(65)-THE MONEY MEASURMENT CONCEPT

The Money Measurement Concept

The money measurement concept states that accounts will only deal with those items to which a monetary value can be attributed.

For example, in the balance sheet of a business monetary values can be attributed to such assets as machinery and stocks of goods.

The money measurement concept introduces limitations to the subject matter of accounts. A business may have intangible assets such as the flair of a good manager or the loyalty of its workforce. These may be important enough to give it a clear superiority over an otherwise identical business, but because they cannot be valued in monetary items they do not appear anywhere in the accounts.

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WELCOME 2010

WE WISH TO OUR READERS FOR GREAT SUCCESS IN 2010

We are providing free theoretical management details for businessmen, students and investors
related to

• Financial accounting
• Cost accounting
• Management accounting
• Financial management
• Taxation
• Business management

As our valuable visitor you are welcome in 2010 and we continue our service in 2010 also.....

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(64)-THE CONSISTENCY CONCEPT

The Consistency Concept

The consistency concept states that similar items should be accorded similar accounting treatments.

Accounting is not an exact science. There are many areas in which judgment must be exercised in attributing money values to items appearing in accounts. Over the years certain procedures and principles have come to be recognized as good accounting practice, but within these limits there are often various acceptable methods of accounting for similar items.

The consistency concept states that in preparing accounts consistency should be observed in two respects.

1. Similar items within a single set of accounts should be given similar accounting treatment.
2. The same treatment should be applied from one period to another in accounting for similar items. This enables valid comparisons to be made from one period to the next (sometimes this called the comparability concept).

Consistency has been sidelined to a certain extend by financial reporting standards. In financial reporting standards is more consider which accounting policy is most appropriate and then apply this policy to give a true and fair view. Changing an accounting policy may contradict the consistency concept.

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(63)-THE PRUDENCE CONCEPT

The Prudence Concept

The prudence concept states that where alternative procedures, or alternative valuations, are possible, the one selected should be the one which gives the most cautions presentation of the business’s financial position or result.

The importance of prudence has diminished over time. Prudence is a desirable quality of financial statements but not bedrock. The key reason for this charge of perspective is that some firms have been over pessimistic and over stated provisions in times of high profits in order to profit smooth.

You should bear this is in mind as you read through the explanation of prudence. On the one hand assets and profits should not be overstated, but a balance sheet must be achieved to prevent the material overstatement of liabilities or losses.

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(62)-THE ACCRUALS CONCEPT OR MATCHING CONCEPT

The Accruals Concept or Matching Concept

The accruals concept states that revenue and costs must be recognized as they are earned or incurred, not as money is received or paid. They must be matched with one another so far as their relationship can be established or justifiably assumed, and debit with in the profit and loss account of the period to which they relate.

Financial Reporting Standards also stipulates that financial statements must be prepared under the accruals concept. This concept is a cornerstone of present day financial statements.

Essentially, the accruals concept states that, in computing profit, revenue earned must be matched against the expenditure incurred in earned it.

The companies act gives legal recognition to the accruals concept, stating that, all income and charges relating to the financial year to which the accounts relate shall be taken into account, without regard to the date of receipt or payment. This has the effect, as we have seen, of requiring business to take credit for sales and purchases when made, rather than when paid for, and also carry unsold stock forward in the balance sheet rather than to deduct its cost from profit for the period.

Example,

If company Y makes 20 shirts at a cost of 100$ and sells them for 200$, she makes a profit of 100$. However, if company Y had only sold 18 shirts, it would have been incorrect to charge its profit and loss account with the cost of twenty shirts, as it still has 2 shirts in stock. If it intends to sell them in June it is likely to make a profit on the sale. Therefore, only the purchase cost of 18 shirts 90$ should be matched with its sales revenue, leaving it with a profit of 90$.

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(61)-THE GOING CONCERN CONCEPT

The Going Concern Concept

The going concern concept implies that the business will continue in operational existence for the foreseeable future, and that there is no intention to put the company into liquidation or to make drastic cutbacks to the scale of operations.

Financial reporting standards 18 stats that the financial statements must be prepared under the going concern basis unless the entity is being or is going to be liquidated or if has ceased trading. The directors of a company must also disclose any significant doubts about the company’s future if and when they arise.

The main significant of the going concern is that the assets of the business should not be valued at their break up value, which is the amount that they would sell for if they were sold off piecemeal and the business were thus broken up.

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(60)-ACCOUNTING CONVENTIONS

Accounting Conventions

Accounting Practice has developed gradually over a matter of centuries. Many of its procedures are operated automatically by people who have never questioned whether alternative methods exits which are just as valid.

However, the procedures in common use imply the acceptance of certain concepts which are by no means self evident; nor are they the only possible concepts. These concepts could be used to build up an accounting framework.

• The going concern concept
• The accruals or matching concept
• The prudent concept
• The consistency concept
• The entity concept
• The money measurement concept
• The separate valuation principle
• The materiality concept
• The historical cost concept
• The stable monetary unit
• The objectivity concept
• The realization concept
• The duality concept
• Substance over from
• The time interval concept

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(59)-SUSPENSE ACCOUNT

Suspense Accounts

Suspense accounts, as well as being used to correct some errors, are also opened when it is not known immediately where to post an amount. When the mystery is solved, the suspense account is closed and the amount correctly posted using a journal entry.

Suspense accounts might contain several items

If more than one error or unidentifiable posting to a ledger accounts arises during an accounting period, they will all be merged together in the same suspense account. In deed, until the causes of the errors are discovered, the bookkeepers are unlikely to know exactly how many errors there are.

There is a balance on a suspense account, together with enough information to make the necessary corrections, leaving a nil balance on the suspense account and correct balances on various other accounts. In practice, of course, finding these errors is far from easy.

Another use of suspense accounts occurs when a bookkeeper does not know in which account to post one side of a transaction. Until then mystery is sorted out, the credit entry can be recorded in a suspense account.

A typical example is when the business receives cash through the post from a source which cannot be determined. The double entry in the accounts would be a debit in the cash book, and a credit to a suspense account.

Suspense accounts are only temporary

It must be stressed that a suspense account can only be temporary. Posting to a suspense account are only made when the bookkeeper does not know yet what to do, or when an error has occurred. Mysteries must be solved, and errors must be corrected. Under no circumstances should there still be a suspense account when it comes to preparing the balance sheet of a business. The suspense account must be cleared and all the correcting entries made before the final accounts are drown up.

None should exist when it comes to drawing up the financial statements at the end of the accounting period.

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(58)-A SUSPENSE ACCOUNT

A Suspense Account

A suspense account is an account showing a balance equal to the difference in a trial balance.
A suspense account is a temporary account which can be opened for a number of reasons. The most common reasons are as follows.

• A trial balance is drawn up which does not balance, means total debits do not equal total credits.
• The bookkeeper of the business knows where to post the credit side of a transaction, but does not know where to post the debit. For an example, a cash payment might be made and must obviously be credited to cash. But the bookkeeper may not know what the payment is for, and so will not know which account to debit.

