Bookkeeping Theory PDF

Most Popular Irish Business Structures Sole Trader A sole tradership is where an individual sets-up and owns their own business. This can be relatively straightforward, quick and inexpensive to do, certainly when compared to setting up a limited company. Any individual can...

Most Popular Irish Business Structures Sole Trader A sole tradership is where an individual sets-up and owns their own business. This can be relatively straightforward, quick and inexpensive to do, certainly when compared to setting up a limited company. Any individual can start up a business and declare to Revenue that they are self-employed. While all businesses are separate business entities to their owners and must be treated as such in the preparation of financial accounts, a sole trader, unlike a limited company, is not a separate legal entity. The owner of the business assumes full responsibility for it. This means that the debts of the business that cannot be met by the business must be met from the personal funds of the business owner. While the production of financial statements and the using accounting standards, e.g. the double entry principle, are not requirements of sole traders, they are still best practice and very common. Money and assets introduced to the business by the owner is called Capital. The business then owes that back to the owner. Any money or goods withdrawn from the business by the owner is known as Drawings. Drawings reduce the Capital owed by the business to the owner. Neither Capital introduced nor Drawings are used in the calculation of profit. Sole traders pay income tax on the profits of their business regardless of whether they take the profit out of the business or not. Partnership A partnership is the same as a sole tradership except that there is more than a single owner. The partners invest the capital into the business and are responsible for its day-to-day operations. A partnership is also not a separate legal entity (i.e. it is unincorporated) Partners are responsible for the business and liable personally for any debts. The partners also share the profits as set out in a partnership agreement. Income tax is paid on these profits, rather than the business being taxed on the profits. Money and assets introduced to the business by partners is called Capital. Any money they withdraw from the business by a partner is known as Drawings. Drawings reduce the Capital owed by the business to the Partner. Each Partner would have separate Capital accounts and Current accounts to keep track of capital and drawings. A Limited Company (LTD) Has a separate legal identity and is constituted in a particular form (incorporated). Its debts are limited to the value of the assets of the business (limited liability) and the owners/directors have no personal liability. Has legal obligations and audit requirements in relation to the production of financial statements? Pays corporation tax on its profits. Is generally more complex and expensive to set up than unincorporated owner managed businesses. Money (other than salary) taken out of the business by a Director for personal use should be posted to the individual Directors Loan Account Not-for-Profit Organisation Includes businesses that are set up in the nature of being religious, charitable, literary, artistic, scientific, or educational purposes. Normally an incorporated business form that is setup and run for a purpose, or purposes, other than making profits. They are normally tax exempt. They can be run by some mix of volunteers and paid staff. Even though they are not run to earn profits they must, however, be run in a financially responsible way. For this Introductory course we will concentrate on the accounts of a sole trader Rachel Solo. Phrases Used when Keeping a Set of Accounts Keeping Business Records A business keeps a record of its financial transactions relating to its primary day-to-day business operations. While keeping the records is secondary to the performance of the business’s operations in generating income and profits it is nonetheless important in keeping track of the activities of a business, e.g. Its earnings, which are usually primarily from sales revenue. Its spending e.g. on purchasing of goods for resale. Its spending on other costs/expenses e.g. utility bills, rent, etc. How much profits have been earned and if the owners have withdrawn any monies. These business records are called a set of Books or a set of Accounts: hence the title bookkeeper or accountant. Why else keep accounts? Keeping an accurate and up to date track of the business activities: - Can help stakeholders, like the owners, see how the business is performing. Can help assessing any tax liabilities of the company. Can help meet statutory requirements e.g. with regard to the filing of various records and financial statements with the government authorities. Can help when applying for funding or valuing the business if the owner decides to sell. In order to keep a set of books you need to understand a few phrases: Transaction Any event that takes place in a business that involves the exchange of money or money.s worth is known as a transaction. For example a sale, the purchase of a business vehicle, taking out a loan, investing capital, buying stock to resell are all transactions. It is still a transaction whether the money has actually changed hands or not. If the payment actually changes hands we call that a cash transaction (even if it is paid by cheque or transfer). If payment is promised at a later date we call that a credit transaction. Ledger A book where a collection of financial information is kept is called a Ledger. During your course you will see Nominal (aka General) Ledgers, Debtors Ledgers and Creditors Ledgers. This can be a physical