Double Entry Book-keeping:

Basic Principles
DOUBLE ENTRY BOOK-KEEPING: BASIC PRINCIPLES

Double Entry Book-keeping: Basic Principles

INTRODUCTION
This part addresses the following areas:

1. Basic Principles.
2. Adjustments to Financial Statements.
3. Books of Prime Entry and Nominal Ledger.
4. Incomplete Records.

The part is structured as follows:

SECTION ONE: BASIC PRINCIPLES
Introduction
Distinction between book keeping and accounting
The business entity principle
The concept of double-entry
The accounting equation
An introduction to the balance sheet

SECTION TWO: PREPARING T ACCOUNTS

Ledger Accounts and T Accounts
The two questions
Balancing the ledger accounts
An introduction to the income statement

SECTION THREE: PREPARATION OF BALANCE SHEET AND

INCOME STATEMENT
The Trial Balance
Assets, expenses and liabilities revenue
The balance sheet in detail
The income statement in detail

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SECTION FOUR: ADJUSTMENTS FOR FINANCIAL STATEMENTS

Credit transactions
Subsidiary books
Accounting documents
Receivables ledger
Payables ledger
The cash book
Control account reconciliations
Bank reconciliations
Prepayments and accruals

SECTION FIVE: INCOMPLETE RECORDS

Each Section concludes with a Glossary of Term and Self Test Questions.

By the end of this part you should be able to:

n demonstrate basic book keeping and accounting skills;

n explain the basis on which financial information is recorded, aggregated and
communicated;
n prepare basic sets of financial statements; and deal with incomplete records.

It is important to note that the format and presentation of the financial statements dealt
with in this part (income statement and balance sheet) do not adhere strictly to those
outlined in Chapter Two of Connolly: International Financial Accounting and Reporting
("Connolly"). This part is primarily concerned with basic book keeping skills.

SECTION ONE: BASIC PRINCIPLES

Introduction

A set of accounting records provides information for the day-to-day running of a busi-
ness and for the periodic preparation of financial statements which show the profit or
loss the business has made (income statement) and the position of the business at
the end of the period (balance sheet). The purpose of this section is to introduce you
to basic book keeping and accounting and thus to explain the basis on which finan-
cial information is recorded, aggregated and communicated. Broadly speaking the
recording aspect of accountancy work is called ‘book keeping’ and this is governed

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by the application of well worn and generally accepted principles. Rather than define
and explain these principles one by one we will look at an individual setting up a busi-
ness and the way in which he records his transactions. Having seen the way in which
transactions are recorded we will be able to look at the preparation of his financial
statements which are the balance sheet and the income statement. First, we will con-
sider some of the broad concepts.

Distinction between Book Keeping and Accounting

The systematic recording and classifying of business transactions is called book keep-
ing. The procedures adopted in book keeping and the interpretation of the results
obtained is called accounting. Accounting is thus a broader term than book keeping and
encompasses the term book keeping since accounting determines the principles to be
used, the records to be kept and the procedures to be followed.

The Business Entity Principle

This is one of the rules of book-keeping and there never is, nor can there be, any
departure from it. This rule is that the business must be thought of as something com-
pletely separate and distinct from those who own it. You must always think in terms of
what the business does and how it is affected by the things it does. Whatever the form
of the business organisation may be – sole trader, partnership or limited company – for
book keeping purposes that organisation is a separate entity. So, if we are discussing
the business of a sole trader we do not take into account his other activities (e.g. per-
sonal possessions and transactions).

The Concept of Double Entry (The Dual Aspect Concept)

If a business is separate and distinct from its owners, it follows that a new business has
nothing until it enters into obligations with its owners or with third parties.
The very first obligation will usually be borrowing from the owner. In the case of a
sole trader the owner is called a proprietor and the position of the business which has
entered into an obligation with its proprietor can be seen as an equation where:

The things owned by the business = the amount owing to the proprietor.

The things owned by the business are called ASSETS and the amount owing to the
proprietor in the beginning is called CAPITAL.

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Therefore the equation becomes:

ASSETS = CAPITAL

Even at this early stage in business we are touching on the concept of double-entry.
We see that to record an asset we must also acknowledge and record an amount
owing in respect of that asset. Thus, for everything owned there is a corresponding
amount owing i.e. there are two ‘sides’. Each transaction that the business undertakes
will require these two ‘sides’ and therefore two book keeping entries – one to record the
asset (the thing owned) and one to record the liability (the amount owing). For every
debit there will be a corresponding credit.

The Accounting Equation

We looked a little earlier at an equation to describe an obligation entered into by the

business with its proprietor:

The things owned by the business = the amount owing to the proprietor.

This equation is the beginning of the accounting equation. The ultimate equation is:

NET ASSETS = PROPRIETOR’S INTEREST

To see how we get from the first stage of the equation to the ultimate accounting
equation we will look at our individual setting up his business and recording the trans-
actions of that business.

The Story of Chris Toffer

Chris Toffer had worked in a newsagents shop ever since he left school and had acquired
a reasonable level of expertise in the trade. A wealthy relative, seeing Chris’s potential,
gave him €1,000 to put towards setting up his own business. Chris already had savings
of €500 in his Building Society and decided to draw this out and put it together with the
€1,000 to finance his business. So he had €1,500 in cash to start with.
At this stage we can establish the first accounting equation that will represent the
separate entity of Toffer’s business:

ASSETS (cash) = CAPITAL (Toffer)

Chris then decided to open a bank account in the name of his business and deposit
€1,450 with the bank leaving €50 as cash in hand (often called ‘petty’ cash).

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The equation now becomes:

€ €
Cash at bank 1,450 CAPITAL X
+ =
Cash in hand 50
1,500

ASSETS = CAPITAL

Having seen the premises from which he wished to operate (which was on sale for
€5,000) Chris realised that his business would need to enter into an obligation with
the Building Society (i.e. borrow money) to get enough money to buy the property. He
arranged a mortgage of €4,500 so that his business would have enough cash. It also
had a liability of €4,500 to the Building Society. Before buying the property, the equa-
tion was:
€ €
Cash at bank X CAPITAL 1,500
+ = +
Cash in hand 50 LIABILITY X
(Building Society)
6,000

ASSETS = CAPITAL + LIABILITIES

The assets of the business are now financed partly by the owner and partly by a third
party.
Using the money that was in the business bank account the business bought the
desired property for €5,000 changing the contents of the equation to:

€ €
Property X CAPITAL 1,500
+ +
Cash at bank X = Building
+ Society 4,500
Cash in hand 50
6,000 6,000

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But we still have:

ASSETS = CAPITAL + LIABILITIES

At this point just check that you understand that although the type of asset held is
changing they are still assets and are still equal to the money owing to the proprietor
(capital) plus any third party liabilities.
The business then bought its first goods from a supplier. The goods, costing €100,
were bought on credit. So the business owned another asset (the goods) and had
another liability (it owed money to the supplier). The supplier to whom a business owes
money is called a creditor, and the amount owed is shown as a ‘payable’ in the balance
sheet.

€ €
Property 5,000 CAPITAL 1,500
+ +
Goods X Payable X
+ = +
Cash at bank 950 Building
Society 4,500
+
Cash in hand 50
6,100 6,100

And still:
ASSETS = CAPITAL + LIABILITIES
All the goods were sold for €175 cash. The equation now changes to:

€ €
Property 5,000 CAPITAL 1,500
+ +
Cash at bank 950 PROFIT X
+ +
Cash at hand X = Payable 100
+
Building
Society 4,500
6,175 6,175

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DOUBLE ENTRY BOOK-KEEPING: BASIC PRINCIPLES

ASSETS = ORIGINAL CAPITAL + PROFIT + LIABILITIES

Toffer had made his first profit! He sold goods which cost him €100 for €175. He
decided to take €25 from the till and go out and celebrate. But remember, it isn’t
Toffer’s money; it belongs to the business so:

€ €
Property 5,000 CAPITAL 1,500
+ +
Cash at bank 950 PROFIT 75
+ Less:
= DRAWINGS X
Cash in hand X +
Payable 100
+
Building
Society 4,500
6,150 6,150

ASSETS = PROPRIETOR’S INTEREST (Capital + Profit – Drawings)

+ LIABILITIES

As you can see drawings is the term used for the money that Toffer (the proprietor)
took out of the business for his own personal use.
We are now nearing the ultimate accounting equation. Taking the equation we have
just derived:
ASSETS = PROPRIETOR’S INTEREST + LIABILITIES
and moving the liabilities to the other side of the equation we have:
ASSETS – LIABILITIES = PROPRIETOR’S INTEREST
or
NET ASSETS = PROPRIETOR’S INTEREST

It is this accounting equation that forms the basis of the balance sheet and we shall
look at the format of a balance sheet in a moment. Before we do that we should look
at the use of the accounting equation itself.
We have seen that where one side of the equation increases (or decreases) the
other side will increase (or decrease) by the same amount. So we can see that if Net

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Assets increase then the Proprietor’s Interest will also increase by the same amount.
Since the Proprietor’s Interest is made up of Capital Introduced + Profit – Drawings we
can say that for any period:
Increase in Net Assets = Capital Introduced (in that
(over a period) period)
+
Profit (in that period)
–
Drawings (in that period)

Therefore, if we know three of these four figures we can calculate the fourth. Let’s
look at an example where we know all the figures except the profit for the year.
At the beginning of the year John’s Net Assets (assets - liabilities) were €5,000. By
the end of the year they had increased to €8,000. We know that during the year he had
introduced capital to the business of €2,500 and drew out €100 for his own personal
expenses.
We can now calculate how much profit he must have made as follows:

Net Assets at ⫺ Net Assets at = Increase in Net Assets

end of year beginning of
year

€8,000 ⫺ €5,000 = €3,000

Increase in Net assets = Capital Introduced + Profit – Drawings

€3,000 = €2,500 + Profit – €100

€3,000 – €2,500 + €100 = Profit

€600 = Profit

We will now move on to look briefly at one of the main financial statements of a busi-
ness – the balance sheet.

An Introduction to the Balance Sheet

It is important to note that the format and presentation of the financial statements dealt
with in this part (income statement and balance sheet) do not adhere strictly to those
outlined in Chapter Two of Connolly: International Financial Accounting and Reporting
("Connolly"). This part is primarily concerned with basic book keeping skills.

