Business Accounting Basics 2010 PDF

Frank Wood’s Frank Wood’s Frank Wood’s...

Frank Wood’s Frank Wood’s Frank Wood’s Business Accounting Basics Business Accounting Basics Business Accounting Basics Frank Wood Frank Wood David Horner David Horner Business Accounting Basics is the ideal introduction into the fundamentals of bookkeeping and financial accounting. The book utilises both the IFRS and IAS framework making the text accessible to students and professionals from all around the globe. Its user-friendly worked examples and clear explanations help students build their knowledge of accounting standards one step at a time. With over 250 assessment questions containing full solutions, Business Accounting Basics is the perfect introduction to Business Accounting. Business Accounting Basics offers: Easy to follow worked examples and explanations of the basics of bookkeeping Logical development of the techniques used for maintaining financial accounting records Full explanation on how to create financial statements for businesses Clear progression throughout the text builds your knowledge of accounting standards Cross referencing to the relevant and up-to-date international accounting standards Over 250 assessment questions with full answers Regular and comprehensive assessment questions with some full answers allow you to monitor your progress and understanding Wood & Horner Business Accounting Basics is ideal for a wide variety of courses in accounting and business. It is particularly useful for those studying for AAT, A level and introductory professional qualifications in financial accounting. www.pearson-books.com Front cover image: © Getty Images CVR_WOOD5008_01_SE_CVR.indd 1 8/6/10 08:45:55 FRANK WOOD’S BUSINESS ACCOUNTING BASICS We work with leading authors to develop the strongest educational materials in business and finance, bringing cutting-edge thinking and best learning practice to a global market. Under a range of well-known imprints, including Financial Times Prentice Hall, we craft high quality print and electronic publications which help readers to understand and apply their content, whether studying or at work. To find out more about the complete range of our publishing, please visit us on the World Wide Web at: www.pearsoned.co.uk FRANK WOOD’S BUSINESS ACCOUNTING BASICS Frank Wood and David Horner Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsoned.co.uk First published 2010 © Pearson Education Limited 2010 The rights of Frank Wood and David Horner to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. Pearson Education is not responsible for third party internet sites. ISBN: 978-0-273-72500-8 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Wood, Frank, 1926–2000. Business accounting basic / Frank Wood and David Horner. p. cm. ISBN 978-0-273-72500-8 (pbk.) 1. Accounting. I. Horner, David, 1970– II. Title. HF5636.W858 2010 657—dc22 2010013482 10 9 8 7 6 5 4 3 2 1 14 13 12 11 10 Typeset in 10.5/12.5pt ITC Garamond Book by 35 Printed and bound by Rotolito Lombarde. Italy Contents Preface xii Chapter 1 Introduction 1 Learning objectives 1 Introduction 1 Sectors in the economy 1 Types of business organisation 2 Business objectives 3 Fundamentals of financial accounting 3 The accounting equation 4 International standards 5 Terminology 5 Summary 5 Chapter review 6 Key terms 6 Review questions 6 Chapter 2 Double-entry bookkeeping 9 Learning objectives 9 Introduction 9 What does the account show? 9 Rules for double-entry transactions 10 Further information for double-entry bookkeeping 12 Accounting for inventory 12 What do we mean by inventory? 13 Double-entry transactions for inventory 13 Returns of inventory 15 Drawings 17 Income and expenses 17 v Contents How many different expense accounts should be opened? 18 Balancing accounts 19 Chapter review 21 Handy hints 22 Key terms 22 Review questions 23 Chapter 3 Financial statements 28 Learning objectives 28 Introduction 28 Trial balance 29 Statement of comprehensive income 30 Statement of financial position 35 Further adjustments to the statement of comprehensive income 38 Chapter review 40 Relevant accounting standards 40 Handy hints 41 Key terms 41 Review questions 42 Chapter 4 Day books and ledgers 52 Learning objectives 52 Introduction 52 Ledgers 52 Day books 53 Cash books 53 Cash and trade discounts 55 Three-column cash books 56 Petty cash book 57 Sales day book 59 Purchases day book 60 Returns day books 62 The journal 63 The use of folio columns 65 Chapter review 65 Handy hints 66 Key terms 66 Review questions 67 vi  Contents Chapter 5 Value added tax 76 Learning objectives 76 Introduction 76 The administration of VAT 76 VAT and double-entry bookkeeping 77 Other items in the VAT account 81 VAT and discounts 82 Chapter review 83 Handy hints 83 Key terms 84 Review questions 84 Chapter 6 Capital and revenue expenditure 88 Learning objectives 88 Introduction 88 Classifying capital and revenue expenditure 88 Joint expenditure 90 Capital and revenue receipts 90 Areas of debate 90 Incorrect classification of expenditure 92 Chapter review 92 Relevant accounting standards 92 Handy hints 92 Key terms 93 Review questions 93 Chapter 7 Accounting concepts and standards 98 Learning objectives 98 Introduction 98 Financial statements – the underlying principles 98 Accounting concepts 100 Introduction to accounting standards 101 Chapter review 103 Handy hints 104 Key terms 104 Review questions 104 vii Contents Chapter 8 Adjustments to the financial statements 107 Learning objectives 107 Introduction 107 Accruals 107 Prepayments 109 Revenue 109 Accruals and prepayments and the statement of financial position 110 Dealing with trial balances when outstanding balances exist 111 Dealing with balances from more than one year 112 Links with other topics 114 Chapter review 114 Handy hints 114 Key terms 114 Review questions 115 Chapter 9 Bad debts and provision for doubtful debts 123 Learning objectives 123 Introduction 123 Accounting for bad debts 123 How can a business minimise the risk of bad debts? 125 Provision for doubtful debts 125 Calculating the size of the provision for doubtful debts 126 Accounting entries for the provision for doubtful debts 126 Provision for doubtful debts and the statement of financial position 128 Bad debts recovered 128 Provision for discounts on debtors 129 Chapter review 130 Handy hints 130 Key terms 130 Review questions 131 1 Chapter 10 Depreciation of non-current assets 135 Learning objectives 135 Introduction 135 Why do assets lose value? 135 Do all assets lose value? 136 Methods of depreciation 137 viii  Contents Straight line method 137 Reducing balance method 137 Depreciation and the statement of financial position 138 A comparison of the two methods 139 Changing methods of depreciation 139 Mid-year purchases and sales 140 Depreciation and double-entry bookkeeping 141 Asset disposal 142 Depreciation of intangible assets 145 Chapter review 145 Relevant accounting standards 146 Handy hints 146 Key terms 146 Review questions 146 Chapter 11 Errors and suspense accounts 151 Learning objectives 151 Introduction 151 Errors that don’t affect the trial balance agreement 151 Correction of the errors 152 Errors that do affect the trial balance agreement 156 Errors and profits 158 Chapter review 159 Handy hints 160 Key terms 160 Review questions 160 Chapter 12 Control accounts 165 Learning objectives 165 Introduction 165 Information used in the control accounts 165 Memorandum accounts 166 Layout of control accounts 167 Other items found in control accounts 169 Use of control accounts 170 Chapter review 174 Handy hints 174 Key terms 174 Review questions 174 ix Contents Chapter 13 Bank reconciliation statements 179 Learning objectives 179 Introduction 179 Procedure for bank reconciliation 180 Identifying items not appearing both in the cash book and on the bank statement 181 Bringing the cash book up to date 182 Updated cash book 183 Producing the bank reconciliation statement 184 Further information concerning construction of bank reconciliation statements 185 Chapter review 186 Handy hints 186 Key terms 186 Review questions 187 Chapter 14 Manufacturing accounts 192 Learning objectives 192 Introduction 192 How costs are classified 192 Prime cost 193 Indirect manufacturing costs 195 After the manufacturing account is completed 197 Factory profit 197 Provision for unrealised profit on unsold inventory 198 Chapter review 