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FA1 Recording Financial Transactions1. Types of Business Transactions and Documentation 3

2. The process of recording business transactions within the accounting and double entry system 21

3. The day books and the Journal 43

4. Cash Transactions 53

5. More on sales and receivables 67

6. More on purchases and payables 79

7. Trial balances and correcting errors 85

8. Labour Costs and Remuneration Methods 95

Answers To Examples 101

Answers To Tests 109

FA1 Recording Financial Transactions (2019 Exams) 1




Chapter 1TYPES OF BUSINESS TRANSACTIONS AND DOCUMENTATION

1. Introduction

This chapter gives a brief introduction to organisations, accounting documentation, and computer-based accounting systems.

2. Types of business transaction

An organisation can be defined as:

A social arrangement which pursues collective goals, which controls its own performance and which has a boundary separating it from its environment.

Organisations can include businesses such as companies and partnerships, clubs, charities, government departments, hospitals and schools.

Even if not strictly a ‘business’ all organisations will have business transactions. Typically these will include:

๏ Purchasing goods and materials. Purchases can be for cash or credit. Cash purchases are paid for immediately and are fairly rare in most businesses. Credit purchases are paid for after some time, typically a month or so

๏ Purchasing services, for example, repair s to equipment, advertising, printing costs.

๏ Sales. Cash sales, for example in shops, are paid for immediately. Credit sales are paid for after some time.

๏ Paying wages and salaries.

๏ Purchase of non-current assets.

๏ Raising finance and paying rewards to the suppliers of finance. For example, owners putting in capital or loans being raised from banks. Owners of the business expect rewards based on a share of the profit; banks usually expect interest to be paid.

๏ Accounting for and paying tax.

๏ Movements of cash and money in the bank account. These movements usually arise from the transactions above.



All to these transactions are summarised at the end of accounting periods into two statements:

Statement of financial position Assets (amounts owned) and Liabilities (amounts owed).

Income statement Income (such as sales) less expenses (such as rent, wages, electricity, raw materials). If income is greater than expenses, a profit will result.

In the statement of financial position, assets are divided into:

Non-current assets such as equipment, premises, motor vehicles. These are kept long-term in the business.

Current assets such as inventory (stock) receivables or cash. These either are cash or will become cash within 12 months.

Liabilities are divided into:

Current liabilities such as amounts that have to be paid to suppliers (trade payables). These liabilities have to be settled within 12 months.

Long-term liabilities These don’t have to be settled until at least 12 months time

3. Types of business documentationEach type of business transaction has its own set of documentation. The documentation is needed to:

๏ Control the progress of the transaction

๏ Record the transaction

๏ Provide a history of how the transaction proceeded. This is sometimes known as an ‘audit trail’

Sometimes the documentation is purely internal; sometimes it arises externally or is sent outside the business. Nowadays, the term ‘documentation’ is not confined to paper documents as many business transactions are mostly handled using computerised records.

Typical documentation is as follows:

Purchase of goods and materials: this will usually be initiated by someone in the warehouse or factory who can see that more materials will soon be needed. Often this person raises a purchase requisition which goes the buyers’ department. Buyers will then raise a purchase order to order goods from the most suitable supplier. Goods, accompanied by the supplier’s delivery note, will be received in the warehouse, where a goods received note will be raised. These must be checked back to the order to ensure that the correct goods are being received. Invoices from suppliers will be received and recorded by the accounting department first in a purchases day book (just a list of invoices received) and then in the payables ledger. Usually suppliers will send statements of account setting out the amounts still owed. Statements act as reminders and also they can be used to check that buyers agree with suppliers’ versions of events. Later the invoices will be paid and a remittance advice sent by the customer to indicate which invoices have been settled.

If goods are returned to suppliers (for example their quality was poor) then buyers will ask for a credit note. This acts like a negative invoice.



Purchasing services: often, these will be recurring items such as rent, electricity, telephone and insurance, and an invoice will be received Sometimes they will be once-off like paying for an advertisement in a newspaper or for the repair of a piece of equipment. These services should have a purchase order. The invoices will be processed by the accounting department who will make sure that the expenses look reasonable compared to previous amounts or who will ensure that the services have been properly ordered and received.

Sales: in a retail organisation sales will be initiated by customers either in a shop or through the internet. Payment will usually take place immediately and the customer given a till (cash register) receipt; a copy of the sales is also recorded by the cash register system. In businesses selling to other businesses, the sales representatives (sales men and sales women) will be responsible for encouraging customers to place sales orders. Once received, orders should result in goods despatch notes being raised and these act as authorisation to despatch the goods from the warehouse and for also sales invoices being created and sent to the customers by the accounting department. The accounting department will also record each invoice in a sales day book (just a list of invoices) and will then record what each customer owes in the receivables ledger.

Most businesses will send customers statements of account which set out the amounts still owed by customers. Statements act as reminders to customers about what needs to be paid and they also allow customers to check that they agree with the seller’s version of events. Payments by credit customers should be accompanied by remittance advices which detail what is being paid.

If goods are returned by customers (for example their quality was poor) then customers will ask for a credit note. This acts like a negative invoice.

Paying employees: large organisations will have a wages and salaries department which is responsible for calculating amounts owing, and dealing with employees who leave and with new joiners. Sometimes the payments are the same every week or month; sometimes they depend on time records (such as clock cards). In both cases employees will receive a wage or salary slip showing their pay and any deductions for tax etc. The amounts to be paid will usually be passed to the accounting department which will look after the cash transfers to employees.

Purchase of non-current assets: The purchase of these assets will often begin with en employee raising a purchase requisition, for example for a new printer, which is then authorised by a manager or by the company accountant. When the invoice is received, someone needs to ensure that the asset has been received and that it is working properly. These payments are handled in a similar way to purchases of goods and raw materials.

Finance. In companies, shares can be issued in exchange for new share capital. Loans will usually be accompanied by a loan agreement setting out the terms of the loan.

Tax will be paid in response to an assessment by the tax authorities.



Movements in cash and bank account amounts require careful documentation. Cash payments are usually small and usually made through the petty cash system where payments will be supported by petty cash vouchers. Payments from bank accounts will be by cheque or credit transfer. Credit transfers can be:

๏ Specially initiated by the company

๏ Automatic constant amounts (standing orders)

๏ Initiated by the person receiving the money (direct debits).

In all cases there should be documentation to back up the payments.

Example 1

What are the two main documents produced at the end of accounting periods and what appears on each?

Question 1 What is the purpose of a statement of account sent to a customer?

A It is a demand for payment

B It states to the customer what goods have been sent

C It tells the customer what is owed as a reminder and as a check

D It states the credit limit on the account.

Question 2 A remittance advice:

A Advises on what has to be paid

B Gives information about what is being paid

C Advises about goods being returned

D Gives information about wages being paid



4. Coding systems

It is universal practice in accounting systems to use coding systems to refer to customers, suppliers, accounts and employees. Codes are used because they are concise and precise, and can be subject to computer checking

Concise: Instead of referring to a product as a “50cm high resolution LED monitor”, the product is given a code such as 50HRL. This is much quicker to write or type.

Precise: There might be several makes of 50cm high resolution LED monitors and information might be confusing and ambiguous if the manufacturer (Sony, Panasonic, Samsung LG etc) wasn’t specified. A code number can therefore be used to ensure that products and people are referred to uniquely eg 50HRLLG.

Automatic processing. Codes can also help in processing transactions. For example if all income-related accounts have the structure 1xxxx, all expense-related accounts have the structure 2xxxx, all asset-related accounts 3xxxx and all liability accounts 4xxxx, then this will help the production of the income statement (all 1xxxx amounts less all 2xxxx amounts) and the statement of financial position (3xxxx as asset amounts and 4xxxx amounts as liabilities). This is particularly needed in computerised accounting systems because the computer cannot understand that, say, rent is an expense, but doesn’t need this understanding so long as rent is coded, say 21892. Because it starts with ‘2’ it will be treated as an expense.

Checking: If all inventory codes are 7 digits long then forms and input screens can be designed for this. Computers can check that all 7 digits are present, and sometime more sophisticated checks can be carried out on the structure off the code. This reduces the chance of errors.



5. Different methods of coding

There are several methods of coding. Codes should be:

๏ Simple to use

๏ Understandable

๏ Concise

๏ Precise

๏ Expandable

Sequential codes

In this method products or customer are simply allocated numbers in sequence:

0001 Abrahams0002 Adkins0003 Ahmad...

This is simple and concise, but as constructed might have some faults:

(1) There is no relationship at all between the code and the item/person being encoded.

(2) Expansion might be difficult once you have over 9999 customer if documents and computer files can hold only four digits. Additionally, if someone called Affleck becomes a customer, he will have to be tagged onto the end of the sequence ie not reflecting alphabetical order. To avoid this problem, often sequence codes proceed as 0010, 0020, 0030…etc so that gaps are built in for future use.

Hierarchical or significant digit codes

In a business, hierarchical codes could be used to code the accounts in the general ledger. For example a code such as 3112 could be interpreted as the Machinery Cost Account, using the following system.

3 1 1 2

1 = expenses2 = income3 = assets4 = liabilities

1 = non-current assets2 = current assets

1 = cost2 = accumulated depreciation

1 = property2 = machinery3 = office equipment4 = motor vehicles



The great advantage of this type of code is that its structure provides information both to human users and to computers. For example, it would be easy to program the compute to work out the total cost of all fixed assets: simply add up all accounts starting 311.

Block codes

These lie somewhere between simple sequence codes and the full, detailed hierarchical code. They start off giving some information but then lose enthusiasm. So for general ledger codes you might have

1xxx = expenses2xxx = income3xxx = assets4xxx = liabilities

You will see in the next chapter that accounting systems rely on double entry bookkeeping. There it is essential that the accounting entries made are precise and before transactions are recorded in the system it would be normal to attach codes to the transactions.

IllustrationWhen a purchase invoice is received from a supplier, three codes would normally be needed:

• The code number of the supplier• The code number of the account which describes the purchase net of sales tax• The code number of the input sales tax.

These codes will allow all the required information to be recorded in the ledger system

Question 3 A company uses the following hierarchical system:

1 = expenses2 = income3 = assets4 = liabilities

1 = non-current assets2 = current assets

1 = cost2 = accumulated depreciation

1 = property2 = machinery3 = office equipment4 = motor vehicles

Which of the following correctly codes for the accumulated depreciation on cars? [Note: cars are non-current assets]

A 1212

B 4124

C 3124

D 2133



Question 4 A company uses a block code with the following structure:

1xxx = expenses

2xxx = income

3xxx = assets

4xxx = liabilities

Which on of the following accounts should not appear in the statement of financial position?

A 4321

B 3214

C 2234

D 3123

Question 5 What is the name given to a code in which the level of detail increases in a logical way as you work through the code?

A Sequence

B Hierarchical or significant digit

C Faceted

D Block

Example 2

List three advantages of using coding systems



6. Examples of business documentation

6.1. Sales invoice

InvoiceXYZ Supplies Ltd

32 Low Road Daventry

To:

Account Number 12938 Invoice number 2293

ABC Company12 High StreetGreenfieldGR12 45H

Date 28 February 2013

Your order 12346

Part number Description Quantity Unit price Value

$

3531 3m iron 3 20.00 60.00

6840 9.5m copper 5 50.00 250.00

Total Net 310.00

Sales tax 20% 62.00

Total Gross 372.00

Terms = 30 days from invoice date

Sales tax registration number 48480132

The invoice shows:๏ Who it is from (XYZ Supplies Ltd)

๏ A unique invoice number (2293)

๏ Who the customer is (ABC Company)

๏ Customer’s account number (12938)

๏ Date of the invoice (28 February 2013)

๏ The customer’s order number (12346 – so that the customer can link it to goods ordered)

๏ Details about goods ordered and now invoiced on this document

๏ Net total, sales tax (VAT) and gross amount due

๏ Terms setting out when the invoice has to be paid by.



6.2. Credit note

Credit noteXYZ Supplies Ltd


To:

Account Number 12938 Credit note number 159


Date 15 March 2013

Against invoice 12346

Part number Description Quantity Unit price Value

$

3531 3m iron 1 20.00 20.00

Total Net 20.00

Sales tax 20% 4.00

Total Gross 24.00


A credit note is like a negative invoice. Credit notes can be issued to correct errors (for example if a previous invoice had used a price that was too high) or to reduce the value of the goods invoiced previously (for example, if were faulty).



6.3. Statement of account

Statement of account

XYZ Supplies Ltd32 Low Road

DaventryTo:

Account Number 12938


Date 31 March 2013

Date Reference Debit Credit Balance

B/f 0.00

28/2/2013 Inv 12346 372.00 372.00

6840 CN 159 24.00 348.00

c/f 348.00


When ABC Company pays the amount owing to XYZ Supplies, it will prepare a remittance advice showing that is paying Invoice 12346 less the amount given in credit. This allows XYZ to keep track of exactly what has been paid and what hasn’t.



6.4. Petty cash voucher

Petty cash voucher XYZ Supplies Ltd


Voucher number 11234

Date 15 February 2013

Description of expenditure Amount

Light bulbs 12.00

Gross amount 12.00

Sales tax @ 20% 2.00

Net amount 10.00

Claimed by Authorised by

--------------------------------------------- ---------------------------------------B BossA Smith

7. Discounts

There are two types of discount that can be offered to customers:

A trade discount (also known as a quantity or bulk discount). This is a simple reduction n the price of the goods. For example, 10% might be offered if at least 10 units are ordered and 20% if at least 100 units are ordered.

A cash (or settlement) discount. This is offered on the condition that payment is received quickly enough. For example, terms might state that a 5% discount is given provided payment is received in less than 30 days. This discount encourages prompt payment.

8. Sales tax

Many countries have a sales tax where an amount is added to goods sold and this amount must later be paid over to the Government. In the UK, the sales tax is called VAT (value added tax).

The amount of the sales before the tax is added is called the net amount, and after tax is added is called the gross amount. Similarly, most purchases will include an amount of sales tax that is charged by the supplier.

It is important to be able to work out gross and net amounts and the amount of tax, and this can best be done by a cost structure.



IllustrationIf sales tax is at 20%, then the cost structure would be:

Net amount + sales tax = Gross amount100 20 120

Once that is established then you can easily move between any of the sales figures using proportions

1) Net amount = 280: therefore Net amount + sales tax = Gross amount

100 20 120280 ? ?

sales tax = 280 x 20/100 = 56, and gross amount = 280 x 120/100 = 336

2) Tax = 40: thereforeNet amount + sales tax = Gross amount

100 20 120? 40 ?

net amount = 40 x100/20 = 200, and gross amount = 40x 120/20 = 240

3) Gross amount = 840: thereforeNet amount + sales tax = Gross amount

100 20 120? 40 ?

sales tax = 840 x 20/120 = 140, and net amount = 840 x 100/120 = 700

Note that this type of calculation was necessary in the petty cash voucher, above. $12 was charged, of which $2 was the VAT and $10 the net cost

If there are bulk or quantity discounts, the VAT is calculated on the amount after the discount.

