Introduction to Accounting Note (1)

DISTANCE LEARNING CENTRE
AHMADU BELLO UNIVERSITY

ZARIA, NIGERIA
COURSE MATERIAL
FOR
BSc. ECONOMICS
ACCT 101: INTRODUCTION TO ACCOUNTING
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COPYRIGHT PAGE
© 2018 Distance Learning Centre, ABU Zaria, Nigeria
All rights reserved. No part of this publication may be reproduced in any form or by any means;
electronic, mechanical, photocopying, recording or otherwise without the prior permission of the
Director, Distance Learning Centre, Ahmadu Bello University, Zaria, Nigeria.
First published 2018 in Nigeria.
ISBN:
Published and printed in Nigeria by:
Ahmadu Bello University Press Ltd,
Ahmadu Bello University,
Zaria, Nigeria.
Tel: +234
E-mail:
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COURSE WRITERS/DEVELOPMENT TEAM
Sandra Ekpot (Subject Matter Expert)
HabibuSabari (Subject Matter Reviewers)
Auwal Nasiru (Language Reviewer)
FatimaAdnan Graphics/Instructional Designers
Ibrahim Otukoya
Prof. Adamu Z. Hassan (Editor)
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QUOTES
Open and Distance Learning has the exceptional ability of meeting the challenges of the three
vectors of dilemma in education delivery – Access, Quality and Cost.
– Sir John Daniels
Money is a tool. Used properly, it makes something beautiful– used wrongly, it makes a mess.
– Bradley Vinson
Money is like manure. If you spread it around, it does a lot of good, but if you pile it up in one
place, it stinks like hell.
– Clint W. Murchison
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CONTENTS
Title Page………………………………………………………………………………………..1
Copyright………………………………………………………………………………………..2
Course Writers/Development Team…………………………………………………………...3
Quotes…………………………………………………………………………………………....4
Table of Content………………………………………………………………………………...5
i. Course Information…………………………………………………………..……………....6
ii. CourseIntroduction and Description…………………………………………..…………...6
iii. Course Prerequisites………………………………………………………..….………...…..7
iv. Course Learning Resources..………………………………………………….………....….7
v. Course Objectives and Outcomes…………………………………………………...………..7
vi. Activities to Meet Course Objectives…………………………………………….….…...….7
vii. Time (To Complete Syllabus/Course)…………….……………………………….………..8
viii. Grading Criteria and Scale…………………………………………………………………9
ix OER Resources………………………………………………………………………
x. ABU DLC Academic Calendar…………………………………………………………..
xi. Course Structure and Outline…….…………………………………..…………………...10
STUDY MODULES…..………………………………………………………………………..16
1.0 Module 1……….……………………………………………………………………………16
Study Session 1: Accounting Concepts………………………………………………………….16
Study Session 2: The Accounting Equation and its Component…………………...……………40
Study Session 3: Basic Documentation……………………………………………...…………..54
Study Session 4: Prime Books, General Ledgers and the Journal…………………...…………..65
2.0 Module 2………..……………………………...…………………………………………....92

Study Session:1 Double Entry and the General Ledger………………………………………….92
Study Session 2: The Balancing of Accounts and the Trial Balance…………………..……….114
Study Session 3: The Cash Book……………………………………………...………………..145
Study Session 4: The Petty Cash Book……………………………………….......…………….154
3.0 Module 3……………..…………………………………………………….……………....165

Study Session 1 Depreciation and Non-Current Assets………………………………………..165
Study Session 2 Bad Debts and Provisions for Bad Debts……………………………………..201
Study Session 3 Financial Ratios……………………………………………………………….216
Study Session 4 Cash Flow Statements……………………………………………...…………236
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i. COURSE INFORMATION
Course Code: ACCT 101 103
Course Title: Introduction to Accounting.
Credit Units: 3 Credit Units.
Year: One
Semester:First
ii. COURSE INTRODUCTION AND DESCRIPTION

Introduction
Welcome to ACCT 101, this is a year one first semester course, I will be your
guide all through the period of this semester.
This course will introduce you to the principles of Accounting and the
methodology of the Accounting process. You will learn to analyse business
transactions, capture the relevant details of these transactions into accounting
records, process them, and produce financial reports containing useful information
that can be used by a variety of decision makers for making informed judgments.
This document is expected to guide you throughout the course.
Description
Accounting deals with real-life transactions which, in the context of organizations,
could be quite voluminous and heterogeneous. The task of capturing each
transaction as it happens and keeping a classified record of the details of each
transaction so as to be able to ultimately measure the net effect of transactions, and
the health and wealth of the organization, is the function of Accounting.
You are expected to learn to identify financial transactions, classify and record
these transactions, and process the data thus generated to produce financial
information necessary for the effective and efficient management of organizations,
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and for other informed decision making. To be able to do this, you must become
conversant with the various groups of users of Accounting information, the kinds
of decision they make and the kinds of information they need to make good
decisions.
iii. COURSE PREREQUISITES

You should note that although this course has no subject pre-requisite, you are
expected to have:
1. Satisfactory level of English proficiency
2. Basic Computer Operations proficiency
3. Online interaction proficiency
4. Web 2.0 and Social media interactive skills
iv. COURSE LEARNING RESOURCES

Anao A.R. (2002). Introduction to Financial Accounting. Longman Nigeria
Limited, Ikeja, Lagos
v. COURSE OUTCOMES
After studying this course, you should be able to:
1. Identify and classify financial transactions, and capture the relevant details
of the transactions into accounting records.
2. Process transactions through the double entry system of book-keeping.
3. Identify uses and users of accounting information.
4. Produce accounting reports to serve the purposes of various decision makers.
5. Analyse and interpret information contained in accounting reports and
statements.
6. Analyse the relationship between accounting principles and the procedures
of accounting processes.
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7. Display skills of accuracy, speed, and orderliness in executing accounting
processes.
vi. ACTIVITIES TO MEET COURSE OBJECTIVES

The objective of this course is to be realized through a combination of assigned
readings and individual and group assignments. The purpose of the readings is to
introduce you to the principles, concepts and procedures, and to illustrate the
application of these in the Accounting process using specially prepared cases and
real-life examples. The assignments are aimed at testing the understanding of
principles and their application, and at developing the skill of working with speed
and neatness, and at the same time avoiding errors.
There is no doubt that developing these skills will require dedication and lots and
lots of practice. This is the only way to learn and be proficient in Accounting; there
is no known alternative. This will also involve strict timing during practice. Some
of the assignments, therefore, will be timed and your time performance will be
evaluated.
There will also be discussions where each you either individually or in a group will
be required to analyse and discuss topics and questions, and respond to the
questions and observations of other. You will also be required to review the work
of others,yours indicating areas where you disagree with them and suggests
improvements to their work. Also, tutorials will be arranged within the two weeks
on campus activities in which questions will be clarified to enable you understand
fully what you’ve learnt.
Specifically, this course shall comprise of the following activities:

i. Studying courseware
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ii. Listening to course audios
iii. Watching relevant course videos
iv. Course assignments (individual and group)
v. Forum discussion participation
vi. Tutorials (optional)
vii. Semester examinations (CBT and essay based).
vii. TIME (TO COMPLETE SYLABUS/COURSE)

A minimum of three hours daily is recommended for this course.
viii. GRADING CRITERIA AND SCALE

Grading Criteria
A. Formative assessment
Grades will be based on the following:
Individual assignments/test (CA 1,2 etc) 20
Group assignments (GCA 1, 2 etc) 10
Discussions/Quizzes/Out of class engagements etc 10
B. Summative assessment (Semester examination)

CBT based 30
Essay based 30
TOTAL 100%
C. Grading Scale:
A = 70-100
B = 60 – 69
C = 50 - 59
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D = 45-49
F = 0-44
D. Feedback
Courseware based:
1. In-text questions and answers (answers preceding references)
2. Self-assessment questions and answers (answers preceding references)
Tutor based:
1. Discussion Forum tutor input
2. Graded Continuous assessments
Student based:
1. Online programme assessment (administration, learning resource,
deployment, and assessment).
IX LINKS TO OPEN EDUCATION RESOURCES

OSS Watch provides tips for selecting open source, or for procuring free or open
software.
SchoolForge and SourceForge are good places to find, create, and publish open
software. SourceForge, for one, has millions of downloads each day.
Open Source Education Foundation and Open Source Initiative, and other
organisation like these, help disseminate knowledge.
Creative Commons has a number of open projects from Khan
Academy to Curriki where teachers and parents can find educational materials for
children or learn about Creative Commons licenses. Also, they recently launched
the School of Open that offers courses on the meaning, application, and impact of
"openness."
Numerous open or open educational resource databases and search engines
exist. Some examples include:
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• OEDb: over 10,000 free courses from universities as well as reviews of colleges
and rankings of college degree programmes
• Open Tapestry: over 100,000 open licensed online learning resources for an
academic and general audience
• OER Commons: over 40,000 open educational resources from elementary school
through to higher education; many of the elementary, middle, and high school
resources are aligned to the Common Core State Standards
• Open Content: a blog, definition, and game of open source as well as a friendly
search engine for open educational resources from MIT, Stanford, and other
universities with subject and description listings
• Academic Earth: over 1,500 video lectures from MIT, Stanford, Berkeley,
Harvard, Princeton, and Yale
• JISC: Joint Information Systems Committee works on behalf of UK higher
education and is involved in many open resources and open projects including
digitising British newspapers from 1620-1900!
Other sources for open education resources
Universities
• The University of Cambridge's guide on Open Educational Resources for Teacher
Education (ORBIT)
• OpenLearn from Open University in the UK
Global
• Unesco's searchable open database is a portal to worldwide courses and research
initiatives
• African Virtual University (http://oer.avu.org/) has numerous modules on subjects
in English, French, and Portuguese
• https://code.google.com/p/course-builder/ is Google's open source software that is
designed to let anyone create online education courses
• Global Voices (http://globalvoicesonline.org/) is an international community of
bloggers who report on blogs and citizen media from around the world, including
on open source and open educational resources
Individuals (which include OERs)
• Librarian Chick: everything from books to quizzes and videos here, includes
directories on open source and open educational resources
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• K-12 Tech Tools: OERs, from art to special education
• Web 2.0: Cool Tools for Schools: audio and video tools
• Web 2.0 Guru: animation and various collections of free open source software
• Livebinders: search, create, or organise digital information binders by age, grade,
or subject (why re-invent the wheel?)
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X. ABU DLC ACADEMIC CALENDAR/PLANNER
PERIOD
Semester Semester 1 Semester 2 Semester 3
Activity JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC
Registration
Resumption
Late Registn.
Facilitation
Revision/
Consolidation
Semester
Examination
N.B: - All Sessions commence in January

- 1 Week break between Semesters and 6 Weeks vocation at end of session.
- Semester 3 is OPTIONAL (Fast-tracking, making up carry-overs & deferments)
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xi. COURSE STRUCTURE AND OUTLINE
Course Structure
WEEK/DAYS MODULE STUDY SESSION ACTIVITY
1 Study Session 1: 1. Read Courseware for the corresponding Study Session.

2. Listen to the Audio on this Study Session
Accounting concepts. 3. View any other Video/U-
Pp. 16 tubehttps://www.youtube.com/watch?v=LABe5Sb2jrs
4. View referred Animation
https://www.youtube.com/watch?v=N2YyiVAO5Do
2 Study Session 2 1. Read Courseware for the corresponding Study Session.
the Accounting 3. View any other Video/U-tube
equations and its https://www.youtube.com/watch?v=3y-
components. Pp. 40 ZfzoER_I,https://www.youtube.com/watch?v=iNWW6b09ZB
I
4. View referred Animationhttps://bit.ly/2BeVFl6,,
https://www.youtube.com/watch?v=T2l9zvz5oAE
Basic Documents. 2. Listen to the Audio on this Study Session
pp. 54 3. View any other Video/U-tube
https://www.youtube.com/watch?v=1ELNME4y2lw
https://www.youtube.com/watch?v=yYXd3Ew-od4
4 Study Session 4Prime 1. Read Courseware for the corresponding Study Session.
STUDY books, General Ledgers 2. Listen to the Audio on this Study Session
and the Journals. 3. View any other Video/U-tube
MODULE 1 https://www.youtube.com/watch?v=KGzXCWdaskk,,
Pp. 65 https://www.youtube.com/watch?v=278qpMgD1nw
https://www.youtube.com/watch?v=aRSMl0eWmt0
https://www.youtube.com/watch?v=IQvZMAAkAkk
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5 Study Session1 1. Read Courseware for the corresponding Study Session.
Double entry and the 3. View any other Video/U-
General ledger. Pp 92 tubehttps://www.youtube.com/watch?v=uA0qod8slgw
https://www.youtube.com/watch?v=HQKV47sDpOY
STUDY The Balance of the 2. Listen to the Audio on this Study Session
accounts and the Trial 3. View any other Video/U-tube
MODULE 2 Balance. Pp 114 https://www.youtube.com/watch?v=0R0SNfYgmjc,,,,,
https://www.youtube.com/watch?v=MQETAaBytJM
4. View referred Animation https://bit.ly/2SIwXka
The Cash Book. Pp 145 2. Listen to the Audio on this Study Session
3. View any other Video/U-tube
https://www.youtube.com/watch?v=A3weTIOAz68,,
https://www.youtube.com/watch?v=VhrI1exG8OY
https://www.youtube.com/watch?v=CRLsZpausK0
The Petty Cashbook. 2. View the Video(s) on this Study Session
Pp 154 3. Listen to the Audio on this Study Session
4. View any other Video/U-tube
https://www.youtube.com/watch?v=BFAryNnSx5E,,
https://www.youtube.com/watch?v=soq-5jyBprI
https://www.youtube.com/watch?v=C_zMpLzfXG4,,
https://www.youtube.com/watch?v=b6Lc4vwnLpI

Depreciation and Non – 3. View any other Video/U-tube
current Assets. Pp 165 https://www.youtube.com/watch?v=9h1AWeBh6zs
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https://www.youtube.com/watch?v=cHik6vtqb94
STUDY Bad Debts and 2. Listen to the Audio on this Study Session
Provision For Bad 3. View any other Video/U-tube
MODULE 3 Debts. Pp 201 https://www.youtube.com/watch?v=bG54gJ37wXQ,,
https://www.youtube.com/watch?v=CsiuTA96I1k
Financial Ratios. 2. Listen to the Audio on this Study Session
Pp 216 3. View any other Video/U-tube
https://www.youtube.com/watch?v=XnL6Gom7N3w
https://www.youtube.com/watch?v=TZZFBkbC2lA
Cash Flow Statements. 2. Listen to the Audio on this Study Session
Pp 236 3. View any other Video/U-tube
https://www.youtube.com/watch?v=SzMbBOtOuJ4,
https://www.youtube.com/watch?v=jfPjXIk6zqo
https://www.youtube.com/watch?v=W9Rttkb1kb8
Week 13 TUTORIALS/REVISION
Week 14 & 15 SEMESTER EXAMINATION
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Course Outline
Module 1
Study Session 1: Accounting Concepts.
Study Session 2: The Accounting Equation and its Component.
Study Session 3: Basic Documentation.
Study Session 4: Prime Books, General Ledgers and the Journal.
Module 2
Study Session 1: Double Entry and the General Ledger.
Study Session 2: The Balancing of Accounts and the Trial Balance.
Study Session 3: The Cash Book.
Study Session 4: The Petty Cash Book.
Module 3
Study Session 1: Depreciation and Non-Current Assets.
Study Session 2: Bad Debts and Provisions for Bad Debts.
Study Session 3: Financial Ratios.
Study Session4: Cash Flow Statements.
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STUDY MODULES
1.0 MODULE 1
Contents
Study Session 1: Accounting Concepts.
Study Session 2: The Accounting Equation and its Component.
Study Session 3: Basic Documentation.
Study Session 4: Prime Books, General Ledgers and the Journal.
STUDY SESSION 1
Accounting Concepts
Section and Subsection Headings
Introduction.
1.0 Learning Outcomes.
2.0 Main Content:
2.1 Definition of Accounting.
2.2 Nature of Accounting.
2.3 Objectives of Accounting.
2.4 Key Accounting Concepts.
2.5 Other Concepts.
2.6 Users of Accounting Information.
3.0 Tutor Marked Assignment (TMA).
4.0 Conclusion/Summary.
5.0 Self-Assessment Questions.
6.0 Additional Activities (Videos, Animations &Out of Class activities).
7.0 References/Further Readings.
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Introduction
Welcome once again. You have embarked on the challenging and rewarding study
of accounting—an old and time honoureddiscipline. History indicates that all
developed societies require certain accounting records which started at about 4000
BCE. Ancient governments kept records of receipts and disbursements and used
procedures to check on the honesty and reliability of employees.A study of the
evolution of accounting suggests that accounting processes have developed
primarily in response to business needs. Also, economic progress has affected the
development of accounting processes. History shows that the higher the level of
civilization, the more elaborates the accounting methods (Garg, 2012).
1.0 Learning Outcome

At the end of this session, you should be able to:
1. Define Accounting.
2. Differentiate between financial Accounting versus Managerial Accounting.
3. Explain key Accounting Concepts, andother Concepts.
2.0 Main Content

2.1 Definition of Accounting
Accounting is a discipline which records, classifies, summarizes and interprets
financial information about the activities of a concern so that intelligent decisions
can be made about the concern. The American Institute of Certified Public
Accountants has defined Financial Accounting as "the art of recording, classifying
and summarizing in a significant manner and in terms of money transactions and
events which in part, at least is of a financial character, and interpreting the results
thereof". American Accounting Association defines accounting as "the process of
identifying, measuring, and communicating economic information to permit
informed judgments and decisions by users of the information. Accounting, then, is
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a measurement and communication process used to report on the activities of
profit-seeking business organizations and not-for-profit organizations. As a
measurement and communication process for business, accounting supplies
information that permits informed judgments and decisions by users of the data.
The accounting process provides financial data for a broad range of individuals
whose objectives in studying the data vary widely. Bank officials, for example,
may study a company's financial statements to evaluate the company's ability to
repay a loan. Prospective investors may compare accounting data from several
companies to decide which company represents the best investment. Accounting
also supplies management with significant financial data useful for decision
making.
Reliable information is necessary before decision makers can make a sound

decision involving the allocation of scarce resources.
Accounting information is valuable because

decision makers can use it to evaluate the
financial consequences of various alternatives.
Accountants eliminate the need for a crystal ball
to estimate the future. They can reduce
uncertainty by using professional judgment to
quantify the future financial impact of taking
action or delaying action. The main purpose of accounting is to ascertain profit or
loss during a specified period, to show financial condition of the business on a
particular date and to have control over the firm's property. Such accounting
records are required to be maintained to measure the income of the business and
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communicate the information so that it may be used by managers, owners and
other interested parties.
In Text Question 1: What is the definition of accounting?
In Text Answer 1: Accounting is a discipline which records, classifies, summarises and

interprets financial information about the activities of a concern so that intelligent decisions
can be made about the concern.
From the above, the following attributes of accounting emerge:

(i) Recording: It is concerned with the recording of financial transactions in an
orderly manner, soon after their occurrence in the proper books of accounts.
(ii) Classifying: It is concerned with the systematic analysis of the recorded data
so as to accumulate the transactions of similar type at one place. This function is
performed by maintaining the ledger in which different accounts are opened to
which related transactions are posted.
(iii) Summarizing: It is concerned with the preparation and presentation of the

classified data in a manner useful to the users. This function involves the
preparation of financial statements such as Income Statement, Balance Sheet, and
Statement of Changes in Financial Position, Statement of Cash Flow, and
Statement of Value Added.
(iv) Interpreting: Nowadays, the aforesaid three functions are performed by

electronic data processing devices and the accountant has to concentrate mainly on
the interpretation aspects of accounting. The accountants should interpret the
statements in a manner useful to action. The accountant should explain not only
what has happened but also (a) why it happened, and (b) what is likely to happen
under specified conditions.
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2.2 Nature of Accounting
As you may know, over the years various definitions and explanations of
accounting have been given by different accounting experts from time to time and
the following aspects comprise the nature of accounting:
i) Accounting as a service activity
Accounting is a service activity. Its function is to provide quantitative information,
primarily financial in nature, about economic entities that is intended to be useful
in making economic decisions, in making reasoned choices among alternative
courses of action. It means that accounting collects financial information for the
various users for taking decisions and tackling business issues. Accounting in itself
cannot create wealth but it produces information which is useful to others and as
such assist in wealth creation and maintenance.
(ii) Accounting as a profession
Accounting is very much a profession. A profession is a career that involves the
acquiring of a specialized formal education before rendering any service.
Accounting is a systematized body of knowledge developed with the development
of trade and business over the past century. The accounting education is being
imparted to the examinees by national and international recognized bodies like The
Institute of Chartered Accountants of India (ICAI), New Delhi in India, American
Institute of Certified Public Accountants (AICPA) in USA and Institute of
Chartered Accountants of Nigeria, (ICAN) in Nigeria etc. The candidates must
pass a vigorous examination in Accounting Theory, Accounting Practice, Auditing
and Business Law. The members of the professional bodies usually have their own
associations or organizations, wherein they are required to compulsorily as
Associate member of the Institute of Chartered Accountants (A.C.A.) and fellow of
the Institute of Chartered Accountants (F.C.A.). In a way, accountancy as a
profession has attained the stature comparable with that of lawyer, medicine or
architecture.
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(iii) Accounting as a social force
Judging from history, accounting was only to serve the interest of the owners.
Under the changing business environment, the discipline of accounting and the
accountant both have to watch and protect the interests of other people who are
directly or indirectly linked with the operation of modern business. The society is
composed of people as customer, shareholders, creditors and investors. The
accounting information/data is to be used to solve the problems of the public at
large such as determination and controlling of prices. Therefore, safeguarding of
public interest can better be facilitated with the help of proper, adequate and
reliable accounting information and as a result of it the society at large is benefited.
(iv) Accounting as a language

Accounting is rightly referred to as the "language of business". It is one means of
reporting and communicating information about a business. As one has to learn a
new language to converse and communicate, so also accounting is to be learned
and practiced to communicate business events. A language and accounting have
common features as regards rules and symbols. Both are based and propounded on
fundamental rules and symbols. In language these are known as grammatical rules
and in accounting, these are termed as accounting rules. The expression, exhibition
and presentation of accounting data such as a numerals and words and debits and
credit are accepted as symbols which are unique to the discipline of accounting.
(v) Accounting as science or art

Science is a systematized body of knowledge. It establishes a relationship of cause
and effect in the various related phenomenon. It is also based on some fundamental
principles. Accounting has its own principles e.g. the double entry system, which
explains that every transaction has two fold aspects i.e. debit and credit. It also lays
down rules of journalizing. So we can say that accounting is a science. Art requires
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a perfect knowledge, interest and experience to do a work efficiently. Art also
teaches us how to do a work in the best possible way by making the best use of the
available resources. Accounting is an art as it also requires knowledge, interest and
experience to maintain the books of accounts in a systematic manner. Everybody
cannot become a good accountant. It can be concluded from the above discussion
that accounting is an art as well as a science.
(vi) Accounting as an information system

Accounting discipline will be the most useful one in the acquisition of all the
business knowledge in the near future. You will realize that people will be
constantly exposed to accounting
information in their everyday life.
Accounting information serves both profit-
seeking business and non-profit
organisations. The accounting system of a
profit-seeking organisation is an
information system designed to provide
relevant financial information on the resources of a business and the effect of their
use. Information is relevant and valuable if the decision makers can use it to
evaluate the financial consequences of various alternatives. Accounting generally
does not generate the basic information (raw financial data), rather the raw
financial data result from the day to day transactions of the business. As an
information system, accounting links an information source or transmitter
(generally the accountant), a channel of communication (generally the financial
statements) and a set of receivers (external users).
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In Text Question 2: What is the nature of accounting?
In Text Answer 2: i) Accounting as a service activity (ii) Accounting as a profession (iii)
Accounting as a social force (iv) Accounting as a language (v) Accounting as science or art
(vi) Accounting as an information system
2.3 Objectives of Accounting

The following are the main objectives of accounting:
1. To keep systematic records: Accounting is done to keep a systematic record of
financial transactions. In the absence of accounting there would have been terrific
burden on human memory which in most cases would have been impossible to
bear.
2. To protect business properties: Accounting provides protection to business

properties from unjustified and unwarranted use. This is possible on account of
accounting supplying the following information to the manager or the proprietor:
(i) The amount of the proprietor's funds invested in the business.
(ii) How much the business has to pay to others?
(iii) How much the business has to recover from others?
(iv) How much the business has in the form of (a) fixed assets, (b) cash in hand, (c)
cash at bank, (d) stock of raw materials, work-in-progress and finished goods?
Information about the above matters helps the proprietor in assuring that the funds
of the business are not necessarily kept idle or under-utilised.
3. To ascertain the operational profit or loss: Accounting helps in ascertaining

the net profit earned or loss suffered on account of carrying out the business. This
is done by keeping a proper record of revenues and expense of a particular period.
The Profit and Loss Account is prepared at the end of a period and if the amount of
revenue for the period is more than the expenditure incurred in earning that
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revenue, there is said to be a profit. In case the expenditure exceeds the revenue,
there is said to be a loss. Profit and Loss Account will help the management,
investors, creditors, etc. in knowing whether the business has proved to be
remunerative or not. In case it has not proved to be remunerative or profitable, the
cause of such a state of affairs will be investigated and necessary remedial steps
will be taken.
4. To ascertain the financial position of the business: The Profit and Loss
Account gives the amount of profit or loss made by the business during a particular
period. However, it is not enough. The businessman must know about his financial
position i.e. where he stands? What he owes and what he owns? This objective is
served by the Balance Sheet or Position Statement. The Balance Sheet is a
statement of assets and liabilities of the business on a particular date. It serves as
barometer for ascertaining the financial health of the business.
5. To facilitate rational decision making: Accounting these days has taken upon
itself the task of collection, analysis and reporting of information at the required
points of time to the required levels of authority in order to facilitate rational
decision-making. The American Accounting Association has also stressed this
point while defining the term accounting when it says that accounting is the
process of identifying, measuring and communicating economic information to
permit informed judgments and decisions by users of the information.
5. Information System: Accounting functions as an information system for

collecting and communicating economic information about the business
enterprise. This information helps the management in taking appropriate
decisions. This function, as stated, is gaining tremendous importance these
days.
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In Test Question 3: Mention the key objectives of accounting
In Text Answer 3: To keep systematic records, To protect business properties, To ascertain the
operational profit or loss, To ascertain the financial position of the business, To facilitate
rational decision making and Information System
2.4 Key Accounting Concepts

Accounting is often called the language of business because the purpose of
accounting is to communicate or report the results of business operations and its
various aspects to various users of accounting information. Accounting could
become an intelligible and commonly understood language if it is based on
generally accepted accounting principles
and concepts. Hence, you must be familiar
with the accounting concepts in financial
statements to understand and use them
properly.The term ‘Concept’ is used to
connote the accounting postulates. These
are necessary assumptions and ideas which
are fundamental to accounting practice.
In other words, fundamental accounting concepts are broad general assumptions
which underline the periodic financial statements of business enterprises. The
reason that some of these terms should be called concepts is that they are basic
assumptions and have a direct bearing on the quality of financial accounting
information. The term ‘convention ‘is used to signify customs or tradition as a
guide to the preparation of accounting statements. The following are the important
accounting concepts or conventions:
1. Money measurement concept. Economic activity is initially recorded and

reported in a common monetary unit of measure—the dollar in the United
27
Statesand Naira in Nigeria. In other words, a fact or transaction which cannot be
expressed in terms of money is not recorded in the accounting books. As money is
accepted both as a medium of exchange and also as a store of value, it has a very
important advantage since a number of assets, which are different, can be
measured and expressed in terms of a common denominator. We must realise that
this concept imposes two limitations. Firstly, there are several facts which though
very important to the business, cannot be recorded in the books of accounts
because they cannot be expressed in money terms.
For example, general health condition of the Managing Director of the company,
working conditions in which a worker has to work, sales policy pursued by the
enterprise, quality of product introduced by the enterprise, though exert a great
influence on the productivity and profitability of the enterprise, are not recorded in
the books. All these have a bearing on the future profitability of the company.
Secondly, use of money implies that we assume stable or constant value of naira.
Taking this assumption means that the changes in the money value in future dates
are conveniently ignored. Most accountants know fully well that purchasing power
of naira does change but very few recognise this fact in accounting books and
make allowance for changing price level.
2. Cost concept or exchange price. Most of the amounts in an accounting system

are the objective money prices determined in the exchange process. Most assets are
recorded at their acquisition cost. According to this concept an asset is ordinarily
entered on the accounting records at the price paid to acquire it. For example, if a
business buys a plant for five thousand naira, the asset would be recorded in the
books at five thousand naira, even if its market value at that time happens to be six
thousand naira. Thus, assets are recorded at their original purchase price and this
cost is the basis for all subsequent accounting for the business. The assets shown in
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the financial statements do not necessarily indicate their present market values.
The term ‘book value’ is used for amount shown in the accounting records. The
asset may systematically be reduced in its value by charging ‘depreciation’. The
prime purpose of depreciation is to allocate the cost of an asset over its useful life
and not to adjust its cost. The term ‘assets,’ denotes the resources which are land,
building, machinery etc. owned by a business. The money values that are assigned
to assets are derived from the cost concept. Cost concept meets three basic norms
of relevance, objectivity and feasibility.
3. Going-concern (continuity) concept. Unless strong evidence exists to the

contrary, accountants assume that the business entity will continue operations into
the indefinite future unless there is good evidence to the contrary. The enterprise is
viewed as a going concern, that is, as continuing in operations, at least in the
foreseeable future. In other words, there is neither the intention nor the necessity to
liquidate the particular business venture in the predictable future. Accountants call
this assumption the going-concern or continuity concept. Assuming that the entity
will continue indefinitely allows accountants to value long-term assets, such as
land, at cost on the balance sheet since they are to be used rather than sold. It is this
assumption which underlies the decision of investors to commit capital to
enterprise. Only on the basis of this assumption can the accounting process remain
stable and achieve the objective of correctly reporting and recording on the capital
invested, the efficiency of management, and the position of the enterprise as a
going concern. However, if the accountant has good reasons to believe that the
business, or some part of it is going to be liquidated or that it will cease to operate
(say within six-month or a year), then the resources could be reported at their
current values. If this concept is not followed, International Accounting Standard
requires the disclosure of the facts in the financial statements together with
reasons.
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4. Periodicity (time periods) concept. According to the periodicity (time periods)
concept, an entity’s life can be meaningfully subdivided into time periods (such as
months or years) to report the results of its economic activities.Itrequires that the
life of the business should be divided into appropriate segments for studying the
financial results shown by the enterprise after each segment. Although the results
of operations of a specific enterprise can be known precisely only after the
business has ceased to operate, its assets have been sold off and liabilities paid off,
the knowledge of the results periodically is also necessary. Those who are
interested in the operating results of business obviously cannot wait till the end.
The accountant must report for the changes in the wealth of a firm for short time
periods. A year is the most common interval on account of prevailing practice,
tradition and government requirements. Some firms adopt financial year of the
government, some other calendar year. Although a twelve-month period is adopted
for external reporting, a shorter span of interval, say one month or three months is
applied for internal reporting purposes. This concept poses difficulty for the
process of allocation of long term costs. All the revenues and all the cost relating to
the year in operation have to be taken into account while matching the earnings
and the cost of those earnings for the any accounting period. Despite the
difficulties which stem from this concept, short term reports are of vital importance
to owners, management, creditors and other interested parties. Hence, the
accountants have no option but to resolve such difficulties.
5. Separate business entity concept. In accounting we make a distinction between

business and the owner. All the books of accounts records day to day financial
transactions from the view point of the business rather than from that of the owner.
The proprietor is considered as a creditor to the extent of the capital brought in
business by him. For instance, when a person invests ₦10.00 into a business, it will
be treated that the business has borrowed that much money from the owner and it
30
will be shown as a ‘liability’ in the books of accounts of business. Thus, in
recording a transaction the important question is how does it affects the business?
For example, if the owner puts cash into the business, he has a claim against the
business for capital brought in. In soar as a limited company is concerned, this
distinction can be easily maintained because a company has a legal entity of its
own. Like a natural person it can engage itself in economic activities of buying,
selling, producing, lending, borrowing and consuming of goods and services.
However, it is difficult to show this distinction in the case of sole proprietorship
and partnership. Nevertheless, accounting still maintains separation of business and
owner. It may be noted that it is only for accounting purpose that partnerships and
sole proprietorship are treated as separate from the owner (s), though law does not
make such distinction.
6. Dual aspect concept. All the transactions and events involving financial
element are recorded. Each of such transactions requires two aspects to be
recorded. The recognition of these two aspects of every transaction is known as a
dual aspect analysis. For example, if a firm sells goods of ₦10,000 this transaction
involves two aspects. One aspect is the delivery of goods and the other aspect is
immediate receipt of cash (in the case of cash sales). The term ‘double entry’ book
keeping has come into vogue because for every transaction, two entries are made.
According to this system the total amount debited always equals the total amount
credited. It follows from ‘dual aspect concept’ that at any point in time owners’
equity and liabilities for any accounting entity will be equal to assets owned by that
entity. This idea could be expressed as the following equalities:
Assets = Liabilities + Owners Equity............... (1)
Owner’s Equity = Assets - Liabilities............... (2)
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The above relationship is known as the ‘Accounting Equation’. The term ‘Owners
Equity’ denotes the resources supplied by the owners of the entity while the term
‘liabilities’ denotes the claim of outside parties such as creditors, debenture-
holders, bank against the assets of the business. Assets are the resources owned by
a business.
7. The Matching concept. This concept is based on the accounting period concept.
Matching is the entire process of periodic earnings measurement, often described
as a process of matching expenses with revenues. In other words, income made by
the enterprise during a period can be measured only when the revenue earned
during a period is compared with the expenditure incurred for earning that revenue.
Broadly speaking revenue is the total amount realised from the sale of goods or
provision of services together with earnings from interest, dividend, and other
items of income. Expenses are cost incurred in connection with the earnings of
revenues. Costs incurred do not become expenses until the goods or services in
question are exchanged. An example of the application of the matching principle is
inventory. Where goods are bought in one accounting year but sold in the next,
their cost is carried forward as inventory at the end of the year and set against the
proceeds of sale in the accounting year in which it occurs. Cost is not synonymous
with expense since expense is sacrifice made, resource consumed in relation to
revenues earned during an accounting period. Only costs that have expired during
an accounting period are considered as expenses. On account of this concept,
adjustments are made for all prepaid expenses, outstanding expenses, accrued
income, etc., while preparing periodic reports.
8. Accrual Concept. It is generally accepted in accounting that the basis of

reporting income is accrual. Accrual concept makes a distinction between the
receipt of cash and the right to receive it, and the payment of cash and the legal
32
obligation to pay it. This concept provides a guideline to the accountant as to how
he should treat the cash receipts and the right related thereto. Accrual principle
tries to evaluate every transaction in terms of its impact on the owner’s equity. The
essence of the accrual concept is that net income arises from events that change the
owner’s equity in a specified period and that these are not necessarily the same as
change in the cash position of the business. Thus it helps in proper measurement of
income.
8. Realisation Concept. Realisation is the process of converting non-cash

resources and rights into money. As accounting principle, it is used to
identify precisely the amount of revenue to be recognised and the amount of
expense to be matched to such revenue for the purpose of income
measurement. According to realisation concept revenue is recognised when
sale is made. Sale is considered to be made at the point when the property in
goods passes to the buyer and he becomes legally liable to pay. This implies
that revenue is generally realised when goods are delivered or services are
rendered. The rationale is that delivery validates a claim against the
customer. However, in case of long run construction contracts revenue is
often recognised on the basis of a proportionate or partial completion
method. Similarly, in case of long run installment sales contracts, revenue is
regarded asrealised only in proportion to the actual cash collection. In each
of these cases are the exceptions to the notion that an exchange is needed to
justify the realisation of revenue.
In Text Question 4: What are the key accounting concepts?