book, but more likely these pays it is a section on your accounting software. Debtors can also be called Customers or Receivables. Creditors can also be called Suppliers or Payables. When you go to work in an organisation get familiar with the phrases they use because not all businesses use the same phrases. We will include a glossary in your resources folder that you may find helpful. Ledger Account The record within a Ledger where you would find all the transaction relating to a specific item is called a Ledger Account. For example, Motor Vehicles, Capital, Purchases or Sales. Capital The extent of the funding put in by the owner(s) is known as capital. This depends on the nature of the business e.g. a business that needs to acquire things like, buildings, vehicles, machinery would need a relatively high level of initial capital. Capital is also known as owners. equity. It is the debt owed to the business owners by the business and so Capital is a liability. For example, if an entrepreneur invested €50,000 to start a business, the amount is recorded in as capital. Most businesses do start with some initial funding invested as capital. This in turn is usually used to acquire assets that will be used to generate income for the business. Drawings As we saw previously, any money a sole trader or partner withdraws from their business is known as Drawings. Many people incorrectly class this as wages. As the owner of the business, you and your business are legally one in the same, you cannot employ yourself or sue yourself for wrongdoing in course and you cannot pay yourself wages. Drawings reduces the liability that is Capital and on your Balance Sheet you will see it deducted from Capital. Remember though that when we spoke about companies, we said that the company is a legal person in its own right. If you own shares in a company, you are not legally the same as the company. In this case if you work in the company you are an employee and so you can be paid wages and have all the other rights of an employee. Purchases When we talk about purchases in accounts, we are referring to the purchase of goods for resale. The purchase of items or services that we do not resell in the course of our business is known as an expense not a purchase. To illustrate this difference let’s imagine that we are a furniture showroom. We buy tables to resell and we also buy carpet cleaner to clean the showroom carpets. The tables will be classed under the heading Purchases., however, the carpet cleaner will be classed under the expense heading Cleaning.. This is a very important distinction. Expenses Expenses can be split into 2 fundamental types of spending. Revenue Expenditure (everyday expenses), this includes what is spent by a business that is incurred in the day-to-day running of its operations, known as Expenses. (or Overheads) Examples include staff salaries, rent, light and heat, insurance, advertising etc. Expenses are sometimes referred to as overheads. As with sales, Expenses can be paid for in cash when the Expense is incurred, or the Expense can be settled at a future date, which is where the Expense is incurred on Credit. Capital expenditure, which is money spent on purchasing non-current (aka fixed, or long term) assets. This spend tends to be on higher value items, where the purpose is for the business to use them to generate revenue, not for resale, of material used in the manufacturing process. They include items like, buildings, machinery, motor vehicles, etc. Assets These are items which the business controls/owns. They are divided into 2 categories as follows: Non-current (Fixed) Assets: These are items which the business controls/owns and uses in the business for economic benefit (e.g. Land & Buildings, Motor Vehicles, Premises, Computers and Fixtures & Fittings). By their nature they are used over a number of years known as their useful life.. Current Assets: These are also items owned by the business but are ones that can be readily turned into cash within a twelve-month period (e.g. inventory, debtors, bank, and cash itself It will be useful to just note at this point that the different current assets carry a varying degree of liquidity (ability/speed to turn into cash). This means that in our list above, cash is already liquid, what is in our bank is the next more readily available to turn into cash, debtors (collecting cash from customers who bought sales on credit), to the lest liquid being inventory as items can physically be in stock for some time before we get customer orders for them and then can get in the cash. Note: Assets can also be described as being Tangible Assets. (i.e. what you can see and touch like Land) or Intangible Assets. (like a brand name or goodwill.) Revenue (Income) Other income: Income for a business may come from sources other than sales, such as, interest income from having money on deposit in a bank account, dividend income, perhaps rental income, income from the sale of a fixed asset. Special Note: Capital investment by the owners, or monies that may come in the form of borrowings from 3rd parties, are not classified in the books as Revenue. Liabilities These are monies that a business owes (debts). Generally, they are also divided into two categories, as follows: Current (short term) Liabilities: Monies which must be paid within a year of the year-end date (e.g. Tax, Short Term Loans, Creditors, Bank Overdraft). Non-current (long term) Liabilities: Debts that extend beyond one year from the year end date (such as, a Mortgage or other form of a Long Term Bank Loan e.g. of 20 Years). Special note: Capital is a very special type of Liability in that it is the only money owed within the business. Every other liability is to outsiders e.g. Bank Loan, Creditors, and Taxes due. Sales Again, in