The amount of sales tax charged on sales is known as output tax (a tax on goods leaving the business). Business suffer sales tax on their purchases as suppliers have to charge sales tax on their sales; that tax is known as input tax (it is the tax on goods coming into the business).

At the end of each tax accounting period, the net of the sales output and input taxes has is paid to or received from the government.



Question 6 Sales tax rate = 15%. Gross sales are $690.

What are the net sales and the sales tax?

A Net = $586.50. Sales tax = $103.5

B Net = $600. Sales tax = $90

C Net = $600. Sales tax = $103.5

D Net = $586.50. Sales tax = $90

Question 7 Sales tax rate = 16%. Full net price before any bulk discount = $3,000. Bulk discount = 20%.

What are the gross sales and the sales tax?

A Gross = $2,784. Sales tax = $480

B Gross = $2,400 Sales tax = $384

C Gross = $3,480. Sales tax = $480

D Gross = $2,784. Sales tax = $384

Question 8

In a period a company charges $4,600 sales tax on its sales. Its purchases from its suppliers cost $6,000 including sales tax at 20%.

What payment/receipt will be made to/received from the government at the end of the period?

A 1,400 received from the government

B 1,400 to be paid to the government

C 3,400 to be received from the government

D 3,600 to be paid to the government



9. The functions and benefits of a computerised accounting system

Most accounting systems are now computerises and these systems should offer the following advantages over manual systems:

๏ faster provision of information

๏ provision of information that would not be easily available without a computerised accounting system

๏ once the system is set up, cheaper information

๏ more accurate information because arithmetic and certain other errors will be eliminated.

Of course sometimes things go wrong and systems break down or incorrect information is produced. IN particular, if incorrect data is entered, incorrect information will be produced (garbage-in, garbage-out, GIGO).

A computerised accounting system can be represented as:

Input ofdata

Processing data

Output of information

Computer files

For example:

Input: Orders are input over the internet

Processing: Prices are accessed on a product file and the order value worked out.

The customers’ account in the receivables ledger (now held on a computer file) is debited.Inventory records (now on a computer file) are updated.

Output: An invoice is printed for the customer.

Despatch information is displayed on a screen in the warehouse to show the goods that have to be sent.



In general there are two types of processing that can be carried out: batch processing and real-time on-line processing.

Batch processing: transactions are accumulated into batches and then all processed together. Because transactions have to be accumulated it means that there is a delay in processing them so the information held in the accounting system is generally out-of-date. For example, if sales transactions were accumulated during the week and processed to the receivables file on the last day of the week, for most of the time the balances shown owing from each customer would be understated. The balances would be correct only just after processing. Batch processing is not so common now.

Real-time, on-line processing: ‘real-time’ means that files are updated as transaction happen; ‘on-line’ means that the files are permanently accessible to be updated. For example, when you withdraw cash from a cash machine, the machine can access your bank account record (it is on-line) to see if you have the funds. When you take the money out your bank account is immediately updated (real-time).

10. Accounting documents and management reports produced.

Many accounting documents and reports will be routine: invoices, statements, sales analyses, monthly sets of financial statements. However, computerised accounting systems excel at producing exception reports.

Exception reporting is the concept of directing managers’ attention to areas of operations which seem to be performing either exceptionally badly or exceptionally well.

If operations are going more or less as planned, then it is assumed that not much management care is needed there. Managers should concentrate their efforts where operations seem to be diverging from what is expected. Exception reports include:

๏ Slow-paying customers

๏ Slow-moving stock

๏ Expenses much greater than expected

๏ Failed password attempts at accessing data.



Question 9 Because computers are machines, the information they produce will always be correct.

Is the above statement true or false?

A True

B False

Question 10 What is exception reporting?

A Expected results are investigated

B All results except are investigated without exception

C Unexpected results are investigated

D Unexceptional results are investigated

11. Risks to dataIn large organisations, which typically can have thousands of transactions, it is very easy for

๏ errors to be made

๏ unauthorised transactions to take place

๏ fraud to be carried out.

Additionally, after data has been successfully recorded it can be lost and this is perhaps an acute danger in computer-based accounting systems where it is very easy to overwrite or erase information.

Good control of all transactions is therefore necessary. ‘Internal control’ is the name given to the system used to control transactions. All transactions should be:

๏ authorised

๏ completely recorded

๏ accurately recorded

๏ safeguarded

An important part of internal control is known as the segregation of duties. This means that transactions are broken down into different stages with a different person being responsible for each stage. So in a purchase transaction, one person should order the goods, another receive and check them, and a third person should pay for them. Because several people are involved in the transaction it will be more difficult for unauthorised transaction to slip through and also each person to some extent checks up on what the previous one has done. For a fraudulent transaction to be processed would probably require collusion (co-operation) between all the parties, and this can be dangerous for the fraudster to organise.

Other types of controls include: signatures to authorise amounts, control totals to ensure all transactions have been processed and the use of sequential documents so check if any go astray.



Accounting data needs to be safeguarded:

๏ If ledgers are maintained manually, then they should be locked each night in a fireproof safe.

๏ If ledgers are computer-based then back-up copies should be taken regularly, ideally daily. Additionally, passwords should be used to prevent improper access to data and all systems should be equipped with virus checkers and firewalls to prevent improper access to data over the internet.

12. Document and record retention policies.Documents and records should be kept for some time in order to:๏ Answer queries (for example, what were the sales over the last 4 years to a certain customer?).

๏ Defend legal actions (for example, a customer alleges some years later that faulty goods had been supplied)

๏ Comply with legislation (for example tax legislation in case an enquiry is launched by the tax authorities).

Typically documents have to be retained for around 5 – 10 years depending on local rules.

The documents do not have to be kept on the business premises and it is now becoming more common to scan the documents and keep computerised images rather than the originals - which can be very bulky and expensive to store.



Chapter 2THE PROCESS OF RECORDING BUSINESS TRANSACTIONS WITHIN THE ACCOUNTING AND DOUBLE ENTRY SYSTEM

1. IntroductionThis chapter gives a brief description of how transactions are recorded in accounting systems, including the use of codes to define information precisely.

2. Recording transactions.

Transactions are first recorded in the books of prime entry and then recorded on the ledger system.

A prime entry record (or book of prime entry) is where a transaction is first recorded.

These records consist of:

๏ The cash book: this records amounts paid into and out of the bank account

๏ The petty cash book: this records small amounts of cash paid for day to day expenses, such as buying postage stamps and teas or coffee for the office.

๏ The sales day book: sales invoices issued to credit customers

๏ The purchases day book: purchase invoices received from suppliers

๏ The journal: where adjustments, such as correcting errors, are first recorded.

Some businesses also have sales returns and purchases returns day books.

The books of prime entry serve to ‘capture’ transactions as soon as possible so that they are not subsequently lost or forgotten about.

The cash book and the petty cash book are part of the double entry system and record cash coming in and going out.

The day books and journal are not part of the ledger (double entry) system, and entries are made from there to the ledgers.



The word ‘ledger’ means a book. In accounting systems there are usually three ledgers:

๏ The general or nominal ledger, which records amounts such as wages, sales, purchases, sales, electricity, travel, advertising, rent, insurance, repairs, receivables, payables and non-current assets. The cash and bank accounts are technically part of this ledger but are usually physically kept in a separate book because cash and bank transactions are so numerous.

๏ The payables ledger (also known as the creditors’ ledger and sometime the purchase ledger). Although the total amount owed to suppliers is recorded in the general ledger, details of exactly what is owed to whom are also recorded in the payables ledger. There is a separate account for each supplier. The sum of the amounts owing in this ledger should agree with the payables balance in the general ledger.

๏ The receivables ledger (also known as the debtors’ ledger and sometimes the sales ledger). Although the total amount owed by customers is recorded in the general ledger, details of exactly what is owed from whom are also recorded in the receivables ledger. There is a separate account for each credit customer. The sum of the amounts owing in this ledger should agree with the receivables balance in the general ledger.



3. The accounting system in diagrammatic form

The accounting system can be depicted as follows:

Receivables ledgerHolds detail of what makes up the total receivables.

An account for each credit customer:

Abramson xAhmad xBerry xBurton xCheridjian x.........

Total x

Sales day book

Lists credit sales.

From this the general ledger sales and receivable control accounts are updated together with the detailed receivables accounts in the receivables ledger

Purchases day book

Lists credit purchases.

From this the general ledger purchases and payables control accounts are updated together with the detailed payables accounts in the payables ledgerJournal

Makes adjustments to accounts in the double entry system

Payables ledgerHolds detail of what makes up the total payables.

An account for each credit supplier:

Adams xBoulez xClarke xDalziel xChun x.........

Total x

The double entry system

General (nominal) ledger

Assets (things owned)

Liabilities(things owed)

Equipment Payables (control)Machinery Bank loansPremisesInventory Owner’s capitalReceivables (control)

Income ExpensesSales Purchases for resaleInterest earned Rent

ElectricityInterest paid......etc

Cash Book

Dr! CrReceipts Payments

Petty cash Book


To recap:

The double entry system consists of the general ledger, the cash book and the petty cash book.

The receivables and payables ledgers provide details of the total receivables and payables that are recorded in the nominal ledger.

The books of prime entry are the cash book, the petty cash book, the sales day book, the purchases day book and the journal.



4. The accounting equation and the principles and practice of double-entry book-keeping

Bookkeeping relies on a number of linked principles:

The transactions of the business are separate from those of its owners

Every transaction gives rise to two effects (or two entries). One entry is known as a credit entry and the other a debit entry.

Things owned by the business equals things owed by the business.

The double entries are often displayed in ‘T’ accounts:

Account nameAccount nameAccount nameAccount name

Debit (DR) side Credit (CR) side

Means: Means:Increase in an asset Decrease in an assetIncrease in an expense Decrease in an expenseDecrease in a liability Increase in a liability(an amount owed) (an amount owed)

Increase in income

The accounts are collected together into ledgers. Remember ‘ledger’ just means ‘’book’ and it used to be that each account had its own page in the books.

Here are some simple, common transactions: remember every transaction has two effects: one debit, one credit. The amounts of debits must equal the amounts of credits.

Purchase of office stationery for cash:

Debit Office stationery (increase in an expense)

Credit Cash (decrease in an asset)

A cash sale:

Debit Cash (increase in an asset)

Credit Sales (increase in income)

A credit sale:

Debit Receivables (increase in an asset)

Credit Sales (increase in income)



Payment by a customer of an amount owing:

Debit Cash (increase in an asset)

Credit Receivables (decrease in an asset)

Purchase, on credit, of goods for resale:

Debit Purchases (increase in an expense. ‘Purchases’ is the name given to purchases for resale)

Credit Payables (increase in a liability).

You should understand that if the double entry as been carried out properly, then the sum of the debit entries should always equal the sum of the credit entries. This should be regularly checked by compiling a trial balance, which is simply all the accounts listed in debit and credit columns and the lists added up. The totals should always agree.

Question 1 What would be the double entry for the payment of wages to employees?

A Dr Employees Cr Wages

B Dr Wages Cr Cash

C Dr Cash Cr Wages

D Dr Cash Cr Employees

Question 2 What would be the double entry for the purchase of a car on credit?

A Dr Garage Cr Cars

B Dr Cars Cr Cash

C Dr Cars Cr Garage

D Dr Garage Cr Cash

Question 3 What would be the double entry for payment of an amount owing to a supplier?

A Dr Purchases Cr Cash

B Dr Supplier Cr Purchases

C Dr Purchases Cr Supplier

D Dr Supplier Cr Cash



5. Starting a business and its initial transactionsTransaction 1

The owner starts up the business in 1/1/2013 by putting $10,000 of cash in as capital.

From the business’s point of view, its cash has increased by $10,000 and its capital has increased by $10,000. Cash is an asset (something owned) and the capital is the amount owed by the business back to its owner.

The double entry would be:

Dr CashCashCashCash Cr

1/1/2013 Capital 10,000

Dr CapitalCapitalCapitalCapital Cr

1/1/2013 Cash 10,000

Notice the cross-referencing between the accounts. The entry in the Cash account is described as ‘Capital’, which is where the cash came from; the entry in the Capital account is described as ‘Cash’, the nature of the capital injected.

Accounting equation:

Things owned, cash $10,000 = Things owed, capital 10,000



Transaction 2

The business buys some equipment for $2,000 cash on 3/1/2013.

Cash has decreased $2,000 and the cost of equipment has increased by $2,000

Dr CashCashCashCash Cr

1/1/2013 Capital 10,000 3/1/2013 Equipment 2,000

Note the balance on this account is Dr 8,000, the net of the Dr and Cr sides

Dr EquipmentEquipmentEquipmentEquipment Cr

3/1/2013 Cash 2,000

The asset of cash decreases and that of equipment increases


1/1/2013 Cash 10,000


Things owned, cash $8,000 + equipment $2,000 = Things owed, capital $10,000



Transaction 3

On 10/1/2013, the business purchases goods for resale for $5,000 on credit.

Dr Cash Cash Cash Cash Cr



3/1/2013 Cash 2,000


1/1/2013 Cash 10,000

Dr InventoryInventoryInventoryInventory Cr

10/1/2013 Suppliers 5,000

Dr SuppliersSuppliersSuppliersSuppliers Cr

10/1/2013 Inventory 5,000

The asset of inventory increases and the liability to suppliers increases


Things owned, cash $8,000 + equipment $2,000 + inventory $5,000

= Things owed, capital $10,000 + suppliers $5,000



Transaction 4

On 15/1/2013, sells half the goods for $4,000 credit.

This will create a profit of 4,000 – 5,000/2 = $1,500. The profit is owed to the owners and is a liability of the business to its owners.

We can look at the sale in two parts: earning $4,000 for a cost of 5,000/2 = 2,500.




3/1/2013 Cash 2,000


1/1/2013 Cash 10,000


10/1/2013 Suppliers 5,000 15/1/2013 Cost of goods sold 2,500


10/1/2013 Inventory 5,000

Dr CustomersCustomersCustomersCustomers Cr

15/1/2013 Profit 4,000



Dr SalesSalesSalesSales Cr

10/1/2013 Customers 4,000

Dr Cost of goods soldCost of goods soldCost of goods soldCost of goods sold Cr

10/1/2013 Inventory 2,500


Things owned, cash $8,000 +equipment $2,000+inventory $2,500 + due from customers $4,000 = $16,500

= Things owed, suppliers $5,000 capital $10,000 + profit [4,000 – 2,500] = $16,500



Transaction 5

On 31/1/2013, the suppliers are paid what they are owed and $100 is paid for rent.

