INTRODUCTION TO ACCOUNTING

Topic one
Definition and purpose of accounting
Accounting is defined as the process of identifying, measuring and reporting economic information to the
users of this information to permit informed judgment.
Accountants frequently use the term entity instead of organizations because it is more inclusive.
Purpose/importance of accounting
It is the process of providing quantitative information about economic entities to aid users in making decisions
concerning the allocation of economic resources.

Four key element in the above definition

1. The process of providing
Which means that there is a series of activities leading up to and including the communication of accounting
information.
These activities are:
(i) Identifying the information events (i.e. selecting economic events, transaction)
(ii) Measuring economic events (quantity in shillings)
(iii) Recording economic events (Record, classify, summarize)
(iv) Communicating economic events (prepare accounting reports, analyze, interpret to the users)

2. Quantitative
It means that the information is communicated by using numbers. Accounting numbers are usually numbers of
monetary units. (shillings, dollars, pounds, euros etc.)

3. Economic Entities
It means that accounting applies to all economic units e.g.
(i) Business organizations e.g.bank, supermarkets.
(ii) Non-business organization
(a) Government agencies.
- local govt cities, municipality, councils
- Central govt ministries and govt departments
- kenya revenue authority
- kenya airports authority

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 (b) Not –for profit organization
- Churches e.g catholic diocese of Nairobi
- Hospitals e.g Aga Khan
- Educational e.g Mt. Kenya university
- Political parties e.g KANU.
4. Decisions concerning the allocation of economic resources which include:
- Whether to buy, sell or hold investment – investment decisions
- Credit decisions; whether to manufacture and sell particular products
- Ferial decision; whether to modify the income tax regulations to stimulate business
attitudes

Basic Principles of Accounting

The principles of a good accounting system must meet the challenges of providing information in an efficient
and effective manner.
All decision makers in practice today need to have a basic knowledge of how an accounting information system
works.
The fundamental principles are as follows:
1. Control principle
Managers need to control and monitor business activities. This principle requires that an accounting
information system should have internal controls.
Internal controls are methods and procedures put in place in an organization to allow managers to control
and monitor business activities.
They include;
- Policies to direct operations towards common organization goals
- Procedures to ensure reliable financial reports.
- safeguards to protect business assets and methods to achieve compliance with laws and regulations
2. Relevance principle
Decision makers need relevant information to make informed decisions.
It requires that an accounting information system report useful,understandable, timely and pertinent
information for effective decision making.
The information system must be designed to capture data that makes a difference in decision making. It is
important that all users of financial information be considered when identifying relevant information for
disclosure.

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3. Compatibility principle.
The information system must be consistent with the goals and objectives of the company.
This principle requires that an accounting information system conform with an organization’s activities,
personnel and structures which constitute that organization.
It also must adapt to unique characteristics of the entity.
4. Flexibility principles
An accounting information system must be able to adjust to changes.
This principle requires that the information system be able to adapt to changes in the company, business
environment and the environment of the decision makers. e.g. technological advancements, competitive
pressures, consumer tastes, regulations and company activities constantly change and therefore the system
has to be designed to adapt to these changes. This will allow business organizations to retain a competitive
edge.
5. Cost-benefit principle
The accounting system must balance cost and benefits. It requires that the benefits from an activity in the
accounting information system to outweigh the cost of that activity. The cost and benefit of an activity such
as reporting certain information impact on the decision of internal and external information users.
They also affect cost of computing personnel and other direct and indirect costs.
Decision regarding other system principles e.g. control, relevance,compatibility and flexibility are also
affected by this principle the nature of the principle put in place of an entity is a reflection of the cost of
planning the system.

CONCEPTS AND CONVENTIONS UNDERLYING ACCOUNTING REPORTING.

1. The business entity concept.

For accounting purposes, a business entity is considered to be separate and distinct from its owner or
owners. For instance, for a travelling agency and a dry cleaning store are operated by the same person but as
two separate proprietorships, the business transactions of each must be recorded summarized and reported
separately resulting in an income statement and a balance sheet for each enterprise.
The purchase of a personal automobile by the owner of these two establishments would not be considered as
resulting to either business entity.
Thus accounting treats each business entity as generating its own revenue, incurring its own expenses,
owning its own assets and owning its own debts.

2. The going concern concept.

Business entities are established with the basic assumption of continued existence.
Thus accountants assume that a business entity will be in existence for as long as is necessary to complete
any projects the business entity plans to undertake.
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 It is because of this concept that assets are considered to have future economic benefits.
Financial statements are prepared on the assumption that the existing business will continue to operate in
future.

3. The stable dollar concept.

Accountants know that the value of the dollar changes overtime, but they cannot build useful statements
with unstable units of measurements.
Therefore they prepare financial statements based on the stable dollar concept.
The term stable dollar means that the dollar of the past year is considered equal in value to a current dollar.
The accounting dollar is thus assumed to be stable it does not change in value overtime.

