1. 1 FINANCIAL ACCOUNTING Week 2: LECTURE 2

2. 2 Learning Objectives What are accounts and what is the ledger? Understand the principles of double entry. Understand the use of journal (books of prime entry) Be familiar with the recording of different transactions Balancing off the ledger accounts. Be familiar with the trial balance Be able to solve exercises.

3. 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 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.

4. 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 €

5. 5 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’

6. 6 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.

7. 7 The duality concept and double entry bookkeeping ACCOUNTSINCREASESDECREASES Asset AccountDebitedCredited Liability AccountCreditedDebited Capital AccountCreditedDebited

8. 8 The duality concept and double entry bookkeeping SUMMARY OF STEPS TO RECORD A TRANSACTION Identify two items that are affected. Consider whether they are being increased or decreased. Decide whether each account should be debited or credited. Check that a debit entry and a credit entry have been made and they are both for the same amount.

9. 9 ACCOUNTING 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 or journals and the Ledger. Journals (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. journals Ledger accounts Financial statements Transactions Store 1Store 2

10. 10 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.

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12. 12 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.

13. 13 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. TRADE TRANSACTIONS 2. Recording Credit Sales and Purchases

14. 14 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)

15. 15 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. TRADE TRANSACTIONS 4. Recording Discounts

16. 16 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.

17. 17 cash Capital 10000 Purchases 200 Sales 250 Rent 150 B/ce c/d 9900 10250 10250 B/ce b/d 9900 Balancing off a statement of financial position ledger account 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)

18. 18 At the year end, the ledger accounts must be closed off 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

19. 19 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) 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

20. 20 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.

21. 21 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

22. 22 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” on the ledger accounts according to whether they are on the debit or credit side.

23. 23 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.

24. 24 Exercises