Chapter 3 Recording Financial Transactions PDF

# Chapter 3 Recording financial transactions ## Introduction - Identify the sources of information for the preparation of accounting records and financial statements - Record transactions and events resulting in income, expenses, assets, liabilities and equity in accordance with the appropriate b...

# Chapter 3 Recording financial transactions ## Introduction - Identify the sources of information for the preparation of accounting records and financial statements - Record transactions and events resulting in income, expenses, assets, liabilities and equity in accordance with the appropriate basis of accounting and the laws, regulations and accounting standards applicable to the financial statements **Specific syllabus learning outcomes are: 1c, d** ## Learning topics 1. Computerised accounting systems 2. Source documents for recording financial transactions 3. Recording bank transactions 4. Petty cash book 5. The payroll ## 1 Computerised accounting systems ### Section overview - The majority of businesses record their financial transactions using a computerised accounting system. - Computerised accounting systems range from simple, off-the-shelf accounting software packages used by small businesses for recording day-to-day transactions, to bespoke systems that fully integrate with other business systems in place in large and complex businesses. - The development of cloud accounting software in recent years has changed how computerised accounting systems are used and accessed. ## 1.1 Accounting system An accounting system is the system in place within a business to allow it to record, process and store financial information. An accounting system enables a business to satisfy the requirement for businesses to maintain records of their financial transactions and allows it to produce relevant and reliable information for stakeholders. In Accounting, we refer to traditional way of recording transactions, using books, as manual accounting system. The vast majority of accounting systems are now computerised. However, accountants still need to understand the accounting principles and processes that lie within a computerised system. At a basic level, computerised accounting systems, like all systems, have inputs, processes and outputs. | Inputs | Processes | Outputs | |---|---|---| | - Source documents - Standing data | - Ledgers - Journals - Calculations - Record keeping | - Reports - Trial balance - Financial statements | These terms will be explained in detail as we progress through the Workbook. ## 1.2 Accounting software packages Accounting software packages are commonly used computerised accounting systems. Accounting software packages range from simple 'off-the-shelf' programs that meet the requirements of a small business, to systems that are fully integrated with businesses other systems such as inventory management and human resource management systems that are used in large and complex organisations. In this Workbook, we will assume that the computerised accounting system is a software package which contains several different modules such as for payroll, for managing balances owed by credit customers or for maintaining a record of non-current assets. One of the modules will be the main accounting record of the business. The modules interact with each other in such a way that information entered into one module will automatically update other relevant modules, for example, recording a credit sale will update both the sales module and the module that manages the balances owed by credit customers. ## 3 Cloud accounting ### Definitions - **Cloud computing:** Cloud computing is a service that provides a business with access to software and data storage via the internet. Instead of being held locally on the user's computer, the software and data are held in 'the cloud', which means they are held remotely on the computer servers of the software service provider. - **Cloud accounting:** Cloud accounting is an application of cloud computing. Accounting software is provided in the cloud by a service provider. The user accesses this software to process their accounting transactions and run reports as they would if the software was installed on their own computer. The main benefit of cloud accounting is that a business can access its accounting records from any computer (or tablet or phone) that has an internet connection. Additionally, because most of the processing and data storage is done on the service provider's servers, and not the business's computers, the business does not need to purchase expensive, sophisticated IT equipment in order to run specialised software or store large amounts of data. As the software is maintained by the service provider, the business may also be able to reduce IT support costs within its own business. Whilst it has many advantages, cloud accounting does have its drawbacks. Cloud accounting requires access to the internet. If a business's internet connection is unreliable, accessing its accounting records held in the cloud will be difficult. There may be server outages on the cloud that would mean that there