2 Dr. Clive Vlieland-Boddy FCA FCCA MBA Barcelona 2009
3 Qualification & Objectives You do not need to become accountants, nor can I achieve that today.You need to have a basic understanding to how financial accounts are created.So we need to appreciate the issue of Double Entry Bookkeeping..
4 History & Reasons Invented over 500 years ago. It was created to ensure that all entries are correctly and accurately recorded.
6 What is “Double Entry”By recording the same entry twice, it enables a higher degree of confidence of the accuracy and completeness of the accounting.
7 Double Entry System Record dual effects of each transaction Each transaction affects at least two accountsEach transaction is recorded with at leastOne debitOne creditTotal debits must equal total credits7
8 Debits and Credits Books of accounts and ledgers are divided in half. On the left is the so called “DEBIT” side.And on the right is the so called “CREDIT” side.
10 T-AccountSimple tool for analysing and determining the balance in a given accountAccount Name(Left Side) Debit(Right Side) Credit10
11 Which account is debited? Which account is credited? The “T” AccountsWhich account is debited?Which account is credited?For what amount?For what amount?Accounts Payable will be debited for $476 and Purchase Returns and Allowances will be credited for $476.11
13 Credits Liabilities Bank Payments Shareholders Funds Incomes (Sales) Profits
14 YES they WILL Debits & Credits If we post the same amount to both the Debit and the Credit side, then when we add up all the debits and the credits….They will total the same.YES they WILL
15 Assets vs LiabilitiesIn Session 2 we talked about assets and liabilities.For every asset there will be a corresponding and equal liabilityEG. If you buy a new car for £10,000 you will owe the garage that sum.
16 Asset Accounts ______________________________________ Debits: Increase I Credits : ReduceAssets I Assets
17 Liability Accounts ______________________________________ Debits: Reduce I Credits : IncreaseLiabilities I Liabilities
18 Equity Accounts ______________________________________ Debits: Reduce I Credits : IncreaseEquity I Equity
19 Equity (Shareholders) Account This represents the funds invested into the company by the owners.It also is the profits that have been generated to date but have not been paid out as dividends. This is really shareholders money that the company retains for future growth.
20 Income Accounts _____________________________________ Debits: Reduce I Credits : IncreaseIncomes I Incomes
21 Expense Accounts _____________________________________ Debits: Increases I Credits: DecreaseExpenditure I Expenditure
22 Rules of Debit and Credit LiabilitiesEquity=+Debit CreditDebit CreditAssets22
23 = + Normal Balances Liabilities Equity Assets + - - + - + Normal Debit CreditDebit CreditDebit CreditNormalBalanceNormalBalanceNormalBalance23
26 The ShareholdersAs the shareholders own the profits that are generated, they are shown in the Shareholders Equity.Thus the net balances of the Incomes and Expenses are shown in Shareholders Equity.
27 Expanding the Rules of Debit and Credit Shareholders Equity_Profits =ShareholdersCapitalExpenses=RevenuesDebit CreditDebit CreditDebit Credit27
28 Profits and Losses ( Incomes & Expenses) Previously we talked about Incomes & Expenses.These result in either a profit or a loss depending on whether the income is greater or less than the expenditures.Therefore the net Profit or loss being owned by the shareholders is shown in the Equity account.
29 How debits and credits affect the different elements of the accounts. Debit/credit▲▼RevenueShareholder EquityLiabilitiesExpensesAssetsCreditDebitAccount
31 Lets work Basic Example 1 ( See page 23) The owners invest €100,000 in cash into the business.So what are the double entries?
32 The Double Entries are: We have to show that the owners (Shareholders) have invested €100,000 into the business.And..We have to show that the bank account has received €100,000
33 Assets Increases This represents a Debit entry to an Asset account. So the bank balance has increased by €100,000.Therefore we increase the bank balance by €100,000.So Debit (DR) Bank Account with €100,000
34 Equity IncreasesThis represents an increase in the Equity account which is a Credit entry.So as the investors have injected €100,000 into the business, we need to increase the Equity account by that sum.So Credit (CR) the Equity account by €100,000.
35 Bank AccountEquity AccountInvestors 100,000100,000 Shares
36 Analysis of Example 1 transaction: Accounts Bank is increasing Equity is increasingCREDITDEBITREFDESCRIPTIONDATEThe Double EntryJun x Bank Account 100,000Equity Account 100,00036
38 Basic Example 2 The company buys a car costing €20,000. It finances this purchase by way of a Bank Loan.
39 Assets Increases This represents a Debit entry to an Asset account. The company has acquired a car costing €20,000.Therefore we increase the Asset account for Cars by €20,000.So Debit (DR) Cars (Vehicles) Account with €20,000
40 Liability IncreasesThis represents an increase in the liability account which is a Credit entry.So as the Bank has lent €20,000 to the business, we need to increase the liability account by that sum.So Credit (CR) the Liability (Bank Loan Account) by €20,000.