200 Handy hints 200 Key terms 200 Review questions 201 Chapter 15 Limited companies 210 Learning objectives 210 Introduction 210 Types of limited company 210 Differences between public and private limited companies 211 Shares and shareholders 212 Debentures 214 x  Contents Financial statements of limited companies 214 Reserves 218 Chapter review 223 Relevant accounting standards 223 Handy hints 224 Key terms 224 Review questions 225 Appendix 1: Answers to review questions 233 Appendix 2: Glossary 298 Index 306 Supporting resources Visit www.pearsoned.co.uk/wood to find valuable online resources For instructors Complete Instructor’s Manual For more information please contact your local Pearson Education sales representative or visit www.pearsoned.co.uk/wood xi Preface Notes for teacher and lecturers This textbook has been written to provide a concise but comprehensive introduction to financial accounting. It is suitable for beginners to this subject area and provides an introduction to the major topics covered within an introductory bookkeeping or financial accounting course. The textbook would be ideal for those studying for A and AS level, IGCSE, Scottish Higher Qualifications, Association of Accounting Technicians, university undergraduate degree courses and professional accountancy qualifications. The textbook is based on the International Financial Reporting Standard (IFRS) and the International Accounting Standard (IAS) framework, meaning it can be used by students across the world rather than any one country in particular. Each chapter begins with learning objectivities which outline what skills and techniques will be acquired by completion of the chapter. The chapter will explore each topic in sufficient detail with explanation of each topic accompanied by fully worked-out examples accompanied by explanations and reference to the relevant international accounting standards throughout. Frequent learning checks appear throughout each chapter in the form of review questions. These are included in each chapter and follow a scale of increasing challenge. This provides accessibility for all students whilst providing the relevant challenge for the student who is keen to practice further as the chapter progresses. Answers for each of the review questions appear at the end of the textbook. The textbook is written on the assumption that the user of the book has limited or no knowledge of accounting. Although each chapter is largely self-contained, the chapters are arranged in a sequential order. This means that review questions in later chapters will require the completion of the subject metier in the earlier chapters. Where review questions require prior knowledge, this is highlighted. Although the textbook is written to comply with international standards so as to maximise its usefulness for students of accounting across the globe, the chapter on Value Added Tax is based on the UK rate as at May 2010 of 17.5%. An Instructor’s Manual, which contains further guidance on the how to use the text- book, how to approach particular topics, as well as additional review questions for each chapter, is available from www.pearsoned.co.uk/wood. Notes for students This textbook is designed to provide a full and comprehensive guide as you begin your study of bookkeeping and financial accounting. It is meant to serve as an introduction to financial accounting, which means that you are not expected to have read any other textbooks in advance of using this particular one. xii  Preface When using this textbook, we would recommend that you always stick to the following guidelines: Always read the learning objectives as you begin to study a new chapter. These objectives give you clear targets for each chapter, which you can check on completion. Ensure that you attempt all the review questions when you have completed the relevant section of each chapter. The questions are designed to be completed as you finish a relevant section so you don’t have to wait until the end of the chapter. Answers to the review questions appear at the end of the textbook. However, we strongly recommend that you only use these answers to review your own progress after you have completed all the questions. Your progression in terms of learning will be severely restricted if you constantly check the answers before you have firmly grasped a topic. As a minimum, you should complete the entire relevant section before you check your own answers. If you are unsure on how to complete a review question, then revisit the relevant section in the chapter. The fully worked-out examples and explanation should provide guidance on how to reach the correct solution. Although financial accounting can seem very complex when undertaking study of the subject for the first time you should see clear improvement as you progress through each chapter. Regular practice through the review questions will help to consolidate your knowledge and understanding of the subject area. Finally, we wish you luck with your studies. Financial accounting is not the easiest subject to get to grips with, but with this textbook, a calculator and some dedication on your part, we are sure that you will be successful. Acknowledgements I would like to dedicate this book to my parents, Mollie and Harold Horner. However, there are also a number of people I would like to thank for support in various ways: Matthew Smith deserves great thanks – for his positive support and encouragement, particularly in the early stages of this book. I owe him. I would also like to thank Sally Nower, John Bellwood and Ian Yates for their suggestions they made in the writing of this book – more often than not, they were spot on. However, great credit must go to the students of Colchester Sixth Form College who, without fail, have made the teaching of Accounting never a bore, and surprisingly fun. xiii CHAPTER 1 Introduction Learning objectives By the end of this chapter you should be able to: Understand the different sectors in the economy Understand the main forms of business organisation within the private sector Understand how the accounting equation can be used and what it represents. Introduction The purpose of this book is to introduce you to the basics of business accounting. This book will cover the basics of the system of financial accounting – from the basics of double-entry bookkeeping to the construction of the financial statements for a simple small business. Although much of this book is aimed at the financial accounts of the sole trader, we will also have a look at the financial accounting practices employed by the limited company. This opening chapter aims to prepare you for what lies ahead. We will consider the various types of business organisation that you come across in your studies and what their major aims are as businesses. Accounting is often seen as a jargon-heavy subject and in this chapter we will also introduce you to some of the terms and concepts that you will be coming across throughout this textbook. This is potentially a confusing area – not helped by changes in some of the terminology over recent years. This text- book uses the most up-to-date terminology possible but at the same time will keep you informed of older terminology. Sectors in the economy It is common to classify economic activity into two sectors: the public sector and the private sector. The public sector The public sector is owned and controlled by the government. This covers all levels of government – from local to central government – and includes all the organisations 1 Business Accounting Basics which are funded by the taxpayer. The public sector is not as large as, say, thirty years ago, due to successive governments pursuing a policy of privatisation (transferring organisations from the public to the private sector), but it still accounts for a signifi- cant proportion of the business activity in the UK. Examples of public sector activity in the UK include the National Health Service and the provision of libraries. The private sector The private sector consists of businesses owned and controlled by private individuals acting either on their own or in groups. Although private sector organisations have to comply with laws and regulations set out by the government, these businesses are free to pursue their own ends. It is business organisations within the private sector that this textbook will be exploring. Types