were temporary restrictions on the ability to access data. There are also potential data security issues, such as an increased risk of data being hacked and loss or damage to data. The business does not retain back-up copies of its data on its local computer, and therefore is reliant on the service provider to provide adequate security. ## 2 Source documents for recording financial transactions ### Section overview - Credit sales make use of sales orders, delivery notes to the customer and sales invoices (which is the source document that is then recorded). - Credit purchases make use of purchase orders, goods received notes and purchase invoices (which is the source document recorded). The purchase invoice is received from the credit supplier. - Invoices show, among other things, what has been sold or purchased and at what price. Trade discounts, VAT and any early-settlement (cash) discounts are also shown, so that the total reflects the full amount that remains to be paid. - Credit notes are negative invoices. ## 2.1 Source documents Whenever a business transaction takes place involving sales or purchases, receiving or paying money, or owing or being owed money, it is necessary for the transaction to be evidenced by a source document. The documents may be hard copy or electronic. Source documents are the documents which are produced by, or input into, a business's accounting system as the starting pointto recording the transactions of a business for accounting purposes. ## 2.2 Recording information from source documents Financial information contained in the source documents is recorded in the computerised accounting system. In respect of a credit sale made, the business needs to record: - the amount of the sale itself - the amount owed by the customer (receivable) - any VAT/discounts - payments subsequently received Some accounting software packages can be integrated with the accounting systems of customers and suppliers in such a way that the systems can exchange relevant information automatically. Whilst the use of Al has reduced the need for intervention from bookkeepers, it is important for professional accountants to understand what information the system is recording and be able to confirm the accuracy of that information. The following sections include more detailed information on the source documents used by businesses and the type of information those documents contain. Chapter 4 will provide further explanation as to how the relevant information is recorded. ## 2.3 Sales system Consider the following stages that arise when a business sells goods on credit to its customers. #### Figure 3.1: Sales system | | Description | |---|---| | **Customer order** | When a customer places an order, a sales order is created detailing the goods or services required and the agreed price. While sales orders are very important from a practical point of view, they are not treated as source documents for recording financial transactions in the business accounts. | | **Dispatch goods** | When the goods or services are delivered to the customer, they are usually accompanied by a delivery note prepared by the seller. This sets out the goods/services delivered, the quantities delivered, the date of delivery and the delivery address. A delivery note is not a source document. The delivery note is most often prepared with reference to the sales order. Once the delivery is complete the delivery note is used to provide information for creating the sales invoice. The delivery note is not a source document for credit transactions.| | **Raise invoice** | The seller wil then prepare and send an invoice to the customer to request payment for the goods or services delivered. Invoices are source documents and need to be recoded in the accounting system. More detail is given in section 2.5 below. | | **Receive payment** | The customer will then settle the invoice either by bank transfer or by cheque or cash. More detail is given in section 3 below. | ## 4 Purchases system Consider the following stages that arise when a business purchases goods on credit from its suppliers. #### Figure 3.2: Purchase System | | Description | |---|---| | **Purchase order** | A business will identify the goods it requires from its supplier and raise a purchase order which is sent to the supplier. The supplier will generate a sales order (see sales system at 2.3 above) based on the purchase order received. A purchase order is not a source document. | | **Receive goods** | Once the goods are received, a goods received note (GRN) is raised by the business to record the receipt of goods. The accounts department will often ask to see the GRN to confrim the goods were delivered before paying a purchase invoice. A GRN is not a source document.| | **Receive invoice** | Sometime later, the business will receive an invoice from the supplier to request payment for the goods delivered. Invoices are source documents and need to be recorded in the accounting system. More detail is given in section 2.5 below. | | **Make payment** | The business will then settle the invoice by transfer to the supplier's bank account or by cheque or cash. More detail is included in section 3 below. | ## 2.5 Invoices Invoices are source documents for credit transactions. - Invoices are used to record transactions which have been made on credit. 