In Text Answer 4: 1. Money measurement concept2. Cost concept or exchange price.
3. Going-concern (continuity) concept.4. Periodicity (time periods) concept
5. Separate Business Entity Concept6. Dual Aspect Concept.7.The Matching concept.
8. Accrual Concept9. Realisation Concept.
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2.5 Other Concepts
The fundamental concepts (going concern and accruals) are discussed above. There
are a number of other concepts that are implicit in the preparation of financial
statements and are so engrained in the process of accounting. To be
comprehensive, a short explanation of each is given in this section.
1. Materiality concept-The materiality concept affects every transaction as
well as financial statements. This concept affects two main areas:
presentation and application of accounting standards. In respect of the first,
this concept assumes that only material items should be disclosed in
financial statements. This is important for achieving the objective of
financial statements as attention being afforded to immaterial items can
mislead the user. The user should be able to look at a set of financial
statements and focus on the important figures, not see a mass of information,
much of which is of no use for economic decision-making. For example, it is
irrelevant to disclose a yearly spend on stationery of N100 and a yearly
spend on coffee of N75, if the company has a turnover of N10 million and
total expenditure of N8 million. The immaterial items need to be grouped
together, or grouped into categories that are material. For example, the
stationery and coffee could be combined into administration expenses that
might have a total of N2.5 million.
2. Historical cost concept/fair value:The historical cost concept allows a user

to assume that all the transactions in an entity’s financial statements reflect
the actual cost price billed, or revenue charged, for items. In addition, it
allows the reader to see the history of the management team’s investment
decision-making from the statement of financial position. This concept is
becoming less relevant now as it is widely believed that historical cost
information does not support financial statements in their aim of producing
34
information that is useful for economic decision-making. In particular, the
impact of inflation means that many of items recorded at historic cost, do not
reflect current value. Measuring items at fair value is deemed to provide
more relevant information. Fair value is defined by the International
Accounting Standards Board (IASB) as the amount for which an asset could
be exchanged, or a liability settled, between knowledgeable, willing parties
in arm’s length transaction.
3. Prudence concept-The prudence concept assumes that the financial

statements have been prepared on a prudent basis. This allows the user to
have confidence that no profits are included that are not earned and, if not
yet received, are reasonably certain to be received. The user can also be
confident that expenses are complete and are not understated, that assets are
not overstated and liabilities are complete and are not understated. At one
time this concept was deemed to be fundamental to the objective of financial
statements (i.e. to provide relevant information to a wide range of users for
economic decision-making). However, it was abused by some companies.
When companies did well they tended to overstate expenses (by creating
provisions for expenditure) and understate revenue. Then, in years when
performance was not strong, the companies reversed the adjustments –
reducing the provisions and the expenses in the year and increasing revenue.
The result was that users could not quite work out how the company really
performed. For this reason, prudence was downgraded and provisions and
manipulations that were based on the prudence concept are no longer
allowed.
4. Substance overform concept-This concept assumes that when accounting

for transactions, the preparer should look at the economic substance of a
35
transaction, not its legal form. This was a reactive concept/standard that was
introduced to try to stop the accounting practices that had emerged of
creating complicated legal transactions which, because of their legal form,
allowed transactions to be omitted from the financial statements. In
particular, debts/ liabilities were arranged in such a manner as to enable
them to be left off the statement of financial position. This would make the
company look stronger, healthier and in general masked the real debt
commitment that the entity had, from the users. This is no longer allowed.
Regardless of the legal contract underlying a transaction, the preparer of the
financial statements has to determine whether the transaction creates an asset
or a liability as defined by the Framework. If the transaction does, then the
preparer has to account for it as such.
5. Separate determination concept-This concept allows the user to look at the

assets, liabilities, income and expenditure and to know that the reported
figure is the total value for each of these elements. The entity should have a
separate record of every asset held. This concept also does not allow a
company to net one element against another. This is important as netting can
mislead users. For example, if a company were able to net its debt against
some assets so that less debt is shown in the statement of financial position,
then the user would be unable to make a proper assessment of the entity’s
ability to pay back the debt as the user would assume the repayments
required to clear it were less than they actually were.
In Text Question 5: Apart from the key accounting concepts, there are a number of other
concepts that are implicit in the preparation of financial statements and are so engrained in
the process of accounting. What are they?
In Text Answer 5: 1. Materiality Concept 2. Historical Cost Concept/Fair Value 3.

Prudence Concept 4.Substance over Form Concept 5. Separate Determination Concept.
36
2.6 Users of Accounting Information
The basic objective of accounting is to
provide information which is useful for
persons inside the organisation and for
persons or groups outside the organisation.
Accounting is the discipline that provides
information on which external and internal users of the information may base
decisions that result in the allocation of economic resources in society.
External users of accounting information

Information plays a very vital role in every aspect of our daily lives, so does it in
business too.
External users are those groups or persons who are outside the organisation for
whom accounting function is performed. Following can be the various external
users of accounting information:
1. Investors: Those who are interested in investing money in an organisation are
interested in knowing the financial health of the organisation and know how safe
the investment already made is and how safe their proposed investment will be. To
know the financial health, they need accounting information which will help them
in evaluating the past performance and future prospects of the organisation. Thus,
investors for their investment decisions are dependent upon accounting information
included in the financial statements. They can know the profitability and the
financial position of the organisation in which they are interested to make that
investment by making a study of the accounting information given in the financial
statements of the organisation.
2. Creditors: Creditors (i.e. supplier of goods and services on credit, bankers and
other lenders of money) want to know the financial position of a concern before
37
giving loans or granting credit. They want to be sure that the concern will not
experience difficulty in making their payment in time i.e. liquid position of the
concern is satisfactory. To know the liquid position, they need accounting
information relating to current assets, quick assets and current liabilities which is
available in the financial statements.
3. Members of non-profit organisations: Members of non-profit organisations

such as schools, colleges, hospitals, clubs, charitable institutions etc. need
accounting information to know how their contributed funds are being utilised and
to ascertain if the organisation deserves continued support or support should be
withdrawn keeping in view the bad performance depicted by the accounting
information and diverted to another organisation. In knowing the performance of
such organisations, criterion will not be the profit made but the main criterion will
be the service provided to the society.
4. Government: Central and State Governments are interested in the accounting

information because they want to know earnings or sales for a particular period for
purposes of taxation. Income tax returns are examples of financial reports which
are prepared with information taken directly from accounting records.
Governments also need accounting information for compiling statistics concerning
business which, in turn helps in compiling national accounts.
5. Consumers: Consumers need accounting information for establishing good

accounting control so that cost of production may be reduced with the resultant
reduction of the prices of goods they buy. Sometimes, prices for some goods are
fixed by the Government, so it needs accounting information to fix reasonable
prices so that consumers and manufacturers are not exploited. Prices are fixed
38
keeping in view fair return to manufacturers on their investments shown in the
accounting records.
6. Research scholars: Accounting information, being a mirror of the financial

performance of a business organisation, is of immense value to the research
scholars who wants to make a study into the financial operations of a
particular firm. To make a study into the financial operations of a particular
firm, the research scholar needs detailed accounting information relating to
purchases, sales, expenses, cost of materials used, current assets, current
liabilities, fixed assets, long term liabilities and shareholders' funds which is
available in the accounting records maintained by the firm.
In Text Question 6: Who are the external users of accounting information?

In Text Answer 6: 1. Investors2.Creditors3.Members of Non-profit Organisations
4.Government 5.Consumers6.Research Scholars.
Internal users of accounting information

Internal users of accounting information are those persons or groups which are
within the organisation.Following are such internal users:
1. Owners: The owners provide funds for the operations of a business and they
want to know whether their funds are being properly used or not. They need
accounting information to know the profitability and the financial position of the
concern in which they have invested their funds. The financial statements prepared
from time to time from accounting records depict them the profitability and the
financial position.
2. Management: Management is the art of getting work done through others; the
management should ensure that the subordinates are doing work properly.
Accounting information is an aid in this respect because it helps a manager in
39
appraising the performance of the subordinates. Actual performance of the
employees can be compared with the budgeted performance they were expected to
achieve and remedial action can be taken if the actual performance is not up to the
mark. Thus, accounting information provides "the eyes and ears to management".
The most important functions of management are planning and controlling.

Preparation of various budgets, such as sales budget, production budget, cash
budget, capital expenditure budget etc., is an important part of planning function
and the starting point for the preparation of the budgets is the accounting
information for the previous year. Controlling is the function of seeing that
programmes laid down in various budgets are being actually achieved i.e. actual
performance ascertained from accounting is compared with the budgeted
performance, enabling the manager to exercise controlling case of weak
performance. Accounting information is also helpful to the management in fixing
reasonable selling prices. In a competitive economy, a
price should be based on cost plus a reasonable rate of
return. If a firm quotes a price which exceeds cost
plus a reasonable rate of return, it probably will not
get the order. On the other hand, if the firm quotes a
price which is less than its cost, it will be given the
order but will incur a loss on account of price being
lower than the cost. So, selling prices should always
be fixed on the basis of accounting data to get the reasonable margin of profit on
sales.
3. Employees: Employees are interested in the financial position of a concern they

serve particularly when payment of bonus depends upon the size of the profits
40
earned. They seek accounting information to know that the bonus being paid to
them is correct.
In Text Question 7: Who are the internal users of the accounting information?
In Text Answer 7: 1. Owners2. Management3.Employees
3.0 Tutor Marked Assignment

Analyse the definition of accounting and briefly explain the objectives of
accounting.
4.0 Summary
In this session, we have defined the concept of accounting, and given its nature.
We have discussed on the objectives of accounting and also discussed the
accounting concepts as well as list out the various users of accounting information.
5.0 Self-Assessment Questions

1. Analyse the definition of accounting by various authors.
2. What are the various interested parties which use accounting information?
3. What is meant by book-keeping and accounting? Is accounting a science or
art?
6.0 Additional Activities (Videos, Animations &Out of Class activities) e.g.

a. Visit U-tube https://www.youtube.com/watch?v=LABe5Sb2jrs Watch the video
& summarise in 1 paragraph
b. View the animation on https://www.youtube.com/watch?v=N2YyiVAO5Do
and critique it in the discussion forum
41
7.0 References/Further Readings
Garg, M. C. (2012).Financial Accounting: Meaning, Nature and Role of
Accounting
Hermanson, E., and Maher (2011).Accounting Principles: A Business Perspective,
Financial Accounting. www.opencollegetextbooks.org
Inanga, E. L. (200). Principles of Accounting, Revised Ed., Heinemann
Educational Books (Nig) PLC, Ibadan, Nigeria.
Mahesh Chand Garg. Financial Accounting: Meaning, Nature and Role of
Accounting
Robert O. Igben (1999). Financial Accounting Made Simple, First Ed., ROI
Publishers, 7, Goloba Street, Isolo, Lagos
42
STUDY SESSION 2
The Accounting Equation and its Components.
Sections and Subsection Headings
Introduction
1.0Learning Outcome.
2.0Main Content:
2.1 The Accounting Process.
2.2 Accounting Equation.
2.3 Account.
2.4 The Accounting Period and Profit Reporting.
2.5 Revenue Expenditure versus Capital Expenditure.

3.0 Tutor Marked Assignment.
4.0Summary.
5.0Self-Assessment Questions.
6.0Additional Activities (Videos, Animations &Out of Class activities).
7.0 References.
Introduction
In the previous session we discussed about various aspect of accounting. In this
session we will be looking at Accounting Equation and its Components. We shall
be considering the components of the accounting equation and how each
component is affected when a transaction takes place.
Any economic transaction or event of a business which can be expressed in
monetary terms should be recorded. As we are aware, accounting is a method of
collecting, recording, classifying, summarizing, presenting and interpreting
financial data of an economic activity. The series of business transactions occurs
during the accounting period and its recording is referred to as accounting process/
43
mechanism. An accounting process is a complete sequence of accounting
procedures which are repeated in the same order during each accounting period.

1. Define the accounting entity.
2. State the accounting equation.
3. Identify the accounting period and profit reporting.
4. Define revenue expenditure versus capital expenditure.
2.0 Main Content

2.1 The Accounting Process
Identification of Transaction: In accounting, only financial transactions are
recorded. A financial transaction is an event which can be expressed in terms of
money and which brings change in the financial position of a business enterprise.
An event is an incident or a happening which may or may not bring any change in
the financial position of a business enterprise. Therefore, all transactions are events
but all events are not transactions. A transaction is a complete action, to an
expected or possible future action. In every transaction, there is movement of value
from one source to another. For example, when goods are purchased for cash, there
is a movement of goods from the seller to
the buyer and a movement of cash from
buyer to the seller. Transactions may be
external (between a business entity and a
second party, e.g., goods sold on credit to
Hari) or internal (do not involve second
44
party, e.g., depreciation charged on the machinery).
Illustration 1
State with reasons whether the following events are transactions or not to Mr.
Nestor, Proprietor, Delton Computers
(i) Mr. Nestor started business with capital (brought in cash) ₦40,000.
(ii) Paid salaries to staff ₦ 5,000.
(iii) Purchased machinery for ₦ 20,000 in cash.
(iv)Placed an order with Sen& Co. for goods for ₦ 5,000.
(v) Opened a Bank account by depositing ₦ 4,000.
(vi) Received pass book from bank.
(vii) Appointed Sohan as Manager on a salary of ₦ 4,000 per month.
(viii)Received interest from bank ₦ 500.
(ix) Received a price list from Lalit.
Solution:
Here, each event is to be considered from the view point of Mr.Nestor's business.
Those events which will change the financial position of the business of
Mr.Nestor, should be regarded as transaction.
(i) It is a transaction, because it changes the financial position of Mr. Nestor's
business. Cash will increase by ₦40,000 and Capital will increase by ₦
40,000.
(ii) It is a transaction, because it changes the financial position of Mr. Nestor's
business. Cash will decrease by ₦ 5,000 and Salaries (expenses) will increase
by ₦ 5,000
(iii) It is a transaction, because it changes the financial position of Mr. Nestor's
business. Machinery comes in and cash goes out.
(iv) It is not a transaction, because it does not change the financial position of the
business.
45
(v) It is a transaction, because it changes the financial position of the business.
Bank balance will increase by ₦ 4,000 and cash balance will decrease by ₦ 4,000.
(vi) It is also not a transaction, because it does not change the financial position of
Mr. Nestor.
(vii) It is also not a transaction, because it does not change the financial position of
Mr. Nestor.
(viii) It is a transaction, because it changes the financial position of Mr. Nestor's
business.
(ix) It is not a transaction, because it does not change the financial position of the
business of Mr. Nestor.
b) Recording the transaction: Journal is the first book of original entry in which all
transactions are recorded event-wise and date-wise and presents a historical record
of all monetary transactions. Journal may further be divided into sub-journals as
well.
i) Classifying: Accounting is the art of classifying business transactions.
Classification means statement setting out for a period where all the similar
transactions relating to a person, a thing, expense, or any other subject are
grouped together under appropriate heads of accounts.
ii) Summarising: Summarising is the art of making the activities of the business
enterprise as classified in the ledger for the use of management or other user
groups i.e. sundry debtors, sundry creditors etc. Summarisation helps in the
preparation of Profit and Loss Account and Balance sheet for a particular
financial year.
iii) Analysis and Interpretation: The financial information or data is recorded in
the books of account must further be analysed and interpreted so to draw
meaningful conclusions. Thus, analysis of accounting information will help the
46
management to assess in the performance of business operation and forming
future plans also.
iv) Presentation or reporting of financialinformation: The end users of
accounting statements must be benefited from analysis and interpretation of
data as some of them are the "shareholders" and other one the "stake holders".
Comparison of past and present statements and reports, use of ratios and trend
analysis are the different tools of analysis and interpretation.
From the above discussion one can conclude that accounting is an art which starts
and includes steps right from recording of business transactions of monetary
character to the communicating or reporting the results thereof to the various
interested parties. For this purpose, the transactions are classified into various
accounts.
In Text Question 1: What is a financial transaction?
In Text Answer 1: A financial transaction is an event which can be expressed in terms of money
and which brings change in the financial position of a business enterprise.
2.2 Accounting Equation

Dual concept states that 'for every debit, there is a credit'. Every transaction should
have two-sided effect to the extent of same amount. This concept has resulted in
accounting equation which states that at any point of time assets of any entity must
be equal (in monetary terms) to the total of owner's equity and outsider's liabilities.
In other words, accounting equation is a statement of equality between the assets
and the sources which finance the assets.
An asset can be defined as a tangible or intangible resource that is owned or

controlled by an accounting entity, and which is expected to generate future
47
economic benefits. Examples of assets include land and buildings, motor vehicles,
plant and machinery, tools, office furniture, fixtures and fittings, office equipment,
goods for resale (known as inventory), amounts owed to the accounting entity by
its customers (i.e. trade receivables), money in a bank account, and cash in hand.
An accounting entity may be viewed as a set of assets and liabilities. Perhaps the
most familiar form this takes is the statement of financial position. As an equation
this would appear as follows:
Proprietor's ownership interest in the business = Net resources of the business
The use of the word 'net' to describe the resources possessed by the business
recognizes that there are some amounts set against or to be deducted from the
assets. There are two major types of such deduction: liabilities and provisions.
A liability can be defined as a legal obligation to transfer assets or provide services

to another entity that arises from some past transaction or event. Liabilities
represent claims by outsiders (compared to the owners, whose claims are equity or
capital) and may include such items as loans made to the business and amounts
owed for goods supplied (i.e. trade payables).
Provisions are amounts provided to allow for liabilities that are anticipated but not
yet quantified precisely, or for reductions in asset values. Examples are bad debts
and depreciation.
Given that liabilities can be regarded as being negative in relation to assets, the
accounting equation can now be stated in the form and is expressed as:
Assets = Sources of Finance

48
Assets may be tangible e.g. land, building, plant, machinery, equipment, furniture,
investments, cash, bank, stock, debtors etc. or intangible e.g. patent rights, trade
marks, goodwill etc.,
Sources include internal i.e. capital provided by the owner and external i.e.
liabilities. Liabilities are the obligations of the business to others/ outsiders. The
above equation gets expanded.
Assets = Liabilities + Capital
All transactions of a business can be referred to this equation:
Assets = Liabilities + Owner's equity
To further explain the transaction of revenues, expenses, losses and gains, the
equation can be expanded thus:
Assets + Expenses = Liabilities + Revenue + Owner's equity or Assets = Liabilities

+ (Revenue – Expenses) + Owner's equity or Assets = Liabilities + Owner's equity
+ Owner's equity (income) which ultimately becomes:
Assets = Liabilities + Owner's equity
Let us consider the facts of the following case, step by step, to understand as to
how the equation remains true even in changed circumstances.
Illustration 2
1. Commenced business with cash₦ 50,000
2. Purchased goods for cash ₦ 20,000 and on credit ₦ 30,000
49
3. Sold goods for cash ₦ 40,000 costing ₦ 30,000
4. Rent paid ₦ 500
5. Bought furniture ₦ 5,000 on credit
6. Bought refrigerator for personal use ₦ 5,000
Solution:
1. Business receives cash ₦ 50,000 (asset) and it owes ₦ 50,000 to the proprietor
as his capital i.e. equity.
Assets - (₦) Liabilities + (₦) Owner’s Equity (₦)

Cash 50,000 NIL Capital 50,000
(2) Purchased goods for cash ₦ 20,000 and on credit ₦ 30,000. Business has
acquired asset namely – goods worth ₦ 50,000 and another asset namely = cash
has decreased by ₦ 20,000 while liability– creditors have been created of ₦
30,000.
Assets - (₦) Liabilities + (₦) Owner’s Equity (₦)

Cash 30,000 Creditors 30,000 Capital 50,000
Goods 50,000
80,000 30,000 50,000
(3) Sold goods for cash ₦ 40,000 costing ₦ 30,000

This transaction has resulted in decrease of goods by ₦ 30,000 and increase in cash
by ₦ 40,000 thus Increasing equity by ₦ 10,000
50
Assets (=) (₦) Liabilities (+) (₦) Owner's equity (₦)
Goods 20,000
90,000 30,000 60,000
(4) Rent paid ₦ 500. This transaction has resulted in an expenditure of ₦500
effecting decrease of cash and equity by ₦ 500 each.
Goods 20,000
89,500 30,000 59,500
(5) Bought furniture on credit ₦ 5,000. This transaction results in acquiring an

asset namely furniture worth ₦ 5,000 and increasing creditors by ₦ 5,000

Goods 20,000
Furniture 5,000
94,500 35,000 59,000
(6) Bought refrigerator for personal use ₦5,000. This transaction will have the
effect of reducing both cash as well as capital by ₦5,000 each.

Goods 20,000
Furniture 5,000
89,500 35,000 54,5000
51
2.3 Account
An account is a summary of the relevant transactions at one place relating to a
particular head. It records not only the amount of transaction but also their effect
and direction.
This equation is based on what is sometimes referred to as the 'duality' or 'dual

aspect concept’. This concept purports that every transaction has two aspects: one
represented by an asset and the other a liability, or two changes in either the assets
or the liabilities. For example, the purchase of an asset on credit will increase the
assets and the liabilities by the same amount. The purchase of a vehicle for cash
will increase the value of the vehicle asset but decrease the amount of the cash
asset. These two aspects of each transaction are also reflected in the duality of
double-entry bookkeeping.
The accounting equation is a fundamental equation and is a valuable basis from

which to begin understanding the whole process of accounting. It sets out the
financial position of the owners at any point in time, although in practice a
complete and detailed statement of financial position may only be produced
periodically, such as monthly or yearly.
In Text Question 2: What is an account?

In Text Answer 2: An account is a summary of the relevant transactions at one place relating
to a particular head. It records not only the amount of transaction but also their effect and
direction.
2.4 The Accounting Period and Profit Reporting

The accounting period concept (sometimes called periodicity concept) is a means
of dividing up the life of an accounting entity into discrete periods for the purpose
of reporting performance for a period of time (in a statement of profit and loss) and
52
showing its financial position at a point in time (in a statement of financial
position). The period of time is usually one year and is often referred to as the
accounting year, financial year or reporting period. Each accounting year of an
entity's life normally ends on the anniversary of its formation, and therefore does
not necessarily coincide with the calendar year. It could thus end on any day of the
calendar year, but for convenience the accounting year is nearly always taken to be
the end of a calendar month, and sometimes adjusted to the end of the calendar
year or to the end of a particular month (e.g. for tax reasons). Some companies
report on their financial position half-yearly or even quarterly. Thus, the
accounting period can be less than one year.
2.5 Revenue Expenditure versus Capital Expenditure

The word 'capital' is associated with items that appear in the statement of financial
position (e.g. owners' capital), whereas the word 'revenue' involve items that
appear in the statement of profit and loss (comprehensive income). Expenditure of
the type that is to be matched against the period's revenue and used up in the period
is called revenue expenditure. Revenue
expenditure will have no value at the end of
the period to which it relates. Revenue
expenditure is distinguished from capital
expenditure - that which represents amounts
which it is appropriate to carry forward as
part of the next year's opening statement of
financial position. Capital expenditure is
carried forward because it will be used over
a number of periods and contributes to
several periods' revenues.
53
What do you understand by the accounting process?
4.0 Summary
In this session, we have discussed on the accounting equation and its components.
The accounting process was highlighted, the statement of financial position and the
accounting equation were stated and illustrated, and the accounting period and
profit reporting were discussed as well as a discussion on revenue expenditure
versus capital expenditure.

1. Pass necessary Journal entries in the books of Narender for the month of March,
2006:
i) An old machinery appearing in books exchanged for a new machinery of
₦5,000.
ii) Issued a cheque for ₦1,000 in favour of landlord for a rent for the month of
March.
iii) Paid electricity bill of ₦450 by cheque.
iv) The goods destroyed by theft ₦ 3,000.
v) Paid wages for the installation of machinery ₦5,000.
vi) Accrued interest ₦1100.
vii) Goods worth ₦4,000 given away by way of charity.
viii) Goods taken by Proprietor worth ₦10,000 for personal use.
2. From the following transactions of Mr. Kamal Mahajan write up journal entries
and post them into ledger.2006
Jan.1 Assets-Cash in hand ₦2,000, Cash at bank ₦5,000, Stock of goods ₦4,000,
Machinery ₦9000, Furniture ₦2,000, Sham owes ₦500,
54
Ram owes ₦3,500. Liabilities - Loan ₦4,000; sum owing to Y ₦3,000.
Jan.2 Sold goods to Pawan₦3,000.
Jan. 5 Received Rs. 2,950 from Pawan in full settlement of his accounts.
Jan. 6 Payment made to Y ₦1,975 by cheque, he allowed discount of ₦25.
Jan. 8 Old furniture sold for ₦200.
Jan. 10 Ram pays ₦3,400 by chequeand discount allowed to him ₦100,
Cheque deposited in bank.
Jan. 13 Paid for repairs to machinery ₦250
Jan. 15 Bank intimates the cheque of Ram has been returned dishonoured.
Jan. 18 Paid municipal taxes ₦200.
Jan. 22 Bought goods from Sita& Co. ₦1,000.
Jan. 25 Goods worth ₦ 600 given away as charity.
Jan. 31 Returned goods to Sita& Co. ₦1,000.
Jan. 31 An amount which was written off as bad debts in 1998 recovered ₦1,000.
3. Pass necessary journal entries and post them in the appropriate Ledger Accounts
of Kamal for the month of January 2006:
1 Started business with ₦2,00,000 in the bank and ₦40,000 cash.
1 Bought shop fitting ₦40,000 and a van ₦60,000, both paid by cheque.
2 Paid rent by cheque₦5,000.
3 Bought goods for resale on credit from Zakir& Co. ₦50,000.
5 Cash sales ₦5,000.
8 Paid wages of assistant in cash ₦1,000.
10 Paid insurance by cheque₦500
12 Cash sales ₦8,000
15 Goods returned to Zakir& Co. ₦6,000.
17 Paid Zakir& Co. ₦30,000 by cheque.
24 Bought stationery and paid in cash ₦500.
55
25 Cash sales ₦5,000.
27 Paid Rao& Co. ₦14,000 by cheque.
31 Paid ₦ 20,000 into the bank.
6.0 Additional Activities (Videos, Animations &Out of Class activities)

a. Visit U-tube https://www.youtube.com/watch?v=3y-ZfzoER_I,
https://www.youtube.com/watch?v=iNWW6b09ZBI . Watch the video &
summarise in 1 paragraph
b. View the animation on http://study.com/academy/lesson/the-accounting-
equation-definition-components.html,,
https://www.youtube.com/watch?v=T2l9zvz5oAE and critique it in the discussion
forum

Limited,Ikeja, Lagos
Aguolu, O. (2010). Financial Accounting.A Practical Approach. Institute for
Development Studies, Enugu, Nigeria
Accounting
56
STUDY SESSION 3
Basic Documentation
Introduction
1.0 Learning Outcome.
2.0 Main Content:
2.1 Source Document.
2.2 Subsidiary Books.
4.0Summary.
5.0 Self-Assessment questions and Answers.
7.0 References/Further Readings.
Introduction
Welcome to session 3 of this course, basic accounting documentation is our focus
of interest.We focused on Accounting Equation and its Components in our
previous session.
Every business transaction tends to be supported by a source document. Source
documents are original documents from which accounting records are kept. Data
from the documents are first assembled and classified before being entered in the
ledger. The books in which the data are first assembled and classified before they
are posted to the ledger are called subsidiary books, so called because they are
subordinate but give support to the ledger which is the principal book of account.
The different kinds of source documents and the subsidiary books are however
discussed.
57
1. Identify the source document.
2. Discuss about subsidiary books.
2.0 Main Content

