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Head 2 book keeping
Accounts
| Term | Definition |
|---|---|
| Principles of accounting | Broad underlying concepts that guide the preparation of financial statements |
| Main financial statements | Income statement and statement of financial position, among others |
| GAAP vs IAS/IFRS | GAAP is used in countries such as the USA; IAS and IFRS are used in countries such as Zambia |
| Bookkeeping (Frank Wood) | The process of recording data relating to accounting transactions in the accounting books |
| Accounting (Frank Wood) | Concerned with the uses accountants make of the bookkeeping information given to them |
| Two stages of the process | Bookkeeping, then accounting |
| First stage: bookkeeping | Preparing the basic accounting records, i.e. recording business transactions in books of account (double entry) |
| Second stage: accounting | Interpreting the information and figures in the accounts to explain the financial condition of the business |
| Four accounting activities | Recording, analysing, summarising, communicating |
| Accounting sequence | Recording data, classifying data, summarising data, communicating information |
| Source documents | Sales invoices, purchases invoices, credit notes, debit notes, cash receipts, payment vouchers/proof of payment (PoP) |
| Accruals concept | All income and charges relating to the financial period are recorded in that period, when entered into and not when settled |
| Consistency concept | Similar accounting policies are followed every year |
| Money measurement concept | Only monetary transactions are recorded |
| Business entity concept | Owner and business are two separate entities |
| Going concern concept | The business is presumed to continue for the foreseeable future (at least 12 months from the reporting date); assets are valued at cost |
| Going concern in doubt | Assets are valued at market value or net realisable value (impairment) |
| Prudence concept | Apply objective judgement; do not overvalue assets or undervalue liabilities; write off long overdue debts as bad debts |
| Separate determination concept | Each individual asset or liability is determined separately (three identical machines each get their own account) |
| Substance over form | Transactions are shown by their economic reality rather than legal form (e.g. a car on asset finance is shown as a non-current asset) |
| Six fundamental accounting concepts | Going concern, consistency, prudence, accruals, separate determination, substance over form |
| Accounting system (CFI) | Organised set of manual and computerised methods, procedures and controls to gather, record, classify, analyse, summarise, interpret and present financial data |
| Double entry system | For every transaction there is a debit and a credit |
| Income statement | Shows profit or loss over a period of time (period statement) |
| Statement of financial position | Shows assets and liabilities at a point in time (position statement); shows the net worth of the business |
| Purposes of accounting | Measuring past performance, controlling resources, planning future programmes |
| Users of accounting information | Investors, customers, suppliers, employees, lenders, management, the public, government (ZRA), competitors |
| Sole trader | Owned and managed by one person; personally liable for all business debts |
| Partnership | Owned jointly by partners; partners are jointly and severally liable for losses |
| Company | Owned by shareholders, managed by directors; private or public; limited liability |
| Non-trading organisations | Clubs, associations and other non profit making organisations |
| Revenue | Resources from normal business activities (sales, interest, royalties, rent, fees); denoted by a credit |
| Expenses | Current or future outflows to pay for items or services (rent, electricity, salaries); denoted by a debit |
| Assets | Economic resources used by the firm to carry on business; denoted by a debit |
| Non-current assets | Long life, used in the business, not bought for resale (buildings, motor vehicles, machinery) |
| Current assets | Held for resale or conversion at a profit, short life: inventory, receivables, bank and cash |
| Liabilities | Financial obligations to others; denoted by a credit |
| Capital (owner's equity) | Resources put into the business by the proprietor; denoted by a credit |
| Non-current liabilities | Not due for repayment in the short term (loans, mortgages) |
| Current liabilities | Due for repayment in the short term: bank overdraft, trade payables, other payables, accruals |
| Profit or loss | Net increase or decrease in total resources earned from business operations |
| Debit side entries | Assets, expenses, losses |
| Credit side entries | Capital, liabilities, income or profit |
| Increasing and reducing accounts | Debit accounts: debit to increase, credit to reduce. Credit accounts: credit to increase, debit to reduce |
| Principal objects of bookkeeping | Keep records of income and expenses (to find profit or loss) and of assets and liabilities (to find financial position) |
| Steps to record a double entry | 1 Identify the items; 2 Know each item's denotation; 3 At least two items are affected; 4 Identify the monetary value; 5 Assign the value to the debit and credit sides |
