1. Financial & Managerial Accounting Lecture 3 & 4 1Chara Charalambous MBA CDA COLLEGE

2. Learning Objectives What are accounts and what is the ledger? Understand the principles of double entry. Understand the use of journal (book of prime entry) Be familiar with the recording of different transactions Balancing off the ledger accounts. Be familiar with the trial balance Understand what is the Financial Information System 2Chara Charalambous MBA CDA COLLEGE

3. Accounts and Ledger ACCOUNT is a table in T- shape which records chronologically the changes caused by the trade transactions that a business proceeds in an item of the assets, liabilities or capital. All Accounts are kept in a book which is called GENERAL LEDGER (‘T’ accounts). There is a ledger account for each asset, liability, revenue and expense item. Ledger accounts are pages in the ledger book with a separate page reserved for each one in order to record transactions. 3Chara Charalambous MBA CDA COLLEGE

4. The duality concept and double entry bookkeeping Each account has two sides - the debit (Dr) and credit (Cr) sides. Dr Name of Account Cr Date Description € Date Description € 4Chara Charalambous MBA CDA COLLEGE

5. The Account Basic summary device Detailed record of all changes that have occurred in a particular asset, liability, or stockholders’ equity Grouped in three broad categories : Assets Liabilities Stockholders’ Equity Chara Charalambous MBA CDA COLLEGE5

6. The duality concept and double entry bookkeeping Each transaction that a business realize affects the financial statements in two ways. These two effects are equal and opposite so as the accounting equation will be always satisfied. Assets = Liabilities + Capital Double Entry Rule: For every debit there is a credit and for every credit there is a debit. Each transaction will affect at least two accounts: ‘the one will be debited and the other will be credited’ 6Chara Charalambous MBA CDA COLLEGE

7. The duality concept and double entry bookkeeping Whether an entry is to the debit or credit side of an account depends on the type of account and the transaction: The Asset Accounts are debited when an increases of asset occurs and are credited when a diminish of asset occurs. The Liability and Capital Accounts are credited when an increase of liability occurs and are debited when a reduce of liability occurs. Debits are not good or bad Neither are credits 7Chara Charalambous MBA CDA COLLEGE

8. The duality concept and double entry bookkeeping ACCOUNTSINCREASESDECREASES Asset AccountDebitedCredited Liability AccountCreditedDebited Capital AccountCreditedDebited 8Chara Charalambous MBA CDA COLLEGE

9. TRADE TRANSACTIONS 1. Recording Cash Transactions Cash transactions are those where payment is made or received immediately. Double Entry in the bank ledger is as follow: – A debit entry is where funds are received. – A credit entry is where funds are paid out. 9Chara Charalambous MBA CDA COLLEGE

10. Credit sales and purchases are transactions where goods or services change hands immediately, however payment is not made right away but in some time in the future. Money that a business is owned is recorded in the receivables or Debtor ledger account. Money that a business owes is recorded in the payables or Creditor ledger account. 10 TRADE TRANSACTIONS 2. Recording Credit Sales and Purchases Chara Charalambous MBA CDA COLLEGE

11. TRADE TRANSACTIONS 3. Recording Sales and Purchases Returns It is normal for customers and a business to return unwanted goods to a business or the supplier respectively. The double entries arising will depend upon whether the returned goods were initially purchased on credit or cash. Originally a credit transactions Originally a cash transactions Sales Returns (returns inwards) Dr Sales (Returns) Cr Receivables/ Debtors Dr Sales (Returns) Cr Cash Purchases Returns (returns outwards) Dr Payables/ Creditors Cr Purchases (Returns) Dr Cash Cr Purchases (Returns) 11Chara Charalambous MBA CDA COLLEGE

12. TRADE TRANSACTIONS 4. Recording Discounts Discounts may be given in the case of credit transactions in order to encourage quick payment. For example a cash discount of 3% is offered to any customers who pay within 14 days. – A business may give its customer a discount - known as Discount Allowed. – A business may receive a discount from a supplier – known as Discount Received. 12Chara Charalambous MBA CDA COLLEGE

13. Recording Discounts Discount Allowed Dr Discount Allowed (expense) X Cr Debtors / Receivables X Discount allowed is treated as all other expenses in Income Statement Discount Received Creditors / PayablesX Discount Received (income) X The income is shown beneath gross profit in the Income Statement. 13Chara Charalambous MBA CDA COLLEGE

