Professional Documents
Culture Documents
WHAT IS BOOKKEEPING?
1.1
b)
1.2
Form of accounts
A set of accounts consists of two principal statements, usually amplified by
detailed notes.
These statements are:
(a)
(b)
The amount of detail in a set of accounts will vary according to the type of
accounts and the people who will be using them. But the same principles will
still apply.
1.3
Types of business
There are 3 types of businesses which we will consider in Accounting and a
brief description of these types of business is given below. What is important to
remember is that regardless of the type of business we are looking at, all
businesses will produce an Income Statement and a Statement of Financial
Position periodically (usually annually).
Sole Trader
A sole trader is usually a small business, such as a plumber or plasterer, the
owner and the manager are the same person.
The sole trader is legally responsible for all of the losses that their business
makes.
Sole traders produce accounts which are not heavily regulated. The sole trader
will usually employ a firm of accountants to prepare the businesss accounts.
Partnership
This is a business owned and managed by two or more people examples of
such are Accountancy and Law firms. Each Partner in this business is a sole
trader for accounting purposes and a Partnership is a collection of sole traders
acting together in one business.
Partnerships produce special Partnership accounts.
Company
A company is not owned by the managers of the business (the directors) but
instead is owned by Shareholders who buy shares in the company and who
elect the Directors to run the company.
A company has limited liability which means that unlike a sole trader, the
owners (i.e. the shareholders) are not responsible for the losses of the
company. The company is its own legal entity.
Companies must produce company accounts and these are heavily regulated
by Company Law and Accounting Standards.
1.4
1.5
1.6
Revision questions
(a)
(b)
(c)
1.7
Answers
(a)
(b)
(c)
(i)
(ii)
(i)
(ii)
Income Statement
2.1
Introduction
In Chapter 1 we saw that the Statement of Financial Position is one of the
principal statements of our financial accounts.
Lets consider what we mean by position: the SOFP considers what the
business OWNS which we refer to as ASSETS and what the business OWES
which we refer as LIABILITIES.
In this chapter we will look at Assets and Liabilities in the Statement of Financial
Position (SOFP) in more detail.
2.2
Assets
As above, Assets are defined things which the business OWNS and can be
broken down into two types:
Non-current assets, and
Current assets.
Non-current assets
Non-current assets can be defined as assets acquired for use within a business
over more than one year (usually several years) with a view to earning profits,
but not for resale.
Without looking at the answer, try to think of some types of assets which a
business would be likely to keep over several years which might help them to
make profits.
Target
about 10.
Answer:
Land, buildings, plant and machinery, patents, motor vehicles, tools, fixtures
and fittings, office equipment, computers, long-term investments, ships, works
of art, locomotives.
Current assets
Current assets are defined as assets acquired for conversion into cash in the
ordinary course of business. These are any assets which are not non-current
assets.
In other words, non-current assets are those which a business keeps and uses
in the long term (usually more than 12 months), and current assets are those
which pass through the business as part of the normal trading process.
Just as people or animals cannot live without blood constantly moving through
their bodies, so a business cannot exist without the constant movement of
current assets.
a)
b)
Inventories
Cash
Receivables these occur when we sell goods to our customers on credit (i.e
they pay us later). When our customer will pay us depends on the credit terms
we offer them but it will usually be within 3 6 months.
2.3
Liabilities
Above we defined a liability as an amount owed by the business. This means
that the business has an obligation to pay money at some future date. As with
assets, there are two types of Liability: Non-Current Liability and Current
Liability.
Non-current liabilities
These are amounts owed by the business, payable in more than one year
after the date of the statement of financial position. Long-term bank loans are
much the common example.
Current Liabilities
A current liability is simply a short-term liability
business, payable within one year.
2.4
(a)
trade payables; - these occur when we buy goods on credit and owe
our supplier money. When we will pay our supplier depends on how
long they give us to pay but this will usually be less than 12 months.
(b)
2.5
Capital
The term capital represents the total amount which the business owes to its
owner, or proprietor. On our SOFP we need to show at that particular date how
much capital there is in the business.
How we calculate capital:
Opening
capital
plus
Capital
injections
plus
Profits
(or) minus
Losses
minus
Drawings
So:
Opening capital
+
+/
2.6
Capital injections
Profits / Losses
Drawings
P PILBEAM:
ASSETS
Non-current assets
Motor vehicles
4,000
Current assets
Inventories
2,000
Trade receivables
Cash
6,300
8,300
Total assets
12,300
10,000
800
Less drawings
(500)
At 31 January
10,300
Non-current liabilities
Current liabilities
Trade payables
2000
2000
12,300
As you can see from the illustration, when we prepare a SOFP we present Noncurrent assets separately from current assets and Non-current liabilities
separately from current liabilities.