accounting terms we class sales as transactions where we deal in the products or services that are our core business. Only these items are included in sales in our accounts. For example if we sold a van that we had used for delivery, this would not be classed as a sale, it would be classed as a disposal of a fixed asset. This again is a very important distinction. Sales are a revenue for the company. Absolutely everything that happens in a business relates to one of these groups called a classification: Purchases Expenses Assets Revenue Liabilities (Including Capital) Sales Use the acronym PEARLS to help you remember the basic classifications and we will use that again later to help you decide how to deal with each group. From now on we will call the full set of Purchases, Expenses, Assets, Revenues, Liabilities and Sales. PEARLS to keep it short. Your first job is to start recognising which category items fall under. We all know what purchases and sales. Still it is important to remember that a business might have many types of sales. For example a shoe shop might break sales down into Lady’s, Men’s and Children’s sections with matching purchases. Doing this would allow you to compare the Gross Profit for each type of sale. But what about the other four elements of PEARLS. Well here are some examples and you should add to the list as you go along and depending on the needs of your business. Expenses Assets Revenues Liabilities Wages Bank & Cash Rental Income Bank Loan Employers PRSI Motor Vehicles Interest Received Capital Travel Closing Stock Dividends Received Creditors Distribution Costs Buildings Discount Received Accruals Utilities Fixtures and Fittings Royalties Pay due to Staff (Net Pay) Stationery Machinery Taxes Due Discount Allowed Goodwill Prepayments Financial Statements Financial Statements are a collection of reports that will tell you all you need to know about the commercial situation of the organisation. They are like the “nutrition label for the business" They tell you what the business is worth, how it is performing, how it is managing its cash and, if it is a company, how much would be left after shareholders and investors were paid back. The two main Financial Statements, are the Trading, Profit and Loss Account and the Balance Sheet. Trading, Profit and Loss Account In every business you want to make profit. You measure profit by deducting all your expenses from all your revenues. If you have more revenue than expenses you have made a profit. If you have more expenses that revenue you have made a loss. We do this on a report called a Trading, Profit and Loss. A simple Trading Profit and Loss would look like this and we will go through all the elements of this example in our recordings. You normally look for two figures: 1. Gross Profit 2. Net Profit Important to know: 1. Gross Profit is Sales minus Cost of Sales. Remember that sales here should only include sales of your business. goods or services. 2. Cost of Sales are the costs directly involved in producing the goods or services that you have sold. Examples would be purchases, if you buy and resell stock, carriage inwards, raw materials and factory labour if you manufacture goods and so on. 3. Net Profit is Gross Profit minus all other business expenses. Balance Sheet You also want to know how much your business is worth. You measure the value by deducting the value of all your Liabilities from the value of all your Assets. We do this on a Balance Sheet. A Balance Sheet Note as previously discussed that Drawings are deducted from Capital. Very important: 1. Expenses and Revenues go into your Trading, Profit and Loss Account 2. Assets, Liabilities, Capital and Drawings go into your Balance Sheet A Chart of Accounts But how does the software know what to put into the Trading, Profit and Loss and what to put into the Balance Sheet? When you set up your accounts system for a client every transaction that affects your PEARLS must be recorded. To do this we set up ledger accounts for each item. The way that they are grouped together is called the Chart of Accounts. Although every business would have a slightly different Chart of Accounts, software packages will use default Charts of Account that you can alter to suit your needs. The principle is the same in a manual accounting system although it is very rare now to see a pure manual set of books: the minimum a small business would use is a spreadsheet system. In the Chart of Accounts every ledger account has a name, brief description and a code number. Similar items would be grouped closely together. That is to say all the Expenses would be grouped together as would the Assets, Revenues and Liabilities etc. For example, if light and heat expenses was 210, telephone could be 220. They are similar expenses and you would leave some free numbers between them just in case you needed to add something later. In software, the system is set up so that the Chart of Accounts (COA) allows you to pull down a Trial Balance, Trading, Profit & Loss Report or a Balance Sheet with all the similar items listed together. For this reason, placing a ledger account in the correct section of the COA is very important. See below an extract from the Big Red Cloud Chart of Accounts Profit and Loss section. Calculation of Trade & Settlement Discount Some important phrases at this point. List price (single item)/ Price list (multiple items) List price, which might also be called full price or catalogue price, is the price that might be advertised without taking into account trade discount, settlement discount or special offers. This enables the supplier to allow different rates of discount for different customers without having to write up a full price list for every customer. Trade Discount This is the discount from the list price