of business organisation There are three main types of business organisation within the private sector. Sole traders A sole trader is a one-person business (the business is owned by one person but others can be employed to work within the business). The sole trader is an unincorporated business organisation. This means that the legal status of the business is no different to that of the owner. If the business cannot pay its debts then it would be up to the owner to clear the debts even if this meant selling personal (non-business) assets to clear the business debt. Sole traders are generally small organisations but are very common – mainly due to the ease of setting up as a sole trader. Partnerships Partnerships are also unincorporated businesses. Historically, a partnership was owned by between two and twenty partners, although the limit on the maximum number of partners was relaxed in 2002. A greater number of owners potentially allows a greater contribution of capital into the business thus increasing the chances of success and minimising risk of failure. However, partners may still have to sell their own pos- sessions to clear the debts of the partnership in certain circumstances. A limited partnership was a variant on the partnership. This form of organisation allowed some (but not all) partners to enjoy limited liability, which meant that they avoided the risk of selling personal possessions. The Limited Liability Partnerships Act of 2000 created a new type of partnership. The Limited Liability Partnership (LLP) is closer in many respects to a limited com- pany in that all members of the LLP (partners) enjoy limited liability. However, the profits are treated as income for the partners rather than that of the organisation which is similar to how other unincorporated organisations (sole traders and ordinary partnerships) are treated. 2  Chapter 1 Introduction Limited companies A company has undergone the process of incorporation. This means a company exists separately from those who own the company. This means that the company will carry on independently from the owners. The owners of limited companies are known as shareholders. There are two types of limited company: public limited companies and private lim- ited companies. They are run by directors elected by the shareholders. It is appropri- ate to talk of a ‘separation of ownership from control’ – it is the shareholders who own the company, but it is the directors and managers who actually run the company. This can potentially cause a conflict of interest as the two groups may have differing objectives. This conflict highlights the importance of having clearly presented and understandable financial statements for user groups to examine and assess. As stated above, this textbook is primarily concerned with the accounts of sole traders, but limited companies will be briefly explored in Chapter 15. You should now attempt review questions 1.1 to 1.4. Business objectives The objectives of the business refer to the long-term aims of the business. It is com- monly assumed that all businesses in the private sector have profit maximisation as their prime objective. This means that business activity will be focused on increasing the profits of the business. The objective of profit maximisation has a certain logic to it – after all, businesses are often set up to generate a return for the owner of the business. In the case of limited companies, the objective of profit maximisation is more formally built into the activities of the business. A limited company is owned by shareholders who often buy shares in a company purely to generate as high a return as possible. Therefore the directors of the company will ensure that the activities of the business are focused on maximising profits. It is argued that businesses in reality do not always focus on profit maximisation as their prime objective. Sole traders and partnerships may have other objectives such as any of the following: Survival Personal objectives Market share growth. Objectives can change over time. A business trading in a period of reduced econ- omic activity (especially a recession) may focus on survival rather than profit maxi- misation. This switch in objectives may mean that decisions are taken which would not normally be considered (e.g. selling assets at a loss simply to raise cash). Fundamentals of financial accounting As mentioned earlier, accounting is often seen as a jargon-heavy subject. First-time students of accounting are often discouraged by the number of new terms that have to be committed to memory. At the end of each chapter there is a list of key terms 3 Business Accounting Basics with brief definitions or explanations. In this chapter we will be introducing you to some of the terms which are seen as crucial and underpinning much of what follows. There are three terms which underpin much of the system of financial accounting: assets, liabilities and capital (or equity). Term Description Assets Assets are the resources which are used by the business as part of the activities of the business (e.g. property, equipment and cash). Liabilities Liabilities represent the debts of the business – i.e. what is owed by the business to others. These may be short-term debts which are to be repaid soon or long-term debts which may be outstanding and owing for many years (e.g. a mortgage). Capital Capital refers to the resources supplied to the business by the owner(s) of the (or equity) business. This capital could be in the form of money or as other assets. You should now attempt review questions 1.5 to 1.8. The accounting equation In Chapter 2 you will be introduced to the system of double-entry bookkeeping. One of the principles that underlie much of the financial accounting within this book is the principle of duality. This relates to the idea that accounting transactions can be considered from two different perspectives. The accounting equation encapsulates this duality and is as follows: Assets = Capital + Liabilities What this equation represents is the two sides of the business – the physical side of the business (i.e. the assets) and the financial side of the business (i.e. the capital and the liabilities). If you think about it the equation must always be true; if there is an increase in the assets of the business then these assets must have been financed through either more resources from the owner (i.e. more capital) or more resources that have been borrowed (i.e. more liabilities). (In Chapter 3 we consider how capital can be increased by the generation of profits earned by the business.) If the equation always holds then we can ascertain the value of the assets of the business (or any other component of the equation) if we know the value of the capi- tal and liabilities (or any other two components). The accounting equation underpins the statement of financial position of the business (see Chapter 3). It also indirectly influences the rules of double-entry bookkeeping (see Chapter 2). You should now attempt review questions 1.9 to 1.12. 4  Chapter 1 Introduction International standards Accounting systems must follow rules. You may be surprised to find that there are dif- ferent ways of recording and presenting accounts and financial statements. Rules and regulations are not as important for the purpose of internal accounts as they are for those for external publication and external use. However, it is good practice and useful to see how the rules and regulations which apply to larger business organisations would also apply to those of a small organisation. Accounting standards are a set of continually evolving documents which provide guidance on various aspects of financial accounting. This textbook will be based on the international standards (IASs and IFRSs) rather than those set out in UK GAAP. This is covered in Chapter 7. Terminology Terminology has evolved over time and unfortunately there are multiple terms used for the same concept. The following table outlines some of the old terms that are used and their equivalent new term. It will be well worth checking with the syllabus requirements of your particular course as there may be some flexibility in which terminology is used. Old term New term 1 Profit and loss account Statement of comprehensive income (or income statement) 2 Balance sheet Statement of financial position 3 Fixed assets Non-current assets 4 Long-term liabilities Non-current liabilities 5 Stock Inventory/inventories 6 Debtors (or accounts receivable) Trade receivables 7 Creditors (or accounts payable) Trade payables 8 Sales revenue Turnover 9 Shareholders’ funds Equity 10 Profit and loss account Retained earnings (appearing as a revenue reserve) Summary Studying accounting can seem daunting at times. It is a challenging subject to study. However, you will quickly realise that there is a certain logic to the accounting tech- niques and procedures, which can be picked up relatively quickly. 