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The balance sheet is a statement of the assets and liabilities of a business at a

particular point in time. The balance sheet is our accounting equation:

NET ASSETS PROPRIETOR’S INTEREST

=
(Assets – Liabilities) (Capital + Profit – Drawings)
But expressed in a different way, as shown below.
€
ASSETS
Non current assets x
Current assets x
x
EQUITY & LIABILITIES
Capital x
Profit x
x
Less: Drawings x
Proprietor’s interest x
Non current liabilities x
Current liabilities x
x

The typical balance sheet might be:

Balance Sheet as at 31st December 200X

Cost Depreciation NBV

ASSETS € € €
Non Current Assets
Property x x x
Plant x x x
Equipment x x x
x x x
Current Assets
Inventory x
Receivables x
Prepayments x
Cash in hand and at bank x x
x
EQUITY AND LIABILITIES
Capital x
Profit for the year x
x
Less: Drawings x
Proprietor’s interest x
Non Current Liabilities
10% loan x

Current Liabilities
Trade payables x
Accruals x x
x

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There are a number of new terms included in the balance sheet that you have not
come across before. You will find an explanation of these later on when we look at the
financial statements in more detail.
We will now look again at Chris Toffer’s business and the position it had reached.
If you remember we had expressed the position of his business in the form of the
accounting equation:
€ € €
Property 5,000 CAPITAL 1,500
+ +
Cash at bank 950 PROFIT 75
Less:
+ = Drawings 25 50
Cash in hand 200 +
Payable 100
+
Building
Society 4,500
6,150 6,150

ASSETS = PROPRIETOR’S INTEREST + LIABILITIES

We can now rearrange this into a balance sheet format.

€ €
ASSETS
Non Current Assets
Property 5,000
Current Assets
Cash at bank 950
Cash in hand 200 1,150
6,150
EQUITY AND LIABILITIES
Capital 1,500
Profit for the period 75
1,575
Less drawings 25
Proprietor’s interests 1,550
Non Current Liabilities`
Loan 4,500
Current Liabilities
Trade payables 100
6,150

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Summary of Section One

From your reading of the notes so far you should understand and be familiar with, the
business entity principle, the double entry nature of every business transaction, the
effect of such transactions on the accounting equation and how the accounting equa-
tion can be expressed in the form of a balance sheet.
A Glossary of Terms follows and you should look through this and be familiar with
the general meaning of these terms.
Following the glossary you will find a section of Self Test Questions to test your
knowledge of the material covered in Section One. Try to answer these questions
without looking at the answers and see how you get on. If you find that you are making
mistakes then re-read the text and try again.

GLOSSARY OF TERMS

Book keeping: The systematic recording and classifying of business

transactions.
Sole trader: A business carried on and owned by a single proprietor.
Assets: Things owned by the business that have some degree of
permanence.
Liabilities: Amounts owing to third parties.
Accounting equation: Assets – Liabilities = Proprietor’s Interest
or
Net Assets = Proprietor’s Interest
Proprietor’s interest: Capital + Profit ⫺ Drawings
Capital: The amount owing to the proprietor by the business represent-
ing the money invested by the proprietor in the business.
Profit: Profit is the remuneration of the proprietor which is arrived
at as: the income produced by selling goods less the cost of
buying the goods and running the business.
Drawings: Amounts withdrawn from the business by the proprietor.
Balance sheet: A statement of the financial position of a business at any
stated point in time.
Creditors: People to whom the business owes money (i.e.
Personification of a liability). This is shown as ‘payables’ in
the balance sheet.

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Debtors: People from whom the business is owed money (i.e.

Personification of an asset). This is shown as ‘receivables’
in the balance sheet.

SELF TEST QUESTIONS – SECTION ONE

1. Things that are of value and are owned by a business are known as assets. A
Lad had just put in €5,000 cash to start a new business of has own, calling the
business Lad Enterprises. What is the value of the assets in the business?
€..........

2. From the point of view of the business there are two ‘side’ to the above transaction.
We know that one ‘side’ is the asset (cash) and the other ‘side’ is called ......... .

3. We can therefore say that the accounting equation for Lad Enterprises would be:

ASSETS (cash) €.......... = ......... (A Lad) €..........

4. Suppose that the business now borrows €1,000 from A Lender. There will now be
€.......... cash in the business.
The value of the assets of the business is therefore €.......... .

5. Looking again at the other ‘sides’ of the transactions, the capital of the business is
€......... and there is a liability to A Lender of €.......... .

6. The accounting equation would now be:

€ €
Cash .......... CAPITAL ..........
=
+
LIABILITY ..........
_____ (Loan) _____

ASSETS = CAPITAL + LIABILITIES

7. If we are discussing the business of Lad Enterprises, we do/do not take into
account A Lad’s other activities.

8. Lad Enterprises acquired a building for €2,000 cash and bought goods (often
called purchases) for €300 paying for them immediately in cash.

The business would now have an asset called ‘building’ of €2,000, an asset
called ‘inventory’ of €300, and €2,300 less of its asset called cash.

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Now show the accounting equation for Lad Enterprises at this stage.

€ €
Building. ......... CAPITAL ..........
+ +
Inventory .......... = LIABILITY ..........
(Loan)
+
Cash ..........

ASSETS = ......... + ..........

9. Goods can also be bought on credit. The business would take delivery of goods
immediately and pay for them at a later date (usually one or two months later).
You are to complete the accounting equation for Lad Enterprises if it buys goods
for €1,200 on credit.

Remember that inventory will increase by €1,200 and a new liability, a trade pay-
able, will appear.
€ €
Building .......... CAPITAL ..........
+ +
Inventory .......... = LIABILITY .........
+ (Payable)
+
Cash .......... LIABILITY ..........
(Loan)

ASSETS = ......... + ..........

10. The accounting equation that we obtained in question (9) can be written in an alterna-
tive form which in accounting terms is called a .......... Sheet.

This is a statement listing the assets of the business less its liabilities to give ....
Assets and shows that they represent the Proprietor’s Interest.

Remember that the typical format of the balance sheet splits assets into NON
CURRENT ASSETS and CURRENT ASSETS and splits liabilities into NON
CURRENT LIABILITIES (which the business will not pay until more than a year
after the date of the balance sheet date) and CURRENT LIABILITIES (which the
business must pay within a year of the date of the balance sheet).

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Assuming that Lad Enterprises will pay its creditor next month and
will repay its loans in two years time we can complete the balance sheet
for Lad Enterprises using the accounting equation from question (9) for
reference.

€ €
ASSETS
Non Current Assets
Building .........
Current Assets
Inventory ........
Cash ........ .........

EQUITY AND LIABILITIES

Capital .........
_____
Proprietor’s interest .........
Non Current Liabilities
Loan .........
Current Liabilities
Payables .........

11. When goods are sold on credit by a business this means that the goods will be
given to the buyer but payment will not be received from him until a later date.
When money is owing to the business from a customer he is known as a receiv-
able. The right to collect money from him is something of value owned by the
business and is therefore an asset.

Goods which had cost €500 were sold by Lad Enterprises for €700 on
credit. The inventory will therefore be reduced by €500 and a new asset called
a receivable of €700 will appear. The business will also have made a profit of
€200.

Complete the balance sheet after this transaction has taken place.

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€ €
ASSETS
Non Current Assets
Building 2,000
Current Assets
Inventory .......
Receivable .......
Cash ....... ........
.......
EQUITY AND LIABILITIES
Capital .........
Profit .........
_____
Non Current Liabilities\
Loan 1,000
Current Liabilities
Payables 1,200
.........

12. State whether the following things could be found in a balance sheet:

a) The business owns some property. YES/NO

b) The business is about to take over another business. YES/NO

c) The proprietor is going to retire shortly. YES/NO

d) The business owes money at the balance sheet date. YES/NO

e) A rival business is about to launch a superior product

on to the market. YES/NO

f) The business is owed money by its customers. YES/NO

g) The proprietor has bought himself a motor bike for his

personal use. YES/NO

13. Continuing with Lad Enterprises and its transactions, A Lad withdrew €100 cash
from the Lad Enterprises bank account for his private use. This will be called draw-
ings. Complete the balance sheet to account for this.

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€ €
ASSETS
Non Current Assets
Building 2,000
Current Assets
Inventory 1,000
Receivable .......
Cash .......
.........
EQUITY AND LIABILITIES
Capital .........
Profit .........
.........
Non Current Liabilities
Loan 1,000
Current Liabilities
Payables .........
.........

14. A Lad next meets the creditor whilst on holiday and pays him €100 from his pri-
vate monies. He does not reimburse himself from Lad Enterprises. Complete the
balance sheet.

€ €
ASSETS
Non Current Assets
Building 2,000
Current Assets
Inventory ........
Receivable 700
Cash ........ ........
........
EQUITY AND LIABILITIES
Capital ........
Profit ........

........
Non Current Liabilities
Loan ........
Current Liabilities
Payables ........
........

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The following three questions (questions 15–17) are graded to

get progressively more difficult. Do not attempt any of them until
your answers to the questions above are consistently correct. Once you
have mastered the principles involved, you should be able to deal with questions
15–17, although you might find question 17 a bit more difficult. Have a serious
attempt at each of these questions before working through the answers. If you get
a correct answer at the first attempt you are doing well with the material covered
in Section One and can move on to Section Two.

15. Prior to the transactions set out below, Brady’s balance sheet was as follows:

€
ASSETS
Current Assets
Inventory 20
Cash 100
120
EQUITY AND LIABILITIES
Capital 100
Current Liabilities
Payable 20
120

Brady now pays €10 in cash for a cash register, sells half of the inventory for €17
cash and pays his creditor.

Prepare an updated balance sheet for Brady, showing his position after these
transactions.

16. The net assets of a business on 1st January 200T amounted to

€9,000. The profit for the six months to 30th June 200T was €1,000 and Smith, the
proprietor, had drawn €600 for his own use. From these figures use the accounting
equation to find the amount of the net assets on 30th June 200T.

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17. The following is a list of assets and liabilities relating to B. Rioch’s retail business
as at 31st December 200T.
€

Shop Fittings 3,000

Cash Registers 2,000
Inventory 22,000
Receivable 8,550
Cash in hand 150
Cash at bank 6,420
Trade payables 4,520

You also know that the business owned premises which cost €8,000
on which there was a mortgage of €7,500. B. Rioch’s capital at 31st December
200T was €43,064 before allowing for personal drawings of €4,964.

Prepare a balance sheet for the business as at 31st December 200T taking
account of all above details.

SELF TEST QUESTIONS – SECTION ONE ANSWERS

1. €5,000
2. CAPITAL
3. ASSETS (cash) €5,000 = CAPITAL (A Lad) €5,000
4. €6,000, €6,000
5. €5,000, €1,000

6.
€ €
CASH 6,000 CAPITAL 5,000
= +
LIABILITY 1,000
_____ (Loan) _____
6,000 6,000

ASSETS = CAPITAL + LIABILITIES

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7. Do not

8.
€ €
Building 2,000 CAPITAL 5,000
+ +
Inventory 300 = LIABILITY 1,000
+ (Loan)
Cash 3,700 _____
6,000 6,000

ASSETS = CAPITAL + LIABILITIES

9.
€ €
Building 2,000 CAPITAL 5,000
+ +
Inventory 1,500 = LIABILITY 1,200
+ (Creditor)
+
Cash 3,700 LIABILITY 1,000
_____ (Loan) _____
7,200 7,200

ASSETS = CAPITAL + LIABILITIES

10.
€
Non Current Assets
Building 2,000
Current Assets
Inventory 1,500
Cash 3,700
7,200
Representing:
Capital 5,000
Proprietor’s Interest 5,000
Non Current Liabilities
Loan 1,000
6,000
Current Liabilities
Payables 1,200
7,200

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11.
€
Non Current Assets
Building 2,000
Current Assets
Inventory 1,000
Receivables 700
Cash 3,700
7,400
Representing:
Capital 5,000
Profit 200
Proprietor’s Interest 5,200
Non Current Liabilities
Loan 1,000
Current Liabilities
Payables 1,200
7,400

12. a) YES
b) NO
c) NO
d) YES
e) NO
f) YES
g) NO

13.
€
Non Current Assets
Building 2,000
Current Assets
Inventory 1,000
Receivables 700
Cash 3,600
7,300
Representing:
Capital 5,000
Profit 200
Less: Drawings (100)
Proprietor’s Interest 5,100

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Non Current Liabilities

Loan 1,000
Current Liabilities
Payables 1,200
7,300

14.
€
Non Current Assets
Building 2,000
Current Assets
Inventory 1,000
Receivables 700
Cash 3,600
7,300
Representing:
Capital 5,000
Profit 200
Less: Drawings –
Proprietor’s interest 5,200
Non Current Liabilities
Loan 1,000
Current Liabilities
Payables 1,100
7,300
15.
€
Non Current Assets
Cash Register 10
Current Assets
Inventory 10
Cash 87
107
Representing:
Capital 100
Profit 7
Proprietor’s interest 107

16.