If you look at the numbers in the SOFP you can see that
Total Assets = Capital + Total Liabilities.
The above equation is known as the Accounting Equation - we will look more
closely at this in chapter 3.
6
2.7
Revision questions
(1)
(2)
(3)
Buildings
(b)
Receivables
(c)
Cash
(d)
(e)
Long-term investments
(4)
(5)
(6)
2.8
Answers
(1)
Non-current assets are assets bought by the business for use over a
number of years, with the aim of earning profits, but not for resale.
(2)
Current assets are assets acquired for conversion into cash in the
ordinary course of business.
(3)
(a)
non-current
(b)
current
(c)
current
(d)
non-current
(e)
non-current
(4)
(5)
(a)
Trade payables
(b)
Bank overdraft
(6)
3.
3.1
Introduction
As mentioned in chapter 1, the Income Statement is a summary of the results
of a businesss transactions for a period ending on the date of the statement of
financial position.
The income statement summarises sales that a business has made and
expenses a business has incurred over a period of time. This leads us to
determine whether the business has made a profit (more sales than expenses)
or if they have made a loss (more expenses than sales).
3.2
Revenue
Less cost of sales
Opening inventories on 1 January 20X1
Purchases
Less closing inventories on 31 Dec 20X1
X
X
(X)
____
(X)
____
Gross profit
Less expenses
Rent
Rates
Lighting and heating
Telephone
Postage
Insurance
Stationery
Office salaries
Accountancy and audit fees
Bank charges and interest
Delivery costs
Van running expenses
Advertising
X
X
X
X
X
X
X
X
X
X
X
X
X
____
(X)
____
Net profit
X
____
3.3
Revenue
Revenue includes sales made for cash and sales made on credit.
3.4
Cost of sales
As the pro forma shows, the way to find the cost of the goods actually sold
during a period is to take:
(a)
(b)
(c)
the cost of goods in stock at the end of the period: closing inventories.
What this does is to take the cost of goods available for sale during the period
(opening inventories plus purchases) and deduct the cost of the goods which
werent sold during the period (closing inventories). This results in the cost of
the goods which were actually sold.
The thing to remember here is that, whereas revenue should be a larger
amount than cost of sales, the actual number of units of goods concerned will
be the same. Cost of sales or cost of goods sold means exactly that: the cost
of the goods actually sold during the year or period. Revenue thus means
the selling price of the goods during the same period.
3.5
Gross Profit
The first part of the income statement (down as far as gross profit) is known in
many businesses as the core profit, since it shows the results of the actual
buying and selling operations of a business (sales we have made compared to
how much it costs us to buy the things which we have sold i.e. the cost of
sales).
As you can see from the pro forma, the gross profit arrived at is the result of
subtracting cost of sales from revenue.
The resulting gross profit is a very useful figure, since it shows how successful
the main activity of the business has been (i.e. the buying and selling of goods,
as opposed to incidental expenses). You would have to be supremely
incompetent to achieve a large loss.
3
3.6
Net Profit
After arriving at gross profit, we must show other items of income and
expenditure (mainly expenditure) which are relevant to the business but are
incidental to it and not part of the buying, selling or manufacturing of the
goods.
After we have taken off all other expenditure of the business the result is Net
Profit as we can see in the Income Statement.
3.7
3.8
Revision questions
(1)
(a)
(b)
(2)
(3)
(4)
(5)
(6)
Following on from (4) and (5), if the business has rental expenses of
5,000 and telephone expenses of 3000,
How much net profit have they made?
3.9
Answers
(1)
(2)
(a)
Gross profit
(b)
Net profit
(3)
Opening inventories
Add
Purchases
Less
Closing inventories
Cost of sales
X
X
(X)
_____
X
_____
(4)
Opening inventory
Add
Purchases
Less
Closing inventories
Cost of sales
20,000
70,000
(30,000)
_____
60,000
_____
(5)
100,000
(60,000)
_______
40,000
_______
Sales
Cost of sales
Gross profit
(6)
Gross profit
Less
40,000
(5,000)
(3,000)
______
32,000
______
Rent
Telephone
Net profit
1.
Examples
5%
= 0.05
15%
= 0.15
One half
percent
of
a = 0.5% = 0.005
125%
= 1.25
3.894%
= 0.03894
Just remember to move the decimal point two places to the left
Example
A sales value of 150,000 will increase by 5% next year. What is next years
value?
