BUSINESS:

Any legal activity which you do to earn profit is called Business and the entity which exists for
this purpose is called Business Entity.

Non-business entities:

It is not just businesses that will need to have accounting information and prepare financial
statements also:

Charities
Clubs
Government (or public sector) organizations

TYPES OF BUSINESS.

Sole Trader: The simplest form of business owned and managed by one person (although there
might be any number of employees) fully and personally liable for any losses that the
businesses might make.
E.g. Small retailer, burglar alarm fitter, painter and decorator.

Partnership: A business owned and operated by two or more people. It is a business owned
jointly by a number of partners (minimum 2). Partners share profits and losses in accordance
with their agreement.
E.g. accounting firms, solicitors, estate agents.

Company: A business owned by many people and operated by many (though not necessarily
the same) people.
Companies are more complex and have the following characteristics:
 Owned by shareholders (or members)
Limited companies are of two types:
 Public (share issue to anyone)
 Private (share issue restricted to friends and family)

BUSINESS TRANSACTIONS.

A transaction is an exchange of interest between two persons or parties or the process in which
the seller transfers the goods or services to the buyer and buyer makes the payment for it is
called transaction.
Every business buys and sells goods or services and gets paid for what it sells and has to pay for
what it buys. Many businesses have employees and have to pay for their work. All businesses
incur expenses for services they receive such as electricity, water, telephone services.
Types of Transactions.

1) Cash transaction. In this transaction the buyer makes the payment immediately either
in advance or at spot.
2) Credit Transaction. In this transaction the buyer is allowed to settle the payment in
future time (credit period).
3) Semi-Cash Transaction. In this transaction the buyer makes the partial payment in cash
and allowed a time period for the rest of payment in future time.
4) Barter transaction. In this transaction the goods & services are exchanged with the
goods and services and the transaction is not settled in cash.

KEEPING A RECORD

Transactions are recorded in accounts. The system of recording transactions is therefore called
the accounting system. It is also called the book keeping system and sometimes ledger
accounts.

An account is a summarized record of transaction in which transactions of similar nature are

recorded.

ACCOUNTING CONSISTS OF THREE MAIN STEPS.

1) Recording: in books of prime entry.

2) Classifying: the transactions according to their nature and posted them in their
particular accounts. e.g. Sales transactions are posted to the sales account and expenses
are posted to the expense accounts.
3) Summarizing: accounting data is transformed into meaningful form and summarized
under two financial statements named as statement of comprehensive income (profit
and loss) and Statement of financial position (balance sheet).

FINANCIAL STATEMENTS:
These are the statements which show the financial performance and financial position of the
company.

Types of financial statements:

Statement of comprehensive income:

It is a statement which shows business financial performance for a certain period by comparing
its income and expenses.

Statement of financial position:

It is a statement which shows business financial position at a given point of time by Presenting
its Assets, Liabilities and Capital.
ACCOUNTING CONCEPTS:

Business Entity Concept.

This principle means that the financial accounting information presented in the financial
statements relates only to the activities of the business and not to those of the owner. From an
accounting perspective the business is treated as being separate from its owners.

Accrual Concept.

This means that transactions are recorded when revenues are earned and when expenses are i
ncurred. This pays no regard to the timing of the cash payment or receipt.

FINANCIAL STATEMENTS.

Financial statements are produced to give information to the users. As mentioned earlier the
most important financial statements are the income statement and balance sheet. These are
prepared under the separate entity concept.
The separate entity concept means the business is treated separately from its owners. This
applies to sole traders, partnerships and incorporated companies.

Elements of Financial Statements.

 Assets
 Expenses
 Drawings
 Liabilities
 Income
 Capital

Expenses and Income are the elements of Income Statement & Rest are the elements of
Balance Sheet.

1) Asset.
An asset is a resource controlled by the entity as a result of past events from which future e
conomic benefits are expected to flow to the entity.
For example, a building that is owned and controlled by a business and that is being used to
house operations and generate revenues would be classed as an asset.

Types of assets:

 Non-Current assets.
 Current Assets.
 Non-Current assets.
 These are long term assets used to generate profit. The business will hold on to these
assets for more than one year. For e.g. Land & buildings, plant &machinery, fixtures &
fittings, motor vehicles, car etc.

Current Assets.
 Short-term assets used for day-to-day operations. These assets are for less than one
year. For e.g. Stock, Receivable (debtors), Prepayment, Bank, Cash etc.

2) Liability.
 A liability is an obligation to transfer economic benefit as a result of past transactions or
events.
For example, an unpaid tax obligation is a liability.