Increase in Net Assets = Capital introduced (in that period)

over a period +
Profit (in that period)
–
Drawings (in that period)

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Net Assets 30th June €9,000 = Nil + €1,000 – €600

Net Assets 30th June = €1,000 – €600 + €9,000
Net Assets 30th June = €9,400

17.

Balance Sheet as at 31st December 200T

€
Non Current Assets
Freehold Premises 8,000
Shop Fittings 3,000
Cash Registers 2,000
13,000
Current Assets
Inventory 22,000
Receivables 8,550
Cash 6,570
50,120
Representing:
Capital 43,064
Less: Drawings 4,964
Proprietor’s interest 38,100
Non Current Liabilities
Loan 7,500
Current Liabilities
Trade payables 4,520
50,120

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DOUBLE ENTRY BOOK-KEEPING: BASIC PRINCIPLES

SECTION TWO: PREPARING T ACCOUNTS

Introduction

The double-entry nature of every business transaction is introduced in Section One. It

is now necessary to examine the records involved in actually recording these transac-
tions. It is from these records, called ‘ledger accounts’, that the financial statements of
a business will be compiled.

Ledger Accounts and T Accounts

A separate ‘ledger account’ is required for each figure that appears in the balance sheet
and the income statement. The reason that they are called ledger accounts is that they
are kept in an accounting book called ‘the ledger’.
Due to the double-entry principle it should be apparent that every transaction will need
to be recorded in two ledger accounts to give a complete picture of the two ‘sides’ of
the transaction. One entry will be a debit entry and the other a credit entry. For every
debit there will be a corresponding credit. A typical ledger account used in manual
book keeping systems is shown below.

Folio
Name of Account
Debit Credit
Date Detail Folio € Date Detail Folio €

As you can see the ledger account is divided into two parts. The debit side (DR) and
the credit side (CR). The debit is always on the left hand side of the account and the
credit on the right. The two sides are set out in exactly the same way. ‘Folio’ means
page and is used for reference. The folio column usually contains the page number of
the ledger account in which the other side of the entry is recorded.
A crude form of ledger account is a ‘T’ account which, as its name suggests, is just a
T-shape. Entries to the left of the ‘T’ are the debits and those to the right are the credits.
So the cash ledger account can be shown in ‘T’ account format as:

Cash Account

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Having established the fact that each transaction has two sides, one a debit and one
a credit, and that these entries will be recorded in ledger accounts (or T accounts) the
next step is to determine which account must be debited and which credited.

The Two Questions

The ledger accounts affected by a transaction will depend on the nature of that transac-
tion. For example, when considering Toffer’s purchase of property, his cash decreased
by €5,000 and was replaced by a new asset (buildings) of €5,000. The logical names
to give the ledger accounts affected in this case would be CASH (which decreases) and
BUILDINGS (which increases). If a ledger account with the relevant description does
not exist then a new one should be opened and given a title which is most descriptive
of the type of entry that will be recorded in it.
In order to decide which account is debited and which credited it is useful to look at
the following table.

A DEBIT ENTRY REPRESENTS A CREDIT ENTRY REPRESENTS

An increase in the value of an ASSET A decrease in the value an ASSET
A decrease in the value of a LIABILITY An increase in the value of a
LIABILITY
An item of EXPENDITURE An item of INCOME

Examples of Recording of Transactions:

1. Buys goods on credit Increase Asset Increase Liability

(DR Inventory) (CR Payables)
2. Buys goods by cheque Increase Asset Decrease Asset
(DR Inventory) (CR Bank)
3. Pay creditor by cheque Decrease Asset Decrease
(CR Bank) Liability
(DR PAyables)
4. Owner pays more capital into Bank Increase Asset Increase Capital
(DR Bank) (CR Capital)
5. Owner takes money out for his own use Decrease Assets Decrease Capital
(CR Bank) (DR Capital)
6. Owner pays creditor from private money Decrease Liability Increase Capital
(DR Payables) (CR Capital)

In practice you do not set up a new account to record each transaction, i.e. you would
only open one bank account and enter all the relevant transactions into it.

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So when we want to make a book keeping entry to represent a transaction we must

ask ourselves two questions:
1. Which two ledger accounts are affected?
2. Which one needs a debit entry? (And hence the other a credit entry).
If we look at an example of a transaction we should be able to see how to decide
on the double-entry for the transaction by asking those two questions.

Example 1:
Mr Smith bought a van for his business. The van cost €400 and Mr Smith paid for it
in cash. How do we record this transaction in the ledger accounts?
1. Which two ledger accounts are affected?
He paid in cash so we will need a Cash Account and he bought a van so we
should have a Van Account.
2. Which one needs a debit entry?
If we consider the transaction we can see that there will be an increase in the
value of an ASSET (the van) and a decrease in the value of an ASSET (cash).
Looking at the table we can that the increase in the value of an asset is a DEBIT,
so we need to debit the Van Account. The CREDIT entry will be to the other
account, cash. (Looking at the table again we can see that this is consistent
since cash is an asset whose value has decreased).
In T account form this will be recorded as:
Van Account Cash Account
DR CR DR CR
Cash purchase €400 Van €400

Example 2:
Mr Smith made a cash payment for rent of €100.
1. Which two ledger accounts are affected?
He paid in cash – cash account
and
He paid for his rent – rent account.
2. Which one needs a debit entry?
Rent is an item of EXPENDITURE which, according to the table, is a DEBIT
entry. So debit the rent Account and credit the other account. (Again if we look
at the cash movement we can see that this represents a decrease in value of an
ASSET and thus needs a CREDIT entry).

In T account form:
Rent Account Cash Account
DR CR DR CR

If you find this difficult to understand it may help to think about debiting the
‘receiving’ account and crediting the ‘giving’ account.

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Example 3:
You are required to open the asset and liability and capital accounts and record the
following transactions for June 200X in the records of C. Williams.
June 1 Started business with €2,000 in cash;
June 2 Paid €1,800 of the opening cash into a bank account for the business;
June 5 Bought office furniture on credit from Betta-Built Limited or €120;
June 8 Bought a motor van paying by cheque €950;
June 12 Bought works machinery from Evans & Sons on credit €560;
June 18 Returned faulty office furniture costing €62 to Betta-Built Limited;
June 25 Sold some of the works machinery for €75 cash;
June 26 Paid amount owing to Betta-Built Limited €58 by cheque;
June 28 Took €100 out of the bank and put it in the cash till; and
June 30 J. Smith lent C. Williams €500, giving him the money by cheque.

Solution
Cash Capital
€ € €
1/6 Capital 2,00 02/6 Bank 1,800 1/6 Cash 2,000
25/6 March 75
28/6 Bank 100

Bank Office Furniture

€ € € €
2/6 Cash 1,800 8/6 Van 950 5/6 Betta-Built 120 Returns 62
30/6 J Smith 500 26/6 Betta 58
28/6 Cash 100

Motor Van Betta-Built Creditor

€ € €
8/6 Bank 950 18/6 Returns 62 5/6 Furniture120
26/6 Bank 58

Works Machinery J Smith Loan

€ € €
12/6 Evans 560 28/6 Cash 75 30/6 Bank 500

Evans
€
12/6 Machinery 560

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Example 4:
You are to enter the following transactions, completing double-entry in the books
for the month of May 200X.

May 1 Started business with €2,000 in the bank;

May 2 Purchased goods €175 on credit form M. Mills;
May 3 Bought fixtures and fittings €150 paying by cheque;
May 5 Sold goods for cash €275;
May 6 Bought goods on credit €114 from S. Waites;
May 10 Paid rent by cash €15;
May 12 Bought stationery €27, paying by cash;
May 18 Goods returned to M. Mills €23;
May 21 Let off part of the premises receiving rent by cheque €5;
May 23 Sold goods on credit to U. Henry for €77;
May 24 Bought a motor van paying by cheque €300;
May 30 Paid the month’s wages by cash €117; and
May 31 The proprietor took cash for himself €44.

Solution

Bank Capital
€ € €
1/5 Capital 2,000 3/5 F & F 150 1/5 Capital 2,000
21/5 Rent 5 24/5 Van 300

Purchases
Mills – Creditor
€ €
€
2/5 Mills 175 18/5 Returns 23
2/5 Purchases 175
6/5 Waites 114

Fixtures and Fittings Sales

€
3/5 Bank 150 €
5/5 Sales 275
23/5 Henry 77

Cash S Waites
€ € €
5/5 Sales 150 10/5 Rent 15 6/5 Purch 114
12/5 Stat 27
30/5 Wages 117
31/5 Drawings 44

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Balancing the Ledger Accounts

As we have seen, a ledger account in its most practical form is like a large letter T. Above
the top of the T will be the name or title of the account. The section below the title is
divided into two halves which are the debit side (left) and the credit side (right). We have
also seen how individual entries are put into ledger accounts to record a transaction.
When we have recorded each transaction we will find that we end up with ledger
accounts which show the transactions in a chronological sequence. For instance, tak-
ing the two transactions entered into by Mr Smith in the previous examples, the cash
account was affected both times and will look like this:

Cash Account
€
Van 400
Rent 100

At the end of a trading period each account will show all the transactions entered
into in the period which have affected it. So the cash account will show all payments
and receipts, the rent account will show all the amounts spent on rent and so on. The
number and titles of the amounts spent on rent and so on. The number and titles of
the accounts that we will have at the end of the period will depend both on the nature
of the transactions and the extent of the analysis of income and expenditure required
by the proprietor.

At the end of a trading period we will want to add up all the debits and all the credits
on each ledger account and find out the BALANCE on every account. The balance will
represent different things depending on the type of ledger account:

n The balance on an asset account will show the current amount of the asset;
n The balance on a liability account will show the current amount owed to the
creditor;
n The balance on an expense account will show how much has been spent in the
trading period; and
n The balance on an income account will show how much has been earned in the
trading period.

Having found the balance on each ledger account we can then put them into either the
balance sheet or the income statement. All the balances on asset and liability accounts
will be shown in the balance sheet and all the balances on income and expenditure
accounts will be shown in the income statement.