2.1 Source Document
1. Invoice- An invoice is a business document prepaid when goods are sold
and is normally sent by the seller to the buyer. It gives details of the goods and the
value of the transaction. To the seller of the goods, the copy of the invoice is a
sales invoice. The same document in the hands of the buyer is called a purchase
invoice. The purpose of the invoice, which is sent by the seller, is primarily to
inform the buyer how much is owed for the goods supplied. It is not a demand for
payment. The information shown on an invoice typically consists of the following
items:
• The name and address of the seller.
• The name and address of the buyer.
• The invoice and delivery note number of the seller (usually the same).
• The date of the invoice.
• The address to which the goods were delivered.
• The buyer's order number.
• The quantity of goods supplied.
• Details/description of the goods supplier.
The buyer checks the invoice against the order and the delivery note (or more
usually with a goods received note prepared by the receiving department). If
correct, the invoice is then entered in the buyer's books. Similarly, a copy of the
invoice would have been entered in the seller's books.
58
2. Debit Note- This document is similar to the invoice. It is usually prepared
whenever it becomes necessary, for one reason or the other, to increase the
amount due from a debtor. An example is where the seller has undercharged a
customer on an invoice. A debit note is sent by the seller if the buyer has been
undercharged on the invoice. It has basically the same layout and information as
the invoice except that instead of details of the goods, it shows details of the
undercharge. It is recorded in the books of the seller and buyer in the same way as
an invoice.
3. Credit Note- The credit note has already been mentioned. It is another
important source document in accounting. In the eyes of the seller, it may be
regarded as the opposite of a sales invoice. Whereas the later debits the
customer’s account with the amount shown, a credit note credits and accordingly
reduces the customer’s indebtedness. This can happen if:
a. The customer has by mistake, been overcharged on the sales invoice,
b. The customer returns some of the goods previously sold to him,
c. Some allowance is to be made to the amount by which the customer’s
account has been credited.
A credit note has basically the same layout and information as an invoice, except
that instead of the details of the goods, it will show the reason why it has been
issued. A credit note will be recorded in the books of the seller and buyer in a
similar way as the invoice, except that the entries are the reverse. This document is
called a credit note because it informs the buyer that the account in the books of
the seller is being credited.
4. Cheque- a cheque is a very important document in paying debts involving

amounts that cannot conveniently be settled in cash. It is defined in the Bills of
59
Exchange Act 1882 as a bill of exchange drawn on a banker, payable on demand.
But then, what is a bill of exchange? We need to know what it is in order to
understand the main features of a cheque both which seem to have similar
characteristics. A bill of exchange is defined as an unconditional order in writing,
addressed by one person to another, signed by the person giving it, requiring the
person to whom it is addressed to pay on demand, or at a fixed determinable future
time, a sum certain in money to or to the order of, a specified person or to the
bearer. This is the most common form of payment in business because of its
convenience and safety. Most cheques are crossed and therefore have to be paid
into a bank account. This makes it possible to trace the cheque if it is stolen and
fraudulently passed on to someone else. A crossed cheque may be paid into
anyone's bank account if the payee endorses the back of the cheque. Any cheque
that can be cashed by a payee in his order over the counter of a bank on which it is
drawn is an open cheque.
The information that must be shown on a cheque consists of the following items:
• The date,
• The signature of the drawer (i.e. payer),
• The name of the drawee (i.e. the bank at which the drawer has the account),
• The name of the payee (i.e. who is to receive the money,
• The words 'Pay’ or 'Order the sum of,
• The amount of money in figures and in words.
The bank account number of the drawer, and the cheque and bank number are also
shown on pre- printed cheques. Since there is only one copy of a cheque, it is
essential to write on the cheque stub to whom the cheque was paid (i.e. the payee),
the amount and what the payment was for. Without this information the books of
account cannot be prepared.
60
5. Receipt- This is a written document issued to acknowledge that money or
valuable property has been received. The date and details of the transaction as well
as the receipt number must be stated on the document. Receipts relating to cash are
called cash receipts. There are other types of receipts but we are mainly interested
in those which are relevant to accounting. The law requires the seller to give the
buyer a receipt for goods or services that have been paid for in cash. However,
there is no legal requirement to do so in the case of payments by cheque.
A receipt must contain the following information:
• The name of the payer,
• The signature of the recipient,
• The amount of money in figures and in words,
• The date.
A receipt is only recorded in the books of account when it relates to cash receipts
and payments.
6. Voucher- these are original document used for obtaining authorization for
all payments irrespective of magnitude or mode. i.e.
whether by cash or cheque or letter. Vouchers in general
provide evidence of the transaction recorded in the
books of account like the receipt for payments made by
cash to outsiders.
In all, the purpose of source documents is to originate

data for accounting records, the data are not recorded directly in the ledger. They
are, instead, first classified and entered in the relevant subsidiary books before
being summarised for entry in the respective ledger accounts.
61
In Text Question 1: Mention the source documents that you know
In Text Answer 1: Invoice, Debit Note, Credit Note, Cheque, Receipt and
Voucher.
2.2 Subsidiary Books

Subsidiary books are books into which transactions isrecorded on a daily basis
from the source documents and from which postings are made periodically to the
relevant accounts in the ledger. This practice prevents the ledger from containing
too many details. The subsidiary books are:
1. The sales day book: Another name for the sales day book is the sales
journal. It records the sale on credit of goods bought specifically for resale.
It is written up from copies of sales invoices and debit notes retained by the
seller. The amount entered in the sales daybook is after deducting trade
discount (but before deducting cash discount). The sales total recorded in
this book are posted periodically (for instance, weekly, monthly, according
to the need) to the credit side of the sales account in the general ledger while
the accounts of individual customers are debited in the sales ledger with the
value of individual sales made to them. A debit entry is thus made in the
individual debtor’s account in the debtor’s ledger and a periodic total is
credited to the sales account in the general ledger in order to complete the
double entry.
2. The purchases day book: The purchase day book is also called purchase
journal. It is a book in which we record the purchase on credit of goods for
resale. It is written up from the invoices and debit notes received from
suppliers. The amount entered in the purchases day book is after deducting
trade discount (but before deducting cash discount). The source document
for making entries are purchase invoices from suppliers.
62
3. The sales returns day book: In which is recorded the goods sold on credit
that are returned by customers. The source of information for making entries
in the returns day book is credit notes retained by the seller.
4. The purchases return day book: In which is recorded the goods purchased
on credit that are returned to suppliers. The source document for making
entries are purchase invoices and credit notes received from suppliers.
5. The petty cash book: This is a book in used is recorded cash received and
cash paid. The source documents for the entries are receipts or petty cash
vouchers where employees are reimbursed expenses.
6. The cash book: This is the book in which are recorded cheques received
(and cash paid into the bank) and payments made by cheque (and cash
withdrawn from the bank). This is written up from the bank paying-in book
stub and cheque book stubs.
7. The Journal: Journal is a historical record of business transactions or

events. The word journal comes from the French word "Jour" meaning
"day". It is a book of original or prime entry written up from the various
source documents. Journal is a primary book for
recording the day to day transactions in a
chronological order i.e. in the order in which they
occur. The journal is a form of diary for business
transactions. This is also called the book of first
entry since every transaction is recorded firstly in the
63
Source Documents Books of Prime Entry
Sales day Book Sales invoices (copy)
Purchase day book Purchase invoices (received)
Sales credit notes Sales credit notes (copy)

(copy)
Purchase credit notes

Purchase returns (received)
day book
Ledger
Petty cash book
Receipts and petty cash
Vouchers
Cheque book stub
Cash book
Paying-in book stub
Invoices for non-

The Journal
currentassets
Source: Thomas and Ward (2012)
journal. It is a book in which are recorded any transactions that are not included in
any of the other books of prime entry. At one time all entries passed through the
journal, but now it is primarily used to record the purchase and sale of non-current
64
assets on credit, the correction of errors, opening entries in a new set of books and
any remaining transfers. Non-current assets are items not bought specifically for
resale, such as land and buildings, machinery or vehicles. The journal is written up
from copies of invoices and adjustments requested by the accountant.
In summary, this model depicts the relationships from the source documents to the
books of primary entry.
In Text Question 2: Subsidiary books are books into which transactions are recorded on a daily
basis from the source documents and from which postings are made periodically to the relevant
accounts in the ledger. What are those books?
In Text Answer 2: The sales day book, The purchases day book, The sales returns day book, The
purchases returns day book, The petty cash book, The cash book and The Journal.
3.0 Tutor Marked Assignments

What are subsidiary books?
4.0 Summary
In this session, we have discussed about the basic documentation and prime books.
We have listed and discussed the source document as well as extensively,
discussed the subsidiary books of entry.

1. Explain what you understand by source documents.
2. Discuss all the subsidiary books that you know.
65
a. Visit U-tube https://www.youtube.com/watch?v=1ELNME4y2lwWatch the
video & summarise in 1 paragraph
b. View the animation on https://www.youtube.com/watch?v=yYXd3Ew-od4 and
critique it in the discussion forum
7.0 References
Accounting
66
STUDY SESSION 4
General Ledger and the Journal
Introduction
2.0 Main Content:
2.1 Prime Books of Primary Entry.
2.2Meaning of Journalising.
2.3 Advantages of Journal.
2.4 Goods Account.
2.5 Important Considerations for Recording the Business Transactions.
2.6 Ledger.
2.7Relationship between Journal and Ledger.
2.8 Balancing of an Account.
4.0 Summary.
7.0 References/ Further Readings
Introduction
We will be dealing withGeneral Ledger and the Journal in this session.
Transactions must first be entered in the books of prime entry before it is recorded
in the general ledger. This is to facilitate the posting of the general ledger because,
transactions of the same types are entered in the same book of prime entry, which
is periodically posted to the general ledger in total. These initial entries in the
prime books do not form part of the double-entry bookkeeping.
67
1. Define and identify the prime books of original entry.
2. Give the meaning of journalizing.
3. List some important considerations for recording
a business transaction.
4. Define a ledger.
5. Discuss how to balance an account.
6. Define a journal.
2.0 Main Content

2.1 Prime Books of Primary Entry
In this session, we shall examine the books of prime entry used in recording credit
transactions. These consist of:
(1) the sales day book,
(2) the purchases day book,
(3) the sales returns day book,
(4) the purchases return day book,
(5) the journal. These prime books have been defined in the previous session.
Some illustrations will be considered in this session.

An illustration of a Prime Book of Primary Entry
Date Particulars L. F. Debit ₦ Credit ₦
The drawing above represents a typical book of prime entry with different
columns. The following are the columns and their recorded items.
68
(a) Date Column: This column shows the date on which the transaction is
recorded. The year and month is written once, till they change.
(b) Particulars Column: Under this column, first the names of the accounts to be
debited, then the names of the accounts to be credited and lastly, the narration (i.e.
a brief explanation of the transaction) are entered.
(c) L.F., i.e. Ledger Folio Column: Under this column, the ledger page number
containing the relevant account is entered at the time of posting.
(d) Debit amount Column: Under this column, the amount to be debited is
entered.
(e) Credit amount Column: Under this column, the amount to be credited is
entered.
2.2Meaning of Journalising
The process of recording a transaction in the journal is called journalising. The
various steps to be followed in journalising business transactions are given below:
Step 1 Ascertain what accounts are involved in a transaction.
Step 2 Ascertain what is the nature of the accounts involved.
Step 3 Ascertain which rule of debit and credit is applicable for each of the
accounts
involved.
Step 4 Ascertain which account is to be debited and which is to be credited.
Step 5 Record the date of transaction in the 'Date column'.
Step 6 Write the name of the account to be debited, very close to the left hand
side (i.e. the line demarcating the 'Date column' and the 'Particulars column')
along with the abbreviation 'Dr.' on the same line against the name of the
account in the 'Particulars column' and the amount to be debited in the 'Debit
Amount column' against the name of the account.
69
Step 7 Write the name of the account to be credited in the next line preceded by the
word 'To' at a few spaces towards right in the 'Particulars column' and the
amount to be credited in the 'Credit Amount column' against the name of the
account.
Step 8 Write 'Narration' (i.e. a brief description of the transaction) within brackets
in
the next line in the 'Particulars column'.
Step 9 Draw a line across the entire 'Particulars column'
to separate one Journal Entryfrom the other.
In Text Question 1: What is the meaning of Journalising?

In Text Answer 1: The process of recording a transaction in the
journal is called journalising.
2.3Advantages of Journal
1. The transactions are recorded in journal as and when they occur so the chances
of errors are minimized.
2. It helps in preparation of ledger.
3. Any transfer from one account to another account is made through Journal.
4. The entry recorded in journals are self- explanatory as it includes narration also.
5. It can record any such transaction which cannot be entered in any other books of
account.
6. Every transaction is recorded in chronological order (date wise) so the chances
of manipulations are reduced.
7. Journal shows all information in respect of a transaction at one place.
8. The closing balances of previous year of accounts related to assets and liabilities
can be brought forward to the next year by passing journal entry in journal.
70
2.4 Goods Account
In accounting the meaning of goods is restricted to only those articles which are
purchased by a businessman with an intention to sell it. For example, if a
businessman purchased typewriter, it will be good for him if he deals in computers
but if he deals in other business say clothes then computers will be asset for him
and clothes will be goods.
Sub-division of goods accounts

The goods account is not opened in accounting books. In place of goods account
the following accounts are opened in the books of accounts:
Purchases account: This is opened for goods purchased on cash and credit.
Sales account: This account is opened for the goods sold on cash and credit.
Purchase returns account or return outward Account: This account is opened

for the goods returned to suppliers.
Sales returns account or return inward account: This account is opened for the
goods returned by customers.
2.5 Important Considerations for Recording the Business Transactions

1. Trade discount
Trade discount is usually allowed on the list price of the goods. It may be allowed
by producer to wholesaler and by wholesaler to retailer for purchase of goods in
large quantity. It is not recorded in the books of account and entry is made only
with the net amount paid or received. For example, purchased goods of list price
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₦8,000 at 15% trade discount from X. In this case, the following entry will be
passed:
₦₦
Purchases Account Dr. 6,800
To X 6,800
(Being goods purchased at 15%Trade discount less list price)
2. Cash discount
Cash discount is a concession allowed by seller to buyer to encourage him to make
early cash payment. It is a Nominal Account. The person who allows discount,
treat it as an expense and debits in his books and it is called discount allowed and
the person who receives discount, treat it as an income and it is called discount
received and credited in his books of account as "Discount Received Account." For
example, X owes ₦6,000 to Y. He pays ₦5,950 in full settlement against the
amount due. In the books of X, the journal entry will be:
₦₦
YDr.6,000
To Cash Account 5,950
To Discount Received account 50
(Being Cash paid and discount received)
In the books of Y ₦₦
Cash Account Dr. 5,950
Discount Allowed Account Dr. 50
To X 6,000
(Being cash received and discount allowed)
3. Goods distributed as free samples

Sometimes business distribute goods as free samples for the purpose of
advertisement. In this case, Advertisement Account is debited and Purchases
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Account is credited. For example, goods costing ₦8000 were distributed as free
sample. To record this transaction following entry will be passed:
₦₦
Advertisement Account Dr. 8,000
To Purchases Account 8,000
4. Interest on capital
Interest paid on capital is an expense. Therefore, interest account should be
debited. On the other hand, the capital of the business increases. So the capital
account should be credited. The entry will be as follows:
Interest on Capital Account Dr.
To Capital Account
5. Interest charged on drawings

If the interest is charged on drawings then it will be an increase in the income of
business, so interest on drawings will be credited. On the other hand, there will be
increase in drawings or decrease in Capital. So Drawings Account will be debited.
To record this, following entry will be passed:
Drawing Account/Capital Account Dr.
To Interest on Drawing Account
6. Depreciation charged on fixed assets

Depreciation is the gradual, permanent decrease in the value of an asset due to
wear and tear and many other causes. Depreciation is an expense so the following
entry will be passed:
Depreciation Account Dr.
To Asset Account
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7. Bad debts
Sometimes a debtor of business fails to pay the amount due from him. Reasons
may be many e.g. he may become insolvent or he may die. Such irrecoverable
amount is a loss to the business. To record this following entry will be passed:
Bad Debts Account Dr.
To Debtor's Account
8. Bad debts recovered

When any amount becomes irrecoverable from any costumer or debtor his account
is closed in the books. If in future any amount is recovered from him then his
personal account will not be credited because that does not exist in the books. So
the following entry is passed:
Cash AccountDr.
ToBad Debts Recovered Account
9. Purchase and sale of investment

When business has some surplus money, it may invest this amount in shares,
debentures or other types of securities. When these securities are purchased, these
are recorded at the purchase price paid. At the time of sale of investment, the sale
price of an investment is recorded in the books of accounts.
The following entry is passed to record the purchase of investment:
Investment Account Dr.
To Cash Account
In case of sale of these securities the entry will be:
Cash Account Dr.
To Investment Account
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10. Loss of goods by fire/accident/theft
A business may suffer loss of goods on account of fire, theft or accident. It is a
business loss and a nominal account. It also reduces the goods at cost price, and
increases the loss/expenses of the business. The entry will be passed as:
Loss by fire/Accident/theft Account Dr.
Insurance Company Account Dr.
To Purchases Account
11. Income tax paid

Income Tax paid should be debited to Capital Account or Drawings Account and
credited to Cash Account in case of sole proprietorship and partnership firms. The
reason behind this is that income tax is a personal expense for the sole trader and
partners because it is paid on income of proprietor. The entry will be as follows:
Capital Account/Drawing Account Dr.
To Cash Account
12. Bank charges

Bank provides various services to their customers. Bank deducts some charges by
debiting the account of customers. It is an expense for the business. To record this,
Bank charges account is debited and bank account is credited in the books of
customer.
13. Drawings account

It is a personal account of the proprietor. When the businessman withdraws cash or
goods from the business for his personal/domestic use it is called as 'drawings'.
Drawings reduce the capital as well as goods/cash balance of the business. The
journal entry is:
Drawings Account Dr.
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To Cash Account
To Purchases Account
14. Personal expenses of the proprietor

When the private expenses such as life insurance premium, income tax, home
telephone bill, tuition fees of the son of the proprietor etc. are paid out of the cash
or bank account of business it should be debited to the Drawings Account of the
proprietor.
15. Sale of asset/property

When the asset of a business is sold, there may occur a profit or loss on its sale. Its
journal entry is:
(i) In case there is a profit on sale of Property/Assets
Cash/Bank Account Dr.
To Asset/Property Account
To Profit on sale of Asset Account
(ii) In case of a loss on sale of asset

Loss on sale of Asset Account Dr.
To Asset Account
16. Amount paid or received on behalf of customer

(i) When the business entity pays the amount on behalf of old reputed customers
such as carriage in anticipation of recovering the same later on, carriage account
should not be opened because carriage is not the expense of the seller. It should be
debited/charged to customer's Personal account.
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(ii) When the business entity receives the amount on behalf of customers from the
third party as mutually settled between the third party and the customer, the
account of the third party/person making the payment should not be opened in the
books of the receiving entity. The journal entry in the books of the entity is:

To Customer/Debtor's Account
17. Amount paid on behalf of creditors

When the creditors/supplier instruct the business entity to make payment on their
behalf, the amount so paid should be debited to creditors account and liability of
the business will decrease accordingly.
18. The events affecting business but they do not involve any transfer/exchange of
money for the time being, they would not be recorded in the financial books.
19. Paid wages/installation charges for erection of machinery

Wages and installation charges are the expenses of nominal nature. But for erection
of machinery no separate account should be opened for such expenses because
these expenses are of capital nature and it will be merged/debited to the cost of
assets i.e. machinery. The journal entry is:
Machinery Account Dr.
To Cash/Bank Account
(Being wages/installation charges paid for the erection of machinery)
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In Text Question 2: Mention some of the Important Considerations for Recording the
Business Transactions.
In Text Answer 2: 1. Trade Discount 2.Cash Discount 3. Goods distributed as free samples
4. Interest on capital 5. Interest charged on Drawings 6. Depreciation charged on Fixed
Assets 7. Bad Debts 8. Bad Debts Recovered 9. Purchase and Sale of investment 10.Loss of
Goods by Fire/Accident/theft.
F. Ledger
Journal is a daily record of all business transactions. In the journal all transactions
relating to persons, expenses, assets, liabilities and incomes are recorded. Journal
does not give a complete picture of the fundamental elements of book keeping i.e.
properties, liabilities, proprietorship accounts and expenses and incomes at a
glance and at one place. Business transactions being recurring in nature, a number
of entries are made for a particular type of transactions such as sales, purchases,
receipts and payments of cash, expenses etc.,
throughout the accounting year. The entries are
therefore scattered over in the Journal. In fact, the
whole Journal will have to be gone through to find
out the combined effect of various transactions on a
particular account. In case, at any time, a
businessman wants to know:
1. How much he has to pay to the suppliers/creditors of goods?
2. How much he has to receive from the customers?
3. What is the total amount of purchases and sales made during a
particular period?
4. How much cash has been spent/incurred on various items of expenses
such as salaries, rent, carriage, stationery?
5. What is the amount of profit or loss made during a particular period?
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6. What is the financial position of the unit on a particular date?
The above mentioned information cannot be easily gathered from the journal itself
because the details of such information are scattered all over the journal. It is thus
of dire need to get a summarised/grouped record of all the transactions relating to a
particular person, or a thing or an expenditure to take managerial decisions. The
mechanics of collecting, assembling and summarisingall transactions of similar
nature at one place can better be served by a book known as 'ledger' i.e. a classified
head of accounts.
Ledger is a principal book of accounts of the enterprise. It is rightly called as the

'King of Books'. Ledger is a set of accounts. Ledger contains the various personal,
real and nominal accounts in which all business transactions of the entity are
recorded. The main function of the ledger is to classify and summarise all the items
appearing in Journal and other books of original entry under appropriate head/set
of accounts so that at the end of the accounting period, each account contains the
complete information of all transaction relating to it.
A ledger therefore is a collection of accounts and may be defined as a summary

statement of all the transactions relating to a person, asset, expense or income
which have taken place during a given period of time and shows their net effect.
2.7 Relationship between Journal and Ledger

Journal and Ledger are the most useful books kept by a business entity. The points
of distinction between the two are given below:
1. The journal is a book of original entry whereas the ledger is the main book of
account.
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2. In the journal business transactions are recorded as and when they occur i.e.
date-wise. However, posting from the journal is done periodically, may be
weekly, fortnightly as per the convenience of the business.
3. The journal does not disclose the complete position of an account. On the other
hand, the ledger indicates the position of each account debit wise or credit
wise, as the case may be. In this way, the net position of each account is known
immediately.
4. The record of transactions in the journal is in the form of journal entries
whereas the record in the ledger is in the form of an account.
Utility of a ledger
The main utilities of a ledger are summarised as under:
a. It provides complete information about all accounts in one book.
b. It enables the ascertainment of the main items of revenues and expenses.
c. It enables the ascertainment of the value of assets and liabilities.
d. It facilitates the preparation of Final Accounts.
Format of a Ledger Account

A ledger account can be prepared in any one of the following two forms:
Form 1
Name of the Account..............
Dr.Cr.
Date Particulars Folio Amount Date Particulars Folio Amount
(N)
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Form 2
Name of the Account...............
Dr. Cr.
Date Particulars Folio Debit Credit Dr./Cr. Balance
Amount Amount
(N) (N)
Illustration 3: From the following transactions of Nestor, find out the nature of
accounts and also state which account should be debited and which should be
credited:
a. Rent paid
b. Interest received
c. Purchased furniture for cash
d. Machinery sold in cash
e. Outstanding salaries
f. Paid to Surinder
Solution:
Analysis of Transactions
Transaction Accounts Involved Nature of Account Debit/Credit
i) Rent paid Rent Account Nominal Account Debit
Cash Account Real Account Credit
ii) Interest Received Cash Account Real Account Debit

Interest Account Nominal Credit
iii) Purchased Furniture Account Real Account Debit

furniture for cash Cash Account Real Account Credit
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iv) Machinery sold in Cash Account Real Account Debit
cash Machinery Account Real Account Credit
v) Outstanding Salary Salary Account Nominal Account Debit

Outstanding Salary Personal Account Credit
Account
Surinder's Account Personal Account Debit
vi) Paid to Surinder Cash Account Real Account Credit
Illustration: Journalise the following transactions:
2005 Naira
Jan. 1 Morgan started business with cash 80,000
Jan. 6 Purchased goods from Ram on credit 30,000
Jan. 8 Sold goods on cash 6,000
Jan. 15 Bought Furniture from Bash for cash 8,000
Jan. 18 Paid Salary to manager 6,500
Jan. 20 Paid Rent to land lord in cash 1,000
Solution:
Journal
Date Particulars L.F. Debit₦ Credit₦
2005 Cash Account Dr. 80,000
To Morgan's Capital Account 80,000
(Being business started with cash)
"6 Purchases Account Dr. 30,000
To Ram's Account (Being purchase on credit) 30,000
"8 Cash Account Dr. 6,000
To Sales Account (Being sold goods for cash) 6,000
" 15 Furniture AccountDr. 8,000
To Cash Account (Being bought furniture for cash) 8,000
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" 18 Salary Account Dr. 6,500
To Cash Account 6,500
(Being salary paid to manager)
" 20 Rent Account Dr. 1,000
To Cash Account (Being rent paid to land lord) 1,000
Compound journal entries

When more than two accounts are involved in a transaction and the transaction is
recorded by means of a single journal entry instead of passing several journal
entries, such single journal entry is termed as 'Compound Journal Entry'.
2.8 Balancing an Account

After transferring the entries from Journal to the ledger, the next stage is to
ascertain the net effect of all the transactions posted to relevant account. When the
posting is completed, most of the accounts may have entries on both sides of the
accounts i.e. debit entries and credits entries. The process of finding out the
difference between the totals of the two sides of a Ledger account is known as
balancing and the difference of the total debits and the total credits of accounts is
known as balance. If the total of the credit side is bigger than the total of the debit
side, the difference is known as credit balance. In the reverse case, it is called debit
balance.
Steps for balancing ledger account

Ledger accounts may be balanced as and when it is required. The balances of
various accounts are ascertained as under:
1. Make the total of both sides of an account in a worksheet.
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2. Write down the higher amount on the side obtained e.g. if the total of the debit
side is ₦6,000 and the credit side is ₦5,500, the amount ₦6,000 is first inserted
in the total on the debit side.
3. Also write down the same total on the other side of the account i.e. the total of
₦6,000 is written against the total on the credit side also.
4. Find out the difference between the two sides of the account. In this example
debit
side is more than credit side; therefore, there is a debit balance of ₦500.
5. This debit balance of ₦500 is to be shown as "By Balance c/d" in the account on
the credit side.
6. Finally, the amount of the closing balance should be brought down as the
opening balance at the beginning of the next day. Remember that if the opening
balance is not written on the next day, the balancing is incomplete.
Balancing of different accounts
Balancing is done either weekly, monthly, quarterly, biannually or annually,
depending on the requirements of the business concern.
Personal Accounts: Personal accounts are balanced regularly to know the

amounts due to the persons or due from the persons. A debit balance of this
account indicate that the person concerned is a debtor of the business concern and
a credit balance indicates that he is a creditor of the business concern. If a personal
account shows no balance at all, it means that the amount due to him or due from
him is settled in full.
Real Accounts: Real accounts are generally balanced at the end of the accounting
year when final accounts are prepared and always show debit balances. But, bank
account may show either a debit balance or a credit balance.
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Nominal Accounts: In fact, nominal accounts are not balanced, as they are to be
closed by transferring them to the final accounts i.e. Trading and Profit and Loss
Account.
Illustration:
Big Sparkle is an electrical goods wholesaler. The transactions during June 20X3,
which are all on credit, were as follows:
1 May Bought on credit from Lightings Ltd various bulbs with a retail price
of ₦1,000 and received 20 per cent trade discount
4 May Sold goods on credit to Electric Reserves Ltd for₦500 and allowed
them 10 per cent trade discount on this amount
8 May Sent Electric Reserves Ltd a credit notes for goods returned that
had a retail valueof₦300
10 May Sold goods on credit to Swiggle Ltd for ₦600 after deducting 40 per
cent trade discount.
12 May Purchased goods with a retail value of ₦1,000 from Swatch Ltd who
allowed 30 percent trade discount.
15May Purchases on credit from Cables Ltd goods costing ₦550.
16 May Sent Swiggles Ltd a credit note' for goods returned that had a retail
value of ₦100.
18 May Swatch Ltd sent us a credit note for ₦300·in respect of goods returned
19 May Received a credit note for goods returned to Lightings Ltd that had a
retail value of ₦250
25 May Sold goods to Gross Retails Ltd on credit for ₦250
27 May Sent Gross Retails Ltd a credit notes for N50 to rectify an overcharge
on their invoice.
28 May Sold goods on credit to Electric Reserves Ltd at a price of ₦569.
29 May Purchased on credit a motor van from Baba Ltd that cost ₦800.
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30 May Sold on credit to Lagos Trading Co. some fixtures and fittings no
longer required in the shop for 350. (Prior. to this the business owned
fixtures costing ₦1,000).
Required
Make the necessary entries in the books of prime entry and general ledger.
Solution
Before starting to undertake double entry, the first step is to summarize the
transactions in the day books. The first part of this solution deals with the
transactions that do not impact on the journal.
Prime Books
Sales day book
Date Name of credit Our invoice Folio Amount₦
customer number
20X3 N
4 May Electric Reserves 100446 F34 450
10 May Swiggle Ltd 100447 F8 600
25 May Gross Retails Ltd 100448 F45 250
28 May Electric Reserves 100449 F15 560
1,860
Sales Returns Day Book
Date credit customer credit note Folio Amount₦

number
20X3 N
8 May Electric Reserves CRN06 F34 270
16 May Swiggle Ltd CRN07 F8 60
27 May Gross Retails CRN08 F45 50
380
Purchases Day Book

Date Name of credit ref no for Folio Amount₦
customer supplier’s
invoice
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20X3
1 May Lightings Ltd Inv460 T23 800
12 May Swatch Ltd 1000672 T5 700
15 May Cables Ltd S0056932 T10 550
2,050
Purchase returns sales book

Date Name of credit ref no for Folio Amount₦
suppliers supplier’s credit
note
20X3 N
18 May Lightings Ltd C00569 T5 300
19 May Swatch Ltd SC452 T23 200
500
Ledgers
The next step is to take the day books and to use them to enter the information into
the main double-entry bookkeeping system (the general ledger, sales ledger and
purchase ledger). These ledger accounts are shown in T account format.
The first two day books to be closed off and posted are those involving customers
(sales day book and the sales return day book). Note the normal double-entry rules
in respect of recording the flow of value are being applied.
General ledger entries
Sales account
20X3 Details₦ 20X3 Details₦
30 May Total per sales day book 1,860
Sales returns account

20X3 Details ₦ 20X3 Details₦
30 May Total per sales returns day book 380
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Sales ledger entries
Electric Reserves Ltd
4 May Sales 450 8 May Returns 270
28 May Sales 560
Swiggle Ltd
Gross Retails Ltd

20X3 Details ₦ 20X3 Details ₦
Next, the two day books involving suppliers (purchases day book and the purchases
return day book) are closed and posted.
Purchase account
20X3 Details₦ 20X3 Details ₦
30May Total purchases day book 2,050 30MayTotal purchases day book 2,050
Purchase returns account

30 May Total per purchases 500
returns day book
Purchase ledger entries

20X3Details ₦ 20X3 Details₦
19 May Returns 200 1 May Purchases 800
Light Ltd
18 May Returns 300 12 May Purchases 700
Purchase account
15 May Purchases 550
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The Journal
The entries required to post the motor van on credit and the sale of fixtures and
fittings are first recorded in the journal before they enter the general ledger
bookkeeping system as follows:
Date Details (account in Folio
Debit Debit CreditCredit
which Amount amount
the ledger entry is to be made) ₦ ₦
20X3 Motor vehicles Dr 800
29 May To Baba Ltd
Being purchase on credit of motor Van Reg no LAG Cr 800
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29 Lagos Trading Co Dr Dr 350 350

May To fixtures and fittings Cr 350
Being sale on credit of shop fittings.
Second, the journal is taken and its entries are posted to the individual ledger
accounts in the general ledger as follows:
Motor vehicles account
29 MayBaba Ltd 800
Baba Ltd account (sundry payable)

29 May Motor vehicles 800
Fixtures and fittings account

1 May Balance b/d 1,000 30 May Lagos Trading Co 350
30 May Balance c/d 650
1,000 1,000
1 June Balance b/d 650
Lagos Trading Co account (sundry receivable)

30 May Fixtures and fittings 350
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Notes
1. The fixtures and fittings that were sold must obviously have already been owned
by the business. Their cost is therefore included in the balance brought down on the
debit side of the fixtures and fittings account along with the cost of other fixtures
and fittings owned at that date.
2. The Lagos Trading Co. is referred to as a sundry receivable and Baba Ltd as a
sundry payable.

Explain the meaning of journal and the advantages of journal
4.0 Summary
We have studied the prime books, general ledger as well as the journal. The prime
books of primary entry were listed and discussed, the meaning of journalising was
highlighted, important considerations for recording the business transactions were
listed and discussed. Also the ledger and journal were extensively discussed with
illustrations.

