Principles of Accounts Notes

Financial accounting- the process of recording, classifying, summarizing and communicating

economic information to users or stake-holders to allow them to make useful decisions.

❖ Record transactions - { 1. Record in words, 2. Record in numbers}

❖ Classifying - {Categorize (group similar things together) }
❖ Summarizing - {Total of how many same items}
❖ Communicate - {Stake-holders / Users}

The Accounting Cycle:

-Various steps in the accounting cycle:

★ 1.) Source Documents: All original information can be obtained from these documents

★ 2.) Books of Original / Prime Entry: The documents are then classified and posted to the
appropriate books of original / prime entry.

★ 3.) The Ledgers: These are books of accounts where records from the Journals are
classified and posted.

★ 4.) Trial Balance: From the records in the Ledger, a trial balance is extracted to check the
accuracy of the double-entry system.

★ 5.) Adjusting Entries: The adjustments are done to comply with the ACCRUAL
CONCEPT.

★ Financial Report: This is the last stage where the Trading, Profit and Loss Accounts and
the Balance Sheet are prepared.
The Accounting Cycle:
- A transaction occurs which produces a Source Document

1.) Journalise / Record transactions in Journal

2.) Post to the Ledger / Record transactions in T-accounts
3.) Extract a Trial Balance
4.) Make adjustments / Prepare adjusting entries
5.) Extract an adjusted Trial Balance
6.) Prepare Financial Statements
Primary Purposes of Financial Accounting:

➢ To provide information that is useful to current and potential stake-holders in making

investment, credit and other related decisions.

➢ To provide information that is helpful to current and potential stake-holders in accessing

the amounts, timing and uncertainty of future cash flows.

➢ To provide information that is accurate / correct in reporting the assets of the business,
any claims on those assets as well as the effects of any pending transactions that will
affect the company’s assets and liabilities.

Secondary Purposes of Financial Accounting:

➢ Records all transactions that occur both good and bad.

➢ To plan how to allocate scarce resources in order to accomplish the objectives of the
business.

➢ To plan ahead by anticipating the needs and wants of the business.

➢ To determine how well a business is performing.

➢ To show how much capital has been invested by the owner, how much funds was used by
the business, the profit / loss made and how much assets / liabilities are left at the end of
the day / month / year.

The Accounting Cycle represents a series of steps taken each accounting period when a
transaction occurs:

- Source Document: written proof that a transaction took place (bill/receipt)

- Journal: Original Entry / Prime Entry / Day Book

- Financial Statements: Income Statement / Balance Sheet / Cash Flow Statement

Components of the Balance Sheet:

Assets : items of value owned by a business.

: a resource of economic value that you own which you expect to provide future benefits

Features of Non-Current / Fixed Assets:

1.) They are permanent in nature / last for a very long time, usually more than 1 year.
2.) They are not for resale but are to be used in the business.
3.) They cannot be easily converted into cash since they are quite expensive.

Features of Current Assets:

1.) They are temporary in nature / last for a short while of less than 1 year.
2.) They are for resale to customers and they are not to be used in the business.
3.) They are easily converted into cash since they are relatively cheaper in cost.
Stock / Inventory: items available to be sold to consumers

Accounts Receivables / Debtors: companies / persons who owes you money

Prepayments: a payment that is made in advance before a debt is due

Bank: the money that a company saves in the bank

Cash: the money kept on the company’s premises in case of emergency or to pay small bills

Liabilities: anything a person / company owes, usually a sum of money

Features of Non-Current Liabilities:

1.) Non-current liabilities are to be paid in more than 1 year.

2.) A mortgage is a loan borrowed / used to purchase or maintain a home, land or other types
of real estate.
3.) A debenture is a long-term loan that you borrow without paying collateral.
Collateral - any asset that can be ceased by the lender to repay the loan.
4.) A bond is a long-term loan which one would need collateral.
Features of Current Liabilities:

1.) Current liabilities must be repaid in 1 year or less.

Capital: financial resources (assets) invested by the owner/s that businesses can use to fund their
operations.

Expenses: the cost of operations that a company incurs to generate revenue.

Eg. rent, electric bills, water bill, salaries

Revenue: money generated / earned from normal business operations.

DOUBLE ENTRY RULES

ITEM TO INCREASE TO DECREASE

Assets Debit Credit

Liabilities Credit Debit

Capital Credit Debit

Expenses Debit Credit

Revenue Credit Debit

● To record stock invested by the owner, we use the following double entry :
debit purchases account and credit capital account.