| Accounting equation | Capital = Assets - Liabilities (C = A - L) |
| Accounting equation rearranged | Assets = Capital + Liabilities |
| Accounting equation when the owner supplies all resources | Capital = Assets |
| Meaning of the equation's sides | Assets show what the resources are; capital plus liabilities show who supplied them |
| Dual aspect | Every transaction has two aspects, a double effect on the business and the accounting equation |
| Effect of transactions on the equation | Each transaction affects two items: both sides increase, both decrease, or one asset rises and another falls (totals unchanged) |
| Owner pays capital into bank | Increase asset (bank) and increase capital |
| Buy inventory on credit | Increase asset (inventory) and increase liability (payables) |
| Sale of inventory on credit | Decrease asset (inventory) and increase asset (receivables) |
| Sale of inventory for cash or cheque | Increase asset (cash/bank) and decrease asset (inventory) |
| Pay a creditor | Decrease asset (bank) and decrease liability (payables) |
| Debtor pays money owing | Increase asset (bank) and decrease asset (receivables) |
| Linking statements of financial position | Opening position + profit (or - loss) +/- cash movements with the proprietor = closing position |
| Separate business entity concept | Accounts relate to the business, not its owner; a sole trader's business is not a separate legal entity but is separate for accounting |
| Order of non-current assets | Listed from those kept longest to those kept shortest in the business |
| Order of current assets | Listed in order of liquidity, from least liquid (inventory) to most liquid (cash) |
| Current vs non-current liabilities | Current: payable within a year; non-current: payable after more than a year |
| Vertical balance sheet layout | Non-current assets + current assets - current liabilities - non-current liabilities = capital (+ profit or - loss) - drawings |
| Working capital | Current assets - current liabilities (net current assets) |
| Ledger account | Shows the history of business transactions for an asset, liability or capital over a period |
| Ledger formats | Vertical (formal, used in business) and T format (mostly a working format) |
| T account sides | Left is debit (Dr); right is credit (Cr) |
| Rule of double entry | Every transaction is entered twice, once on the debit side and once on the credit side; the order does not matter |
| Inventory accounts | Purchases, returns inwards, sales and returns outwards accounts |
| Increase in inventory | Purchases account debited; returns inwards account debited |
| Decrease in inventory | Sales account credited; returns outwards account credited |
| Returns inwards (sales returns) | Goods returned to the firm by customers; debit side |
| Returns outwards (purchases returns) | Goods returned by the firm to suppliers; credit side |
| Credit purchase entry | Debit purchases account, credit supplier's account |
| Cash purchase entry | Debit purchases account, credit cash account |
| Credit sale entry | Debit customer's account, credit sales account |
| Cash sale entry | Debit cash account, credit sales account |
| Returns inwards entry | Debit returns inwards, credit customer's account |
| Returns outwards entry | Debit supplier's account, credit returns outwards |
| What counts as a purchase or sale | Only goods the business trades in (for a computer firm, computers are purchases; a calculator for office use is not) |
| Cash vs credit transaction records | Cash: no customer or supplier account needed; credit: record who owes or is owed until payment |
| Expense account rule | Debit the expense account whenever an expense is incurred, whether paid or on credit |
| Revenue account rule | Credit the revenue account whenever revenue is earned, whether paid or on credit |
| Profit formula | Profit = Revenue - Expenses |
| Effect of profit or loss on capital | Profit increases capital; loss reduces capital |
| Why expenses are debited | Expenses reduce capital, and reductions in capital are debit entries |
| Why revenue is credited | Revenue increases capital, and increases in capital are credit entries |
| Rent paid in cash entry | Debit rent account, credit cash account |
| Rent received in cash entry | Debit cash account, credit rent received account |
| Drawings | Resources taken out of the business by the owner for personal use; denoted by a debit; NOT an expense; reduces capital |
| New capital formula | Capital at beginning +/- net profit or loss - drawings |
| Drawings of goods entry | Debit drawings account, credit purchases account |
| Why use a drawings account | The capital account is important and not for small transactions; drawings are transferred to the debit side of capital at year end |
| Balancing an account: step 1 | Total the debits and credits and make a memorandum note of the totals |
| Balancing an account: step 2 | Insert the higher total at the bottom of both sides, leaving one line for balance c/d |
| Balancing an account: step 3 | On the side with the lower total, insert balance c/d to bring it up to the higher total |
| Balancing an account: step 4 | Show the same figure on the other side, below the totals, as balance b/d |