Types of Liabilities:
 Non-Current Liabilities.
 Current Liabilities.

Non-Current Liabilities.
 These are long term liabilities over one year which are owed to third parties. For e.g.
Long term Bank loan, Car Lease. etc

Current Liabilities.
 These are liabilities owed to third parties but which are due in less than one year’s time.
For e.g. Trade payable (Trade creditor), Taxation, Bank overdraft etc.

3) Capital.
The amount which is invested in the business is called capital. It is normally replaced by
the word equity in the case of companies. The investment can be made in the form of
Assets or cash.
Equity.
This is the 'residual interest' in a business and represents what is left when the business
is wound up, all the assets sold and all the outstanding liabilities paid. It is effectively
what is paid back to the owners (shareholders) when the business ceases to trade.

4) Income.
This is the recognition of the inflow of economic benefit to the entity in the reporting
period. This can be achieved, for example, by earning sales revenue or through the
increase in value of an asset in other words it is the Inflow of economic benefits e.g.
sales, interest earned rental income etc.
 Types of Income.
Direct Income.

 The earned income which is directly generated from the operations is called direct
income. For examples Sales (Revenue) of the business, Salary of the employee
generated from the employment.

In-direct Income.
 The earned income which is in-directly generated from the operations is called in-direct
income. For e.g. Interest earned, Rent of the rental property or any other part time
income.

5) Expenses.

This is the recognition of the outflow of economic benefit from an entity in the reporting
period. This can be achieved, for example, by purchasing goods or services off another
entity or through the reduction in value of an asset in other words Indicates
money spent for rent, electricity, telephone, insurance, salaries and wages, marketing,
discounts etc.

TYPES OF EXPENSES
Direct expense.
 The Expenses which are directly related to the production are called Direct Expenses
such as Direct Material cost, Direct Labour cost etc.
In-direct expense.
 The Expenses which are in-directly related to the production are called In-Direct
Expenses such as salaries of the staff, Electricity bill, Rent expense etc.

6) Drawings
Amounts or goods taken out of the business by the owner for his personal use. It
directly decreases his interest (capital) in the business, as business is separate from its
owner (separate entity concept).
Drawings in Goods.
 When goods taken out of the business by the owner for his personal use.
Drawings in Cash.
o When cash taken out of the business by the owner for his personal use.

OTHER IMPORTANT TERMINOLOGIES:

 Profit
It is excess of revenue over expenditure.

 Loss
It is excess of expense over revenue.
 Debtor/ Receivable
A person to whom the business has sold items and by whom the business is owed
money. A receivable is an asset of business (the right to receive payment is owned by
the business) e.g. Sale of any Non-current asset (Transaction is of credit nature).

 Trade debtor / Trade Receivable

A person who owes the business money for debts incurred in the course of trading
operations i.e. because the business has sold its goods or services.
E.g. Business is involved in producing medicine and sale of those medicines on credit to
its customer.
All trade debtors are current assets of the business.

 Creditor/ payable.
A person from whom a business has purchased items and to whom a business owes
money. An account payable is a liability of the business. E.g. Purchase of a plant and
machinery on credit.

 Trade creditor/Trade payable.

A person to whom a business owes money for debts incurred in the course of trading
operations. The term might refer to debts still outstanding which arise from the
purchase from suppliers of materials, components or goods for resale.
E.g. Purchase of stock of chairs for resale on credit. These are the current liabilities of
business.

 All trade payables are current liability of the business.

CHAPTER NO 2: ACCOUNTING CYCLE.

Transactions are recorded in accounts. The system of recording transactions is therefore called
the accounting system. It is also called the book keeping system and sometimes ledger
accounts, where as An account is a summarized record of transaction in which transactions of
similar nature are recorded.

ACCOUNTING STEPS:

Invoice ( Source
Transaction Day Book
document)
1 3
2

Trial Balance Ledger Journal

6 5 4

Income
Balance Sheet
Statement
8
7

1) TRANSACTIONS.

2) Cash transaction. In this transaction the buyer makes the payment immediately either
in advance or at spot.
3) Credit Transaction. In this transaction the buyer is allowed to settle the payment in
future time (credit period).
4) Semi-Cash Transaction. In this transaction the buyer makes the partial payment in cash
and allowed a time period for the rest of payment in future time.
5) Barter transaction. In this transaction the goods & services are exchanged with the
goods and services and the transaction is not settled in cash.

2) INVOICE:

A demand for payment of the transaction

 3) DAYBOOK (PRIME BOOK).