● To record loans invested by the owner, we use the following double entry :
debit capital account and credit loan account.

● Anything the owner withdraws for personal or private use is called ‘drawings’.
Drawings are always debited.

● To record stock withdrawn by the owner for personal or private use, we use the
double entry : debit drawings account and credit purchases account.

● Anytime you buy / purchase an item on credit, you get a creditor. This means
creditors are increasing. To increase a creditor account, we credit.
Anytime you borrow, you get a creditor.

TYPES OF STOCK ACCOUNTS:

1.) Purchases a/c : to record stock bought by the business to sell to customers.

2.) Purchases Returns a/c OR Returns Outwards a/c : to record stock previously bought by
the business now returned to suppliers.

3.) Sales a/c : to record stock sold by the business to customers.

4.) Sales Returns a/c OR Return Inwards a/c : to record stock previously sold by the business
now returned by customers.
Anytime you sell an item on credit, you get a debtor. This means debtors are increasing. To
increase a debtor, you debit.
 1.) When an expense is paid, the double entry used is :
debit the expense account and credit the bank / cash account. Each expense goes in
its own account.

2.) When a revenue is received, the double entry used is :

debit cash / bank account and credit the revenue account. Each revenue goes in its
own account.

3.) The bank account is a CURRENT ASSET when it has a DEBIT BALANCE B/D BUT
the bank becomes a CURRENT LIABILITY when it has a CREDIT BALANCE B/D.

RULES FOR CLOSING OFF ACCOUNTS:

1.) All stock accounts (purchases, purchases returns, sales, sales returns) are closed
off to the TRADING ACCOUNT.

2.) All expense accounts and all revenue accounts are closed off to the PROFIT AND
LOSS ACCOUNT.

3.) The drawings account is closed off to the CAPITAL ACCOUNT.

4.) All other accounts (assets, liabilities, capital) are BALANCED OFF.

TYPES OF LEDGERS:

1.) Purchases Ledger - contains accounts for creditors.

2.) Sales Ledger - contains accounts for debtors.
3.) General Ledger - contains all other accounts.
Classes of Accounts:

1.) Personal Accounts : accounts for persons who conduct business with the entity.
: Eg. Owners (Capital and Drawings), Debtors, Creditors.

2.) Impersonal Accounts : there are 2 types of impersonal accounts, ‘Real’ and ‘Nominal.’

- Real Accounts : account for assets and liabilities.

Eg. Land, Building, Premises, Plant, Machinery, Equipment, Motor Vehicles,

Fixtures, Fittings, Furniture, Bank, Cash, Bank Overdraft, Loans

- Nominal Accounts : accounts for Stock, Expenses and Revenues.

Trial Balance Definition:

- A book-keeping or accounting report that lists the balances in each of an organization’s

Purchases Ledger, Sales Ledger and General Ledger Accounts .

- The accounts with zero balances will not be listed.

- The debit balance amounts are listed in a column with the heading “Debit Balances” and the
credit balance amounts are listed in another column with the heading “Credit Balances.”

- The total of each of these two columns should be identical.

- A company prepares a Trial Balance periodically, usually at the end of every reporting period.

Purposes of preparing a Trial Balance:

- To ensure the entries in a company’s book-keeping system are mathematically correct.

Limitations of a Trial Balance:

1. It does not prove that all transactions have been recorded.

2. It does not prove that the Ledgers are correct.

3. Numerous errors may exist even though the Trial Balance columns agree.

4. It cannot find the missing entry from the Journal. You have to physically review all records.

5. It cannot find the missing entry from the Ledger. You have to physically review all records.

6. It cannot protect the repeated postings.

7. It cannot prevent errors from occurring.

Procedures in preparing a Trial Balance:

1. Refer to each account. Any balance transferred to the Trading Account, the Profit and Loss
Account, the Capital Account and any Balances Carried Down, except for the Capital Account,
should be sent to the Trial Balance.

2. For the Capital Account, only transfer the Balance Brought Down and Additional Capital
invested.

3. Closing Stock is never recorded in the Trial Balance.

JOURNALS:

A journal is also called ‘a book of Prime Entry,’ ‘a book of Original Entry,’ or ‘a Day Book.’

Types of Journals:

1.) Purchases
2.) Purchases Returns
3.) Sales
4.) Sales Returns
5.) Cash Book
6.) General

* Cash Book is the only book of original entry that forms part of the double-entry system.
* Cash Book is a ledger a/c.