In the both cases, a temporary suspense account is opened up until the problem is sorted out.
Use of suspense account; when the trial balance does not balance

When an error has occurred which results in an imbalance between total debits and total credits in the ledger accounts, the first step is to open a suspense account.

For example, suppose an accountant drawn up a trial balance and finds that, for some reason he cannot immediately discover, total debits exceed total credit by 150$.

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(57)-DETAILS ABOUT ERRORS IN ACCOUNTING

Details about Errors in Accounting

Errors of transposition

An error of transposition is when two digits in an amount are accidentally recorded the wrong way round.

For example, suppose that a sale is recorded in the sales account as 10560$, but it has been incorrectly recorded in the total debtors account as 10650$. The error is the transposition of the 6 and 5.

Errors of omission

An error of omission means failing to record a transaction at all, or making a debit or credit entry, but not the corresponding double entry.

Foe example, If a business receives an invoice from a supplier for 500$, the transaction might be omitted from the book entirely. As a result, both the total debit and the total credits of the business will be out by 500$.

Error of principle

An error of principle involves making a double entry in the belief that the transaction is being entered in the correct accounts, but subsequently finding out that the accounting entry breaks the rule of an accounting principle or concept.

For example, repairs to a machine costing 300$ should be treated as revenue or expenditure, and debited to a repair account. If, instead, the repair costs are added to the cost of the fixed asset as capital expenditure an error of principle would have occurred. As a result, although total debits still equal total credits, the repairs account is 300$ less than it should be and the cost of the fixed asset is 300$ grater than it should be.

Error of commission

Errors of commission are where the bookkeepers make a mistake in carrying out his or her task of recording transaction in the accounts.

For example, putting a debit entry or a credit entry in the wrong account or errors of casting (adding up)

Compensating errors

Compensating errors are errors which are, coincidentally, equal and opposite of one another.

For example, two transposition errors of 540$ might occur in extracting ledger balances, one on each side of the double entry. In the administration expenses account, 2282$ might be written instead of 2822$, while in the sundry income account, 8391$ might be written instead of 8931$. Both the debits and the credits would be 540$ too low, and the mistake would be not apparent when trial balance is cast. Consequently, compensating errors hide the fact that there are errors in then trial balance.

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(56)-TYPES OF ERRORS IN ACCOUNTING

Types of Errors in Accounting

It is not really possible to draw up a complete list of all the errors which might be made by bookkeepers and accountants. Even if you tried, it is more than likely that as soon as you finished, someone would commit a completely new error that you had never even dreamed of,
However it is possible to describe five types of error which cover most of the errors which might occur.

They are follows,

• Errors of transposition
• Errors of omission
• Errors of principle
• Errors of commission
• Compensating errors

Once an error has been detected, it needs to be put right.

• If the correction involves a double entry in the ledger accounts, then it is done by using a journal entry in the journal.
• When the error breaks the rule of double entry, then it is corrected by the use of a suspense account as well as a journal entry.

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(55)-THE OPERATION OF CONTROL ACCOUNTS

The Operation of Control Accounts

• The two most important control accounts are those for debtors and creditors control accounts. They are part of the double entry system.
• Cash books and day books are totally periodically and the appropriate totals are posted to the control accounts.
• The individual entries in cash and day books will have been entered one by one in the appropriate personal accounts contained in the sales ledger and purchase ledger. These personal accounts are not part of the double entry system, they are memorandum only.
• At suitable intervals the balances on personal accounts are extracted from the ledgers, listed and totaled. The total of the outstanding balances can then be reconciled to the balance on the appropriate control account and any errors located and corrected.

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(54)-BALANCING AND AGREEING CONTROL ACCOUNTS

Balancing and Agreeing control Accounts

The control account should be balanced regularly (at least monthly) and the balance on the account agreed with the sum of the individual debtors or creditors balances extracted from the sales or bought ledger respectively.

It is one of the sad facts of an accountant’s life that more often than not the balance on the control account does not agree with the sum of balances extracted, for on or more of the following reasons.

• An incorrect amount may be posted to the control account because of a miscast of the total in the book of prime entry. The nominal ledger debit and credit posting will than balance, but the control account balance will not agree with the sum of individual balances extracted from the sales ledger or purchase ledger. A journal entry must than be made in the nominal ledger to correct the control account and the corresponding sales or expense account.
• A transposition error may occur in posting an individual’s balance from the book of prime entry to the memorandum ledger.
• A transaction may be recorded in the control account and not in the memorandum ledger, or vice versa. This requires an entry in the ledger that has been missed out which means a double posing if the control account has to be corrected, and a single posting if it is individual’s balance in the memorandum ledger that is at fault.
• The sum of balance extracted from the memorandum ledger may be incorrectly extracted or miscast. This would involve simple correcting the total of the balances.

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(53)-THE PURPOSE OF CONTROL ACCOUNTS

The Purpose of Control Accounts

The reasons for having control accounts are as follows.

(1)-Check on the accuracy

They provide a check on the accuracy of entries made in the personal accounts in the sales ledger and purchase ledger. It is very easy to make a mistake in posting entries, because there might be hundreds of entries to make. Figures might get transposed. Some entries might be omitted altogether, so that an invoice or a payment transaction does not appear in a personal account as it should. By comparing,

• The total balance on the debtors control account with the total of individual balances on the personal accounts in the sales ledger.
• The total balance on the creditors control account with the total of individual balances on the personal accounts in the purchase ledger.
  It is possible to identify the fact that errors have been made.

(2)- Location of errors

The control accounts could also assist in the location of errors, where posting to the control accounts are made daily or weekly, or even monthly. If a clerk fails to record an invoice or a payment in a personal account, or makes a transaction error, it would be a formidable task to locate the error or errors at the end of a year, say, given the hundreds or thousands of transactions during the year.

By using the control account, a comparison with the individual balances in the sales or purchase ledger can be made for every week or day of the month, and the error found much more quickly than if control accounts did not exist.

(3)- For internal check

Where there is a separate of clerical bookkeeping duties, the control account provides an internal check. The person posting entries to the control accounts will act as check on a different person whose job it is to post entries to the sales and purchase ledger accounts.

(4)- More simply and quickly

To provide debtors and creditors balances more quickly for producing a trial balance or balance sheet. A single balance on a control account is obviously expected simpler and quickly than many individual balances in the sales or purchase ledger.

This means also that the number of accounts in the double entry bookkeeping system can be kept down to a manageable size, since the personal accounts are memorandum accounts only and the control accounts instead provide the accounts required for a double entry system.

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(52)-CONTROL ACCOUNTS

Control Accounts

A control account is an account in the nominal ledger in which a record is kept of the total value of a number of similar but individual items.

Control accounts are used chiefly for debtors and creditors.