The rent is an expense and decreases the profit. Paying suppliers what is owed to them has no effect on profits.


1/1/2013 Capital 10 000 3/1/2013 Equipment 2 000

31/1/2013 Suppliers 5 000

31/1/2013 Rent 100


3/1/2013 Cash 2 000


1/1/2013 Cash 10 000


10/1/2013 Suppliers 5 000 15/1/2013 Cost of goods sold 2 500


31/1/2013 Cash 5 000 10/1/2013 Inventory 5 000

Dr CustomersCustomersCustomersCustomers Cr

15/1/2013 Profit 4 000

Dr RentRentRentRent Cr

31/1/2013 Cash 100



Dr SalesSalesSalesSales Cr

10/1/2013 Customers 4,000

Dr Cost of goods soldCost of goods soldCost of goods soldCost of goods sold Cr

10/1/2013 Inventory 2,500


Things owned, cash $2,900+equipment $2,000+inventory $2,500 + due from customers $4,000 = $11,400

= Things owed, capital $10,000 + profit [4,000- 2,500 – 100 (rent)] = $11,400

6. Trial balances

At any stage, the sums of debit balances and credit balances should be the same. This is because we were strict to always have equal debit and credit entries.

These totals are the trial balance

Example 1

Produce a trial balance for the above accounts: Dr balances Cr balances

Totals



7. Statements of financial position and statement of comprehensive income (income statement)

The accounts can also be used to produce a statement of financial position and an income statement.

๏ Statement of financial position: the assets and liabilities (things owned and things owed) at a point in time

๏ Income statements: income and expenses for the period.

Note that capital put in or taken out by the owners is neither income or expense. It is simply the owner changing his or her investment in the business.

The trial balance amounts can be marked up with SOFP or IS to show which document they form part of:

Dr CR

Cash 2,900 Asset: SOFP

Equipment 2,000 Asset: SOFP

Capital 10,000 Liability: SOFP

Inventory 2,500 Asset: SOFP

Suppliers – – Liability: SOFPCustomers 4,000 Asset: SOFP

Sales 4,000 Income: IS

Cost of goods sold 2,500 Expense: IS

Rent 100 Expense: IS

Total 14,000 14,000



Income statement for January 2013Sales 4,000

Cost of goods sold (2,500)

Gross profit 1,500

Rent (100)

Net profit 1,400

Statement of financial position as at 31 January 2013Assets

Equipment 2,000

Inventory 2,500

Cash 2,900

Due from customers 4,000

11,400

Liabilities

Capital introduced 10,000

Profit 1,400

11,400

Note that the profit made by the business is added to the liabilities in the SOFP. This is because profit is owed to the owners and becomes part of the capital of the business.

Profits taken out of the business are know as ‘Drawings’ (derived from ‘withdrawals’). If the owner removed $1,000 profits then cash would go down $1,000 and drawings up by $1,000. The liability side of the SOFP would then look like:

Liabilities Capital introduced 10,000

Profit 1,400

Drawings (1,000)

10,400



8. Carrying down balances

Look at this account:

CashCashCashCashCapital introduced 2,000 Wages 200Sales 3,000 Purchases 1,400Sales 100 Rent 200

Heating 100

To find out how much cash there is now, you have to find the balance on the account ie the net debit or credit amount.

Debits = 2,000 + 3,000 + 100 = 5,100

Credits = 200 + 1,400 + 200 + 100 = 1,900

Therefore balance = Dr 5,100 – Cr 1,900 = = Dr 3,200

This means that there is $3,200 cash i.e. and asset of $3,200.

In bookkeeping finding the balance is done in a very formal way:

1. At the bottom of the Dr and Cr sides, enter the larger of the two totals. Here that would be 5,100.

CashCashCashCashCapital introduced 2,000 Wages 200

Sales 3,000 Purchases 1,400

Sales 100 Rent 200

Heating 100

5,100 5,100

2. To make the smaller column add up to that you have to enter the ‘balancing figure’. Here 3,200 needs to be entered on the credit side. This is marked with ‘Balance c/d’ (‘c/d’ meaning ‘carried down’).



Sales 100 Rent 200

Heating 100

Balance c/d 3,200

5,100 5,100



3. This figure is brought down below the totals on the other side. Here $3,200 would be brought down (b/d) on the debit side.



Sales 100 Rent 200

Heating 100

Balance c/d 3,200

5,100 5,100

Balance b/d 3,200

A balance brought down on the debit side of the cash account means that there is an asset of cash.

Example 2

Show how the balance would be carried down on this account:SalesSalesSalesSales

21/6/2013 Returns 550 1/6/2013 Cash 250

25/6/2013 Returns 32 3/6/2013 Credit sales 1,395

29/6/2013 Cash 49



Example 3

James started business as an art dealer in 1 January 2013. His transactions in January 2013 were:

1. Introduced $6,000 capital

2. Bought Picture A for $1,000 cash

3. Bought three identical prints for $1,500 in total, on credit, from V V Gogh

4. Sold Picture A for $1,900 cash [Hint: deal with the sale for $1,900 cash and also transfer the cost of the sale from inventory to the Cost of Goods Sold Account]

5. Sold one of the prints for $850 on credit to L D Vinci

6. Paid rent of $1,000

7. Paid electricity bill of $250

8. Paid V V Gogh half of what was owed.

9. Received the full amount owing from L D Vinci

10. Withdrew $500 from the business for personal living expenses

11. Received a bill for $300 for repairs, but didn’t pay it yet.

12. Bought a computer for $750.

You are required to (a) write up the required ledger accounts for those transactions (there are accounts on the next

page), (b) calculate the balances on each account(c) produce a trial balance for the end of the period (d) state for each account on the trial balance whether it is an asset, liability, item of income or

item of expense.

CashCashCashCash

CapitalCapitalCapitalCapital



InventoryInventoryInventoryInventory

SalesSalesSalesSales

Cost of goods soldCost of goods soldCost of goods soldCost of goods sold

V V GoghV V GoghV V GoghV V Gogh

L D VinciL D VinciL D VinciL D Vinci



ElectricityElectricityElectricityElectricity

RentRentRentRent

RepairsRepairsRepairsRepairs

Repair companyRepair companyRepair companyRepair company

ComputerComputerComputerComputer

DrawingsDrawingsDrawingsDrawings



13. The accounting equation and profit

You have seen how the accounting equation should always hold true:

Things owed = Things owned

If $10,000 cash in introduced as capital, then the equation is:

(1) Things owed $10,000 (Capital) = Things owned $10,000 (Cash)

If the business trades and makes profits of, say $6,000, then the business has become ‘richer’ by £6,000 and the owner’s stake in the business (capital) will have increased by $6,000.

(2) Things owed [$10,000 + $6,000] (Capital) = Things owned $16,000

If the business borrows $2,000, then cash will increase by that amount, but the business will also owe money to the bank:

(3) Things owed [$10,000 + $6,000] (Capital) + $2,000 = Things owned $18,000

or

(4) [$10,000 + $6,000] (Capital) = $18,000 – $2,000 [Loan] = Net assets $16,000

Comparing equations 1 and 4, Capital has increased by $6,000 because a profit has been made and this is reflected in the increase in net assets from $10,000 to $16,000.

Profit makes businesses richer.

However, profit and capital can be withdrawn from a business and this will reduce the net assets of the business. So, if the owner withdrew money to live on (made drawings) of $2,000, the assets would reduce by $2,000 and the equation would be:

(5) [$10,000 + $6,000 – 2,000] (Capital) = $16,000 –$2,000[Loan] = Net assets $14,000

So, comparing equations 1 and 5, we can say that:

Increase in net assets between two dates $(14,000 – 10,000) =

Capital introduced in the period ($Nil) + Profit ($6,000) – Drawings ($2,000) = $4,000.

Remember:

Increase in net assets = capital introduced + profit - drawings



Question 4 On 1 January 2013 a business had net assets of $15,000

On 31 January 2013, net assets amounted to £19,000.

No capital had been introduced in January, but the owner had made drawings of $750.

What profits were made in January?

A $4,000

B $4,750

C $3,250



Additional capital of $1,000 had been introduced in January, but the owner had made drawings of $400


A $3,400

B $4,000

C $4,600

D $5,400



A loss of $7,000 had been made and the owner withdrew $1,000 to live on.

What additional capital was introduced to the business in January?

A $8,000

B $6,000

C $7,000

D $10,000



Question 7

On 1 January 2013 and 31 January 2013 a business had the following assets and liabilities:

1 January 31 January$ $

Cash 10,000 12,000Owed to suppliers 3,000 4,000Owed from customers 2,000 1,000Equipment 6,000 10,000Bank loan 2,000 5,000

No additional capital had been introduced, but the owner withdrew $800 to live on.


A $1,000

B $5,800

C $200

D $1,800



Chapter 3THE DAY BOOKS AND THE JOURNAL

1. Introduction

This chapter shows how the day books and journal are used to feed information into the double-entry system and into the receivables and payables ledgers.

2. The accounting system

For convenience, the diagram of the accounting system is produced again:




Total x

Sales day book

Lists credit sales.


Purchases day book







Total x








Cash Book


Petty cash Book


We will look first at what day books are used for.



3. The purchases day book (PDB)

This book records of all the invoices received by a business from its credit suppliers. Before invoices are listed here, they should be approved for payment as the invoices will progress from here to the ledgers and eventual payment.

The PDB is just a list. A simple PDB would be as follows:

Date Details Supplier’s account number

Net amount

Sales tax amount

Gross amount

4/2/2013 ABC Ltd 123 1000 200 12008/2/2013 CDE Ltd 234 400 80 4808/2/2013 FGH Ltd 332 1200 240 14409/2/2013 IJK Ltd 346 150 30 180

TOTALS 2750 550 3300

Notes

1. Despite its name, the purchases day book does not have to be totalled every day.

2. The total of the net amount, sales tax amount and gross amount columns should add across (known as cross-casting). If they don’t, an error has been made somewhere.

3. The total of the gross amount column is how much extra we owe suppliers because of these invoices.

4. The total of the net amount column is the cost of how much extra has been purchased.

5. The total of the sales tax amount is simply the total of the sales tax relating to these invoices. This can be recovered from the government.

The postings that would be made to account for these purchases transactions are:

In the general ledger

Credit: Payables control account (total payables) 3,300Debit: Purchases account 2,750Debit: Sales tax account 550

3,300 3,300

These entries reflect that $3,300 is owed to suppliers for goods of $2,750 and sales tax of $550.



In addition, in the Payables Ledger, each of the suppliers is credited with the gross amount of their invoices

Supplier’s account number

Details Gross amount

123 ABC Ltd 1200234 CDE Ltd 480332 FGH Ltd 1440346 IJK Ltd 180

Note: the Payables Ledger is not part of the double entry system: it is a memorandum entry.

If everything has been done properly, the sum of the detailed accounts in the payables ledger will agree with the payables Control Account in the general ledger.

This system fulfils the following functions:

1. The control account provides an instant answer as to what is owed to suppliers in total

2. The detailed ledger accounts in the Payables Ledger give information about exactly what is owed to whom

3. Ensuring the control account and the sum of the ledger balances agree will reduce the chance of an error having occurred in the postings.

4. The sales day book (SDB)This book records of all the invoices issued by a business to its credit customers before they are sent out to customers.

The SDB is simply a list. A simple SDB would be as follows:

Date Details Customer’s account number

Net amount

Sales tax amount

Gross amount

4/2/2013 PQR Ltd 378 400 80 4808/2/2013 STU Ltd 388 300 60 3608/2/2013 VWX Ltd 587 200 40 2409/2/2013 YZA Ltd 775 120 24 144

TOTALS 1020 204 1224

Notes

1. Despite its name the sales day book does not have to be totalled every day.

2. The total of the net amount, sales tax amount and gross amount columns should add across (known as cross-casting). If they don’t, an error has been made somewhere.

3. The total of the gross amount column is how much extra we are owed by customers because of these invoices.

4. The total of the net amount column is the pre-tax sales value of the extra sales.

5. The total of the sales tax amount is simply the total of the sales tax relating to these invoices. This will be paid to the government (after off-setting any input sales tax).

The posting that would be made to account for these sales transactions are:



In the general ledger

Debit Sales control account (total receivables) 1,224Credit Sales account 1,020Credit Sales tax account 204

1,224 1,224

These entries reflect that $1,224 is owed by customers for goods of $1,020 and sales tax of $204.

In addition, in the Receivables Ledger, each of the customers is debited with the gross amount of their invoices

Details Gross amountPQR Ltd 480STU Ltd 360VWX Ltd 240YZA Ltd 144

Note: the Receivables Ledger is not part of the double entry system: it is a memorandum entry. If everything has been done properly, the sum of the detailed accounts in the receivables ledger will agree with the receivables Control Account in the general ledger.

This system fulfils the following functions:

1. The control account provides an instant answer as to what is owed by customers in total

2. The detailed ledger accounts in the Receivables Ledger give information about exactly who owes what.

3. Ensuring the control account and the sum of the ledger balances agree will reduce the chance of an error having occurred in the postings.



4. Control account reconciliations

The receivables and payables control accounts should always agree with the sum of the balances on the receivables and payables ledgers respectively. If they don’t, then an error must haven been made and needs to be corrected.

Correcting control account and ledger errors is a common exam requirement.

Illustration 1A receivables control account balance is $3,825. The three receivable account balances in the receivables ledger are as follows:

Customer name Amount owingA Ltd 1,800B Ltd 1,500C Ltd 652Total 3,952

Something must have gone wrong because the control account balance does not agree with the total of the individual balances.

Investigation of the entries shows the following errors:1. An invoice for $425 in the day book was posted to C Ltd’s account as $452.2. An invoice for $500 in the day book was posted as $200 to B’s account3. The sales day book was undercast (ie added up by too little) by $400

SolutionList of balances b/fList of balances b/f 3,9521 $452 – 425 = $27 too much debited to C Ltd (27)2 $500 - $200 = $300 too little posted to B Ltd 300Corrected listCorrected list 4,225

Control account balanceControl account balance 3,8253 Undercasting error 400

4,225

It is vital to understand which entries come from where.

Individual lines in the day book affect postings to the receivables (or payables) ledger

Totals in the day book affect postings to the receivables (or payables) control account.



Question 1 The total columns in a purchases day book are as follows:

Date Details Supplier’s account number

Net amount Sales tax amount

Gross amount

.. .. ..