41 Vehicle AccountBank LoanCar ,00020,000 New Loan
42 Analysis of Example 2 transaction: Vehicles Account is increasing Bank Loan is increasingCREDITDEBITREFDESCRIPTIONDATEThe Double EntryJun x Vehicles Account 20,000Bank Loan 20,00042
44 Basic Example 3The company repays €5,000 to the bank to reduce the loan of €20,000 it took out to buy the car.
45 Assets Decreases This represents a Credit entry to an Asset account. The company has reduce the bank by €5,000.Therefore we decrease the Bank Account by €5,000.So Credit (CR) Bank Account with €5,000
46 Liability DecreasesThis represents an decrease in the liability account which is a Debit entry.So as the Bank Loan has been reduced by €5,000, we need to decrease the liability account by that sum.So Debit (DR) the Liability (Bank Loan Account) by €5,000.
47 Bank LoanBank AccountRepay Loan 5,0005,000 Repay Loan
48 Analysis of Example 3 transaction: Accounts Loan is reducing Bank Account is reducingCREDITDEBITREFDESCRIPTIONDATEThe Double EntryJun x Bank Loan 5,000Bank Account 5,00048
50 Basic Example 4The company buys 20 widgets costing €3,000 each that it will resell (inventories or stocks) with a total value of €60,000 but still owes the supplier for them.
51 Assets Increases This represents a Debit entry to an Asset account. The company has acquired inventories of goods it will sell costing €60,000.Therefore we increase the Asset account for Inventories by €60,000.So Debit (DR) Inventories Account with €60,000
52 Liability IncreasesThis represents an increase in the liability account which is a Credit entry.So as the company owes the supplier €60,000, we need to increase the liability account by that sum.So Credit (CR) the Liability (Accounts Payable Account) by €60,000.
53 InventoriesAccounts PayableWidgets ,00060,000 Supplier of Widgets
54 Analysis of Example 4 transaction: Inventories are increasing Accounts Payable is increasingCREDITDEBITREFDESCRIPTIONDATEThe Double EntryJun x Inventories 60,000Accounts Payable 60,00054
56 Basic Example 5The company sells 6 of the widgets it has to customers for €25,000 allowing 90 days for them to pay for the goods.
57 Accounts ReceivableSales of WidgetsCustomer x 25,00025,000 Sales
58 Analysis of Example 5 transaction: Accounts Receivable is increasing Sales is increasingCREDITDEBITREFDESCRIPTIONDATEThe Double EntryJun x Accounts Receivable 25,000Sales of Widgets 25,00058
59 But we need to match income with expenditure….. We have shown the total sales of 6 units but as yet no cost has been matched against this revenue.We need to transfer from inventories the cost of the 6 widgets sold.
60 Asset ReducesInventories will be reduced by 6 units at €3,000 = €18,000So Credit Inventories by $18,000
61 Inventories We bought 20 widgets We have now sold 6 widgets How many do we have left in inventories?Yes 16.And what is therefore the value of the inventories.Yes 16 * £3000 = £48,000
62 ExpenseThis is an expense, it will represent a movement in the profit or loss which belongs to the shareholders.As it is an expense, it will be a debit to the Cost of Sales Account.So Debit Cost of Sales Account with €18,000
63 Cost of Goods Sold Inventories Cost of 6 Widgets 18,000 18,000 Widgets Sold
64 Further Analysis of Example 5 transaction: Cost of Sales is increasing Inventories are reducingCREDITDEBITREFDESCRIPTIONDATEThe Double EntryJun x Cost of Goods Sold 18,000Inventories of Widgets 18,00064
66 Finally – Basic Example 6 The company receives the telephone bill for the last 3 months for €1,000.It has received…. Not actually paid it!
67 This is an ExpenseThis represents a Debit entry to the expense account.The company has incurred telephone expense of €1,000. This reduces the profits that the shareholders get.So Debit (DR) Telephone Account with €1,000
68 Liability IncreasesThis represents an increase in the liability accounts as the telephone company is owed €1,000.So Credit (CR) the Liability (Accounts Payable Account) by €1,000.
69 TelephoneAccounts PayablePhone Bill ,0001,000 Phone Co
70 Analysis of Example 6 transaction: Expense Account – Telephone is increasingAccounts Payable is increasingCREDITDEBITREFDESCRIPTIONDATEThe Double EntryJun x Telephone Expense ,000Accounts Payable 1,00070
77 Incomes & Expenditures We have stated that as profits and losses are the property of the shareholders.Then in the Balance Sheet, Incomes & Expenditures are shown in the Equity Account.So the total of all the Income and Expenditure accounts are shown in the Balance Sheet as Equity.
78 Revenue = Equity Account This represents an increase in the Equity account which is a Credit entry, as this creates profits which belongs to the shareholders.So as the company has generated incomes of €25,000, we need to increase the Equity account by that sum.So Credit (CR) the Equity by €25,000.
79 Locating Trial Balance Errors What if it doesn’t balance?Is the addition correct?Are all accounts listed?Are the balances listed correctly?79
80 Locating Trial Balance Errors Divide the difference by twoIs there a debit/credit balance for this amount posted in the wrong column?Divide the difference by 9. If evenly divisible, the error may be a slide or transposition error80
81 The bank reconciliation . . . A critical control activity for cash.81