14. Balancing off a statement of financial position ledger account cash Capital 10000 Purchases 200 Sales 250 Rent 150 B/ce c/d 9900 10250 10250 B/ce b/d 9900 14 1.Total both sides of the T account and find the larger total. In the example the larger total is in debit side. 2.Put the larger in the total box on the debit and credit side. 3.Calculate the difference between the large side and the small side and set the figure in the small side naming it Balance c/d (carried down) 4.Carry the balance down diagonally and call it “balance b/f” (brought forward) Chara Charalambous MBA CDA COLLEGE

15. ADJUSTMENTS  Accrued expenses – The expenses which have been used up in the current year, but have not yet been paid.  Prepaid expenses – those to be used in the following period but have been paid in advance this period. Lecturer: Chara Charalambous15 added in the total expenses and goes in the Profit and Loss account also goes to Balance sheet in the Current liabilities side and is called Accrued Expenses. we deduct it from the total expense so in Profit and Loss account goes the expense which is related to this year.Also goes in the Balance Sheet in the side of Current assets named Prepaid expenses.

16. ADJUSTMENTS - INCOME Accrued income – The income which has been earned in the current period but has not yet been received. Prepaid income – The income to be earned in the following period but has been received in advance. Chara Charalambous MBA CDA COLLEGE16 We record the whole (paid + unpaid) income in the Profit and Loss Account. also goes in the Balance sheet in the side of current assets and is called accrued income. we deduct the prepaid income from the total amount of the income which goes in the Profit and Loss account (because is not related to the year) And also this amount goes to Balance sheet in the side of current liabilities and is called prepaid income. In this case we mean the income from other sources than the clients for e.g. the bank interest, rents e.t.c)

17. Also known as “bookkeeping cycle ”, is the process of recording and processing the accounting events of a company. The series of steps begin when a transaction occurs and end with its inclusion in the financial statements. The main steps of the accounting cycle are: Collecting and analyzing data from transactions and events. Posting entries to the general ledger. Adjusting entries appropriately. Preparing an adjusted trial balance. Organizing the accounts into the financial statements. Closing the books. Preparing a post-closing trial balance to check the accounts.. Chara Charalambous MBA CDA COLLEGE17 Accounting Cycle During Period

18. ACCOUNTING PROCESS AND RECORDS ▲ Accounting records are any listing or book which records the transactions of a business in a logical manner. This is achieved by the use of books of prime entry and the Ledger. Journals ( Journal is one of the books of prime entry) is a detail diary in which the transactions of each day are recorded. They are used as an initial ‘store’ of information of the business transactions prior to storing the information in the ledger accounts. 18 journals Ledger accounts Trial BalanceTransactions Step 1Step 2 Chara Charalambous MBA CDA COLLEGE Financial statements Make Adjusting entries Post Closing Trial Balance Closing the Accounts

19. The Accounting Process Transaction Journal General Ledger (T- Accounts) Trial Balance Adjusting entries (adjust for the accruals, prepayments, not-earned revenue and prepaid revenue) Closing and Balancing the Accounts Financial Statements (Income Statement and Balance Sheet) Post Closing Trial Balance Documents verifying a transaction: Bank deposit documentation Invoices Cheques Stock certificates Chara Charalambous MBA CDA COLLEGE19

20. ACCOUNTING RECORDS ▲ The journal is called a book of prime entry meaning the ‘first book’. A Journal is prepared in a specific format as shown in the next slide. 20Chara Charalambous MBA CDA COLLEGE

21. 21Chara Charalambous MBA CDA COLLEGE

22. Journal Four parts: a)Date of transaction b)Title of account debited with dollar amount c)Title of account credited with dollar amount d)Brief explanation of transaction Chara Charalambous MBA CDA COLLEGE22

23. To sum up: the Journal and the Ledger Journal Chronological record of transactions Organized by date Ledger The book holding all the accounts and their balances Organized by account Chara Charalambous MBA CDA COLLEGE23

24. 24 Book of Prime EntryTransaction type Sales Day BookCredit Sales Purchases Day BookCredit Purchases Sales Returns day BookReturns of goods sold on credit Purchases returns day bookReturns of goods bought on credit Cash BookAll bank transactions Petty Cash BookAll small cash transactions Other Books of Prime Entry

25. END OF THE YEAR END OF ACCOUNTING PERIOD At the year end, the ledger accounts must be closed off (concerns accounts that closes – temporary accounts) or balanced (concerns accounts that their balance is transferred to next year- permanent accounts) and transfer the balances in the next accounting period. Balancing the account will result in: – A balance c/f (being the asset / liability at the end of the accounting period). equals – A balance b/f (being the asset / liability at the start of the next accounting period). Balance c/d = Balance b/d Chara Charalambous MBA CDA COLLEGE25