A Debtors Control Account

A debtor’s control account is an account in which records are kept of transactions involving all debtors in total. The balance on the debtors control account at any time will be the total amount due to the business at that time from its debtors.

A Creditors Control Account

A creditor’s control account is an account in which records are kept of transactions involving all creditors in total, and the balance on this account at any time will be the total amount owed by the business at that time to its creditors.

Although control accounts are used mainly in accounting for debtors and creditors, they can also be kept for other items, such as stocks of goods, wages and salaries. The first important idea to remember, however, is that a control account is an account which keeps a total record for a collective item which in reality consists of many individual items.

A control account is an impersonal ledger account which will appear in the nominal ledger.

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(51)-BANK RECONCILIATION

Bank Reconciliation

Bank reconciliation is a comparison of a bank statement with the cash book.

Differences between the balance on the bank statement and the balance in the cash book will be errors or timing differences, and they should be identified and satisfactorily explained.

The differences fall into three categories,

1. Errors
2. Bank charges or interest
3. Time differences

Bank reconciliation is needed to identify and account for the differences between the cash book and the bank statement.

What to look for when doing bank reconciliation

The cash book and bank statement will rarely agree at a given date. If you are doing bank reconciliation, you may have to look for the following items.

• Corrections and adjustments to the cash book
  1. -Payments made into the account or from the account by way of standing order, which have not yet been entered in the cash book.
  2. -Dividends received, paid direct into the bank account but not yet entered in the cash book.
  3. -Bank interest and bank charges, not yet entered in the cash book.
• Items reconciling the correct cash book balance to the bank statement.
  1. -Cheques drawn by the business and credited in the cash book, which have not yet been presented to the bank, or “cleared” and so do not yet appear on the bank statement.
  2. -Cheques received by the business, paid into the bank and debited in the cash book, but which have not yet been cleared and entered in the account by the bank, and so do not yet appear on the bank statement.

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(50)-THE BANK STATEMENT

The Bank Statement

It is common practice for a business to issue a monthly statement to each credit customer, terming,

• The balance he owed on his account at the beginning of the month
• New debts incurred by the customer during the month
• Payments made by him during the month
• The balance he owes on his account at the end of the month

In the same way, a bank statement is sent by a bank to its short term debtors and creditors.

Customer with bank overdrafts and customers with money in their account itemizing the balance on the account at the beginning of the period, receipts into the account and payments from the account during the period, and the balance at the end of the period.

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(49)-BANK STATEMENT AND CASH BOOK

Bank Statement and Cash Book

The cash book of a business is the record of how much cash the business believes that it has in the bank. In the same way, you yourself might keep a private record of how much money you think you have in your own personal account at your bank, perhaps by making a note in your cheque book of income received and the cheques you write.

If you do keep such a record you will probably agree that when your bank sends you a bank statement from time to time the amount it shows as being the balance in your account is rarely exactly the amount that you have calculated for yourself as being your current balance.

Why might your own estimate of your bank balance be different from the amount shown on your bank statement?

There are three common explanations.

1. Error.
   Error in calculation, or recording income and payments, are more likely to have been made by you than by the bank, but it is conceivable that the bank has made a mistake too.
2. Bank charges or bank interest.
   The bank might deduct charges for interest on an overdraft or for its service, which you are not informed about until you receive the bank statement.
3. The differences
   There might be some cheques that you have received and paid into the bank, but which have not yet been “cleared” and added to your account.

Similarly, you might have made some payments by cheque, and reduced the balance in your account accordingly in the record that you keep, but the person who receives the cheque might not bank at a while.

If you do keep a personal record of your cash position at the bank, and if you do check your periodic bank statements against what you think you should have in your account, you are doing exactly the same thing that the bookkeepers of a business do when they make a bank reconciliation.

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(48)-WHAT IS BANK RECONCILIATION

What is Bank Reconciliation

Bank reconciliation is a comparison of a bank statement with the cask book. Differences between the balances on the bank statement and the balance in the cask book will be errors or timing differences, and they should be identified and satisfactorily explained.

We will discuss our next posts about bank reconciliations.

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(47)-THE FIXED ASSET REGISTER AND THE NOMINAL LEDGER

The Fixed Asset Register and the Nominal Ledger

The fixed assets register is not part of the double entry and is there for memorandum and control purposes.

The fixed assets register must be reconciled to the nominal ledger to make sure that all additions, disposals and depreciation charges have been posted.

For example, the total of all the cost figures in the register for motor vehicles should equal the balance on the motor vehicle cost account in nominal ledger. The same goes for accumulated depreciation.

The fixed asset register and the physical assets

It is possible that the fixed assets register may not reconcile with the fixed assets actually presents. This may be for the following reasons,

• Asset has been stolen or damaged, which has not been noticed or recorded
• Excessive wear and tear or obsolescence has not been recorded
• New assets not yet recorded in the register because it has not been kept up to date
• Errors made in entering details in the register
• Improvement and modifications have not been recorded in the register

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(46)-THE FIXED ASSET REGISTER

The Fixed Asset Register

Nearly all organization keeps fixed assets register. This is a listing of all fixed assets owned by the organization, broken down perhaps by department, location or asset type.

A fixed assets register is maintained primarily for internal purposes. It shows organizations investment in capital equipment. A fixed asset register is also part of the internal control system. Fixed assets registers are sometimes called real accounts.

Data kept in a fixed assets register

• The internal reference number for each physical identification purpose
• Manufactures serial number for maintain purposes
• Description of asset
• Location of asset
• Department which owns asset
• Purchase date for calculation of depreciation
• Cost
• Depreciation method and estimated useful life for calculation of depreciation
• Net book value or written down value
• Purchase of an asset
• Sale of an asset
• Loss or destruction of an asset
• Transfer of an assets between departments
• Reason of estimated useful life of an asset
• Scrapping of an asset
• Revaluation of an asset

Outputs from a fixed assets register

• Reconciliations of net book value to the nominal ledger
• Depreciation charges posted to the nominal ledger
• Physical verification for audit purposes

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(45)-VALUATION BASIS OF FIXED ASSETS

Valuation Basis of Fixed Assets

The following valuation basis should be used for properties that are not impaired.

• Specialized properties should be valued on the basis of depreciated replacement cost.
  Specialized properties are those which, due to their specialized nature, are rarely, if ever, sold on the open market for single occupation for a continuation of their existing use, except as part of a sale of the business in occupation.

Example; oil refineries, chemical works, power stations, or schools, colleges and universities where there is no competing market demand from other organizations using these types of property in the locality.

• Non specialized properties should be value on the basis of existing use value.
• Properties surplus to an entities requirements should be value on the basis of open market value.

Where there is an indication of impairment, an impairment review should be carried out in accordance with Financial Reporting Standards. The asset should be recorded at the lower of revalued amount and recoverable amount.

Tangible fixed assets other than properties should be valued using market value or, if not obtainable, depreciated replacement cost.