1. What is meant by Journal? Discuss the steps in journalising.
2. Define ledger. Explain the procedure for balancing a ledger account.
3. What is meant by posting? How is posting made from the journal in the
ledger? Explain with suitable examples.
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6.0 Additional Activities (Videos, Animations & Out of Class activities) e.g.
a. Visit U-tube https://www.youtube.com/watch?v=KGzXCWdaskk,,
https://www.youtube.com/watch?v=278qpMgD1nw . Watch the video &
b. View the animation on https://www.youtube.com/watch?v=aRSMl0eWmt0,,,,
https://www.youtube.com/watch?v=IQvZMAAkAkk and critique it in the
discussion forum
7.0 References/Further Reading

Garg, M. C. (2012).Financial Accounting: Meaning, Nature and Role of
Accounting
Hermanson, E., and Maher (2011).Accounting Principles: A Business Perspective,
Financial Accounting. www.opencollegetextbooks.org
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2.0 MODULE 2
Content
Study Session 1: Double Entry and the General Ledger.
Study Session 2: The Balancing of Accounts and the Trial Balance.
Study Session 3: The Cash Book.
Study Session 4: The Petty Cash Book.
STUDY SESSION 1
Double Entry and the General Ledger
Introduction.
2.0 Main Content
2.1The Principles of Double-Entry.
2.2 Ledger entries for cash transactions.
2.3 Ledger entries for credit transactions.
2.4 Ledger Account Balances.
4.0Summary.
7.0 References.
Introduction
Welcome to session 1, in module 2, we will be about Double Entry and the
GeneralLedger. We will see if this session is anyway intertwined with what we
discussed in the previous session.
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You should understand that, to be able to account properly, accountants need to
understand bookkeeping. Double-entry bookkeeping is a systematic method of
recording an enterprise's transactions in a book called the general ledger, or simply
the 'ledger'. Double-entry bookkeeping is an application of the dual aspect concept.
Under this concept each transaction affects two accounts (hence the name 'double-
entry') and records a flow of value between the accounts. In accounting, a language
has developed to indicate the direction of the flow, to debit an account means to
have value flow into that account, whereas to credit an account means to have
value flow out of that account. Convention has it that a debit always means an
adjustment to the left-hand side of the ledger account, whereas a credit means an
adjustment to the right-hand side of the ledger account. Some people find it easier
to think of debits as being a '+' and a credit as being a '-'.

1. State the principles of double entry.
2. Identify a T-account.
3. Describe ledger entries for cash and credit transactions.
4. Describe ledger entries for returns inward and outward.
2.0 Main Content

2.1 The Principles of Double-Entry
We have to understand what the principles of double entry are. Each page of the
ledger is split into two halves: the left half is called the debit side and the right
half is called the credit side. The ledger is divided into sections called accounts.
In practice, each of these accounts is on a separate page. There is usually an
'account' for every class of expenditure, income, asset, and liability. Separate
accounts are created to also record transactions in and out of the business by its
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owner. For example, there are typically separate accounts for wages expenses, for
stationery, for heat and light, for motor vehicles, loans, drawings, capital
introduced by the owner, and so on. There could be 1,000 accounts, depending on
the detail required by management. Each of these accounts' can be traced to the
financial statements. More detail is provided in the ledger than is provided in the
statement of profit and loss and in the statement of financial position, as too-much
detail would reduce the understanding of the information being presented. So, the
expenses, income, assets and liabilities are usually combined in company financial
statements to provide meaningful information
Double-entry bookkeeping is an
application of the dual aspect concept.
Under this concept each transaction
affects two accounts and records a flow
of value between the accounts. In
accounting, a language has developed to
indicate the direction of the flow, to debit an account means to have value flow
into that account, whereas to credit an account means to have value flow out of that
account. Convention has it that a debit always means an adjustment to the left-hand
side of the ledger account, whereas a credit means an adjustment to the right-hand-
side of the ledger account. Some people find it easier to think of debits as being a
'+' and a credit as being a '-'.
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The following is an example of what a double entry account looks like:
DrCr
Date Particulars Amount Date Particulars Amount
The right hand side of the account is called the credit side. It reflects the giving of
value by the particular account. The payment of cash for the motor vehicle bought
for ₦7000 is shown by crediting cash account with the sum as a giver of value to
motor vehicle account. The accounts in these two examples, assuming the value of
the motor vehicle took place on 1st May, 2010, will appear as follows:
Motor Vehicle Account

Dr. Cr
2010 Cash Account ₦ ₦
May 1 7000
The motor vehicle account has received value of ₦7000 from cash account. This is
denoted by a debit entry in the above account. All future purchases of vehicles will
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be similarly recorded as debit entries in this newly opened account, sales and
disposals of motor vehicle being recorded as credit entries.
Cash Account
Dr Cr
2010 Motor Vehicle ₦
May 1 Account 7000
Cash account has given value worth ₦7000 to the motor vehicle account. The
giving of value is shown by a credit entry in the cash account. Thus for every debit
entry in one account, there must be an equal credit entry in another account. The
general rule of double entry is to debit the account that receives value and credit
the account which gives value with the amount involved
The money value of each transaction is entered once on each side of the general
ledger in different accounts. The actual process of placing the bookkeeping entry in
each account is called 'posting the transaction' or simply 'posting: For example, if
we take one transaction such as the sale of goods for cash of ₦10,000 on 6
January, this would be recorded (posted) as follows:
T-accounts
Many textbooks create a simplified version of a ledger account called a 'T' account
to teach bookkeeping. A 'T' account leaves out some of the detail that is given in
ledger accounts, such as the reference to the folio page (the pages in a ledger are
typically called folios) and contains less lines. A typical 'T' account looks like the
following:
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Dr. Account Name Cr.
Date Particulars ₦ Date Particulars ₦
The date column is the date of the transaction, the details column outlines the other
account being posted to (so that the transaction can be traced) and the N column
records the amount that is being posted Just like the ledger, flows of value to the
account will be debited to the left-hand side, and flows of value from the account
are recorded on the right-hand side (credited). A separate T account is opened for
every type of expense, asset, liability, income and transaction with the owner
(capital introduced and separately, drawings).
Three steps are required for every double-entry transaction:

1. Determine the two accounts to be adjusted.
2. Consider the flow of value (which account does it go to? which account does it
leave?).
3. Identify the money value that is transferring.
In a transaction for the sale of goods for cash of ₦7000 on 1, May.

1. The two accounts affected are the sales account and the cash account.
2. Cash comes in (debit); therefore, the value must leave the sales account (credit).
3. The value transferring is ₦7000. The same occurs with cheques received and
paid, except that they are entered in an account called the bank account instead of
the cash account.
2.2 Ledger Entries for Cash Transactions

When you starts a business, usually investing some money (Capital) into the
business. This is debited to the cash or bank account (depending on whether it is
cash or a cheque) and credited to a capital introduced account. Money introduced
97
at a later date by the proprietor as additional capital is treated in the same way. Any
money withdrawn by the proprietor is credited in the cash or bank account
(depending on whether it is cash or a cheque) and debited to a drawings account.
These accounts are never netted against each other.
Sometimes businesses also borrow money.

The amount received is debited to the cash
or bank account (depending on whether it
is cash or a cheque) and credited to an
account in the name of the lender, who is
referred to as a loan creditor.
Illustration: Complete the following table

showing which accounts are to be debited and which are to be credited in the
spaces provided:
Debit Credit
a) Bought computer for cash
b) A loan of ₦20,000 is received by cheque
c) A loan of ₦10,000 is received by cheque from Ige
d) Paid Stationery by cheque
e) Paid rates by cash
f) Owner wrote a cheque to himself
g) Owner put cash into the business
h) Owner buys a washing machine for his home and pay by
cheque
98
Debit Credit
a) ). Bought office Office computer a/c Cash a/c
computer for cash
b). Bought lorry for cash Motor vehicles a/c Cash a/c
c). A loan of ₦20,000 is Bank a/c Earls a/c (Loan creditor)
received by cheque from Ige
d). Paid stationery by cheque Stationery a/c Bank a/c
e). Paid rates by cash Rate a/c Cash a/c
f). Owner wrote a cheque to Drawings a/c Bank a/c
himself
g). Owner put cash into the Cash a/c Capital introduced a/c
business
h). Owner buys a washing Drawings a/c Bank a/c
machine for his home and pay
by cheque
Double entry is now taken a step further by introducing monetary values and T
account entries. The entries for various cash transactions are illustrated below
Illustration
PreetyTety started business on 1 January 20X3 as a grocer with capital (in cash) of
₦10,000. She also borrowed₦5000 in cash from Lagon Bank Ltd. Her transactions
during January, which are all in cash, were as follows:
1 Jan Paid one month's rent for the shop: ₦1,000

2 Jan Bought fixtures and fittings for the shop: ₦3,000,
8 Jan Purchased goods for resale: ₦4,000,
9 Jan Paid ₦250 carriage inwards,
10 Jan Bought stationery for ₦500,
15 Jan Paid ₦2,000 in wages for shop assistant,
99
20 Jan Cash taken by PreetyTrety for her private use: ₦1,500,
31 Jan Cash takings for month: ₦6,000.
You are required to write up the accounts in the general ledger

Solution
Cash account
20X3 Details ₦ 20x3 Details ₦
1 Jan Rent 1000
1 Jan Capital 10,000 2 Jan Fixtures And Fittings 3000
1 Jan Loan-Lagon Bank Ltd 5,000 8 Jan Purchases 4000
31 Jan Sales revenue 6,000 9 Jan Carriage inwards 250
10 Jan Stationery 500
15 Jan Wages 2000
20 Jan Drawings 1500
Capital Introduced Account

1 Jan Cash 10,000
Loan-Lagon Bank account

1 Jan Cash 5000
Rent Account
1 Jan Cash 1000
Fixtures and fittings account

2 Jan Cash 3000
100
Purchase Account
8 Jan Cash4000
Carriage inwards account

9 Jan Cash 250
Stationery account
10 Jan Cash 500
Wages Account
15 Jan Cash 2000
Drawings Account
20 Jan Cash 1500
Sales Revenue Account

31 Jan Cash 6000
Note:
1. The narrative in the details column of an account specifies the name of the-
account that contains the other entry for each transaction.
2. Carriage inwards refers to haulage costs relating to goods that this business has
purchased and is responsible for transporting from the sellers' premises.
101
2.3 Ledger Entries for Credit Transactions
The entries in the ledger for credit transactions are more complicated than those for
cash transactions. This is because a credit transaction involves at least two (and
sometimes three) events, each of which is recorded in double-entry form. In this
section, credit bookkeeping is explained using the most common types of credit
transactions, the purchase and sale of inventory. Movements in inventory are not
recorded in an inventory account because the value moving out of the account
(sale) is different from the value moving into the account (the purchase). Putting
the two transactions in one account would be an example of netting (off-set),
which is not allowed under law. Users are interested in knowing sales figures; it is
one of the growth indicators. They are also interested in knowing the value of
items that were sold. Therefore, they want to see purchases. The difference
between the sales value and the purchase value of the item(s) sold is the gross
profit on the item(s) and this information is disclosed separately in the statement of
profit and loss (covered later). In addition to sales and purchases, there are two
other types of inventory movement that have to be recorded separately: purchase
returns and sales returns. The level of sales returns gives an indication of the
quality of the entity's products and the level of purchase returns provides
information on the entity's purchasing policy. Therefore, inventory movements are
recorded in four separate accounts. This is illustrated below.
Movements inwards Movement outwards

Postings Postings
Purchases Sales
Debit Credit
Sales returns (returns inwards) Purchase returns (returns outwards)
Debit Credit
102
Postings to the purchases and sales
returns ledger accounts will always be
on the debit side and these accounts
will always have a debit balance, and
postings to the sales and purchase
returns ledger accounts will always be
on the credit side and these accounts
will always have a credit balance. A
walked-through example of the double-entry posting to the appropriate T accounts
is now provided. At this stage it is assumed that the sales ledger and the purchase
ledger are not kept separate from the general ledger, so each credit customer and
credit supplier have their own account in the general ledger.
Credit sales
The first event consists of the purchase or sale of goods on credit as evidenced by
an invoice. The invoice is recorded in the ledger as follows:
1 Feb Sold goods on credit to AB Ltd for ₦5000
The first step is to identify the two accounts affected: The sales account and AB
Ltd account. The next step is to identify the flow of value: The goods represent
the value and the goods physically go to AB Ltd (so the value leaves the sales
account (credit) and flows to AB Ltd.’s account (debit)).
The next step is to identify the monetary value flowing between the accounts: In
this case it is ₦5000.
Sales Account AB Ltd Account

20X3 Details ₦20X3 Details ₦Feb 20X3 Details₦20x3 Details ₦
1 Feb AB Ltd 5000 31 Jan Cash 5000
103
The amount outstanding on credit from a credit customer is referred to as a trade
receivable. In the above example, the balance owing from AB Ltd is a trade
receivable of the business whose books are being prepared.
Credit purchases
2 Feb Purchased goods on credit from CD Ltd for ₦2,500.
The first step is to identify the two accounts affected: The purchases account and
CD Ltd account.
The next step is to identify the flow of value: The goods represent the value and
they physically come from CD Ltd (so the value flows to the purchases account
(debit) and from CD Ltd account (credit).
this case it is ₦2,500.
. CD Ltd account Purchases account

20X3 Details₦20X3 Details ₦ 20x3 Details ₦ 20x3 Details ₦
2 Feb Purchases 2,500 2 Feb CD Ltd 2,500
The amount owing to a business or person from whom goods are purchased on
credit is referred to as trade payable. In the above example, the balance owing to
CD Ltd is a trade payable of the business whose books are being prepared. In the
UK, trade payables are commonly called'creditors'. The term 'creditor' arises from
the existence of an account in the purchaser's books which contains more on the
credit side than on the debit side. IASs do not use the term 'creditor'.
104
Sales returns
A second event that may occur when goods are bought and sold on credit is the
return of goods. This can arise for example when some of the goods delivered were
not ordered, or are defective. When goods are returned the seller sends the buyer a
credit note. This is recorded in the ledger as follows:
3 Feb AB Ltd returned goods invoiced for ₦1,000.
The first step is to identify the two accounts affected: The returns inward account
and AB Ltd account.
The next step is to identify the flow of value: The goods represent the value and
they come from AB Ltd (so the value flows to the returns inward account (debit)
and comes from AB Ltd.’s account (credit)).
The next step is to identify the monetary value flowing between the accounts. In
this case it is ₦1,000.
Return inward account AB Ltd account

20X3 Details ₦20x3 Details₦ 20X3 Details ₦20x3 Details ₦
3 Feb AB Ltd 1,000 1 Feb Sales 5,000 3 Feb Returns 1000
Inward
Purchase returns
This is an everyday occurrence, you may have some experience on this at a point
in time.Similarly, goods received may be defective, or not fit for purpose. These
will be returned to the supplier. They are not treated as a reduction in purchases,
but are recorded in a separate account, the returns outward account.
105
Then on 4 Feb the entity returned goods to CD Ltd invoiced for ₦500
The first step is to identify the two accounts affected: The returns outward account
and CD Ltd account.
The next step is to identify the flow of value. The goods represent the value and
they go to CD Ltd (so the value flows to CD Ltd.’s account (debit) and comes from
the returns outward account (credit).
CD Ltd account Returns outwards account

20X3 Details₦20X3 Details ₦ 20X3 Details₦20X3 Details₦
3 Feb Returns 500 2 Feb Purchases 2500 4 Feb CD Ltd 500
The balance on the customer's (AB Ltd) and supplier's (CD Ltd) accounts thus
show the amounts of money owed at any point in time.
Receiving funds from credit customers

The third event that occurs when goods are bought and sold on credit is the transfer
of money in settlement of the debt. The entries on settlement of a trade receivable
account by a credit customer, is recorded in the ledger as follows:
5 Feb Received from AB Ltd cash of ₦4000
The first step is to identify the two accounts affected: The cash account and AB
Ltd account.
The next step is to identify the flow of value: Money is the value and it flows to
the cash account (debit) and flows from AB Ltd.’s account (credit).
106
Cash account AB Ltd account
20X3 Details₦ 20X3 Details ₦ 20X3 Details ₦ 20X3 Details ₦
5 Feb AB Ltd 1000 1 Feb Sales 5000 3 Feb Returns 1000
Inward
5 Feb Cash 4000
Paying credit suppliers

The entries on settlement of a trade payable account by the business, is recorded in
the ledger as follows:
6 Feb Paid CD Ltd ₦2000 in cash
The first step is to identify the two accounts affected: The cash account and CD
Ltd account.
The next step is to identify the flow of value: Money is the value and it flows from
the cash account (credit) and flows to CD Ltd.’s account (debit).
CD Ltd account Returns outwards account
20X3 Details₦20X3 Details ₦ 20X3 Details ₦ 20X3 Details ₦
4 Feb Returns 500 2 Feb Purchases 2500 5 Feb AB Ltd 40004 Feb CD Ltd 500
Outward
6 Feb Cash 2000
107
An illustration of both credit and cheque transactions is shown below. The three
steps are not shown in each instance. This is something that is done subconsciously
and is not recorded.
Illustration
Eagle Ltd commenced business on 1 July 20X2 as a wholesale greengrocer with a
capital in the bank of ₦2,000,000. His transactions during July were as follows:
1 July Bought a second-hand van by cheque for ₦800,000
3 July Paid insurance on the van by cheque for N150, 000
7 July Purchased goods costing ₦250,000 on credit from A. Bami
11 July Sold goods on credit to B. Ghandi amounting to ₦450,000
14 July Paid carriage outwards by cheque amounting to ₦20,000
16 July Returned goods to A. Bami of ₦50,000
18 July Repairs to van paid by cheque: ₦30,000
20 July B. Ghandi returned goods of ₦75,000
23 July Sent A. Bami a cheque for ₦140,000
26 July Received a cheque from B. Ghandi for ₦240,000
31 July Paid telephone bill by cheque: ₦65,000
31 July Paid electric bill by cheque: ₦45,000
You are required to write up the accounts in the general ledger.

Solution
Bank account
20X2 Details ₦’000 20X2 Details ₦’000
1 July Capital 2,000 1 July Van 800
26 July B. Ghandi240 3 July Motor expenses 150
14 July Carriage outward 20
18 July Motor expenses 30
23 July A. Bami140
31 July Telephone and postage 65
31 July Light and heat 45
108
Capital Account
1 July Bank 2,000
Van Account
20X2 Details ₦’000 20X2 Details₦’000
1 July Bank 800
Motor Expenses Account

3 July Bank 150
18 July Bank 30
Purchases Account
7 July A. Bami250
A. Bami account (trade payable)

16 July Returns 50 7 July Purchases 250
23 July Bank 140
Sales Account
11 July B. Ghandi450
B. Ghandi account (trade receivable)

11 July Sales 450 20 July Returns 75
26 July Bank 240
Purchase returns (outwards) account

20X2 Details₦’000 20X2 Details ₦’000
109
16 July A. Bami50
Sales returns (inwards) account

20X2 Details₦’000 20X2 Details ₦’000
20 July B. Ghandi75
Carriage outwards account

14 July Bank 20
Telephone and postage account

31 July Bank 65
Light and heat account

31 July Bank 45
Adjustments for drawings and capital introduced

Drawings may take a number of forms in addition to cash. For example, it is
common for the owner to take goods out of the business for his or her personal
consumption. This requires an adjustment that may be done by either of two
entries:
1. debit drawings and credit purchases with the cost of the goods to the business; or
2. debit drawings and credit sales where the goods are deemed to be taken at some
other value such as the normal selling price.
2.4Ledger Account Balances

Each account can be totaled, to give a balance that represents all the transactions
affecting that account in the period. This balance can then be transferred to the
statement of profit and loss or the statement of financial position. The main
110
purposes of the ledger accounting system are to provide a
means of ascertaining the total amount of each type of income
and expenditure, the total value of the assets owned by the
business (e.g. cash), and how much is owed to and by the
business. For example, the cash account shows how much
money the business has at any time. When the total amount of money on the debit
side of an account is greater than that on the credit side, the account is said to have
a debit balance. When the reverse is the case, the account is said to have a credit
balance. An account that contains a debit balance represents either an asset (such
as cash) or an expense or loss. An account with a credit balance represents capital,
a liability, income (such as sales) or again

Discuss the principles of double entry
4.0 Conclusion/Summary
In this session, you have learnt on the double entry and general ledger. The
principles of double entry were given, you were introduced to T-accounts, ledger
entries for both cash and credit accounts were discussed, entries also for sales
return and purchase returns, also for receiving and paying funds to customers were
treated.

1. Discuss the principles of double entry.
2. Explain the differences between ledger entries for cash transactions and
ledger entries for credit transactions.
3. What do you understand by ledger account balances?
111
a. Visit U-tube https://www.youtube.com/watch?v=uA0qod8slgw Watch the video
& summarise in 1 paragraph
b. View the animation on https://www.youtube.com/watch?v=HQKV47sDpOY
and critique it in the discussion forum.
7.0 References
ICAN Study Pack (2006).Fundamentals of Financial Accounting.VI Publishing
Limited, Lagos, Nigeria
Accounting.
Publishers, 7, Goloba Street, Isolo, Lagos.
112
STUDY SESSION 2
The Balancing of Accounts and the Trial Balance
Sections and subsections Headings
Introduction
2.0 Main Content.
2.1The Nature of Balancing of Accounts.
2.2 The Trial Balance.
2.3Accounting Errors.
3.0 Tutor Marked Assignments.
4.0Summary.
6.0 Additional Activities (Videos, Animations &out of Class activities).
7.0 References.
Introduction
We will be discussing about Balancing of Accounts and Trial Balancing in this
session, in our previous session we talked about Double Entry and the General
Ledger.
In every account, when there are several entries, we find the cumulative total and
calculate the difference between the debit and the credit totals of the account. The
process, by which this difference is ascertained, is called balancing the account,
and this is done periodically, as the owner of the business requires the information.
Balancing is done either weekly, monthly, quarterly, biannually or annually,

depending on the requirements of the business concern.
113
1. Discuss the trial balance,
2. List the objectives of the trial balance,
3. List the limitations of the trial balance,
4. Discuss the accounting errors.
2.0 Main Content

2.1The Nature of Balancing of Accounts
Personal accounts are balanced regularly to know the amounts due to the persons
or due from the persons.
A debit balance of this account indicate that the person concerned is a debtor of the
business concern and a credit balance
indicates that he is a creditor of the business
concern. If a personal account shows no
balance at all, it means that the amount due to
him or due from him is settled in full. Real
accounts are generally balanced at the end of
the accounting year when final accounts are prepared. They always show debit
balances. But, bank account may show either a debit balance or a credit balance.
Nominal accounts are not balanced, as they are to be closed by transferring them to
the final accounts i.e. Trading and Profit and LossAccounts.
The procedure for balancing an account is as follows:

1. Leave one blank line under the last entry in the ledger account and draw parallel
lines on the top and bottom of the next line in the amounts column on each
side. When this happens, it marks the end of the period. All the transactions
114
before the total lines represent the period that has just ended and the area after
the total lines represents the new period.
2. Add up each side of the ledger account (the debit and credit sides) and calculate
the difference.
3. If the amount of the debit side exceeds that on the credit side, enter the
difference on the credit side immediately after the last entry on that side in the
blank line for this purpose. This is the closing balance on the account and
should be done on the both sides of the account. The result is that with the
entered closing balance, both sides balances will total exactly.
4. Enter the total of each side of the ledger account between the parallel lines.
These two figures should now be the same.
5. There are three descriptions used to close off accounts. These descriptions
identify where the closing balance will end up in the new period:
a. When the ledger account is a statement of financial position account (an asset,
capital or liability account), the closing balance within the period (before the
parallel lines) should be described as the 'balance carried down' (Bal. C/D).
Enter the same figure on the opposite side below the parallel lines. This should
be described as the 'balance brought down' (Bal. b/d).
b. When the account is a statement of profit and loss account (income or expense
accounts for example sales, wages, etc.) the closing balance transfers to the
statement of profit and loss (P/L) account and should be described as such.
This is a T account that is set up to determine the profit or loss made in the
period.
c. Finally, any account that represents a movement in owners' capital (drawings,
capital introduced and the statement of profit and loss account) will be
balanced off to the owners' capital account. Therefore, the description showing
the destination of the closing balance on these accounts will be 'owners'
'capital: The owners' capital account is a statement of financial position
115
account. As all movements take place in the latter-mentioned accounts, this
account will only have the opening balance. When all the movement accounts
are closed and the balances transferred to this account, it will be closed and the
balance carried down to the next period. This is the last account to be closed
off.
Illustration: Enter the following transactions in the Journal of Rameh, and post
them to the Ledger. 2006
Jan. 1 Assets in hand: Cash N 630; Cash at Bank ₦23,100;

Stock of goods; N 26,400; M. & Co., ₦6,750.
Liabilities: Marathi & Co. N3, 880; Ram & Sons ₦3000.
"2Received a cheque from M. & Co. in full settlement₦ 6,650
“4 Sold goods to Chand & Sons on credit ₦1,440
Carriage paid ₦35
Sold goods to G. & Co. for cash ₦3,120
“5 Brought goods from Ram & Sons on credit ₦4,000
Paid Marathi & Co. by cheque in full settlement ₦3,800
“6 Bought goods from Chatterjee₦6,300
“13 Returned goods to Chatterjee (not being up to specifications) ₦300
“16 Goods used personally by proprietor ₦50
“17 Sold goods to M. & Co ₦5,000
“20Cheque received from Chand & Sons ₦1,440
“22 Bank advises Chand & Sons cheque returned unpaid
“24 Cash deposited with bank ₦2,000
“27Cheque sent to Chatterjee (Discount allowed ₦150) 5,850
“31 Paid salaries N600
Paid rent N300
116
Drew for personal use out of bank ₦500
Solution:
Journal
Date Particulars L.F. Dr.₦ Cr. ₦
Jan. 1 Cash A/c Dr. 630
2006 Bank A/c Dr. 23,100
Stock of Goods A/c Dr. 26,400
M. & Co. Dr. 6,750
To Marathi & Co 3,880
To Ram & Sons 3,000
To Ramesh's Capital A/c 50,000
(Being balances of various assets
& liabilities brought forward)
2 Bank A/c Dr. 6,650
Discount Allowed A/cDr. 100
To M. & Co. 6,750
(Being a cheque received from M.
& Co. & Discount allowed)
Chand & Sons A/c Dr. 1,440
To Sales A/c 1,440
(Being goods sold on credit)
35
Carriage Outwards A/c Dr.
To Cash A/c 35
(Being the carriage paid)
Cash A/cDr. 3,120
To Sales A/c
(Being goods sold for cash) 3,120
Purchases A/c Dr. 4,000
To Ram & Sons 4,000
(Being goods purchased on credit)
Marathi & Co. A/c Dr.
To Bank A/c 3,880
To Discount A/c 3,800
(Being payment made to Marathi & 80
Co.in full settlement & discount
117
received)
Purchases A/c Dr.
6,300 6,300
To Chatterjee
(Being goods purchased on credit)
ChatterjeeDr.
To Returns Outwards A/c 300
300
(Being goods returned to Chatterjee)
Drawings A/cDr.
To Purchases A/c 50 50
(Being goods withdrawn for
personal use)
M. & Co. Dr.
To Sales A/c 5,000
5,000
(Being goods sold on credit)
Bank A/c Dr.
1,440
To Chand & Sons A/c 1,440
(Being a cheque received from
Chand & Sons)
Chand & Sons A/cDr.
1,440 1,440
To Bank A/c
(Being the cheque of Chand &
Sons dishonoured)
Bank A/c Dr.
2,000 2,000
To Cash A/c (Being cash deposited
into bank)
Chatterjee A/c Dr.

5,850
To Bank A/c 6,000
To Discount Received A/c 150
(Being payment made to Chatterjee
and discount received)
Salaries A/c Dr. 600
To Cash A/c 600
(Being salaries paid)
Rent A/c Dr. 300
To Cash A/c 300
(Being rent paid)
Drawings A/c Dr.
To Bank A/c
500
(Being cash withdrawn from bank 500
for personal use)
118
Ledger of Ramesh
Dr.Capital Account Cr.

Date Particulars Folio Amount ₦ Date Particulars Folio Amount ₦
2006 2006 By Balance b/f 50,000
Jan. To Balance c/d 50,000 Jan.1 ₦50,000
31 ₦50,000 Feb. 1
By Balance b/d ₦50,000
Dr.Stock of Goods Account Cr.

Date Particulars Folio Amount Date Particulars Foli Amount
₦ o ₦
2006 To Balance b/f 26,400 2006
Jan. 1 26,000 Jan.3 By Balance c/d 26,400
1
Feb.1 Balance b/d 26,400
Dr.Cash Account Cr
₦ ₦
2006 2006
Jan. 1 To Balance b/f 630
Jan.
Jan. 4 To Sales A/c 3,120 By Carriage Out- 35
4
wards A/c
24 By Bank A/c 2,000
31 By Salaries A/c 600
31 By Rent A/c
300
31 By Balance c/d 815
3,750 3,750
Feb.1 To Balance b/d 815
119
Dr.Bank Account Cr.
₦ ₦
2006 2006
Jan. 1
2 1 To Balance b/f 23100 Jan.
20 To M. & Co. 6 6,650 5 By Marathi & Co. 3,800
24 To Chand & Sons 1,440
22 By Chand & Sons 1,440
To Cash A/c 2,000
27 By Chatterjee 5,850
31 By Drawings 500
31 By Balance c/d 21,600
33,190
Feb.1 33,190
Balance b/d 21,600
Dr.M. & Co.'s Account Cr.

₦ ₦
2006 2006
Jan. 1 To Balance b/f 6,750 Jan.
17 To Sales A/c 5,000 1 By Bank A/c 6,650
2 By Discount
Allowed A/c 100
By Balance c/d 5,000
11,750 11,750
Feb.1 To Balance b/d 5,000
120
Dr.Marathi& Co.'s AccountCr.
₦ ₦
2006 2006
Jan. 5 To Bank A/c 3,800 Jan.
5 To Discount 1 By Balance b/f 3,880
Received A/c 80
3,880 3,880
Dr.Ram&Sons's Account Cr.

₦ ₦
2006 2006
Jan To Balance c/d 7,000 Jan. 1 By Balance b/f 3,000
31 Jan.31 By Purchase A/c 4,000
7000 7,000
Feb. 1 By Balance b/d 7,000
Dr.Chand& Sons' Account Cr.

₦ ₦
2006 2006
Jan.4 To Sales A/c 1,440 Jan. 20 By Bank A/c 1,440
22 To Bank A/c 1,440 31 By balance c/d 1,440
2,880 2,880
Feb. To Balance b/d 1,440
1
121
Dr.Chatterjee's Account Cr.
₦ ₦
2006 2006
Jan. 13 To Returns Jan. 6 Purchases A/c 6,300
Outwards A/c 300
27 To Bank A/c 5,850
27 To Discount
Received A/c 150
6,300 6,300
Dr.Purchases Account Cr.

₦ ₦
2006 2006
Jan. 5 To Ram & Sons 4,000 Jan.16 By Drawings A/c 50
6 To Chatterjee 6,300 Jan. 31 By Balance c/d 10,250
10,300 10,300
Feb. 1 To Balance b/d 10,250
Dr.Sales Account Cr.

₦ ₦
2006 2006
Jan. 4 By Chand & Sons 1,440
4 A/c 3,120
Jan. 31 To Balance c/d 9,560 17 By Cash A/c 5,000
9,500 By M. & Co. 9,500
Feb.1 By Balance b/d 9,560
122
Dr.Discount Allowed Account Cr.
₦ ₦
2006 2006
Jan. 2 To M. & Co. 100 Jan. 31 By Balance c/d 100
100 100
Feb. 1 To Balance c/d 100
Dr.Carriage Outwards Account Cr.

₦ ₦
2006 2006
Jan. 4 To Cash A/c 35 Jan. 31 By Balance c/d 35
35 35
Feb. 1 To Balance b/d 35
Dr.Discount Received Account Cr.

₦ ₦
2006 2006
Jan. 5 By Marathi & Co. 80
Jan. 31 To Balance c/d 230 27 By Chatterjee A/c 150
230 230
Feb. 1 By Balance b/d 230
Dr.Return Outwards Account Cr.

₦ ₦
2006 2006
Jan. 31 To balance c/d 300 Jan. 13 By Chatterjee 300
300 300
Feb. 1 By Balance b/d 300
123
Dr.Drawings Account Cr.
₦ ₦
2006 2006
Jan. 16 To Purchases A/c 50
31 To Bank A/c 500 Jan. 31 By Balance c/d 550
550 550
Dr.Salaries Account Cr.

₦ ₦
2006 2006
600 600
Dr.Rent Account Cr.