.. .. ..

TOTALS 4,000 800 4,800

To where are these figures posted in the ledgers?

A Debit Purchases 4,800 Credit Suppliers 4,800

B Debit Purchases 4,000 Credit Sales tax 800 Credit suppliers 4,800

C Credit Purchases 4,000 Credit sales tax 800 Debit suppliers 4,800

D Debit Purchases 4,000 Debit sales tax 800 Credit suppliers 4,800

Question 2 The total columns in a sales day book are as follows:

Date Details Customer’s account number

Net amount Sales tax amount

Gross amount

.. .. ..

.. .. ..

TOTALS 6,000 1,200 7,200

To where are these figures posted in the ledgers?

A Credit Sales 7,200 Debit Customers 7,200

B Credit Sales 6,000 Debit Sales tax 1,200 Debit Customers 7,200

C Credit Sales 6,000 Credit Sales tax 1,200 Debit Customers 7,200

D Credit Sales 6,000 Debit Sales tax 1,200 Credit Customers 7,200

Question 3

A debit balance of $100 on an individual’s ledger account in the payables ledger has been listed as a credit balance when adding up the list of balances.

To correct the reconciliation of the control account with the list of balances:

Control account List of balances

A Cr 200 Increase by 100

B Cr 100 Increase by 200

C No effect Decrease by 200

D No effect Decrease by 100



Question 4 For the last week of the accounting period, purchases net of sales tax totalled $70,000. The sales tax amounted to $15,000. $85,000 has been credited to the suppliers’ control account as: $83,000.

To correct the reconciliation of the control account with the list of balances:

Control account List of balances

A Cr 2,000 No effect

B Cr 2,000 Increase by $2,000

C Dr 13,000 No effect

D Dr 15,000 No effect

Question 5 The sales day book has been overcast by $1,000.

The effect of this error is to:

A Overstate sales, overstate the control account, overstate the total of the accounts in the receivables ledger

B Overstate sales, understate the control account, no effect on the total of the accounts in the receivables ledger.

C Overstate sales, overstate the control account, no effect on the total of the accounts in the receivables ledger.

D Understate sales, overstate the control account, no effect on the total of the accounts in the receivables ledger.

Question 6

An invoice to AGS Ltd of value $4,300 was listed in the sales day book as $3,400.

To correct this error, which corrections are needed?

Control account AGS’s account in the receivables ledger

Sales account in the general ledger

A Dr 900 Dr 900 Cr 900B Dr 900 No effect Cr 900C Cr 900 Cr 900 Dr 900D Dr 900 Dr 900 No effect



5. Returns day books

In addition to sales and purchases day books, some businesses have sales returns day books and purchases returns day books. Credit notes issued to customers or received from suppliers are listed there.

They act as ‘negative’ day books. Therefore the following postings are made:

Sales returns day book:

Total: Dr Sales Cr Receivables control account

Individual lines: Cr individual customers’ accounts

Purchase returns day books

Total: Cr Purchases Dr Payables control account

Individual lines: Dr individual suppliers’ accounts

6. The journal

The journal is used as the book of prime entry for transactions or adjustments that are not initiated anywhere else. Examples include:

๏ Correction of errors

๏ Off-set of amounts owed and owing. For example $1,400 is owed from ABC Ltd in the receivables ledger and $1,600 is owed to ABC Ltd in the payables ledger (ABC Ltd is both a customer and a supplier). The two amounts can be offset and only $200 needs to be paid.

๏ Dealing irrecoverable debts

The traditional way of setting out a journal is:

Journal number 1411 Dr CrDr ABC Ltd in the payables ledger 1,400 Cr ABC Ltd in the receivables ledger 1,400Being the offset of amounts payable and receivable 1,400 1,400

Authorised byAuthorised byAuthorised by



Example 1

An amount of $350 paid for the repair of a machine was incorrectly treated as the purchase of a new machine.

What is the correcting journal?Journal number Dr Cr


Example 2

An amount of $1789 received from XYZ in settlement of an invoice was incorrectly treated as a new sale.

What is the correcting journal?Journal number Dr Cr






Chapter 4CASH TRANSACTIONS

1. Introduction

This chapter shows the use of the cash book and petty cash book.

2. The cash books in the accounting system

The cash book and the petty cash book are books of prime entry and are part of the double entry system. The cash book records the flows of money in the bank account of the business; the petty cash book records relatively small amounts of cash expenditure on items like paying for coffee for the office, reimbursing employees for taxi fares, buying some pens for cash from the local stationery shop.




Total x

Sales day book

Lists credit sales.


Purchases day book







Total x








Cash Book


Petty cash Book




3. Types of payment from the bank

Payments can be made from a bank account in four main ways:

๏ Cheque: see later

๏ Internet transfer: now very common. It is vitally important that account log-on details are kept secure. In addition to user-known passwords, some banks now issue devices that generate unique use-once codes. Access to the bank account is then possible only by someone who both knows the password and who possesses the device.

๏ Direct debit. Here the person receiving the funds has the right to extract them from the bank account. This is often used by institutions like insurance companies to collect insurance premiums from clients. The process can be completely automated.

๏ Standing order. Here the person paying instructs their bank to pay a regular amount to the recipient. This is often used to pay regular amounts like rent. The process can be completely automated.

In addition, banks can remove funds from accounts for interest and bank charges.

4. Cheques and the clearing system

Cheques are unconditional orders in writing given to a bank (the drawee) by the person paying out of his or her bank account (the drawer of the cheque) to pay an amount to the payee (the person receiving the money).

Here is a typical UK cheque

Counterfoil Cheque

HSBC is the bank (the drawee ie the institution on whom the cheque is drawn and the order to pay given).

Mr J Tar is the drawer (the person paying the money)

40-07-05 and 21745175 are numbers that identify the bank branch and the bank account

202546 is the cheque number (for identification)



The numbers printed at the top right are reproduced in special machine-readable characters at the bottom of the cheque and these allow automatic processing of the cheque.

The cheque can be torn out of the cheque book leaving a counterfoil onto which details should also be entered.

When completed, the cheque would look like:

ABC Co Ltd

One thousand five hundredpounds only

ABC Company Ltd--------------15 January 2013

15 /1/2013

1500.00

1,500 - 00

The ABC Company Ltd is the payee (the person who will receive the funds)

Cheque books must be kept securely as the signature of the authorised person (J Tar) could be forged (falsified) and cheques made out improperly to steal funds.

Note that the payee is written as “ABC Company Ltd-------------------“ and the amount as “One thousand five hundred pounds only”. The line after Ltd and the word ‘only’ are to prevent changes being made.

All cheques should be accounted for, even those which are made out incorrectly and scrapped: the cheque should be marked “VOID” in large letters and kept in the cheque book.

When ABC Ltd receives the cheque it is important to pay the cheque into the bank promptly. Delay increases the risk of the cheque being lost, stolen or of J Tar not having the funds to pay.

When ABC Company receives the cheque it must be paid into the company’s bank. This is done using a Paying-in slip.

ABC will list cheque details on the reverse of the slip, and the total on the front.

The total will appear in ABC’s bank account at the end of the day, but that does not mean that funds have been safely transferred: the amount is only provisional. The cheque from J Tar has to be sent



back to his bank to see if there is enough money in the account. If there is, then Tar’s bank will send the money to ABC’s bank and the funds are transferred at that point.

This process is known as ‘clearing the cheque’ and it takes around three days (Internet transfers are usually completed in a couple of hours).

If J Tar did not have enough funds to pay the money, then the cheque is sent back to ABC’s bank and from there to ABC marked ‘Refer to Drawer’. This means that the cheque has been dishonoured or ‘bounced’. ABC then has to pursue the matter with Tar and the funds that had provisionally appeared in ABC’s account are removed.

5. The cash book

The cash book is the cash account of the business and is where bank account receipts and payments are recorded. In a simple ‘T’ account it would look like;

Cash BookDr (Receipts) Cr (Payments)



Cash BookDr (Receipts) Cr (Payments)Balance b/d 1,200 Paid to C Clark 404Cash sales 240 Paid to D Drake 172Received from A Smith 360 Wages 1200Cash sales 120 Cash purchases 72Received from B Bodkin 600 Tax 300

Balance c/d 3722,520 2,520

Balance b/d 372

Notes:

1. At the start of the period there is cash of $1,200.

2. The receipts from Smith and Bodkin will be the settlement of sales invoices.

3. The payments to Clark and Drake will be the payment for purchases invoices.

4. At the end of the period there is cash of $372

Although the cash book would work perfectly well in this format, it does mean that every entry has to be posted individually to the other side of an account in the general ledger. A more efficient arrangement would be as follows:



Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments)

Total Cash sales

Receivables Total Cash purchases

Payables Wages Sundry

Balance b/d

1,200 Paid to C Clark

404 404

Cash sales 240 240 Paid to D Drake

172 172

Received from A Smith

360 360 Wages 1200 1200

Cash sales 120 120 Cash purchases

72 72

Received from B Bodkin

600 600 Tax 300 300Tax

Balance c/d 3722,520 360 960 2,520 72 576 1200 300

Balance b/d

372

This is called an analysed cash book.

Remember, the cash book is part of the double entry, so the in debit entries in the cash book are debits in the double entry system. However, their corresponding credit entries for those items have not been. The entries required can be made from the total of each column:

Cr Sales 360

Cr Receivables ledger control account 960

In addition, the memoranda accounts of A Smith and B Bodkin in the Receivables ledger would have to be updated.

Similarly, the credit entries have been recorded in the double entry system, but the corresponding debit entries for those items have not been. The entries required can be made from the total of each column:

Dr Purchases 72

Dr Payables ledger control account 576

Dr Wages 1200

Dr Tax 300

In addition, the memoranda accounts of C Clark and D Drake in the Payables ledger would have to be updated.



5. Cash book with sales tax

Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments) Cash Book Dr (Receipts) Cr (Payments)

Total Sales tax

Cash sales

Receivables Total Sales tax

Cash purchases

Payables Wages Sundry

Balance b/d 1,200Paid toC Clark 404 404

Cash sales 240 40 200Paid toD Drake 172 172

Received from A Smith 360 360 Wages 1200 1200

Cash sales 120 20 100Cash purchases 72 12 60

Received from B Bodkin

600 600 Tax 300300Tax

Balance c/d 3722520 60 300 960 2520 12 60 576 1200 300

Balance b/d 372

The introduction of sales tax alters the cells that are shaded.

Assume sales tax is at 20%

On the debit side, cash sales of $240 and $120 were made, but some of these amounts are the sales tax and some the net sales. These have to be accounted for separately.

Gross sales $240; net sales $200; sales tax $40

Gross sales $120; net sales $100; sales tax $20

Cash of $240 plus $120 was received and these amount are in the total column of the cash book.

$300, the total of the cash sale column would be credit to the Sales account

$60, the total of the sales tax column would be credited to the sales tax account.

There is no sales tax implication arising from the amounts received from A Smith and B Bodkin. These are not new sales and are merely these customers paying what they owe.

On the credit side, cash purchases of $72 were made and $72 was paid out. However, only $60 of this was the net purchases; the $12 was sales tax on these purchases.

$60 will be debited to the purchases account

$12 will be debited to the sales tax account

Wages and Tax are not subject to sales tax.

The payments to Clark and Drake are not new purchases so there is no sales tax implications. These payments are simply settling what is owed.



6. Bank reconciliations

The cash account (or cash book) records the movements of cash in the business’s bank account. Of course, there are usually many cash movements and it is easy for errors to be made. Fortunately, banks will normally send regular bank statements to their customers (or these can be downloaded or viewed over the Internet) and, by comparing the bank’s version with the cash book version, businesses have a very valuable way of checking that their bank account contains no errors.

However, often the cash book balance and the bank statement balance will differ because of timing and other differences. For example:

1. The bank might have made interest charges that have not yet been reflected in the cash book.

2. Cheques issued by the organisation and credited to their cash book, might not yet have reached the payee and not yet gone through the bank account (ie not yet cleared).

3. The organisation might have forgotten to enter standing orders or direct debits in its Cash Book, though these will have been paid by the bank.

4. Sometimes if an amount is paid at a different bank, it takes time to make its way to the bank account.

It is therefore necessary to carry out a bank reconciliation to ensure that any difference between the balance shown on the bank statement can be reconciled to (made to agree with) the balance in the cash book.

Bank reconciliations are in indispensable part of the internal control system of a business: cash has many movements and it is a very desirable asset so the accuracy of cash records has to be checked regularly

Here’s an example:

Dr(Receipts) Cash BookCash BookCash Book Cr

(Payments)Balance b/d 1 May 2013Balance b/d 1 May 2013 1,900 CN 1200 200

CN 1201 150

Paid in 31 May 2013Paid in 31 May 2013 360 CN 1202 388

CN1203 290

Balance c/d 31 May 2013 1,232

2,260 2,260

Balance b/d 1 June 2013Balance b/d 1 June 2013 1,232

[CN = cheque number]



Note CN = cheque number; DD = direct debit; SO = standing order.

Dr Bank Statement - Safe Bank IncBank Statement - Safe Bank IncBank Statement - Safe Bank Inc Cr

12011201 200 Balance b/d 1 May 2013 1,900

DDDD 50

Bank chargesBank charges 5

12021202 290

Balance c/d 31 May 2013Balance c/d 31 May 2013 1,355

1,900 1,900

Balance b/d 1 June 2013 1,355

Note that things seem to be reversed on the bank statement. This is the bank’s document showing its relationship with its customers. If the customer has $1,900 cash in the bank on 1 May then on that date the bank owes its customer $1,900. The customer is therefore a creditor of the bank and this will show a credit balance on the bank statement.

As cash leaves the account then the bank owes the customer less and debits these amounts from the account.

You will see that the closing balances do not agree here: $1,232 compared to $1,355. We have to see if the difference can be explained logically by performing a bank reconciliation.

First compare the two documents and mark off each item which appears on both: they cannot be the cause of any difference.


(Payments)Balance b/d 1 May 2013Balance b/d 1 May 2013 √ 1,900 CN 1200 √ 200

CN 1201 150

Paid in 31 May 2013Paid in 31 May 2013 360 CN 1202 388

CN1203 √ 290

Balance c/d 31 May 2013 1,232

2,260 2,260


Dr Bank Statement - Safe Bank IncBank Statement - Safe Bank IncBank Statement - Safe Bank Inc Cr

12011201 √ 200 Balance b/d 1 May 2013 √ 1,900DDDD 50Bank chargesBank charges 512021202 √ 290

Balance c/d 31 May 2013Balance c/d 31 May 2013 1,3551,900 1,900

Balance b/d 1 June 2013 1,355



Then bring each document up to date for the reconciling items

Bank statementBank statementBank statementBank statementOpening balance 1,355Less: cheques in cash book not yet on bank statement CN 1201 150

CN 1020 388(538)

Add: amount paid in but not yet on bank statement 360

Up-to-date balance 1,177


(Payments)


Direct debit 50

Bank charges 5

Correct bal c/d 1 June 2013 1,177

1,232 Balance b/d 1 June 2013 1,355

You will see that the two balances now agree.