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In order to balance the ledger accounts we take each account in turn and;
(a) add up the debit entries;
(b) add up the credit entries;
(c) compare the two totals; and
(d) put in a figure (the balance) which will make both sides equal.
This is easier to see if we take a ledger account which we want to balance.

Example 1:
Consider the following six transactions:

1. A proprietor put €2,000 cash into his business;

2. Cash was paid for a van €400;
3. Cash was paid for rent €100;
4. Cash was paid for electricity €20;
5. Cash was paid to purchase goods €200; and
6. The goods were sold for €500 cash.

First of all we need to establish the necessary double-entry for each transaction
and record all transactions in the relevant ledger accounts.

Transaction 1: The two accounts affected are the cash and capital accounts.
The debit will be to the cash account (increase in the value of an
asset).
The credit will be to the capital account (which you could either
accept because it is the other side of the entry or prove by seeing
that it is an increase in the value of a liability).
Transaction 2: The two accounts affected are the cash and van accounts.
The debit will be to the van account (increase in value of an
asset).
The credit will be to the cash account (decrease in value of an
asset).
Transaction 3: The two accounts affected are the cash and rent accounts.
The debit will be to the rent account (an item of expenditure).
The credit will be to the cash account (decrease in value of an
asset).
Transaction 4: The two accounts affected are the cash and electricity accounts.
The debit will be to take the electricity account (an item of
expenditure).
The credit will be to the cash account (decrease in an asset).

(Continued overleaf )

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Transaction 5: The two accounts affected are the cash and purchases accounts.
The debit will be to the purchases account (an item of expenditure).
The credit will be to the cash account (decrease in value of an
asset).
Transaction 6: The two accounts affected are the cash and sales accounts.
The debit will be to the cash account (increase in value of an
asset).
The credit will be to the sales account (an item of income).

To balance all these ledger accounts and find the figures to include in the balance
sheet and the income statement we can take each in turn and ‘Rule Off’ or ‘Balance’
the accounts.
First let’s look at the cash account.

Cash Account
€ €
Capital 2,000 Van 400
Rent 100
Electricity 20
Sales 500 Purchases 200
BALANCE 1,780
2,500 2,500

The value of the debit entries exceeds the value of the credit entries by €1,780. This
amount has to be put in on the credit side in order to make both sides total €2,500.
Next we can balance the Capital Account.

Capital Account
€ €
BALANCE 2,000 Cash 2,000
2,000 2,000

This time the value of the credit entry is greater so the balance is put on the debit
side to make both totals equal.

We then perform the same exercise on the van account.

Van Account
€ €
Cash 400 BALANCE 400
400 400

(Continued overleaf )

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The debits exceed the credits so the balance is put on the credit side.
For both the rent account and the electricity account the debits exceed the credits
so the balance is put on the credit side to make both sides balance giving:

Rent Account Electricity Account

€ € € €
Cash 100 Cash 20 Cash 20 BALANCE 20
100 100 20 20

Likewise the purchase account:

Purchase Account
€ €
Cash 200 BALANCE 200
200 200

Finally, the credits on the sales account exceed the debits so the balance is put on
the debit side.

Sales Account
€ €
BALANCE 500 Cash 500
500 500

When debits exceed credits the balance (which is put on the credit side) is called a
DEBIT BALANCE.
When credits exceed debits the balance (which is put on the debit side) is called a
CREDIT BALANCE.
We then use these balances in our balance sheet and income statement as follows:
A DEBIT BALANCE (excess of debits over credits) will represent either:

(a) an asset in the balance sheet; or

(b) an expense in the income statement.

A CREDIT BALANCE (excess of credits over debits) will represent either:

(a) a liability in the balance sheet; or

(b) income in the income statement.

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Thus the:
(i) debit balance on the cash account of €1,780 is an asset in the balance
sheet;
(ii) credit balance on the capital account is a liability in the balance sheet;
(iii) debit balance on the van account is an asset in the balance sheet;
(iv) debit balance on the rent account is an expense in the income statement;
(v) debit balance on the electricity account is an expense in the income statement;
(vi) debit balance on the purchases account is an expense in the income statement;
and
(vii) credit balance on the sales account is income in the income statement.

Example 2:
Enter the following in the personal accounts only: do not write up the other accounts.
Balance down each personal account at the end of the month. After completing this,
state which of the balances represents debtors and those which are creditors.
Sept 1 Sales on credit to D. Williams €458, J. Moore €235 and G. Grant €98;
Sept 2 Purchases on credit A. White €77, H. Samuels €231 and P. Owens €65;
Sept 8 Sales on credit to J. Moore €444 and F. Franklin €249;
Sept 10 Purchases on credit from H. Samuels €12 and O. Oliver €222;
Sept 12 Returns inwards from G. Grant €9 and J. Moore €26;
Sept 17 We returned goods to H. Samuels €24 and O. Oliver €12;
Sept 20 We paid A. White by cheque €77;
Sept 24 D. Williams paid us by cheque €300;
Sept 26 We paid O. Oliver by cash €210;
Sept 28 D. Williams paid us by cash €100; and
Sept 30 F. Franklin pays us by cheque €249.

Solution
D. Williams J. Moore
€ € € €
1/9 Sales 458 24/9 Bank 300 1/9 Sales 235 17/9 Returns 26
28/9 Cash 100 8/9 Sales 444 Bal c/d 653
30/9 Bal c/d 58 679 679
458 458 Bal b/d 653
Bal b/d 58
(Continued overleaf )

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G. Grant A. White
€ € € €
1/9 Sales 98 17/9 Returns 9 20/9 Bank 77 2/9 Purchases 77
Bal c/d 89
98 98
Bal b/d 89

H. Samuels P. Owen
€ € € €
17/9 Returns 24 2/9 Purch 231 Bal c/d 65 7/9 Purch 65
Bal c/d 219 10/9 Purch 12
243 243
Bal b/d 219
F. Franklin D. Oliver
€ € € €
8/9 Sales 249 30/9 Bank 249 17/9 Returns 12 10/9 Purch 222
26/9 Cash 210
222 222

We are now ready to look at the format of an income statement into which we will put
the relevant balances.

An Introduction to the Income Statement

It is important to note that the format and presentation of the financial statements dealt
with in this part (income statement and balance sheet) do not adhere strictly to those
outlined in Chapter Two of Connolly: International Financial Accounting and Reporting
("Connolly"). This part is primarily concerned with basic book keeping skills.
The income statement shows a detailed analysis of the income and expenditure in
a period which has resulted in the profit (or loss) for the period.
An income statement might be presented as follows:

Income statement for the Year Ended 31st December 200Z

€ €
Sales x
Less: Cost of Goods Sold
Opening inventory x
Purchases of goods x
x
Less: Closing inventory (x) (x)
Gross Profit x
(Continued overleaf )

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Less Expenses:
Rent x
Rates x
Lighting and Heating x
Stationery x
Insurance x
Salaries x
Accountancy charges x
Bank charges x (x)
Net Profit for the Year x

Note how brackets around a figure can be used to indicate that it is being deducted
from the figure above it.
If we now look at our balanced T accounts again we can use the balances to pro-
duce a balance sheet and income statement to reflect the six transactions entered into
by the business.

Cash Account Capital Account

€ € € €
Capital 2,000 Van 400 Balance 2,000 Cash 2,000
Rent 100
Electricity 20
Sales 500 Purchases 200
Balance 1,780 2,000 2,000
2,500 2,500

Van Account Rent Account

€ € € €
Cash 400 Balance 400 Cash 100 Balance 100
400 400 100 100

Electricity Account Purchases Account

€ € € €
Cash 20 Balance 20 Cash 200 Balance 200
20 20 200 200

Sales Account
€ €
Balance 500 Cash 500
500 500

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Income Statement for the Period Ended XXXX

€ €
Sales (Balance on Sales Account) 500
Less: Cost of Goods Sold
Opening inventory –
Purchases of goods (Balance on Purchases Account) 200
200
Less: Closing inventory –
200
Gross Profit 300
Less Expenses:
Rent (Balance on Rent Account) 100
Electricity (Balance on Electricity Account) 20
120
Net Profit 180

Please note that the narrative in brackets is only to help you see where the numbers
have come from. Also ‘A/C’ or ‘a/c’ is a common abbreviation that could be used for
‘Account’.

Balance Sheet as at XXXX

ASSETS €
Non Current Assets
Motor Vehicles (Balance on Van a/c) 400
Current Assets
Cash (Balance on Cash a/c) 1,780
2,180
EQUITY AND LIABILITIES
Capital (Balance on Capital a/c) 2,000
Profit 180
2,180

Please note that the profit figure is the same as the Net Profit figure in the income
statement since it is the first period for which accounts have been drawn up.

Summary of Section Two

In Section Two we have looked at Ledger Accounts and their abbreviated form, T
accounts, and have seen how transactions are recorded over time to give a chrono-
logical record of events. We have also seen how, at the end of a given period, we can
‘rule off’ or ‘balance’ the ledger accounts to find the figures to include in the balance
sheet and income statement.

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A Glossary of Terms covered in Section Two follows and you should familiarise your-
self with these terms. Following the glossary is a section of Self Test Questions which
test your knowledge of the material covered to date and you should attempt these and
re-read the relevant part of the text (whether Section One or Section Two) covering the
areas with which you have difficulty. Try to answer these questions without looking at
the answers and see how you get on. If you find that you are making mistakes then
re-read the text and try again.

GLOSSARY OF TERMS

Ledger accounts: These are the ‘books of account’ that form a permanent record
of all transactions undertaken by the business. The accounts
are headed according to the type of transaction they are to
reflect. Examples are the cash account, purchases account
etc.

T accounts: These are abbreviated forms of the ledger accounts and are
used as a practical substitute for the full ledger accounts when
making entries to record transactions. They may be looked
upon as being the bare essentials of a ledger account.

Debit entries: Entries made on the left of the ledger account to represent
increases in assets, decrease in liabilities and items of
expenditure.

Credit entries: Entries made on the right of the ledger account represent
decreases in assets, increases in liabilities and items of
income.

Ruling off: Totaling all the debit entries and all the credit entries in a ledger
account to find the balance on that account.

Account balance: The difference between the total debit and total credit entries on
an account.

Debit balance: The account balance obtained if total debits exceed total
credits.

Credit balance: The account balance obtained if total credits exceed total
debits.

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SELF TEST QUESTIONS – SECTION TWO

1. Ledger accounts are used to record business transactions. For every transaction
two entries are required. These are a debit entry to the ...... side of the account
and a ...... entry to the ..... side.

2. For every transaction the amount of the debit entry must ...... the amount of the
credit entry.

3. A ‘T account’ is an abbreviated version of a ledger account. Using the T account

presentation complete the account heading and the debit entry to record the
receipt of €100 cash.

4. The following transactions were carried out by a business. State whether the entry
to the ledger account indicated is a debit or a credit. (Refer to the table in the text
if you are unable to work it out otherwise.)