₦ ₦
2006 2006
300 300
At this stage, all the ledger accounts (except the capital account) have been closed;
therefore, the statement of profit and loss ledger account can be closed. The
balance represents the period's profit or loss. If the sum of the debit side (expenses)
is greater than the sum of the credit entries then the entity has made a loss in the
period; if the credit side (income) is greater, then the entity has made a profit in the
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period. Either way the balance is transferred to the owners' capital account. The
account can either be a debit or a credit, so it is good practice to add up each side
and determine the largest before proceeding with the closure. No balance will
appear in the next period. Like the bank, the balance on this account. An
accounting process is a complete sequence with the recording of the transactions
and ending with the preparation of the final accounts. Journal is concerned with the
recording of financial transactions in an orderly manner, soon after their
occurrence. The function of systematic analysis of the recorded data to accumulate
the transactions of similar type at one place is performed by maintaining the ledger
in which different accounts are opened to which transactions are posted
2.2 The Trial Balance

A Trial Balance is a two-column schedule listing the titles and balances of all the
accounts in the order in which they appear in the ledger. The debit balances are
listed in the left-hand column and the credit balances in the right-hand column. In
the case of the General Ledger, the totals of the two columns should agree. The
ledger accounts in the worked example have all been prepared in accordance with
the general double entry principle that every debit entry must have a corresponding
credit entry. If this rule has been strictly followed, then the sum of the debit entries
in all the accounts should show this information. The statement which is prepared
to show this information, as indicated is called Trial Balance. The purpose of trial
balance is to provide:
1. A test of the arithmetical accuracy of entries made in the different accounts. To
ascertain whether the total of the ledger accounts with debit balances equals to the
total of the ledger accounts with credit balances. If so, this proves that the same
money value of each transaction has been entered on both sides of the general
ledger. It also proves the arithmetic accuracy of the ledger account. However, a
trial balance can agree but there may still be errors in the ledger. For example, an
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amount may have been entered on the correct side but in the wrong account, or a
transaction could have been completely omitted.
2. The trial balance is also used for the preparation of final financial statements that
show the profit or loss for the period and assets and liabilities at the end of that
period. In practice this is done in the form of an extended trial balance.
All the ledger accounts end up in two reports in the financial statements: the
statement of profit and loss and the statement of financial position. It should be
noted that the trail balance does not form part of the double-entry process; shown
in detail above. The trial balance is just a memorandum that is used to check that
the ledger accounts balance and assist in preparing the financial statements for
disclosure purposes. As mentioned before, it is expected that expenses, returns
inward and assets will have debit balances and income, returns outward, capital,
and liabilities will have credit balances. It is, therefore, at the end of the financial
year or at any other time, the balances of all the ledger accounts are extracted and
are recorded in a statement known as Trial Balance and finally totalled up to see
whether the total of debit balances is equal to the total of credit balances.
The agreement of the Trial Balance reveals that both the aspects of each
transaction have been recorded and that the books are arithmetically accurate. If
both the sides of Trial Balance do not agree to each other, it shows that there are
some errors, which must be detected and rectified if the correct final accounts are
to be prepared.Thus, Trial Balance forms a connecting link between the ledger
accounts and the final accounts.
In Text Question 1: What is a trial balance?
In Text Answer 1: A Trial Balance is a two-column schedule listing the titles and balances of
all the accounts in the order in which they appear in the ledger.
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Objectives of preparing trial balance
The following are the main objectives of preparing the trial balance:
(i) To check the arithmetical accuracy of books of accounts: According to the
principle of double entry system of bookkeeping, every business transaction has
two aspects, debit and credit. The agreement of the trial balance is a proof of the
arithmetical accuracy of the books of accounts. However, it is not a conclusive
evidence of their accuracy as there may be certain errors, which the Trial Balance
may not be able to disclose.
(ii) Helpful in preparing final accounts: The trial balance records the balances of all
the ledger accounts at one place which helps in the preparation of final accounts,
i.e. Trading and Profit and Loss Account and Balance Sheet. But, unless the trial
balance agrees, the final accounts cannot be prepared. So, if the trial balance does
not agree, errors are located and necessary corrections are made at the earliest, so
that there may not be unnecessary delay in the preparation of the final accounts.
(iii) To serve as an aid to the management: By comparing the trial balances of
different years changes in figures of certain important items such as purchases,
sales, debtors etc. are ascertained and their analysis is made for taking managerial
decisions. It serves as an aid to the management.
Limitations of trial balance

The following are the main limitations of the Trial Balance:
(i) Trial Balance can be prepared only in those concerns where double entry system
of accounting is adopted.
(ii) Though trial balance gives arithmetic accuracy of the books of accounts but
there are certain errors, which are not disclosed by the trial balance. That is why it
is said that trial balance is not a conclusive proof of the accuracy of the books of
accounts.
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(iii) If trial balance is not prepared correctly then the final accounts prepared will
not reflect the true and fair view of the state of affairs of the business. Whatever
conclusions and decisions are made by the various groups of persons will not be
correct and will mislead such persons.
Methods of preparation of trial balance

A trial balance can be prepared by the following two methods:
a. Total method: In this method, the debit and credit totals of each
account are shown in the two amount columns (one for the debit total
and the other for the credit total).
b. Balance method: In this method, the difference of each amount is
extracted. If debit side of an account is bigger in amount than the
credit side, the difference is put in the debit column of the Trial
Balance and if the credit side is bigger, the difference is written in the
credit column of the Trial Balance.
A specimen of a trial is given below:

TRIAL BALANCE OF …………… AS ON ……………..
Name of the account Debit Credit
Illustration:
Using the entries from the ledger accounts of Eagle Ltd in study session 4, it is the
period end (31 July) and the ledger accounts are being closed for the purposes of
preparing the financial statements. This illustration will take you step by step
through the stages of closing off an entity's books. An example of the three
different types of account and the different way of closing them off is highlighted.
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Identify the type of account it is, leave a gap below the longest column of figures
and put totals on both the credit and debit sides of the account. Add up each side of
the ledger account and calculate the difference. In this instance the debit side totals
₦2,240 and the credit side totals ₦1,250. As the debit side has a larger balance,
this will be the expected sign of the opening balance in the next period. This
account will be regarded as having a debit balance (debits > credits). The larger of
the sides will be the amount that goes in the totals' column (₦2,240), as follows:
Bank account
20x2 Details ₦ 20X2 Details₦
1 July Capital 2,000 1 July Vehicle 800
26 July B. Ghandi 240 3 July Motor expenses 150
_____ 14 July Carriage outwards 20
2,240 18 July Motor expenses 30
23 July A. Bami 140
_____
2,240
Work out the dosing balance and put it in the correct side. In this instance, the
closing balance is ₦990 (₦2,240 - ₦1,250) and the balance will have to go on the
credit side of the account, otherwise the numbers on the credit side will not add up
to ₦2,240. This is shown as follows:
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Bank account
20x2 Details ₦‘000 20X2 Details₦’000
1 July Capital 2,000 1 July Vehicle 800
26 July B. Ghandi 240 3 July Motor expenses 150
14 July Carriage outwards 20
23 July A. Bamidele140
31 July Balance c/d 990
_____ _____
2,240 2,240
1 Aug Balance b/d 990
Closing a movement in capital account - the capital introduced account

This account is a movement in capital account and the balance on it will be
transferred to the capital account at the period end (as this is a new business, the
capital account will have to be opened).
Capital Introduction Account

31 July Capital a/c 2,000 1 July Bank 2,000
_____
2,000
2,000
The double-entry to close the capital introduced account is provided in journal

form to assist your understanding.
Capital Account
20X2 Details₦’000 20X2 Details₦’000
31 July Capital introduced a/c 2,000
The capital account is not closed yet, it is the last ledger account to close as the
statement of profit and loss account is closed off to this account.
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Motor Vehicle Account
1 July Bank 800 31 July Balance c/d 800
___
800
800
As an asset, the motor vehicles account is a statement of financial position account;

therefore, the closing- balance is carried into the next period.
Closing a revenue type account - the motor expenses account
As a revenue expense, this account will balance into the statement of profit and
loss ledger account and will have no opening balance in the next period. The
statement of profit and loss ledger account for this period has to be opened to
receive this expense.
Motor Expenses Account

3 July Bank 150 31 July Statement of P&L a/c 180
18July Bank 30
___
180
180
The motor expenses account is described as having a debit balance as the debit side
is greatest and the balance is carried into the debit side of the statement of profit
and loss ledger account. The statement of profit and loss ledger account is not
closed at this time.
Statement of profit and loss account
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The next account to be closed is the purchases account. As a revenue expense, this
is a statement of profit and loss account, hence will be closed off in the same
manner as the motor vehicles account.
Purchases Account
7 July A. Bamidele 250
____ 31 July Statement of P&L a/c 250
250 250
Statement of Profit and Loss Account

20X2 Details ₦’000 20X2 DetailsN’000
31 July Purchases 250
The next account to be closed is A. Bami's trade payable account. As a liability,

this account is a statement of financial position account; hence the balance will be
carried into the next period.
A. Bami account (trade payable)

16 July Returns 50 7 July Purchases 250
23 July Bank 140
31 July Balance c/d 60 ___
250 250
The sales revenue account is a revenue account, as such it will be closed off to the
statement of profit and loss ledger account.
Sales Revenue Account
July 31 Statement of P&L a/c 450 11 July B. Ghandi 450
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Statement of Profit and Loss Account
July 31 Motor 180 31 Sales Revenue 450
July 31 Purchases 250
B. Ghandi's account is a trade receivable. Trade receivables are current assets also
referred to as debtors, which are statements of financial position ledger accounts;
therefore, the closing balance will be carried forward into the next period.
B. Ghandi account (trade receivable)

11 July Sales revenue 450 20 July Returns 750
____ 26 July Bank 240
450 31 July Balance c/d 135
1 Aug Balance b/d 135 450
The purchase returns account is a revenue account; as such the balance is

transferred to the statement of profit and loss ledger account.
Purchase returns (return outwards) account

31 July Statement of P&L a/c 50 16July A. Bami 50
50 ___
50

31 July Motor expenses 180 31 July Sales revenue 450
31 July Purchases 250 31 July Purchase returns 50
Likewise, the sales returns account is a revenue account; as such the balance is
transferred to the statement of profit and loss ledger account.
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Sales returns (return inwards) account
20 July B. Ghandi 75 31 July Statement of P&L a/c 75
___ 75
75

31 July Purchases 250 31 July Purchases returns 50
31 July Sales returns 75
Carriage outwards, telephone and postage and heat and light are revenue expenses;
therefore, the balances will be transferred to the statement of profit and loss ledger
account.
Carriage outwards account

___ 20
20
Telephone and postage account

___
65 65
Heat and Lighting account

___ 45
45
At this stage all the ledger accounts (except the capital account) have been closed;
therefore, the statement of profit and loss ledger account can be closed. The
balance represents the period's profit or loss. If the sum of the debit side (expenses)
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is greater than the sum of the credit entries then the entity has made a loss in the
period; if the credit side (income) is greater, then the entity has made a profit in the
period. Either way the balance is transferred to the owners' capital account. No
balance will appear in the next period. Like the bank, the balance on this account
can either be a debit or a credit, so it is good practice to add up each side and
determine the largest before proceeding with the closure. In this instance the debit
side is larger at N635, 000 whereas the credit side adds to N500, 000. Therefore
the balance is a loss.

31 July Purchases 250 31 July Purchases returns 50
31 July Sales returns 75 31 July capital a/c 135
31 July Carriage outward 20 635
31 July Heat and light 45
___
635
At this stage the capital ledger account (a statement of financial position account)
can be closed with the balance carried forward into the next period to reflect the
owner's investment in the business on that date. This becomes the opening capital
balance in the new period.
Capital Account
31 July Loss from P/L a/c 135 31 July Capital introduced a/c 2,000
31 July Balance c/d 1,865 _____
2,000 2,000
31 July Balance b/d 1,865
The purposes and preparation of a trial balance

The trial balance is neither part of the general ledger nor is it a book of prime entry
(although it is often prepared on paper with the same ruling as the journal). It is a
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list of the balances in the general ledger at the end of an accounting period. Since
every transaction recorded in the ledger consists of both a debit and a credit entry,
the total of the balances on each side should be the same. This is checked by
entering on the trial balance the balance of each account in the ledger, and adding
up each side
The purpose of the trial balance may be summarised as follows:

1. To ascertain whether the total of the ledger accounts with debit balances equals
to the total of the ledger accounts with credit balances. If so, this proves that the
same money value of each transaction has been entered on both sides of the
general ledger. It also proves the arithmetic accuracy of the ledger account.
However, a trial balance can agree but there may still be errors in the ledger. For
example, an amount may have been entered on the correct side but in the wrong
account, or a transaction could have been completely omitted.
2. The trial balance is also used for the preparation of final financial statements that
show the profit or loss for the period and assets and liabilities at the end of that
period. In practice this is done in the form of an extended trial balance.
All the ledger accounts end up in two reports in the financial statements: the
statement of profit and loss and the statement of financial position. It should be
noted that the trail balance does not form part of the double-entry process; shown
in detail above. The trial balance is just a memorandum that is used to check that
the ledger accounts balance and assist in preparing the financial statements for
disclosure purposes. As mentioned before, it is expected that expenses, returns
inward and assets will have debit balances and income, returns outward, capital,
and liabilities will have credit balances.
136
Below is an illustration of a trial balance prepared from the entries of Eagle Ltd.
Eagle Ltd
Trial balance as at 31 July 20X2
Name of account Debit Credit
₦’000 ₦’000
Bank 990
Capital introduced 2,000
Motor vehicles 800
Motor expense 180
Purchase 250
A. Brown (trade payable) 60
Sales revenue 450
B. Green (trade receivable) 135
Purchases returns 50
Sales returns 75
Carriage outwards 20
Telephone and postage 65
Heat and light 45 _____
2,560 2,560
Note: the capital account and the statement of profit and loss account are not listed
as these accounts only include the closing balances of other ledger accounts. To
include them in the trial balance would be to account for all their component
accounts twice.
2.3 Accounting Errors

If the two sides of a trial balance agree, it is an evidence of the arithmetical
accuracy of the entries made in the Ledger. But even if the trial balance agrees, it
does not necessarily mean that the accounting records are free from all errors,
137
because there are certain types of errors, which are not revealed by a Trial Balance.
Therefore, a Trial Balance should not be regarded as a conclusive proof of
accuracy of accounts.
In accounting, an error is a mistake committed by the bookkeeper
(Accountant/Accounts Clerk) while recording or maintaining the books of
accounts. An error is an innocent and non-deliberate act or lapse on the part of the
persons involved in recording business transactions. It may occur while the
transactions are originally recorded in the books of original entries i.e. Journal,
Purchase Book, Sales Book, Purchase, Return Book, Sales Return Book, Bills
Receivable Book, Bills Payable Book and Cash Book, or while the ledger accounts
are posted or balanced or even when the trial balance is prepared. These errors may
affect the arithmetical accuracy of the trial balance or may defeat the very purpose
of accounting. These errors can be classified as follows:
1. Clerical errors
2. Errors of Principle
A brief description of the above errors are given below:
Clerical errors: we shall deal with each accounting errors in this part of our
discussion.
Clerical errors are those errors, which are committed by the clerical staff during the
course of recording business transactions in the books of accounts. These errors
are:
1. Errors of omission
2. Errors of commission
3. Compensating errors
4. Errors of duplication
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Errors of omission: When business transaction is either completely or partly
omitted to be recorded in the books of prime entry it is called an ‘error of
omission’. When a business transaction is omitted completely, it is called a
‘complete error of omission”, and when a business transaction is partly omitted, it
is called a “partial error of omission”. A complete error of omission does not affect
the agreement of trial balance whereas a partial error of omission may or may not
affect the agreement of trial balance.
Omission of recording a business transaction either completely or partly, omission

of ledger posting, omission of casting and balancing of an account and omission of
carrying forward are some examples of the errors of omission. An example of a
complete error of omission is goods purchased or sold may not be recorded in the
purchase book or sales book at all. This error will not affect the trial balance. An
example of a partial error of omission is goods purchased for ₦5,500 recorded in
Purchase Book for ₦ 550. This is a partial error of omission. This error will also
not affect the agreement of trial balance. Another example of a partial error of
omission is that if goods purchased for ₦5,500 is recorded in the Purchase Book
for ₦5,500 but the personal account of the supplier is not posted with any amount
on the credit side in the ledger, it is a partial error of omission and it will affect the
agreement of trial balance.
Error of commission: Such errors are generally committed by the clerical staff
due to their negligence during the course of recording business transactions in the
books of accounts. Though, the rules of debit and credit are followed properly yet
some mistakes are committed. These mistakes may be due to wrong posting of a
business transaction either to a wrong account or on the wrong side of an account,
or due to wrong casting (addition) i.e. over-casting or under-casting or due to
wrong balancing of the accounts in the ledger.
139
Compensating errors: Compensating errors are those errors, which cancel or
compensate themselves. These errors arise when an error is either compensated or
counter-balanced by another error or errors so that of the other on the debit or
credit side neutralizes the adverse effect of one on credit side or debit side. For
example, over-posting on one side may be compensated by under posting of an
equal amount on the same side of the same account or over posting of one side of
an account may be compensated by an equal overprinting on the opposite side of
some other account. But these errors do not affect the trial balance. The error
would have no effect on the trial balance. It would not affect the accuracy of the
balance sheet and the profit of the year will be correctly stated.
Errors of duplication: When a business transaction is recorded twice in the prime

books and posted in the Ledger in the respective accounts twice, the error is known
as
a) The ‘Error of Duplication’. These errors do not affect the trial balance.
(b) Errors of principle-When a business transaction is recorded in the books of
original entries by violating the basic/fundamental principles of accountancy called
an error of principle. It occurs when a transaction is posted to the wrong class of
account. Some examples of these errors are:
(i) When revenue expenditure is treated as capital expenditure or vice-versa, e.g.
building purchased is debited to the purchase account instead of the building
account.
(ii) Revenue expenses debited to the personal account instead of the expenses
account, e.g. salary paid to Mr. Ashok, a clerk, for the month of June, debited to
Ashok’s account instead of salary account. These errors do not affect the Trial
Balance.
140
In Text Question 2: Clerical errors are those errors, which are committed by the clerical
staff during the course of recording business transactions in the books of accounts. What are
those errors?
In Text Answer 2`: 1. Errors of omission 2.Errors of commission 3.Compensating errors
4.Errors of duplication.
Correcting errors in a trial balance

The following procedure can be adopted when a trial balance fails to agree. These
procedures will minimize effort and time spent looking for the errors.
1. Recast the trial balance.
2. Check that no ledger account has been omitted from the trial balance. This
sometimes happens with the cash and bank balances as they are usually in
separate books.
3. Check that each amount entered in the trial balance is on the correct side. This is
quick to do once you become familiar with the nature of different ledger
accounts.
4. Check to see that the amounts entered in the trial balance are the same as those
shown in the ledger accounts.
5. If the error has still not been found, it will then be necessary to check all the
entries in the general ledger.
6. If the difference between the totals of the trial balance is divisible by nine, then
it is likely that a ledger account balance or a transaction has been transposed
incorrectly - for example, if the heat and light account had been recorded as
₦54,000 instead of ₦45,000 or the account B. Ghandi had been recorded at
₦315,000 instead of ₦135,000. In these instances careful consideration should
be given to looking for this type of error.
It is also worth noting that often in examinations no marks are given for correct
trial balance totals. You will therefore only lose marks for the error that caused it
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to disagree. Thus, do not spend more than a few minutes trying to make a trial
balance agree.

1. The cashbook of Mr.Sherush₦8,364 as bank balance on 31st December 2005.
But you find that this does not agree with the balance as shown by passbook.
On scrutiny you find the following discrepancies:
(a) On 15th Dec. 2005 the payment side of cashbook was undercast by ₦100.
(b) A cheque for ₦131 issued on 25th December 2005 was taken in cash column.
(c) One deposit of ₦150 was recorded in cash book as if there is not bank column
therein.
(d) On 18th Dec. 2005 the debit balance of ₦1,526 as on the previous day was
brought forward as credit balance.
(e) Of the total cheques amounting to ₦11,514 drawn in last week of December
2005, cheques aggregating ₦7,815 encashed in December.
(f) Dividends of ₦250 collected by bank and subscription of ₦200 paid by it were
not recorded in cash book.
(g) One outgoing cheque of ₦350 was recorded twice in the cash book.
2. From the following Trial Balance (containing obvious errors) prepare a correct
Trial Balance:
Particulars Debit₦ Credit ₦

Purchases 60,000
Reverse fund 20,000
Sales 1,000,000
Purchase returns 1,000
Sales returns 2,000
Opening stock 30,000
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Closing stock 40,000
Expenses 20,000
Outstanding expenses 2,000
Bank balance 5,000
Assets 50,000
Debtors 80,000
Creditors 30,000
Capital 94,000
Suspense account (difference 10,000
in books)
2,72,000 2,72,000
4.0 Summary
In this session, you have learnt about the balancing of account and the trial
balance. The purposes of the trial balance were highlighted, the preparation of the
trial balance was discussed with appropriate illustrations, and accounting errors
were listed and explained as well as how to identify errors in the trial balance.

What are the limitations of trial balance?

a. Visit U-tube https://www.youtube.com/watch?v=0R0SNfYgmjc,,,,,
https://www.youtube.com/watch?v=MQETAaBytJM . Watch the video &
b. View the animation on http://study.com/academy/lesson/journal-entries-and-
trial-balance-in-accounting.html and critique it in the discussion forum
143
7.0 References /Further Reading
Accounting
Publishers, 7, Goloba Street, Isolo, Lagos.
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STUDY SESSION 3
The Cash Book
Introduction
2.0 Main Content:
2.1 Contra entry.
2.2 Forms of Cash Book.
3.0 Tutor Marked Assignments.
4.0Summary.
5.0 Self-Assessment questions and Answers.
7.0 References.
Introduction
Let’s see if session three will be as interesting like the last session we just finished.
Dealing with Cash Book is a very interesting topic.
The cash book is both a book of original entry and a ledger account for all cash and
bank transactions involving receipts and payments whether in cash or by cheque.
This is a book or record in which bank/cash transactions are recorded. These
include receipts (from customers) and payments (to suppliers) as well as bank
charges, interest received. In other words, it is to cash transactions what Purchases
and Sales Day Books are to credit purchases and credit sales respectively. A cash
book is a type of day book, recording transactions where the balance will be
included in the trial balance.
145
The cash book is regularly reconciled with the bank statement as an internal
control check. Cash transactions not made through the bank are generally recorded
in a petty-cash book. The purpose of the cashbook is to decongest the ledger by
taking the bank account and cash account out of the ledger and combining them in
one subsidiary book called the cashbook. It is also a ledger account because it has
debit and credit sides and any entry in one of the sides is only one-half of the
double entry involved in the transaction. A debit entry in the cash book, for
example, calls for a corresponding credit entry to be made in another account. Thus
a receipt of N400.00 from a debtor requires a debit entry in the cash book and a
credit entry in the debtor’s account in the sales ledger. The reverse is true for
payments.
1.0 Learning Outcomes

At the end of this study session, you should be able to:
1. Define contra entry
2. Define the cash book
3. List the forms of cash books
4. describe how to make entries in the two and three column cash books
2.0 Main Content

2.1 Contra Entry
An accounting transaction involves two accounts and there may be a transaction
where both cash account and bank account are involved. Since in the ledger there
is no separate cash account and bank account, therefore, no posting will be done
from the cash book to the ledger in case of such a transaction. The transaction will
be recorded on both the side of the cash book. Such an accounting entry, which is
recorded on the both the sides of the cash book, is known as contra entry. In order
to give hint for the purpose the word ‘C’ is written in the ledger folio.
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2.2 Forms of Cash Book
The cash book is a ledger in the sense that it is designed in the form of a cash
account and records cash receipts on the debit side and cash payments on the credit
side. Thus, the cash book is both a journal and a ledger. The cash books take many
forms. Although they differ in form, they perform the same functions. Some forms
of cash books that will be considered in this session are:
1. The general cash book which is made up of:
- The two column cash book and
- The three column cash book
The two column cash book

The two column cash book is so called because, for both debit and credit entries, it
has two columns, one for recording cash transactions and the other for bank
transactions. It is therefore, used for recording mixed cash and bank transactions.
When any money is received, whether by cheque or in cash, the cash column
which receives value is debited and the cash column which gives value is credited.
The entry involving the payment of cash into the bank is called a contra-entry and
is denoted by “c”in the folio column. A contra-entry may be defined as the transfer
of an item from one side of one account to the identical side of another account.
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All payments in cash are recorded by crediting the cash column of the book. If the
payment is by cheque, the bank column is credited. When cash is withdrawn from
the bank, the cash column is debited and the bank column is credited with the
amount involved. This is another contra-entry.
Example
Record the following in a two column cash book. Balance the cash book and bring
down the balances of cash in hand and cash at bank at the end of the period.
20x12
April 2 Introduced₦2,900 cash into the business as capital
April 4 Paid ₦1,850 of the capital into bank
April 10 Cash purchases ₦300
April 15 Cash sales ₦450
April 20 Purchases by cheque₦700
April 25 Cash sales ₦650
April 28 Office expenses paid for in cash ₦30
April 29 Cash paid into bank ₦1,000
April 30 Wages paid by cheque₦75
Solution:
Two-Column Cash Book
Dr.Cr.
Date Particular Folio Cash Bank Date Particular Folio Cash Bank
s s
20x12 ₦ ₦ 20x12 ₦ ₦
April 2 Capital 2900 April 4 Bank C 1,850
4 Cash C 1,850 10 Purchases 300
15 Sales 450 20 Purchases 700
25 Sales 650 28 Office
29 Cash C 1,000 expenses 30
₦4,000 ₦2,850 29 Bank C 1,000
30 Wages 75
May 1 Balance b/d 820 2,075 30 Balance c/d 820 2,075
₦4,000 ₦2,850
148
The source documents from which entries are made in the cash book are
copies of the cash receipts, (issued to customers for cash received), and
payments vouchers (i.e. original documents used to obtain authorization for
payments). The carbon copies of the cash receipts are used to make entries on
the debit side and the payments vouchers to make entries on the credit side of
the cash book.
The cash book is therefore a combination of the cash account and the bank
account which are kept in the ledger. Another form is the three column cash
book which is considered below.
In Text Question 1: What is a cash book?
In Text Answer 1: The cash book is a ledger in the sense that it is designed in the form of a cash
account and records cash receipts on the debit side and cash payments on the credit side
The three column cash book

This is similar to the two-column cash book except that the discount column is
added to both the debit and the credit side. The debit side, records receipts while
the credit side records payments. All cash receipts, deposits into bank and discount
allowed are recorded on receipt side and all cash payments, withdrawals from bank
and discount received are recorded on the payment side. The purpose of the
discount column in the debit side is, therefore to record discounts which are
allowed to customers when the business receives cash from them. Similarly, the
discounts column on the credit side is for discounts which the business receives
from its suppliers when payments are made to them. An entry in either of these
discount columns us not an entry in an account. The columns are merely collection
points from which the totals must be posted periodically, say monthly, to the
discount allowed and discount received in the general ledger respectively.
149
Example
Record the following in a three-column cash book. Balance the cash book and
bring down the balances of cash in hand and cash at bank at the end of the period.
20x12
March 2 Cash sales, ₦136
March 3 Received cheque from Amadin& Co ₦285
March 5 Purchased goods for cash, ₦120
March 6 Cash sales, ₦184
March 7 Paid to E. Nelson ₦65 discount received ₦300
March 9 Paid cash into bank, ₦100
March 11 Paid E. Faith cheque₦156 received ₦4 discount
March 12 Received from A. Osarobo cash ₦98discount allowed ₦2
March 13 Received from E. Oluwaseun₦97 discount allowed ₦3
March 15 Sold goods and received cheque, ₦330
March 16 Withdrew cash from bank, ₦108
March 17 Purchased goods for cash, ₦88
March 19 Received cheque from B. Olumide₦237
March 21 Sold goods for cash ₦119
March 22 Paid cash into bank ₦300
March 25 Paid Aminu cheque₦86 received discount ₦2
150
March 26 Paid cheque to ChineduObimma₦216
March 26 Purchased goods and paid cheque N816
March 27 Cheque received from B. Olumide was dishonoured by bankers
March 28 Paid vehicle insurance by cheque₦46
Balance the cash book and bring down the balances of cash in hand and at bank on
31st march,
2016. The total of the discount allowed column will be posted to the debit side of
the discount
Allowed account in the general ledger. Similarly, discount received is posted in
total at the end of
Dr.Three Column Cash Book Cr.

Date Particulars Disc. Cash Bank Date Particulars Disc. Cash Bank
20x12 ₦ ₦ ₦ 20x12 ₦ ₦ ₦
April2 Sales 136 April5 Purchases 120
3 Amadu& 7 E. Nelson 3 65
co 5 285 9 Bank 100
6 Sales 184 11 E. Faith 4 156
9 Cash (c) 100 16 Cash 108
12 Osaro A. 2 98 17 Purchases 88
13 Seun E. 3 97 22 Bank 300
15 Sales 330 25 Bank 2 86
16 Bank(c) 108 26 Chinedu O. 216
19 Olum B. 237 26 Purchases 186
21 Sales 119 27 Olum B. 237
22 Cash 300 28 Vehicle Ins 46
10 742 1,252 Bal c/d 69 217
9 742 1,252
May 1 Bal c/d 69 217
Sometimes the total credit entries in the bank column may exceed the total debit
entries
indicating an excess of payments over receipts, (i.e. a credit instead of a debit).
151
3.0 Tutor Marked Assignments
Explain the forms of cash book
4.0 Summary
In this session, you have learnt about the cash book. The contra entry principle was
highlighted, the forms of cash book were listed, the two and three column cash
books were discussed with illustrations.

1. Pass necessary journal entries in the books of Hardener for the month of March
2001:
i) An old machinery appearing in books exchanged for a new machinery of
₦5,000.
ii) Issued a cheque for ₦1,000 in favour of landlord for a rent for the month of
March.
iii) Paid electricity bill of ₦450 by cheque.
iv) The goods destroyed by theft ₦3,000.
v) Paid wages for the installation of machinery ₦5,000.
vi) Accrued interest ₦1100.
vii) Goods worth ₦4,000 given away by way of charity.
viii) Goods taken by Proprietor worth ₦10,000 for personal use.
2. Pass necessary journal entries and post them in the appropriate subsidiary books
of Kampala for the month of January 2001:
i) Started business with ₦2,000,000 in the bank and ₦40,000 cash.
ii) Bought shop fitting ₦40,000 and a van ₦60,000, both paid by cheque.
iii) Paid rent by cheque₦5,000.
iv) Bought goods for resale on credit from Fakir and Co. ₦50,000.
152
v) Cash sales ₦5,000.
vi) Paid wages of assistant in cash ₦1,000.
vii) Paid insurance by cheque₦500
viii) Cash sales ₦8,000
ix) Goods returned to Fakir and Co. ₦6,000
x) Paid Fakir and Co. ₦30,000 by cheque.
xi) Bought stationery and paid in cash ₦500.
xii) Cash sales ₦15,000.
xiii) Paid Raju and Co. ₦14,000 by cheque.
xiv) Paid ₦20,000 into the bank.

a. Visit U-tube https://www.youtube.com/watch?v=A3weTIOAz68,,
https://www.youtube.com/watch?v=VhrI1exG8OY . Watch the video &
b. View the animation on https://www.youtube.com/watch?v=CRLsZpausK0

Accounting.
153
STUDY SESSION 4
The Petty Cash Book
Introduction
2.0 Main Content:
2.1 Definition of Petty Cash Book.
2.2 The Imprest System.
2.3The Bank Cash Book.
4.0 Summary.
7.0 References.
Introduction
Petty Cash Book is equally an interesting
topic just as that of Cash Book from the
previous session.
The petty cash book is a book for recording
cash transactions which are considered too
small in value to be paid for by cheque. Any
large amounts of cash received and cash takings are usually paid into the bank and
thus recorded in the cash book.