5 Business Accounting Basics A lot of the content of an accounting course can be reduced to simple rules. Commit these rules to memory – use them through practical application and a lot of the difficulties you may face studying accounting will be overcome. It is vital that you don’t study accounting passively. This textbook has many ques- tions designed to test your understanding. Work with the text and complete the review questions as you progress. We wish you good luck with your studies. Chapter review By now you should understand the following: The different types of business organisation What is meant by the accounting equation and how it can be used Differences in terminology used within accounting. Key terms Public sector Sector in the economy owned and controlled by the government Private sector Sector in the economy owned and controlled by private groups and individuals Sole trader A business organisation owned and controlled by one person Partnership A business organisation owned and controlled by a small group of people Unincorporated business A business organisation in which the owners and the busi- ness are, in legal terms, the same as each other Limited liability Where one is limited to losing no more than their original investment in a company Limited company A business organisation which has undergone incorporation and therefore exists as a legal entity separate from its owner(s) Business objectives The aim or purpose of a business – i.e. what it is trying to achieve Profit maximisation Where a business aims to generate as much profit as is possible Assets Resources used within a business (e.g. equipment) Liabilities Debts and other borrowings of a business Capital (or equity) Resources provided to a business by the owner(s) of the business REVIEW QUESTIONS 1.1 Outline three advantages of operating as a sole trader as compared to operating as a partnership. 1.2 Give three reasons why a sole trader may wish to convert into a partnership with others. 1.3 Suggest three reasons why one may prefer to operate as a company rather than as a sole trader. 6  Chapter 1 Introduction 1.4 Explain what is meant by a ‘separation of ownership from control’ in the context of limited companies. 1.5 Explain why profit maximisation is likely to be the prime objective of a company. 1.6 Classify the following into assets or liabilities: (a) Business premises (b) Bank overdraft (c) Money owed by others to the business (d) Equipment owned by the business (e) Mortgage on premises (f ) Cash held in till (g) Unpaid bill. 1.7 Classify the following into assets or liabilities: (a) Money owed to suppliers (b) Vehicles used by the business (c) Goods bought with the intention of their being sold for a profit (d) Computer used in the business (e) Bank loan to be repaid within the next year (f ) Amount owing for office fixtures bought on credit. 1.8 Classify the following into assets or liabilities: (a) Amount that business will need to pay another business for purchases of equipment (b) Cash in bank account (c) Balance on savings account (d) Bill paid in advance (e) Amount due to be paid in next month for business rates (f ) Delivery van. 1.9 Complete the gaps in the table below: Assets Liabilities Capital £ £ £ (a) ? 4,100 1,300 (b) 3,870 ? 2,680 (c) 9,875 ? 8,680 (d) ? 543 637 (e) 6,767 1,107 ? 1.10 Complete the gaps in the table below: Assets Liabilities Capital £ £ £ (a) 12,231 ? 7,887 (b) 23,434 18,312 ? (c) ? 23,111 51,312 (d) 54,524 9,090 ? (e) 31,231 ? 20,022 7 Business Accounting Basics 1.11 Complete the gaps in the table below: Assets Liabilities Capital £ £ £ (a) ? 31,221 33,343 (b) ? 23,123 76,990 (c) 64,564 ? 54,693 (d) 76,575 11,200 ? (e) 86,788 31,231 ? 1.12 A business provides the following figures. £ Property 54,000 Equipment 8,200 Bank 1,150 Loan 15,900 Based on the above data ascertain the size of the capital of the business. 8 CHAPTER 2 Double-entry bookkeeping Learning objectives By the end of this chapter you should be able to: Understand the nature and content of double-entry accounts Enter transactions correctly into accounts for a variety of transactions Balance off accounts at the end of the accounting period. Introduction Business transactions are recorded in accounts. The maintenance and recording of transactions within these accounts is known as double-entry bookkeeping. The ‘double-entry’ term is used because each transaction can be seen to have two separate effects on the business. For example, buying a new machine for cash would affect both the asset of machinery, and the asset of cash. Similarly, selling inventory on credit would affect the asset of inventory, and the liability of trade payables. A double-entry account would normally appear as follows: A double-entry account Account name Debit side (Dr) Credit side (Cr) Date Account details Amount (£) Date Account details Amount (£) What does the account show? Given the ‘T’ shaped appearance of the accounts they are often referred to as ‘T’ accounts. Each of these accounts will show the following: Account name The name of the account refers to the type of transaction. For example, if the account is dealing with buying or selling machinery, then the account could simply be known as ‘machinery’. This means that each different type of transaction would be recorded in a separate account. 9 Business Accounting Basics Debits and credits The debit side (Dr) and credit side (Cr) refer to the left-hand and right-hand sides of each account. These terms can be used to refer to how entries are made. For example, if we talk of ‘debiting’ an account, all we mean is that we would be placing an entry on the debit side – the left-hand side – of the account. Account details The details element of each side of the account will contain the name of the other account which the transaction also affects. As a form of symmetry, each transaction will affect two accounts – hence the term ‘double-entry’ – and the details included in each account will refer to the other account to be affected. There are some basic principles that must be applied when recording double-entry transactions: 1 Every transaction requires two entries to be made in separate accounts. 2 Every transaction requires one debit entry and one credit entry to be made in each of the two accounts. Rules for double-entry transactions It is vital that transactions are recorded correctly. For this we need to establish on which ‘side’ of the account each transaction needs to be recorded – i.e. should we ‘debit’ or ‘credit’ an account? This will depend on the type of account that we are dealing with. In Chapter 1 we were introduced to the terms asset, liability and capital. To start with we will consider three separate types of account: for assets, liabilities and capital. The rules for recording the double-entry transactions are as follows: all Asset accounts Debit Credit INCREASES entered HERE DECREASES entered HERE all Liability accounts Debit Credit DECREASES entered HERE INCREASES entered HERE all Capital accounts Debit Credit DECREASES entered HERE INCREASES entered HERE These rules will make more sense if we see some examples of them in action. Example 2.1 On 1 November, the owner places £5,000 of her own money into the bank account of the new business. 10  Chapter 2 Double-entry bookkeeping Explanation The asset of bank has increased – so we debit that account. The capital of the business has increased – so we credit that account. Bank £ £ 1 Nov Capital 5,000 Capital £ £ 1 Nov Bank 5,000 Notice how the detail of each transaction cross-references the other account to be affected – providing a useful way of locating the other account that is to be affected by the transaction. Example 2.2 On 3 November, machinery is purchased for £2,000, payment made by cheque. Explanation The asset of machinery has increased – so we debit that account. The asset of bank has decreased due to the payment made – so we credit that account. Machinery £ 3 Nov Bank 2,000 Bank £ 3 Nov Machinery 2,000 Example 2.3 On 9 November, equipment is purchased on credit from Perkins Ltd for £320. Explanation The asset of equipment has increased – so we debit that account. The liability of creditor* Perkins Ltd has increased – so we credit that account. Equipment £ 9 Nov Perkins Ltd 320 Perkins Ltd £ 9 Nov Equipment 320 * Note: A creditor is someone the business owes money to who is likely to be repaid in the near future. 