| Debit balance b/d | The account has a debit balance (a personal account would be a debtor) |
| Credit balance b/d | The account has a credit balance (a personal account would be a creditor) |
| Dates for balance c/d and b/d | Balance c/d is dated the last day of the period ending; balance b/d is dated the opening day of the next period |
| Carried forward (c/f) and brought forward (b/f) | Totals carried from the bottom of one page to the top of the next when an account fills a page; not used when balancing accounts |
| Purpose of a trial balance | Check that for every debit entry there is a reciprocating credit entry (arithmetical accuracy of postings) |
| Listing balances in a trial balance | A balance c/d on the credit side of an account (a debit balance) goes on the debit side of the TB; a balance c/d on the debit side (a credit balance) goes on the credit side |
| Trial balance date | Drawn as at the last day of the accounting period |
| Trial balance totals | Total debits must equal total credits |
| A balanced trial balance | Does not mean there are no errors; it can balance even when errors exist |
| Other use of a trial balance | Source for drawing up a firm's final accounts |
| Errors not affecting the trial balance (7) | Omission, commission, principle, original entry, compensating, complete reversal, transposition |
| Error of omission | No entry of the transaction has been made at all |
| Error of commission | Amount correctly posted but to the wrong account |
| Error of principle | Item posted to the wrong type of account (e.g. equipment sale credited to Sales instead of Equipment) |
| Error of original entry | Incorrect amount posted to both accounts (e.g. K550 misread as K500) |
| Compensating errors | Two or more errors cancel each other out |
| Complete reversal of entries | Correct accounts used but the debit and credit postings are reversed |
| Transposition error | Wrong sequence of digits entered on both sides (e.g. K162 instead of K261) |
| Correcting errors that do not affect the TB | Use a Journal |
| Discrepancy divisible by nine | Suggests figures were transposed (e.g. 63 entered as 36) |
| Steps when the trial balance does not balance | Re-add both sides; find the discrepancy and look for that amount; halve it and look again; check for divisibility by 9; check balances and columns; include all outstanding balances; recheck entries since the last TB |
| Purpose of the income statement | Show whether the business made a profit during the period |
| Purpose of the statement of financial position | Show the net worth of the business at the reporting date |
| Source of income statement items | The trial balance |
| Closing inventory | Always placed outside the trial balance |
| Other income examples | Rent receivable, interest received, discount received, bad debts recovered, allowance for doubtful debts recovered |
| Expense examples | Carriage outwards, discount allowed, interest on loan, rent, bad debts, allowance for doubtful debts (expense), depreciation |
| Net sales | Sales - returns inwards |
| Gross profit formula | Net sales - cost of goods sold |
| Gross profit vs gross loss | Gross profit when sales exceed cost of goods sold; gross loss when cost of goods sold exceeds sales |
| Cost of goods sold formula | Opening inventory + purchases + carriage inwards - returns outwards - closing inventory |
| Carriage inwards | Cost of moving purchased goods to the warehouse; added in cost of goods sold |
| Carriage outwards | Cost of delivering goods to customers; an expense |
| Net profit formula | Gross profit + other income - expenses |
| Net profit vs net loss | Net profit when gross profit (plus other income) exceeds expenses; otherwise a net loss |
| Preparing the statement of financial position | Listing balances as assets, liabilities and capital (unlike the income statement, which uses double entry) |
| Components of capital on the statement | Capital, net profit/(loss), drawings |
| Books of original entry | Books in which transactions are first recorded before being entered in the ledgers |
| Six books of original entry | Sales day book, purchases day book, returns inwards day book, returns outwards day book, cash book, journal |
| Sales day book | Records credit sales (information from sales invoices) |
| Purchases day book | Records credit purchases (information from suppliers' invoices) |
| Returns inwards day book | Records returns from customers (from credit notes) |
| Returns outwards day book | Records returns to suppliers (from debit notes) |
| Cash book | Records only cash transactions, either receipts or payments |
| Journal | Used for any other transactions: depreciation, bad debts, allowances for doubtful debts, interest, bank charges, etc. |
| Uses of the journal | Bad debts, depreciation, allowance for doubtful debts, correcting errors, opening balances, adjustments, disposal of assets, accruals, prepayments |
| Credit note | Issued to the buyer when goods sold are returned |
| Debit note | Issued by the purchaser to the supplier when purchased goods are returned |
| Three divisions of the ledger | Sales ledger, purchases ledger, general ledger |
| Sales ledger | Records sales (customers' personal accounts carry SL folio numbers) |
| Purchases ledger | Records purchases (suppliers' personal accounts carry PL folio numbers) |