4. The cost principle.

The cost principle specifies that assets acquired by a business entity are to be recorded at the exchange price
paid for them. The price the buyer pays in exchange for an asset is known as the Historical cost.
It is called Historical cost because once recorded, the cost of the asset remains unchanged.
It is important to realize that the assets listed on the balance sheet are measured in dollar amounts that
represent the Historical cost of those assets, not what presently could be obtained from their sale.

5. The objectivity concept.

The cost of an asset is established by an exchange transaction between an informed buyer and informed
seller.
Evidence of the exchange price agreed upon can be found in documents such as purchases invoices, sale
invoices, property deeds transfers of titles and other similar documents.
The objectivity concept requires that this exchange price or the Historical cost be confirmed by an
independent party by simply reviewing the information in the sale documents.
The objectivity concept establishes the reasons for recording assets at cost. Any value other than cost could
not be agreed upon by independent parties, even if they were experts in determining value of assets.

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 ACCOUNTING EQUATION.
The goal of the accounting activity for a business entity is to prepare financial statements that describe the
entity.
These statements cannot be prepared until the financial information of the business entity has been recorded,
classified and summarized. All f/s rely on a simple relationship called the basic accounting model:
expressed by the balance sheet equation. Which is;
Assets = liabilities + owners’ equity
A =L +OE (capital)

Asset represents resources owned by the business entity

Liabilities and owners’ equity represents the claims of those who supply the asset.
Since owners’ equity represents the difference between asset and liabilities, the equation is always in
balance.

Accounting Terminologies
1. Accounts receivables: short term monetary asset that arise from sales on credit to customers at either a
wholesale or retail level.
2. Account payable: it is an amount owed by the business for delivered goods or completed services
3. Accrual basis: is a method of accounting that recognizes revenue when earned other than when
collected and expenses when incurred rather than when paid.
4. Asset: are economic resources that are owned and controlled by a business and are expected to provide
future benefits to the business e.g. land, property, building, cash in bank etc.
5. Liabilities: they are obligations to pay cash, transfer asset or provide services to someone else in future
as a result of past transactions or events.
6. Equity: it is the remaining interest in the asset of a business after liabilities have been deducted.
7. Revenues: they are inflowsof asset or reduction in liabilitiesor a communication of both resulting from
providing products or services to customers.
8. Expenses: they are outflows of asset or other decreases in asset resulting from providing products or
services to customers.
9. Net profit is the difference between revenues and expenses.
10. Balance sheet/statement of financial position: it is a statement that represents the financial position of
the company at a particular date.
Income statement/statement of comprehensive income:it is a financial statement that reports the company’s revenues
and expenses over an interval of time.

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Users of financial statements and their information needs
The parties that use accounting information are frequently called stakeholders. They can either have direct
or indirect interest in organization that issues accounting reports.
Stakeholders that have a direct interest include – owners, managers, creditors, suppliers and employees.
These individuals are directly affected by what happens in business

Owners/investors/stockholders and employees prosper when the business makes profits.

They are both Internal and External users. These are;

1. Manager
When managers are performing their functions of planning, directing and controlling. Management makes
many decisions and informed judgments e.g. when considering expansion of a product line.
(i) Planning involves; identifying and measuring the cost and benefits
(ii) Directing involves communicating the strategies selected
(iii) Controlling involves identifying, measuring and communicating the result of the product during and
after its implementation

2. Investors
They use accounting information when considering whether to invest in the shares of a company also to
help assess the amount, timing and uncertainties of future cash returns on their investments.

3. Creditors/suppliers/lenders
They use accounting information when determining how much merchandise to shift to a customer before
receiving payment. Creditors assess the probabilities of collection and risk of late or non-payment.
Banks also become creditors when they make loans and thus have similar needs for accounting information.

4. Tax authority
Use accounting information in making taxation decisions

5. Shareholders
Use accounting information for assessing the returns and risk in accounting services.
6. Regulationin making regulation decisions
7. Economic planners; use accounting information to analyze and forecast economic activities
8. Labour unions; studythe financial statements of a company as part of preparation for contract
negotiations. They would want to know if the company has the ability to pay increased wages and
benefits.
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9. Customers;are interested in whether the company will continue to honour product warranties and
otherwise support its product lines.
(i) Internal users–those who manage the business (offices and other decision makers)
(ii) External users – those outsidethe business who have either a present or potential interest
(a) Direct financial interest (investors and creditors)
(b) An indirect financial interest;
- tax authority
- regulation agencies
- labour unions
- customers
- economic planners

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Week 2. Topic 2

Double entry concept.

Forany business transaction there are two entries i.e. a debit and a credit entry.
Debit – Dr
Credit – Cr

Asset; Increase – Dr
Decrease – Credit

Owner’s equity and liabilities: Increase – credit

Decrease – debit

Ledgers
It is a record containingall the accounts used by an organization or business.
The ledger keeps in one place all the information about changes in specific account balances.
NBcompanies may use various kinds of ledgers, however all the ledgers fall in one or two broad
categories; - subsidiary ledgers
- general ledgers
The general ledger contains all the accounts that feature on the accounting statement e.g. all
balancesheet a/cs and income statements.
The general ledger should be arranged in a financial statement order beginning with;
(a) Balance sheet a/c first in order of Asset, liabilities and owner’s equity.
(b) Followed by income statement account i.e. Revenue a/c and expense a/c.