Example 1

On 31 July 2013, the cash book of Pizazz Ltd showed a debit balance (ie cash at the bank) of $200. The bank statement showed a credit balance of (ie Pizazz had cash in the account) of $339.

The following errors and differences were found;

1. Cheques in the cash book of $500 had not been presented for payment (ie had this amount had not yet left the bank account).

2. An amount of $250 paid in had not yet been credited to the bank account.

3. The credit side of the cash book had been undercast by $70 (ie under-added) by $70 when working out the closing balance of $200

4. A payment of $40 by a customer had been sent directly to the bank and was not in the cash book.

5. Bank charges of $31 had been taken by the bank but were not in the cash book.

6. The bank had taken $50 out of the bank account because a cheque from a customer that had been credited to the bank account later ‘bounced’ ie was dishonoured. This was not reflected in the Cash Book

Reconcile the bank account and the cash book, adjusting each as appropriate:




(Payments)Balance b/d 31 July 2013Balance b/d 31 July 2013 200

Bank statementBank statementBank statementBank statementOpening balance 339

Up-to-date balance

7. Petty cash

The petty cash book will look similar to the main cash book and will usually have analysis columns. Usually the only source of funds will be when the petty cash is topped up by cash from the main bank account, though occasionally there will be small amounts received from staff as payment for personal photocopying, use of the firm’s postage and so on.

DebitDebitDebit CreditCreditCreditCreditCreditCreditCredit

Date Narrative Total$

Date Narrative Total$

Refreshments Post Fares Stationery

Petty cash is usually kept in a small locking box, the petty cash box.

As payments of cash are made, a petty cash voucher will be filled in showing the amount and purpose of the payment. Ideally, any receipts for the purchase will be stapled to the petty cash voucher and the voucher approved by a manager or supervisor.

Petty cash is usually kept on the imprest system as this prevents too much cash accumulating in the petty cash box. Under this system, on the presentation of the vouchers the balance is topped-up, back to an agreed amount (the petty cash float). The amount of the top-up should equal the sum of the vouchers and the vouchers are filed away.

At any stage, the total of the cash and the vouchers in the box should add back to the agreed maximum balance.



IllustrationPetty cash float = $100. During the week of 12 July, petty cash amounts paid out amounted to $68 and all amounts were supported by petty cash vouchers and receipts.

Just prior to reimbursement:

Cash in the box should be = 100 – 68 = $32; vouchers amount to $68

Cash + Vouchers = $100 (the agreed float)

The reimbursement process is:Petty cash float = 100Less: authorised expenditure (68)

32Petty cash reimbursement 68Re-established float 100

Question 1 A bank reconciliation can be best described as:

A Part of the double entry system

B Part of the books of prime entry

C A way of checking that the opening balance in the cash account can be reconciled to the closing balance on the bank statement

D An essential part of an organisation’s internal control system

Question 2 In the credit side of an analysed cash book there is a column headed Payables.

What double entries are made from this column?

A Dr Purchases with the total of the column; Cr Creditors control account with the total; Cr individual creditors with each entry in the column

B Dr Creditors control account with the total; Dr individual creditors with each entry in the column

C Cr Creditors control account with the total; Cr individual creditors with each entry in the column

D Dr Purchases with the total of the column



Question 3 The following information is to be used to prepare a bank reconciliation:

Balance per cash book 31/3/2013 5,700 Dr

Amounts paid in not yet appearing on the bank statement(uncredited lodgements) 1,367

Unpresented cheques 3,880

Bank charges not in cash book 70

Receipt from a customer sent to bank but not in cash book 403

What is the balance shown on the bank statement as at 31/3/2013?

A 8,213

B 6,033

C 3,520

D 8,546

Question 4 A bank a statement shows a balance of $750 overdrawn

The statement shows bank charges of $75 that have not been credited to the cash book.

There are also unpresented cheques totalling $800 and uncredited lodgements of $330

The bank overdraft on the balance sheet should be:

A 1,145

B 1,295

C 1,220

D 750

Question 5 The receivables column in debit side of a cash book has been added up by $100 too much.

When the list of receivables balances is being reconciled with the receivables ledger control account, what correction(s) will be needed?

A No correction is needed

B The receivables control account balance needs to be increased by $100

C The receivables control account balance needs to be decreased by $100

D The sum of the list of balances needs to be increased by $100



Question 6 Walton Ltd operates a petty cash imprest system. During the month an amount of $5 was received from a member of staff for private photocopying and petty cash vouchers amounting to $45 were approved.

If the agreed float is $100, how much will the petty cash need to be topped up by at the end of the month?

A $45

B $40

C $60

D $35





Chapter 5MORE ON SALES AND RECEIVABLES

1. Introduction

This chapter looks in a little more detail at sales transactions and the receivables ledger

2. Recap of the receivables ledger system

Entries in the receivables ledger arise from two main sources:

๏ The sales day book (SDB), where new credit sales are first recorded.

๏ The cash book(CB) where receipts from credit customers are first recorded (in the receivables ledger column, on the debit side)

Additionally there will be occasional postings made from:

๏ The journal (eg the offset of debts to an account in the payables ledger)

The entries made from the sales day book will be:

๏ Dr Receivables control account with the total of the SDB gross amount column

๏ Cr Sales Account with the total of the SDB net amount column

๏ Cr Sales Tax Account with the total of the SDB sales tax amount column.

In addition, each line in the gross column of the SDB will be used to Debit individual accounts in the Receivables Ledger so as to record exactly who owes what.

The entries made from the cash book will be:

๏ Cr Receivables control account with the total of the Receivables Ledger column

In addition, each line in the Receivables column of the Cash Book will be used to Credit individual accounts in the Receivables Ledger so as to record exactly who has paid.

The accounting documents used are:

1. When sales are made, invoices will be issued to customers

2. Statements will be sent regularly to customers, setting out what is owed and what has been paid.

3. Remittance advices will be received from customers when they pay to explain which invoices are being settled.



4. Credit control

Credit control is the name given to the process of trying to ensure that cash is eventually received for all credit sales.

The process starts with a new customer applying for credit and this should initiate some investigation, such as:

๏ Asking for the applicant’s recent financial statements.

๏ Enquiries to a credit reference agency to see if the applicant has any history of poor payments.

Based on these investigations, the applicant will be accepted or rejected. A credit limit should be set for all customers.

Once credit sales have been made, each customer should be encouraged to pay according to the terms of the contract. There are three ways of proceeding:

๏ Send statements. These often act as a gentle reminder about what’s due.

๏ Settlement discounts. For example, pay 5% less if paid within 30 days.

๏ Prepare aged receivables analyses and act accordingly on the information contained there.

5. Settlement discounts

For example, an invoice is issued to DFH Ltd for $700 on 2nd January 2013 with terms offering a settlement discount of 5% is settled within 30 days. The invoice was paid on 25th January 2013. Therefore, because it was paid on time the amount due will be $700 x 95% = $665.

The discount of $35 is an expense of the business. The customer has been ‘let off’ $35 for prompt payment.

The entries in the DFH’s account would be:

DFH LtdDFH LtdDFH LtdDFH Ltd2/1/2013 Sales day book 700 25/1/2013 Cash book 665

Settlement discount 35

700 700

The settlement discount is debited to the Discounts Allowed account in the general ledger. This is an expense account.

Occasionally there is a memorandum settlement discount column in the cash book so that, in the case above, $665 would be the amount of cash received and $35 would be entered in the memorandum column. The sum of the memorandum discount column would be debited to the Discounts Allowed account.

It is important to realise that the receivables control account should always reflect in total whatever happens the individual accounts. So, if a customer is given a settlement discount, this must also be credited to the control account.



For example, consider a company with just three customers:

ABC LtdABC LtdABC LtdABC LtdSales day book 700

DEF LtdDEF LtdDEF LtdDEF LtdSales day book 400

GHI LtdGHI LtdGHI LtdGHI LtdSales day book 200

Receivables control accountReceivables control accountReceivables control accountReceivables control accountB/f 1,300

You will see that, the control account balance agrees with the sum of the individual balances in the receivables ledger ($1,300 = $700 + $400 + $200)

Each is entitled to a settlement discount of 5% if the amounts are paid within 30 days. ABC Ltd and DEF Ltd pay within this time limit; GHI does not and pays only $100 of what is owed.



A cash book extract would be:

Cash book (Dr side)Cash book (Dr side)Cash book (Dr side)Cash book (Dr side)Cash book (Dr side)Narrative Total Discount Receivables

ledgerOther….

ABC Ltd 665 35 665DEF Ltd 380 20 380GHI Ltd 100 - 100

1,145 55 1,145

Dr Discounts allowed account $55Cr Receivables control account $55

Cr Receivables control account $1,145

Post to individual accounts in the

receivables ledger.

ABC LtdABC LtdABC LtdABC LtdSales day book 700 Cash 665

Discount 35

700 700

DEF LtdDEF LtdDEF LtdDEF LtdSales day book 400 Cash 380

Discount 20

400 400

GHI LtdGHI LtdGHI LtdGHI LtdSales day book 200 Cash 100

Bal c/d 100

200 200Bal b/d 100

Receivables control accountReceivables control accountReceivables control accountReceivables control accountB/f 1,300 Cash 1145

Discounts allowed 55Bal c/d 100

1,300 1300

Note that the sun of the individual balances (now GHI Ltd only) still equals the balance on the control account.

Note that a settlement discount is entirely different to a bulk or trade discount. The bulk or trade discount is to all intents and purposes a straight reduction in the selling price and the only amounts every invoiced or treated as a sale are after the discount has been removed.

With a settlement discount, the sales and the invoices are for the full amount (after the trade discount) and the discount is contingent upon prompt payment.



Question 1

A customer’s invoice and payment details are as follows:

Invoice date Invoice amount5 May 2013 $1,2008 May 2013 $40012 May 2013 $50025 May 2013 $1,000

All the invoices offered a 2.5% discount for payment at or before 30 days and all were settled by a payment on 9 June 2013.

How much should the payment be for and how much is the discount?

A Payment = $3,100; discount = $37.50

B Payment = $3,062.50; discount = $37.50

C Payment = $3,052.50; discount = $47.50

D Payment = $3,022.50; discount = $77.50

Question 2

The normal price of a purchase is $800, but a customer has negotiated a trade discount of 20%.

The invoice is dated 16 June 2013 and offers a 5% discount for payment within 45 days. Payment is received on 25 July 2013.

What amounts should be posted to the Sales account and to the Discount Allowed account in the general ledger?

(Ignore sales tax)

A Credit Sales account $800; debit discounts allowed account $192

B Credit Sales account $640; credit discounts allowed account $32

C Credit Sales account $640; debit discounts allowed account $32

D Credit Sales account $608; debit discounts allowed account $40



6. Aged receivables analysis

This looks at all the invoices still owed by customers and displays them in age categories.

Typically the age categories are something like:

≤ 30 days

30 to ≤ 60 days

60 to ≤ 90 days

90 to ≤ 180 days

> 180 days

Usually, the older an unpaid debt becomes, the less likely to be paid. Also, as debts become older more extreme action is likely to be taken to try to force payment. For example, final warnings, then taking customers to court.

The layout of an aged analysis is usually something along the lines of:

Customer Total ≤ 30 days 30 to ≤ 60 days

60 to ≤ 90 days

90 to ≤ 180 days

> 180 days

Aardvark 1,200 1,100 100Benson 900 600 300Chandos 100 100Draghi 600 500 100Ephram 500 100 200 200Fahrook 800 800: : : : : : :: : : : : : :Total 94,560 85,382 5,993 2,085 800 300% 100.0 90.3 6.3 2.2 0.9 0.3

To be able to work out how old debts are, it is essential to know what exactly which invoices have been paid. This is where remittance advices are important because they allow specific matched to be carried out.



For example, consider this customer’s account:

ABC LtdABC LtdABC LtdABC LtdInvoice 125 3/1/2013 700 Invoice 135 23/1/2013 1,000Invoice 178 5/2/2013 500Invoice 201 4/3/2013 2,300Invoice 233 12/3/2013 950Invoice 278 2/3/2013 620 Bal c/d 6,070

6,070 6,070

The customer sends a cheque for $3,800, and this is accompanied by a remittance advice as follows:

ABC Ltd49 High Street

REMITTANCE ADVICE

Date 31/3/2013

ABC Ltd49 High Street

REMITTANCE ADVICE

Date 31/3/2013

Invoices paid: $

Invoice 135 23/1/2013 1,000Invoice 178 5/2/2013 500Invoice 201 4/3/2013 2,300

TOTAL REMITTANCE Cheque 585493 3,800

The payments set out on the remittance advice have to be matched as follows:

ABC LtdABC LtdABC LtdABC LtdInvoice 125 3/1/2013 700 Invoice 135 23/1/2013 1,000 Invoice 135 31/3/2013 1,000Invoice 178 5/2/2013 500 Invoice 178 31/3/2013 500Invoice 201 4/3/2013 2,300 Invoice 201 31/3/2013 2,300Invoice 233 12/3/2013 950Invoice 278 2/3/2013 620 Bal c/d 2,270

6,070 6,070



The matched items can be cleared out of the account to leave:

ABC LtdABC LtdABC LtdABC LtdInvoice 125 3/1/2013 700 Invoice 233 12/3/2013 950Invoice 278 2/3/2013 620 Bal c/d 31/3/2013 2,270

2,270 2,270

A valid aged analysis can be performed on the outstanding amounts.

7. Irrecoverable (bad) debtsSometimes, despite all efforts to sell only to credit-worthy customers and to follow up old amounts carefully, it becomes clear that a debt is irrecoverable and no money will ever be received. Perhaps the customer has gone into liquidation (or simply disappeared!)

There is then no point in continuing to record the debt as a receivable (an asset) when it is worthless: the amount should be written off, ie reduced to zero. This is an expense to the business and will be recorded in an irrecoverable debts account (sometimes called a bad debts account).

As always, whatever adjustment you make to an individual debtor you must make to the receivables control account too. Writing off bad debts is one use of the journal.