150,000
7,500
Add together
157,500
157,500
Examples to try
___________
___________
Example
A sales value of 150,000 will decrease by 10% next year. What is next years
value?
This year
150,000
15,000
Subtract decrease
135,000
A 10% decrease means that the new figure is 90% of the old value.
A 15% decrease would be 85%, a 3% decrease 97% and so on..
150,000 x 0.90 =
135,000
Examples to try
___________
___________
2.
Example 1
Y = a + bx
If Y = 100,000; b = 4 per unit; and x = 2000 units: What is a?
Solution
100000 = a + 4 x 2000
100000 = a + 8000
100000 8000 = a
a = 920000
Example 2
D0
P0 =
Divi yield
Solution
Example 3
Solution
Example 4
Solution
Have a go
1. A business has Cash of 5000 and receivables of 6000, Payables of 4000 what is capital?
2. A sole trader has capital of 100000, inventory of 60000, loans of 40000 what is cash?
3. A sole trader has Assets of 50000, Liabilities of 20000, opening capital of
5000 - how much profit did the business make?
Answers
4.1
Dual Effect
A consequence of the Accounting Equation is that every transaction will have
two effects (a dual effect).
Lets think about how we can apply that to an example.
Suppose you are in business as a shopkeeper.
(a)
(i)
(ii)
Cash
10,000
Capital 10,000
(b)
You buy goods from a wholesaler for 4,000 cash. What are the two
effects of this?
(i)
(ii)
Accounting equation:
Inventories
Cash
(c)
Assets
4,000
6,000
= Liabilities + Capital
Capital 10,000
________
________
10,000
10,000
________
________
You buy goods from another wholesaler for 2,000, who says he will
send you a bill later. What are the two effects of this?
(i)
(ii)
Accounting equation:
Inventories
Cash
(d)
Assets
6,000
6,000
= Liabilities
Payables 2,000
+ Capital
Capital 10,000
________
________
12,000
12,000
________
________
You sell goods to a customer for 4000 and allow them to pay you at
the end of the month. What are the two effects of this?
(i)
(ii)
Inventories
Cash
Receivables
Assets
2,000
6,000
4,000
= Liabilities
Payables 2,000
+ Capital
Capital 10,000
________
________
12,000
12,000
________
________
There is nothing that a business can do which will not have this dual effect not
even right at the beginning, when you first started up the business and put your
money in as capital.
3
4.2
Inventory
You will consider Inventory a lot in future studies but for now we need to be
happy that Inventory is a current asset. However, when we are considering the
Accounting Equation and the Dual Effect we do not need to consider whether
Inventory has gone up or down.
This is because Inventory is something called a year end adjustment and
therefore is only thought about at the end of the year when the accounts are
being completed. You will see a lot of year end adjustments later in your
studies.
When looking at the dual effect and Inventories are involved we consider
buying Inventory to be a Purchase, which is an expense in the Income
Statement and this will reduce profit. The sale of Inventories is regarded as
Income in the Income Statement which will increase profits.
Remember that if we make a profit then Capital goes up and if we make a loss
Capital goes down.
4.3
You start up the business by putting 10,000 into the business. What are
the two effects of this?
(i)
(ii)
Assets
Cash
10000
10000
Liabilities
0
=
Capital
Capital
10000
10000
You buy goods from a wholesaler for 4,000 cash. What are the two
effects of this?
(i)
(ii)
Assets
Cash
Liabilities
6000
6000
(c)
0
=
Capital
Capital
10000
4000 =
6000
6000
You buy goods from another wholesaler for 2,000, who says he will
send you a bill later. What are the two effects of this?
(i)
(ii)
Accounting equation:
Assets
Cash
Liabilities
Payable
2000
6000
6000
(d)
Capital
Capital
6000
2000 =
4000
6000
You sell goods to a customer for 4000 and allow them to pay you at
the end of the month. What are the two effects of this?
(i)
(ii)
Cash
Receivables
6000
4000
10000
Liabilities
Payable 2000 +
=
10000
Capital
Capital
4000 +
4000 =
8000
This was the activity that we asked you to complete. The answers are set out below.
Record the accounting equation for Doras business after each of the following
transactions:
(1)
Dora starts her business with 20,000 paid into a new business bank
account.