'On credit' means goods or services are supplied but payment is not made straight away as there is a 'period of credit' before payment is due. - When a business sells goods or services on credit to a customer, it sends out a sales invoice. The invoice details should match the details on the delivery note. The invoice is a request for the customer to pay what is owed. Sales invoices can be manually prepared and entered into the accounting system by the bookkeeper or automatically generated by the accounting system. Invoices raised are sequentially numbered, so that the business can keep track of all the sales invoices it sends out. - When a business buys goods or services on credit it receives a purchase invoice from the supplier. The details on the invoice should match the details on the purchase order (to confirm goods were actually ordered and at what price) and the goods received note (to confirm the quantity of goods received). A purchase invoice received by the customer is the same document as the sales invoice raised by the supplier. Information usually shown on an invoice includes the following: - invoice number - name and address of seller and purchaser - sale date - product/service description - quantity and unit price of what has been sold (eg, 20 pairs of shoes at CU25 a pair) - details of trade or bulk discount, if any (eg, 10% reduction in cost if buying over 100 pairs of shoes) and any early settlement (cash) discount offered for payment by an agreed date - total invoice amount including VAT details, if appropriate - the date by which payment is due, account details for the transfer of funds and other terms of sale - a remittance advice slip may also be included if settlement by cheque is permitted. The customer will include the remittance advice slip with their payment so that the seller can identify what outstanding amounts are being settled by the payment. ## 2.6 Credit notes Suppose Creative Supplies sent out a sales invoice to a customer for 20 dinner plates, but the bookkeeper responsible for creating the invoice accidentally input in a total of CU162.10, instead of CU62.10. The customer has been overcharged by CU100. What are Creative Supplies to do? Another customer received 15 plates from Creative Supplies but found that they had all been broken in the post. Although the customer has received an invoice for, say, CU45.60, it has no intention of paying it because the plates were substandard. Again, what is Creative Supplies to do? The answer is that Creative Supplies sends out credit notes to its customers. It will be made out in the same way as an invoice, but with a 'credit note number' instead of a 'sales invoice number'. ### Definition **Credit note:** A document issued to a customer relating to returned goods, or refunds when a customer has been overcharged for whatever reason. It can be regarded as a negative invoice. It is a source document for credit transactions. ## 2.6.1 Debit notes A debit note might be issued to a supplier as a means of formally requesting a credit note from that supplier. A debit note is not a source document. ## 2.7 VAT Value added tax (VAT) is a sales tax added to most sales invoices in the Bangladesh. Details for calculating and recording VAT are discussed in Chapter 4. As well as the sale or purchase amount, the business also normally needs to record VAT on each invoice or credit note. This amount will ultimately be paid to or received/adjusted from VAT Authority. ## 2.8 Other source documents So far, we have only considered source documents for sales and purchases on credit, ie, sales and purchase invoices and credit notes. Other source documents are also used for transactions involving settlement of credit transactions (by digital wallet, card payment or bank transfer), cash, wages and other matters, as we shall see. ## Interactive question 1: Credit note Fill in the blanks. Creative Supplies sends out a ______ where a customer has been overcharged on a ________. ## 3 Recording bank transactions ### Section overview - Businesses have constant and instant access to their bank accounts via electronic banking. - Electronic banking allows a business to create a transaction report at any point in time. - Transaction reports are source documents for transactions through the cash at bank account. - Some businesses have accounting software packages which are integrated with electronic banking systems, allowing banking transactions to be recorded directly in the business's accounting system. ## 3.1 Electronic banking Electronic banking has changed how businesses record transactions through the bank. Traditionally, a business' bookkeeper would maintain a separate cash book in which all bank and cash transactions were recorded. At the end of each month, the bank would send the business a bank statement. The bookkeeper would then use the bank statement to check the transactions were correctly recorded and that no transactions were omitted. Electronic banking