| General ledger | Various ledgers for transactions such as expenses, fixed assets and capital |
| Two types of account in the general ledger | Personal and impersonal |
| Personal accounts | Receivables and payables ledgers |
| Impersonal accounts | Real accounts and nominal accounts |
| Real accounts | Where possessions such as assets are recorded |
| Nominal accounts | Where expenses, income and capital are recorded |
| Sales day book posting | Total credited to the Sales account; individual customers' accounts debited |
| Purchases day book posting | Total debited to the Purchases account; individual suppliers' accounts credited |
| Information in a day book | Date of invoice, details of buyer/seller, invoice number, folio number, invoice amount |
| Cash book layout | Cash and bank columns side by side on both the debit and credit sides |
| Two column cash book | Two columns on each side: cash and bank |
| Three column cash book | Adds a discount allowed column (debit side) and a discount received column (credit side) |
| Petty cash book | Cash book for small amounts (newspapers, stationery, postage, taxi); run on the imprest system |
| Imprest system | A petty cash float is set and then reimbursed by the amount spent, restoring it to the allocated amount |
| Cash left in petty cash | Float - amount spent |
| Petty cash reimbursement | The amount spent during the period |
| Objective of a bank reconciliation | Show the cause of any difference between the cash book and bank statement balances |
| First step of a bank reconciliation | Update the cash book with items on the bank statement that are not in the cash book |
| Bank statement payments missing from cash book | Bank charges and commissions, interest on loan or overdraft, standing orders, transfers out, dishonoured cheques |
| Bank statement receipts missing from cash book | Interest on deposits, transfers in |
| Causes of remaining differences | Timing differences: unpresented payments and uncredited deposits (undeposited receipts) |
| Reconciliation from updated cash book | Updated cash book balance + unpresented payments - uncredited deposits = bank statement balance |
| Reconciliation from bank statement | Bank statement balance + uncredited deposits - unpresented payments = updated cash book balance |
| Adjustments to financial statements | Accruals, prepayments, allowance for doubtful debts, depreciation, interest on loan |
| Accruals | Expenses incurred in one period but settled or billed in the next; they are expenses of the period they were incurred |
| Accrual calculation | Expense due for the period - amount paid (e.g. K6,000 due - K5,500 paid = K500 accrued) |
| Accrual entry | Debit the expense account, credit accruals (a current liability) |
| Prepayments | Payments made now for goods or services consumed in a future period; not expenses of the period paid |
| Prepayment entry | Credit the expense account, debit prepayments (receivables, a current asset) |
| Bad debt | A debt certain not to be paid; it is an expense |
| Bad debt entry | Debit bad debts (expense, P&L), credit the receivable's account |
| Bad debts recovered | A written-off debt later recovered in part or full; treated as other income |
| Allowance for doubtful debts | Provision, as a percentage or amount of receivables, for debts likely to prove bad (applies prudence) |
| Allowance for doubtful debts entry | Debit allowance for doubtful debts (expense, P&L), credit allowance for doubtful debts account (statement of financial position) |
| Allowance in the statement of financial position | Deducted from receivables to give net receivables |
| Increase in the allowance | Only the increase is charged as an expense |
| Reduction in the allowance | The reduction is treated as income (other income in the income statement) |
| Depreciation | Part of the cost of a non-current asset consumed through usage, obsolescence, depletion, physical deterioration and time |
| Depreciation in the income statement | Charged as an expense; charged in full in the year of purchase regardless of purchase date |
| Depreciation in year of disposal | Not charged in the year the asset is disposed of |
| Simple depreciation formula | Cost - scrap (residue) value |
| Two main depreciation methods | Straight-line and diminishing (reducing) balance |
| Straight-line method | Constant charge every year: (cost - scrap value) x rate, or divided by years; ends at nil or the stated residue |
| Rate from years of life | 100 / number of years (4 years = 25%) |
| Straight-line with a residue value | Subtract the scrap value from cost first, then apply the rate (K150,000 - K20,000 = K130,000 x 25% = K32,500) |
| Diminishing balance method | Year 1 as straight-line; later years use the previous year's net book value; charge is not constant; an asset always keeps a residue |
| Net book value (NBV) | Cost - accumulated depreciation |
| Depreciation entry | Debit depreciation (expense), credit provision for accumulated depreciation |
| Where depreciation balances go | Depreciation account to the income statement; provision for depreciation to the statement of financial position, where it accumulates each year |
| Asset disposal account | Credit: sale proceeds and accumulated depreciation. Debit: cost of the asset |
Created by:
Eddard