ACCOUNTING AND FINANCE
ESSENTIAL STUDY GUIDE
CONTAINING
UNIT 2 REVISION NOTES
ACCOUNTING AND FINANCE
Going Solo
UNIT
2A
SOLE TRADER
CAPITAL
BANK LOAN
LEASE
RENT
CHEQUE
REVISION
NOTES
MORTGAGE
INTEREST
PAYEE
DRAWER
BANK STATEMENT
DRAWEE
CHEQUE COUNTERFOIL
BANK OVERDRAFT
CURRENT ACCOUNT
STARTING UP IN BUSINESS
SOLE TRADER is the name given to a business that is set up and managed by one
person. The money invested in it by its owner is called CAPITAL. Sole Traders make
their own decisions, can keep any profits but must also suffer any losses.
Premises will be required which could be purchased with a MORTGAGE
(ie borrowing from a bank or building society) or if this is not possible other options are
to RENT (pay monthly to the owner for use of the property) or LEASE (purchase for a
fixed period only).
In order to set up a business the sole trader may need to borrow money from a bank. A
BANK LOAN is taken out for a fixed period of time eg £10,000 over a 5-year period.
The whole amount is immediately available for use by the business. The loan has to be
paid back in regular payments eg monthly, together with a rate of INTEREST as set by
the Bank. Here is an example:
LOAN
TOTAL TO BE REPAID
MONTHLY REPAYMENT
£10,000 over 5 years with a 15% interest rate
£10,000 + £1,500 interest = £11,500
£11,500  60 months
= £192 each month
The most common type of Bank Account used by businesses is a CURRENT
ACCOUNT. Money is withdrawn from a Current Account by completing a CHEQUE.
A cheque is a written order from the account holder (the drawer) to the bank (the
drawee), to pay a specified amount of money from the holder’s account to the person or
firm named on the cheque (the payee).
2
ACCOUNTING AND FINANCE
Going Solo
UNIT
2B
REVISION
NOTES
The 3 parties involved in a cheque:
1
2
3
The Drawer – the person who writes out the cheque ie pays the money
The Payee - the person or firm being paid
The Drawee – the drawer’s bank
Here is an example of a cheque – it must show:
 the amount in words and figures
 the date on which the cheque is written
 the signature of the drawer
the drawee
Tayside Bank
the payee
32 – 80 – 32
Tayside Bank
Today's date
Today's date
Frasers
Pay
(Desk)
One Hundred and Fifty Pounds only
Frasers
£150 -
account no
£ 150 ----------the
drawer
Jean
000462351 0321
counterfoil
bank
sort
code
cheque no
The CHEQUE COUNTERFOIL is the part that stays in the drawer’s cheque book
after paying the cheque over and is a record of who, when, how much and what was
being paid for eg a new piece of office equipment or a heating and lighting bill.
The bank CURRENT ACCOUNT in the ledger will normally have a debit balance and
is an asset in the Balance Sheet but when the amount paid out of the account is greater
than the balance in the account, there is a BANK OVERDRAFT ie a credit balance and
this is a liability in the Balance Sheet. It is possible for the account holder to pre-arrange
with the bank to have overdraft facilities up to a certain limit, sometimes interest-free. If
the overdraft limit is exceeded or has not been pre-arranged with the bank then interest
will be charged on the amount overdrawn. The interest charged by the bank is an
expense in the Profit and Loss Account.
Each month the bank sends account holders a BANK STATEMENT detailing all
money paid in and out of the account during the month.
3
ACCOUNTING AND FINANCE
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UNIT
2C
INVOICE
COPY INVOICE
CREDIT NOTE
COPY CREDIT NOTE
RECEIPT
CHEQUE
PURCHASES
REVISION
NOTES
COPY RECEIPT
VAT
BANK STATEMENT
CASH DISCOUNT
SALES
THE LEDGER
This is the section of a firm's books in which individual accounts are kept on a double entry
basis. Each transaction generates a document which contains the information that is posted
(entered) into the relevant accounts. An INVOICE is the bill sent by the seller to the buyer
who has purchased on credit. It shows the date, quantity, description, unit price, total price,
trade discount, VAT and the terms of payment for the PURCHASES of goods (stock)
bought for re-sale.
VAT is a tax paid on SALES by the buyer and is collected for the Customs and Excise
by the seller. It is charged on sales after all discounts have been deducted. For VAT
purposes it must be assumed that the customer will pay the account promptly enough to
qualify for any CASH DISCOUNT offered as an incentive to pay on time.
Example – Terms 5% Cash Monthly:Goods
Less 10% Trade Discount
£120.00
12.00
Net Goods Value
Add VAT
Total Value of Goods
£108.00
17.96
£125.96
VAT WORKINGS:
Net Good Value
Less 5% Cash Discount
£108.00
5.40
Value on which VAT is charged
£102.60
VAT at 17.5% (102.60 x 17.5%)
17.96
4
ACCOUNTING AND FINANCE
Going Solo
UNIT
2C
REVISION
NOTES
COPY INVOICE is the document kept by the seller and entered into SALES account.