All transactions are initially recorded in a book of prime (or original) entry. Entry of a
transaction to a book of prime entry does not record the double entry required for that
transaction. Producing a list of similar transactions means that the periodic total can be
accounted for rather than each individual transaction. This reduces the number of entries into
the accounting system and so reduces the chances for error.

BOOK OF PRIME ENTRY DOCUMENTS RECORDED SUMMARISED AND POSTED TO

Sales day book Sales invoices, credit notes sent Receivables ledger/control account
Sales returns day book Sales returns, credit notes Receivables ledger/ control a/c
Purchase day book Purchase invoices, credit notes Payables ledger/control account
Purchase returns day book Purchase returns/credit notes received Payables ledger/ control a/c
Cash book Cash paid and received Nominal ledger
Petty cash book Notes and coin paid and received Nominal ledger

SUMMARISING SOURCE DOCUMENTS

NEED FOR SUMMARY LEDGER USED

Summaries need to be kept of all the transactions Receivables ledger
undertaken with an individual supplier or Payables ledger
customer invoices, credit notes, or cash so that a
net amount due or owed can be calculated.
Summaries need to be kept of all the transactions General ledger
undertaken with all suppliers and customers so a (a) Receivables ledger control account
total for receivables and a total for payables can (b) Payables ledger control account
be calculated.

EXPLANATION:

1) SALES DAYBOOK.

Date Invoice Debtor Debtor Total VAT Sales 1 Sales 2

ledger Ref
10.10.16

2) SALES RETURN DAYBOOK.

Date Credit Debtor Debtor Total VAT Sales

Note ledger Ref Net
10.10.16
  The sale to Jones Co for $105 is also recorded on page 14 of the receivables ledger.
 Invoice number is unique generated by the business's sales system.

RECORDING SALES.
 3) PURCHASE DAYBOOK.

Date Reference Creditor Creditor Total VAT Purchases Expenses

ledger Ref

4) PURCHASE RETURN DAYBOOK.

Date Credit No Creditor Creditor Total VAT Net

ledger Ref

 The purchase from Cook Co for $315 is also recorded on page 31 of the payable ledger.

RECORDING PURCHASE
 5) CASH RECEIPT BOOK.

It records:
 Cash receipt from debtors
 Cash Receipt from all other sources

Date Receipt Debtor Total VAT Sales Rent Received Discount

from ledger allowed
Debtors Ref
Debtor

 Discount columns are

memorandum column
and do not form part of
the cash book.
 VAT on credit sales is
never recorded in CRB
because it is already
recorded in SDB
 VAT as cash sales is
recoded in CRB because
we are recording this
transaction for the first
time.

6) CASH PAYMENT BOOK.

It records:
 Cash payments to creditors
 Cash payments to all other parties.

Date Cheque Payee Creditor Creditor Total VAT Purchases Interest Drawings
Ledger Ref Paid

 VAT on credit purchases is never recorded in CPB because already recorded in PDB.
 VAT as cash purchases is recorded in CPB because we are recording this transaction for the first
time
Cash receipts Recording and Documentation.
Cash receipts should be properly controlled as they are of high importance for a business to maintain a
reasonable cash position.
The controls will arise from the following concerns:
 Receipts must be banked promptly.
 Record of receipts must be complete.
 Loss of receipts through theft or accident must be prevented.

Remittance advices
When a cheque arrives from a trade customer, it is usually accompanied by a remittance
advice.
A remittance advice shows which payments the cheque covers.
Procedure to compare receipts with Remittance advice

 Check that amounts shown on remittance advice add up to the total

 Compare total with amount of receipt
 In case of disagreement, mark the difference
 Send the cheque to be banked and then record the receipt

If there are differences, these will be dealt with by the sales ledger department.

Receipts
A receipt is a document given by the seller or the buyer when goods change hands in exchange
for payment. It may be a till receipt, a written receipt or some other form of receipt.

Till receipts
Cash registers or tills are used mainly in retail shops where the money is handed over directly
by the customer when the transaction takes place, in form of cash, cheques and card vouchers.
Written receipts
Where a cash register is not used, a written or typed receipt may be required. The information
that appears on the receipt should be same to the one produced by a till receipt.
 Name of selling business
 Date of transaction
 Total value of goods purchased
 Sales tax registration number
 Amount rendered by customer
 Till number

Evidence of payment other than in cash

 Credit card—signed credit card voucher.
 Debit card—signed debit card voucher
 Cheque—payment will appear on customer’s bank statement
 Banker’s draft—issuing bank will hold record of items issued.

Cash: physical security considerations

Money
Cash comprise notes and coin which make up the legal tender of a country.