154
1. Define Petty Cash Book, and
2. The Bank Cash Book.
2.0 Main Content

2.1 Definition of Petty Cash Book
Let start by defining what is Cash Book.
Like the bank cash book, the petty cash book is both a book of original entry and a
ledger account. The method of recording cash in both is similar. Cash receipts are
debited and payments are credited. The basic difference is in the source of cash
receipts. Whereas there are many sources for the bank cash book, the petty cash
account include office expenses, postage and small items of stationary. The petty
cash book is written up from receipts and petty cash vouchers (where employees
are reimbursed expenses).
This book is used for the purpose of recording the petty expenses so that the main
cash book is relieved of the detailed records of these petty expenses. Normally, one
person is handed over a small amount to meet the petty expenses of a given period
(say, week, fortnight or month) and is authorized to make such payments and to
record them in a separate cash book. Such person, such amount and such cash
books are called as ‘Petty Cashier’, ‘Impress’ and ‘Petty cash Book’ respectively.
The Petty Cash Book may or may not be maintained on ‘Imprest System’. Under
both the systems (i.e. Imprest and Non-imprest), the petty cashier submits the Petty
Cash Book to the Head Cashier who examines the Petty Cash Book. Under the
Imprestsystem, the Head Cashier makes the reimbursement of the amount spent by
the Petty Cashier but under Non-Imprest system, the Head Cashier may handover
the Cash to the Petty Cashier equal to/more than less than the amount spent. The
155
format of Petty Cash Book may be designed according to the requirements of the
business.
In Text Question 1: What is a petty cash book?
In Text Answer 1: The petty cash book is both a book of original entry and a ledger account.
2.2 The Imprest System

Many firms also operate their petty cash on an imprest system. At the beginning of
each period (week or month) the petty cashier has a fixed amount of cash referred
to as a float. At the end of each period (or the start of the next) the petty cashier is
reimbursed the exact amount spent during the period, thus making the float up to
its original amount. The reimbursement usually takes the form of a cheque drawn
for cash. The amount of the petty cash float is determined by reference to the
normal level of petty cash expenditure in each period. The purpose of the imprest
system is to exercise effective control over the petty cash disbursements.
The advantages of the imprest system

Let see the advantages of the imprest System.
The advantages are:
1. It facilitates control of the total petty cash expenditure in each period as the petty
cashier cannot spend more than the amount of the float, except by applying to
the management for an increase.
2. It deters theft of cash by the petty' cashier since a large cash balance cannot be
accumulated by drawing cash from the bank at irregular intervals.
3. The entries in the petty cash book are kept up to date because the cash
expenditure is not reimbursed until the petty cash book is written up and the
total amount of expenditure for the period is known.
156
4. It discourages the practice of loans from petty cash since these would have to be
accounted for at the end of the period, and in addition may result in insufficient
cash to meet the necessary expenditure.
Example
Record the following in the petty cash book having the following separate
columns. (a) Office Expenses (b) Postages (c) Transport and Travelling (d)
Stationary. The petty cash book is kept under the imprest system and the imprest
amount is N50.
20x12
April 1 Receivedimprest from main cashier ₦50
April 2 paid travelling expenses ₦10
Repaired filling cabinet ₦5
Bought typing papers ₦2, 50
April 3 Bought envelops ₦1, 50
Paid office sundry expenses ₦5.00
April 5 Paid parcel post charges ₦4.00
April 5 Paid taxi fare ₦2.00
April 7 Miscellaneous office expenses ₦10.00
Paid S. Edo, a creditor, the balance of his account of ₦6.00
Balance the petty cash at the end of the week, bring down the balance and record
the imprest reimbursement for the week’s expenditure, also post the items to the
relevant accounts in the ledger.
157
158
Columnar Petty Cash Book (Imprest System)
Receipts Cash Date Particulars Voucher Total Office Postages Transp and Stationery Ledger Folio
book number payments expense travelling
folio
₦ ₦ ₦ ₦ ₦ ₦
20x12
₦ April Petty cash
50.00 CB12 1 Travelling 1 10.00
expenses 10.00
2 Filing 2 5.00
cabinet 5.00
Repairs 2.50
Typing 3
Papers 4 2.50 1.50
3 Envelops 1.50
Office
Sundry 5 5.00
Expenses 5.00
5 Parcel 4.00
post 6 2.00
Charges 7 4.00
Taxi fares 2.00
Miscellan 10.00
eous 8 6.00
office 9 10.00 20.00 4.00 12.00 4.00 6.00
expenses 6.00
S. Edo c/d 46.00 GL18 GL16 GL21 PL15
b/d 4.00 GL20
₦50.00 CB15 ₦50.00
159
4.00
46.00
Mar.8 Balance
Petty
Cash
General Ledger
Dr. Office Expenses Folio 18 Cr.
Date Particulars Folio Amount Date Particulars Folio amount
20x12 ₦ 20x12 ₦
March 7 Petty Cash PCB 10 20.00
Dr. Postages Cr.

20x12 ₦ 20x12 ₦
March 7 Petty cash PCB 10 4.00
Dr. Transport and Travelling Folio 16 Cr.

20x12 ₦ 20x12 ₦
160
Dr. Stationery Folio 21 Cr.
20x12 ₦ 20x12 ₦
Dr. Purchases Ledger Folio 15 Cr.

Date Particulars Folio Amount Date Particulars Folio amount
20x12 ₦ 20x12 ₦
March 7 Petty cash PCB10 6.00 April 1 Balance b/d 6.00
Observe that instead of posting each item of expenditure to the respective ledger
accounts when the transaction takes place, only the totals under each column at the
end of the period are posted.
2.3The Bank Cash Book

The bank cash book is used in businesses where all receipts are paid into the bank
and all payments are made by cheque. In large businesses, all payments (except for
small expenses) should be made by cheque. Where this is the practice, all receipts
of cash whether in currency notes, cheques or coins, are paid directly into the bank.
Cheques can then be drawn on the bank for cash needed for sundry expenses. A
cash book called a petty cash book is maintained for this purpose. A separate book
called the bank cash book is kept for recording details of receipts and payments.
The only difference between the bank cash book and the three-column cash book is
the replacement of a case column with a details column on both the debit and credit
sides. The details of receipts are shown in the debit side in the details column and
that for payments on a similar column on the creditside.
161
Illustration
Enter the following transactions in the bank cash book of a sole trader who pays all
cash receipts daily into the bank and makes all payments by cheques.
20x12
May 1 Balance at bank ₦500
May 2 S. Bello sends the trader a cheque for ₦190 in full settlement of his balance
of ₦200Received ₦250 for cash sales
May 4 Paid Kingsway Stores Ltd ₦195 in full discharge of their account for ₦200
May 7 Withdraw ₦248 from the bank of which N108 was for the week’s wages
and ₦140 for petty cash
May 8 Received ₦100 from P. Nkanta less 5% cash discount.
Balance the bank cash book and show the balance in hand. Ledger accounts are not
required.
Dr. Bank Cash Book Cr.
Date Particulars Fol Disc Deta Bank Date particulars Fol Dis detai Bank
io . ils io c. ls
20x12 ₦ ₦ ₦ 20x12 ₦ ₦ ₦
May 1 Balance b/d 500 May 4 Kingsway
Stores 5 195
May 2 S. Bello 10 190 Petty cash 140
Sales 250 440 Wages 180 248
May 8 P. Nkanta 5 95 95 May 8 Balance c/d 592
15 ₦1,035 5 ₦1,035
May 9 Balance b/d 592
The discount allowed total of ₦15 will be posted to the debit side of the discount
allowed in the general ledger. The corresponding credit entries are ₦10 and ₦5 to
the accounts of S. Bello and P. Nkanta, respectively, in the sales ledger.
162
In Text Question 2: Where is a bank cash book used?
In Text Answer 2: The bank cash book is used in businesses where all receipts are paid into the
bank and all payments are made by cheque

Discuss the Imprest system
4.0 Summary
In this session you have learnt about the petty cash book, the bank cash book and
the imprest system of accounting. You have also learnt the advantages of the
imprestsystem.

1. C. Harrow has a petty cash book that is used to record his cash receipts and
payments. This also incorporates an imprest system that has a float of ₦400,000.
During February 20X4 the following cash transactions took place:
1 Feb Purchases: ₦31,000
3 Feb Wages: ₦28,000
6 Feb Petrol for delivery van: ₦9,000
8 Feb Bus fares: ₦3,000
11 Feb Pens and pencils: ₦8,000
12 Feb Payments for casual labour: ₦25,000
14 Feb Repairs to delivery van: ₦17,000
16 Feb Copying paper: ₦15,000
19 Feb Goods for resale: ₦22,000
20 Feb Train fares: ₦12,000
21 Feb Repairs to premises: ₦35,000
163
22 Feb Postage stamps: ₦6,000
23 Feb Drawings: ₦20,000
24 Feb Taxi fares: ₦7,000
25 Feb Envelopes: ₦4,000
26 Feb Purchases: ₦18,000
27 Feb Wages: ₦30,000
28 Feb Petrol for deliver van: ₦14,000
On 28 February 20X4 the cash float was restored to ₦400,000.
Record the above in the petty cash book using appropriate analysis columns and
make the necessary entries in the ledger.
2. Analyse the definition of a cash book

3. What is the imprest system, what are the advantages of the imprest system?

a. Visit U-tube
https://www.youtube.com/watch?v=BFAryNnSx5E,,https://www.youtube.com/wat
ch?v=soq-5jyBprI . Watch the video & summarise in 1 paragraph
b. View the animation on https://www.youtube.com/watch?v=C_zMpLzfXG4,,
https://www.youtube.com/watch?v=b6Lc4vwnLpI and critique it in the discussion
forum
7.0 References
164
Accounting.
165
3.0 MODULE 3
Content
Study Session 1: Depreciation and Non-Current Assets
Study Session 2: Bad Debts and Provisions for Bad Debts
Study Session 3: Financial Ratios
Study Session4: Cash Flow Statements
STUDY SESSION 1
Depreciation and Non-current Assets
Introduction.
2.0 Main Content:
2.1The Nature and Types of Non-Current Assets.
2.2The Recognition and Valuation of Non-Current Assets.
2.3 The Nature of Depreciation.
4.0 Summary.
5.0Self-Assessment Questions.
7.0 References.
Introduction
Welcome to module 3, this module will equally be as interesting just like the
previous module.
Generally, you should understand that, the term depreciation is used to denote
decrease in value but in accounting, this term is used to denote decrease in the
166
book value of fixed asset. It is a fall in the value of fixed asset due to use, passage
of time or obsolescence. Obsolescence occurs as a result of technological or other
changes unexpected at the time of purchase.

1. discuss the nature of depreciation,
2. define depreciation,
3. define some terms related to depreciation,
4. list the causes of depreciation,
5. identify the basic elements of depreciation,
6. list the methods of calculation depreciation.
2.0 Main Content

2.1 The Nature and Types of Non-Current Assets
An asset is a resource controlled by the enterprise as a result of past events and
from which future economic benefits are expected to flow to the enterprise' (the
Framework) (IASC, 1989).
The ability to generate future economic benefits is arguably the most important
criterion in determining whether expenditure is to be classified as an asset, or not.
Assets are categorised as being either current or non- current into cash or near cash
in the near future -usually in a period of less than one year. Current assets include
assets whose useful economic lives do not exceed one year before they are
transformed into other kinds of assets. Current assets include inventories, trade
receivables, short-term financial assets (investments), bank and cash.
167
Non-current assets are items not specifically bought for resale but to be used in the
production or distribution of those goods normally sold by the business. They are
durable goods that usually last for several years, and are normally kept by a
business for more than one accounting year. However, expenditure on such items
is only regarded as a non-current asset if it is of a material amount.
The Accounting Standards Committee (ASC) defines a non-current asset as an

asset that:
a. is held by an enterprise for use in the production or supply of goods and
services, for rental to others, or for administrative purposes and may include
items held for the maintenance or repair of such assets;
b. has been acquired or constructed with the intention of being used on a
continuing basis; and
c. is not intended for sale in the ordinary course of a business.
Money spent on non-current assets is referred to as capital expenditure. All other

costs and expenses are referred to as revenue expenditure. The latter are entered in
the statement of profit and loss for the year in which the costs are incurred.
Non-current assets are classified as either tangible or intangible.
Tangible assets are assets that have physical substance. Examples are motor
vehicle, inventory, etc.
Intangible assets are defined as identifiable non-monetary assets without physical

substance: Examples include goodwill, patents, trademarks, copyrights, fishing
licenses, milk quota, franchises, customer or supplier relationships, mortgage
168
servicing rights, customer loyalty, market share, brand name and development
expenditure such as expenditure creating computer software.
Goodwill usually arises in the statement of financial position because at some time
in the past the business has taken over, or been formed from, another business.
In Text Question 1: What is an asset?

In Text Answer 1: An asset is a resource controlled by the enterprise as a result of past events
and from which future economic benefits are expected to flow to the enterprise'
2.2 The Recognition and Valuation of Non-Current Assets

The term 'valuation' refers to the amount at which assets are shown in the statement
of financial position. IAS 16 allows non-current tangible assets to be valued using
two approaches: historical cost and the alternative treatment, re-valued amount.
Historical cost
In historical cost accounting, non-current assets are valued at their historical cost
less the aggregate/accumulated depreciation from the date of acquisition to the date
of the statement of financial position. The resulting figure is known as the written-
down value (WDV), net book value (NBV) or net carrying amount. Depreciation is
discussed below.
Re-valued amount
The Companies Act 2006 and IAS 16 allow companies to revalue their tangible
non-current assets and show them in the statement of financial position at fair
value rather than historical cost. This is known as the alternative treatment.
• The carrying value for an asset accounted for under historical cost is its net book
value.
169
• The carrying amount for a re-valued asset is its fair value at the date of the
revaluation less any subsequent accumulated depreciation and subsequent
accumulated impairment losses.
The current value of a tangible non- current asset to the business is the lower of
replacement cost and recoverable amount. The recoverable amount is the higher of
fair value and value in use.
In Text Question 2: 1. What do you understand by valuation?

2. IAS 16 allows non-current tangible assets to be valued using two approaches, what are they?
In text Answer 2: 1. The term 'valuation' refers to the amount at which assets are shown in the
statement of financial position.
2. Historical cost and Re-valued amount.
2.3 The Nature of Depreciation

This is just like everything in life, it must lose its value as life goes on with
continues usage.
The purchase of a non-current asset occurs in one year but the revenue generated
from its use normally arises over a number of years. This is referred to as its useful
(economic) life. In IAS 16 the useful life of an asset is defined as 'the period over
which an asset is expected to be available for use by an entity; or the number of
production or similar units expected to be obtained from the asset by an entity'.
If the cost of non-current assets were treated as an expense in the statement of
profit and loss in the year of purchase, this would probably result in an excessive
loss in that year, and excessive profits in the years in which the revenue arose. This
gives a misleading view of the profits and
losses of each year and distorts
comparisons over time.
Thus, the cost of a non-current asset is not
170
treated as an expense in the year of purchase but rather carried forward and written
off to the statement of profit and loss over the useful economic life of the asset in
the form of depreciation. The part of the cost of an asset that is 'used up' or
'consumed' in each year of the asset's useful economic life must be set against the
revenue that this generates (in conjunction with other factors of production). That
part of the cost of a non-current asset, which is 'used up' or 'consumed' during an
accounting period, is referred to as 'depreciation; Thus, depreciation may be
defined as the allocation of the cost of a non-current asset over the accounting
periods that comprise its useful economic life to the business according to some
criterion regarding IAS 16 defines depreciation as 'the systematic allocation of the
depreciable amount of an asset over its useful life' where the depreciable amount is
'the cost of the asset, or other amount attributed to that asset, less its residual value:
The allocation tries to measure the reduction in the economic benefits available
from the tangible non-current asset or to capture the economic benefits that have
been consumed during the period. Consumption is generally considered to include
the wearing-out, using-up or other reduction in
Definition of depreciation
Depreciation is the permanent and continuous decrease in the book value of a
fixed asset due to use, obsolescence, expiration of legal rights or any other cause.
According to the Institute of Chartered Accountants of England and Wales,
“Depreciation represents that part of the cost of a fixed asset to its owner which is
not recoverable when the asset is finally out of use by him. Provision against this
loss of capital is an integral cost of conducting the business during the effective
commercial life of the asset and is not dependent on the amount of profit earned”.
Depreciation is not the result of fluctuations in the value of fixed assets since the
fluctuation is concerned with the market price of the fixed asset whereas the
depreciation is concerned with the historical cost.
171
An analysis of the definition given above highlights the characteristics of
depreciation as follows:
(a) It is related to fixed assets only.
(b) It is a fall in the book value of an asset.
(c) The fall in the book value of an asset is due to the use of the asset in business
operations, obsolescence, expiration of legal rights or any other cause.
(d) It is a permanent decrease in the book value of an asset.
(e) It is a continuous decrease in the book value of an asset.
In Text Question 3: What is depreciation?

In Text Answer 3: Depreciation is the permanent and continuous decrease in the book
value of a fixed asset due to use, obsolescence, expiration of legal rights or any other
cause.
Definition of terms: depreciation, depletion, obsolescence and amortisation

The terms depreciation, depletion and amortisation are used often interchangeably.
However, these different terms have been developed in accounting usage for
describing this process for different types of assets. These terms have been
described as follows:
Depreciation
Depreciation is concerned with charging the cost of man-made fixed assets to
operation (and not with determination of asset value for the balance sheet). In other
words, the term 'depreciation' is used when expired utility of physical asset
(building, machinery, or equipment) is to be recorded.
Depletion
This term is applied to the process of removing an available but irreplaceable
resource such as extracting coal from a coal miner or oil out of an oil well.
Depletion differs from depreciation in that the former implies removal of a natural
resource, while the latter implies a reduction in the service capacity of an asset.
172
Amortisation
The process of writing off intangible assets is termed as amortisation. The
intangible assets like patents, copyrights, leaseholds and goodwill are recorded at
cost in the books of account, many of these assets have a limited useful life and
are, therefore, written off.
Obsolescence
It refers to the decline in the useful life of an asset because of factors like:
(i) Technological advancements
(ii) Changes in the market demand of the product
(iii) Legal or other restrictions
(iv) Improvement in production process.
Meaning of depreciation accounting

According to the American Institute of Certified Public Accountants (AICPA),
“Depreciation Accounting is a system of accounting which aims to distribute cost
or the basic value of tangible capital assets less salvage (if any), over the estimated
useful life of the unit (which may be group of assets) in a systematic and rational
manner. It is a process of allocation and not of valuation.
Causes of Depreciation
The main causes of depreciation include the following:
(a) Physical wear and tear: When the fixed assets are put to use, the value of such
assets may decrease. Such decrease in the value of assets is said to be due to
physical wear and tear.
(b) With the passage of time: When the assets are exposed to the forces of nature
like whether, winds, rains, etc., the value of such assets may decrease even if
they are not put to any use.
173
(c) Changes in economic environment: The value of an asset may decrease due to
decrease in the demand of the asset. The demand of the asset may decrease due
to technological changes, changes in the habits of consumers.
(d) Expiration of legal rights: When the use of an asset (e.g., patents, leases) is
governed by the time bound arrangement, the value of such assets may
decrease with the passage of time.
Need For Providing Depreciation

The need for providing depreciation in accounting records arises due to any one or
more of the following objectives to be achieved:
(a) To ascertain true results of operations: For proper matching of costs with
revenues, it is necessary to charge the depreciation (cost) against income
(revenue) in each accounting period. Unless the depreciation is charged against
income, the result of operations would stand overstated. As a result the Income
Statement would fail to present a true and fair view of the result of operations
of an accounting entity.
(b) To present true and fair view of the financial position: For presenting a true and
fair view of the financial position, it is necessary to charge the depreciation. If
the depreciation is not charged, the unexpired cost of the asset concerned
would be overstated. As a result, the Position Statement (i.e. the Balance Sheet)
would not present a true and fair view of the financial position of an accounting
entity.
(c) To ascertain the true cost of production: For ascertaining the cost of production,
it is necessary to charge depreciation as an item of cost of production. If the
depreciation on fixed assets is not charged, the cost records, would not present
a true and fair view of the cost of production.
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(d) To comply with legal requirements: In case of companies, it is compulsory to
charge depreciation on fixed assets before it
declares dividend [Sec. 205(1) of the Companies
Act, 1956].
(e) To accumulate funds for replacement of assets :
A portion of profits is set aside in the form of
depreciation and accumulated each year to
provide a definite amount at a certain future date
for the specific purpose of replacement of the
asset at the end of its useful life.
Basic Elements of Depreciation

In order to assess depreciation amount to be charged in respect of an asset in an
accounting period the following three important factors should be considered:
1. Cost of the asset: The knowledge about the cost of the asset is very essential
for determining the amount of depreciation to be charged to the profit and
loss account. The cost of the asset includes the invoice price of the asset less
any trade discount plus all costs essential to make the asset usable. Cost of
transportation and transit insurance are included in acquisition cost.
However, the financial charges such as interest on money borrowed for the
purchase for the purchase of the asset, should not be included in the cost of
the asset.
2. Estimated life of the asset: Estimated life generally means that for how many
years or hours an asset could be used in business with ordinary repairs
forgenerating revenues. For estimating useful life of an asset one must begin
with the consideration of its physical life and the modifications, if any,
made, factors of obsolescence and experience with similar assets. In fact, the
economic life of an asset is shorter than its physical life. The physical life is
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based mostly on internal policies such as intensity of use, repairs,
maintenance and replacements. The economic life, on the other hand, is
based mostly on external factors such as obsolescence from technological
changes.
3. Scrap. Value of the Asset: The salvage value of the asset is that value which
is estimated to be realised on account of the sale of the asset at the end of its
useful life. This value should be calculated after deducting the disposal costs
from the sale value of the asset. If the scrap value is considered as
insignificant, it is normally regarded as nil
Methods of Calculating Depreciation

The following are various methods of allocating depreciation in use:
1. Fixed instalment method or straight line method.
2. Machine hour rate method.
3. Diminishing Balance method.
4. Sum of years digits method.
5. Annuity method.
6. Depreciation Fund Method.
7. Insurance Policy Method.
8. Depletion Method.
Some of the enlisted methods will be discussed in details. They are:

1. Straight Line Method: This is also known as fixed instalment method.
Under this method the depreciation is charged on the uniform basis year after year.
When the amount of depreciation charged yearly under this method is plotted on a
graph paper, we shall get a straight line. Thus, the straight line method assumes
that depreciations is a function, of time rather than use in the sense that each
accounting period received the same benefit from using the asset as every other
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period. The formula for calculating depreciation charge for each accounting period
is :
Amount of annual Depreciation = original cost of the fixed assets –residual value
estimated life in years
For example, if an asset cost ₦50,000 and it will have a residual value of ₦2000 at
the end of its useful life of 10 years, the amount of annual depreciation will be
₦4800 and it will be calculated as follow:
Depreciation =₦ 50,000-2000
10 years
This method has many shortcomings. First, it does not take into consideration the
seasonal fluctuations, booms and depression. The amount of depreciation is the
same in that year in which the machine is used day and night to that inanother year
in which it is used for some months. Second, it ignores the interest on the money
spent on the acquisition of that asset. Third, the total charge for use of asset (i.e.,
depreciation and repairs) goes on increasing form year to year though the assets
might have been use uniformly from year to year. For example, repairs cost
together with depreciation charge in the beginning years is much less than what it
is in the later year. Thus, each subsequent year is burdened with grater charge for
the use of asset on account of increasing cost on repairs.
Illustration - I: H. Ltd. purchased machinery on 1st January. 2000 for ₦29000 and
spent ₦2000 on its cartage and ₦1,000 on its erection. Machinery is estimated to
have a scrap value of ₦5000 at the end of its useful life of 5 year. The accounts are
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closed every year on 31st December. Prepare the machinery account for five years
charging depreciation according to straight line method.
Solution
Machinery Account
₦ ₦
1990 To Bank 22 Dec. 31 By Depre. 4
Jan. 1 To Bank 2 Dec.31 By Bal c/d 21
To Bank 1 25
25
2001 By Depr. 4
Jan. 1 To Bal. b/d 21 2001 Bal. c/d 17
Dec. 31 21
21
2002 By Depr. 4
Dec. 31 17
2003 17 By Depr. 4
Dec. 1 13
2004 13
Jan. 1 To Bal. b/d 9 2004 By Depr. 4
Dec. 31 By Bal. c/d 5
9 9
This method is very suitable particularly in case of those assets which get
depreciated more on account of expire of period e.g. lease hold properties, patents,
etc.
2. Machine hour rate method: In case of this method, the running time of the
asset is taken into account for the purpose of calculating the amount of
depreciation. It is suitable for charging depreciation on plant and machinery, air-
crafts, gliders, etc. The amount of depreciation is calculated as follows:
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For example, if machinery has been purchased for ₦20000 and it will have a scrap
value of ₦1000 at the end of its useful life of 1900 hours, the amount of
depreciation per hour will be computed as follows:
Depreciation = Acquisition cost of the asset – scrap value

Life of the asset in hours
=₦ 20,000-1000
1900hrs
= ₦10 per hour
If in a particular year, the machine runs for 490 hours, the amount of depreciation
will be ₦4900 (i.e., ₦ 10x490). It is obvious from this example that under machine
hour rate method the amount of depreciation is closely related with the frequency
of use of an asset. The simplicity in calculations and understanding is the main
advantage of these methods. However, it can be used only in case of those assets
whose life can be measured in terms of working time.
3. Written down value method: This is also known as Diminishing Balance

method. Under the diminishing balance method depreciation is charged at fixed
rate on the reducing balance (i.e., cost less depreciation) every year. Thus, the
amount of depreciation goes on decreasing every year. Under this method also the
amount of depreciation is transferred to profit and loss account in each of the year
and in the balance sheet the asset is shown at book value after reducing
depreciation from it.
For example, if an asset is purchased for ₦10,000 and depreciation is to be charged
at 20% p.a. on reducing balance system then the depreciation for the first year will
be ₦2000. In the second year, it will ₦1600 (i.e. 20% of 8000), in the third year
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₦1280 (i.e. 20% of 6400) and so on. The rate of depreciation under this method
can be computed by using the following formula:
Depreciation rate = 1-n √Net scrap value

Acquisition cost
Depreciation = 1-3 3375

27000
1 – 15/30 = 50%
For example, if the cost of an asset is ₦27000, scrap value ₦ 3375, economic life 3
year, the rate of depreciation would be:
Depreciation Rate = 1-3

= 50%
Merits of diminishing balance method:

(i) It is very easy to understand and calculate the amount of depreciation
despite the early variation in the book value after depreciation.
(ii) This method put an equal burden for use of the asset on each subsequent
year since the amount of depreciation goes on decreasing for each
subsequent year while the charge for repairs goes on increasing for each
subsequent year.
(iii) This method has also been approved by the income tax act applicable in
India.
(iv) Asset is never reduced to zero because if the rate of depreciation is (say)
20%. Then even when asset is reduced to very small value, there must
remain the 80% of that small value as on written off balance.
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Demerit:
(i) It ignores the interest on the capital committed to purchase that asset.
(ii) It does not provide adequately for replacing the asset at the end of its life.
(iii) The calculation of rate of depreciation is not so simple.
(iv) The formula for calculating the rate of depreciation can be applied only
when there is some residual of the asset.
Suitability:
This method is suitable in those cases where the receipts are expected to decline as
the asset gets older and, it is believed that the allocation of depreciation of
depreciation ought to be related to the pattern of assets expected receipts.
Illustration 2: A company purchases Machinery on 1st April 1990 for ₦20,000.
Prepare the machinery account for three years charging depreciation @ 25% p.a.
according to the written Down value Method.
Machinery Accounts
Date Particulars Amount₦ Date Particulars Amount ₦
1990 To Bank 20 2001 By Depr. 5
April 1 March 31 By Bal. c/d 15
20 20
2001 To Bal. b/d 15 2002 By Depr. 3.8
April 1 March 31 By Bal. c/d 11.2
15 15
2002 To Bal b/d 11.2 2003 By Depr. 2.8
April 1 March 31 By Bal. c/d 8.4
11.2 11.2
4. Sum of years digits (SYD) method: Under this method the annual amount
of depreciation that will be expensed in the statement of profit and loss is
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computed by multiplying the depreciable amount by a fraction. The denominator in
this fraction is the same each year, and is the sum of a decreasing arithmetic
progression, the first number of which is the useful life of the asset and the last is
one. For example, where an asset has a useful life of three years, the denominator
is calculated as follows (3 + 2 + 1 = 6), with the numerator in the fraction being the
number of years of the asset's remaining useful life at the start of the accounting
year in question (e.g. 3 years, 2 years, 1 year). Therefore, in year one the
depreciable amount will be multiplied by in year two the depreciable amount will
be multiplied by and so on.
This method gives a decreasing annual charge for depreciation over the useful life
of the asset that is similar to, but not the same amount as, the reducing balance
method. The arguments for and against the sum of the years' digits method are thus
the same as those relating to the reducing balance method except that the former is
simpler. Moreover, the difference in the annual depreciation expense highlights the
arbitrary nature of the different assumptions about the rates of decline that are built
into the two methods.
Under this method also the amount of depreciation goes on diminishing in the
future years similar to that under diminishing Balance method. Also the amount of
depreciation that will be expensed in the statement of profit and loss is computed
by multiplying the depreciable amount by a fraction. The denominator in this
fraction is the same each year, and is the sum of a decreasing arithmetic
progression, the first number of which is the useful life of the asset and the last is
one. For example, where an asset has a useful life of five years, the denominator is
calculated as follows (4+3 + 2 + 1 = 10), with the numerator in the fraction being
the number of years of the asset's remaining useful life at the start of the
accounting year in question (e.g. 4years, 3 years, 2 years, 1 year). Therefore, in
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year one the depreciable amount will be multiplied by in year two the depreciable
amount will be multiplied by and so on.
For calculating the amount of depreciation to be charged to the profit and loss
account this method takes into account cost, scrape value, and life of the asset. The
following formula is used for determining depreciation:
Depreciation = Remaining life of the Asset at the end of the Year + 1 x Acquisition
cost
Sum of the Digits Representing the Life of the Asset
For example, an asset having an effective life of 5 years is purchased at a cost of

₦20,000. It is estimated that its scrap value at the end of its effective life will be
₦2000. The depreciation on this asset, if SYD method is followed, will be
calculated as follows from one to five years:
Depreciable value = ₦20,000-₦200= ₦18,000
Year Depreciation Amount

No Digit Workings Annual Depreciation
₦
1 4 4/10*18000 7200
2 3 3/10*18000 5400
3 2 2/10*18000 3600
4 1 1/10*18000 1800
10 18000
5. Annuity method: Sofar, we have described such methods of charging

depreciation which ignore the interest factor. Also, sometimes it becomes
inconvenient for a company to follow any of the methods discussed earlier. Under
such circumstances the company may use some special depreciation systems.
Annuity method is one of these special systems of depreciation. Under this system,
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the depreciation is charged on the basis that besides losing the acquisition cost of
the asset the business also loses interest on the amount used for purchasing the
asset. Here, interest refers to that income which the business would have earned
otherwise if the money used in buying the asset would have been committed in
some other profitable investment. Therefore, under the annuity method the amount
of total depreciation is determined by adding the cost and interest thereon at an
expected rate. The annuity table is used to help in the determination of the amount
of depreciation. A specimen of Annuity Table is as follows:
Annuity Table
Year 3% 4% 5% 6%
4 0.269027 0.275490 0.282012 0.288591
5 0.218335 0.224627 0.230975 0.237376
6 0.184598 0.190762 0.197012 0.213363
7 0.160506 0.166610 0.172820 1.179135
8 0.142456 0.148528 0.154722 0.161036
9 0.128434 0.134493 0.140690 0.147022
10 0.117231 0.12391 0.129505 0.135868
In case depreciation is charged according to this method, the following accounting

entries are passed:
(i) Purchase of an asset
Asset Account Dr.
To Bank
(ii) For charging interest
Asset Account Dr.
To Interest Account
(iii) For chargingdepreciation:
Depreciation Account Dr.
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To Asset Account
Evaluation of annuity method
Merits:
(i) This method keep into account interest on money spent on the purchase of
the asset.
(ii) The value of the asset become zero at the end of life.
Demerits.
(i) This method is comparatively more difficult than the methods discussed so far.
(ii) It makes no arrangement of money to replace the old asset with the new one at
the expiry of its life.
(iii) Under this method the burden on the profit and loss account is no similar in
each
year because the depreciation remains constant year after year but the interest
goes on decreasing.
4. Depreciation fund method: Business assets become useless at the expiry

of their life and, therefore, need replacement. However, all the methods of
depreciation discussed above do not help in accumulating the amount which can
be readily available for the replacement of the asset its useful life comes to an
end. Depreciation fund method takes care of such a contingency as it incorporates
the benefits of depreciating the asset as well as accumulating the necessary
amount for its replacement. Under this method, the amount of depreciation
charged from the profit and loss account is invested in certain securities carrying
a particular rate of interest. The interest received on the investment in such
securities is also invested every year together with the amount of annual
depreciation. In the last of the life of asset the depreciation amount is set aside
interest is received as usual. But the amount is not invested because the amount is
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immediately needed for the purchase of new asset. Rather all the investments so
far accumulated are sold away. Cashrealised on the sale of investments is utilised
for the purchase of new asset. The following accounting entries are generally
made in order to work out this system of depreciation.
1. At the end of the first year

(i) for setting aside the amount of depreciation : The amount to be charge by way
of depreciation is determined on the basis of sinking Fund Table given as an
Appendix at the end of every book of accountancy.
Depreciation AccountDr.
To Depreciation Fund Account (or Sinking Fund A/c)
(ii) For investing the amount charged by way of depreciation:
Depreciation Fund Investment A/cDr.
To Bank A/c
In the second and subsequent years

(i) For receiving interest. The interest on the balance of Depreciation
Fund Investment outstanding in the beginning of each year will be received by the
end of the year. This entry is:
Bank AccountDr.
To Depreciation Fund Account
(ii) For setting aside the amount of depreciation
Profit and Loss A/c Dr.
To Depreciation Fund A/c
(iii) For investing the amount
Depreciation Fund Investment A/cDr.
To Bank A/c
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(Annual installment of depreciation and interest received invested) 3. In the last
year
(i) For receiving interest:
Bank A/c Dr.
(ii) For setting aside the amount of depreciation
Profit and loss A/c Dr.
To depreciation Fund A/c
Note: In the last year no investment will be made, because the amount is
immediately required for the purchase of new asset.
(iii) For the sale of investment:
Bank A/c Dr.
To Depreciation Fund Investment A/c
(iv) For the transfer of profit or loss on sale on investments: The profit or loss on
the sale of these investments is transferred to the Depreciation Fund Account.
The entry for loss:
Depreciation Fund A/c Dr.
To Depreciation Fund Investment A/c
The entry for profit
Depreciation Fund Investment A/c
(v) For the sale of old asset:
Bank A/c Dr.
To asset A/c
(vi) The depreciation fund is transferred to asset account and any balance left in the
asset account is transferred to profit and loss account. The entry is:
Depreciation Fund A/c.Dr.
To asset A/c
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(vii) The balance in Asset Account represents profit or loss. Therefore it will be
transferred to the profit and loss account. (viii) The cash realised on the sale of
investments and the old asset is utilised for the purchase of new asset.
7. Insurance Policy Method: Under this method, instead of investing the money
in securities an insurance policy for the required amount is taken. The amount of
the policy is such that it is adequate to replace the asset when it is worn out. Afixed
sum equal to the amount do depreciation is paid as premium every year.Company
receiving premium allows a small rate of interest on compound basis. Atthe
maturity of the policy, the insurance company pays the agreed amount withwhich
the new asset can be purchased. Accounting entries will be made as follows.
1. First and every subsequent years:

(a) Depreciation Insurance policy A/c Dr.
To Bank
(Entry in the beginning of the year for payment of insurance premium)
(b) Profit and loss Account Dr.
To Depreciation fund A/c
(Entry at the end of the year for providing depreciation)
2. Last year:
(a) Bank A/c Dr.
To Depreciation Policy A/c
(Entry for the amount of policy received)
(b) For transfer of profit on insurance policy:
Depreciation Insurance Policy A/c Dr.
(c) For transfer of accumulated depreciation to the asset account:
Depreciation Fund A/c Dr.
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To Asset A/c
(d) On purchase of new asset:
On purchase of new asset:
New Asset A/c Dr.
To Bank
8. Depletion method: This is also known as productive output method.

