89
Bank statement
Opening balance
Less: 1 cheques in cash book not yet on bank statement
Add: 2 amount paid in but not yet on bank statement
Up-to-date balance
339
(500)
250
89
Chapter 5
Example 1
$
Initial amount of receivables
125,000
Written off
(6,000)
119,000
Allowances
– specific
– general 4% x (119,000 – 12,000)
12,000
4,280
(16,280)
102,720
Chapter 6
No examples
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Chapter 7
Example 1
Balance
Cash (in credit at the
bank))
Petty cash
Sales
Dr
CR
8,175
8,175
Asset
24
24
Asset
123,758
123,758
Income
Purchases
84,758
84,758
Expense
Wages
15,893
15,893
Expense
Equipment
38,600
38,600
Asset
3,340
3,340
Expense
254
254
Expense
10,392
10,392
Rent
Electricity
Receivables
Asset
Payables
5,678
5,678
Liability
Bank loan
12,000
12,000
Liability
Capital
20,000
20,000
Liability to owners
161,436 161,436
Example 2
Journal number 1411
Dr Purchases
Dr
900
Cr Payables control account
Cr
900
Being the correction of undercast purchases day book
Authorised by
Journal number 1411
Dr Rent
Cr Receivables control account
Dr
350
Cr
350
Being the correction of a rental payment
Authorised by
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Example 3
Adjustment
Dr
CR
Dr
CR
Dr
CR
Cash
2,700
2,700
Equipment
1,800
1,800
Capital
10,000
Inventory
2,500
Suppliers
–
Customers
2,700
–
200
4,000
Cost of goods sold
200
400
2,456
Suspense account
500
400
644
16,700
4,200
2,500
100
Wages
2,700
4,200
2,500
Rent
Total
2,500
4,000
Sales
10,000
2,056
644
16,700
16,900
16,900
Chapter 8
Example 1
Note: each unit is expected to take 40 x 60/120 = 20 minutes
$
Basic wages for 44 hours = 44 x $7 =
308.00
Overtime premium 4 x $7 x ½ =
14.00
Extra units 15 x $5
75.00
Overtime premium that could be associated with the extra units
15 x 1/3 x $7 x 1/2
-17.50
379.50
Example 2
Gross wages 46 x $10 =
Tax and other deductions 25% x (460 – 120) =
$460
(85)
Net pay
$375
Payroll taxes $460 x 10%
$46
Total payments by employer to tax authorities = $85 + $46 = $131
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Example 3
Wages Control Account
31/3 Wages and salaries account
[gross wages]
31/3 Wages and salaries account
[employer’s payroll tax]
1/4 Cash (paid to employees)
31/3 Wages and salaries account
[45,000 – 8,000 – 4,000]
34,000 [employer’s pension contribution]
15/4 Cash (paid to tax authorities)
[8,000 + 4,000]
12,000
20/4 Cash (paid to pension fund)
[3,000 + 5,000]
8.000
54,000
Wages and Salaries Account
31/3 Wages and salaries account
[gross wages]
45,000
31/3 Wages and salaries account
[employer’s payroll tax]
4,000
31/3 Wages and salaries account
[employer’s pension contribution]
5,000 31/3 Balance c/d
45,000
45,000
4,000
5,000
54,000
45,000
45,000
The brought down balance at the end of March is carried forward and April’s amounts will be added
to that, and so on, to accumulate the wages cost for the year.
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ANSWERS TO TESTS
Chapter 1
Question 1
C
Question 2
B
Question 3
C
Question 4
C
This is an item of income so would be on the income statements.
Question 5
B
Question 6
B
690 x 100/115 = 600; 690 x 15/115 = 90
Question 7
D
3000 x 80% x 1.16 = 2784; 3000 x 80% x 16% = 384
Question 8
D
Output tax = $4,600; input tax = $1,000 ie 6,000 x 20/120. So, $3,600 has to be paid
Question 9
B
Remember: garbage in, garbage out
Question 10
C
Chapter 2
Question 1
B
The asset of cash decreases; the expense of wages increases
Question 2
C
The asset of cars increases as does the liability to the garage.
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Question 3
D
Cash decreases as does the liability to the supplier
Question 4
B
Increase in net assets = 19,000 – 15,000 = 4,000.
Had there been no drawings nor capital introduced this would be the profit. However, net assets
have increased by $4,000 despite drawings of $750, so profit must have been $4,750.
Or:
Increase in net assets = Capital introduced + Profit – Drawings
4,000
Nil
P
-
750
So, P = 4,000 + 750 = 4,750
Question 5
A
Increase in net assets =
Capital introduced
4,000
+
Profit –
Drawings
+
P
–
400
+ Profit
–
Drawings
– 7,000
–
1,000
1,000
So, P = 4,000 + 400 – 1000 = 3,400
Question 6
B
Increase in net assets = Capital introduced
–2,000
C
So,
C = 7,000 + 1,000 - 2,000 = 6,000
$7,000 loss and $1000 drawings have flowed out of the business. This would have reduced the net
assets by $8,000, but they fell by only $2,000. Therefore $6,000 must have been injected as new
capital.