Format of a ledger a/c

e.g cash account

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Each account in the ledger is coded or numbered for easy identification

Trial balance
It is a listing of general ledger account and their balances at a particular point in time.

The purpose of trial balance is to check mathematical equity on debit and credit account.

Example of a trial balance

Capital and revenue expenditure

Revenue Expenditure

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These are expenses incurred in the process of generating revenue. These expenditures are charged to the profit
and loss account i.e. the income statement. They include but not limited to

Salaries and wages – Dr Expense

Rent and rates

Insurance - Cr cash at bank

Stationery and postage – Reduces profit and capital

Light and heating

Capital Expenditure

These are expenditures incurred in the process of establishing the business. They are incurred in Acquisition of
fixed assets for the business. They include purchase of,

Machinery

Motor vehicles

Furniture etc

Revenue incomes

Income generated by business:

 Rent received
 Interest received
 Commission received

Capital incomes

Cash received from sale of an asset e.g machinery sold for cash sh. 10,000

Dr: cash

Cr: machinery disposal

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THE ACCOUNTING EQUATION
A business owns properties. These properties are called assets. The assets are the business resources that
enable it to trade and carry out trading. They are financed or funded by the owners of the business who
put in funds.
These funds, includeassets that the owner may put in called capital. Other persons who are not owners
of the firm may also finance assets. Funds from these sources are called liabilities.
The total assets must be equal to the total funding i.e. both from owners and non-owners. This is
expressed inform of accounting equation which is stated as follows:
ASSETS = CAPITAL+LIABILITIES

Each item in this equation is briefly explained below.

Assets:
An asset is a resource controlled by a business entity/firm as a result of past events for which economic
benefits are expected to flow to the firm.
An example is if a business sells goods on credit then it has an asset called a debtor. The past event is the
sale on credit and the resource is a debtor. This debtor is expected to pay so that economic benefits will
flow towards the firm i.e. in form of cash once the customers pays.
Assets are classified into two main types:
i) Non-current assets (formerly called fixed assets).
ii) Current assets.
Non-current assets are acquired by the business to assist in earning revenues and not for resale. They are
normally expected to be in business for a period of more than one year.
Major examples include:
 Land and buildings
 Plant and machinery
 Fixtures, furniture, fittings and equipment
 Motor vehicles
Current assets are not expected to last for more than one year. They are in most cases directly related to
the trading activities of the firm. Examples include:
 Stock of goods – for purpose of selling.
 Trade debtors/accounts receivables – owe the business amounts as a resort of trading.
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 Other debtors – owe the firm amounts other than for trading.
 Cash at bank.
 Cash in hand.

Liabilities:
These are obligations of a business as a result of past events settlement of which is expected to result to an
economic outflow of amounts from the firm. An example is when a business buys goods on credit, then
the firm has a liability called creditor. The past event is the credit purchase and the liability being the
creditor the firm will pay cash to the creditor and therefore there is an out flow of cash from the business.
Liabilities are also classified into two main classes.
i) Non-current liabilities (or long term liabilities)
ii) Current liabilities.
Non-current liabilities are expected to last or be paid after one year. This includes long-term loans from
banks or other financial institutions. Current liabilities last for a period of less than one year and therefore
will be paid within one year. Major examples:
 Trade creditors/or accounts payable – owed amounts as a result ofbusiness buying goods on credit.
 Other creditors - owed amounts for services supplied to the firmother than goods.
 Bank overdraft - amounts advanced by the bank for a short-termperiod.

Capital:
This is the residual amount on the owner’s interest in the firm after deducting liabilities from the assets.
The Accounting equation can be expressed in a simple report called the Balance Sheet.

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Format

NOTE: Net assets should be the same as the total of Capital and Non Current Liabilities.

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 WEEK 3
TOPIC 3
BOOKS OF ORIGINAL ENTRY
1. Sales day book
2. Sales return day book
3. Purchases day book
4. Purchases return day book

1. Sales day book/journal

It records all the sales invoices issued by the firm during a particular
Financial period.
The format is as follows (with simple records of invoice).

2. Sales returns day book/journal

It is also called the returns inwards day-book. It records all the credit notes raised by the firm and sent to
customers during a particular financial period, it has the following format.

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3. Purchases day book/journal
It records all the purchase invoices received by the firm
during a particular financial period. It has the following format (including records of invoices).

4. Purchases return journal/day book

It is also called the returns outwards daybook. It records all the debit notes received by the firm from the
creditors during a particular financial period. It has the following format.