There are two money accounts:

- Bank a/c for Cheques
- Cash a/c for Cash

Each journal is associated with a source document.

Journal Source Document

Purchases Journal Invoice / Original Invoice

Purchases Returns Journal Original Credit Note

Sales Journal Duplicate Invoice

Sales Returns Journal Duplicate Credit Note

Cash Book Receipt / Cash Bill / Cash Register Slip /

Cheque Butt

General Journal Memo / Invoice

Purpose and Use:

- Purchases Journal is used to record purchases of stock bought on CREDIT ONLY.

- Purchases Returns Journal is used to record return purchases of stock bought on CREDIT.

- Sales Journal is used to record stock sold on CREDIT ONLY.

- Sales Returns Journal is used to record return stock sold on CREDIT.

- Cash Book is used to record cash and cheques received and cash and cheques paid.

- General Journal is used to record : opening entries

: closing entries
: to make year end adjustments
: to correct errors
: to record the purchase of fixed assets on credit.
: to record the sale of fixed assets on credit.

* You can either have:

- An overdrawn / overdraft balance which you CREDIT.

- Normal Balance which you DEBIT.

* A contra-entry happens when money is taken from 1 money account and transferred to another.

In the Three Column Cash Book, the Discounts Allowed column is an Expense so we debit it.
However, the Discounts Received column is a revenue so we credit it.
There are 2 T-accounts associated with the Three-Column Cash Book:

The first account is displayed below:

The second account is displayed below:

VN- Voucher Number

PL - Purchases Ledger
SL - Sales Ledger
GL - General Ledger

STOCK ONLY (CREDIT)

STOCK RETURNED ONLY (CREDIT)

STOCK ONLY (CREDIT)

STOCK RETURNS ONLY (CREDIT)
GENERAL JOURNAL

To record an opening entry:

ONLY FOR OPENING ENTRY:

Working 1: How to calculate Capital

Capital = Assets - Liabilities

Assets are first and are CLOSE to the margin.

Liabilities are second and are AWAY from the margin.
Capital is ALWAYS third and is AWAY from the margin.

DEBIT AND CREDIT COLUMNS MUST BE EQUAL.

To record Non-Monetary Capital Invested:
DEPRECIATION:

Depreciation is what happens when assets lose value over time until the value of the asset
becomes zero. In simple terms, depreciation is the loss in value of a non-current asset.

There are two ways in which can be used to calculate depreciation:

1.) Straight Line Method

2.) Reducing Balance Method

Year Cost Price Depreciation Expense Accumulated Depreciation Net Book Value

$ $ $ $

REMEMBER:
1.) Cost Price remains the same throughout all the years of depreciation.

2.) Depreciation Expense remains the same throughout all the years of depreciation.
Eg. Year 1 depreciation = $10 & Year 2 depreciation = $10

3.) Accumulated Depreciation is all the depreciation added together for each year.
Eg. Year 1 depreciation = $10 & Year 2 depreciation = $10
Accumulated Depreciation for Year 2 = $10 +$10 = $20

4.) Net Book Value = Cost Price - Accumulated Depreciation

REMEMBER:

1.) Only use the cost price in the 1st year.

2.) Find depreciation expense of the cost price in the 1st year.

3.) After that, use the net book value from above (NET BOOK VALUE B/D).

4.) Find the depreciation expense of the net book value for all the years after the 1st year.

5.) Cost Price remains the same.

6.) Depreciation expenses will have varying numbers (may even have cents).

7.) Accumulated Depreciation is all the depreciation added together for each year.

8.) Net Book Value = Cost Price - Accumulated Depreciation

Year Cost Price Depreciation Expense Accumulated Net Book Value

Depreciation

$ $ $ $
To find time, 100% is divided by the rate of depreciation.