Risks related to cash

 Forgery (Fake notes)
 Theft

Protective measures

 Cash register security

 Safes
 Protective glass
 Security guards
 Frequent banking
 Cash should never be sent by post

Segregation of duties

This is where the receiving and recording functions are kept separate. One person will receive,
count and perhaps bank the money, while another person will record the money received. This
will reduce the possibility of fraud. It is an effective internal control.

THE PETTY CASH BOOK

The book of prime entry which keeps a cumulative record of the small amounts of cash
received into and paid out of the cash float.
There are usually more payments than receipts, and petty cash must be ‘toppedup' from time
to time with cash from the business bank account.

JOURNAL:
The other items which do not pass through these five books are much less common, and
sometimes much more complicated. It would be easy for a bookkeeper to forget the details of
these transactions if they were made directly into the ledger accounts from the source
documents and, if the bookkeeper left the business, it could be impossible to understand such
bookkeeping entries.

What is needed is a form of diary to record such transactions, before the entries are made in
the double entry accounts. This book is called the Journal. For each transaction it will contain:
 the date
 the name of account(s) to be debited and the amount(s)
 the name of the account(s) to be credited and the amount(s)
 a description and explanation of the transaction (this is called a narrative)
 A folio reference to the source documents giving proof of the transaction.

Some of the main uses of the Journal are listed below. It must not be thought that this is a
complete list.

 The purchase and sale of fixed assets on credit.

 Writing off bad debts.
 The correction of errors in the ledger accounts.
 Opening entries. These are the entries needed to open a new set of books.
 Adjustments to any of the entries in the ledgers.

The layout of Journal:

Debit and Credit:

Are the two financial indictors which show the change (increase/decrease) in elements of
financial statements.
LEDGER:

ACCOUNTING EQUATION:

The consequence of the separate entity concept is that a business will buy assets using
borrowed funds or capital.
So,

 Assets = Capital + Liabilities

We Can expand the above equation as following:

Assets = Capital + Liabilities + Profit –Loss – Drawings

Or
Assets – Liabilities = Capital + Profit –Loss – Drawings

 Net Assets = Capital + Profit –Loss – Drawings

 Assets = Capital Introduced + Profit retained in the previous period + Profit earned in
the current period – Drawings

 Assets = Opening Capital + Capital Introduced in the current period + Profit retained in
the previous period + Profit earned in the current period – Drawings.

Or it can be changed in the business equation as:

 Profits earned in the current period = increase / decrease in net assets in current
period + Drawings in the current period – capital introduced in the current period.
OR
  Opening Net Assets + Capital Injections + Profit – Drawings = Closing Capital
OR

 Increase in Net Assets = Capital Injections + Profit – Drawings

FINANCIAL STATEMENTS FORMAT.

INCOME STATEMENT

Business Name
Income Statement
for the year ended 31 December 2015
$ $
Sales X
Costs of sales X
Gross profit X
Selling costs X
Distribution costs X
Administration expenses X (X)
Profits for the year X

STATEMENT OF FINANCIAL POSITION

Business Name
Statement of Financial Position as at 31 December 2015

$ $
Non-current assets
Land and buildings X
Plant and machinery X
Fixtures and fittings X X

Current assets
Inventory X
Receivables X
Prepayment X
Bank X
Cash X X
X
Capital
Proprietor’s capital X
Retained profits X X

Non-current liabilities
Loan X

Current liabilities
Bank overdraft X
Payables X X

EXPENDITURE.

CAPITAL EXPENDITURE REVENUE EXPENDITURE

Used to bring the asset in running condition. Related to the trading activities of a
particular accounting period, also include
losses (Loss on sale of fixed asset).
Expenditure on existing NCA aimed at increasing Maintenance of existing earning capacity
their existing earning capacity. of NCA.
Long term in nature as the business intends to Short term in nature usually one
receive the benefits of the expenditure over a accounting period.
long period of time
Becomes the part of cost of Asset. Not becomes the part of cost but
expensed out in Income statement.
Doesn’t affect the profit and loss of the period. Does affect the profit and loss of the
period.
Expenditure on acquisition of NCA for the use in Expenditure incurred on assets usually for
business not for the resale purpose. the resale purpose.
Dr. Asset Dr. Income Statement(Expense)
Cr. Cash/Bank/Payable Cr. Cash/Bank/Payable

CAPITAL EXPENDITURE REVENUE

EXPENDITURE
Purchase price Repairs
Legal Fees Renewals
Delivery costs Repainting
subsequent expenditure which enhances the asset Administration
trials and tests General overheads
site preparation costs Training costs
related professional fees (solicitors, architects Wastage
engineers)
Installation Other Maintenance
expenditures

Capital Income.
Proceeds from the sale of non-trading assets (NCA) are known as capital income. Profit on sale
of fixed asset is shown in income statement of the year in which the sale takes place.