Look at this example:

Total receivables account (control account) Total receivables account (control account) Total receivables account (control account) Total receivables account (control account) Bal b/d 1/1/2013 9,700 Total receipts 102,500Total sales 105,000

Bal c/d 31/12/2013 12,200114,700 114,700

One of the receivables accounts in the receivables ledger is:

Badone Ltd Badone Ltd Badone Ltd Badone Ltd Bal b/d 1/1/2013 1,300Sales 15/1/2013 2,500

Bal c/d 31/12/2013 3,8003,800 3,800

It has been decided that none of the $3,800 due from Badone Ltd will be recovered and that this amount should be written off.



The journal to do this is:

Journal number 1411 Dr CrDr Irrecoverable debts account 3,800 Cr Receivables control account 3,800Being the write-off of irrecoverable debts 3,800 3,800Authorised byAuthorised byAuthorised by

The accounts would then be:

Total receivables account (control account) Total receivables account (control account) Total receivables account (control account) Total receivables account (control account) Bal b/d 1/1/2013 9,700 Total receipts 102,500Total sales 105,000 Irrecoverable debts 3,800

Bal c/d 31/12/2013 8,400114,700 114,700

Bal b/d 31/12/2013 8,400

One of the receivables accounts in the receivables ledger is:

Badone Ltd Badone Ltd Badone Ltd Badone Ltd Bal b/d 1/1/2013 1,300 Written off 3,800Sales 15/1/2013 2,500

3,800 3,800

Irrecoverable debts Irrecoverable debts Irrecoverable debts Irrecoverable debts Total receivables account 3,800 Bal c/d 3,800

3,800 3,800

8. Irrecoverable (bad) debts and sales taxDebts are not usually written off until all reasonable hope of recovery is gone and this usually takes time. Sales tax will probably have been charged on the sales giving rise to the debt, and will have been paid over to the government. Now it is clear that the sales tax will never be collected from the defaulting customer.

Sellers can get relief for the sales tax on debts written off, provided the debt written off was at least six months old.

So, if the $3,800 above contained sales tax at 20%, the sales tax content of that debt would be $3,800/6 = $633.33 and the net amount of the sale would be 3,166.67 (check: 3,166.67 x 20% = $633.33).



Therefore, the cost of the irrecoverable debt is reduced by the sales tax amount as follows:

Irrecoverable debts Irrecoverable debts Irrecoverable debts Irrecoverable debts Total receivables account 3,800.00 Sales tax account 633.33

Bal c/d 3,166.673,800.00 3,800.67

The debit to the sales tax account will reduce what has to be paid to the government in the future, so gives tax relief on the irrecoverable sales tax.

9. Allowances for irrecoverable debts

Once a write-off occurs the debt is, in effect, forgotten about and will not be pursued. However, before that stage is reached it will often begin to look unlikely that the debt will be recovered, but the company does not yet want to give up all hope and does not want to write off the debt. Nevertheless, to value the debt at its full amount would be over-optimistic.

In this case, an allowance can be made to reduce the value of the receivables. The allowance can be calculated using a combination off approaches:

๏ A specific debt is identified as ‘doubtful’. This will be a specific allowance for irrecoverable receivables.

๏ Our experience might show that, say 4%, of debts generally have to be written off, though we do not know now which ones these will be. This might sometime be known as a general allowance for irrecoverable receivables.

Example 1

On 31 December 2013, the total receivables are $125,000.

Of these:

1. An amount of $6,000 is to be written off as it is clearly not recoverable.

2. An amount of £12,000 is thought to be in danger of not being recoverable and a 100% allowance is to be made for that.

3. 4% of remaining receivables are to have an allowance.

What value of receivables will appear on the statement of financial position as at 31 December 2013?



Question 3 At the start of a period a customer owed $12,345 and sales for the year were $11,346. During the year the customer paid $10,463 and was allowed discounts of $228.

It is though wise to make an allowance against irrecoverable debts in respect off this customer of 25%.

How much will the allowance against irrecoverable debts be?

A $228

B $3,307

C $3,364

D $3,250

Question 4 What does an aged receivables analysis show?

A The age of invoices

B The age of payments

C The age of sales

D The age of customers

Question 5 A debt of $34,615 has been written off. Sales tax is 15%.

What is the final cost of the write-off and how much sales tax can be recovered in respect to the write-off?

A Sales tax recoverable = $5,192.25; final cost of the write-off = $34,615

B Sales tax recoverable = $4,515; final cost of the write-off = $34,615

C Sales tax recoverable = $4,515; final cost of the write-off = $30,100

D Sales tax recoverable = $5,192.25; final cost of the write-off = $30,100





Chapter 6MORE ON PURCHASES AND PAYABLES

1. Introduction

This chapter looks in a little more detail at purchase transactions and the payables ledger

2. Recap of the payables ledger system

Entries in the payables ledger arise from two main sources:

๏ The purchase day book (PDB), where new credit purchase invoices are first recorded.

๏ The cash book(CB) where payments to credit customers are first recorded (in the payables ledger column, on the credit side)

Additionally there will be occasional postings made from:

๏ The journal (eg the offset of amounts to an account in the receivables ledger)

The entries made from the purchases day book will be:

๏ Cr Payables control account with the total of the PDB gross amount column

๏ Dr Purchases Account with the total of the PDB net amount column

๏ Dr Sales Tax Account with the total of the PDB sales tax amount column.

In addition, each line in the gross column of the PDB will be used to Credit individual accounts in the Payables Ledger so as to record exactly what is owed to whom.

The entries made from the cash book will be:

๏ Dr Payables control account with the total of the Payables Ledger column

In addition, each line in the Payables column of the Cash Book will be used to Debit individual accounts in the Payables Ledger so as to record exactly to whom payments have been made.

The accounting documents used are:

1. When purchases are made, invoices will be received from suppliers

2. Statements will be received regularly from suppliers, setting out what is still owed and what has been paid.

3. When payments are made Remittance advices should be sent to suppliers to explain which invoices are being settled.



4. Credit control

Suppliers should exercise credit control on their customers. The process starts with a new customer applying for credit and this should initiate some investigation, such as:

๏ Asking for the applicant’s recent financial statements.

๏ Enquiries to a credit reference agency to see if the applicant has any history of poor payments in the past,

Based on these investigations, the applicant will be accepted or rejected. A credit limit should be set for all customers and it is important to ensure that when more goods are being ordered that the credit limit will not be exceeded otherwise delivery is likely to be delayed.

To encourage payment, suppliers often:

๏ Send statements. These often act as a gentle reminder about what’s due.

๏ Offer settlement discounts. For example, pay 5% less if paid within 30 days.

5. Settlement discounts

For example, an invoice is issued by RSQ Ltd for $900 on 5th June 2013 with terms offering a settlement discount of 5% is settled within 30 days. The invoice was paid on 25th July 2013. Therefore, because it was paid on time the amount due will be $900 x 95% = $855.

The discount of $45 is a reduction in the expense of the business buying the goods. The supplier has ‘let off’ the buyer $45 for prompt payment.

The entries in the RSQ’s account would be:

RSJ LtdRSJ LtdRSJ LtdRSJ Ltd25/7/2013 Cash book 855 Purchases day book 5/6/2013 900Settlement discount 45

900 900

The settlement discount is credited to the Discounts Received account in the general ledger. This is an income account.

Occasionally there is a memorandum settlement discount column in the cash book so that, in the case above, $855 would be the amount of cash received and $55 would be entered in the memorandum column. The sum of the memorandum discount column would be credited to the Discounts Received account.

It is important to realise that the receivables control account should always reflect in total whatever happens the individual accounts. So, if a customer is given a settlement discount, this must also be credited to the control account.



For example, consider a company with just three suppliers:

PQR LtdPQR LtdPQR LtdPQR LtdPurchases day book 650

RST LtdRST LtdRST LtdRST LtdPurchases day book 800

UVW LtdUVW LtdUVW LtdUVW LtdPurchases day book 400

Payables control accountPayables control accountPayables control accountPayables control account Balance B/f 1,850

You will see that, the control account balance agrees with the sum of the individual balances in the payables ledger ($1,850 = $650 + $800 + $400)

Each customer offers a settlement discount of 4% if the amounts are paid within 30 days. PQR Ltd and RST Ltd are paid within this time limit; UVW is not and is paid only $120 of what is owed.

A cash book extract would be:

Cash book (Cr side)Cash book (Cr side)Cash book (Cr side)Cash book (Cr side)Cash book (Cr side)Narrative Total Discount Payables

ledgerOther….

PQR Ltd 624 26 624RST Ltd 768 32 768UVW Ltd 120 - 120

1,512 58 1,512

Cr Discounts received account $58Dr Payables control account $58

Dr Payables control account $1,512

Post to individual accounts in the payables

ledger.



For example, consider a company with just three suppliers:

PQR LtdPQR LtdPQR LtdPQR LtdCash 624 Purchases day book 650Discount 26

650 650

RST LtdRST LtdRST LtdRST Ltd Cash 768 Purchases day book 800Discount 32

800 800

UVW LtdUVW LtdUVW LtdUVW LtdCash 120 Purchases day book 400Bal c/d 280

400 400

Payables control accountPayables control accountPayables control accountPayables control account Cash 1,512 B/f 1,850Discounts received 58Bal c/d 280 Bal c/d

1,850 1.850

Note that the sun of the individual balances (now UVW Ltd only) still equals the balance on the control account.

Note that a settlement discount is entirely different to a bulk or trade discount. The bulk or trade discount is to all intents and purposes a straight reduction in the selling price and the only amounts every invoiced or treated as a purchase are after the discount has been removed.

With a settlement discount, the purchases and the invoices are for the full amount (after trade discount) and the discount is contingent upon prompt payment.



Question 1 A supplier’s invoices and details of payments made are as follows:

Invoice date Invoice amount5 June 2013 $2,4008 June 2013 $80015 June 2013 $1,00025 June 2013 $2,000

All the invoices offered a 5% discount for payment at or before 30 days and all were settled by a payment on 10 July 2013.

How much should the payment be for and how much is the discount received?

A Payment = $6,200; discount = $75

B Payment = $6,125; discount = $150

C Payment = $6,105; discount = $95

D Payment = $6,050; discount = $150

Question 2 The normal price of a purchase is $2,800, but a trade discount of 25% has been negotiated

The invoice is dated 20 July 2013 and offers a 3% discount for payment within 30 days. Payment is received by the supplier on 15 August 2013.

What amounts should be posted to the Purchases account and to the Discount Received account in the general ledger?

(Ignore sales tax)

A Credit Sales account $2,800; debit discounts received account $84

B Credit Sales account $2,100; credit discounts received account $63

C Credit Sales account $2,100; debit discounts received account $63

D Credit Sales account $2,037; credit discounts received account $84



6. Making payments to suppliers

Invoices should be paid when due otherwise:

๏ Valuable settlement discounts will be lost

๏ Suppliers might become reluctant to continue to give credit because they fear invoices will not be paid.

Payments due lists can be prepared from the Payables ledger. This is rather like the Aged Receivables Analysis. A senior official will then go through this list and mark which payments to make.

Payments can be made by internet transfer or by cheque, but before payments are made they have to be carefully authorised to prevent incorrect amounts being paid - or defrauded from the company.

Often the person approving the payment will want to see the supplier’s invoice, the goods received note and a copy of the authorised purchase order. Together, these three documents provide a good standard of proof that the supplier should be paid.

All payments should be accompanied by a remittance advice that sets out what is being paid so that the supplier can keep track of the account.

For example, consider this supplier’s account in the books of Azed Ltd:

ABC LtdABC LtdABC LtdABC Ltd Invoice 2125 4/2/2013 1,700

Invoice 2135 3/2/2013 1,000Invoice 2178 6/3/2013 1,500Invoice 2201 5/4/2013 2,300Invoice 2233 13/4/2013 950

Bal c/d 8,070 Invoice 2278 23/4/2013 6208,070 8,070

The supplier, ABC Ltd, is sent a cheque for $3,800, and this is accompanied by a remittance advice as follows:

Azed Ltd65 Low Road

REMITTANCE ADVICEABC Ltd

Date 30/4/2013

Azed Ltd65 Low Road

REMITTANCE ADVICEABC Ltd

Date 30/4/2013Invoices paid: $Invoice 2135 3/2/2013 1,000Invoice 2178 6/3/2013 1,500Invoice 2201 5/4/2013 2,300

TOTAL REMITTANCE Cheque 489013 US$4,800



Chapter 7TRIAL BALANCES AND CORRECTING ERRORS

1. Introduction

This chapter gives a brief revision of extracting trial balances and then investigates the errors that could have occurred in a bookkeeping system.

2. Recording transactions and the trial balance

The double entry system consists of:

๏ The cash book: this records amounts paid into and out of the bank account

๏ The petty cash book: this records small amounts of cash paid for day to day expenses, such as buying postage stamps and teas or coffee for the office.

๏ The general or nominal ledger, which records amounts such as wages, sales, purchases, sales, electricity, travel, advertising, rent, insurance, repairs, receivables, payables and non-current assets.

In addition there were two detailed memoranda ledgers

๏ The payables ledger which details of exactly what is owed to whom are also recorded here. The sum of the amounts owing in this ledger should agree with the payables balance in the general ledger.

๏ The receivables ledger which details of exactly what is owed from whom are also recorded here. There is a separate account for each credit customer. The sum of the amounts owing in this ledger should agree with the receivables balance in the general ledger.



IF double entry had been carried out correctly then the values of all credits should equal the value of all credits made and when balances on each account are worked out, the sum of the debit balances should equal the sum of the credit balances. The document showing this is the trial balance. For example:

Dr CR Type of accountCash 2,900 AssetEquipment 2,000 AssetCapital 10,000 Liability (to owners)Inventory 2,500 AssetSuppliers – – LiabilityCustomers 4,000 AssetSales 4,000 IncomeCost of goods sold 2,500 ExpenseRent 100 ExpenseTotal 14,000 14,000

Example 1

Produce a trial balance for the above accounts by listing each amount as appropriate in the Dr or Cr columns, and label each asset, liability, income or expense:

Balance Dr CRCash (in credit at the bank) 8,175

Petty cash 24Sales 123,758Purchases 84,758Wages 15,893Equipment 38,600Rent 3,340Electricity 254Receivables 10,392Payables 5,678Bank loan 12,000Capital 20,000

Totals

Trial balances should be taken out regularly (at least monthly) to see if something has gone wrong with the maintenance of double entry. It is much easier finding an error in one month’s postings than a whole year’s.

However, trial balances will not detect all errors: they only detect errors where the debit does not equal the credit entry, or where the trial balance has been taken out incorrectly.



Errors not found by trial balance can be categorised as:๏ Errors of commission

Example: an expense of rent was incorrectly debited to the wages account.

Example: the purchases day book had been added up to be $8,900 when the correct total was $9,800. Both purchases and the payables control account would then have $900 (ie $9,800 - £8,900) too little posted to them, but the double entry would have been maintained.