In this method, it is essential to make an estimate of the units of output the asset
will produce in its life time. This method is suitable in case of mines, queries, etc.,
where it is possible to make an estimate of the total output likely to be available.
Depreciation is calculated per unit of output. Formula for calculating the
depreciation rate is as under:
r = Acquisition Cost –Scrap Value

Units of Output
Example: If a mine is purchased for 50 and it is estimated that the total quantity of
mineral in the mine is 100tonnes, the rate of depreciation would be:
r = ₦ 50 = ₦ 0.5
100
Hence, the rate of depreciation is 5percent per tonne. This method is useful where
the output can be measured effectively, and the utility of the asset is directly
related to its production use. Thus, the method provides the benefit of correlating
the amount of depreciation with the productive use of asset.
Illustration
In order to record depreciation, a provision for depreciation may or may not be
maintained. In case a ‘Provision for Depreciation Account’ is maintained, the
189
respective asset appears at its original cost since the depreciation is credited to
‘Provision for Depreciation Account’ instead of the ‘Respective Asset Account’. In
case a ‘Provision for Depreciation Account’ is not maintained, the respective asset
appears at a written down value since the depreciation is credited to the
‘Respective Asset Account’. The accounting entries under both these cases are
summarised as under:
Case When a provision for Depreciation When a provision for
Account is Maintained Depreciation Account is not
maintained
a. For providing Depreciation Dr. Depreciation A/c Dr.
Depreciation To provision for Depreciation To Asset A/c
b. For closure of Profit and Loss A/c Dr. Profit and Loss A/c Dr.
Depreciation To Depreciation A/c To Depreciation A/c
A/c
c. On disposal of (1) For transfer of original cost of 1.For recording sales proceed
an Asset asset disposed off Cash A/c/ Bank A/c Dr.
Asset Disposal A/c Dr. To Asset A/c
To Asset A/c 2.For transfer of profit/Loss
(ii) For transfer of accumulation on Asset disposed off
depreciation on asset disposed off 3.For transfer of profit and
Provision for depreciation A/c Dr. loss on asset disposed off
(iii) For recording sale proceeds (a) In case of profit
Cash A/c/ bank A/c Dr. Asset A/c Dr.
To Asset Disposal A/c To profit and loss A/c
(iv)For transfer of the balance in (b) In case of Loss reverse of
Asset Disposal Account the above entry will be passed
(a)In case of profit
Asset Disposal A/cDr.
To profit and Loss A/c
(b)In case of loss, reverse of the above
entry will be passed.
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Notes:
i. Book Value as on date of Sale = Original Cost–Total Depreciation till
date of sale
ii. Profit=Sale Proceeds – Book Value as on date of sale
iii. Loss=Book value as on date of sale – Sale Proceeds
iv. In case of exchange of an asset, sale proceeds imply the ‘Trade in
allowance’ (i.e. the amount at which the vendor agrees to acquire the old
asset).
v. In case of destruction/damage of an insured asset by fire or accident, sale
proceeds imply claim admitted by Insurance Company together with
salvage value (if any).
Illustration: On 1st Jan. 2006, X Ltd. purchased a machinery for ₦12,000,000. On

1st July 1998, a part of the machinery purchased on 1st Jan. 2006 for ₦800,000 was
sold for ₦ 450,000 and a new machinery at a cost of ₦1,580,000 was purchased
and installed on the same date. The company has adopted the method of providing
10% p.a. depreciation on the original cost of the machinery.
Required: Show the necessary leader accounts assuming that (a) Provision for
Depreciation Account is not maintained, (b) Provision for Depreciation Account is
maintained.
Solution:
(a) When Provision for Depreciation Account is not maintained
Dr. Machinery Account Cr.
Date Particulars Amount ₦ Date Particulars Amount ₦
01.01.06 To Bank A/c 12,000,000 31.12.06 By Depreciation 1,200,000
A/c 10,800,000
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12,000,000 By Balance c/d 12,000,000
01.01.97 To Balance b/d 10,800,000 31.12.97 1,200,000
10,800,000 By Depreciation 9,600,000
A/c 10,800,000
01.01.98 To Balance b/d 9,600,000 01.07.98 By Balance c/d 450,000
01.07.98 By Bank A/c 150,000
By Profit & Loss 1,200,000
A/c
By Depreciation 9,380,000
11,180,000 31.12.98 A/c
By Balance c/d 11,180,000
(b) When ‘Provision for Depreciation Account is maintained

Dr. Machinery Account (at original cost) Cr.
01.01.06 To Bank A/c 12,000,000 31.12.06 By Balance c/d 12,000,000
01.01.97 To Balance b/d 12,000,000 31.12.97 By Balance c/d 12,000,000
01.01.98 To Balance b/d 12,000,000 01.07.98 By Asset Disposal 800,000
01.07.98 To Bank A/c 1,580,000 31.12.98 A/c 12,780,000
13,580,000 By Balance c/d 13,580,000
Dr. Provision for Depreciation Account Cr.

31.12.06 To Balance c/d 1,200,000 31.12.06 By Profit & Loss 1,200,000
31.12.97 To Balance c/d 2,40,000 01.01.97 A/c 1,200,000
2,40,000 31.12.97 By Balance b/d 1,200,000
01.01.98 By Profit & Loss 2,400,000
01.07.98 To Asset Disposal 200,000 31.12.98 A/c
31.12.98 A/c 3,430,900 By Balance b/d 2,400,000
To Balance c/d 3,630,900 By Profit & Loss 1,230,900
A/c 3,630,900
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Dr. Asset Disposal Account Cr.
01.07.98 To Machinery A/c 800,000 01.07.98 By Provision for
Depreciation A/c 200,000
By Bank A/c 450,000
By Profit & Loss 150,000
A/c
800,000 (Loss on sale) 800,000
Working Notes:
(i) Calculation of Loss on Sale of Machinery
A. Original Cost as on 1.1.06 800,000
B. Less: Depreciation @ 10% p.a. on 80,000 80,000
C. Balance as on 1.1.97 (A–B) 720,000
D. Less: Depreciation @ 10% p.a. on 800,000 80,000
E. Balance as on 1.1.98 (C–D) 640,000
F. Less: Depreciation @ 10% p.a. on ₦ 800,000 for 6 months 40,000
G. Balance as on 1.7.98 (E–F) 600,000
H. Less: Sale proceeds 450,000
I. Loss on Sale (G–H) 150,000
(ii) Calculation of Depreciation for 1998

(a) On ₦ 1,120,000 for 1 year 112,000
(b) On ₦ 60,000 for 1/2 year 6,000
(c) On ₦ 158,000 for 1/2 year 7900
125,900
In Text Question 4: Mention the methods of calculating depreciation?

In Text Answer 4: 1. Straight Line Method 2. Machine Hour Rate Method 3. Written
Down Value Method 4. Sun of Years Digit Method 5.Annuity Method 6.Depreciation
193
1. Briefly explain what you understand by depreciation
2. Why is it necessary to calculate depreciation? Discuss various factors which are
considered for calculating depreciation.
3. How do the matching principle and going concern concept apply to
depreciation?
4. Explain the circumstances under which different methods of depreciation can be
employed.
4.0 Summary
In this session, we took a look at depreciation.Depreciation is a gradual reduction
in the economic value of an asset from any cause. The depreciation occurs because
of constant use, passage of time, depletion, obsolescence, accidents and permanent
fall in the market value. The need for providing depreciation arises to ascertain the
profit or losses, to show the assets at its reasonable value, for replacement of
assets, to reduce income tax, etc. The various methods of allocating depreciation
include: fixed instalment methods, machine hour rate method, diminishing balance
method, sum of years digits method, annuity method, depreciation fund method,
insurance policy method and depletion method. The straight line method is very
suitable particularly in case of those assets which get depreciated more on account
of expire of period i.e. lease hold properties, patents etc.
Diminishing balance method is suitable in those cases where the receipts are
expected to decline as the asset gets older and, it is believed that the allocation of
depreciation ought to be related to the pattern of assets expected receipts. In case
an asset is sold during the course of the year, the amount realisedshould be credited
to the Asset Account. The amount of depreciation for the period of which the asset
194
has been used should be written off in the usual manner. Any balance in the Asset
Account will represent profit or loss on disposal of the asset.

1. Distinguish between the following:
(a) Straight line method and diminishing balance method.
(b) Annuity method and depreciation Fund method.
(c) Depreciation and depletion.

a. Visit U-tube https://www.youtube.com/watch?v=9h1AWeBh6zs . Watch the
b. View the animation on https://www.youtube.com/watch?v=cHik6vtqb94 and
7.0 References
Adeniyi, A. A. (2008). Management Accounting, Fourth Edition. El-toda Ventures
Limited, Lagos128
Igben, R.O. (2014) Financial Accounting Made Simple. Mushin: ROI Publishers
Accounting
195
STUDY SESSION 2
Bad Debts and Provisions for Bad Debts
Introduction
2.0 Main Content.
2.1The Nature and Ledger Entries for Bad Debts.
2.2 The Nature and Ledger Entries for Provisions for Bad Debts.
2.3 Provision for Bad Debts and Doubtful Debts.
4.0 Summary.
5.0 Self-assessment Questions.
7.0 References.
Introduction
This is one aspect of accounting that no business like to deal with reasons why is
because of loss of its financial stand be a small or large scale of business.
In this session, we shall be discussing about bad debts and provision for bad debts.
Transactions on credit between the business and the customer give rise to debts.
Bad debts are debts which have become irrecoverable because of inability of the
debtor to pay, disappearance of the debtor and debt of the debtor. A debt is
doubtful when there is uncertainty about its being paid in full by the debtor. In
such cases, adjustment has to be made in the annual accounts. If no adjustment is
made for debts that have proved bad, the amount of debtors in the book would be
overstated. Similarly, the period’s profit would be overstated (or loss understated)
by the same amount. To avoid this, the amount due from the debtors is reduced by
196
crediting debtors and debiting bad debts account. The balance in the bad debt
account is subsequently transferred to the profit and loss account.

1. identify the Nature and Ledger Entries for Bad Debts,
2. identify the Nature and Ledger Entries for Provisions
for Bad Debts,
3. discuss the illustration for bad debt,
4. discuss provision for bad debt and doubtful debt.
2.0 Main Content

2.1 The Nature and Ledger Entries for Bad Debts
When goods are sold on credit, it sometimes transpires that the customer is
unwilling or unable to pay the amount owed. This is referred to as a bad or
irrecoverable debt. The decision to treat a debt as bad is a matter of judgement. A
debt may be regarded as irrecoverable for a number of reasons, such as being
unable to trace the credit customer, it not being worthwhile financially to take the
credit customer to court, or the credit customer being bankrupt. However, if a
credit customer is bankrupt, this does not necessarily mean that the whole of the
debt is irrecoverable. When a person is bankrupt, his or her possessions are seized
and sold in order to pay the creditors.Such payments are often made in instalments
known as 'dividends'. Frequently, the dividends do not consist of the repayment of
the whole of the debt. Thus, when the 'final dividend' is received, the remainder of
the debt is irrecoverable.
When a debt is regarded as irrecoverable the entries in the ledger are as follows:
Debit: Bad debts ledger account
197
Credit: Trade receivables ledger account (the individual credit customer's account
would also be amended in the sales ledger)
Occasionally, debts previously written off as bad are subsequently paid. When this
happens, the ledger entries are the reverse of the above, and the trade receivables
ledger account is credited with the money received in the normal way.
Debit: Trade receivables ledger account (the individual credit customer's account
would be amended in the sales ledger)
Credit: Bad debts ledger account
At the end of the accounting year, the balance on the bad debts account is
transferred to the statement of profit and loss.
In Text Question: What is a bad or irrevocable debt?

In Text Answer: When goods are sold on credit, it sometimes transpires that the customer is
unwilling or unable to pay the amount owed, it is then referred to as a bad or irrecoverable debt.
2.2 The Nature and Ledger Entries for Provisions for Bad Debts
A provision is the setting-aside of income to meet a known or highly probable
future liability or loss, the amount and/or timing of which cannot be ascertained
exactly, and is thus an estimate. An example would be a provision for damages
payable resulting from a legal action where the verdict had gone against the
business but the amount of the damages had not been fixed by the court at the end
of the accounting year, If the damages had been fixed, these would be treated not
as a provision but as a liability, Another example of a provision is depreciation.
198
You should note that when accountants talk of setting aside income, what they
mean is that 'funds' are being retained in the business but not put into a separate
bank account. The funds are automatically retained in the business by designating
part of the income as a provision, since this reduces the profit that is available for
withdrawal by the owner(s) of the business.
The need for a provision for bad/doubtful debts essentially arises because goods
sold and recognized as sales revenue in one accounting year may not become
known to be a bad debt until the following accounting year. Thus, the profit of the
year in which the goods are sold would be overstated by the amount of the bad
debt. In order to adjust for this, a provision in respect of probable bad debts is
created in the year of sale (matching concept).
A provision for bad debts may consist of either a specific provision or a general
provision, or both. A specific provision involves ascertaining which particular
credit customers at the year-end are unlikely to pay their debts. A general provision
is an estimate of the total amount of bad debts computed using a percentage (based
on previous years' figures) of the trade receivables at the end of the current year.
Where both specific and general provisions are made, the two amounts are added
together and the total is entered in the general ledger.
The accounting entries in respect of a provision for bad debts are made after the
trial balance has been extracted when the statement of profit and loss is being
prepared. It is important to appreciate that any balance on a provision for bad debts
account shown in a trial balance must therefore relate to the balance at the end of
the previous year. A charge (or credit) is made to the statement of profit and loss in
each year that consists of an amount necessary to increase (or decrease) the
provision at the end of the previous year to the amount required at the end of the
current year.
199
An increase in a provision always consists of:
Debit: Profit and loss account (increase in provision for bad debts)
Credit: Provision for bad debts account
A decrease in a provision is entered:

Debit: Provision for bad debts account
Credit: Profit and loss account (decrease in provision for bad debts)
The balance on the provision for bad debts account at the end of the year is
deducted from trade receivables in the statement of financial position to give the
net amount that is expected to be received from credit customers - that is, their net
realizable value. The principle is similar to that applied in the case of a provision
for depreciation where the accumulated depreciation at the end of the year, as
shown by the balance on the provision for depreciation account, is deducted from
the cost of the non-current asset in the statement of financial position. All other
provisions such as for legal costs, damages or fines are shown in the statement of
financial position as a current liability or non-current liability, depending on
whether they are payable within one year or more from the date of the statement of
financial position. The treatment of bad debts and provisions for bad debts is
illustrated below
Illustration
During the year up to 31st December, 20x12, a debit balance of ₦30 in the accounts
of B. Job, which has been standing since the beginning of the year, was found to be
irrecoverable. Credit sales of ₦450 were made to Chiamakasubsequently closed his
business and could pay 10k in the naira. The balance was irrecoverable. Make
adjustments in the relevant books of accounts.
200
Journal
Date Particulars Folio Debit Credit
20x12 ₦ ₦
Dec. 31 Bad Debts Gl 60 30
Dr. Gl30 30
Dec. 31 Bad Debts GL 405
Dr. 60 405
Chiamaka GL
Being bad debt written off on final 36
payment of 10k in naira
Dec. 31 Profit and Loss GL 435
Dr. 92 435
Bad Debts GL
Being bad debts for the year transferred to 60
profit and Loss Account
The calculation of the figure for Chiamaka’s bad debts needs explanation. Her debt
was originally ₦450. For every N she owed, she could pay only 10k after she
closed her business. Therefore, for a debt of ₦450, she only pay 1/10 x ₦450
which gives ₦45. The rest, ₦405, is bad debt.
Dr. B. Job Folio 30 Cr.

20x12 ₦ 20x12 Bad Debts GL 60 ₦
Jan. 1 Balance b/d 30 Dec.31 30
₦30 ₦30
201
Dr. Chiamaka Folio 36 Cr.
20x12 ₦ 20x12 Bank GL10 ₦
Dec. 31 Sales GL 450 Dec. Bad Debts GL60 45
50 31 405
₦450 ₦450
GENERAL LEDGER
Dr. Bad Debts Cr.
20x12 ₦ 20x12 Profit and Loss ₦
Dec. 31 R. Job GL 30 Dec.31 Gl 92 435
30
Chiamaka 405
SL 36 435 435
Dr. Profit and Loss Account Cr.

20x12 ₦ 20x12 ₦
Dec. 31 Bad Debt GL 60 435
435
Suppose B. Job unexpectedly pays the amount due in January, 20x12, then, for
record purposes, all the entries previously made would have to be reversed. The
procedure would be as follows:
202
SALES LEDGER
Dr. B. Job Folio 30 Cr.
20x12 ₦ 20x12 GL 60 ₦
Jan. 1 Balance b/d 300 Dec.31 Bad Debts 300
20x12 ₦ Jan. 1 ₦
Jan 1 Bad Debts Bank GL 10 300
recovered GL 70 300
300 300
GENERAL LEDGER
Dr. Bad Debts Recovered Folio 70 Cr.
20x12 Profit and ₦ 20x12 ₦
Dec. 31 Loss 30
Jan. 1 B. Job SL 30 30
30 30
The bad debts recovered is credited to the Profit and Loss Account and debited to
Bad Debts Recovered Accounts as illustrated.
2.3 Provision for Bad Debts and Doubtful Debts

A provision may be defined as any amount written off or retained for the purpose
of meeting any known liability or fall in the value of an asset in situations in which
the exact amount involved cannot be accurately determined. An example of such is
a bad or doubtful debt which brings about a fall in the value of a class of assets-
debtors. The accountant is able, by past experience to estimate what percentage of
total debtors are unlikely to pay. Assuming that past experience has shown that 5%
203
of debtors tend not to pay, then a provision of that magnitude would be made by
debiting the Profit and Loss Account and crediting Provision for Bad and Doubtful
Debts account.
Illustration
The balance in the Sales Ledger on 31st December, 20x12, total ₦9,600 and it is
decided to make a provision for Bad and Doubtful Debts equal to 5% of the
debtors. Show necessary adjusting entries.
Journal
Date Particulars Folio Dr. Cr.
20x12 ₦ ₦
Dec. 31 Profit and Loss GL48 480
Provision for Bad and Doubtful debt GL 22 480
Being provision for bad and Doubtful Debts
of 5% of the debtors outstanding at 31st
December, 20x12, of N9,600
GENERAL LEDGER
Dr. Provision for Bad and Doubtful Debts
Folio 22 Cr.
20x12 20x12 N
Dec. 31 Balance c/d 480 Dec.31 Profit and
Loss GL 48 480
480 480
Jan.1 b/d 480
204
Dr. Profit and Loss Account Folio 48 Cr.
20x12 ₦ 20x12 ₦
Dec. 31 Provision
for bad
and
doubtful GL 22 480
debts
Balance Sheet as at31st December, 20x12

(Assets Side Only)
Assets Amount
N
Current Assets
Sundry debtors 9,600
Less: Provision for bad and doubtful debts 480
₦9,120
3.0Tutor Marked Assignment

1. What is a bad debt?
2. A business has an accounting year ending on 31 July. It sells goods on credit and
on 31 July 20X3 had trade receivables of ₦15,680,000. This includes debts of
₦410,000 due from A. Wall and ₦270,000 from B. Wood, both of which were
regarded as irrecoverable. The business has decided to create a provision for bad
debts at 31 July 20X3 of 4 per cent of trade receivables. Previously there was no
provision for bad debts. You are required to show the ledger entries in respect of
the above bad debts and provision for bad debts.
205
4.0 Summary
In this session, we treated the definition of bad debts, the nature of bad debts and
ledger entries for bad debts. We also treated the nature and ledger entries for the
provision for bad debts
5.0 Self-Assessment Question

1. What do you understand by the term 'bad debts'? In what circumstances
might a debt be treated as irrecoverable?
2. Explain the nature of a provision.

a. Visit U-tube https://www.youtube.com/watch?v=bG54gJ37wXQ,,
https://www.youtube.com/watch?v=CsiuTA96I1k . Watch the video & summarise
in 1 paragraph

Abohi, A.A. (2003). Basic Cost Accounting 2, Second Edition. Justice Jeco
Publishers Ltd, Benin City.
Adeniyi, A. A. (2008). Management Accounting, Fourth Edition. El-toda Ventures
Limited, Lagos128
206
STUDY SESSION 3
Financial Ratios
Introduction
1.0 Learning Outcomes.
2.0 Main Content.
2.1 Definition of Financial Ratios.
2.2 Interpretation of Ratios.
2.3 Managerial Uses of Ratio Analysis.
2.4 Draw Backs of Ratio Analysis.
2.5 Classification of Ratios.
4.0Summary.
5.0Self-assessment Questions.
6.0Additional Activities.
7.0 References.
Introduction
In this session, you will be introduced to the various financial ratios that are used
to analyse the financial statement. Ratio is the relationship between two or more
financial or statistical data in a financial statement. A ratio is a simple arithmetical
expression of the relationship of one number to another. According to Accountant's
Handbook by Wixon, Kellandbedbord, "a ratio" is an expression of the quantitative
relationship between two numbers". In simple language ratio is one number
expressed in terms of the other and can be worked out by dividing one number into
the other. Ratio is a quantitative factor which expresses the relationship between
two or more values. Financial ratio is a proportion or fraction or percentage which
207
expresses the relationship between items contained in different financial
statements. It is mostly used to determine or rather evaluate performance.
For example, company A can utilize financial ratio to analyse financial statements
prepared in say 2007. The company could in like manner analyse the body of
records prepared in 2007 and 2008 for comparison purposes (which is intra
company analysis). A situation which company A compares her records using
financial ratios with the records of another company, it is said to have done
intercompany analysis. For instance, this relationship can be expressed as (i)
percentages, say, net profits are 20 per cent of sales (assuming net profits of
₦20,000 and sales of ₦1,00,000), (ii) fraction (net profit is one-fourth of sales) and
(iii) proportion of numbers (the relationship between net profits and sales is1:4).
Various categories of financial ratios are in use and will be considered for this
study. An analysis of financial statements is the process of critically examining in
detail accounting information given in the financial statements. For the purpose of
analysis, individual items are studied, their interrelationships with other related
figures

1. Define financial ratios and Interpret ratios,
2. List the managerial uses of ratio analysis,
3. Tate the drawback of ratio analysis,
4. Classify of ratios: liquidity ratios, activity ratios, leverage/capital structure,
coverage ratios and profitability ratios,
5. Discuss the illustration of ratios.
208
2.0 Main Content
2.1 Definition of Financial Ratios
Financial ratios are also simply referred to as accounting ratios. It is a powerful
tool in that it reveals to the company a picture capable of company’s resuscitation
and sustainability. The rational of ratio analysis lies in the fact that it makes related
information comparable. A single figure by itself has no meaning but when
expressed in terms of a related figure, it yields significant inferences. Ratio
analysis helps in financial forecasting, making comparisons, evaluating solvency
position of a firm, etc. For instance, the fact that the net profits of a firm amount to,
say, N20 throws no light on its adequacy or otherwise. The figure of net profit has
to be considered in relation to other variables. How does it stand in relation to
sales? What does it represent by way of return on total assets used or total capital
employed? In case net profits are shown in terms of their relationship with items
such as sales, assets, capital employed, equity capital and so on, meaningful
conclusions can be drawn regarding their adequacy.
Ratio analysis, thus, as a quantitative tool, enables analysts to draw quantitative

answers to questions such as: Are the net profits adequate? Are the assets being
used efficiently? Can the firm meet its current obligations and so on? However,
ratio analysis is not an end in itself. Calculation of mere ratios does not serve any
purpose, unless several appropriate ratios are analysed and interpreted. The
following are the four steps involved in the
ratio analysis:
(i) Selection of relevant data
from the financial statements
depending upon the objective
of the analysis.
209
(ii) Calculation of appropriate ratios from the above data.
(iii) Comparison of the calculated ratios with the ratios of the same
firm in the past, or the ratios developed from projected financial
statements or the ratios of some other firms or the comparison
with ratios of industry to which the firm belongs.
(iv) Interpretation of the ratio.
In Text Question 1: What is a financial Ratio?

In Text Answer 1: Financial ratios are also simply referred to as accounting ratios. It is a
powerful tool in that it reveals to the company a picture capable of company’s resuscitation
andsustainability.
2.2 Interpretation of Ratios

The interpretation of ratios is an important factor. Though calculation is also
important but it is only a clerical task whereas interpretation needs skills,
intelligence and foresightedness. The interpretation of the ratios can be done in the
following ways:
1. Single Absolute Ratio: Generally speaking one cannot draw meaningful
conclusions when a single ratio is considered in isolation. But single ratios may be
studied in relation to certain rules of thumb which are based upon well proven
contentions as for example 2:1 is considered to be a good ratio for current assets to
current liabilities.
2. Groups of Ratio: Ratios may be interpreted by calculating a group of related

ratios. A single ratio supported by related additional ratios becomes more
understandable and meaningful.
210
3. Historical Comparisons: One of the easiest and most popular ways of
evaluating the performance of the firm is to compare its present ratios with the past
ratios called comparison over time.
4. Projected Ratios: Ratios can also be calculated for future standard based upon
the projected financial statements. Ratio calculation on actual financial statements
can be used for comparison with the standard ratios to find out variance, if any.
Such variance helps in interpreting and taking corrective action for improvement in
future.
5. Inter-firm Comparison: Ratios of one firm can also be compared with the
ratios of some other selected firms in the same industry at the same point of time.
2.3 Managerial Uses of Ratio Analysis

The following are the important managerial uses of ratio analysis:
1. Helps in Financial Forecasting: Ratio analysis is very helpful in financial
forecasting. Ratios relating to past sales, profits and financial position form the
basis for setting future trends.
2. Helps in Comparison: With the help of ratio analysis, ideal ratios can be
composed and they can be used for comparing a firm's progress and performance.
Inter-firm comparison or comparison with industry averages is made possible by
the ratio analysis.
3. Financial Solvency of the Firm: Ratio analysis indicates the trends in financial
solvency of the firm. Solvency has two dimensions-long-term solvency and short-
term solvency. Long-term solvency refers to the financial viability of a firm and it
is closely related with the existing financial structure. On the other hand, short-
term solvency is the liquidity position of the firm. With the help of ratio analysis
211
conclusions can be drawn regarding the firm's liquidity and long-term solvency
position.
4. Evaluation of Operating Efficiency: Ratio analysis throws light on the degree of

efficiency in the management and utilisation of its assets and resources. Various
activity ratios measure this kind of operational efficiency and indicate the
guidelines for economy in costs, operations and time.
5. Communication Value: Different financial ratios communicate the strength and
financial standing of the firm to the internal and external parties. They indicate the
over-all profitability of the firm.
6. Others Uses: Financial ratios are very helpful in the diagnosis of financial health
of a firm. They highlight the liquidity, solvency, profitability and capital gearing
etc. of the firm.
2.4Draw Backs of Ratio Analysis:

1) Limited use of a single ratio: Ratio can be useful only when they are
computed in a sufficient large number. A single ratio would not be able to
convey anything. At the same time, if too many ratios are calculated, they
are likely to confuse instead of revealing any meaningful conclusion.
2) Effect of inherent limitations of accounting: Because ratios are computed

from historical accounting records, so they also possess those limitations and
weaknesses as accounting records possess.
3) Lack of proper standards: While making comparisons, it is always a

challenging job to find out an adequate standard. It is not possible to
calculate exact and well accepted absolute standard, so a quality range is
212
used for this purpose. If actual performance is within this range, it may be
regarded as satisfactory.
4) Past is not indicator of future: It is not always possible to make future

estimates on the basis of the past as it always does not come true.
5) No allowance for change in price level: While making comparisons of
ratios, no allowance for changes in general price level is made. A change in
price level can seriously affect the validity of comparisons of ratios
computed for different time periods.
6) Difference in definitions: Comparisons are also made difficult due to
differences in definitions of various financial terms. The terms like gross
profit, net profit, operating profit etc. have not precise definitions and an
established procedure for their computation.
7) Window Dressing: Financial statements can easily be window dressed to
present a better picture of its financial and profitability position to outsiders.
Hence one has to be careful while making decision on the basis of ratios
calculated from such window dressing made by a firm.
8) Personal Bias: Ratios are only means of
financial analysis and is not an end in itself.
Ratios have to be interpreted carefully because
the same ratio can be looked at, in different
ways.
In Text Question 2: What are the draw backs of Ratio Analysis?