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
Answers
(1) Cash
Capital
Assets
Cash
(2) Purchases
Trade Payables
Assets
Cash
20,000
20,000
=
Liabilities
20,000
20,000
2,000
2,000
=
Liabilities
20,000Trade payables
20,000
(3) Cash
5,000
Non-current assets
5,000
Assets
Cash
=
Liabilities
15,000Trade payables
+ Capital
Capital
+ Capital
2,000 Capital
Profit / (loss)
2,000
+ Capital
2,000 Capital
20,000
20,000
20,000
(2,000)
18,000
20,000
Assets
Cash
NCA
Trade receivables
(5) Cash
Trade payables
Profit / (loss)
5,000
20,000
3,500
3,500
= Liabilities
15,000Trade payables
5,000
3,500
23,500
1,800
1,800
Assets
Cash
(15,000 1,800)
NCA
Trade receivables
=
Liabilities
13,200Trade payables
(2,000 1,800)
5,000
3,500
21,700
(7) Cash
Trade receivables
Assets
Cash
(18,200 + 2,700)
NCA
Trade receivables
(3,500 2,700)
2,000
+ Capital
2,000Capital
Profit/(loss)
(3,500 2,000)
2,000
+
200
= Liabilities
18,200Trade payables
NCL
5,000
3,500
26,700
2,700
2,700
Capital
Capital
Profit / (loss)
200
(2,000)
18,000
20,000
1,500
21,500
20,000
1,500
21,500
+ Capital
200Capital
5,000Profit / (loss)
20,000
1,500
5,200
21,500
=
Liabilities
20,900Trade payables
NCL
5,000
800
+ Capital
200Capital
5,000Profit / (loss)
20,000
1,500
26,700
300
5,200
21,500
(10) Cash
Drawings
Assets
Cash
(20,350 200)
NCA
Trade receivables
300
=
Liabilities
20,600Trade payables
NCL
5,000
800
26,400
+ Capital
200Capital
5,000Profit / (loss)
(1,500 300)
20,000
1,200
5,200
21,200
+ Capital
200Capital
5,000Profit / (loss)
(1,200 250)
20,000
950
5,200
20,950
250
250
=
Liabilities
20,350Trade payables
NCL
5,000
800
26,150
200
200
=
Liabilities
20,150Trade payables
NCL
5,000
800
25,950
+ Capital
200Capital
5,000Profit / (loss)
Drawings
20,000
950
(200)
5,200
20,750
Double Entry
5.1
Introduction
In the previous chapter we considered the impact of transactions on the Accounting Equation.
In this chapter we take this a step further and think about the impact of transactions using the
terminology debit and credit to show the dual effect of each transaction.
5.2
DEBIT (increase)
CREDIT (increases)
It follows that:
a decrease in an expense, asset or drawings is a credit, and
a decrease in a liability, income or capital is a debit
33
You start up the business by putting 10,000 into the business. What are the two effects of this?
The businesses cash goes up by 10,000. (Assets )
The businesss capital goes up 10,000 (Capital )
(i)
(ii)
Double Entry
Dr Cash 10000
Cr Capital 10000
Although expenses have an ultimate impact on Capital, Expenses are one of the 6 types of account which
we consider so we dont need to look just at the impact on capital but can consider expenses on their own.
Therefore, as purchase expenses have increased we debit purchases.
Cash is an asset and cash has fallen. We debit to increase assets an conversely we credit to reduce assets
and we need to reduce cash by 4,000
34
Double Entry
Dr Purchases Expenses 4000
Cr Cash 4000
You buy goods from another wholesaler for 2,000, who says he will send you a bill later. What are the
two effects of this?
(i)
(ii)
Capital
Again, we have a purchase expense and to increase our total purchases expenses we
need to debit purchases expenses another 2,000.
We have bought the goods on credit but this time we have not paid cash and
therefore we do not need to reduce cash. Instead we have paid on credit and created
a liability. Therefore we want to increase liabilities. To increase a liability we credit.
Double Entry
Dr Purchases Expenses 2000
Cr Payables (Liabilities) 2000
You sell goods to a customer for 4000 and allow them to pay you at the end of the month. What are
the two effects of this?
(i)
(ii)
The customer now owes the business money ( i.e. a receivable of 4,000). (Assets )
The business has income from a sale ( profit, Capital)
Here we have made a sale which means that we will have income in our income statement. To increase
income we credit. The customer has not paid us yet, they still owe us money and therefore we have a
receivable which is an asset. To increase assets we debit.
Double Entry
Dr Receivables 4000
Cr Sales 4000 (income)
You must always have an equal and opposite debit and credit.