Transaction Ledger Account

(a) The purchase of a factory Factory a/c

(b) The sale of goods for cash Sales a/c
(c) Payment for electricity Electricity a/c
(d) The purchase of goods for cash Purchases a/c
(e) Payment for rent in cash Cash a/c
(f) The sale of goods on credit Receivables a/c
(g) The purchase of goods on credit Payables a/c
(h) The receipt of a cash from a debtor Receivables a/c
(i) The payment of cash to a creditor Payables a/c
(j) The receipt of cash from the proprietor Capital a/c

5. State for each transaction listed below which account should be debited and
which credited (ask yourself the ‘Two Questions’).
(a) Made a cash payment for rent
(b) Paid salaries in cash
(c) Sold goods for cash
(d) Bought a machine on credit
(e) Collected cash from a debtor

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(f) The proprietor withdrew cash

(g) Sold goods on credit

6. We buy goods on credit costing €800. This is an increase in our liability to our
creditors. We later pay half of this amount to the creditor. This results in a ......... in
our liability. Complete the following account to reflect these two transactions.
Creditors Accounts
€ €

7. Entries reflecting an increase in an asset, decrease in a liability or an item of

expenditure are ...... entries.
Entries reflecting a decrease in an asset, increase in a liability or an item of
income are ......entries.

8. Balancing a ledger account is the process of making the debit and credit sides
equal in value by writing the difference between them on the smaller side. If the
following is the cash account for the first week of business, how much cash does
the business have at the end of the week?

Cash Account
€ €
Capital 4,000 Rent 1,000
Sales 2,300 Purchaes 6,000
Sales 2,900

9. Is the balance in question (8) a debit or a credit balance?

10. If a proprietor introduces €5,000 into his business he is said to have introduced
....... Show the book keeping effects of this by completing the following statement:

The entries required to reflect the above transaction are:

Debit Cash a/c and ...... ...... a/c with €5000.

11. State what kind of balance (a debit balance or credit balance) you would expect to
find on each of the following ledger accounts
(a) Capital a/c
(b) Receivables a/c
(c) Payables a/c
(d) Expense a/c (e.g. rent)

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(e) Sales a/c

(f) Purchases a/c
(g) Machine a/c

Do not attempt the next two questions until your answers to the
questions above are consistently correct. Once you have mastered the prin-
ciples involved, you should be able to deal with questions 12 and 13. Have a
serious attempt at each of these questions before working through the answers.
If you get a correct answer at the first attempt you are doing well with the material
covered in Section Two and can move on to Section Three.

12. Rule off and extract the balance on the following T accounts and state whether the
balance is a debit or a credit balance.

Buildings a/c
€ €
Cash purchase Sale of
of property 2,000 property 1,200
Cash purchase
of property 1,200

Cash a/c
€ €
Capital 1,000 Property 2,000
Mortgage 3,000 Inventory 500
Capital 1,500 Property 1,200
Property 1,200
Sales 300

Mortgage a/c Capital a/c

€ € €
Cash 3,000 Cash 1,000
Cash 1,500

Inventory a/c Sales a/c

€ € € €
Cash 500 Cash 300

13. Mr Rabo, who runs a tailors shop, has asked you to write up his ledger accounts
from a bundle of cheques and other information available to you. After several
hours work you are able to categorise the various bits of paper as follows:

€
Payments to cloth wholesalers for purchases 1,500
Payment of rates 40
Sales for cash 8,000

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Sales for credit 120

Lease payments for rental of shop 270
Received from customers to whom sales on credit had been made 25
Cloth bought from wholesalers on credit 6,290

Mr Rabo also paid €1,000 into the business as his capital contribution.
Mr Rabo tells you that the documents given to you represent the whole of the first
year’s business except for an amount of €500 in the cash a/c which had arisen
from a loan made by his aunt to the business in the initial stages of trading.
From this information write up the ledger accounts in T account form and identify
the balance remaining on each account.
Then prepare the income statement and balance sheet.

SELF TEST QUESTIONS – SECTION TWO ANSWERS

1. Left, credit, right
2. Equal
3. Cash Account
€ €
Receipt 100

4. (a) Dr. (An increase in an asset)

(b) Cr. (An item of income)
(c) Dr. (An item of expenditure)
(d) Dr. (An item of expenditure)
(e) Cr. (A decrease in an asset)
(f) Dr. (An increase in an asset)
(g) Cr. (An increase in a liability)
(h) Cr. (A decrease in an asset)
(i) Dr. (A decrease in a liability)
(j) Cr. (An increase in a liability)

5. (a) Dr Rent a/c Cr Cash a/c

(b) Dr Salaries a/c Cr Cash a/c
(c) Dr Cash a/c Cr Sales a/c
(d) Dr Machine a/c Cr Payables a/c
(e) Dr Cash a/c Cr Receivables a/c
(f) Dr Drawings a/c Cr Cash a/c
(g) Dr Receivables a/c Cr Sales a/c

6. Decrease

Payables Account
€ €
Cash 400 Purchases 800

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DOUBLE ENTRY BOOK-KEEPING: BASIC PRINCIPLES

7. Debit, Credit
8.

Cash Account
€ €
Capital 4,000 Rent 1,000
Sales 2,300 Purchases 6,000
Sales 2,900 Balance 2,200
9,200 9,200

The business will therefore have €2,200 cash at the end of the week.

9. A debit balance. (This means that there is an asset balance at the end of the
week.)
10. Capital, Credit, Capital

11. (a) Credit Balance

(b) Debit Balance
(c) Credit Balance
(d) Debit Balance
(e) Credit Balance
(f) Debit Balance
(g) Debit Balance

12.

Buildings a/c
€ €
Cash Purchase of property 2,000 Sale of property 1,200
Cash purchase of property 1,200 Balance 2,000
3,200 3,200

Debit balance of €2,000.

Cash a/c
€ €
Capital 1,000 Property 2,000
Mortgage 3,000 Balance 500
Capital 1,500 Property 1,200
Property 1,200
Sales 300 Balance 3,000
7,000 7,000

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Debit balance of €3,300.

Mortgage a/c Capital a/c

€ € € €
Balance 3,000 Cash 3,000 Balance 2,500 Cash 1,000
Cash 1,500
3,000 3,000 2,500 2,500
Credit balance of €3,000 Credit balance of €2,500

Inventory a/c Sales a/c

€ € € €
Cash 500 Balance 500 Balance 300 Cash 300
500 500 300 300
Debit balance of €500. Credit balance of €300.

13.

Cash a/c Purchase a/c

€ € € €
1) Loan 500 3) Purchase 1,500 3) Cash 1,500
2) Capital 1,000 6) Rates 40 4) Creditors 6,290 Balance 7,790
5) Sales 8,000 7) Lease
Rental 270
9) Debtors 25 Balance 7,715
9,525 9,525 7,790 7,790

Debtors a/c Rates a/c

€ € € €
8) Sales on Cash 25 6) Cash 40 Balance 40
Credit 120 Balance 95
120 120 40 40

Lease Rental a/c Capital a/c

€ € € €
7) Cash 270 Balance 270 Balance 1,000 2) Cash 1,000
270 270 1,000 1,000

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Loan a/c Sales a/c

€ € € €
Balance 500 1) Cash 500 Balance 8,120 5) Cash sales 8,000
500 500 8) Credit Sales 120
8,120 8,120

Creditors a/c
€ €
Balance 6,290 4) Purchases 6,290
6,290 6,290

The numbers beside the entries are so that you can more easily follow the double
entry for a traction

Income Statement for the Period Ended XXXX

€ €
Sales 8,120
Cost of Sales
Opening inventory –
Purchases 7,790
Closing inventory –
Gross Profit 330
Expenses
Rates 40
Lease 270 310
Net Profit 20

Balance Sheet as at XXXX

Current Assets €
Receivables 95
Cash 7,715
7,810
Capital 1,000
Net profit 20
1,020
Non Current Liabilities
Loan 500
Current Liabilities
Payables 6,290
7,810

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SECTION THREE: PREPARATION OF BALANCE SHEET AND INCOME STATEMENT

Introduction

We have seen how individual ledger accounts can be balanced and how these bal-
ances fit into the balance sheet or income statement. In order to ensure that the total
of debit entries made to the various ledger accounts is equal to the total of the credit
entries and also to provide us with a summary of all the balances that exist on the
ledger accounts it is usual to extract a TRIAL BALANCE before preparing the balance
sheet and income statement.

The Trial Balance

A Trial Balance can be prepared at any time during the year. The most important Trial
Balance is the one extracted at the end of the year before preparing the financial
statements of the business.
Once the ledger accounts have been balanced, every ledger account is listed and
the balance of each account is inserted under either the debit column or the credit
column (depending on whether the balance is a debit balance or a credit balance).
Both columns are totaled and by virtue of the double-entry principle should be equal.
If they are not equal then there must be an error in the books of account.

A pro forma Trial Balance is shown below:

Dr. Cr.
€ €
Capital account x
Property x
Shop fittings x
Van x
Mortgage x
Cash account x
Wages x
Rates x
Purchases x
Sales x
Drawings x
Receivables x
Payables – x
x x

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DOUBLE ENTRY BOOK-KEEPING: BASIC PRINCIPLES

As mentioned above the total of the debits should equal the total of the credits due
to the double-entry principle. The sort of errors that would cause an ‘imbalance’ in a
Trial Balance would be:
(a) Transposition Error
This is when the individual digits making up a number have been written in the
wrong order in one of the two ledger accounts. An example would be where
a gas bill of €61 was paid and recorded in the gas account as (Dr) €61 but
recorded in the cash account as (Cr) €16. This would cause the total of the
debit balances in the Trial Balance to exceed the total of the credit balances
by €45. (When a transposition error has occurred it will always cause a differ-
ence which is divisible 9).
(b) One-sided Entry
This is where only one ‘side’ of the entry has been recorded in the books of
account. For instance if we paid the gas bill and only recorded the entry in the
gas account.
(c) Casting Error
A casting error is an addition error. If a ledger account was incorrectly added
up when we were trying to balance it we would derive an incorrect amount for
the balance.
If a Trial Balance is extracted and doesn’t balance we have to check for the
above errors in the ledger accounts to find and correct the mistake. Even when
the Trial Balance does balance all we can be sure of is the arithmetic accuracy
of the ledger accounts.
There are other errors which can occur which would not cause an imbalance.
These are:
(d) Errors of Omission
Where a transaction has taken place and we have not recorded either side of
the entry but left it out altogether. The Trial Balance will balance since an equal
amount has been left out on both the debit and credit sides.
(e) Errors of Commission
This is where the double-entry is made but to the wrong account. For example
the payment for gas is credited correctly to the cash account but debited to
the wages account. The Trial Balance will still balance since a debit and cor-
responding credit entry have been made.
(f) Errors of Principle
These are similar to errors of commission but instead of making the entry to
the correct type of account (in (b) above the debit should have been to gas,
and expense, and was made to wages, also an expense) it is treated funda-
mentally incorrectly. For example if the debit entry is posted to the van account
(which is a fixed asset account and part of the balance sheet) rather than the
gas account (which is an expense account and part of the income statement).
Again the Trial Balance will balance but will not be correct.