CREDIT NOTE is the document sent by the supplier to the customer who has returned
goods which are faulty or damaged. This is posted to the PURCHASES RETURNS
ACCOUNT (also known as Returns Outwards Account).
COPY CREDIT NOTE is the document kept by the supplier and used to enter into the
SALES RETURNS ACCOUNT (also known as Returns Inwards Account).
A RECEIPT is the document given to a customer paying in cash or by cheque. The
Receipt is used to enter into the customer's CASH OR BANK ACCOUNT.
COPY RECEIPT is the document kept by the supplier and posted to the supplier's
CASH OR BANK ACCOUNT – to summarise:SOURCE
DOCUMENT
KIND OF
TRANSACTION
POSTING TO
ACCOUNTS
Invoice
Copy Invoice
Credit Note
Copy Credit Note
Cheque
Cheque Counterfoil
Receipt
Copy Receipt
Till Roll
Credit Purchase
Credit Sale
Purchases Returned on credit
Sales Returned on credit
Payment Received
Payment out of Bank
Payment out of Cash/Bank
Received Cash/Bank
Cash Sales
Dr Purchases Dr VAT Cr Creditor
Dr Debtor Cr Sales Cr VAT
Dr Creditor Cr Pur Returns Cr VAT
Dr Sales Returns Dr VAT Cr Debtor
Dr Bank
Cr Debtor
Dr Creditor or Expense Cr Bank
Dr Creditor or Expense Cr Cash/Bank
Dr Cash/Bank
Cr Debtor
Dr Cash
Cr Sales Cr VAT
TRIAL BALANCE
The accuracy of the double entry in the ledger should be checked on a regular basis (eg
weekly) by transferring the ledger account balances to a Trial Balance. The total of the
debit balances should equal the total of the credit balances. In the trial balance the
following types of accounts have:
DEBIT BALANCES
Asset accounts
Expense accounts
Purchases account
Sales Returns account
Debtors' accounts
Discount allowed account
Drawings Accounts
VAT (debit balance)
CREDIT BALANCES
Gains accounts
Sales account
Purchases Returns account
Creditors' accounts
Discount Received account
Capital account
Bank Overdraft
VAT (credit balance)
5
ACCOUNTING AND FINANCE
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UNIT
2D
REVISION
NOTES
TRADING AND PROFIT AND LOSS ACCOUNT
TRADING ACCOUNT
COST OF SALES
GROSS PROFIT
EXPENSES
PROFIT AND LOSS ACCOUNT
GAINS
NET PROFIT
NET LOSS
RETURNS IN
RETURNS OUT
CARRIAGE IN
BAD DEBTS
DISCOUNT ALLOWED
CARRIAGE OUT
COMMISSION RECEIVED
DISCOUNT RECEIVED
DRAWINGS
FINAL ACCOUNTS
Once the balances have been gathered together in the Trial Balance, this provides the
information to complete the Trading and Profit and Loss Account and Balance Sheet –
these 2 statements together comprise the final accounts which, by law, must be prepared
at least once a year.
A TRADING AND PROFIT AND LOSS ACCOUNT is a statement in which the
profit made from buying and selling (trading) goods over a period of time is calculated.
The TRADING ACCOUNT is the section where all the figures relating to trading
(buying, selling and returning) goods go. It is where the cost of the goods sold to
customers (COST OF SALES) is deducted from the amount charged to customers, to
leave GROSS PROFIT ie the profit before paying EXPENSES (the regular bills that
firms have to pay).
In the PROFT AND LOSS ACCOUNT we add on to Gross Profit, any GAINS ie
items received by the firm eg COMMISSION RECEIVED on sales and rent received
from someone you sub-let part of your premises to, before deducting all expenses for the
period.
6
ACCOUNTING AND FINANCE
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UNIT
2D/E
REVISION
NOTES
EXPENSES (such as Heating & Lighting, Wages, Salaries and Carriage Out) are paid
for out of gross profit leaving NET PROFIT (profit after expenses). If total expenses
are higher than gross profit then a NET LOSS is recorded.
RETURNS IN, otherwise known as Sales Returns, is the value of the goods brought
back by customers because they are faulty, damaged or not as ordered. This is deducted
from Sales to give Net Sales in the Trading Account.
RETURNS OUT, otherwise known as Purchases Returns, is the value of the goods
returned to suppliers because they are faulty, damaged or not as ordered. This is
deducted from Purchases to give Net Purchases in the Trading Account.
CARRIAGE OUT is the cost of transporting goods sold to customers. This is an
expense in the Profit and Loss Account.