11 Business Accounting Basics Example 2.4 On 14 November, the £320 owing to Perkins Ltd is paid by cheque. Explanation The asset of bank has decreased – so we credit this account. The liability of creditor has decreased – so we debit this account. Bank £ 14 Nov Perkins Ltd 320 Perkins Ltd £ 14 Nov Bank 320 Further information for double-entry bookkeeping The books which contain the accounts that record these transactions are known as ledgers. In reality, most accounts will contain more than one transaction and one single account could easily take up many pages in the ledger. In Chapter 4 we show how these ledgers are sub-divided. When completing questions that involve maintaining double-entry accounts, it is a good idea to read through the complete list of transactions first so as to get a rough idea of how many entries will be needed in each account. This will mean that you can leave sufficient space to make all the entries in that account – it will start to look untidy if you have to restart an account later on in your workings due to leaving insufficient space for transactions. Typically, the bank and cash accounts are used frequently, whereas the capital account is only affected by one or two entries. You should now attempt review questions 2.1 to 2.7. Accounting for inventory Goods that are bought with the intention of being sold are referred to as inventory. Inventory is an asset and will therefore follow the rules of an asset account. However, bookkeeping for inventory is not as straightforward as you might think. Consider the following account: Inventory 2010 £ 2010 £ 8 Apr Purchases 300 6 May Sales 300 12  Chapter 2 Double-entry bookkeeping It would be tempting to think that the balance on this account is zero – with the inventory purchased in April all being sold in May. However, it is likely that the selling price of the inventory differed from the purchase price of the inventory (i.e. it was sold for a profit) and, as a result, we cannot actually determine how much inventory is left within the business. The solution is to have separate accounts for different movements of inventory. There are four separate accounts to record different movements in inventory: The four accounts for inventory 1 Purchases – for purchases of inventory 2 Sales – for sales of inventory 3 Returns inwards – when a customer returns inventory to the firm. 4 Returns outwards – when the business returns inventory to the supplier. What do we mean by inventory? Initially we will use examples where firms are not manufacturers of goods. Profits are earned by these businesses trading in goods: buying goods and selling these goods on to customers. This may be unrepresentative of many businesses today, but it simplifies matters to start with. Inventory refers to goods that the firm buys with the intention of selling at a profit. What is counted as inventory will depend on the type of business we are dealing with. For example, a business buying and selling computers would count purchases of com- puters as inventory – and would enter these into the purchases account. However, another firm may see the purchase of a computer as the purchase of an asset and the entry for this purchase would be in a ‘computer’ account. Many accounting students are initially unsure whether something counts as the purchase of an asset or the purchase of inventory. This distinction between purchases of assets and purchases of inventory is important as it has implications later on for calculating the profit of the business. Double-entry transactions for inventory Inventory is an asset and will therefore follow the rules of an asset account. It is possible that both purchases and sales will be either for immediate payment or receipt – these would be referred to as ‘cash transactions’. However, they may be on ‘credit terms’ where the payment or receipt is made at a later date. It is worth pointing out that the term ‘cash’ – as in ‘cash sales’ – can include payment or receipt by cheque; it is only referred to as ‘cash’ to distinguish it from credit terms. Nature of inventory transaction Cash transaction = Immediate payment Credit transaction = Payment made at a later date 13 Business Accounting Basics Credit terms are normally offered when one business trades with another business. The credit period offered can vary, but 30 days is a typical period offered. The double- entry transactions for credit transactions will be completed in two stages: firstly, the initial credit transaction, and secondly, the payment made or received in final settlement of the account owing or owed. Example 2.5: purchases of inventory On 10 November, the business purchases £450 of inventory. Whether the firm pays for this immediately by cheque, or purchases it on credit terms, can be shown easily in the following accounts. The purchase of inventory will require a debit entry into the purchases account as an asset has increased, but there are two options for the corresponding credit entry: A = Cash purchase B = Credit purchase A Cash purchases Purchases £ £ 10 Nov Bank 450 Bank £ £ 10 Nov Purchases 450 Explanation If the inventory is paid for immediately, then a credit entry will be made in the bank account – an asset has decreased. B Credit purchases Purchases £ £ 10 Nov Creditor 450 Creditor £ £ 10 Nov Purchases 450 Explanation If the inventory is bought on credit, then a credit entry will be made in the creditor’s account – a liability has increased. Example 2.6: sales of inventory On 19 April, the business sells £870 of inventory. Again, we can illustrate the accounts for both cash sales and for credit sales. 14  Chapter 2 Double-entry bookkeeping The sale of inventory will require a credit entry in the sales account as the asset of inventory is being reduced. Again, there are two options for the corresponding debit entry: A = Cash sale B = Credit sale A Cash sales Sales £ £ 19 Apr Bank 870 Bank £ £ 19 Apr Sales 870 Explanation If the sale is for immediate receipt, we would debit the bank account – as an asset is being increased. B Credit sales Sales £ £ 19 Apr Debtor 870 Debtor £ £ 19 Apr Sales 870 Explanation If the sale is on credit then we would debit the account of the debtor,* as an asset is being increased. * Note: Debtors are people or other businesses that owe the business money – usually for sales made to them on credit. The repayment of the amount owing is expected in the near future. Returns of inventory It is possible that goods will be returned to the original supplier. This is not something that the supplier will allow automatically, but if there is some issue with the order, such as the order itself being incorrect, or the items faulty, then it is normal practice for the goods to be returned. Both returns inwards and returns outwards are asset of inventory accounts and will therefore follow the rules of an asset account. 15 Business Accounting Basics Returns inwards refer to the goods which are sent back to the firm from the customer. For this reason they are also known as sales returns. Example 2.7 Goods previously sold on credit to C Smith for £189 were returned to the firm on 12 March due to the goods being faulty. Returns inwards £ £ 12 Mar C Smith 189 C Smith £ £ 12 Mar Returns inwards 189 The returns inwards represent an increase in the asset of inventory which means we will debit that account. By returning goods C Smith will owe the firm less money which reduces the asset of debtor which means we credit Smith’s account. Returns outwards refer to the goods which the business returns to the original suppliers. They are purchases that are unsuitable and for this reason are also known as purchases returns. Example 2.8 Goods previously purchased from L McCormack for £212 were found to be faulty and were subsequently returned to him on 5 April. Returns outwards £ £ 5 Apr L McCormack 212 L McCormack £ £ 5 Apr Returns outwards 212 Returns outwards represent a decrease in the asset of inventory which will mean we credit this account. By returning goods we will owe McCormack less money which reduces the liability of trade payables which means we debit McCormack’s account. Returns Returns inwards (sales returns) Inventory returned to the business from the customer Returns outwards (purchases returns) Inventory returned by the business to the supplier You should now attempt review questions 2.8 to 2.14. 