46 © Chartered Accountants Ireland

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(g) Compensating Errors

These are where one error is exactly compensated by another error in the
opposite direction. The totals of the debit balances and credit balances in the
Trial Balance will still be equal when a compensating error has occurred.
(h) Error of Prime Entry
Where the original (or prime) entry in incorrectly entered i.e. completely the
wrong amount is recorded. In this case we still have a double-entry which will
be equal but totally incorrect.

The objective of the Trial Balance is therefore twofold. It is to detect any arithmetic
errors in the books of account and also to act as a summary of all the balances on
the ledger accounts representing assets, liabilities, expenditure and income. From this
summary the financial statements can be prepared.

Example 1:
Record the following transactions for the month of May, balance off the ledger
accounts and extract a Trial Balance as at 31st May.
May 1 Started firm with capital in cash of €250;
May 2 Bought goods on credit form the following persons: D Ellis €54, C
Mendez 87, K Gibson €25, D Booth €76 and L Lowe €64;
May 4 Sold goods on credit to: C Bailey €43, B Hughes €62 and H Spencer
€176;
May 6 Paid rent by cash €12;
May 9 Bailey paid us his account by cheque €43;
May 10 H Spencer paid us €150 by cheque;
May 12 We paid the following by cheque: K Gibson €25 and D Ellis €54;
May 15 Paid carriage by cash €23;
May 18 Bought goods on credit from C Mendez €43 and D Booth €110;
May 21 Sold goods on credit to B Hughes €67; and
May 31 Paid rent by cheque €18.

Solution

Capital
€ €
Bal c/d 250 1/5 Cash 25
250 250
Bal b/d 250

D Ellis – Payable
€ €
12/5 Bank 54 2/5 Purchases 54
(Continued overleaf )

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DOUBLE ENTRY BOOK-KEEPING: BASIC PRINCIPLES

K Gibson – Payable
€ €
12/5 Bank 25 2/5 Purchases 25

L Lowe – Payable
€ €
Bal c/d 64 2/5 Purchases 64
64 64
Bal b/d 64

B Hughes – Receivable
€ €
4/5 Sales 62
2/5 Sales 67 Bal c/d 129
129 129
Bal b/d 129

Rent
€ €
6/5 Cash 12
3/5 Bank 18 Bal c/d 30
30 30
Bal b/d 30

Bank
€ €
9/5 Bailey 43 12/5 Ellis 54
10/5 Spencer 150 12/5 Gibson 25
31/5 Rent 18
Bal c/d 96
193 193
Bal b/d 96

Cash
€ €
1/5 Capital 250 6/5 Rent 12
15/5 Carr 23
Bal c/d 215
250 250
Bal c/d 215

C Mendez – Payable
€ €
2/5 Purchases 87
Bal c/d 130 18/5 Purchases 43
130 130
Bal b/d 130
(Continued overleaf )

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D Booth – Payable
€ €
2/5 Purchases 76
Bal c/d 186 18/5 Purchases 110
186 186
Bal b/d 186

C Bailey – Receivable
€ €
4/5 Sales 43 9/5 Bank 43

H Spencer – Receivable
€ €
4/5 Sales 176 10/5 Bank 150
Bal c/d 26
176 176
Bal b/d 26

Carriage
€ €
15/5 Cash 23
Bal c/d 23
23 23

Bank
€ €
9/5 Bailey 43 12/5 Ellis 54
10/5 Spencer 150 12/5 Gibson 25
31/5 Rent 18
Bal c/d 96
193 193
Bal b/d 96

Purchases
€ €
D Ellis 54
C Mendez 87
K Gibson 25
D Booth 76
L Lowe 64
C Mendez 43 Bal c/d 459
D Booth 110
459 459
Bal b/d 459

Sales
€ €
4/5 Bailey 43
Hughes 62
(Continued overleaf )

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DOUBLE ENTRY BOOK-KEEPING: BASIC PRINCIPLES

Spencer 176
Bal c/d 348 Hughes 67
348 348
Bal b/d 348

Trial Balance
Debit Credit
€ €
Cash 215
Receivables – Hughes 129
– Spencer 26
Purchases 459
Rent 30
Bank 96
Carriage 23
Capital 250
Payables – Mendez 130
– Booth 186
– Lowe 64
Sales 348
978 978

Example 2:
Record the following transactions for the month of June in the records of J Collins,
balance off the ledger accounts and extract a Trial Balance as at 30th June.
June 1 Started business with €10,000 in the bank and €300 cash;
June 1 Bought goods on credit from J Carby €400, F McIntyre €1,188
and C. Morrison €1,344;
June 2 Bought shop fittings by cheque €240;
June 3 Bought shop fittings on credit from M Johnson Limited €575;
June 5 Paid insurance by cash €88;
June 6 Bought motor van paying by cheque €3,200;
June 7 Sold goods for cash €140;
June 7 Sold goods on credit to: W Graham & Co. €450, F Phillips
Limited €246 and D R Edwards €80;
June 8 Bought office stationery €180 on credit from D Ball & Co;
June 9 Paid rent by cheque €75;
June 10 Paid rates by cheque €250;
June 11 We returned goods to F McIntyre €168;
June 12 Paid D Ball & Co €180 by cheque;
June 13 Sold goods on credit to KP Prince & Co €220, F Phillips Limited
€154 and Kay & Edwards Limited €270;
June 14 Goods returned to us by W Graham & Co €40;
(Continued overleaf )

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June 15 Paid wages by cash €120;

June 16 Loan from D Clayton by cheque €500;
June 17 W Graham & Co paid us the amount owing by cheque €410;
June 18 Some of the stationery was bought unwisely. We sell it for cash
€15;
June 20 We had overpaid insurance. A refund of €8 received by cheque;
June 21 Paid motor expenses by cash €55;
June 23 Paid wages by cash €120;
June 25 Cheques received from KP Prince & Co €220 and F Phillips
Limited €100 (as part payment);
June 26 Some of shop fittings were unsuitable and were returned to
M Johnson Limited €25;
June 28 Paid F. McIntyre €1,188 and rent €75; and
June 30 J Collins took drawings by cheque €200.

Solution

Capital
€ €
30/6 Bank 200 1/6 Bank 10,000
Bal c/d 10,100 1/6 Cash 300
10,300 10,300
Bal b/d 10,100
Purchases
€ €
1/6 J Carby 400 1/6 McIntyre 168
1/6 FMcInt 1,188
1/6 Morrisson 1,344 Bal c/d 2,764
2,932 2,932
Bal b/d 2,764
C Morrisson
€ €
Bal c/d 1,344 1/6 Purchases 1,344
1,344 1,344
Bal b/d 1,344
Shop Fittings
€ €
2/6 Bank 240 8/6 Returns 25
3/6 M Johnson 575 Bal c/d 790
(Continued overleaf )

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DOUBLE ENTRY BOOK-KEEPING: BASIC PRINCIPLES

815 815
Bal b/d 790
Insurance
€ €
5/6 Cash 88 20/6 Bank 8
Bal c/d 80
88 88
Bal b/d 80
W Graham
€ €
8/6 Sales 450 14/6 Returns 40
13/6 Bank 410
450 450
Bank
€ €
1/6 Capital 10,000 2/6 Fittings 240
16/6 Loan 500 6/6 MV 3,200
17/6 Graham 410 9/6 Rent 75
20/6 Insurance 8 8/6 Rates 250
25/6 Prince 220 12/6 Ball 180
25/6 Phillips 100 28/6 McIntyre 1,188
28/6 Rent 75
30/6 Capital 200
11,238 Bal c/d 5,830
Bal b/d 5,380 11,238
E Edwards
€ €
7/6 Sales 80 Bal c/d 80
80 80
Bal b/d 80
D Ball & Co
€ €
12/6 Bank 180 8/6 Stationery 180
180 180
Rates
€ €
9/6 Bank 250 Bal c/d 250
1,344 250
Bal b/d 250
(Continued overleaf )

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Kay & Edwards

€ €
13/6 Sales 270 Bal c/d 270
270 270
Bal b/d 270
D Clayton – Loan
€ €
Bal c/d 500 16/6 Bank 500
500 500
Bal b/d 500
Cash
€ €
1/6 Capital 300 5/6 Insurance 88
7/6 Sales 140 15/6 Wages 120
18/6 Sales 15 21/6 Motor exp 55
21/6 Wages 120
Bal c/d 72
455 455
Bal b/d 72
J Carby
€ €
Bal c/d 400 1/6 Purchases 400
400 400
Bal b/d 400
F McIntyre
€ €
11/6 Returns 168 1/6 Purchases 1,188
28/6 Bank 1,188 Bal c/d 168
1,356 1,356
Bal b/d 168
M Johnson
€ €
26/6 Returns 25 3/6 Fittings 575
Bal c/d 550
575 575
Bal b/d 550
Motor Van
€ €
6/6 Bank 3,200 Bal c/d 3,200
(Continued overleaf )

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3,200 3,200
Bal b/d 3,200
F Phillips
€ €
7/6 Sales 246 25/6 Bank 100
13/6 Sales 154 Bal c/d 300
400 400
Bal b/d 300
Sales
€ €
14/6 Graham 40 7/6 Cash 140
8/6 Graham 450
7/6 Phillips 246
8/16 EDS 80
13/6 Prince 220
13/6 Phillips 154
Bal c/d 1,520 13/6 Kay & Edws 270
1,560 1,560
Bal b/d 1,520
Stationery
€ €
8/6 D Ball 180 18/6 Bank 15
Bal c/d 165
180 180
Bal b/d 165
Rent
€ €
9/6 Bank 75
28/6 Bank 75 Bal c/d 150
150 150
Bal b/d 150
Prince
€ €
9/6 Sales 220 25/6 Bank 220
220 220
Wages
€ €
15/6 Cash 120 Bal c/d 240
21/6 Cash 120
(Continued overleaf )

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240 240
Bal b/d 240
Motor Expenses
€ €
21/6 Cash 55 Bal c/d 55
55 55
Bal b/d 55
Trial Balance
Dr. Cr.
€ €
Capital 10,100
Bank 5,830
Cash 72
Purchases 2,764
J Carby 400
F McIntyre 168
C Morrisson 1,344
Shop Fittings 790
M Johnson 550
Insurance 80
Motor Van 3,200
Sales 1,520
F Phillips 300
Edwards 80
Stationery 165
Rent 150
Rates 250
Kay & 270
Edwards
Wages 240
D Clayton 500
Motor 55
expenses
14,414 14,414

Assets v Expenses and Liabilities v Revenue

We have seen that transactions are recorded in ledger accounts and that the ledger
account balances are used to prepare the financial statements. We have also seen