means businesses now have constant, realtime access to their bank accounts and can use the information recorded by the bank to update their accounting records on a regular basis. Sophisticated accounting software packages can be integrated with the external banking system in such a way that bank transactions are automatically recorded in the relevant account codes. Such systems use Al to recognise 'known' receipts and payments and match them against the relevant transaction. In such a case, the bookkeeper will receive a transaction report which details transactions already matched, and therefore already recorded, and others which still need to be matched. Any 'unknown' transactions are recorded in a temporary account known as a 'suspense account' (see Chapter 6 for more detail) and will be reported on an exception report, to be investigated by the accountant. Once identified, the suspense account will be removed and the transaction will be recorded in the correct account within the accounting system. Other software packages will not have direct access to the business' banking system but can accept information held on reports that are extracted from the banking system. On a regular basis, the business will download a transaction report from the business' banking system which shows all the receipts and payments in a given period. The transaction report is the source document for transactions through the business cash at bank account. The data on the transaction report is then uploaded into the accounting software. Many software packages will use Al to perform a match on 'known' transactions and process these appropriately, in much the same way that a system that is integrated with the bank will. As was described above, unmatched transactions will appear on an exception report for further investigation. #### Figure 3.4: Electronic Banking matching | Transaction report | Uploaded | Accounting system | Match | |---|---|---|---| | Deposits Withdrawals | | | Matches to transactions - system can suggest or manual | | 650 | | Sales invoice 001 customer ABC 650 | Once matched, accounting system processes | | (900) | | Purchase invoice supplier XYZ 900 | | | (1,220) | | Purchase invoice supplier JKL 1,300 | Unmatched items require investigation Accountant discovers that prompt payment discount taken hence amount paid is less than invoice total | ## 3.2 Cash at bank account In the accounting system, the cash at bank account is used to record all receipts and payments made through the business bank account. We will assume that most business transactions take place through the electronic transfer of funds either by payment card, digital wallet payment, direct bank transfer, standing order or direct debit. Bank interest and charges made directly by the bank are also made electronically. These transactions will all be shown in the bank transaction report and are recorded in the accounting records (in the cash at bank account) as described in the above section. Businesses may also handle physical cash and cheques which must also be recorded in the cash at bank account. The total amounts of cash withdrawn or paid into the bank will be shown on the transaction report downloaded from the electronic banking system and are likely to be identified as unmatched exceptions by the accounting system. Once investigated and identified, these payments or deposits will be entered into the accounting system, in the cash at bank account, as described above. Some cash, in notes and coins, is usually kept on the business premises in order to make occasional payments for odd items of expense. This cash is usually accounted for separately in a petty cash book. ## 4 Petty cash book ### Section overview - The petty cash book is a record of all payments out of and receipts into petty cash. - Petty cash is the cash (notes and coins) that an entity keeps on the premises for incidental expenditure. - Under an imprest system, petty cash is kept at a fixed 'float' amount, which is made up of notes, coins and vouchers representing payments from and receipts of petty cash. - The amount of notes and coins used to 'top up' petty cash will be equal to the total of the vouchers issued for petty cash receipts and payments. - The petty cash book is analysed to record the different types of petty cash expense plus VAT on petty cash purchases. ## 4.1 What is the petty cash book used for? Most businesses keep a small amount of 'petty cash' on the premises to make occasional small payments in cash, eg, staff refreshments, postage stamps, taxi fares, etc. This is often called the cashfloat or petty cash. ### Definition **Petty cash book**: The book or spreadsheet in which payments and receipts of petty cash are recorded. Petty cash transactions -- including VAT on payments where relevant -- need to be recorded, otherwise petty cash could be abused for personal expenses or even stolen. There are usually more payments than receipts, and petty cash must be "topped up" from time to time with cash from the business bank account. A typical layout of a petty cash book is as follows. #### Petty cash book | Receipts | Date | Narrative | Payments | VAT | Milk | Postage | Travel | Other | |---|---|---|---|---|---|---|---|---| | CU | 20X7 | | CU | CU | CU | CU | CU | CU | | 250 | 1 Sept | Bal b/d | | | | | | | | | | Milk bill | 25 | | 25 | | | | | | | Postage stamps | 5 | | | 5 | | | | | | Taxi fare | | | | | 10 | | | | | Flowers -- sick staff | 15 | | | | | 15 | | 250 | | Bal c/d | 195 | 0 | 25 | 5 | 10 | 15 | Under the imprest system of managing petty cash, the amount of money in petty cash is kept an agreed sum, the imprest amount or "float" (CU250 in the example above). Expense items are recordedon vouchers as they occur, so that at any time: Cash still held in petty cash + vouchers for payments = petty cash imprest amountUsing the example above: Cash still held in petty cash + Plus vouchers for payments (25 +5 + 10 + 15) = Imprest amount CU 195 55 250 The total float is made up regularly to the imprest amount (here CU250) by means of a cash payment from the bank account into petty cash. The amount of the "top up" into petty cash will be the total ofthe voucher payments since the previous top up. The total for each type of expenditure and the amounts withdrawn from the bank must be recordedin the accounting system (covered in Chapter 4). ## Interactive question 3: Petty cash imprest Mitchell maintains a petty cash float with an imprest amount of CU250. At the end of June, vouchers in the petty cash box totalled CU112 and the amount of cash remaining in the box was CU91. **Requirement** Which of the following would explain the difference? A. A petty cash voucher totalling CU47 is missing. B. An employee received CU47 too little when being paid from petty cash. C. A voucher for CU47 was put in the petty cash box but no cash was taken. D. The amount of cash remaining was miscounted and was overstated by CU47. ## 5 The payroll ### Section overview - The payroll is the record of employee wages and salaries and is the source document for expenses relating to employees. - The amount actually paid to employees is called net pay; this is less than gross pay since the employer pays over what the employee owes directly to Income Tax Authority (for income tax) and the pension plan (for any employee pension contribution). - Gross payroll cost is more than employees' gross pay since the employer has to pay additional employer pension contributions to the pension plan. ## 5.1 What is the payroll used for? ### Definition **Payroll**: The record of wages and salaries costs. The payroll records all the individual amounts that appear on employees' payslips, namely: - gross pay to employees: - income tax - employee's pension contributions - net pay (cash ppid to employees) - additional costs for the employer: - employer's pension contributions Gross pay is not the amount paid to the employee. The employer needs to make deductions from gross pay before paying net pay to the employee. ## Context example: Payroll Sunny Climes Ltd employs three people: Anja earns CU36,000 a year; Mark earns CU33,000 a year; and Dipak earns CU30,000 a year. The gross pay in September for each employee is as follows: | | CU | |---|---| | Anja | 3,000 | | Mark | 2,750 | | Dipak | 2,500 | However, these are not the amounts that each employee will receive. Sunny Climes Ltd first of all has to deduct income tax from gross pay under the withholding tax rule to be paid to Commissioner of Taxes. As it runs a pension scheme, it has to deduct each employee's pension contribution, to be paid to the pension fund trustees. #### Deductions | | Withholding tax | Pension | Net pay | Gross pay | |---|---|---|---|---| | CU | CU | CU | CU | CU | | Anja | 550 | 150 | 2,300 | 3,000 | | Mark | 500 | 135 | 2,115 | 2,750 | | Dipak | 460 | 125 | 1,915 | 2,500 | | | 1,510 | 410 | 6,330 | 8,250 | **Deductions + Net pay = Gross pay** The employees will receive the net pay. The employer has deducted amounts the employees owe to other people from the gross pay the employer owes to them. This is not the end of the story, however; the employer makes contribution to the pension plan, over and above the amount ofgross pay. The final payroll will be as follows: #### Deductions | | WHt | Employee Contribution | Net pay | Grosspay | Employer Contribution | Total payroll cost | |---|---|---|---|---|---|---| | CU | CU | CU | CU | CU | CU | CU | | Anja | 550 | 150 | 2,300 | 3,000 | 200 | 3,200 | | Mark | 500 | 135 | 2,115 | 2,750 | 180 | 2,930 | | Dipak | 460 | 125 | 1,915 | 2,500 | 165 | 2,665 | | | 1,510 | 410 | 6,330 | 8,250 | 545 | 8,975 | **Gross pay + Employer's NI + Employer pension = Total payroll cost** The total payroll cost for Sunny Climes Ltd is CU8,975. This is paid out as follows: CU Employees (net pay) 6,330 Withholding Tax 1,510 Pension plan: Employee and employer pension (410 + 545) 955 Total payroll cost 8,975 ## Interactive question 4: Payroll Fantab Ltd has 10 employees who had gross pay of CU190,000 per annum between them in 20X4. In that year, Fantab Ltd made net pay payments to employees of CU129,200 and paid CUCU0,900 to the pension plan. Its total payroll cost was CU220,400. **Requirement** How much did Fantab Ltd pay to Commissioner of Taxes in respect of payroll withholding tax?