There are 4 T-accounts associated with depreciation. They are:

1.) Profit & Loss a/c

2.) *asset* Provision for Depreciation a/c
3.) *asset* At Cost a/c
4.) Bank a/c

Double entries to account for Depreciation:

- Debit the profit & loss a/c
- Credit the provision for depreciation a/c
BAD DEBTS:

1. Debit - Debtor a/c

Credit - Sales a/c
To record goods sold on credit to debtor

2. Debit - Bank a/c OR Cash a/c

Credit - Debtor a/c
To record money paid by debtor

3. Debit - Bad Debt Expense a/c

Credit - Debtor a/c
To record unpaid money/bad debt by debtor

4. Debit - Profit and Loss a/c

Credit - Bad Debt Expense a/c
To close off bad debt expenses at year end

There are 5 accounts associated with Bad Debts. They are:

- Sales a/c
- Bank a/c
- Profit & Loss a/c
- Bad Debt Expense a/c
- Debtor a/c
BAD DEBTS RECOVERED:

1. Debit - Debtor a/c

Credit - Bad debt recovered a/c
To reopen debtor a/c with the sum of money being paid

2. Debit - Bank a/c

Credit - Debtor a/c
To record money paid by debtor

3. Debit - Bad debt recovered a/c

Credit - Profit and loss a/c
To close off bad debt recovered revenue at year end

Recovered/ Received a/c is a REVENUE A/C.

$O.25 IN THE DOLLAR : $1.00 is owed but $0.25 is paid.

DOUBTFUL DEBTS:
Doubtful debts calculations:
= % x accounts receivables/ debtors
ACCRUALS AND PREPAYMENTS:
PROFITABILITY RATIOS:

Average capital
= opening + closing capital / 2

LIQUIDITY RATIOS:
EFFICIENCY RATIOS:

ACCOUNTING EQUATION:

ASSETS = LIABILITIES + CAPITAL

CASH FLOW PROJECTIONS:

Disbursements - 1st $
Receipts - 2nd $

‘Inflow’ goes under cash receipts.

‘Outflow’ goes under cash disbursements.

Surplus = Receipts is more than Disbursements.

Deficit = Receipts is less than Disbursements.
BUDGETS:

A budget is a cost plan expressed in financial terms.

* Purpose of budgeting:

- Planning
- Communication
- Responsibility

*Types of budgets:

1. Production
2. Sales
3. Purchases
 PRODUCTION BUDGET

Jan Feb Mar

Opening inventory 80 120 220

Production required ? 240 ? 400 ? 340

? 320 ? 520 ? 560

Less : Sales (200) (300) (220)

120 220 340

A sales budget is a budget that shows estimated sales for a period.

Eg. John plans to sell 5000 units per month at $20 per unit. Prepare the sales budget for
Jan, Feb and Mar.

Jan Feb Mar Total

Expected sales (units) 5000 5000 5000 15000

Sp/unit 20 20 20 20

Expected sales 100000 100000 100000 300000

A purchases budget is a budget which shows estimated purchases for a period.

Eg. John plans to purchase 5 units of direct materials at $10 per unit. Prepare the
purchases budget for Jan, Feb and Mar.

Jan Feb Mar Total

Purchases (units) 5 5 5 15

Cost /unit 10 10 10 10

Expected purchases 50 50 50 150

PARTNERSHIPS:

Each partner has 2 accounts.

1. Capital a/c
2. Current a/c

Capital a/c - fixed / fluctuating

Fixed capital - records only the capital

Profit and losses are shared equally.

No interest paid on capital, no interest charged.
Working partners will not receive salary 5% interest on loans.
LIMITED LIABILITY COMPANIES:

The word ‘limited’ or the acronym ‘LTD’ means it is a PRIVATE LIMITED COMPANY
where the acronym ‘PLC’ means it is a PUBLIC LIMITED COMPANY.

Cumulative Preference Shares: whatever dividend is not paid, ROLLS over into the next
year.

Non-Cumulative Preference Shares: whatever dividend is not paid DOES NOT ROLL over
into the next year.

DIFFERENCE BETWEEN A DEBENTURE AND A BOND?

- Debenture: unsecured by assets and is riskier than a bond. There is also a fixed
interest rate. (There are NO assets to use as collateral.)

- Bond: secured by assets and is less risky than a debenture. There is a fixed interest
rate. ( Assets ARE USED as collateral)

Debenture interest is an EXPENSE as it is a fee you pay. (Fixed interest rate.)

Dividend is a REVENUE that you receive for investing capital in the business. (Varied
interest rate.)

SHARE VALUES:

1. PAR Value = Cost Price

2. MARKET Value = Selling Price

At $ - PAR value / C.P

For $ - Market value / S.P

S.P - C.P = Profit/Loss

Selling price is debited in the Bank a/c.

