Module 4: Introduction to Bookkeeping and Accountingemsstudents.weebly.com/.../introduction_to_bookkeeping_and_accou… · Module 4: Introduction to Bookkeeping and Accounting 12

Module 4: Introduction to Bookkeeping and Accounting

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1. An Introduction to Bookkeeping and Accounting

For a business to be successful they have to monitor their financial records. Financial

information must be:

Transparent – without bias

Valid – without lies

Consistent – the same from one financial period to another

Comparable – it must be useable across industries

Reliable – free from errors

The bookkeeping and accounting cycle

The bookkeeping cycle is a monthly cycle that ends with a trial balance. The

accounting cycle includes the bookkeeping cycle but ends with the annual financial

statements. The accounting cycle is therefore a yearly cycle.


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The Accounting Equation

In the last step above you noticed the abbreviation A = O + L

These is called the accounting equation and is re-shuffled to read as follows:

OWNER’S EQUITY = ASSETS – LIAIBILITIES

This is the framework of accounting!!!

As you can see there are 3 elements that make up the accounting equation, namely,

assets, liabilities and owners equity. These will now be explained in detail:

Assets

Assets refer to all cash on hand as well as items that can be sold for cash in the

future, provided these items are not used up in the business within one year.

Assets are all the cash and potential cash that come into the business.

Activity 1

I. From the list below identify the items that will be regarded as assets and

why:

Office equipment

Advertising costs

Traffic Fines

A favourable bank balance

Stock

Vehicles

Office consumables

II. Briefy explain the accounting cycle.

Please note that office consumables will be used up in a relatively short period of

time and therefore should be considered an operating expense.

Assets are further classified into FIXED or CURRENT assets:

Fixed Assets – These are assets that are not expected to be turned into cash within a

year eg. Land, buildings, vehicles and machinery.

Current Assets – These assets are cash or likely to be turned into cash in a year eg.

Stock, debtors (money owed to the business by customers), bank, petty cash.


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Liabilities

Liabilities are debts. They represent what the business owes and must be paid back in

the future.

Liabilities include bank loans, creditors and bonds.

Like assets , liabilities are divided into 2 categories:

Long Term Liabilities – These are long term debts. It is expected that the business

will not pay any of theses back within a year eg. Bank loans and bonds

Current Liabilities – These are short term debts, It is expected that theses debts will

be paid back in less than a year eg. Creditors, short term loan, bank overdraft.

Owner’s Equity

Owner’s equity is the net wealth of the owner in his/her business after subtracting

the total liabilities and total assets.

Activity 2

P 15 JB


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Learning Example

P 18 JB

When only assets and liabilities are involved in a transaction, there will be no effect

on the owner’s equity. If a business buys an asset, takes out a loan or pays off a loan

it does not affect the owners wealth


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Activity 3

Proprietary Accounts

Proprietary accounts are often referred to as the accounts of the owners. These

accounts are used when recording capital contributions to and withdrawals from the

business by the owner. In a Sole Ownership, the capital account is used for

contributions by the owner, while the drawings accounts is used for the owners

withdrawals from the business.

The reason for starting up a business is to make money. Making money means

increasing the owners equity. The only way by which owners equity can be increased,

is by earning income and ensuring that the total income exceeds the total expenses.

Examples of income accounts:

Sales

Services rendered

Rent income

Examples of expense accounts are:


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Cost of sales

Rent expenses

Telephone

Advertising

Repairs and maintenance

Stationery

Packing material

Learning example


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Activity 4

Complete the following table by marking the correct box with a X.

Name of account

Fixed Asset

Current asset

Long Term Liability

Current liability

Income Expenses Owner’s Equity

Equipment Wages Stock Capital Bond Creditors Control

Rent income

Rent expense

Cost of sales

Drawings Land and Buildings

Stationery Advertising Machinery


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Activity 5


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Spreadsheets

Networth is the wealth of a person reflected by his assets less his liabilities.

Assets = Liabilities + Net worth

Which can be juggled around to:

Assets – Liabilities = Net worth

A persons net worth and the composition of assets and liabilities can change on a

daily basis. In order to keep track of these changes, in order to keep track of these

transactions it is possible to use a spreadsheet based on the accounting equation.

You will notice that there is always a double sided effect to these transactions. For

example if you buy a movie ticket for R50, your assets (cash on hand) will decrease

and your net worth will decrease.

Learning Example:

We will use the second version of this equation (ie A = L + NW)

On the 1 Feb 2001 Mark Mikhize has R60 cash on hand, R500 in a bank account and

clothes worth R1000. These are his only assets. He has no liabilities. His net worth is

therefore R1560. The following transactions occurred over the next 2 weeks:

Feb 2 Mark went to movies and paid R30 for cash and popcorn

Feb 3 Mark borrowed R600 from his father and deposited it into his bank account.

Feb 5 Mark bought new clothes for R220. He used the money in his bank account.

Feb 7 Mark earned R80 cash by working at the local video shop.

Feb 8 Mark gave his sister a birthday present of R20 cash.

Feb 10 Mark bought a mini hi fi on credit from hi fi suppliers for R450. He has 3

months to pay.

Feb 11 Mark earned R120from working at the video shop. He banked this amount.

Feb 12 Repaid his father R100 and paid him R15 interest.

Feb 13 Mark donated clothes worth R40 to the SPCA for fundraising.

Feb 14 Mark paid Hi Fi Suppliers R150 of the amount that he owed.

Use a spreadsheet to record these transactions and show the change to Assets,

Liaibilities and Net Worth.


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Practice Exercise

New Era Gr 8 task 8.13 and 8.14


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The rules of double entry

So far we have focused on thinking behind accounting. We have seen that every

transaction can be analysed under the accounting equation and with each transaction

the equation can be balanced.

Now we will look at the infamous rule of double entry:

In a business we have to know :

1. What the money was spent on ?

2. How the business was funded?

In other words each financial transaction has a double sided effect. Consequently the

Accounting Equation will be in balance. If the left hand side of the equation changes

so will the left hand side.

JB p25


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Documents

Module 4: Introduction to Bookkeeping and Accountingemsstudents.weebly.com/.../introduction_to_bookkeeping_and_accou… · Module 4: Introduction to Bookkeeping and Accounting 12