Example 2. (Frankwood adapted)

You are to enter the following items in the books, post to personal accounts, and show transfers to the
general ledger.
19x5
July 1 Credit purchases from: K Hill £3800; M Norman £500; N Senior £106.
“ 3 Credit sales to: E Rigby £510; E Phillips £246; F Thompson £356.
5 Credit purchases from: R Morton £200; J Cook £180; D Edwards £410; C Davies £66.
“ 8 Credit sales to: A Green £307; H George £250; J Ferguson £185.
“ 12 Returns outwards to: M Norman £30; N Senior £16.

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“ 14 Returns inwards from: E Phillips £18; F Thompson £22.
“ 20 Credit sales to: E Phillips £188; F Powell £310; E Lee £420.
“ 24 Credit purchases from: Ferguson £550; K Ennevor £900.
“ 31 Returns inwards from: E Phillips £27; E. Rigby £30.
“ 31 Returns outwards to: J Cook £13; C Davies £11.

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In the books of original entry there are also:
 Cash receipt journal
 Cash payment journal
 General journal

These two journals (Cash payment journal and Cash receipt journal) are combined to form:
 Two column cash book
 Three column cash book

Two column cash book

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The balance carried down (Bal c/d) for cash in hand and cash at bank will form part of the ledger balances and
the discounts allowed and discounts received columns will be added and the totals posted to the respective
discount accounts. The discount allowed total will be posted to the debit side of the discount allowed account in
the general ledger and the total of the discount received will be posted to the credit side of the discount-received
account of the general ledger.

Cash at bank can have either a credit or debit balance. A debit balance means the firm has some cash at the
bank and a credit balance means that the account at the bank is overdrawn. (the firm owes the bank some
money).

Example 2.7

Write up a two-column cashbook from the following details, and balance off as at the end of the month:
2003.

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Three column cashbook

Example
A three-column cashbook is to be written up from the following details, balanced off, and the relevant discount
accounts in the general ledger shown.

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General journal

It records information from other correspondence (information that is not recorded in the above books of prime
entry). It explains the type of entries that will be made in the ledger accounts giving a reason for these entries.

The type of transactions recorded here are:

i. Writing off of assets from the accounts e.g. bad-debts.

ii. Drawings for goods or other assets from the business by the owner, not cash drawings.
iii. Purchase or sale of non-current assets on credit.

Uses of general journal

 To record purchases and sales of fixed assets on credit

 To write off bad debts
 To record drawings(private use) of assets other than cash
 To record the returns of fixed assets
 To record opening entries (A=OE + L)

The format is as shown:

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WEEK 5
TOPIC 4
ERRORS ON ACCOUNTS
There are two types of errors in accounts:
• Errors that don’t affect the trial balance
• Errors that affect the trial balance

Errors that don’t affect the trial balance

The trial balance produced from the accounts appears to be okay/correct, i.e the debits are the sameas the
credits. However, on taking a close check on the balances and transactions posted, errors may have been
made and therefore the balances shown on the trial balance may be incorrect i.e. under/over stated.
There are 6 main types of errors that don’t affect the trial balance and these are explained as follows:

a) Error of omission
Here, a transaction is completely omitted from the accounts and therefore the double entry is not made e.g. a
sales invoice of £400 is not posted in the sales journal therefore no entry is made in the debtor’s account andthe
sales account i.e. both debit of £400 in debtor’s account and credit of £ 400 in the sales account.
The effect of the error is that it will understate both the debtors and the sales.
To correct this error, the transaction is posted in the books by:

Debiting debtors £400

Crediting sales £400

b) Error of Commission
This error occurs when a transaction is posted to a wrong account but the account is of the sameclass.
Example: a credit sale to T Thompson is posted to L Thompson’s account for an amount of £ 200. Instead of a
debit to T Thompson’s account it is made to L Thompson’s account and the corresponding credit in the sales
account is correct.
Although the debit entry is made into the wrong account, the two accounts are of the same class i.e. debtors.
To correct this error a transfer is made from L Thompson’s account to T Thompson by:
£
(i) Debit T Thompson a/c 200
(ii) Credit L Thompson a/c 200

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 c) Error of principle
In this type of error a transaction is posted not only to the wrong account but also of a different class e.g. Motor
vehicle purchased for £ 400 is posted to the motor vehicle expenses a/c. (Instead of debiting motor vehicles, we
debited motor vehicle expenses a/c and the credit entry in the cashbook is correct)
The motor vehicles account is a non-current asset, and motor vehicles expenses a/c is an expense account.
Therefore a capital expenditure has been posted as revenue expenditure.
To correct this error a transfer is made from the motor expenses account to the motor vehicles a/c by:
£
(i) Debit Motor vehicles a/c 400
(ii) Credit Motor expenses a/c 400

d) Complete reversal of entries

A transaction is posted to the correct accounts but to the wrong sides of the accounts i.e. a debit is posted as a
credit and a credit is posted as a debit. Example: cash drawn from the bank of £150 for business use is posted as
a debit in the bank account and credit in cash in hand.
To correct this error, two entries are made in the relevant accounts:

(i) Correct the error

(ii) Post the transaction correctly

The entries will therefore be as follows:

(i) Debit Cash in hand by £150
(ii) Credit bank by £150

To correct the error of £ 150 posted in the wrong sides of these account
(ii) Debit cash by £150
Credit bank by £150
To post the entries correctly

e) Error of Original entry

Here a transaction is posted to the correct accounts but the amount posted is not correct i.e. it is either

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 Under/over stated. In some cases, this is known as a transposition error e.g. cash received from a debtor of £980
is credited/posted to the customer’s account as £890.
To correct this error, the amount understated or overstated is posted to these accounts to reflect the correct
balance. In this case, we will:
£
Debit cash book 90
Credit debtors 90

f) Compensating Errors
These are errors that tend to cancel out each other i.e. if the effect of one error is to understate the debits or
credits then another error may take place to overstate the debits or credits by the same amount, hence
canceling out each other. E.g. if the balance c/d of the purchases a/c is £3,980 but shown in the trial balance as
£3,890 and another error carried to the trial balance of fixture amounting to £4,540 instead of £4,450:

This type of error is corrected by use of a suspense account.

Illustration
The audit of A. Barnes Book for the year ended 31st dec 2012 identified the following errors.
a) A machine purchased for sh. 1200 had been debited to the purchases account.
b) Good purchased from A. Burton for sh. 1500 were credit to the account of G. Burton
c) An invoice from A. Smith for sh. 2700 had been misplaced
d) Goods sold to A. White for sh. 1750 were entered in the sales day book as sh. 1570
e) The salaries and wages account was over added by sh. 350 and similarly rent received had also been added by
sh. 350
Required:
I. Identify the error
II. Draw the correcting journal entries

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 Answers

(a) Error of principle

(b) Error of commission

(c) Error of ommission

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(d) Error in original entry

(e) Compensating error

Errors That Affect The Trial Balance And The Suspense Account
These types of errors are reflected on the trial balance because the debits will not be the same as the credits. The
debits may be more than the credits and vice versa.
Examples include:
1. Transaction is posted on one side of the accounts i.e. only a debit entry or a credit entry. Example cash received
from a debtor is debited to the cashbook and no other entry is made in the account, i.e. no credit entry on the
debtor’s a/c.
2. A transaction is posted on one side of both the accounts i.e. two debits or two credits. Example a payment to a
creditor of £ 300 is credited in the cashbook and also credited in the creditor’s accounts.
3. A transaction is posted correctly but different amounts i.e. debit is not the same as the credit. Example – cash
received from a debtor of £ 450 is debited in the cashbook as £ 450 and credited as £ 540 in the debtor’s a/c.
4. Error on balances of accounts – i.e. understatement or overstatement of an account balance due to mathematical
errors.
5. Balance on an account is shown on the wrong side of the account when opening the ledger accounts or when
taken up to the trial balance. Example Bal c/d in the cash book for cash at bank of £ 2000 is shown as a credit
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 i.e. an overdraft, instead of a debit in the trial balance. The balance may also be brought down as an overdraft
instead of a debit balance in the trial balance.
6. A balance is omitted from the trial balance on the accounts in total.
To correct the above errors, the appropriate or the adjusting entries are made through an account called a
suspense account.
The difference in the accounts is posted to this account and the entries to correct the accounts are posted here.
The balance to be shown on the suspense accounts depends on which side the error is shown on the trial
balance.

Example 1
A trial balance was extracted from the books of Hamilton and it was found that the debit exceeded the credit by
sh. 4000. This amount was entered in the account and subsequent investigations revealed the following errors:
(i) The purchases were overadded by sh. 2000
(ii) An amount paid to A. Smith was debited to his a/c as sh. 9800 instead of 8900
(iii) The sales were undercast by sh. 1100

Required;

Practice problem
When extracting the trial balance of XYZ limited as at 31st Dec 2012, it was observed that the total of the debits
exceeded the credit by sh. 23, 800. Investigation revealed the following;
(i) Sales had been overcast by sh. 1500
(ii) Return outwards account had not been credited with an amount of sh. 6132
(iii) A payment by a debtor of sh. 15000 by direct bank transfer had not been entered in the debtor a/c.
(iv) A cash purchase of sh. 232 had been recorded in the cashbook only.
(v) A receipt from a debtor amounting to sh. 2200 received had been debited to his a/c.

Required;
(i) Journal entries to correct the above errors

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(ii) Suspense account duly balance

Soln

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 Example 2
A bookkeeper extracted a trial balance on 31 December 2002 that failed to agree by £3,300, a shortage on the
credit side of the trial balance. A suspense account was opened for the difference.
In January 2003 the following errors made in 2003 were found:
(i) Sales daybook had been undercast by £1,000.
(ii) Sales of £2,500 to J Churchill had been debited in error to Jane account.
(iii) Rent account had been undercast by £700.
(iv) Discounts received account had been under cast by £3,000.
(v) The sale of a motor vehicle at book value had been credited in error to Sales account £3,600.
You are required to:
a) Show the journal entries necessary to correct the errors.
b) Draw up the suspense account after the errors described have been corrected.
c) If the net profit had previously been calculated at£79,000 for the year ended 31 December 2002,show the
calculations of the corrected net profit