16  Chapter 2 Double-entry bookkeeping Drawings In Example 2.1 we looked at the owner of the business adding resources to the business in the form of extra capital. However, it is perfectly possible that the owner will take resources out of the business for personal use. Resources taken out of the business by the owner are known as drawings. As the owner will be withdrawing assets from the business, the relevant asset account will be credited; the debit entry is in the drawings account. Hence, the double-entry for drawings is completed as follows: Account to be debited Account to be credited Drawings Asset withdrawn by owner Example 2.9 On 1 October, the owner of the firm takes out £500 from the business bank account for her own use. Drawings £ 1 Oct Bank 500 Bank £ 1 Oct Drawings 500 The total drawings for the year would be transferred to the capital account at the end of the trading period. This will adjust the existing capital of the business to give us the new capital account balance for the following trading period – this adjustment will also appear on the statement of financial position. Income and expenses Businesses will incur expenses as part of their normal trading operations. Common expenses incurred by businesses would include rent, insurance and wages. In addition, the business may have other income in addition to the sales revenue earned from sell- ing goods. Additional forms of income for the business may include rental income (known as rent received). The double-entry account transactions to record income and expenses are straight- forward. It is often easier to think of these transactions in terms of their effect on the bank or cash account – as a payment will involve the bank or cash account being credited, the debit entry for this transaction must be in the relevant expense account. Similarly, if money is received as business income then we would debit either the cash account or the bank account. This means that the credit entry for this transaction would be in the relevant income account. 17 Business Accounting Basics For expenses: Account to be debited Account to be credited Expense Bank or cash For income and other revenues: Account to be debited Account to be credited Bank or cash Income Example 2.10 On 9 March, the firm paid wages of £140 in cash. Wages £ 9 Mar Cash 140 Cash £ 9 Mar Wages 140 Example 2.11 On 9 March, the firm received a cheque for £250 in respect of rent received. Rent received £ 9 Mar Bank 250 Bank £ 9 Mar Rent received 250 How many different expense accounts should be opened? An account should be opened for each separate expense generated by the business. However, it is possible that some of the smaller expenses that are incurred, for example tea or coffee costs for a staff office, could be kept in a ‘general’ or a ‘sundry’ expenses account. It is better to keep each expense separate so as to provide information for the managers of the business as to what expenses are being incurred, and thus give them information that can be used to control these costs and prevent them rising too quickly. 18  Chapter 2 Double-entry bookkeeping Another way of separating out the accounts is to ensure that expense and income accounts remain separate. For example, some firms will have an account for both rent as an expense, and rent as an income. Here, two separate accounts are maintained with the account dealing with rental income referred to as rent received, and the account dealing with the expense of rent simply referred to as rent. If there is any doubt in knowing whether you are dealing with an income or an expense account then just look at the entries made within the account – the expense account will have the debit entry referring to the means of payment – as in the above example. Incomes will be credited to the income account as the money received for the income would be debited to either bank or cash. You should now attempt review questions 2.15 to 2.19. Balancing accounts At the end of a given accounting period (which could be weekly, monthly or yearly), the double-entry accounts will be balanced. The main purpose of balancing the accounts is so that the financial statements of the business can be produced. Balancing off accounts involves comparing the totals of the debit entries in the individual accounts with the total of the credit entries. The balance on an account arises where there is a difference between the total of the debits and the total of the credits. The different ways in which accounts can be balanced are as follows: Example 2.12: where no balance exists Some accounts will exist where the totals of the debits and credits are equal. In these cases, there is no balance on the account. Bank 2010 £ 2010 £ Jan 8 Sales 86 Jan 11 Purchases 345 Jan 15 Cash 112 Jan 14 Wages 290 Jan 18 Equipment 750 Jan 19 Vehicle 2,313 Jan 26 Loan 2,000 2,948 2,948 S Moorcroft 2010 £ 2010 £ Jan 17 Sales 112 Jan 24 Cash 112 In these two cases, the total of the debits is equal to the total of the credits. The tech- nique to finish the accounts is as follows: Where there are multiple entries in the account (e.g. see the bank account above): Total up each column and write the totals alongside each other – on the same line down. Double underline these totals. 19 Business Accounting Basics Where there is only one entry on each side of the account (e.g. the account of S Moorcroft above): Double underline the account. Example 2.13: entries only on one side of the account Some accounts will exist where there are only entries on one side of the account. Where the totals on each side are not the same then there is a balance on each account. Purchases 2010 £ 2010 £ Feb 2 R Johns 13 Feb 28 Balance c/d 411 Feb 8 F Spencer 76 Feb 12 O Tye 230 Feb 20 I Shipsom 92 411 411 Mar 1 Balance b/d 411 I Shipsom 2010 £ 2010 £ Feb 28 Balance c/d 92 Feb 20 Purchases 92 Mar 1 Balance b/d 92 In the purchases account we enter the balancing figure (the amount needed to ensure the two sides are equal) on the credit side. In the account of I Shipsom, there is only one entry in the account (on the credit side) and so we only need the equiva- lent entry on the debit side of the account. The insertion of these balancing items means the totals of each side now equal and the totals and ruling off can take place as in the earlier example. The term ‘balance c/d’ refers to the balance on the account to be carried down to the next period of time. Confusingly, this term is the ‘balancing amount’ but not the balance. Notice that on the two accounts above, the balancing figure is then brought down (‘balance b/d’) to the opposite side of the account for the next period of time. This is the actual balance – in the case of Purchases, it is a debit balance of £411. In the case of I Shipsom, there is a credit balance of £92 on the account. Be careful here: it is the balance b/d which represents the actual balance on the account, not the balance c/d which is simply the balancing figure. It is good practice to always bring the balance down to the start of the next account- ing period – even if not asked for. Example 2.14: entries on both sides of the account In some accounts there will be multiple entries in the accounts and the totals of each side will not be equal, as in the following account: 20  Chapter 2 Double-entry bookkeeping C Flint 2010 £ 2010 £ Apr 5 Sales 24 Apr 7 Returns inwards 11 Apr 19 Sales 36 Apr 12 Bank 56 Apr 24 Sales 28 To balance off this account we would complete the account as follows: C Flint 2010 £ 2010 £ Apr 5 Sales 24 Apr 7 Returns inwards 11 Apr 19 Sales 36 Apr 12 Bank 56 Apr 24 Sales 28 Apr 30 Balance c/d 21 88 88 May 1 Balance b/d 21 In the above account, there is a debit balance of £21. This means that C Flint owes the business £21 – a debit balance reflects the fact that the above account receivable is an asset of the business. General rules for balancing accounts Although balancing accounts is fairly straightforward, it can initially cause problems. Most problems can be avoided if the following points are remembered: Balances only exist if there is a difference between the totals on each side of the account. The totals of each side of the account are not the balances. The balancing figure on the account will be the amount needed to ensure the totals of each side are equal. Ensure that the totals of the accounts are written on the same line down. Bring the balance down on to the opposite side of the account from the balancing figure. You should now attempt review questions 2.20 to 2.22. Chapter review By now you should understand the following: How to record basic transactions for asset, liability and capital accounts How to account for inventory transactions in the accounts How to account for drawings, income and expenses How to balance off accounts. 