๏ Errors of omission

Example: an invoice from a supplier is not entered into the purchases day book at all, so no entry is made for that transaction.

๏ Compensating errors

Example: rent paid of $210 is debited to the rent account as £120 (error = $90 too little debited) and cash sales of $540 are credited to the sales account as $450 (error = $90 too little credited).

๏ Errors of principle

Example: the expense of rent of £350 was incorrectly posted to a receivables account. This error is worse than the error of commission above because it will affect the profit of the business. Instead of adding to an expense, the value of an asset has increased.

A common cause of errors, rather than a type of error, is a transposition error, such as writing 1234 instead of 1324. A way to try to see if transposition might have been a cause of an error is to see if the error is evenly divisible by 9. For example 1324 – 1234 = 90 which can obviously be divided by nine without a remainder. A transposition error could therefore have been the cause of the error.

Any of the types errors described above will not cause a trial balance not to balance. The errors once found are easy to correct by journal.

Example 2

What would be the correcting journals for the error of commission and the error of principle set out above?Journal number Dr Cr


Journal number Dr Cr




If a trial balance does not balance then:

1. A one sided error must have occurred (Such as Credit cash $120, Debit Purchases $100 and forgetting about the sales tax of $20).

2. The production of the trial balance is incorrect. For example, leaving out an account or listing it on the wrong side of the trial balance.

Non-balancing trial balances often use a suspense account to indicate the amount by which the two sides differ, and as errors are found, the suspense account can be brought back to zero, indicating that the two columns of the trial balance agree.

For example: if the trial balance produced was this:

Dr CRCash 2,700Equipment 1,800Capital 10,000Inventory 2,500Suppliers – 2,700Customers 4,000Sales 4,000Cost of goods sold 2,500Rent 100Wages 2,456

Total 16,056 16,700

Then a suspense account would be introduced to make it balance:

Dr CRCash 2,700Equipment 1,800Capital 10,000Inventory 2,500Suppliers – 2,700Customers 4,000Sales 4,000Cost of goods sold 2,500Rent 100Wages 2,456Suspense account 644Total 16,700 16,700

This suspense account indicates that there was originally more on the credit side than on the debit side so that more debits are needed.



An investigation of the differences then needs to be carried out. Let’s say that the following errors were found:

1. Rent of £400 had been charged to wages.

2. Cash received of £200 had been assumed to be from a customer paying an invoice in the receivables ledger. In fact it was a new sale.

3. Petty cash of $44 has been left out of the trial balance

4. A sales day book total of $820 had been debited to receivables (customers) as $280, though had been correctly posted to the sales account.

5. Discounts allowed to customer of $30 had been credited to the sales account rather then debited to the discounts allowed account.

Now look at each error and decide how to correct it. Also think carefully if it would have caused the trial balance not to balance: if so, the suspense account will be affected.

Example 3

Errors 1 and 2 would not cause the trial balance to be out of balance. They are errors of commission and principle.

Adjust the trial balance to correct these errors:AdjustmentAdjustment

Dr CR Dr CR Dr CRCash 2,700Equipment 1,800Capital 10,000Inventory 2,500Suppliers – 2,700Customers 4,000Sales 4,000Cost of goods sold 2,500Rent 100Wages 2,456Suspense account 644Total 16,700 16,700



The trial balance with the adjustments so far will be as follows:

AdjustmentAdjustmentDr CR Dr CR Dr CR

Cash 2,700Equipment 1,800Capital 10,000Inventory 2,500Suppliers – 2,700Customers 4,000 200Sales 4,000 200Cost of goods sold 2,500Rent 100 400Wages 2,456 400Suspense account 644Total 16,700 16,700 600 600

The remaining errors are all of a one-sided nature, and as they are corrected, the suspense account can be updated. [Note the suspense account is not a real ‘T’ account; it is just a way of tracking the errors].

It is easy to make the wrong adjustments in the suspense account. The key is to think:

1. How are the accounts or trial balance to be corrected? What side is to be adjusted and by how much?

2. Having worked that out, the suspense account entry is always on the other side.

Continuing with the example;

Error 3

$44 has been left out of the trial balance. $44 needs to be introduced on the debit side of the trial balance so the suspense account will be credited $44.

Error 4

Receivables were debited by $280 when they should have been debited by $820. The size of the error is therefore $540 and this needs to be an extra debit to receivables. Therefore, credit the suspense account by $540.

Error 5

$30 had been credited to sales rather than debited to discounts allowed. The size of the error is $30 x 2 = $60. $30 has to be debited (ie come out of) to the sales account and $30 debited into the discount account.



The memorandum suspense account ‘T’ account would therefore be:

Suspense accountSuspense accountSuspense accountSuspense accountBalance b/f 644 Error 3 $44 petty cash put into the trial balance 44

Error 4 Extra $540 into receivables (customers) 540Error 5 $30 out of sales and into discounts 60

644 644

The trial balance would be:


Cash 2,700 2,700Petty cash 44 44Equipment 1,800 1,800Capital 10,000 10,000Inventory 2,500 2,500Suppliers – 2,700 – 2,700

Customers 4,000200540 4,740

Sales 4,000 30 200 4,170Discounts allowed 30 30Cost of goods sold 2,500 2,500Rent 100 400 500Wages 2,456 400 2,056Suspense account 644 644Total 16,900 16,900 1,244 1,244 16,870 16,870

Question 1 Which of the following errors would cause a trial balance not to balance?

1. Debiting the purchase of a car to the Purchases account instead of the Motor Vehicles account.

2. Debiting cash received to the cash book and crediting payables instead of Receivables

3. Listing discounts allowed to customers as a credit balance

4. Listing petty cash as a debit balance.

A 1, 2, 3 and 4

B 2, 3 and 4 only

C 3 only

D 3 and 4 only



Question 2 A debit balance in the general ledger of £1123 was listed in the trial balance as $2123 credit.

By how much does this cause the trial balance not to balance?

A 3,246

B 1,000

C 3,266

D 1,633

Question 3 The trial balance of Mazar Ltd does not balance and a suspense account has been created. Cash paid to a credit card account of $5,641 has been posted to the credit card account as $5,146.

Which of the following entries is the correct adjustment?

A Dr Credit card company 990 Cr Suspense account 990

B Dr Credit card company 495 Cr Suspense account 495

C Dr Suspense account 495 Cr Credit card account 495

D Dr Suspense account 990 Cr Credit card account 990

Question 4 A trial balance does not balance. One of the errors discovered was made in writing off a bad debt of $500. The receivables ledger entry handled correctly, but the Irrecoverable Debts Account was credited with $500.

The correcting entry would be to;

A Dr Irrecoverable Debts 500 Cr Suspense Account 500

B Dr Irrecoverable Debts 1,000 Cr Suspense Account 1,000

C Dr Suspense Account 1,000 Cr Irrecoverable Debts 1,000

D Dr Suspense Account 500 Cr Irrecoverable Debts 500

Question 5 A company made sales of $2,950 inclusive of sales tax at 18%.

The company debited the Receivables account $2,950, credited sales $2,950 and credited the Sales Tax account $531.

What corrections are required?

A Dr Receivables account $450; Cr Suspense account $450

B Dr Sales $531; Cr Suspense account $531

C Cr Sales $531; Cr Sales tax $450; Cr Suspense account $81

D Dr Sales $450; Dr Sales tax $81; Cr Suspense account $531



Question 6 A sales order from a customer slips down the back of a desk before goods are despatched or invoiced.

Which of the following errors in the accounting system has been committed?

A An error of omission

B An error of commission

C An error of principle

D None of the above

Question 7 A company was owed $4,300 by a customer and there was to be a 5% settlement discount if the amount was paid within 30 days.

The amount net of the discount was received after 25 days and this was debited to the cash book. $4,300 was credited to the memorandum receivables account and to the receivables control account to indicate that the debt had been fully settled in accordance with the terms offered.

When a trial balance is extracted, what will be the suspense account that is needed initially?

A $4,085 Dr

B $4,085 Cr

C $215 Cr

D $215 Dr

Question 8 An amount of $1,239 paid to a supplier to settle an invoice was treated as a new purchase.

What adjustment is needed to correct this error?

A Dr Supplier $1,239 Cr Suspense account $1,239

B Dr Supplier $1,239 Cr Purchases $1,239

C Cr Suspense account $1,239 Dr Supplier $1,239

D Dr Purchases $1,239 Cr Supplier $1,239



Question 9 A company was owed $500 by ABC Ltd and owed $600 to ABC Ltd. It was decided to offset these amounts to the fullest extent so as to leave a net balance of $100. The company debited Receivables $500 and credited Payables $500.

Which of the following statements is true?

A These are the correct entries to carry out the offset.

B This will cause the trial balance not to balance by $100

C These are not the correct entries, but the trial balance will still balance.

D This will cause the trial balance not to balance by $500

Question 10 Petty cash amounting to $56 was listed on the wrong side of the trial balance.

What adjustment is needed to correct this error?

A Dr Trial balance petty cash line $56; Cr suspense account $56

B Cr Trial balance petty cash line $56 Dr suspense account $56

C Dr Trial balance petty cash line $112; Cr suspense account $112

D Cr Trial balance petty cash line $112; Dr suspense account $112



Chapter 8LABOUR COSTS AND REMUNERATION METHODS

1. Introduction

This chapter looks at how remuneration is calculated and accounted for.

2. Remuneration methods and systems

Large organisations will have a wages and salaries department which is responsible for calculating amounts owing, dealing with employees who leave and with new joiners. Sometimes the payments to each employee are the same every week or month; sometimes they depend on time records (such as clock cards), production records, or some other type of calculation. In all cases employees will receive a wage or salary slip showing their pay and any deductions for tax etc.

The amounts to be paid will usually be passed to the accounting department which will look after the cash transfers to employees, the tax authorities and any other recipient, such as pension funds.

Employees can be paid by:๏ Cash

๏ Cheque

๏ Credit transfer to their bank account

Cash payments are becoming much less common. They were labour intensive as envelopes had to be filled with the correct cash for each employee. There were also considerable security issues as the cash needed for a large workforce was very significant and an attractive target for robbery.

Additionally, as wages were being handed out, care was needed to ensure that the right people received the cash and that they evidenced, by signing a register, that their wages had been received.



3. Labour costs

Labour costs can arise from:

๏ Basic wage or salary

๏ Overtime premiums

๏ Bonuses

๏ Commission (for example so much per sale made)

๏ Holiday pay

๏ Sick Pay

๏ Payroll taxes

Many countries pay wages and salaries under a ‘pay as you earn scheme’ which means that the employer deducts the employees’ income tax from the gross wage and pays that over directly to the tax authority. Only the net amount after tax is then paid to the employee.

Employee remuneration can be based on the following approaches:

1. A constant weekly or monthly amount

This is easy to calculate:

Labour cost = remuneration per period x number of periods

2. An amount based on hours worked (basic plus overtime)

Illustration52 hours are worked in a week. Basic week is 40 hours, the basic rate of pay = $10, and overtime is paid at time and one half.

Basic pay: hours worked @ basic rate 52 x $10 520Overtime premium : (52 – 40) x $10 x 50% 60

Total pay US$580

3. An amount based on units produced: piecework

Often there is a guaranteed minimum amount of pay so as to comply with minimum wage rate legislation.

IllustrationMinimum pay/week = $250Piece rate = $3/unit

If 100 units are made in a week then the pay will be $3 x 100 = $300

If 80 units are made in a week then the pay will by $250 (because the piece rate amount would be only $240



4. An amount based on productivity

There are many different types of bonus scheme and any question would have to set out the precise rules.

IllustrationBasic pay = $9/hour for a 40 hour week. Normal production in that time = 120 unitsBonus = 50% of the time saved on production paid at time and a third

What will be the total wage in a week in which 150 units are made in 40 hours?

Answer:

$

Basic pay = 40 x $9 360

150 units should take 50 hours

150 units did take 40 hours

Hours saved 10 hours

Bonus = 50% x 10 x 9 x 1 ⅓ 60

Total pay 420

5. An initial amount plus a bonus

Here, for example, the bonus could be part of a profit share. Full instructions would have to be supplied as to how to calculate the amounts.

Example 1

Employees are paid $7/hour for a standard 40 hour week. Overtime is paid at time and one half.

The employee is expected to make at least 120 units in a week, and to encourage productivity, each unit in excess of 120 will generate an additional payment of $5 less any overtime premium that would relate to the time the additional unit would normally take.

What is an employee’s wages in a week in which 135 units are made and the employee works 44 hours?



6. Gross and net earnings

Gross pay: the total amount earned by the employee

Net pay: the amount paid to the employee after the employer makes deductions for income tax and certain statutory amounts.

Total labour cost to employer: employees’ gross pay plus any additional payroll taxes and pension contributions that the employer has to bear.

Example 2

An employee is paid at the rate of $10/hour.

Tax and other deductions amount to 25% for weekly income in excess of $120

Employer payroll taxes = 10% gross wages

If an employee works 46 hours in a week, what are the employee’s gross pay, net pay and the total amounts that have to be paid by the employer to the tax authorities?

7. Accounting for labour costsLabour costs can be accounted for using a Salaries and Wages Control account

Dr CrStep 1Step 1Step 1Step 1Step 1

Dr Wages and Salaries account with gross wagesWages and Salaries account with gross wages XCr Wages Control account with gross wages X

Step 2Step 2Step 2Step 2Step 2Dr Wages and Salaries account with additional employer’s costsWages and Salaries account with additional employer’s costs X

Cr Wages Control account with additional employer’s costs X

Step 3 (payment of net wages to employee)Step 3 (payment of net wages to employee)Step 3 (payment of net wages to employee)Step 3 (payment of net wages to employee)Step 3 (payment of net wages to employee)Dr Wages Control account with net wagesWages Control account with net wages X

Cr Cash with net wages X

Step 4 (payment of deductions to government)Step 4 (payment of deductions to government)Step 4 (payment of deductions to government)Step 4 (payment of deductions to government)Step 4 (payment of deductions to government)Dr Wages Control account with employee deductionsWages Control account with employee deductions X

Cr Cash with employee deductions X

Step 5 (payment of other amounts to government etc)Step 5 (payment of other amounts to government etc)Step 5 (payment of other amounts to government etc)Step 5 (payment of other amounts to government etc)Step 5 (payment of other amounts to government etc)Dr Wages Control account with other amounts dueWages Control account with other amounts due X

Cr Cash with other amounts due X



Example 3

Show the following transactions in Wages Control account and the Wages and Salaries account1. 31 March, gross wages calculated as $45,000; deductions for employees’ taxes = $8,000;

deductions for employee pensions = £3,000.