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DOUBLE ENTRY BOOK-KEEPING: BASIC PRINCIPLES

that the balances on asset and liability accounts are put into the balance sheet while
balances on income and expenditure accounts are put into the income statement.
We should now look a little closer at the difference between assets and expenses
and liabilities and revenue i.e. when is a debit balance an asset and when is it an
expense? Also when is a credit balance a liability and when is it revenue?
Generally, assets contain some degree of permanence whilst expense items pro-
vide no future benefits.
A debit balance on a van account is an asset. This is because we would expect the
benefit of its use to continue for some time. Compare this to the debit balance on an
electricity account. This is an expense since the electricity has been used and paid
for and there is no expectancy of any future benefits being derived.
All the asset balances are shown in the balance sheet as these are the assets
which will be ‘carried forward’ for use in a future period of trading.
All the expense balances are shown in the income statement as these are the
expenses which have been incurred in the period to enable the business to trade.
These expenses are ‘matched’ with revenue relating to the same period.
If we look at the difference between a liability and revenue we will see that similar
criteria apply.
Again the distinction is basically one of timing. A liability is a commitment to a future
settlement whilst revenue is the income earned in a period of trading.
A credit balance on a capital account is a liability. This is because it is an amount
which will have to be paid in the future. Compare this to the credit balance on a sales
account. This is revenue since the sales have been made during the period.
All the revenue balances are shown in the income statement as this is income
earned by the business during the period. This revenue is ‘matched’ with the expenses
relating to the same period.
When we are balancing our ledger accounts or T accounts it is the convention to
show whether the balances have been ‘carried forward’ to future periods (and there-
fore included in the balance sheet) or whether the balances represent expenses and
revenue of the trading period (and are therefore included in the income statement).
This is done as follows:
In this cash account we have a debit balance at the end of the period which rep-
resents an asset. This balance has been described as ‘balance c/f’ which means

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Cash Account
€ €
Capital 4,000 Rent 1,000
Sales 2,300 Purchases 6,000
Sales 2,900 Balance c/f 2,200
9,200 9,200
Balance c/f 2,200

‘balance carried forward’. At the beginning of the next period it is shown as ‘balance
b/f’ which means ‘balance brought forward’. These expressions may be further abbre-
viated to ‘bal. c/f’ and ‘bal. b/f’.
This indicates that the balances are being carried forward to a future period in the
balance sheet.
Another expression which is commonly used to indicate the carrying of a balance
to a future period is ‘balance carried down’. This is abbreviated to ‘balance c/d’ or ‘bal.
c/d’. The opening balance in the next period would then be called ‘balance brought
down’. This is abbreviated to ‘balance b/d’ or ‘bal. b/d’ and is shown below

Cash Account
€ €
Capital 4,000 Rent 1,000
Sales 2,300 Purchases 6,000
Sales 2,900 Balance 2,200
9,200 9,200
Balance c/f 2,200

Whether you use the term ‘forward’ or ‘down’ is largely a matter of taste but, which-
ever you use, be consistent.
For ledger accounts with balances which are to be included in the income statement
the balance is ‘transferred’. This indicates that the account has been ‘closed off’ i.e.
that all entries for the relevant period have been made and that the total has been
included in the income statement. So the rent account would be shown as:
This procedure for ‘closing the books’ can seem confusing at first but will soon become
a semi-automatic reaction when you are used to dealing with ledger accounts.

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Rent Account
€ €
Cash 1,000 Trif to IS 1,000
1,000 1,000
The sales account would be shown as:
Sales Account
€ €
Trif to IS 5,200 Cash 2,300
Cash 2,900
5,200 5,200

The six transactions used at the end of Section Two are shown below in T account
format so that you can practice closing off the T accounts.
Decide whether the balance would be carried in the balance sheet (B/S) or
transferred to the income statement (IS) and enter the appropriate narrative and
balancing figure.

Cash Account = B/S Capital Account = B/S

€ € € €
Capital 2,000 Van 400 Cash 2,000
Sales 500 Rent 100
Electricity 20 2,000 2,000
Purchases 200
2,500 2,500
Van Account = B/S Rent Account = B/S
€ € € €
Cash 400 Cash 100
400 400 100 100
Electricity Account = IS Purchases Account = IS
€ € € €
Cash 20 Cash 200
20 20 200 200
Sales Account = IS
€ €
Cash 500
500 500
(Continued overleaf )

58 © Chartered Accountants Ireland

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The suggested solution is below.

Cash Account Capital Account
€ € € €
Capital 2,000 Van 400 Bal. c/d 2000 2,000
Sales 500 Rent 100 Cash 2,000
Electricity 20 2,000 Bal. c/d 2,000
Purchases 200
Bal. c/f 1,780
2,500 2,500
Bal. b/f 1,780
Van Account Rent Account
€ € € €
Cash 400 Bal. b/d 400 Cash 100 Trfr to IS 100
400 400 100 100
Bal. b/d 400
Electricity Account Purchases Account
€ € € €
Cash 20 Trfr to IS 20 Cash Trfr to IS 200
20 20 200
Sales Account
€ €
Trfr to IS 500 Cash 500
500 500

For the ledger accounts whose balances have been transferred to the income state-
ment there will be no opening balance in the following period. You can think of the
transfer as being a double-entry. For example, the balance on the rent account has
been transferred by crediting the rent account and debiting the income statement.
In fact, you can think of the income statement as T accounts to which the balances
on the rent account, electricity account, purchases account and sales account in the
previous example have been transferred. The income statement T accounts would
then look like this:

When (hopefully) a Net Profit is made in the next period it too will be carried in the
balance sheet. Thus the Net Profits of the first and second years’ trading will be added
together in second years’ balance sheet to show the total net profit made since the
business began. This figure is often referred to as ‘reserves’.

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Income Statement Income Statement

€ € € €

Purchases 200 Sales 500 Rent 100 Gross Profit 300

Gross Profit Electricity 20

Trfr IS 300 Net Profit c/d 180

500 500
300 300
Net Profit c/d 180

Balance Sheet as at 31st December 200X

Cost Depreciation NBV
ASSETS € € €
Non Current Assets
Property x x x
Plant x x x
Equipment x x x
x x x
Current Assets
Inventory x
Receivables x
Prepayments x x
Cash in hand and at bank x x
€
EQUITY AND LIABILITIES
Capital x
Profit for the year x
x
Less: Drawings x
Proprietor’s interest x
Non Current Liabilities
10% loan x
Current Liabilities
Trade payables x
Accruals x x
x

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The Balance Sheet in Detail

We will now look again at the pro forma balance sheet and explain each major cat-
egory of asset and liability in a bit more detail.
Non Current Assets:
A non current asset is an asset acquired for use within the business, with a view to
earning profits from it use. A non current asset is not acquired for resale.
Non current assets are usually held and used by a business for a number of years.
Each year that the asset is used will wear it out a little until it reaches the end of its
useful life (with the exception of freehold land which is considered to have a finite
useful life). It would not be ‘correct’ or ‘fair’ to continually include non current assets
in the financial statements at their original cost. The financial statements try to rec-
ognise that the cost of the asset is gradually consumed as it wears out – this is done
by gradually writing off the asset cost in the income statement over several account-
ing periods. This process is known as depreciation. This annual depreciation charge
becomes an expense of trading and is included in the income statement with other
expenses incurred in order to trade.
‘Depreciation is the measure of the wearing out, consumption, or other reduction in
the useful economic life of a fixed asset, whether arising from use, passage of time, or
obsolescence through technical or market changes. Depreciation should be allocated
so as to charge a fair proportion of cost or valuation of the asset to each accounting
period expected to benefit from its use’.
The total amount of depreciation to be charged is usually its cost less any expected
residual sales value at the end of the assets life.
Non current assets are normally valued in the balance sheet at cost less ‘accumu-
lated depreciation’. Accumulated depreciation is the depreciation charge made in the
first year that the asset is owned and used, plus the depreciation charge is made in
the second year of ownership etc. The name given to the cost of the asset less accu-
mulated depreciation is ‘Net Book Value’ (NBV). This is the figure on the right hand
side of the pro forma balance sheet.

Causes of Depreciation

1. Physical Depreciation
(a) Wear and tear – when motor vehicles, equipment etc. are used they even-
tually wear out;

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(b) Erosion – land may be eroded or wasted by wind, rain, sun etc. and motor
vehicles will rust and wood rot etc.

2. Economic Factors
(a) Obsolescence — assets can become out of date as more advanced
models are introduced;
(b) Inadequacy – the asset is no longer used because of changes in the size
of the firm.
These economic factors do not necessarily mean the asset is destroyed etc. It
may be used by another company.

3. Time Factor
Some assets have a fixed legal life e.g. building lease, patent.

4. Depletion
Some assets have a wasting character, perhaps due to the extraction of
raw materials from them i.e. natural resources such as mines, oil wells and
quarries.

Depreciation as an Allocation of Cost

Depreciation in total over the life of the asset is simply its cost less the amount
received when put out of use.
Depreciation allocates cost to each accounting period, but there is no ‘true’ method
of performing this task. Cost should be allocated over the life of the asset in such a
way as to charge it as equitably as possible to the periods in which the asset is used.
But in practice this has considerable difficulties:

1. Apart from a few assets, e.g. lease, how accurately can a firm assess an
asset’s useful life?
2. How does one measure usage? (especially in advance) How should cost then
be apportioned?
3. Other expenses may effect the rate/speed of depreciation e.g. repairs, main-
tenance etc.
4. How can a company predict NRV in x years?

The calculation of depreciation is not an exact science and is done mainly as an

accounting custom.

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Choice of Method

The purpose of depreciation is to spread the total cost of the asset over the periods
in which it is available to be used. The method chosen should be that which allocates
cost to each period in accordance with the amount of benefit gained from the use of
the asset in the period. The two most common methods are:

(i) Straight Line Method

The total depreciable amount is charged in equal instalments to each account-
ing period over the expected useful life of the asset.
i.e. = Cost of Asset – Residual Value
Expected Useful Life of Asset
(To the present owner)
Example: Fixed Asset cost €15,000
Estimated useful life 3 years
No residual value
Depreciation charge per annum = €15,000 = €5,000 per annum
3
Therefore €5,000 is charged to the income statement each year.

Effect on Balance Sheet:

Year 1 Year 2 Year 3
€ € €
Cost of Asset 15,000 15,000 15,000
Accumulated 5,000 10,000 15,000
Depreciation
Net Book Value 10,000 5,000

The straight line method assumes that the business enjoys equal benefits from
the use of the asset in every period throughout its life.

(ii) Reducing Balance Method

The reducing balance method of depreciation calculates the annual deprecia-
tion charge as a fixed percentage of the net book value of the asset as at the
end of the previous period.

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Example: Fixed Asset cost €10,000

Residual value €2,160
Rate of depreciation 40% reducing balance
* Total depreciable amount = €10,000 – €2,160 = €7,840
€
Asset at cost 10,000
Depreciation year 1 (40%) 4,000
Net book value at end year 1 6,000
* Depreciation year 2 (40%) 2,400
Net book value at end year 2 3,600
Depreciation year 3 (40%) 1,440
Net book value at end year 3 2,160
Effect on Balance Sheet:
Year 1 Year 2 Year 3
€ € €
Cost of Asset 10,000 10,000 10,000
Accumulated Depreciation 4,000 6,400 7,840
Net Book Value 6,000 3,600 2,160

Reducing balance method assumes that the benefits obtained by the business
from using the asset decline over time.

But which method should be used?