that the supplier allows a particular customer or group of customers. This discount can be used to promote certain products or to encourage certain groups of customers to buy the supplier’s products. For example, a supplier could allow a trade discount of 35% minimum to all customers so that they can sell on a product at a profit. However, they might give a new customer 50% discount for the first six months to encourage them to try out products. After the six months elapsed the customer would revert to the normal 35% trade discount. Since the discount is off a price list there is no need to update the price list every time a new discount rate is required. Trade discount is usually shown on the face of an invoice because it does not have any additional conditions attached to it. Settlement Discount (aka Prompt Payment Discount) This is a discount that is given to customers to encourage them to pay earlier than the standard payment terms. For example, if terms agreed are 30 days a supplier might allow 2.5% discount for payment within 7 days. Settlement discount is applied after trade discount if any. For example: List price €200 Trade discount 10% Settlement discount 5% within 7 days. Calculation of net price charged = 200 * 90% = 180 (Where did 90% come from? If you get trade discount of 10% you pay 100%-10%=90%) Then 180* 95% = €171 net price. (Where did 95% come from? If you get settlement discount of 5% you pay 100%-5%=95% of the remainder after trade discount) Let’s go back to our simple invoice and look at trade and settlement discount on it. Let’s imagine that this would be the invoices without trade or settlement discount. Let’s say that trade discount is 25% and that settlement discount is 5%. You want to calculate how much the customer would pay if both discounts applied. Trade Discount 25% on the above invoice €355 * 25% = €88.75 Trade Discount €355 - €88.75 = €266.25 to pay after trade discount Settlement Discount 5% after Trade discount €266.25 * 5% = €13.31 Settlement Discount €266.25 - €13.31 = €252.94 to pay after both Trade and Settlement Discount It is very important to note that this is not the same as adding the two discount figures together. So you cannot just apply 25% plus 5% = 30% discount. That would give us €355 * 30% = €106.50 discount and €248.50 to pay which is incorrect. You must do the Trade Discount first and the Settlement Discount after. Credit Control Credit control about getting paid the money you.re owed. You want to reduce the time between supplying a customer and getting paid. Your aim should be to give enough credit to entice the customer to deal with you in a controlled, agreed and organised way. The task of collecting money normally falls into the tasks of the accounts department and so we will talk about it here on our course. It is simply amazing how many people do not have a system in place for collecting money from credit sales. If you have no system, you leave yourself at the whim of your customer. You customer may have pressures of their own and you may not be high on the list of priorities for them. Despite having agreed terms with you they may operate on a.pay on request. basis and may not pay at all until you contact them. Even for a small business, the benefits of using software and keeping your software records up to date cannot be overstated. Where possible, choose a cloud software that can print invoices and statements and accept bank feeds. Many software packages can include automated statements and emails to late payers. This will integrate your invoicing, credit control and bank receipts and allow you to update on the go. Nothing forgotten, nothing left to chance. If you are not yet using software, credit control, while still possible, becomes much more difficult. When I complete year end accounts for clients in my practice, I see invoices with no payments, duplicate invoices, receipts with no invoice to match and work done with no invoices. In advance of setting up any customer on credit there are some things to think of. 1. Spend time setting up your terms of trade policy. Have it documented, abide by it and enforce it. Make sure your clients have a copy or integrate it with your invoices/contracts. 2. This is a team effort. a. Keep your sales team informed of problems that may arise or have arisen. b. Train your credit controller (and that may be yourself!) in listening, persuasion, negotiation. c. As owner you should have simple, clear guidelines in place and communicate any deviation from the norm with your team. 3. Credit should not be given automatically. Make sure to do credit checks on each client that requests credit terms. Start low and build credit terms only if the customer respects the terms you have agreed. Set reminders to check credit rating again after a suitable length of time. 4. Don’t forget to insist on stage payments where the work on hand is long term or you have to purchase goods to complete the task. Remember that once goods are in a client’s house it is very difficult, time consuming and bad PR trying to get them back if payment does not follow. Make sure, if this affects you, to include retention terms. 5. As your business grows, consider whether it is time to employ a credit controller within your team or to train an existing staff member to take on that role. 6. Automate statements and reminders and provide aged debtors reports. 