35
5.3
Dr Cash 2500
Cr Sales 2500
Since cash is an asset and we debit to increase assets and Sales are income and we credit to
increase income.
(2)
Dr Purchases 6000
Cr Payables 6000
Since purchases are an expense and we need to increase expenses to do so we Debit. As we
now owe our supplier money, we have a payable which is a liability. To increase liabilities we
credit.
(3)
Dr Purchases 3000
Cr Cash 3000
As above, purchases are an expense and we need to increase expenses therefore we debit
expenses. This time we have paid in cash and therefore we need to reduce the cash of the
business and to reduce an asset, which is what cash is, we credit.
(4)
Sold all the fruit bought in (2) above for 7,500 on credit to R Glossop.
Dr Receivables 7500
Cr Sales 7500
Whenever we make a sale we will have income in our income statement and to increase
income we credit. When we make a sale on credit the customer owes us money which for us
is an asset (called a receivable) and to increase an asset we Debit.
36
(5)
Dr Payables 3500
Cr Cash 3500
Remember in (2) above we bought the goods from Wholesalers on credit. Therefore we had a
payable which is a liability.
If we are now paying some of that Liability off we are reducing how much we owe. To reduce
a liability we Debit the liability. Also, we are paying out cash and therefore cash is falling.
Cash is an asset and to reduce an asset we Credit.
(6)
Dr Cash 7500
Cr Receivable 7500
Remember from (4) above that we sold to R Glossop on credit and therefore we had a
receivable since he still owed us money. As he has now paid us we need to reduce this
receivable (asset) and to reduce assets we credit. Also, he has now paid us some cash and to
increase cash we debit cash since cash is an asset.
(7)
(8)
Dr Drawings 400
Cr Cash 400
If a sole trader takes anything out of the business this is called drawings.
Although Drawings will ultimately reduce capital, Drawings is an account which we keep
separate and is one of the 6 accounts which we can consider for the dual effect.
To increase Drawings we Debit. If the cash of the business has gone down then we need to
reduce cash. Cash in an asset and to reduce and asset we credit.
37
(9)
Hopefully you will see from the above illustration that there is always and equal debit and credit to every
transaction. Remember to always consider what are the two accounts which are being affected and then to
use DEAD CLIC.
38
This was the activity that we asked you to complete. The answers are set out below.
Edward opened a bookshop. The following transactions took place:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
(14)
Answers
1
Dr
Cr
Cash
Capital
20,000
20,000
Dr
Cr
Rent expenses
Cash
1,500
1,500
Dr
Cr
Purchases
Cash
350
350
Dr
Stationery
55
Cr
Cash
55
Dr
Cr
Purchases
Trade payables
245
245
Dr
Cr
Cash
Sales
1,200
1,200
Dr
Cr
Trade payables
Cash
150
150
Dr
Cr
Motor vehicles
Cash
3,500
3,500
Dr
Cr
Trade receivables
Sales
150
150
10
Dr
Cr
Drawings
Cash
250
250
11
Dr
Cr
Stationery
Cash
30
30
12
Dr
Cr
Motor expenses
Cash
120
120
13
Dr
Cr
Cash
Trade receivables
75
75
14
Dr
Cr
Electricity expense
Cash
30
30
Task
Using the numbers provided, try to prepare an Income Statement and Statement of Financial
Position.
Hint:
It helps if you draw up an Income Statement and a Statement of Financial Position with no numbers
in it first. You can use the illustrations provided in Chapter 2 for the Statement of Financial Position
and Chapter 3 for the Income Statement.
You also need a complete Income Statement before you complete the Statement of Financial
Position as what we get for profit or loss from the Income Statement is included in the Capital part
of the Statement of Financial Position.
Cash
Capital
Rent expense
Purchases
Stationery
Trade payables
Sales
Motor vehicles
Trade receivables
Drawings
Motor expenses
Electricity expense
15,290
20,000
1,500
595
85
95
1,350
3,500
75
250
120
30
Answer
Income statement
Sales
Cost of sales
Opening inventory
Purchases
Closing inventory
1,350
595
(595)
755
Gross profit
Expenses
Rent
Stationery
Motor expenses
Electricity
1,500
85
120
30
(1,735)
(980)
Net loss
Balance sheet
Non-current assets
Motor vehicles
Current assets
Inventory
Trade receivables
Cash
3,500
75
15,290
15,365
18,865
Caital
Capital introduced
Loss
Drawings
20,000
(980)
(250)
18,770
Current liabilities
Trade payables
95
18,865