Cost price is credited in the Share Capital a/c.
Credit Share Premium a/c. (PROFIT)
Debenture Interest Expense :
= % x debenture value

Preference Shares Dividend:

= % of number of shares sold x PAR value

Profit available to Ordinary Shareholders:

= net profit - preference share dividend

Ordinary Share Dividend

= net profit - preference share dividend / number of ordinary shares sold

NON-PROFIT ORGANIZATIONS:

Non-profit organizations get their funds through donations, fundraising activities and
subscriptions/ membership fees.

Subscriptions and donations as well as bar takings are DEBITED.

CONTROL ACCOUNTS:

A control account is a general ledger account which shows the balance of all associated
subsidiary accounts.

There are 2 types of control accounts:

1. Debtors Control Account OR Sales Ledger Control Account
2. Creditors Control Account OR Purchases Ledger Control Account

The purpose of control accounts is to determine how much is owed to a business or to their
creditors.
BANK RECONCILIATION STATEMENTS:

Define the term 'bank reconciliation statement'

A bank reconciliation statement is a document that compares the balances of an
individual's or a business's bank account with the bank statement provided by the bank. It
helps identify any discrepancies or differences between the two balances. The statement
includes a list of transactions that have been recorded by the individual or business but
may not yet be reflected in the bank statement, such as outstanding checks or deposits in
transit. By reconciling these differences, one can ensure that the bank account's records
are accurate and up to date.

Define the term ‘bank statement'

A bank statement is a document that shows all the transactions in your bank account. It
includes deposits, withdrawals, and any fees or charges. It helps you keep track of your
finances.

Explain the purposes/uses of bank reconciliation statements:

Bank reconciliation statements serve several purposes in managing finances. They are used
to:

1. Identify discrepancies: Bank reconciliation statements help identify any discrepancies

between the bank statement and the individual's or business's records. This could include
errors in recording transactions, missing or duplicate entries, or bank fees that were not
accounted for.

2. Ensure accuracy: By comparing the bank statement with the account records, bank
reconciliation statements help ensure the accuracy of financial information. It allows
individuals or businesses to catch any errors or omissions and make the necessary
adjustments.

3. Detecting fraud or unauthorized transactions: Bank reconciliation statements

detect any fraudulent or unauthorized transactions.
regularly reconciling the bank statement, individuals or businesses can identify any
suspicious activity and take appropriate action.
4. Maintain cash flow: Reconciling bank statements helps individuals or businesses
maintain an accurate picture of their cash flow. It allows them to track outstanding
checks, deposits in transit, and other factors that may affect their available funds.

5. Facilitate financial decision-making: Accurate and up-to-date financial information is

crucial for making informed financial decisions. Bank reconciliation statements provide a
clear overview of the financial position, allowing individuals or businesses to make better
financial choices.

Overall, bank reconciliation statements play a vital role in ensuring the accuracy of
financial records, detecting errors or fraud, and maintaining a healthy financial position.
ERRORS:
CORRECTION OF ERRORS:

A suspense account is a type of account used to store transactions that cannot be correctly
categorized at the time of the payment. It is used to record these transactions temporarily
since the account where it should be stored is unknown at the time of the transaction.

COMPANY
GENERAL JOURNAL

Date Details Folio Debit Credit

$ $

a/c to dr is 1st x

a/c to cr is 2nd x

To correct error of -
COMPANY
STATEMENT OF REVISED NET PROFIT

# ERROR EFFECT

Net Profit b/d x

1 Decrease in Purchases x

2 Increase in Bank x

3 Increase in Discounts Allowed Expense (x)

4 Customer Mix Up x

5 Correcting Creditor’s Payment x

Corrected Net Profit c/d xx

STOCK VALUATION:

There are 3 methods:

- LIFO : LAST IN FIRST OUT

- FIFO : FIRST IN FIRST OUT
- AVCO : AVERAGE COST METHOD

COMPANY
TRADING A/C
FOR THE MONTH ENDED

Sales x

Less: Cost of Sales (opening stock + purchases - closing stock) (x)

Gross Profit xx

*Selling Price OR Sales is recorded in the Trading a/c.

MANUFACTURING ACCOUNTS:

Direct cost / Direct material cost / Direct labour cost / Direct expenses can be directly
traced back to the product whereas ‘indirect cost’ is the opposite of direct cost.

Overhead cost also called Indirect cost / Production overheads / Manufacturing overheads.

Cost per unit = cost of goods manufactured divided by number of units manufactured
=$

There are 3 types of stock:

- Raw materials
- Work-in progress
- Finished goods

A manufacturing account is ONLY made for a company that is making a good/s.