21 Business Accounting Basics Handy hints The following hints will help you avoid errors. Always ensure that you make two entries for each double-entry transaction. Always complete one debit entry and one credit entry for each transaction. Memorise the basic rules for asset, liability and capital accounts – use a prompt card until you can memorise these rules. Leave plenty of room when drawing up accounts – for extra entries and also room for balancing off the account. Inventory is accounted for just as any other asset. Each separate expense should be kept in a separate account. Incomes and expenses should be kept in separate accounts and not combined. Key terms Bookkeeping The system of recording and maintaining financial transactions in accounts Double-entry The system by which accounting entries are recorded in two accounts Debit Accounting entry on the left-hand side of an account Credit Accounting entry on the right-hand side of an account Account A place where a particular type of transaction is recorded Ledger A book containing double-entry accounts Inventory Goods purchased with the intention of being sold by the business for a profit Debtor A person or business that owes a business money and will repay in the near future Creditor A person or business that a business owes money to and that is expected to be repaid within the near future Purchases Inventory purchased by a business for the purpose of resale Sales Inventory sold by a business Returns inwards Inventory previously sold by a business which is returned to the firm by the customer (usually because of unsuitability of the inventory) Returns outwards Inventory previously purchased by a business which is returned to the original supplier (usually because of unsuitability of the inventory) Drawings Resources (e.g. cash) taken out of a business by the owner for private use Expenses Costs incurred by a business in the day-to-day running of the business Income Revenue earned by a business as part of the business’s operations Balance The outstanding amount remaining when an account is balanced – measured by the difference between the totals of the debit column and the credit column in an indi- vidual account 22  Chapter 2 Double-entry bookkeeping REVIEW QUESTIONS 2.1 For the following transactions state which accounts should be debited, and which should be credited. (a) Equipment bought on credit from M Sparks. (b) Motor car bought and payment made by cheque. (c) Owner pays own money into bank account. (d) Fixtures sold on credit to J Harker. (e) Cheque sent to A Johnson, a creditor. (f ) Cash received from P Shortland, a debtor. 2.2 Write up the following transactions in double-entry accounts of J White. 1 March White places £900 of his own money into the cash till for business use. 4 March He places £500 of the cash into a business bank account. 8 March White buys £400 of machinery, paying by cheque. 12 March White buys shop fittings for £200 on credit from M Yeates. 13 March Machinery worth £200 is sold for the same value for cash. 19 March White decided to bring his own computer into the business at a valuation of £380. 2.3 Record the following transactions for S Vernon’s first month of business operations. 2009 2 January £25,000 of owner’s money placed into business bank account. 7 January Premises are bought for £15,000, payment made by cheque. 14 January £900 from bank paid into cash till. 17 January Fixtures are purchased for £4,000 on credit from C Platt. 19 January Office supplies bought for cash £500. 23 January Fixtures worth £750 sold for the same amount on credit to D Hammond. 2.4 Write up the following transactions in the double-entry accounts for S Nower for April 2011. 8 April Bank loan taken out for £18,000 which is paid directly into the bank account. 11 April Plant purchased for £4,000 payment made by cheque. 15 April Nower brings her own car into the business at a valuation of £8,000. 18 April Machinery bought on credit from J Bellwood for £2,500. 23 April Plant sold on credit to C Roberts for £800. 26 April Bellwood paid in full by cheque. 2.5 Write up the following transactions in the double-entry accounts for K Johnson for August 2012. 2 August Johnson places £950 of her own money into the cash till. 3 August Johnson borrows £1,200 from J Tahoulan – which is placed into the bank account. 7 August A delivery van is bought on credit for £1,000 from S Wells. 12 August Machinery is purchased for £340 cash. 19 August Johnson sends Tahoulan a cheque for £600 as part repayment of the loan. 27 August A cheque for the full amount is posted to Wells – with £400 cash paid into the bank account to cover the cheque. 2.6 Record the following transactions in ledger accounts for R Wheatcroft for July 2013. 1 July Wheatcroft places £300 of his own money into the business cash till. 3 July Wheatcroft places £1,000 of his own money into the business bank account. 23 Business Accounting Basics 5 July Machinery is bought for £400 with payment made by cheque. 12 July Equipment is bought on credit for £250 from B Street. 14 July A motor car is bought on credit for £1,300 from C Alexander. 18 July A cheque is sent to B Street for £250. 21 July Wheatcroft places £200 of the cash into the bank. 2.7 Record the following transactions in ledger accounts for I Sharp for March 2009. 1 March Owner borrows £10,000 from the Essex Bank which is immediately paid into bank. 3 March Machinery is purchased for £950, payment to be made by cheque. 5 March Sharp transfers £1,000 from the bank into the cash till. 12 March Equipment is purchased from T Wilson on credit for £450. 14 March Motor vehicle for £2,000 is purchased by cheque. 19 March Sharp sends £200 of equipment back to Wilson – it was faulty. 24 March Sharp settles his account with Wilson by making payment by cash. 2.8 For the following transactions, state the accounts to be debited and credited. (a) Firm buys inventory and pays immediately by cheque. (b) Goods returned to the original supplier, A Rahman, due to them being faulty. (c) Garage purchases cars for resale on credit from Autocars Ltd. (d) Greengrocer purchases fruit for cash. (e) Garage sells a recovery vehicle that had been used within the business on credit to Rescuecars Ltd. 2.9 For the following transactions state the accounts to be debited and credited. (a) Goods sold to K Jones on credit are returned due to unsuitability. (b) Butcher purchases new bacon slicer, paying by cheque. (c) Baker sends buns back to A Francis, the original supplier, due to them being stale. (d) Fast food outlet sells pizzas for cash. (e) Local shop sells counter on credit to E Polley. 2.10 Draw up the double-entry accounts to record the following transactions. 1 Mar Goods bought on credit for £32 from T Burke. 3 Mar Goods bought on credit for £81 from W Randlesome. 9 Mar We return goods to Burke worth £12. 12 Mar We pay Randlesome by cheque for the full £81. 15 Mar We settle our account with Burke by a cash payment of £20. 2.11 Write up the following transactions in the double-entry accounts in the books of M Cousins for the month of December 2014. 1 Dec Cousins opens a business bank account with £8,000 of his own money. 4 Dec Fixtures and fittings purchased for £2,200 on credit from P Lambert. 11 Dec Goods purchased on credit from K Symons for £85. 13 Dec Goods purchased for £41 – payment made by cheque. 15 Dec Goods sold on credit to G Williams for £95. 17 Dec Goods sold on credit to P Parkinson for £124. 22 Dec Williams returns £23 of goods due to them being faulty. 