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(44)-FINANCIAL REPORTING STANDARDS RULES FOR FIXED ASSET REVALUATION

Financial Reporting Standards Rules for Fixed Asset Revaluation

An entity may adopt a policy of revaluation tangible fixed assets. Where this policy is adopted it must be applied consistently to all assets of the same class.

A class of fixed assets is a category of tangible fixed assets having a similar nature function of use in the business of an entity.

Where an asset is revalued its carrying amount should be its current value as at the balance sheet date current value being the lower of replacement cost and recoverable amount.
To achieve he above, the standard stats that a full valuation should be carried out at least every five years with an interim valuation in year3. If it is likely that there has been a material change in value, interim valuation in year 1, 2 and 4 should also be carried out.

A full valuation should be conducted by either a qualified external value or a qualified internal value, provided that the valuation has been subject to review by a qualified external assessor. An interim valuation may be carried out by either an external or internal assessor.

For certain types of assets, there may be an active second hand market for the asset or appropriate indices may exist, so that the directors can establish the assets value with reasonable reliability and therefore avoid the need to use the services of a qualified assessor.

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(43)-TANGIBLE FIXED ASSETS

Tangible Fixed Assets

A tangible fixed asset should initial measured at cost.

Cost is purchase price and any cost directly attributable to bringing the asset into working condition for its intended use.
For example of directly attributable costs are;

• Acquisition costs such as stamp duty
• Cost of site preparation and clearance
• Initial delivery and handling costs
• Installing costs
• Professional fees like legal fees
• The estimated cost of dismantling and removing the asset and restoring the site
  Any abnormal costs, such as those arising from design error, industrial disputes or idle capacity are not directly attributable costs and therefore should not be capitalized as part of the cost of the asset.

Finance costs

The capitalization of finance costs, including interest, is optional. However if an entity does capitalize finance costs they must do so consistently.

All finance costs that are directly attributable to the construction of a tangible fixed asset should be capitalized as part of the cost of the asset.

Directly attributable finance costs are those that would have been avoided if there had been no expenditure on the asset.

If Finance costs are capitalized, capitalization should start when,

• Finance costs are being incurred
• Expenditure on the asset is being incurred
• Activities necessary to get the asset ready for use are in progress

Capitalization of finance costs should cease when the asset is ready for use.

Subsequent expenditure

Subsequent expenditure on a tangible fixed asset should only be capitalized in the following three circumstances.

1. It enhances the economic benefits over and above those previously estimated. An example might be modifications made to a piece of machinery that increases its capacity or useful life.
2. A component of an asset that has been treated separately for depreciation purposes has been restored or replaced.
3. It relates to a major inspection or overhaul that restores economic benefits that have been consumed and reflected in the depreciation charge.

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(42)-DISCLOSURES FOR FIXED ASSETS IN FINANCIAL STATEMENTS

Disclosures for Fixed Assets in Financial Statements

Notes to the accounts must show, for each class of fixed assets, an analysis of the movements on both cost and depreciation provisions.

Where any fixed assets of a company other than listed investments are included in the accounts at an alternative accounting valuation, the following information must also be given.

• The years so far as they are known to the directors in which the assets were severally valued and the several values.
• In the case of assets that have been valued during the financial period, the names of the persons who valued them or particulars of their qualification for doing so and whichever is stated the bases if valuation used by them.

A note to the accounts must classify land and buildings under the headings of;

• Freehold property
• Leasehold property,
• Long leaseholds in which the unexpired term of the lease at the balance sheet date is not less than 50 years
• Short leaseholds which are all leaseholds other than long leaseholds.

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(41)-REVALUATION RESERVES FOR FIXED ASSETS

Revaluation Reserves for Fixed Assets

Where the value of any fixed asset is determined by using the alternative accounting rules the amount of profit or loss arising must be credited or as the case may be debited to a separate reserve, the revaluation reserve. The calculation of the relevant amounts should be based on the written down values of the assets prior to revaluation.

The revaluation reserve must be reduced to the extent that the amounts standing to the credit of the reserves are, in the opinion of the directors of the company, no longer necessary for the purpose of the accounting policies adopted by the company.

However, an amount may only be transferred from the reserve to the profit and loss account if either,

• The amount in question was previously charged to that account.
• It represents realized profit.

The only other transfer possible from the revaluation reserve is on capitalization, that is, when a bonus issue is made.

The amount of a revaluation reserve must be shown under a separate sub heading on the balance sheet. However the reserve need not necessarily be called a “revaluation reserve”.

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(40)-VALUATION OF FIXED ASSETS

Valuation of Fixed Assets

Where an asset is purchased, its cost is simply the purchase price plus any expenses incidental to its acquisition.

Where an asset is produced by a company for its own use, its production cost must include the cost of row materials, consumables and other attribute direct costs such as labour cost. Production cost may additionally include a reasonable proportion of indirect costs, together with the interest on any capital borrowed to finance production of the asset.

The cost of any fixed asset having a limited economic life, whether purchase price or production cost, must reduced by provisions for depreciation calculated to write off the cost, less any residual value, systematically over the period of the assets useful life. This very general requirement is supplemented by the more detailed provisions of financial reporting standards.

Provision for a permanent reducing in value of a fixed asset must be made in the profit and loss account and the asset should be disclosed at the reduced amount in the balance sheet. Any such provision should be disclosed on the face of the profit and loss account or by way of note. Where a provision becomes no longer necessary, because the conditions giving rise to it have altered, it should be written back, and again disclosed should be made.

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(39)-LEDGER ACCOUNTING ENTRIES FOR THE FIXED ASSET DISPOSALS

Ledger Accounting entries for the Fixed Asset Disposals

A profit on disposal is an item of other income in the profit and loss account, and a loss on disposal is an item of expense in the profit and loss account.

It is customary in ledger accounting to record the disposal of fixed assets in a disposal of fixed asset account. The profit or loss on disposal is the difference between,

• The sale price of the asset, and
• The net book value of the asset at the time of sale.

The relevant items which must appear in the disposal of fixed assets account are therefore,

• The value of the asset, at cost or revalued amount.
• The accumulated depreciation up to the date of sale.
• The sale price of the asset.

For the disposal of fixed assets; ledger accounting entries are as follows,

1. Transfer the cost of fixed asset, to disposal of fixed asset account.
   Disposal of fixed asset account --Debit
   Fixed asset account --Credit
2. Transfer the accumulated depreciation on the asset as at the date of sale.
   Provision for depreciation account --Debit
   Disposal of fixed asset account --Credit
3. Transfer the sale price of the asset. The sale is therefore not recorded in a sales account, but in the disposal of fixed asset account itself.
   Debtor account or cash book --Debit
   Disposal of fixed asset account --Credit
4. The balance on the disposal account is the profit or loss on disposal and the corresponding double entry is recorded in the profit and loss account,
   • If loss
   Profit and loss account --Debit
   Disposal of fixed asset account --Credit
   • If profit
   Disposal of fixed account --Debit
   Profit and loss account --Credit

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(38)-ACCOUNTING FOR FIXED ASSET DISPOSALS

Accounting For Fixed Asset Disposals

Fixed assets are not purchased by a business with the intention of reselling them in the normal course of trade. However they might be sold off at some stage for example a business may sell fixed assets when their useful life is over.