26. The following accounts are closing off and they are not transferring a balance to the next accounting period: 1. Expenses accounts and Purchases account 2. Income accounts (e.g. sales, discounts received, other income) Instead they are transferring the balancing figure on the smallest side at the Income statement (depending if it goes to trading a/c or profit & loss a/c) LEDGER ACCOUNTS THAT ARE TRANSFERING AT THE INCOME STATEMENT DO NOT HAVE AN OPENING BALANCE NEXT YEAR/NEXT ACCOUNTING PERIOD 26Chara Charalambous MBA CDA COLLEGE

27. Classes of Accounts Personal Accounts: The accounts which represent persons, organizations, claims and liabilities examples are debtors, creditors, loans, prepayments, accruals, drawings, capital. Real Accounts: The accounts which represent assets, Examples are cash, bank, stock, fixed assets. Nominal Accounts: The accounts which represent expenses, losses, incomes, profits. Examples are purchases, sales, expenses. Also called Temporary Accounts because the are related to one year only and they are closed at the end of the year and next year they will not have balance they start from zero. Lecturer: Chara Charalambous27 Personal Accounts and Real Accounts are Permanent accounts are not closed at the end of the year, they will have balance next year and all these accounts are Balance Sheet Accounts.

28. CAPITAL ACCOUNT At the start of the next accounting period the capital account will have an opening balance, i.e. A balance b/f equal to the amount that is owed to the owner at the start of that period. This amount is equal to what was owed to the owner at the start of the previous period, plus any capital that the owner introduced in the period, plus any profits earned in the period less any drawings taken out in the period. Therefore we transfer the balance of the Income Statement - profit or loss- and the balance on the drawings account to the capital account at the end of the period so that it will have the correct opening balance at the start of the next. 28Chara Charalambous MBA CDA COLLEGE

29. Capital Account Loss for the year x B/ce b/d x Drawings x Net Profit x B/ce c/d x Cash injections x x x B/ce b/d x 29Chara Charalambous MBA CDA COLLEGE

30. Supplies During 2007, Scott Company purchased $15,500 of supplies. Scott recorded the expenditures as Supplies. On December 31, a count of the supplies indicated $2,655 on hand. What adjustment is required? During 2007, Scott Company purchased $15,500 of supplies. Scott recorded the expenditures as Supplies. On December 31, a count of the supplies indicated $2,655 on hand. What adjustment is required? 126 652 P1

31. Chart of Accounts: List of all accounts used by a company Chara Charalambous MBA CDA COLLEGE31

32. Example of Journal: Ned Brown opened a medical practice in San Diego, California. 1 Record the preceding transactions in the journal of Ned Brown, M.D., P.C. Include an explanation. Jan 1: The business received $29,000 cash and issued common stock. Jan 2 Purchased medical supplies on account, $14,000. Jan 2 Paid monthly office rent of $2,600. Jan 3 Recorded $8,000 revenue for service rendered to patients on account. Chara Charalambous MBA CDA COLLEGE32

33. DATEDESCRIPTIONDEBITCREDIT JAN 1Cash29000 Common Stock29000 Issued stock Chara Charalambous MBA CDA COLLEGE33 Jan. 2: Purchased medical supplies on credit, $14,000. Medical Supplies, an asset, is increasing.Assets increase with debits. On credit increases accounts payable, a liability Increase liabilities with credits DATEDESCRIPTIONDEBITCREDIT JAN 2Medical supplies14000 Accounts payable14000 Purchased supplies on account Jan 1: The business received $29,000 cash and issued common stock Cash received indicates cash increases Cash is an Asset; Assets increase with debits.Issued common stock; indicates equity is increasing Increase equity with credits

34. Chara Charalambous MBA CDA COLLEGE34 Jan. 2: Paid monthly office rent of $2,600.Paid rent, an expense, expense is increasing.Expenses increase with debits.Paid cash, cash is an asset,decrease assets with credits DATEDESCRIPTIONDEBITCREDIT JAN 2Rent Expense2600 Cash2600 Paid Office Rent Jan. 3: Recorded $8,000 revenue for service rendered to patients on credit. On credit indicates Accounts receivable increase.Accounts receivable is an Asset, Assets increase with debits.Rendered services, services are revenues, indicates revenues are increasing Increase revenues with credits DATEDESCRIPTIONDEBITCREDIT JAN 3Accounts receivable8000 Service Revenue8000 Performed service on account