2.12 Write up the following transactions in the double-entry accounts of J Lam for the month of February 2009. 24  Chapter 2 Double-entry bookkeeping 2 February Lam places £400 of his own money into the cash till. 3 February Purchases made on credit for £47 from P Jackson. 5 February Purchases made on credit for £43 from K Sage. 8 February Goods returned to Jackson worth £11. 14 February Sales of good for cash – £102. 17 February Sales of goods on credit for £95 to L Burrell. 21 February Cash paid to Jackson – £36. 24 February Burrell returns goods worth £28. 2.13 Construct the ledger accounts for S Gillespie from the following transactions. 2015 1 June Gillespie places £6,000 of his own money into the business bank account. 4 June Gillespie borrows £4,000 from M Lockwood – money paid into the bank account. 8 June Purchases on credit: £76 from P Reid, £65 from C Coyne. 16 June Premises purchased for £50,000 – financed entirely by a mortgage from Woodseats Building Society. 21 June Sales made on credit: £240 to P Baldwin, £340 to J Dunne. 25 June Sales for cash – £250. 26 June Purchase of equipment for £950 – payment made by cheque. 29 June Baldwin returns goods worth £50. 2.14 Write up in the following transactions in the double-entry accounts of J Jackson. 2008 1 September Jackson transfers £4,500 of his own money into the business bank account. 3 September Jackson purchases goods for resale from S Painter for £123 and from C Throup for £89. 5 September Goods are sold for £121 cash. 12 September Jackson buys a motor vehicle for £2,900, payment by cheque. 13 September Jackson returns goods worth £87 to Painter. 18 September Jackson sells goods on credit to J Brown for £187. 21 September Brown returns goods worth £31. 27 September Jackson pays Throup in full by cheque. 29 September Brown settles her account in full by cash. 2.15 For the following transactions state which accounts should be debited, and which should be credited. (a) Rent paid by cheque. (b) Goods for resale purchased for cash from S Barnes. (c) Goods sold on credit to A Stacey. (d) Commission received paid into the business bank account. (e) Owner takes a computer used by the business to use as her own personal computer. (f ) Cash held in till paid into bank. 2.16 For the following transactions state which accounts should be debited, and which should be credited. (a) Insurance paid in cash. (b) Goods previously purchased returned to J Nesbit. (c) Cash banked. (d) Purchases on credit from G Thompson. (e) Marketing costs paid by cheque. (f ) Car used in business sold for cash. 25 Business Accounting Basics 2.17 For the following transactions state which accounts should be debited, and which should be credited. (a) Private car to be used in future within business. (b) Wages paid by cash. (c) Goods purchased for resale taken by owner for private use. (d) Rental income received by cheque. (e) Goods returned by J Spillane, a customer. (f ) R Hinds lends the business £400 cash. 2.18 Will Pierce runs a small business. Construct the ledger accounts from the following transactions. 2014 1 August Pierce borrows £5,000 from K Johnson and places this into the bank. 1 August Pierce transfers £1,000 from the bank into cash. 3 August Wages paid by cheque – £320. 4 August Pierce purchases goods on credit from D Rooney for £52. 11 August Cash sales – £340. 15 August Pierce pays insurance of £85 in cash. 20 August Pierce pays his private car insurance using business cash of £28. 2.19 The following transactions relate to the business of J Clover for the month of May 2009. From the details, construct the ledger accounts. 2009 1 May Goods purchased on credit from C Donner for £32. 3 May Goods purchased on credit from J Holmes for £74. 5 May Cash sales of £318 paid directly into the bank. 6 May Rent of £54 received in cash. 8 May Clover returns goods to Donner worth £12. 11 May Advertising of £19 paid by cheque. 14 May Fixtures and fittings bought on credit for £820 from J Read. 19 May Sales on credit to N Bell for £93. 23 May Holmes paid in full in cash. 24 May Clover withdraws £100 from the bank for personal use. 2.20 Construct the double-entry accounts of Helen Clews from the following transactions and balance off each account at the end of the month. 2010 1 November Clews opens a business bank account with £8,500 of her own money. 3 November Machinery is bought for £1,500, payment made by cheque. 4 November Machinery insurance of £95 is paid by cheque. 7 November Purchases on credit are made as follows: £65 from M Hodge, and £21 from B Bolder. 10 November A vehicle is bought for £4,300 on credit from Mark Sterland. 14 November Sales on credit are made of £272 to M Smith. 16 November Goods worth £34 are returned to Hodge. 18 November Smith sends Clews a cheque for the full amount. 21 November Clews pays Bolder £21 by cheque. 24 November Sales are made for £180 on credit to T Curran. 2.21 Post the following transactions to the double-entry accounts of D Weir and balance off the accounts at 30 April 2017. 26  Chapter 2 Double-entry bookkeeping 2017 1 April Owner places £500 of her own money into the business bank account. 4 April Goods purchased on credit from J Sheridan for £67. 5 April Goods purchased on credit from P King for £98. 8 April Sales made on credit to C Turner for £99. 12 April Owner returns goods worth £22 to King. 16 April Commission received £45 cash. 18 April Sales made on credit to R Nilsson for £178. 20 April Nilsson returns £58 of the goods that he purchased. 24 April Owner withdraws £100 from the bank for own private use. 25 April Cash received totalling £50 from Turner. 28 April Wages paid by cheque £134. 2.22 Construct the double-entry accounts for the following transactions of N James, a sole trader, and balance off each account at the end of the month. 2016 1 January Business is started with opening up of a bank account with private money totalling £3,000. 3 January Fixtures bought on credit from K Wesson for £870. 5 January Goods purchased on credit from S Johnson for £96. 9 January Goods purchased on credit from P Jones for £45. 13 January Money transferred to the cash till from the bank totalling £600. 14 January Jones paid in full in cash. 16 January Insurance paid by cheque £33. 19 January Advertising paid by cash £45. 20 January Sales on credit of £205 to S Welsh. 22 January Rent received of £70 cash. 26 January Welsh returned £60 of goods. 28 January Cheque received from Welsh for £100. 27  CHAPTER 3 Financial statements Learning objectives By the end of this chapter you should be able to: Construct a trial balance from a set of ledger accounts Understand the uses and limitations of a trial balance Understand the meaning and different measures of profit Construct the statement of comprehensive income Construct the statement of financial position. Introduction One of the most important uses of the double-entry system of bookkeeping is to pro- duce the financial statements of the business (also known as the final accounts of the business). These statements provide crucial information on business performance. According to IAS 1, the following are classified as the financial statements: Statement of comprehensive income Statement of financial position Statement of changes in equity Statement of cash flows Notes providing a summary of accounting policies and other explanations. According to IAS 1, the objective of the financial statements is to provide infor- mation about the financial position and financial performance of the business for a period of time. In this chapter we will only be looking at the following: Statement of comprehensive income Statement of financial position. Once the double-entry accounts have been balanced off (see Chapter 2) then it is possible to construct a trial balance for the business which will facilitate our con- struction of the financial statements. In this chapter we will be looking at the financial statements of a sole trader – that is an organisation owned by one person. Although accounting standards do not apply to sole traders as they would to limited companies we will still introduce some of the terminology used in the presentation of limited company accounts. 28  Chapter 3 Financial statements Trial balance Double-entry accounts are used to calculate the level of profit earned by a business. They can also be used to take a measure of the business’s size and financial structure. Before any of this is completed it is customary to extr