Whenever a business sells something it makes a profit or loss. So when fixed assets are disposed of there is a profit or loss on disposal. This is a capital gain or a capital loss.

These gains or losses are reported in the profit and loss account of the business but not as a trading profit. They are commonly referred to as profit on disposal of fixed assets or loss on disposal.

The profit or loss on the disposal of a fixed is the difference between,

• The net book value of the asset at the time of its sale.
• Its net sale price which is the price minus any costs of making the sale.

A profit is made when the sale price exceeds the net book value and a loss is made when the sale price is less than the net book value.

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(37)-PROVISION FOR DEPRECIATION

Provision for Depreciation

A provision for depreciation is the amount written off for the wearing out of fixed assets.
There are two basic aspects of the provision for depreciation to remember,

• A depreciation charge (provision) is made in the profit and loss account in each accounting period for every depreciable fixed asset. Nearly all fixed assets are depreciable, the most important exceptions being freehold land and long term investments.
• The total accumulated depreciation on a fixed asset builds up as the asset gets older. Unlike a provision for doubtful debts, therefore, the total provision for depreciation is always getting larger, until the fixed asset is fully depreciated.

The similarly in the accounting treatment of the provision for doubtful debts and the provision for depreciation may become apparent.

The ledger accounting entries for the provision for depreciation are as follows.

• There is a provision for depreciation account for each separate category of fixed assets, for example land and building, furniture and fittings.
• The depreciation charge for an accounting period is a charge against profit. It is an increase in the provision for depreciation and is accounted as follows, with the depreciation charge for the period.
  Profit and loss account-- Debit
  Provision for depreciation account --Credit
• The balance on the provision for depreciation account is the total accumulated depreciation. This is always a credit balance brought forward in the ledger account for depreciation.
• The fixed asset accounts are unaffected by depreciation. Fixed assets are recorded in these accounts at cost or at their re valuated amount.
• In the balance sheet of the business, the total balance on the provision for depreciation account is set against the value of fixed asset accounts to derive the net book value of the fixed assets.

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(36)-APPLYING A DEPRECIATION METHOD CONSISTENTLY

Applying a depreciation method consistently

It is up to the business concerned to decide which method of depreciation to apply to its fixed assets. Once that decision has been made, however it should not be charged the chosen method of depreciation should be applied consistently from year to year.

Similarly it is up to the business to decide what a sensible life span for a fixed asset should be. Again once that life span has been chosen, it should be charged unless something unexpected happens to the fixed asset.

It is permissible for a business to depreciate different categories of fixed assets in different ways. For example, if a business owns three cars, then each car would normally be depreciated in the same way; but another category of fixed asset, say, photocopiers can be depreciating using a different method.

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(35)-METHODS OF DEPRECIATION

Methods of Depreciation

There are several different methods of depreciation. Of these the ones are,

• Straight line method.
• Reducing balance method.
• Sum of the digits method.

Straight line method

The total depreciable amount is charged in equal installments to each accounting period over the expected useful life of the asset. So the net book value of the fixed declines at a steady rate, or in a straight line over time.

The annual depreciation charge = (cost of asset – Residual value) / Expected useful life of the asset

Reducing balance method

The reducing balance method of depreciation calculates the depreciation charge as a fixed percentage of the net book value of the asset, as at the end of the accounting period.

The annual depreciation charge = (cost of asset – accumulated depreciation) x Percentage

Sum of the digits method

This is a variant of the reducing balance method, based on the estimated useful life of an asset.
If an asset has an estimated useful life of three years, then the digits 1, 2 and 3 are added together, giving a total of 6. Depreciation of 3/6 for first year, 2/6 for second year, 1/6 for third year of the depreciable amount is charged in the respective years.

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(34)-DEPRECIATION IN THE ACCOUNTS OF A BUSINESS

Depreciation in the accounts of a business

When a fixed asset is depreciated, two things must be accounted for,

1. The charge for depreciation is a cost or expense of the accounting period. Depreciation is an expense in the profit and loss account.
2. At a same time the fixed asset is wearing out and diminishing in value. So the value of the fixed asset in the balance sheet must be reduced by the amount of depreciation charged. The balance sheet value of the fixed asset will be its net book value which is the value after depreciation in the books of account of the business.

The amount of depreciation will build up or accumulate over time, as more depreciation is charged in each successive accounting period. This accumulated depreciation is a provision because it provides for the fall in value in use of the fixed asset. The term provision for depreciation means the accumulated depreciation of a fixed asset.

The Depreciable Amount

The total amount to be charged over the life of a fixed asset or depreciable amount is usually its cost less any expected residual sales value or disposal value at the end of the asset’s life.

Example,
A fixed asset costing 50000$ which has expected life of five years and an expected residual value of 5000$, should be depreciated by 45000$ in total over the five year period.

A fixed asset costing 50000$ which has expected life of five years and an expected residual value of nil, should be depreciated by 50000$ in total over the five year period.

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(33)-FIXED ASSETS DEPRECIATION

Fixed Assets Depreciation

Depreciation can be described as a means of spreading the cost of a fixed asset over its useful life, and so matching the cost against the full period during which it earns profits for the business. Depreciation charges are an example of the application of the matching concept to calculate profits.

Depreciation has two important aspects.

1. Depreciation is a measure of the wearing out or depletion of a fixed asset through use, time or obsolescence.
2. Depreciation charges should be spread fairly over a fixed asset’s life, and so allocated to the accounting periods which are expected to benefit from the asset’s use.

A fixed asset is acquired for use within a business with a view to earning profits. Its life extends over more than one accounting period, and so it earns profits over more than one period. In contrast, a current asset is used and replaced many times within the period. Foe example stock is sold and replaced, debtors increase with sales and decrease with payment received.

When a business acquires a fixed asset, it will have some idea about how long its useful life will be and might decide,

• To keep on using the fixed asset until it becomes completely worn out, useless and worthless.
• To sell off the fixed asset at the end of its useful life, either by selling it as a second hand item or as scraps.

Since a fixed asset has a cost, and a limited useful life, and its value eventually declines, it follows that a charge should be made in the trading, profit and loss account to reflect the use that is made of the asset by the business. This charge is called depreciation.