Revenue Income.
Proceeds from the sale of trading assets (CA) are known as revenue income. It includes Rent,
interest received, dividends received, profits profit on sale of fixed assets.

NOTE.
Both Capital and Revenue incomes are shown in income statement.

Effects on Profit.
If capital expenditure is charged as Revenue charge.
 NCA would be understated in Balance Sheet
 Expenses will be over stated in Income Statement
 Finally profit would be understated.

If revenue expenditure is charged as Capital expenditure.

 NCA would be overstated
 Expenses will be understated in Income Statement
 Finally Profit would be overstated.

Discount.
Discount is the reduction in the price of goods below the amount at which those goods would
normally be sold to other customers of supplier. Discount is normally expressed in %.

Types of Discount
1. Trade Discount
2. Settlement / Cash Discount

Trade Discount.
Trade discounts are given to try and increase the volume of sales being made by the supplier. B
y
the selling price, buying items in bulk then becomes more attractive. If you are able to source y
our
products cheaper, you can then also sell them on to the consumer cheaper too. For example, if
we were to buy over 1000 items, the supplier might be able to drop the price of those items by
5%.
Accounting for trade discounts
From an accounting perspective, trade discounts are deducted at the point of sale. When acco
unting for a sale that is subject to a trade discount - it is the net amount that should be recorde
d i.e. the trade discount does not get recorded separately.

Question.
Oliver sells goods with a book value of $1,000 to Sam on a cash basis and allows her a trade disc
ount of 10%.
Required:
Show how the above should be recorded in both the books of Oliver and Sam.

Answers.
Oliver's books:
Dr Cash 900
Cr Sales 900
(Net sale = $1,000 – 10%)
Sam's books:
Dr Purchases 900
Cr Cash 900
(Net purchase = $1,000 – 10%)

Settlement / Cash Discount.

A reduction in the amount payable to the supplier in return for immediate or very early
payment in cash, rather than purchase on credit. Normally Cash discount is an incentive for a
customer to pay early or promptly
 Related to only credit transactions.
 Settlement discount is calculated on the net amount (List Price — Trade discount) at the
time of receipt from the debtors.
 Calculation of cash discount is never shown on the invoice; its terms are mentioned as
foot note (because of its indefinite nature).

Accounting for settlement discounts

Discounts may be given in the case of credit transactions for prompt payment:
A business may give its customer a discount – known as Discount allowed.
A business may receive a discount from a supplier – known as Discount received.
The correct double entries are:

Discount allowed (Recorded as indirect Expense in Income Statement)

Dr Discount allowed (expense) X
Cr Receivables X
Discount received (Recorded as indirect Income in Income Statement)
Dr Payables X
Cr Discount received (income) X

Question.
George owes a supplier, Herbie, $2,000 and Herbie has offered George a cash discount of 3% fo
r payment within ten days. George pays Herbie within ten days.
George
owed $3,400 by a customer, Iris. George offers a cash discount to his customers of 2.5% if they
pay within 14 days and Iris takes advantage of the cash discount offered to her.

Solution:
Payable 2000 - (3% * 2000) = 1940
Receivable 3400 – (2.5% * 3400) = 3315

Rebate.
A rebate is overall reduction in price unit for customers who buys or use over a certain number
of units per year. A rebate will be given in one of the following forms.
 A reduction in the bill for the following year
 A refund for the calculated rebate amount

Allowances.
Allowances are; if a certain number of units are ordered at one time then a few extra units are
given free (e.g. buy two get one free).

Note.
3/10 Net 45
Meaning 3% discount is offered if payment is made within 10 days, otherwise net amount is
due within 45 days.
 Numerator is always the discount percentage
 Denominator is the maximum period to avail cash discount
 Last figure is the maximum credit period allowed.

Ali purchases goods for $10,000 less 10% trade discount. He also takes
advantage of a 2% cash discount for prompt payment. How much will Ali
pay?

$
Cost of goods 10,000
Trade discount (1,000) (10% x 10,000)
Net cost 9,000
Cash discount (180) (2% x 9,000)
Amount paid 8,820
Ledger Accounting.
The general ledger is the heart of the accounting system. It contains a separate account for
each item that appears in the balance sheet and income statement. Most ledgers are now
computerized e.g. SAGE, QuickBooks. Each account is given a code, which may comprise of
numbers, text or both.

Journal Entries.
Entries to the ledger are made through journal entries. This is simply writing out the amount,
the account code, description and whether it’s a debit or credit entry