7. Don.t be shy: Credit Control is not for the faint hearted but remember, it is your money. Once you have the above in place, what are the steps to good Credit Control? Agree terms with your client and ensure that they have acknowledged those terms. Send the invoice as soon as possible after order/delivery/completion. Ensure that your figures are correct to avoid looking unprofessional and causing unnecessary work for your customer. Respond promptly to any disputes. Aim to have the issue resolved within the same cycle so that payment can issue. Send a reminder shortly in advance of the payment due date. Send statements as a matter of routine, for example every month end, and print your Aged Debtors report, making sure your accounts are up to date. (The joys of cloud software and bank feeds.) Have a 1, 2, 3 system in place for late payment. Email, phone call, visit. In some cases a call from the business owner may have more weight than a call from accounting staff. Follow up promptly and prioritise large debts. You are legally entitled to charge interest and also to levy the cost of unpaid cheques/ direct debits back to the customer and you should do so to enforce.actions have consequences. into your relationship with your late payer. Enforce your policy around halting supply until payment is made. Use a Debt Agency if you cannot collect. Even if this erodes your margin it ensures that you do not earn the reputation of being easy to withhold payment from. Cash is the lifeblood of your business. You have a responsibility to yourself and your staff to safeguard the viability of that business. Credit Control may sometimes feel uncomfortable, but, like every other skill, it gets easier with practice. Professional Ethics Whether you carry out your own accounts or have someone do it for you, ethics is an important consideration and worth conversation. Ethics is to do with moral standards and a code of rules which defines the context in which people behave. Businesses can carry an expectation to behave ethically and when they do this can reflect positively on the perception of the business by customers leading to increased trust and profit. Professional bodies like the ACCA and CPA will set a level of ethical behaviour expected by its members in their Professional Conduct Regulations.. An accounts job carries responsibilities because tracking the flow of money through a business is an important function based on considerable trust. It is important that you perform your tasks, diligently, carefully and honestly. At the heart of this is that you behave honestly and perform your work accurately. If this basic ethos is followed, then everything else should follow. The 5 fundamental principles 1. Integrity To conduct yourself in a straightforward and honest way in all professional and business dealings, implying fair dealing and truthfulness. There is an expectation that you work in a way that is honest, transparent and fair. 2. Objectivity To act without bias or conflict of interest or allowing any undue influence of others to infringe on your professional judgements or actions and behaviours relevant to the business in your role in accounts. 3. Professional competence & Duty of Care To carry out your role in accounts with the requisite professional knowledge and skill that will ensure that the business/client or employer is in receipt of a competent service that takes account of current developments in practice, legislation. To provide this diligently and in accordance with applicable technical and professional standards. You are expected to act competently in your work, with due care and professionalism. It is your duty to do ensure that things are done correctly, accurately and on time. 4. Confidentiality To respect the confidentiality of information acquired as a result of professional and business relationships and, therefore, not disclose any such information to third parties without proper and specific authority, unless there is a legal or professional right or duty to disclose, nor use the information for the personal advantage of the member or any third party. 5. Professional behaviour Member must comply with relevant laws and regulations that avoid any action that discredits the profession. Your behaviour should avoid bringing yourself or your client/employer into disrepute. For example, poor standard of work or worse still, criminal offences can tarnish the good name of you and/or your business or the business you work in. Key Differences Between Manual Accounting and Computerised Accounting Manual accounting involves the use of paper and pencil to record financial transactions, while Computerised accounting uses specialized software. Manual accounting is more prone to errors due to manual data entry, while Computerised accounting has built-in error checking and validation. Manual accounting requires more physical storage space for paper records, while Computerised accounting stores data electronically. Manual accounting can be time-consuming, while Computerised accounting can process transactions more quickly. Manual accounting can be more challenging to audit, while Computerised accounting provides clear audit trails. Manual accounting often requires a larger staff to manage, while Computerised accounting can be done by fewer people. Manual accounting may not provide real-time financial information, while Computerised accounting can provide up-to-date financial data. Manual accounting does not provide the same level of data analysis and reporting capabilities as Computerised accounting. Manual accounting does not provide the same level of security and data backup as Computerised accounting. Data Protection Always remember that when you have access to information about clients, suppliers and staff you have Data Protection obligations. Obtain and process personal data lawfully, fairly and in a transparent manner. Keep it only for one or more specified and explicit lawful purpose(s) Process it only in ways compatible with the purpose of which it was given initially. Keep data accurate, relevant and not excessive. Retain it no longer than is necessary for the specified purpose or purposes. Keep personal data safe and secure.