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(32)-ACCOUNTING FOR STOCKS (SUMMARY)

Accounting for Stocks (Summary)

• The quantity of stocks held at the year end is established by means of a physical count of stock in an annual stocktaking exercise, or by a continuous stock take.
• The value of these stocks is then calculated, taking the lower of cost and net realizable value for each separate item or group of stock items.
• In order to value the stocks, some rule of thumb must be adopted. The possibilities include FIFO, LIFO, and average costs. But in financial accounts FIFO or average cost should normally used.
• Net realizable value (NRV) is the selling price less all costs to completion and less selling costs.
• Cost comprises purchase costs and cost of conversion.
• The value of closing stocks is accounted for in the nominal ledger by debiting a stock account and crediting the trading account at the end of an accounting period. The stock will therefore always have a debit balances at the end of a period, and this balance will be shown in the balance sheet as a current asset for stocks.
• Opening stocks brought forward in the stock account are transferred to the trading account, and so at the end of the accounting year the balance on the stock account ceases to be the opening stock value brought forward, and becomes instead the closing stock value caught forward.
• The statutory regulations and accounting standards requires that the balance sheet should show subdivided as follows, Stocks
  1. Raw materials and consumables.
  2. Work in progress.
  3. Finished goods and goods for resale.
  4. Payments on account.

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(31)-REPORTING REGULATIONS FOR STOCKS

Statutory Regulations and Accounting Standards Requirements for Stocks

In the most businesses the value put on stock is an important factor in the determination of profit. Stock valuation is however, a highly subjective exercise and consequently there is a wide variety of different methods used in practice.

The statutory regulations and accounting standards requirements have been developed to achieve greater uniformity in the valuation methods used and in the disclosure in financial statements prepared under the historical cost convention.

Accounting standards defines stocks and work in progress as,

• Goods or other assets purchased for resale.
• Consumable stores.
• Raw materials and components purchased for incorporation into products for sale.
• Products and services in intermediate stages of completion.
• Long term contract balances.
• Finished goods.

In published accounts the companies act requires that these stock categories should be grouped and disclosed under the following heading,

• Raw materials and consumables stocks.
• Work in progress stocks.
• Finished goods and goods for resale.
• Payments on account. This is presumably intended to cover the case of a company which has paid for stock items but not yet received them into stock.

Determination of the cost of stock

To determine profit costs should be matched with related revenues. Since the cost of unsold stock and work in progress at the end of an accounting period has been incurred in the expectation of future sales revenue, it is appropriate to carry these costs forward in the balance sheet and charge them against the profits of the period in which the future sales revenue is eventually earned.

As the explanatory note to accounting standards expresses;

“If there is no reasonable expectation of sufficient future revenue to cover cost incurred the irrecoverable cost should be charged to revenue in the year under review. Thus stocks normally need to be stated at cost or if lower at net realized value”

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(30)-VALUING STOCKS

Valuing Stocks

Determining the purchase cost

Stock may be raw materials or components bought from suppliers, finished goods which have been made by the business but not yet sold, or work in the process of production, but only part completed. It will simplify matters however if we think about the historical cost of purchased raw materials and components which ought to be their purchase price.

When the storekeeper issues components to production he will simply pull out from the bin the nearest components to hand, which may have arrived in the latest consignment or in an earlier consignment or in several different consignments. Our concern is to devise a pricing technique, a rule of thumb which we can to attribute a cost to each of the components issued from stores.

There are several techniques which are used in practice,

1. First in first out (FIFO)
   This assumes that materials are issued out of stock in the order in which they were delivered into stock. The components issued are deemed to have formed part of the oldest consignment still unused and are cost accordingly.
2. Last in first out (LIFO)
   This involves the opposite first in first out system; the components issued to production originally formed part of the most recent delivered.
3. Average cost
   As purchase prices change with each new consignment, the average price of components in the bin is constantly changed. Average cost may be simple average cost or weighted average cost.

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(29)-VALUING STOCKS

Valuing Stocks

There are several methods which in theory might be used for the valuation of stock items.

1. Stocks might be valued at their historical cost – The cost at which they were originally bought.
2. Stock might be valued at net realizable value – Valued at their selling price less any costs still to be incurred in getting them ready for sale and then selling them.
3. Stock might be valued at their expected selling price – The use of selling prices in stock valuation is ruled out because this would create a profit for the business before the stock has been sold.
4. Stock might be valued at the amount it would cost to replace them – This amount is referred to as the current replacement cost of stocks.

The argument developed above suggests that the rule to follow is that stocks should be valued at cost, or if lower, net realizable value. The accounting treatment of stock is governed by an accounting standard that stats stock should be valued at the lower of cost and net realizable value.

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(28)-STOCKTAKING

Stocktaking

Business trading is continuous activity, but accounting statements must be drawn up at a particular date. In preparing a balance sheet it is necessary to summarize the activity of a business so as to determine its assets and liabilities at a given moment. This includes establishing the quantities of stocks on hand, which can create problems.

• A business buys stocks continually during its trading operations and either sells the goods onwards to customers or incorporates them as raw materials in manufactured products. This constant moment of stocks makes it difficult to establish what exactly is held at any precise moment.
• In simple cases, when a business holds easily counted and relatively small amounts of stock, quantities of stock on hand at the balance sheet date can be determined by physically counting in a stock take.
• The continuous nature of trading activity may cause a problem in that stock movements will not necessarily cease during the time that the physical stock take is in progress. To close down the business while the count takes place, or to keep detailed records of stock movements during the course of the stock take.
• Closing down the business for a short period for a stock take is considerably easier than trying to keep detailed records of stock movements during a stock take.
• One obstacle is overcome once a business has established how much stock is on hand. But another of the problems noted in the introduction immediately raises its head.

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(27)-ACCOUNTING FOR STOCKS

Accounting for Stocks

To calculate gross profit it is necessary to work out the cost of goods sold, and in order to calculate the cost of goods sold it is necessary to have value for the opening stock and closing stock.

• Normally purchases are introduced to the trading account.
  Trading account - Debit
  Purchases account - Credit
• When a stock take is made the business will have a value for its closing stock and the double entry is,
  Stock account - Debit
  Trading account - Credit
• Closing stock at the end of one period becomes opening stock at the start of the next period. The stock account remains uncharged until the end of the next period when the value of opening stock is taken to the trading account,
  Trading account - Debit
  Stock account - Credit
  

This stock account is only ever used at the end of an accounting period, when the business counts up and values the stock in hand in a stock take. The debit balance of on stock account represents an asset, which will be shown as part of current assets in the balance sheet.

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(26)-ACCOUNTING ENTRIES FOR PROVISION FOR DOUBTFUL DEBTS

Accounting Entries for Provision for Doubtful Debts

For this provision a business might know from past experience that say 5% of debtors balances are unlikely to be collected. It would then be considered prudent to make a general provision of 5%.

It may be that no particular customers are regarded as suspect and so it is not possible to write off any individual customer balances as bad debts. The procedure is then to leave the total debtors balances completely untouched, but to open up a provision account by the following entries,

Doubtful debts account - Debit
Provisions for doubtful debts - Credit

When preparing a balance sheet the credit balance on the provision account is deducted from the total debts balances in the debtors’ ledger.

In subsequent years adjustments may be needed to the amount of the provision. The procedure to be followed then is as follows.