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 WEEK 6
TOPIC 5 CONTROL LEDGER ACCOUNTS
The personal accounts of individual debtors are kept in the sales ledger and the personal accounts of individual
creditors are maintained in the purchases ledger.
Control accounts are prepared for these two ledgers.
The sales ledger control account is an account in which records are kept for transactions involving all
debtors/receivables and the balance on the control account at any time from its debtors.
The purchases control account contains records of transactions involving all creditors and the balance on these
accounts at any time will be the total amount owed by the business to its creditors.
Purpose of control accounts
i. To provide for arithmetic check on the postings made in the individual account i.e. either the sales
ledger or the purchases ledger.
ii. To provide a quick total of the debtors and creditors balances to be shown in the trial balance.
iii.To detect and prevent errors and frauds on the debtor and creditors account.
iv.To facilitate delegation of duties especially where the debtors and creditors are many.

Sources of information for control accounts

Control accounts for debtors and creditors are prepared from the totals in the subsidiary book

The format and source of information for control accounts is as follows

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When writting up a control account imagine writing up a personal account but in totals
This means that items debited in a personal a/c in a personal a/c will also be debited in the control a/c and vice
versa.

Contra Entries
These are entries made in the debtor and creditors ledger control accounts.
If there are two accounts in these two ledgers by the same person or firm.
E.g A. Smith purchases and sells goods to P. Burton. During the year 2008 he purchased goods on credit for sh.
15, 900 and sold for sh. 18, 500 to p. Burton. Show the two personal account in the book of A. Smirth.

Week 7: Topic 6
Petty cash book is a record of all the petty cash vouchers raised and kept by the cashier.

The petty cash vouchers will show summary expenses paid by the cashier and this information is listed and
classified in the petty cash book under the headings of the relevant expenses such as:

 Postage and stationery

 Traveling
 Cleaning expenses.

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The balance c/d of the petty cash book will signify the balance of cash in hand or form part of cash in hand.
The totals of the expenses are posted to the debit side of the expense accounts. If a firm operates another
cashbook in addition to the petty cash book, then the totals of the expenses will also be posted on the credit side
of the cash in hand cashbook.

The Imprest system

This system of accounting operates on a simple principle that the cashier is refunded the exact amount spent on
the expenses during a particular financial period. At the beginning of each period, a cash float is agreed upon
and the cashier is given this amount to start with. Once the cashier makes payments for the period he will get a
total of all the payments made against which he will claim a reimbursement of the same amount that will bring
back the amount to the cash float at the beginning of the period.

This is demonstrated as follows:

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Required:

Prepare a detailed petty cash book showing the balance to be carried forward to the next period and the relevant
expense accounts, as they would appear on the General Ledger.

36
Week 8Topic 8.
BANK RECONCILIATION STATEMENTS

The cashbook for cash at bank records all the transactions taking place at the bank i.e. the movements of the
account held with the bank. The bank will send information relating to this account using a bank statement
for the firm to compare.
Ideally, the records as per the bank and the cashbook should be the same and therefore the balance carried
down in the cashbook should be the same as the balance carried down by the bank in the bank statement.
In practice however, this is not the case and the two (balance as per the bank and firm) are different. A bank
reconciliation statement explains the difference between the balance at the bank as per the cashbook and
balance at bank as per the bank statement.
Causes of the differences:
i) Items Appearing In The Cashbook And Not Reflected In The Bank Statement.
Unpresented Cheques: Cheques issued by the firm for payment to the creditors or to other supplies but
have not been presented to the firm’s bank for payment.
Uncredited deposits/cheques: These are cheques received from customers and other sources for which
the firm has banked but the bank has not yet availed the funds by crediting the firm’s account.
Errors made in the cashbook
These include:
• Payments over/understated
• Deposits over/understated
• Deposits and payments misposted
• Overcastting and undercasting the Bal c/d in the cashbook.
ii) Items appearing in the bank statement and not reflected in the cashbook:
Bank charges: These charges include service, commission or cheques.
Interest charges on overdrafts.
Direct Debits (standing orders) e.g. to pay Alico insurance.
Dishonored cheques
A cheque would be dishonored because:
• Stale cheques
• Post – dated cheques

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 • Insufficient funds
• Differences in amounts in words and figures.
Direct credits
Interest Income/Dividend incomes
Errors of The Bank Statement (Made By The Bank).
Such errors include:
• Overstating/understating.
• Deposits
• Withdrawals

The Purposes of a bank reconciliation statement.

1. To update the cashbook with some of the items appearing in the bank statement e.g. bank charges,
interest charges and dishonoured cheques and make adjustments for any errors reflected in the
cashbook.
2. To detect and prevent errors or frauds relating to the cashbook.
3. To detect and prevent errors or frauds relating to the bank.

Steps in preparing a bank reconciliation statement.