2. 31 March, employer’s payroll tax calculated as $4,000

3. 31 March, employer’s pension contributions = $5,000

4. 1 April, employees paid amounts due

5. 15 April, tax authorities paid amounts due.

6. 20 April, pensions fund paid amounts due

Question 1 A company has the following components in its wages calculations:

Gross wages calculated as $76,000

Deductions for employees’ taxes = $20,000

Deductions for employee pensions = £12,000.

Employer’s payroll tax calculated as $15,000

Employer’s pension contributions = $16,000

Which of the following is correct?

A Employees are paid $72,000 net; total employment cost to employer = $91,000

B Employees are paid $76,000 net; total employment cost to employer = $107,000

C Employees are paid $44,000 net; total employment cost to employer = $107,000

D Employees are paid $60,000 net; total employment cost to employer = $77,000

Question 2 Under most systems of tax, what do employers pay to employees?

A Gross wages

B Gross wages less employees’ deductions less employers’ payroll tax

C Gross wages less employees’ deductions

D Gross wages less employers’ payroll tax





ANSWERS TO EXAMPLES

Chapter 1Example 1

Statement of financial position: shows assets and liabilities

Income statement: shows income and expenses

Example 2

Any three of:

๏ Concise

๏ Precise

๏ Enables automatic processing

๏ Enables checking

Chapter 2Example 1

Dr CRCash 2,900Equipment 2,000Capital 10,000Inventory 2,500Suppliers – –Customers 4,000Sales 4,000Cost of goods sold 2,500Rent 100Total 14,000 14,000

Example 2

SalesSalesSalesSales21/6/2103 Returns 550 1/6/2013 Cash 25025/6/2013 Returns 32 3/6/2013 Credit sales 1,395Balance carried down 1,112 29/6/2013 Cash 49

1,694 1,694

Balance brought down 1,112



Example 3

CashCashCashCash1 Capital 6,000 2 Inventory 1,0004 Sales 1,900 6 Rent 1,0009 LD Vinci 850 7 Electricity 250

8 VV Gogh 75010 Drawings 50012 Cash 750Balance c/d 4,500

8,750 8,750Balance b/d 4,500

CapitalCapitalCapitalCapitalBalance c/d 6,000 1 Cash 6,000

6,000 6,000Balance b/d 6,000

InventoryInventoryInventoryInventory2 Cash 1,000 4 Cost of goods sold 1,0003 V V Gogh 1,500 5 Cost of goods sold 500

Balance c/d 1,0002,500 2,500

Balance b/d 1,000

SalesSalesSalesSales4 Cash 1,900

Balance c/d 2,750 5 L D Vinci 8502,750 2,750

Balance c/d 2,750

Cost of goods soldCost of goods soldCost of goods soldCost of goods sold4 Inventory 1,0005 Inventory 500 Balance c/d 1,500

1,500 1,500Balance b/d 1,500

V V GoghV V GoghV V GoghV V Gogh8 Cash 750 3 Inventory 1,500Balance c/d 750

1,500 1,500Balance c/d 750



L D VinciL D VinciL D VinciL D Vinci5 Sales 850 9 Cash 850

850 850

ElectricityElectricityElectricityElectricity7 Cash 250 Balance c/d 250

250 250Balance b/d 250

RentRentRentRent6 Rent 1,000 Balance c/d 1,000

1,000 1,000Balance b/d 1,000

RepairsRepairsRepairsRepairs11 Repair company 300 Balance c/d 300


Repair companyRepair companyRepair companyRepair companyBalance c/d 300 11 Repairs 300


ComputerComputerComputerComputer12 Computer 750 Balance c/d 750


DrawingsDrawingsDrawingsDrawings10 Cash 500 Balance c/d 500




Trial balance

Account Dr CrCash 4,500 AssetCapital 6,000 LiabilityInventory 1,000 AssetSales 2,750 IncomeCost of goods sold 1,500 ExpenseV V Gogh 750 LiabilityL D Vinci – –Electricity 250 ExpenseRent 1,000 ExpenseRepairs 300 ExpenseRepair company 300 LiabilityComputer 750 AssetDrawings 500 Reduction in a liability

9,800 9,800

Chapter 3Example 1

Journal number Dr CrDr Repairs 350 Cr Machinery cost account 350Being the correction of the treatment of a repair invoice as an addition to machinery

350 350

Authorised by

Example 2

Journal number Dr CrDr Sales 1789 Cr XYZ Ltd 1789Being the correction of an amount treated as a new sale but which was the settlement off a debt.

1789 1789

Authorised by



Chapter 4Example 1


(Payments)Balance b/d 31 July 2013Balance b/d 31 July 2013 200

4 Receipt not recorded4 Receipt not recorded 40 3 Undercast correction 70

5 Bank charges not recorded 31

6 Bounced cheque 50

Balance c/d 31 July 2013 89

240 240

Balance b/d 1 August 2013Balance b/d 1 August 2013 89

Bank statementBank statementOpening balance 339Less: 1 cheques in cash book not yet on bank statement (500)Add: 2 amount paid in but not yet on bank statement 250Up-to-date balance 89

Chapter 5Example 1

$Initial amount of receivables 125,000Written off (6,000)

119,000Allowances – specific 12,000 – general 4% x (119,000 – 12,000) 4,280

(16,280)

102,720

Chapter 6No examples



Chapter 7Example 1

Balance Dr CRCash (in credit at the bank)) 8,175 8,175 Asset

Petty cash 24 24 AssetSales 123,758 123,758 IncomePurchases 84,758 84,758 ExpenseWages 15,893 15,893 ExpenseEquipment 38,600 38,600 AssetRent 3,340 3,340 ExpenseElectricity 254 254 ExpenseReceivables 10,392 10,392 AssetPayables 5,678 5,678 LiabilityBank loan 12,000 12,000 LiabilityCapital 20,000 20,000 Liability to owners

161,436 161,436

Example 2

Journal number 1411 Dr CrDr Purchases 900 Cr Payables control account 900Being the correction of undercast purchases day bookAuthorised byAuthorised byAuthorised by

Journal number 1411 Dr CrDr Rent 350 Cr Receivables control account 350Being the correction of a rental paymentAuthorised byAuthorised byAuthorised by



Example 3


Cash 2,700 2,700Equipment 1,800 1,800Capital 10,000 10,000Inventory 2,500 2,500Suppliers – 2,700 – 2,700Customers 4,000 200 4,200Sales 4,000 200 4,200Cost of goods sold 2,500 2,500Rent 100 400 500Wages 2,456 400 2,056Suspense account 644 644Total 16,700 16,700 16,900 16,900

Chapter 8Example 1

Note: each unit is expected to take 40 x 60/120 = 20 minutes

$Basic wages for 44 hours = 44 x $7 = 308.00Overtime premium 4 x $7 x ½ = 14.00Extra units 15 x $5 75.00Overtime premium that could be associated with the extra units15 x 1/3 x $7 x 1/2 -17.50

379.50

Example 2

Gross wages 46 x $10 = $460Tax and other deductions 25% x (460 – 120) = (85)Net pay $375

Payroll taxes $460 x 10% $46

Total payments by employer to tax authorities = $85 + $46 = $131



Example 3

Wages Control AccountWages Control AccountWages Control AccountWages Control Account31/3 Wages and salaries account [gross wages] 45,00031/3 Wages and salaries account [employer’s payroll tax] 4,000

1/4 Cash (paid to employees) [45,000 – 8,000 – 4,000] 34,000

31/3 Wages and salaries account [employer’s pension contribution] 5,000

15/4 Cash (paid to tax authorities) [8,000 + 4,000] 12,00020/4 Cash (paid to pension fund) [3,000 + 5,000] 8.000

54,000 54,000

Wages and Salaries AccountWages and Salaries AccountWages and Salaries AccountWages and Salaries Account31/3 Wages and salaries account [gross wages] 45,00031/3 Wages and salaries account [employer’s payroll tax] 4,00031/3 Wages and salaries account [employer’s pension contribution] 5,000 31/3 Balance c/d 45,000

45,000 45,000

The brought down balance at the end of March is carried forward and April’s amounts will be added to that, and so on, to accumulate the wages cost for the year.



ANSWERS TO TESTS

Chapter 1Question 1C

Question 2B

Question 3C

Question 4C This is an item of income so would be on the income statements.

Question 5B

Question 6B 690 x 100/115 = 600; 690 x 15/115 = 90

Question 7D 3000 x 80% x 1.16 = 2784; 3000 x 80% x 16% = 384

Question 8D Output tax = $4,600; input tax = $1,000 ie 6,000 x 20/120. So, $3,600 has to be paid

Question 9B Remember: garbage in, garbage out

Question 10C

Chapter 2Question 1

B The asset of cash decreases; the expense of wages increases

Question 2

C The asset of cars increases as does the liability to the garage.



Question 3

D Cash decreases as does the liability to the supplier

Question 4 B Increase in net assets = 19,000 – 15,000 = 4,000.

Had there been no drawings nor capital introduced this would be the profit. However, net assets have increased by $4,000 despite drawings of $750, so profit must have been $4,750.

Or:

Increase in net assets = Capital introduced + Profit – Drawings

4,000 Nil P - 750

So, P = 4,000 + 750 = 4,750

Question 5

A Increase in net assets = Capital introduced + Profit – Drawings

4,000 1,000 + P – 400

So, P = 4,000 + 400 – 1000 = 3,400

Question 6

B Increase in net assets = Capital introduced + Profit – Drawings

–2,000 C – 7,000 – 1,000

So, C = 7,000 + 1,000 - 2,000 = 6,000

$7,000 loss and $1000 drawings have flowed out of the business. This would have reduced the net assets by $8,000, but they fell by only $2,000. Therefore $6,000 must have been injected as new capital.

Question 7

D

Net assets 1 January 31 January$ $

Cash 10,000 12,000Owed from customers 2,000 1,000Equipment 6,000 10,000Assets 18,000 23,000Owed to suppliers (3,000) (4,000)Bank loan (2,000) (5,000)Net assets 13,000 14,000

Increase in net assets = $1,000 and the owner withdrew $800, so profits must have been $1,800.



Chapter 3Question 1D Remember, total debits must equal total credits in the double entry system.

Question 2C Remember, total debits must equal total credits in the double entry system

Question 3C The control account is not affected by errors in extracting and adding up the list of balances

from the payables ledger. Had the $100 been treated correctly it would have been like a negative figure; it was treated as positive so the error is $200.

Question 4A Totals are posted to control accounts and an extra $2,000 has to be posted to correct it. The list

of balances does not depend on total postings from the day book

Question 5C Totals in the sales day book are posted to the receivables control account and the sales account,

not to the individual accounts in the receivables ledger.

Question 6A The error is in the initial recording of the invoice so everything flowing from that will be wrong.

Chapter 4Question 1D

Question 2B The double entry is CR Cash (already in the cash book) DR Payables (in total and the individual

accounts).



Question 3D


(Payments)

Balance b/d 31 July 2013Balance b/d 31 July 2013 5,700

Receipt not recordedReceipt not recorded 403

Bank charges not recorded 70

Balance c/d 31 July 2013 6,033

6,103 6,103

6,033

Bank statementBank statementOpening balance ?Less: amount paid in but not yet on bank statement 1,367Add: cheques in cash book not yet on bank statement (3,880)Up-to-date balance 6,033

X must be 6033 + 3880 – 1,367 = 8,546

Question 4C


(Payments)

Balance b/d 1,145

Receipt not recordedReceipt not recorded

Bank charges not recorded 75

Balance c/d Balance c/d 1,220

1,220 1,220

Balance b/d 1 August 2013 1,220

Bank statementBank statementOpening balance o/d (750)Less: amount paid in but not yet on bank statement 330Add: cheques in cash book not yet on bank statement -800Up-to-date balance (1220)

X must be 6033 + 3880 – 1,367 = 8,546

Question 5B $100 too much will have been credited to the receivables control account from the cash book

column total.

Question 6B Net expenditure = 45 – 5 = $40, so that will be the amount of reimbursement needed.



Chapter 5Question 1B Discounts of 2.5% are available on the debts of $500 and $1,000: $1,500 x 2.5% = $37.50.

The total payment should therefore be: $3,100 - $37.50 = $3,062.50

Question 2C Sales = 800 x 80% = $640; settlement discount = 5% x 640 = $32.

The settlement discount is debited to the discounts allowed account.

Question 3D Amount owing at period end before discount = $12,345 +11,346 – 10,463 – 228 = $13,000. 25%

of $13,000 = $3,250

Question 4A Note that C is wrong. The age of debts begins running from the date of the invoice

Question 5C Sales tax content = $34,615 x 15/115 = 4,515. The net amount of the sale = $30,100

Chapter 6Question 1D Discounts of 5% are available on the debts of $1,000 and $2,000: $3,000 x 5% = $150. The total

payment should therefore be: $6,200 - $150 = $6,050

Question 2C Sales = 2,800 x 75% = $2,100; settlement discount = 3% x 2,100 = $63.

The settlement discount is credited to the discounts received account.

Chapter 7Question 1C In 1 and 2 the double entry is arithmetically complete, though wrong in principle. In 4, petty

cash should be, and is, listed as a debit.

Question 2A 1123 is missing from the debit side and 2123 has been arbitrarily introduced to the credit side.

The error is therefore 1123 + 2123 = 3246

Question 3B There had been too few debits made by $5,641 - $5,146 = $495. The adjustment is to debit the

credit card company with $495 more and to credit the suspense account with $495.

Question 4B $500 was not just left out, it was posted to the wrong side making the Irrecoverable Debts

account $1,000 too little.



Question 5D Entries should have been:

Dr Receivables 2950 Cr Sales 2500 Cr Sales tax 450

Entries were:

Dr Receivables 2950 Cr Sales 2950 Cr Sales tax 531

Differences: Over 450 Over 81

Question 6D This is not an error in the accounting system. No goods have been despatched and no

transactions have been updated and the accounting records are correct

An error of omission would have occurred if the goods had been despatched and invoice for them had not been recorded anywhere

Question 7D At present the Dr to cash is $4,300 x 95% = $4,085 and the credit to the customer is $4,300.

There is a difference of $215 which is $215 too much to credits. The Suspense account will be $215 Debit to make the trial balance balance.

Question 8B

Question 9C The double entry was complete, but the wrong way round

Question 10C Petty cash should be a debit entry, but was placed on the wrong side of the trial balance: 2 x 56

= 112

Chapter 8Question 1C Employees are paid 76,000 - 20,000 - 12,000 = 44,000. Total employment cost to employer =

76,000 + 15,000 + 16,000 = 107,000

Question 2C Employer’s payroll taxes are not a deduction from employees’ wages.