CARRIAGE IN is the cost of delivery charged on Purchases and is added to the cost of
Purchases in the Trading Account ie it is part of the Cost of Sales.
(CASH) DISCOUNT ALLOWED is a reduction given to debtors to encourage them to
pay promptly and is treated as an expense in Profit and Loss. (CASH) DISCOUNT
RECEIVED is a reduction given by creditors to encourage us to pay them promptly.
BAD DEBTS are debtors who, after all attempts have been made to collect what is
owed by them, still fail to pay, their debt is eventually ‘written off’. This involves
crediting their account in the ledger to close it down and debiting the Bad Debts
Account. The balance of the Bad Debts Account is an expense in Profit and Loss.
COMMISSION is money paid to encourage higher sales. When it is paid to the firm's
salespeople then it is an expense. COMMISSION RECEIVED is when the firm is
given a reward for selling more of the manufacturer's products. It is a Gain and
therefore added to Gross Profit in the Profit and Loss Account.
CASH DISCOUNT
This is a financial incentive to pay promptly. It benefits firms who trade on credit to
collect the money owed to them quickly as this allows the firm to pay its creditors on
time. Terms can be offered eg 5% monthly, which means if a firms pays its debt before
the end of the following month, they will get another 5% off their bill. It is important
that when VAT is calculated for the Invoice it is on the cost of goods after both Trade
and Cash Discounts (it has to be assumed that customers will pay in time to qualify for
the Cash Discount also).
7
ACCOUNTING AND FINANCE
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UNIT
2D
CASH BUDGET
REVISION
NOTES
OPENING BALANCE
CLOSING BALANCE
A CASH BUDGET is a statement prepared to forecast how much cash will be left at
the end of the coming week, month or year.
It shows the OPENING BALANCE (the amount in the Bank at the beginning of the
period) plus all cash coming in, less all cash going out, to arrive at the CLOSING
BALANCE (the amount in the Bank at the end of the period).
Reasons for preparing a Cash Budget are to:







calculate how much is expected to come in during the coming week/month/year
calculate how much cash is expected to be spent during the coming week/month/
year
show how much cash is likely to be left at the end of the coming week/month/year
plan future spending
predict the likelihood of running short of cash (liquidity problems)
tell how long it will take to reach a certain target for the bank balance
help judge if items of spending or borrowing can be afforded.
CASH BUDGET
Jan
Feb
Mar
Opening Balance
Add Receipts:
XXX
XXX
Total Receipts
Receipts + Opening Bal
Less Payments:
XXX
XXX
Total Payments
Closing Balance
8
Apr
May
ACCOUNTING AND FINANCE
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UNIT
2F
BREAK EVEN ANALYSIS
FIXED COSTS
VARIABLE COSTS
TOTAL COSTS
BREAK-EVEN POINT
CONTRIBUTION
REVISION
NOTES
VARIABLE COSTS
BREAK-EVEN POINT
ROYALTIES
BREAK-EVEN ANALYSIS is used to show the level of sales required to just cover all
the costs, making neither a profit nor a loss.
FIXED COSTS are those that remain the same regardless of the level of sales and
which must be paid even if no sales are made eg rent. VARIABLE COSTS vary
directly with the level of sales eg Roylaties. ROYALTIES are paid to the owner of a
design or name for using it.
TOTAL COSTS is Fixed Costs plus Variable Costs.
BREAK-EVEN POINT is the number of sales at which neither a profit nor loss is
made. CONTRIBUTION is the selling price minus the variable cost per unit.
BREAK EVEN CHART:
It is a line graph plotting Sales Revenue and Total Costs - the break even point is
indicated where the two lines cross. This shows the level of sales needed to cover all
costs. May not give as accurate a reading as the formula method.
1200
1000
800
600
400
200
0
9
7
5
3
Sales Revenue
Total Costs
1
COSTS AND
REVENUE
BREAK EVEN CHART
NO OF UNITS
9
ACCOUNTING AND FINANCE
Going Solo
UNIT
2F
REVISION
NOTES
BREAK EVEN FORMULA:
Break Even Point (in units) = Total Fixed Costs
Contribution per unit (ie Selling Price-Variable Cost)
Break Even Point (sales revenue) = Break Even Point in units X Selling Price
BREAK EVEN SCHEDULE:
This is a table which lists units, fixed costs, variable costs, total costs and sales revenue
The break even point is the number of units at which total costs = sales revenue
Units
Fixed Costs
Variable Costs
Total Costs
Total Sales Revenue
0
3,000
0
3,000
0
1,000
3,000
2,000
5,000
3,000
2,000
3,000
4,000
7,000
6,000
3,000
3,000
6,000
9,000
9,000 (this is break even point)
4,000
3,000
8,000
11,000
12,000
5,000
3,000
10,000
13,000
15,000
10
11
12