1. To update the cashbook with the items appearing in the bank statement and not appearing in the
cashbook except for errors in the bank statement. Adjustments should also be made for errors in the
cashbook.
2. Compare the debit side of the cashbook with the credit side of the bank statement to determine the
uncredited deposits by the bank.
3. Compare the credit side of the cashbook with the debit side of the bank statement to determine the
unpresented cheques.
4. Prepare the bank reconciliation statement which will show:
a) Unpresented cheques
b) Uncredited deposits
c) Errors on the bank statement
d) The updated cashbook balance.

The format is as follows:

38
Note 1: These types of errors will have an effect of increasing the balance at bank e.g. an overstated deposit
or an understated payment by the bank.
Note 2: These types of errors will have an effect of decreasing the balance at bank e.g. an understated deposit
or an overstated payment by the bank, or making an unknown payment.

Illustration

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 Week 9:Topic 9
I. Provisions for depreciation
II. Provisions for bad debts
Depreciation
It is the loss of value of a non-current asset throughout its period of use by the firm. IAS 16 on property,
plant and equipment defines depreciation as the allocation of a depreciable amount of a non-current asset
over its estimated useful life.
Under the matching concept, all incomes or revenues and expenses for a particular period should be
reported in the financial statements and because depreciation is an expense of the business therefore, it will
be charged in the P&L A/C.
Causes of Depreciation

1. Physical Factors

a) Wear and tear: Some non-current assets depreciate or lose value due to use overtime
e.g. machinery and motor vehicles.
b) Rot/decay/rust:: This happens on assets that are not well maintained by the firm e.g.
Some machines.

2. Economic Factors
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a) Inadequacy: Some assets lose value due to them becoming inadequate e.g. when a
business grows or expands then some buildings may become inadequate due to
space. Also some machines that are unable to manufacture a large number of
goods.
b) Obsolescence: Some assets become obsolete due to change in technology or different
methods of production e.g. computers.

3. Time Factors

Some assets have a legal fixed time e.g. properties on lease.

4. Depletion

This occurs when some assets have a wasting character due to extraction of raw materials, minerals or oil.
Such assets include mines, oil wells, and quarries.
Methods of Calculating Depreciation

These are the methods developed to assist in estimating the amount of depreciation to be charged in the P&L
a/c as an expense.
The methods chosen by a firm should be in accordance with the agreed accounting practice, accounting
standards and suit the firm’s non-current assets. There are 2 main methods of estimating depreciation and 5
others that will apply in a firm’s situation.
The main methods are: Straight-line method and Reducing Balance method. The other 5 methods include:
i. Sum of the digits methods – uses a formular.
ii. Revaluation method – applies to a non-current asset of low value.
iii. Machine-Hour method – depreciation is based on number of hours a machine is expected to operate
(manufacturing process).
iv. Unit of output method – depreciation is based on the number of units a machine is expected to
produce.
v. Depletion of units – depreciation is based on number of units extracted from the asset.
Straight-Line Method
This method ensures that a uniform amount of depreciation is charged in the P&L a/c for a particular asset

41
and is based on the following formular:

Cost of Asset – Residual Value

Estimated useful life of asset.

Residual Value
The amount the firm expects to sell the asset after the period of use in the firm, also called Sales Value /
Scrap Value.

Estimated Useful Life

The period the asset is expected to be used in the firm.

Example
A firm buys a machine for £100,000 which it expects to use in the firm for eight years. After the eight years
the machine will be sold for £20,000. Under the straight-line method, the depreciation amount will be
computed as follows:

This means for this asset £10,000 will be charged in the P&L account as depreciation expense on the
machine.
The straight line method assumes that benefits accruing on use of a non-current asset are spread out evenly
over the life of the asset e.g. buildings use straight-line method.
Reducing Balance Method
The firm determines a fixed percentage rate that is applied on the cost of the asset during the first period of
use. The same rate is applied in the subsequent financial periods but the rate is applied on the reduced value
of the asset. (Cost of asset – total depreciation provided to date).
This method ensures that higher amount of depreciation are charged in the P&L account in the earlier
periods of use and lower amounts in the latter periods of use as shown in the following example:

Example

42
 Assume a firm buys machinery for £100,000 and provides depreciation on machines at 20% p.a. on reducing
balance method. The depreciation charged to the P&L will be as follows for the next 3 years.

Reducing balance method (diminishing balance method) assumes that benefits accruing from the use of
an asset are higher in the first periods of use and lower in the latter periods e.g.
 Fixtures, furniture and fitting.
 Plant and machinery.
 Motor vehicles.

ACCOUNTING TREATMENT ON DEPRECIATION

When non-current assets are depreciated, a new account for each type of asset is opened; this account is
called a provision for depreciation whereby the following entries will be made:
Debit – P&L a/c
Credit – Provision for depreciation a/c
With the amount of depreciation charged for the period.