In Text Answer 2: 1. Limited use of a single ratio: 2. Effect of inherent limitations of accounting
3. Lack of proper standards 4. Past is not indicator of future 5. No allowance for change in price
level 6. Difference in definitions 7. Window Dressing 8. Personal Bias.
213
2.5 Classification of Ratios
Ratios can be classified into five broad groups: (i) Liquidity ratios (ii) Activity
ratios
(iii) Leverage/Capital structure ratios (iv) Coverage ratios (v) Profitability ratios.
Liquidity Ratios: Liquidity refers to the ability of a firm to meet its current
obligations as and when they become due. The importance of adequate liquidity
in the sense of the ability of a firm to meet current/short-term obligations when
they become due for payment can hardly be overstressed. In fact, liquidity is a
prerequisite for the very survival of a firm. The ratios which indicate the liquidity
of a firm are (i) net working capital, (ii) current ratio, (iii) acid test/quick ratio, (iv)
super quick ratio, (v) basic defensive interval.
i. Net Working Capital: The first measurement of liquidity of a firm is to

compute its Net Working capital (NWC). NWC is really not a ratio, but it is
frequently employed as a measure of a company's liquidity position. NWC
represents the excess of current assets over current liabilities. A firm should have
sufficient NWC in order to be able to meet the claims of the creditors and the day-
to-day needs of business. The greater the amount of NWC, the greater the liquidity
of the firm.Inadequate working capital is the first sign of financial problems for a
firm. It is useful for purposes of internal control also.
NWC = Total Current Assets – Total Current Liabilities
Illustration:The following data has been given in respect of two general insurance
firms. Calculate their NWC and comment upon the liquidity position.
Company X Company Y
Total Current Assets₦2,80,000₦1,30,000
214
Total Current Liabilities ₦2,20,000₦1,10,000
Solution:
NWC = TCA–TCL
Company X: ₦280,000–₦220,000 = ₦60,000.
Company Y: ₦130,000–₦110,000 = ₦20,000.
X Company has three times NWC in comparison to Y Company, hence it is more

liquid. However, the size of NWC alone is not an appropriate measure of the
liquidity position of a firm. The composition of current assets is also important in
this respect.
ii. CurrentRatio: Current ratio is the most common ratio for measuring liquidity.
Being related to working capital analysis, it is also called the working capital ratio.
The current ratio is the ratio of total current assets to total current liabilities.This
ratio compares total current assets with total current liabilities. In other words, it
measures the ability of a company to meet its current liabilities as they fall due, out
of its current assets. It is calculated using:
Current Ratio = Current Assets

Current Liabilities
As a measure of short-term financial liquidity, it indicates the rupees of current

assets available for each rupee of current liability. The higher the current ratio, the
larger the amount of rupees available per rupee of current liability, the more the
firm's ability to meet current obligations and the greater the safety of funds of
short-term creditors. If the result is greater than 1, the firm presumably has
sufficient current assets to meet its current liabilities. A ratio of 2:1 (two times
215
current assets of current liabilities) is considered satisfactory as a rule of thumb.
Thus, a good current ratio, in a way, provides a margin of safety to the creditors.
iii. Acid-Test/Quick Ratio :One defect of the current ratio is that it fails to convey
any information on the composition of the current assets of a firm. A rupee of cash
is considered equivalent to a rupee of inventory or receivables. But it is not so. A
rupee of cash is more readily available to meet current obligations than a rupee of,
say, inventory. This impairs the usefulness of the current ratio. The acid test ratio is
a measure of liquidity designed to overcome this defect of the current ratio. It is
often referred to as quick ratio because it is a measurement of a firm's ability to
convert its current assets quickly into cash in order to meet its current liabilities.
This ratio shows the extent to which cash and assets most readily convertible to
cash can meet the demand of short term creditors. It is also referred to as acid test
ratio. Thus, it is a measure of quick or acid liquidity.
Acid-test ratio = Quick Assets

Current Liabilities
The term quick assets refers to current assets which can be converted into cash
immediately or at a short notice without diminution of value. Included in this
category of current assets are (i) cash and bank balances; (ii) short-term marketable
securities and (iii) debtors/receivables. Thus, the current assets which are excluded
are: prepaid expenses and inventory. The exclusion of inventory is based on the
reasoning that it is not easily and readily convertible into cash. Prepaid expenses
by their very nature are not available to pay off current debts. An acid-test ratio of
1:1 or greater is recommended.
iv. Cash-Position Ratio or Super-Quick Ratio: It is a variant of Quick ratio.

When liquidity is highly restricted in terms of cash and cash equivalents, this ratio
216
should be calculated. It is calculated by dividing the super-quick current assets by
the current liabilities of a firm. The super-quick current assets are cash and
marketable securities. It can be calculated as below:
Cash-Position Ratio = Cash + Marketable Securities

Current Liabilities
The term quick assets refers to current assets which can be converted into cash
immediately or at a short notice without diminution of value. Included in this
category of current assets are (i) cash and bank balances; (ii) short-term marketable
securities and (iii) debtors/receivables. Thus, the current assets which are excluded
are: prepaid expenses and inventory. The exclusion of inventory is based on the
reasoning that it is not easily and readily convertible into cash. Prepaid expenses
by their very nature are not available to pay off current debts. An acid-test ratio
of1:1 or greater is recommended.
Profitability ratios: Profitability is the ability to sell goods and services above
cost and earn reasonable returns on capital. Therefore, profitability ratios are those
concerned with efficiency and performance in terms of return.
i. Net Profit Margin: This is the ratio of net profit before tax to sales. It
measures the rate at which income accrues from sales. This ratio offers a ready
means of comparing the operating efficiency of two or more firms or the same firm
for two different periods. In other words, it is calculated thus:
Net profit before tax × 100
Sales 1
ii. Return on assets managed: This ratio is defined as the relationship between
net profit before tax and total assets. They also opined that, it attempts to measure
the rate of efficiency in the use of the firm’s total assets. It is worthy of note that
217
net profit for this purpose should strictly include interests. This is mathematically
obtained as:
Trading profit + loan interest + debentures interest x 100
Fixed assets + current assets
iii.Return on capital employed: This ratio relates earnings to long term funds
only. They affirm that the ratio measures efficiency in the use of long term funds
after stating capital employed as equity funds plus all long and medium term loans.
ROCE shows the efficiency of management in utilization of the resources placed at
its disposal. It is also called primary ratio being the most important measure of
profitability and efficiency. It is calculated as:
Trading profit + loan interest + debentures interest × 100

Long term funds 1
OR
Profit X 100
Capital employed 1
iv. Return on equity: This ratio shows the relationship between earnings and
net equity, that is the total funds due to the ordinary shareholders which usually
comprise nominal capital plus all retention and reserves. Earnings here is, not
profit after interest and taxes. It is calculated thus:
Earnings (or profit after taxation) ×100
Net equity (or shareholder’s fund) 1
218
Illustration
ITF LIMITED
Five Years Financial Summary
_______________________________________________________________________
Year Ended 31st May 1988 1989 1990 1991 1992
₦ ₦ ₦ ₦ ₦
Funds Employed
Ordinary Share Capital 14,797 14,797 14,797 18,497 23,121
Capital reserve 16,518 32,166 32,472 30,902 31,252
Revenue reserve 13226 17589 21609 24674 23968
Shareholders Fund 44541 64502 68878 74073 78341
Deferred Taxation 5,427 11,154 10,810 13,004 15,479
Deferred Income - - 5,979 6,066 4,666
9.75% Debentures Stock - - - 20,000 20,000
Unsecured Loans 9,342 10,158 9,080 7,000 11,000
59,310 85,814 94,747 120,143129,486
Employment of Funds
Fixed Assets 34,977 70575 73,309 87,274106,657
Net Current Assets 24,333 15,239 21,538 32,869 22,829
Turnover and Profit
Turnover 229,796 291,572 319,731 367,966380,033
Profit before Taxation 12,283 7,272 14,090 16,474 15,508
Profit after Taxation 5,733 4,353 6,979 8,816 7,617
Dividends 1,835 2,072 2,959 3,699 3,699
Additional information:
219
Some of the assets and liabilities of the company are indicated thus:
1982 1981
₦ ₦
Fixed Assets 106,657 87,274
Current Assets 160,231 138,126
Current liabilities 137,402 105,257
Stock 142,934
The interest on unsecured loans is 8.02%
Required: Calculate liquidity and profitability ratios of ITF limited for 1982.
SOLUTION
For liquidity ratios:
i. Current ratio = Current assets
Current liabilities
₦160,231
= ₦137,402 =1.7 : 1
ii. Quick assets ratio = current assets - stock

current liabilities
=₦160,231- N142,934
₦137,402= 0.13 : 1
For profitability ratios:
i. Net profit margin = net profit before tax = ₦15,508,000 = 4.08%

Sales ₦380,033,000
ii. Return on assets margin = trading profit + loan interest + debenture interest
fixed assets + current assets
= ₦15,508,000 + N882,000 + ₦1,950,000

₦106,657,000 + ₦160,231,000 = 6.87%
220
iii. Return on capital employed =
trading profit + loan interest + debentures interest
long term funds
= ₦15,508,000 + ₦882,000 + ₦1,950,000

₦129,486,000
= ₦18,340,000
₦129,486,000 =14.16%
iv. Return on equity = ₦7,617,000

₦78,341,000 = 9.72%
In Text Question 3:Ratios can be classified into five broad groups, what are
they?
In Text Answer 3: (i) Liquidity ratios (ii) Activity ratios

1. Explain the types of financial ratios that you know
2. Ratios like statistics have a set of principles and finality about them which at
times may be misleading." discuss with illustrations.
3."The study of financial analysis is simply memorising a bunch of ratios and gives
the yours very little opportunity for creative problem solving." Do you agree
with it? Explain.
4.0 Summary
In this session, the various financial ratios such as Liquidity and Profitability ratios
were examined. The definition of financial ratios, interpretations managerial uses,
drawbacks and classification of ratios were given with illustration.
221
1. State the meaning of expression "Return on Capital Employed" and point out the
advantages the business would derive from its use.
2. Discuss the importance of ratio analysis for inter-firm and intra-firm comparison
including circumstances responsible for its limitations, if any.

a. Visit U-tube https://www.youtube.com/watch?v=XnL6Gom7N3wWatch the
b. View the animation on https://www.youtube.com/watch?v=TZZFBkbC2lA
7.0 References
ICAN Study Pack (2006).Fundamentals of Financial Accounting.VIPublishing
Accounting
222
STUDY SESSION 4
Cash/Fund Flow Statement
Introduction
2.0 Main Content
2.1 Meaning of Funds.
2.2 Cash flow Statement.
2.3 Classification of cash flows.
2.4 Rule of Cash Flow.
2.5 Working Capital.
2.6 The Significance of Cash.
2.7. The objectives of a cash flow statement.
4.0 Summary.
5.0 Self-assessment Questions.
7.0 References.
Introduction
Welcome to session 4, we will be looking at cash/fund flow in this session of
study, and it’s important in accounting.
The Funds Flow Statement is a statement which shows the movement of funds and
is a report of the financial operations of the business undertaking. It indicates
various means by which funds were obtained during particular period and the ways
inwhich these funds were employed. In simple words, it is a statement of sources
and applications of funds.
223
1.0 Learning Outcomes
1. State the meaning of funds.
2. Discuss on cash flow statement.
3. Discuss on the classification of cash flows.
4. State the rules of cash flow.
5. Discuss on Working Capital.
6. List the objectives of a cash flow statement.
7. Describe the working of cash flows statement.
8. Classification of cash flows.
2.0 Main Content

2.1 Meaning of Funds
The term 'funds' has been defined in a number of ways:
(a) In a narrow sense, it means cash and a Funds Flow
Statement prepared on this basis is called a cash flow
statement. Such a statement enumerates net effects of the
various business transactions on cash and takes into
account receipts and disbursements of cash.
(b) In a broader sense, the term 'funds' refers to money

values in whatever form it may exist. Here funds mean all financial resources, used
in business whether in the form of men, material, money, machinery and others.
(c) In a popular sense, the term 'funds' means working capital, i.e., the excess of
current assets over current liabilities. The working capital concept of funds has
emerged due to the fact that total resources of a business are invested partly in
224
fixed assets in the form of fixed capital and partly kept in form of liquid or near
liquid form as working capital.
The concept of funds as working capital is the most popular one and in this lesson
we shall refer to 'funds' as working capital.
The term 'flow' on the other hand means movement and includes both 'inflow' and
'outflow' whereas, the term 'flow of funds' means transfer of economic values from
one asset or equity to another.
Cash includes cash in hand and deposits repayable on demand with any bank or
other financial institutions. It also includes deposits in foreign currency.
i. Cash Equivalents: These are short term highly liquid investments which are
readily convertible into known amounts of cash without notice and which were
within three months of maturity when acquired less advances from banks repayable
within three months from the date of the advance. They also include investment
and advances in foreign currencies provided that they are highly liquid and are
readily convertible to known amounts of cash without notice and are within three
months of maturity.
ii. Cash flow: This is an increase or decrease in the amount of cash or cash
equivalents resulting from a transaction.
In Text Question 1: What is the meaning of funds?

In Text Answer 1: Funds has been defined in a popular sense to mean working capital, i.e.,
the excess of current assets over current liabilities.
225
2.2 CashFlow Statement
A cash flow statement provides information on the sources of cash flows into the
company and the utilization of the cash by the company. One big advantage which
a cash flow statement has is that it enables users of financial statement to assess the
company’s liquidity and short term viability.
Flow of funds is said to have taken place when any transaction makes changesin
the amount of funds available before happening of the transaction. If the effect
oftransaction results in the increase of funds, it is called a source of funds and if
itresults in the decrease of funds, it is known as an application of funds. Further, in
casethe transaction does not change funds, it is said to have not resulted in the flow
of funds according to the working capital concept of funds, the term 'flow of
funds'refers to the movement of funds in the working capital. If any transaction
results in theincrease in working capital, it is said to be a source or inflow of funds
and if it resultsin the decrease of working capital, it is said to be an application or
outflow of funds. The Funds Flow Statement is a financial statement which reveals
the methods by which the business has been financed and how it has used its funds
between the opening and closing Balance Sheet dates. According to Anthony, "The
Funds Flow Statement describes the sources from which additional funds were
derived and the uses to which these funds were put". The analysis of such
statements over periods of time clearly shows the sources from which past
activities have been financed and brings to highlight the uses to which such funds
have been put. The statement is known by various titles, such as, Statement of
Sources and Applications of Funds, Statement of Changes in Working Capital,
Where Got and Gone Statement and Statement of Resources Provided and
Applied.
In Text Question 2: What sort of information does a cash flow statement provides?
In Text Answer 2: A cash flow statement provides information on the sources of cash
flows into the company and the utilization of the cash by the company.
226
2.3 Classification of Cash Flows
A statement of cash flow, present cash flows according to the activities, which give
rise to them. The classification is as stated below:
Operating activities: These include normal trading activities of an enterprise e.g.
production and delivery of goods and services and other supporting activities
included in determining operating profit.
Investing activities: These relates to acquisition and disposal of fixed assets,
statement of properties and other productive assets held for use in producing the
usual goods and services other than stock held for processing or resale.
Financial activities: These include resources obtained from lenders and awareness
of enterprises and reporting the amount obtained either as they become due or
when there is surplus for the needs of the enterprise. They also include the payment
of returns to providers of such financing in form of interest and dividends as well
as expenses directly related to obtaining the finance.
2.4 Rule of Cash Flow

The flow of funds occurs when a transaction changes on one hand, a non-current
account and on the other hand, a current account and vice-versa. When a change in
a non-current account e.g., fixed assets, long-term liabilities, reserves and surplus,
fictitious assets, etc., is followed by a change in another non-current account, it
does not amount to flow of funds. This is because of the fact that in such cases
neither the working capital increases nor decreases. Similar, when a change in one
current account results in a change in another current account, it does not affect
funds. Funds move from non-current to current transactions or vice-versa only. In
simple language funds move when a transaction affects (i) current asset and a fixed
asset, (ii) a fixed and a current liability, (iii) a current asset and a fixed liability,
(iv) a fixed liability and current liability, and funds do not move when the
227
transaction affects fixed assets and fixed liability or current assets and current
liabilities.
In Text Question 3: What are the classifications of cash flows?

In Text Answer 3: Operating Activities, Investing Activities and Financial Activities
Examples
a) Transactions which involves only the current accounts and hence do not result in
the flow of funds:
1. Cash collected from debtors.
2. Bills receivables realised.
3. Cash paid to creditors.
4. Payment or discharge of bills payable.
5. Issued bills payable to trade creditors.
6. Received acceptances from customers.
7. Raising of short-term loans.
8. Sale of purchased for cash or credit.
9. Goods purchased for cash or credit.
b) Transactions which involve only non-current accounts and hence do not result in
the flow of funds:
1. Purchase of one new machine in exchange of two old machines.
2. Purchase of building or furniture in exchange of land.
3. Conversion of debentures into shares.
4. Redemption of preference shares in exchange of debentures.
5. Transfers to General Reserves, etc.
6. Payment of bonus in the form of shares.
228
7. Purchase of fixed assets in exchange of shares, debentures, bonds or long-term
loans.
8. Writing off of fictitious assets.
9. Writing off an accumulated losses or discount on issue of shares.
c) Transactions which involve both current and non-current accounts and hence
result in the flow of funds:
1. Issue of shares for cash.
2. Issue of debentures for cash.
3. Raising of long-term loans.
4. Sale of fixed assets on cash or credit.
5. Sale of trade investments.
6. Redemption of Preference shares.
7. Redemption of debentures.
8. Purchase of fixed assets on cash or credit.
9. Purchase of long-term/trade investments.
10. Payment of bonus in cash.
11. Repayment of long-term loans.
12. Issue of shares against purchase of stock-in-trade.
2.5Working Capital
Capital should be considered as the life line of any business be it small or large
scale. In the interpretation of balance sheets, working capital ratio is one of the
most important ratios. It ascertains or measures the wellbeing of a business
enterprise. This is so because the profit making ability and hence the long term
survival of a business concern, to a large extent, is tied to the availability of the
working capital. Working capital is a term used to represent the excess of current
229
assets over current liabilities. In most business organizations, working capital is
represented by:
Current Assets:
Stock
Debtors Total
Cash
Less Current liabilities:
Creditors
Bank overdraft Total
Short-term loans
Working capital (Net Current Asset) becomes significant because of its ability to
be converted to cash. This is so because its only when working capital is converted
to cash can profit be earned. A business carries stock to be able to sustain its
business activities with the hope that such stocks will eventually be converted to
cash. Debtors arise in a business as a result of credit sales with the hope that cash
will be received in due course. Conversely, creditors arise from purchases which
carry a liability of payment on a future date. When credit is allowed to a customer
(debtors), it leads to an increase in the working capital requirement, but when
credit is received (creditors) it reduces the requirement for working capital.
2.6The Significance of Cash

Cash flows (in and out) of a business enterprise are the most fundamental event
upon which investors base their decisions. Cash attains this significance because it
represents generally the purchasing power, which can be transferred readily in an
exchange economy.
230
With only few exceptions, businesses acquire assets and rights to goods and
services for sale to customers at a profit. Most accounting measurements are based
on past, present and expected flows of cash. Revenue is generally measured in
terms of net cash expected to be received from the sale of goods or services.
Expenses are generally measured in terms of cash paid or payable for goods and
services.
Accruals represent the allocation to the current period of future or expected
receipts and payments for services. Deferrals represent the allocation to a future
period of current receipts or payments. The theoretical measurement of assets,
liabilities, income and expenses are based heavily on actual and expected cash
flows. The present value of an asset is usually defined as the discounted value of
expected net receipts to be derived from the asset. Liabilities can be measured in
terms of the total discounted amounts to be paid in the future.
2.7The Objectives of a Cash Flow Statement

Statement of Cash Flows requires that a Cash Flow Statement be prepared in
accordance with the standard, and presented as an integral part of the financial
statement for each period for which financial statements are presented. The Cash
Flow Statement is prepared with the following objectives in view:
i. To evaluate an entity’s ability to generate cash and cash equivalents and the
timing and certainty of their generation,
ii. To evaluate an entity’s financial structure which affects its liquidity and
solvency and its ability to meet its obligations and to pay dividends
iii. To understand the difference between profit and loss for the period and net cash
flow from operating activities,
iv. To compare the operating performance of different entities since the net
operating cash flow reported in a cash flow statement is unaffected by
231
accounting choices and judgments under accruals basis and accounting policies
used in determining the profit or loss of an entity, and
v. To enable users develop models to assess and compare the present value of
future cash flows of different entities.
Vi. To help understand the changes in assets and asset sources which are not
readily evident in the Income Statement or the financial position statement.
vii. To inform as at how the loans to the business have been used, and
viii. To point out the financial strengths and weaknesses of the business.
Related to the above objectives are the following advantages of using cash flow
accounting over the former funds flow accounting method.
Advantages of Using Cash Flow Accounting

a. The survival of an entity depends on its ability to generate cash. Hence, Cash
Flow accounting directs attention towards this critical issue.
b. Flow is more understandable than profit performance, which is dependent on
accounting conventions and concepts.
c. Creditors are more interested in the ability of the company to pay its debts than
in its profitability. Profit is an indication that cash is likely to be available
whereas cash accounting shows exactly the cash that is available.
d. Cash flow reporting provides a better means of comparing the result of different
companies than the traditional profit reporting.
e. Cash flow reporting satisfies more the needs of users, for instance:
i. It provides management the relevant information for decision making, and
ii. It provides shareholders a more realistic basis of stewardship: the ability
to pay dividend rather than the profit made.
f. Cash flow forecasts are easier to prepare and are more useful than the profit
forecast.
232
g. Cash flow accounts are easier to audit than accounts based on the accruals
concept.
h. Unless to someone with a good knowledge of accounting, cash flow is easier to
understand than the accruals concept.
i. Cash flow can be both retrospective and a forecast of the future. This is of great
accounting value to users of accounting information.
j. Forecast can be subsequently monitored by the use of variance analysis which
compares actual cash flows with the forecast.
Procedure for preparing a funds flow statement
Funds flow statement is a method by which we study changes in the financial
position of a business enterprise between beginning and ending financial
statements dates. Hence, the Funds Flow Statement is prepared by comparing two
Balance Sheets and with the help of such other information derived from the
accounts as may be needed. Broadly speaking, the preparation of a Funds Flow
Statement consists of following two parts:
1. Statement or Schedule of Changes in Working Capital
2. Statement of Sources and Application of Funds
1. Statement or Schedule of Changes in Working Capital

Working Capital means the excess of current assets over current liabilities.
Statement of changes in working capital is prepared to show the changes in the
working capital between the two Balance Sheet dates. This statement is prepared
with the help of current assets and current liabilities derived from the two Balance
Sheets.
The changes in the amount of any current asset or current liability in the current
Balance Sheet as compared to that of the previous Balance Sheet either results in
increase or decrease in working capital. The difference is recorded for each
233
individual current asset and current liability. In case a current asset in the current
period is more than in the previous period, the effect is an increase in working
capital and it is recorded in the increase column. But if a current liability in the
current period is more than in the previous period, the effect is decrease in working
capital and it is recorded in the decrease column or vice versa. The total increase
and the total decrease are compared and the difference shows the net increase or
net decrease in working capital. It is worth noting that schedule of changes in
working capital is prepared only from current assets and current liabilities and the
other information is not of any use for preparing this statement. A typical form of
statement or schedule of changes in working capital is as follows:
TYM LTD
Cash Flow Statement forthe Year Ended 31st December 2012
₦ ₦
Operating Activities
Operating Profit
Adjustment for items not involving
Movement of Cash:
Depreciation x
Amortization x
Profit And Loss on Sale of Fixed Assets x
Profit and Loss on Sale of Investment x
Deferred Income Recognized x
Cash Inflow before working capital charges x
Increase/decrease in stock x
Increase/decrease in debtors x
Increase/decrease in creditors x
Increase in Accruals x x
Tax paid (x)
Cash Inflow from Operation Activities
234
Investing Activities
Purchase of fixed assets x
Purchase of investment x
Sale of fixed assets x
Sale of fixed asset investment x
Dividend received x
Interest received x
Net cash inflow from investing activities
Financial Activities
Issue of shares x
Redemption of shares (x)
Issue of debentures x
Redemption of debentures (x)
Dividend paid (x)
Interest paid (x) x
Net cash inflow from investing activities
Increase/decrease in cash and cash enquires x
Cash and cash equivalent of the beginning x
Cash and cash equivalent of the end x
In Text Question 4: What is a fund flow statement?

In Text Answer 4: Funds flow statement is a method by which we study changes in the
financial position of a business enterprise between beginning and ending financial statements
dates.
Illustration
From the following information in the books of Joy Ltd, prepare a Cash Flow
Statement for the Year Ended 31st December 2009.
235
Balance Sheet As At 31st December
2008 2009
₦ ₦ ₦ ₦
Fixed Asset at cost 8,300 5600
Less Depreciation 3,150 2300
5,150 3,300
Current Assets:
Stock 5,516 7,204
3,994 3,120
180 3,814 210 2,910
90 60
Cash 9,420 10,174
Current Liabilities due within One Year:
Creditors 1,416 1,520
Taxation 735 580
Proposed Dividend 1,200 800
Bank Overdraft 629 3,980 105 3,005
5,400 7,169
Working Capital
Less: Creditors Failing
Due after one year 500 3,000
Loan Capital 10,090 7,469
Financed By:
Capital Reserves: ₦ ₦
Share Capital 5,000 4,000
Share Premium 1,000 -
Share Premium
Profit and Loss Account 4,090 3,469
10,090 7,469
Profit for the year
Less Taxation for the coming year - 2,556
735 1,821
Undistributed Profit b/f 3,469 5,290
Less: Proposed Dividends 1,200 4,090
236
Solution
JOY LTD
Cash Flow Statement for the Year Ended 31st December, 2009
₦ ₦
Cash Flow from Operation Activities
Profit before taxation 2,556
Adjustment for items not involving cash
Depreciation of fixed assets 1,590
Profit on sales of fixed asset (85) 1,505
Working Capital Charges:
Decrease in stock 1,688
Increase in debtors (904)
Decrease in creditors and accruals (104) 680 4,741
Tax paid (580)
Cash inflow from Operation Activities 4,161
Cash Inflow from Investing Activities:
Purchase of fixed asset (3,820)
Proceeds from Sale of Fixed Asset 463
Net Cash Inflows from Investing Activities (3,355)
Cash Flows from Financing Activities:
Net proceeds of Capital Floatation 2,000
Debentures Redemption (2500)
Dividend paid (800)
Net Cash Inflow from Financing Activities (1,300)
Net Decrease in Cash and Cash Equivalent (494)
Cash and Cash Equivalent at 1st January (45)
Cash and Cash Equivalent at 31/12/2009 (539)
For any business, it is important to ensure that sufficient profits are made to
finance the business activities and sufficient cash funds are available as and when
needed.
237
Uses of Funds Flow Statement
The various uses of Funds Flow Statement are summarised:
(a) As a tool of historical analysis, it provides an answer to some of the important
financial questions such as:
i. How was it possible to distribute dividend in excess of current earnings
or in the presence of a net loss for the period? (i.e. the firm might have
raised funds from other sources also in addition to funds from
operations).
ii. Why has the net working capital decreased although the net income for
the period has gone up? (i.e. the firm might have applied the funds more
than the sources of funds).
iii. Why has the net working capital increased even though there has been a
net loss for the period? (i.e., the firm might have raised the funds more
than the application of funds).
iv. What happened to the proceeds of the sale of plant and equipment? (e.g.,
the firm might have purchased some fixed assets or it might have
redeemed the redeemable debentures or preference shares)
v. Why did the firm resort to long-term borrowings in spite of large profits?
(b) As a tool of planning, the Projected Fund Flow Statement enables the
management to plan its future investments, operating and financial activities such
as the repayment of long-term loans and interest thereon, modernisation or
expansion of plant, payment of cash dividend etc.
(c) Along with a Schedule of Changes in Working Capital, the Funds Flow
Statement helps in managing and utilizing the working capital. The management
(You) can knowthe adequacy or otherwise of the working capital and can plan for
the effective use of surplus working capital or can make arrangement in case of
inadequacy of working capital. Besides this, the management can identify the
magnitude and directions of changes in various components of working capital and
238
if there is any undesired situation such as heavy inventory accumulations, heavy
funds locked up in receivables than normally required, the necessary action may be
taken so as to achieve the desired level thereof.
Limitations of funds flow statement

The major limitations of Funds Flow Statement are summarised below:
(a) It ignores the non-fund transactions. In other words, it does not take into
consideration those transactions which do not affect the working capital e.g., issue
of shares against the purchase of fixed assets, conversion of debentures into equity
shares.
(b) It is a secondary data based statement. It merely rearranges the primary data
already appearing in other statements viz. Income Statement and Balance Sheet.
(c) It is basically historical in nature, unless Projected Funds Flow Statements are
prepared to plan for the future.

1. What are the classifications of cash flows?
2. Is depreciation a source of funds? Justify your answer
4.0 Summary
In this session, we have taken a look at the cash flow statement. The classification
of cash flow was made, the rules of cash flow were given, working capital was
defined, and the objective of cash flow statement was given as well as an
illustration and limitations given. A funds flow statement is an essential tool for the
financial analysis and is of primary importance to the financial management. Now-
a-days, it is being widely used by the financial analysts, credit granting institutions
and financial managers. The basic purpose of a funds flow statement is to reveal
the changes in the working capital on the two balance sheet dates. It also describes
239
the sources from which additional working capital has been financed and the uses
to which working capital has been applied. Such a statement is particularly useful
in assessing the growth of the firm, its resulting financial needs and in determining
the best way of financing these needs. By making use of projected funds flow
statements, the management can come to know the adequacy or inadequacy of
working capital even in advance. One can plan the intermediate and long-term
financing of the firm, repayment of long-term debts, expansion of the business and
allocation of resources.

1. What do you mean by 'funds from operation'? How will you determine it?
2. State six the importance or significance of Funds Flow Statement.

a. Visit U-tubehttps://www.youtube.com/watch?v=SzMbBOtOuJ4,,
https://www.youtube.com/watch?v=jfPjXIk6zqo . Watch the video & summarise
in 1 paragraph
b. View the animation on https://www.youtube.com/watch?v=W9Rttkb1kb8 and
7.0 References
ICAN Study Pack (2006).Fundamentals of Financial Accounting. VIPublishing
240
Accounting
241

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DISTANCE LEARNING CENTRE

AHMADU BELLO UNIVERSITY

ACCT 101: INTRODUCTION TO ACCOUNTING

First published 2018 in Nigeria.

Published and printed in Nigeria by:

Ahmadu Bello University Press Ltd,

Ahmadu Bello University,

2.0 Module 2………..……………………………...…………………………………………....92

3.0 Module 3……………..…………………………………………………….……………....165

ii. COURSE INTRODUCTION AND DESCRIPTION

iii. COURSE PREREQUISITES

iv. COURSE LEARNING RESOURCES

vi. ACTIVITIES TO MEET COURSE OBJECTIVES

Specifically, this course shall comprise of the following activities:

vii. TIME (TO COMPLETE SYLABUS/COURSE)

viii. GRADING CRITERIA AND SCALE

B. Summative assessment (Semester examination)

IX LINKS TO OPEN EDUCATION RESOURCES

N.B: - All Sessions commence in January

1 Study Session 1: 1. Read Courseware for the corresponding Study Session.

9 Study Session1 1. Read Courseware for the corresponding Study Session.

Week 14 & 15 SEMESTER EXAMINATION

1.0 Learning Outcome

2.0 Main Content

Reliable information is necessary before decision makers can make a sound

Accounting information is valuable because

In Text Question 1: What is the definition of accounting?

In Text Answer 1: Accounting is a discipline which records, classifies, summarises and

From the above, the following attributes of accounting emerge:

(iii) Summarizing: It is concerned with the preparation and presentation of the

(iv) Interpreting: Nowadays, the aforesaid three functions are performed by

(iv) Accounting as a language

(v) Accounting as science or art

(vi) Accounting as an information system

2.3 Objectives of Accounting

2. To protect business properties: Accounting provides protection to business

3. To ascertain the operational profit or loss: Accounting helps in ascertaining

5. Information System: Accounting functions as an information system for

2.4 Key Accounting Concepts

1. Money measurement concept. Economic activity is initially recorded and

2. Cost concept or exchange price. Most of the amounts in an accounting system

3. Going-concern (continuity) concept. Unless strong evidence exists to the

5. Separate business entity concept. In accounting we make a distinction between

8. Accrual Concept. It is generally accepted in accounting that the basis of

8. Realisation Concept. Realisation is the process of converting non-cash

In Text Question 4: What are the key accounting concepts?

2. Historical cost concept/fair value:The historical cost concept allows a user

3. Prudence concept-The prudence concept assumes that the financial

4. Substance overform concept-This concept assumes that when accounting

5. Separate determination concept-This concept allows the user to look at the

In Text Answer 5: 1. Materiality Concept 2. Historical Cost Concept/Fair Value 3.

External users of accounting information

3. Members of non-profit organisations: Members of non-profit organisations

4. Government: Central and State Governments are interested in the accounting

5. Consumers: Consumers need accounting information for establishing good

6. Research scholars: Accounting information, being a mirror of the financial

In Text Question 6: Who are the external users of accounting information?

Internal users of accounting information

The most important functions of management are planning and controlling.

3. Employees: Employees are interested in the financial position of a concern they