Question 7
D
Net assets
Cash
Owed from customers
Equipment
Assets
Owed to suppliers
Bank loan
Net assets
1 January 31 January
$
$
10,000
12,000
2,000
1,000
6,000
10,000
18,000
23,000
(3,000)
(4,000)
(2,000)
(5,000)
13,000
14,000
Increase in net assets = $1,000 and the owner withdrew $800, so profits must have been $1,800.
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Chapter 3
Question 1
D
Remember, total debits must equal total credits in the double entry system.
Question 2
C
Remember, total debits must equal total credits in the double entry system
Question 3
C
The control account is not affected by errors in extracting and adding up the list of balances
from the payables ledger. Had the $100 been treated correctly it would have been like a
negative figure; it was treated as positive so the error is $200.
Question 4
A
Totals are posted to control accounts and an extra $2,000 has to be posted to correct it. The list
of balances does not depend on total postings from the day book
Question 5
C
Totals in the sales day book are posted to the receivables control account and the sales account,
not to the individual accounts in the receivables ledger.
Question 6
A
The error is in the initial recording of the invoice so everything flowing from that will be wrong.
Chapter 4
Question 1
D
Question 2
B
The double entry is CR Cash (already in the cash book) DR Payables (in total and the individual
accounts).
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Question 3
D
Dr
(Receipts)
Balance b/d 31 July 2013
Receipt not recorded
Cr
(Payments)
Cash Book
5,700
403
Bank charges not recorded
Balance c/d 31 July 2013
70
6,033
6,103
6,103
6,033
Bank statement
Opening balance
Less: amount paid in but not yet on bank statement
Add: cheques in cash book not yet on bank statement
Up-to-date balance
?
1,367
(3,880)
6,033
X must be 6033 + 3880 – 1,367 = 8,546
Question 4
C
Dr
(Receipts)
Cr
(Payments)
Cash Book
Balance b/d
1,145
Receipt not recorded
Bank charges not recorded
Balance c/d
1,220
1,220
1,220
Balance b/d 1 August 2013
Bank statement
Opening balance
Less: amount paid in but not yet on bank statement
Add: cheques in cash book not yet on bank statement
Up-to-date balance
75
1,220
o/d (750)
330
-800
(1220)
X must be 6033 + 3880 – 1,367 = 8,546
Question 5
B
$100 too much will have been credited to the receivables control account from the cash book
column total.
Question 6
B
Net expenditure = 45 – 5 = $40, so that will be the amount of reimbursement needed.
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Chapter 5
Question 1
B
Discounts of 2.5% are available on the debts of $500 and $1,000: $1,500 x 2.5% = $37.50.
The total payment should therefore be: $3,100 - $37.50 = $3,062.50
Question 2
C
Sales = 800 x 80% = $640; settlement discount = 5% x 640 = $32.
The settlement discount is debited to the discounts allowed account.
Question 3
D
Amount owing at period end before discount = $12,345 +11,346 – 10,463 – 228 = $13,000. 25%
of $13,000 = $3,250
Question 4
A
Note that C is wrong. The age of debts begins running from the date of the invoice
Question 5
C
Sales tax content = $34,615 x 15/115 = 4,515. The net amount of the sale = $30,100
Chapter 6
Question 1
D
Discounts of 5% are available on the debts of $1,000 and $2,000: $3,000 x 5% = $150. The total
payment should therefore be: $6,200 - $150 = $6,050
Question 2
C
Sales = 2,800 x 75% = $2,100; settlement discount = 3% x 2,100 = $63.
The settlement discount is credited to the discounts received account.
Chapter 7
Question 1
C
In 1 and 2 the double entry is arithmetically complete, though wrong in principle. In 4, petty
cash should be, and is, listed as a debit.
Question 2
A
1123 is missing from the debit side and 2123 has been arbitrarily introduced to the credit side.
The error is therefore 1123 + 2123 = 3246
Question 3
B
There had been too few debits made by $5,641 - $5,146 = $495. The adjustment is to debit the
credit card company with $495 more and to credit the suspense account with $495.
Question 4
B
$500 was not just left out, it was posted to the wrong side making the Irrecoverable Debts
account $1,000 too little.
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Question 5
D
Entries should have been:
Dr Receivables 2950
Cr Sales 2500
Cr Sales tax 450
Dr Receivables 2950
Cr Sales 2950
Cr Sales tax 531
Differences:
Over
Over
Entries were:
450
81
Question 6
D
This is not an error in the accounting system. No goods have been despatched and no
transactions have been updated and the accounting records are correct
An error of omission would have occurred if the goods had been despatched and invoice for
them had not been recorded anywhere
Question 7
D
At present the Dr to cash is $4,300 x 95% = $4,085 and the credit to the customer is $4,300.
There is a difference of $215 which is $215 too much to credits. The Suspense account will be
$215 Debit to make the trial balance balance.
Question 8
B
Question 9
C
The double entry was complete, but the wrong way round
Question 10
C
Petty cash should be a debit entry, but was placed on the wrong side of the trial balance: 2 x 56
= 112
Chapter 8
Question 1
C
Employees are paid 76,000 - 20,000 - 12,000 = 44,000. Total employment cost to employer =
76,000 + 15,000 + 16,000 = 107,000
Question 2
C
Employer’s payroll taxes are not a deduction from employees’ wages.
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