• Calculate the new provisions required.
• Compare it with existing balance on the provision account.
• Calculate increase or decrease required.
• If a higher provision is required
  Provision of doubtful debts - Credit
  Profit and loss account - Debit
• If a lower provision is needed now than before
  Profit and loss account - Credit
  Provision for doubtful debts - Debit

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(25)-ACCOUNTING ENTRIES FOR BAD DEBTS WRITE OFF

Accounting entries for bad debts write off

For bad debts written off there is a bad debts account. The double entry bookkeeping is fairly straightforward, but there are two separate transactions to record.

• When it is decided that a particular debt will not be paid, the customer is no longer called an outstanding debtor, and becomes a bad debt.
  Bad debts account (expense) - Debit
  Debtors account - Credit
• At the end of the accounting period, the balance on the bad debts account is transferred to the profit and loss account.
  Profit and loss account - Debit
  Bad debts account - credit

Where a bad debt is subsequently recovered in the same accounting period, you simply reverse the entries in above and so there will be no need to carry out the entries in above.
Debtors account - Debit
Bad debts account - Credit

However, where a bad debt is subsequently recovered in a later accounting period the accounting entries will be as follows.
Debtors account - Debit
Bad debts recovered - Credit

Bad debts recovered account identifying as income in the profit and loss account.

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(24)-PROVISIONS FOR DOUBTFUL DEBTS

Provisions For Doubtful Debts

When bad debts are written off, specific owed to the business are identified as unlikely ever to be collected, however because of the risks involved in selling goods on credit, it might be accepted that a certain percentage of outstanding debts at any time are unlikely to be collected.

But although it might be estimated that, say 10% debts will turn out bad the business will not know until later which specific debts are bad.

A general provision for doubtful debts is an estimate of the percentage of debt which are not expected to be paid.

• When a provision is first made the amount of this initial provision is charged as an expense in the profit and account of the business.
• When a provision already exists but subsequently increased in size, the amount of the increase in provision is charged as an expense in the profit and loss account for the period in which the increase provision is made.
• When a provision already exits but subsequently reduce in size, the amount of the decrease in provision is provision is recorded as an item of income in the profit and loss account.

The value of debtors in the balance sheet must be shown after deducting the provision for doubtful debts.

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(23)-BAD DEBTS

Bad Debts

A bad debt is a debt which is not expected to be prepaid.

Customers who buy goods on credit might fail to pay for them, perhaps out of dishonesty or perhaps because they have gone bankrupt and cannot pay. For one or another, a business might decide to give up expecting payment and to write the debt off.

When a business decides that a particular debt is unlikely ever to be repaid, the amount of the debt should be written off as an expense in the profit and loss account. However bad debts written off are accounted for as follows,

• Sales are shown at their invoice value in the trading account. The sale has been made and gross profit should be earned. The subsequent failure to collect the debt is a separate matter, which is reported in the profit and loss account.
• Bad debts written off are shown as an expense in the profit and loss account.
• If bad debts written off and subsequently paid, the amount recovered should be recorded as additional income in the profit and loss account of the period in which the payment is received.

Double entries

1. Accounting bad debts
   Bad Debts account (Debit)
   Debtors account (Credit)
2. Writing off bad debts
   Profit and loss account (Debit)
   Bad Debts account (Credit)
3. bad debts written off and subsequently paid
   Cash account (Debit)
   Bad debts received (Credit)
4. Recorded bad debts written off and subsequently paid as additional income in the profit and loss account.
   Bad debts received (Debit)
   Profit and loss account (Credit)

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(22)-ACCOUNTING FOR DISCOUNTS

Accounting for Discounts

A discount is a reduction in the price of goods below the amount at which those goods would normally be sold to other customers of the supplier. Discounts can identified as two parts,

1. Trade Discounts – Trade discounts is a reduction in the catalogue price of an article, given by a wholesaler or manufacturer to a retailer. It is often given in return for bulk purchase orders.
2. Cash Discounts or settlement discounts – Cash discounts is a reduction in the amount payable for the purchase of goods or services in return for payment in cash rather than taking credit.

Trade Discounts

This is a reduction in the cost of goods owing to the nature of the trading transaction. For example a customer might quoted a price 2$ per unit for a particular item, but lower price of say 0.5$ per unit if the item is bought in quantities of say 200 units or more at a time.

In an accounting trade discounts are recorded in only to the day books, its not transfer to journal.

Cash Discounts or Settlement Discounts

This is a reduction in the amount payable to the supplier, in return for immediate payment in cash, rather than purchase on credit. For example a suppler might charge 2000$ for goods, but offer a discount of, say 10% if the goods are paid for immediately in cash.

In an accounting trade discounts are recorded in cash book first and transfer it into journal.

Trade discounts received

It should be deducted from the gross cost of purchase. It’s recorded as shown below

• Total creditors (Debit)
• Discounts received (Credit)
• Cash account (Credit)

At the end of the accounting period discounts received account is transfer to the profit and loss account

• Discounts received (Debit)
• Profit and loss account (Credit)

Trade discounts allowed

It should be deducted from the gross sales price. It’s recorded as shown below

• Cash account (Debit)
• Discounts allowed (Debit)
• Total debtors (Credit)

At the end of the accounting period discounts allowed account is transfer to the profit and loss account

• Profit and loss account (Debit)
• Discounts received (Credit)

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(21)-CALCULATING COST OF GOODS SOLD

Calculating Cost of Goods Sold

Opening stock value -------------------------------------XXX
(+)Cost of Purchase or cost of production -----XXX
(-) Closing stock value -----------------------------------(XX)
Cost of Goods Sold ---------------------------------------XXX

Goods might be unsold at the end of an accounting period and so still be held in stock at the end of the period. The purchase cost or production cost of these goods should not be included therefore in the cost of sales of the period, that’s why we doing stock adjustment like above.

Goods written off or written down

A business might be unable to sell all the goods of purchase or produced, because might be happen to the goods before they sold,

• Goods might be damaged.
• Goods might be stolen.
• Goods might become obsolete or out of fashion.

In the causes like that we should remove that cost from cost of goods sold,

Opening stock value --------------------------------XXX
(+)Cost of Purchase or cost of production ---XXX
(-) Damaged stocks -------------------------------(XX)
(-) Stolen stock -------------------------------------(XX)
(-) Closing stock value -----------------------------(XX)
Cost of Goods Sold --------------------------------XXX

Also we should write off that cost in the profit and loss account.

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(20)-NEED OF ACCOUNTING INFORMATION (EXTERNAL PARTIES)

Need of Accounting Information (External parties)

We can identify external parties as below,

1. Trade contacts.
2. Providers of finance to the company.
3. Employees of the business.
4. The Inland Revenue.
5. Government and their agencies.
6. Financial analysts and advisers.
7. The public.

Trade Contacts

This includes suppliers who supply goods and customers who purchase the goods or services. Suppliers want to know about ability to pay debts; customers want to know that the company is a secure source of supply.