Example on straight-line method

The entries will be as follows:
Debit – P&L a/c with £10,000
Credit – Provision for depreciation. Machines a/c with £10,000 being depreciation provided for the
machine.
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The final accounts extracts will be shown as follows:

(a) Profit And Loss Account (Extract) for the year ended

DISPOSALS OF ASSETS
A firm may dispose off its non-current assets in the following 3 ways:
i. Selling the asset.
ii. Asset being written-off from damage/accident/theft.
iii. Asset is scrapped/not used anymore.
When an asset is disposed and is no longer used by the firm, the appropriate entries should be made in the
asset account and the total depreciation provided to date on the asset and the entries required will depend on
the type of disposal.
When the asset is sold, the following entries will be made:
(a) Debit – asset disposal a/c
Credit – asset a/c
44
With the cost of the asset being disposed.
(b) Debit – provision for depreciation of asset a/c.
Credit – asset disposal a/c
With the total depreciation provided to date on the asset.
(c) Debit – cashbook.
Credit – asset disposal a/c
With the cash received on disposal.
When an asset is written off as a result of damage/accident/theft. If it was insured and the insurance
company accept liability but by the end of the period the insurance company has not yet paid.
(a) Debit – asset disposal a/c
Credit – asset a/c
With the cost of the asset damaged.
(b) Debit – provision for depreciation of asset a/c
Credit – asset disposal a/c
(c) Debit – insurance receivable a/c
Credit – asset disposal a/c
With the amount expected from the insurance
Illustration
A company depreciates its plant at the rate of 20 per cent per annum, straight line method, for each month of
ownership. From the following details draw up the plant account and the provision for depreciation account
for each of the years 1999, 2000, 2001 and 2002.

You are also required to draw up the plant disposal account and the extracts from the balance sheet as at the
end of each year

45
46
PROVISION FOR BAD AND DOUBTFUL DEBTS
Some debtors may not pay up their accounts for various reasons e.g. a debtor may go out of business. When
a debtor is not able to pay up his/her account this becomes a bad debt. Therefore the business/firm should
write it off from the accounts and thus it becomes an expense that should be charged in the profit & loss
account.
In practice a firm may also be unable to collect all the amounts due from debtors. This is because a section of
the debtors will not honor their obligations. The problem posed by this situation is that it is difficult to
47
identify the debtors who are unlikely to pay their accounts. Furthermore the amount that will not be collected
may also be difficult to ascertain. These debts that the firm may not collect are called doubtful debts. A firm
should therefore provide for such debts by charging the provision in the profit and loss account. Provision
for doubtful debts maybe specific or general.
Accounting For Bad & Doubtful Debts.
Bad debts
When a debt becomes bad the following entries will be made:
i. Debit bad debts account
Credit debtors account with the amount owing.
ii. Debit Profit and Loss Account.
Credit bad – debts account to transfer the balance on the bad – debts account to the Profit and Loss
Account.
Doubtful Debts
A provision for doubtful debts can either be for a specific or a general provision. A specific provision is
where a debtor is known and chances of recovering the debt are low.
The general provision is where a provision is made on the balance of the total debtors i.e. Debtors less Bad
debts and specific provision.
The accounting treatment of provision for doubtful debts depends on the year of trading and the entries will
be as follows. If it is the 1st year of trading (1st year of making provision):

i. Debit P&L a/c.

ii. Credit provision for doubtful debts (with total amount of the provision).
In the subsequent periods, it will depend on whether if it is an increase or decrease required on the provision.

If it is an increase:
i. Debit P&L a/c.
ii. Credit provision for doubtful debts (with increase only).

If it is a decrease:
i. Debit provision for doubtful debts.
ii. Credit P&L a/c (with the decrease in provision only).

48
A firm started trading in the year 1999, the balance on the debtor’s account was £400,000. Bad debts
amounting to £40,000 were written off from this balance, there was a specific provision of £5,000 to be made
to one of the debtors and a general provision of £5% was to be made on the balance of the debtors. The
ledger accounts of 1999 were as follows:

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Week 10
TOPIC 10
FINAL STATEMENT
TRADING, PROFIT AND LOSS ACCOUNT

TRADING ACCOUNT
The trading account summarises the trading activities (sale and purchase of goods/stocks) of the business and
tries to determine the gross profit for the relevant financial period. The gross profit is then taken up in the profit
and loss account as part of the income.

Format for the trading account:

50
 Example:
From the following details draw up the trading account of Springs for the year ended 31 December 2002, which
was his first year in business.

SOLUTION

51
 (b) PROFIT AND LOSS ACCOUNT
It shows the net profit or net loss that the business has made from all the activities during a financial
period.
The net profit (or loss) is determined by deducting all the expenses from all the incomes of the same
financial
period.
In practice, the trading account is combined together with the net profit and loss account into one
report so
that the format is as shown below:

52
53
Example
From the following trial balance of P Boones draw up a trading and profit and loss account for the
yearended 30 September 2002, and a balance sheet as at that date.

Additional information:
Closing stock for the year was 29,460.

54
55
(c) BALANCE SHEET
This is a simple report that shows the assets and liabilities of the business and the capital of the owner as at a
certain point in time. The format is at shown below:

56
The balance Sheet of P Boones in example 2.3 will be produced as follows:

57