35. Chara Charalambous MBA CDA COLLEGE35 Copying amounts from the journal to the ledger

36. THE TRIAL BALANCE Once all ledger accounts have been balanced off a trial balance is prepared. A trial balance is a list of the “balance b/f” of the ledger accounts according to whether they are on the debit or credit side. 36Chara Charalambous MBA CDA COLLEGE

37. The purpose of a trial balance is: – To check that for every debit entry made, an equal credit entry has been made since the total amount of the two columns must be equal. – As a first step in preparing the financial statements. Note that a number of adjustments will be made after the trial balance is extracted. These adjustments do not therefore appear in the trial balance. 37Chara Charalambous MBA CDA COLLEGE

38. 38 Prepare the Trial Balance Trial Balance of Ned Brown, M.D., P.C. DRCR Cash26400 Accounts receivable8000 Medical supplies14000 Accounts payable14000 Common stock29000 Service revenue8000 Rent expense2600 Total51000

39. Post-Closing Trial Balance A post-closing trial balance is a list of permanent accounts and their balances from the ledger after all closing entries have been journalized and posted. It lists the balances for all accounts not closed. These accounts comprise a company’s assets, liabilities and equity, which are identical to those in the balance sheet. The aim is to verify that (1) total debits equal total credits for permanent accounts, and (2) all temporary accounts have zero balances. Chara Charalambous MBA CDA COLLEGE39

40. ACCOUNTING PROCESS AND RECORDS ▲ Accounting records are any listing or book which records the transactions of a business in a logical manner. This is achieved by the use of books of prime entry and the Ledger. Journals ( Journal is one of the books of prime entry) is a detail diary in which the transactions of each day are recorded. They are used as an initial ‘store’ of information of the business transactions prior to storing the information in the ledger accounts. 40 journals Ledger accounts Trial BalanceTransactions Step 1Step 2 Chara Charalambous MBA CDA COLLEGE Financial statements Make Adjusting entries Post Closing Trial Balance Closing the Accounts

41. Ledger Accounts and the division of the Ledger  In a manual system, ledgers can be thought of books containing the individual accounts: – The general ledger contains all accounts or a summary of all accounts necessary to produce the trial balance and financial statements. – The accounts in ‘Debtors ledger’ contains an account for each credit customer to show how much each one owes. An account to summarize and gather all information is normally contained within the general ledger and is named ‘Debtors control account’. – The accounts in ‘Creditors ledger’ contains an account for each credit supplier to show how much they are owed. An account to summarize and gather all information is normally contained within the general ledger and is named ‘Creditors control account’. 41Chara Charalambous MBA CDA COLLEGE

42. Steps of Recording Credit Sales Transactions 42 Debtors Control Account Step 3: General Ledger Step 2: Secondary Ledger-Debtors Ledger Customer A Customer DCustomer C Customer B 2,500 1,500 500 1,000 Bal. 5,500 Step1: Books of Prime entry: Sales Day Book & Cash Book & Sales Returns Day Book Sales account Debtors Control 5500 Chara Charalambous MBA CDA COLLEGE

43. Control Accounts If a business keeps individual accounts in the Debtors or Creditors ledger and also keeps a control account in the general ledger ONLY ONE can be part of the double entry system : either individual accounts or control accounts! The other exist for memorandum purposes. Normally in this case of business the control accounts are part of double entry and individuals accounts are kept for information reasons. 43Chara Charalambous MBA CDA COLLEGE

44. Control Accounts The usefulness of control accounts is that they reduce the time it takes to find out the total amount owed by receivables and owed to payables. Also the risk of making errors when totaling several individual accounts is also reduced. Even when control accounts are kept, a business must still keep a record of how much each customer owes them and how much they owe each supplier, therefore the creditors accounts ledger and debtors accounts ledger are always part of the accounting system. 44Chara Charalambous MBA CDA COLLEGE

45. 45 Individual Accounts part of accounting system: Debtor Jake Dr 4500 Debtor Bella Dr 3000 Debtor Fizz Dr 2200 Debtor Milo Dr 10000 Debtor Max Dr 500 TOTAL 20200 The total receivable should then be posted to the control account Debtors Control Account part of double entry: Dr Debtors Control a/c 20200 Cr Sales a/c 20200 Control Accounts Chara Charalambous MBA CDA COLLEGE

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