Providers of finance to the business

These include long term loans and short term overdraft the bank or financial institution want to know and ensure that the company is able to keep up with interest payments and repay the amount advanced.

Employees of the business

They want to know about financial situation, because their careers and size of their wages depend on it.

The Inland Revenue

They want to know about profit of the company.

Government and their agencies

They are interested in the allocation of resources and therefore in the activities of enterprises.

Financial analysts and advisers

Financial analysts and advisers, who need information for their clients or audience,

The public

Public wants to know affect members of the public.

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(19)-NEED OF ACCOUNTING INFORMATION (INTERNAL PARTIES)

Need of Accounting Information (Internal Parties)

There are two main internal parties need accounting information in business,

1. Managers Of the company.
2. Shareholders of the company.

Managers of the company

Managers of a business need the most information, to help them take their planning and control decisions, and they have special access to information about the business, because they can get people to give them the types of statements they want.

These people appointed by the company’s owners to supervise day to day activities of the company. They need information about the company’s financial situation as it is currently and as it is expected to be in the future.

When managers want a large amount of information about the cost and profitability of individual products or different parts of their business they can arrange to obtain it through a system of cost and management accounting.

Shareholders of the company

These will want to access how effectively management is performing its stewardship function. They want to know profitability of the company and how much profit they can afford withdraw from the business for their own use.

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(18)-ACCRUALS AND PREPAYMENTS

Accruals and Prepayments

The net profit for a period should be calculated by charging the expenses which are relate to that period, if we preparing financial statements of a business for a period of eight months it would be appropriate to charge eight months expenses and income.

Accruals

Accruals or accrued expenses are expenses which are charged against the profit for a particular period, even though they have not yet been paid for,
For example assume one of the company paid 240$ telephone bill for the year 2008/2009 but they have to pay 20$ more for that period, in the financial statements

• We charged to income and expenses account 260$.
• We show 20$ as accrued expenses in the balance sheet under the topic of current liabilities.

Prepayments

Prepayments are payments which have been made in one accounting period, but should not be charged against profit until a later period because they relate to that later period.
For example assume one of the company paid 240$ but they have to pay 250$ for the year 2008/2009 then we can see they paid 10$ prepayments for the accounting period, in the financial statements

• We charged to income and expenses account 240$.
• We show 10$ as prepayments in the balance sheet under the topic of current assets.

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(17)-EXAMPLE- TRIAL BALANCE AND PROFIT AND LOSS ACCOUNT

Example Trial Balance and Profit and Loss Account

One of the trading company prepared ledger books and find following balances as at 31 March 2009

Cash ------------------------------(Dr) 430
Bank ------------------------------(Dr) 192
Capital ----------------------------(Cr) 500
Rent -------------------------------(Dr) 60
Carriage ---------------------------(Dr) 46
Creditors --------------------------(Cr) 760
Debtors ----------------------------(Dr) 510
Purchases -------------------------(Dr) 918
Sales -------------------------------(Cr) 696
We prepare profit and loss account using income and expenses balances,

Profit and Loss Account
Sales -------------------------------------------------------------696
(-)Cost of sales (Purchases because no stocks) -----918
Gross profit ----------------------------------------------------(222)
(-) Expenses
Rents -------------------------------------------------------------(60)
Carriage --------------------------------------------------------(46)
Loss for the period -----------------------------------------(328)

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(16)-AN EXAMPLE FOR BOOKKEEPING

An Example for Bookkeeping

A business is established with capital of $ 4000, and this amount is paid into bank account by proprietor. During the first year’s trading, following transactions occurred.

Purchases of goods for resale on credit $ 8600
Payments to trade creditors $ 7200
Sales all on credit $ 11600
Payments from debtors $ 6400
Fixed assets purchased fir cash $ 3000
Other expenses all paid in cash $ 1800
You can see below how to prepare ledger accounts (Double entries).

The first thing is to open ledger accounts. Cash account, Capital account, Creditors account, Purchase account, fixed assets account, Sales account, Debtor account, other expenses account.
Double entries for above transactions

(1). Established with capital of $ 4000
Cash account ---------(Dr) 4000
Capital account -------(Cr) 4000

(2). Purchases of goods for resale on credit $ 8600
Purchases account ---(Dr) 8600
Creditors account ----(Cr) 8600

(3). Payments to trade creditors $ 7200
Creditors account ----(Dr) 7200
Cash account ---------(Cr) 7200

(4). Sales all on credit $ 11600
Debtors account ------(Dr) 11600
Sales account ---------(Cr) 11600

(5). Payments from debtors $ 6400
Cash account ---------(Dr) 6400
Debtors account ------(Cr) 6400

(6). Fixed assets purchased fir cash $ 3000
Fixed assets account --(Dr) 3000
Cash account ----------(Cr) 3000

(7). other expenses all paid in cash $ 1800
Other expenses account -(Dr) 1800
Cash account -------------(Cr) 1800

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(15)-THE TRIAL BALANCE

The Trial Balance

At the end of the accounting period, a balance is struck on each accounting in turn. This means that all the debits on the account are totaled and so are all the credits. If the total debits exceed the total credits there is said to be a debit balance on the account if the credits exceed the debits then the account has a credit balance.

This list is called trial balance. It does not matter in what order the various accounts are listed.
The trial balance is a list of ledger balances shown in debit and credit columns.

There is no foolproof method, but a technique which shows up the more obvious mistakes is to prepare a trial balance.
If the two columns of the trial balance are not equal, there must be an error in recording the transactions in the accounts.

However trial balance not discloses the following types of errors.

• Error of principal.
• The posting of a credit or debit to the correct side of ledger but to a wrong account.
• The complete omission of a transaction.
• Compensation errors. An error is exactly cancelled by another error elsewhere.

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(14)-THE SALES LEDGER AND PURCHASE LEDGER

The Sales Ledger and Purchase Ledger

The accounts in the general ledger relate to types of income, expense, asset, liability excreta rather than to the person whom the money is paid or from whom it received. They are called impersonal accounts.

There is also a need personal account most commonly for debtors and creditors. These are contained in the sales ledger and purchase ledger.

Personal accounts include details of transactions which have already been summarized in ledger accounts. The personal account do not therefore form part of the double entry system, as otherwise transaction would be recorded twice over. They are memorandum accounts.

The Sales Ledger

The sales ledger is a ledger for customer’s personal accounts. The sales day book provides a chronological record of invoices sent out by a business to credit customers. A business should also keep a record of how much money each individual credit customers owes, and what is this total debt consists of. The businesses need personal accounts for each customer and it helps,

• Staff must be able to tell customer how much he currently owes.
• To send out statements to customers at the each month.
• The managers of the business will want to keep a check on the credit position of each customer.
• Need to match payments received against debt owed.

The Purchase Ledger

The purchase ledger is a ledger for supplier’s personal accounts. There is separate account for each individual supplier.
After entries are made in the purchase day book, cash book of purchase retains day book they are posted to the supplier’s personal accounts in the purchase ledger.

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