Understanding the process of recording financial transaction Types of Income & Expenditure Capital Income: Funds received from the sale of capital assets. Eg; Proceeds from the sale of motor vehicles of machinery, broken, end of life, write off Revenue Income: Funds received from the sale of goods. Eg; Sales of goods, interest received, and rent received Capital expenditure: Funds spent on non-current assets. Eg; motor vehicles, plant and equipment, land and buildings, computer equipment and office equipment. Capex (Capital Expense) Revenue expenditure: Funds spent on day-to-day expenses/operations. Eg; purchase of goods for sale, stationary, motor expenses, insurance, and rents and rates. Opex (Operating Expense) Non-current assets: A non-current asset that will be used by an organization for more than one year. These non-current assets are separately disclosed in the statement of financial position (balance sheet). The cost of these assets can be spread over the number of years the asset is going to be used for. This is known as depreciation. Recording financial transactions In order to produce financial statements on a periodic basis, all commercial transactions must be recorded into the organization’s accounting records. Double entry booking There are three keys principles to double entry bookkeeping. 1. Dual effects 2. Separate entity concept 3. Accounting equation Dual effects: Every transaction carried out will have two financial effects. Eg; purchase a van for 1000 paying in cash, the dual effect of this transaction is 1. You have a can (which increases your non-current assets) 2. You have spent 1000 in cash (reducing your bank balance) Separate entity concept: A business is a separate entity from its owner (for accounting purpose) Eg: Ben starts his own business by putting 10,000 into a business bank account. The transaction is viewed from the business perspective, still using the dual effect. The dual effect of this transaction is 1. The business ha 10,000 of cash in its bank account/ increase the current assets. The business owes Ben 10,000 (this is considered to be a liability- it is known as capital) The accounting equation Assets – Liabilities = Capital It reflects a summarize version of the statement of financial position Asset Equipment Cash in bank Inventory Total Liabilities Bank loan 25400 4000 2100 31500 7500 Asset - Liabilities = Capital 31500 - 7500 = 24000 Asset = Capital + Liabilities 31500 = 24000 + 31500 Asset: An asset if a resource controlled by an entity. Eg; Motor vehicles, Land & buildings, Plant and equipment, Inventory, bank account, petty cash, trade receivable Liability: A liability is an amount owed by the entity. Eg; bank overdraft, trade payable, bank loan, VAT liability Capital: Capital represents funds introduced by the owners. Eg; Cash introduced, personal assets introduced Ledger accounting: is a method of recording a number of transactions into an organization’s accounting records to make the process more efficient. Each category of transaction will have its own ledger account (sometimes known as a T account, due to its appearance) Collectively this group of ledger accounts are known as the general or nominal ledger when using computerized accounting package. Each ledger account will usually be given a numerical general ledger code. The dual effect of each transaction will now be referred to as debit and credit entries. Every transaction will have a debit and credit entry of equal value. Date Debit Ledger account Value Date Credit Ledger account Value In order to identify the correct dual effect of a financial transaction, we use the acronyms DEAD and CLIC to help remind of which transactions are considered debits and which are credits. It is useful to have the ledger account below for reference throughout the examples and illustrations as a prompt when practicing double entry bookkeeping. Debit Date Ledger account Value Date Ledger account Debits reflect an INCREASE in Credits reflect an INCREASE in Expenditure Purchase (goods for resale) Sales return (Return inward) Discount allowed Electricity Stationary Staff wages Liabilities Bank overdraft Bank loan Trade payable (PLCA) VAT liability Assets Bank and cash Trade receivables (SLCA/ Sale ledger control account) Land and buildings Plant and machinery Drawings Cash or goods taken out of the business by the owner Decrease in Liabilities Cash Credit Come in Income Sales Purchase return (Return outward) Discount received Rent received Commissions received Capital Amounts input the business by the owner Decrease in Assets Goes out Value Balancing off ledger accounts When all transactions for the accounting period have been entered into the ledger accounts, each ledger account must be balanced off to identity the total amount remaining on each account. Steps to balance off a ledger 1. 2. 3. 4. Add up the debit side of the ledger account. Add up the credit side of the ledger account. Use the higher of the two amounts as the total for both the debit and credit sides. This means that one of the sides need a balancing figure inserting to ensure it adds up to the total entered, this is known as the balance carried down (balance c/d) 5. The balance carried down must then be brought down (balance b/d) to the opposite side of the ledger account (underneath of the totals) to reflect the opening position for the following accounting period. Date Particular Folio Capital A/C Amount (MMK) Date Particular Folio L-1 Amount (MMK) 2007 1-May By Bank A/C 31-May Balance c/d CB-1 2,000,000 2,000,000 2,000,000 2,000,000 1-Jun Balance b/d 2,000,000 Trial balance A trial balance is produced once all the ledger accounts have been balance off. It is a control mechanism to ensure all transactions processed have had a debit and credit entry of equal amount entered into a ledger account. It does not ensure that the ledger accounts are correct (a transaction may have been mis posted to the wrong account, for example a rent expense may have been debited to electricity in error), but it is good initial check of the accuracy of transaction processing. The trial balance is a summary of the balances brought down on each ledger account. Total of Debit Balance = Total of Credit Balance Books of Prime Entry (Day Book) Sales daybook The sales daybook (SDB) is a record of all credit sales invoices raised. The details of all credit sales invoices for a period of time (daily or weekly) will be added to the SDB. The total of the SDB will then be entered into the ledger accounts (known as the General Ledger) using double entry bookkeeping. - Trade receivables (International term)/ Account Receivable Trade debtors (UK term) Sales ledger control account (SLCA) (Used in computer-based examination) All the three terms refer to the same ledger accounts which contains the amount due from customers. Gross VAT Net As the totals from the sales day book (SDB) are used to process transactins into the general ledger, it is difficult to monitor which customers owes what amount from the sales ledger control accounts (SLCA) alone. A separate ledger, the sales ledger is maintained through individual customer accounts. This is aso know as the subsidiary slaes ledger. The sales ledger is not part of the double entry system and is maintained only to provide a breakdown of the total in the sales ledger control account. The Sales Return Day Book The sales return daybook (SRDB) is a record of all sales credit notes raised. The totals of the SRDB will then be entered into the ledger accounts (General Ledger) using double entry bookkeeping. The Discounts Allowed Day Book The discount allowed daybook is a record of all credit notes raised when customers take a prompt payment discount. The original sales invoice will have been entered into the sales daybook at the full amount, therefore an adjustment is needed to reflect the discounted amount received from the customer. The total of the discount allowed daybook will then be entered into the ledger accounts (know as the general ledger) using double entry bookkeeping. Statements of account A statement of account will be produced on a regular basis (monthly) from the customer account in the sales ledger. The statement of account is sent to the customers with an outstanding debt to remind them that the debt is due for payment. This procedure promotes good credit control. The statement of account details all outstanding invoices and credit notes at the statement date. Supplier Statement of accounts The Cash Book The cash book is a book of prime entry. It provides a record of all amounts received into the bank and paid out of the bank account.