(a) If the main value is to be obtained in early years, reducing balance may be
appropriate as it charges more in early years.
The advocates of reducing balance argue that it helps to even out the total
charged as expenses for the use of the asset each year i.e. depreciation is not
the only cost charged, also are running costs and repairs and maintenance that
increases with age.

Early Years Later Years

Higher depreciation Approximates to Lower depreciation
+ +
Lower repairs Higher repairs

(b) If the benifits are to be gained evenly over the years, straight line method
would be appropriate.

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Depreciation Provisions and Assets Bought/Sold

There are two main methods of calculating depreciation provisions for assets bought
or sold during an accounting period.

1. Ignore dates when bought or sold and charge full year’s depreciation on the
assets in use at the end of the period.
i.e. full year of depreciation in year of purchase and none in year of sale.

2. Calculate on a monthly basis.

Recording Depreciation

Separate accounts are set up for – Asset (at cost)

– Depreciation Provision

No entry is made in the asset account for depreciation; instead it is shown in a

separate provision account.
Dr. Depreciation IS
Cr. Depreciation Provision B/S

Example
A company with a 31/12 year end buys a machine on 1/1/0R for €2,000. It is to
be depreciated at 20% pa R.B.
Machinery Income Statement
200R € € €
200R 400
1/1/0R Cash 2,000 200S 320
200T 256
Depreciation Provision Balance Sheet
200R € 200R € 31.12.0R € €
Machinery at 2,000
cost
31/12 Bal c/d 400 31/12 P+L 400 Depreciation 400 1600
at cost
200S 200S 31.12.0S
1/1 Bal b/d 400 Machinery at 2,000
cost
(Continued overleaf )

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31/12 Bal c/d 720 31/12 P+L 320 Depreciation 720 1280
720 720
200T 200T 31.12.0T
1/1 Bal b/d 720 Machinery at 2,000
cost
31/12 Bal c/d 976 31/12 P+L 256 Depreciation 976 1,024
976 976

Change in the Remaining Expected Life of Asset

When there is a revision of the remaining expected life of an asset, the remaining
un-depreciated amount should be charged over the revised remaining useful life.

Example: Fixed Asset cost €20,000

EUL 10 years
Residual value NIL
Initially, the straight line depreciation charged per annum would be €2,000
(€20,000 / 10). However, if after two years it was realised that there was only
six more years use left in the asset, then:
Revised €16,000 = €2,667 per annum
Depreciation charge: 6 years
i.e. Net book value at
date of change Revised
RUEL

The Disposal of an Asset

Fixed assets are not purchased with the intention of reselling them in the normal
course of trade: however a business might decide to sell off a fixed asset long before
its useful life has ended.When we charge depreciation, we have to make judgments
(or guesses). We cannot be absolutely certain how long we will keep the asset in use,
nor can we be certain at the date of purchase how much cash will be received for the
asset when we dispose of it. To get our guesses absolutely correct would be quite
rare. This means that when we dispose of an asset, the cash received for it is usually
different from our original guess.
When an asset is sold there is likely to be a profit / loss on the disposal and this is
calculated as being the difference between:

n the net book value of the asset at the time of sale; and
n its net sales price, which is the price minus any costs of making the sale.

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A profit is made when the sale price exceeds the net book vale and a loss is made
when the sale price is less than the net book value.
This can be shown by looking at a simple illustration. At the end of 200T, the value
of the machinery on the balance sheet is shown as €1,024. We can now see the
entries needed if (1) the machinery was sold on 2nd January 200U for €1,070 and
then (2) if instead it had been sold for €950.

(a) Transfer the cost price of the assets (Dr) Machinery Disposals a/c
sold to an Asset Disposal Account (Cr) Machinery Account
(in this case a Machinery Disposals
Account).
(b) Transfer the depreciation already (Dr) Provisions for Depreciation
charged to the Asset Disposal – Machinery
Account. (Cr) Machinery Disposals Account
(c) For remittance received on disposal. (Dr) Cash Book
(Cr) Machinery Disposals Account
(d) Transfer balance (difference) on
Machinery Disposals Account to
the income statement.
If the difference is on the debit side (Dr) Machinery Disposals Account
of thedisposal account, it is a profit (Cr) Income statement
on sale.
If the difference is on the credit side (Dr) Income statement
of the disposal account, it is a loss (Cr) Machinery Disposals Account
on sale.

Example 1 — Depreciation:
A company starts in business on 1 January 200W, the financial year end being
31st December. The company bought machinery as follows:
200W 1st January 1 machinery costing €800;
200X 1st July 2 machines costing €500 each;
st
1 October 1 machine costing €600; and
200Z 1st April 1 machine costing €200.
The company depreciates machinery at the rate of 10 per cent per annum
straight line, with machines being depreciated for each proportion of a year.
You are to show:
(a) The machinery account;
(b) The provision for depreciation account; and
(c) The balance sheet extracts for each of the years 200W, 200X, 200Y and
200Z. (Continued overleaf )

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Solution
Machinery Provision for Depreciation
€ € € €
1.1.W Bank 800 31.12.W Bal c/d 800 31.12.W Bal c/d 80 W Depr 80
800 800 80 80
1.1.X Bal b/d 800 1.1.X Bal b/d 80
1.7.X 1,000 31.12.X Bal c/d 225 X Depr 145
1.10.X 600 31.12.X Bal c/d 2,400 225 225
2,400 2,400 1.1.YBal b/d 225
1.1.Y Bal b/d 2,400 31.12.Y Bal c/d 2,400 31.12.Y Bal c/d 465 Y Depr 240
2,400 2,400 465 465
1.1.Z Bal b/d 2,400 1.1.Z Bal b/d 465
1.1.Z 200 31.12.Z Bal c/d 2,600 31.12.Z Bal c/d 720 Z Depr 255
2,600 2,600 720 720
Bal b/d 2,600 Bal b/d 720
Balance Sheet Extracts:
200W 200X 200Y 200Z
€ € € €
Cost 800 2,400 2,400 2,600
Accum. depreciation (80) (225) (465) (720)
NBV 720 2,175 1,935 1,880

Example 2 — Depreciation:
On 1 January 200W, John Smith purchased six machines for €1,500 each. His
accounting year ends on 31st December. Depreciation at the rate of 10% per
annum on cost has been charged against income each year, and credited to a
provision for depreciation account. On 1st January 200X, one machine was sold
for €1,250 and on 1st January 200Y a second machine was sold for €1,150. An
improved model which cost €2,800 was purchased on 1st July 200X. Depreciation
was charged on this new machine at the same rate as that on earlier purchase.
Required
(a) the machinery a/c and the provision for depreciation a/c for 200W, 200X and
200Y; and
(b) the entry for machines in the balance sheet at 31st December 200Y.
Solution
Machinery
€ €
1.1.W Bank 9,000 31.12.W Bal c/d 9,000
9,000 9,000
1.1.X Bal b/d 9,000 1.1.X Disposal 1,500
1.7.X 2,800 31.12.X Bal c/d 10,300
(Continued overleaf )

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11,800 11,800
1.1.Y Bal b/d 10,300 1.1.Y Disposal 1,500
31.12.Y Bal c/d 8,800
10,300 10,300
1.1.Z Bal b/d 8,800
Provision for Depreciation
€ €
31.12.W Bal c/d 900 W Depr Exp 900
900 900
1.1.X Disposal 150 1.1.X Bal b/d 900
31.12.X Bal c/d 1,640 X Depr Exp 890 (*)
1,790 1,790
1.1.Y Disposal 300 1.1.Y Bal b/d 1,640
31.12.Y Bal c/d 2,220 Y Depr Exp 880 (**)
2,520 2,520
1.1.Z Bal b/d 2,220
Disposal
200X € €
Machinery 1,500 Acc. Depr 150
Bank 1,250
IS – Loss 100
1,500 1,500
200Z
Machinery 1,500 Acc. Depr 300
Bank 1,150
IS – Loss 50
1,500 1,500
(*) (5 x €1500 x 10%) + (€2800 x 10% x 6/12) = €890
(**) (4 x €1500 x 10%) + (€2800 x 10%) = €880

Current Assets:

Current assets are assets acquired by the business with the intention of turning them
into cash in the ordinary course of business within one year. Cash itself is also a cur-
rent asset whether ‘cash in hand’ or ‘cash at bank’. The main categories of current
assets are inventory, receivables and cash.
‘Receivables’ can be divided into:

(a) Trade receivables – people owe money to the business for goods bought on
credit in the ordinary course of business;

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(b) Other receivables – anyone else owing money to the business; and
(c) Prepayments – amounts of money paid by the business prior to the balance
sheet date for items which will not be used by the business until the next
accounting period e.g. rent paid for in advance.

Current assets should never be valued at more than their ‘net realisable value’ i.e.
the amount of cash they will earn for the business when they are converted to cash
less any further costs that the business will need to incur in order to convert them
into cash. Consequently, it may be necessary to make a provision for bad debts in the
financial statements.

Bad Debts

Bad debts arise where a customer buys goods on credit and fails to pay for them.

Specific bad debts

For many businesses a large proportion (if not all) of sales are on credit. The com-
pany is therefore taking a risk that customers may never pay their accounts. But this
is a ‘normal business risk’ and therefore ‘bad debts’ are a normal business expense
which should be charged to the income statement.
When a debt is found to be bad (i.e. specific), it should be written off as the balance
in the debtors account is worthless i.e. ‘asset’ had no value. For example:

Originally – DR Receivables
CR Sales
When bad – DR Bad Debts a/c
CR Receivables
At Year end – DR IS
CR Bad Debts

General provision for bad debts

In addition to accounting for specific bad debts we also need to make a provision for
potential/general bad debts i.e. sales that may not get paid. Receivables are an asset
in the balance sheet and if everyone paid this asset would be turned into an asset of
‘cash’. But we must consider if our asset of ‘receivables’ is realistic.

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Frequently companies/industries have a fair knowledge of what percentage of

credit sales will turn bad. If the receivables figure is not fully recoverable, we should
provide now. But how do we estimate the bad debt provision?

1. Look at each account and judge those that are likely to go bad (aged receiva-
bles list).

2. Using past experience, and provide a percentage.

When a provision is first made, the amount of the initial provision is charged as an
expense in the income statement, for the period in which provision is created.
DR Bad Debts Expenses a/c (IS)
CR Bad Debts Provision a/c (B/S)
When a provision already exists, but is subsequently increased in size, the amount
of the increase is charged as an expense in the income statement, for the period in
which provision is made.
DR Bad Debts Expenses a/c (IS)
CR Bad Debts Provision a/c (B/S)
When a provision already exists, but is subsequently reduced in size, the amount of
the decrease in provision is recorded as an item of income in the income statement,
for the period in which the reduction in provision is made.
DR Bad Debts Expenses a/c (IS)
CR Bad Debts Provision a/c (B/S)
Note – In the balance sheet, the value of receivables must be shown after deducting
the provision for doubtful debts.

Bad debts recovered

It is not uncommon for a debt written off in previous years to be recovered:

1. Reinstate the debt
DR Receivables
CR B/D Recovered a/c (not sales)
The reasons for reinstating the debt are to have a detailed history of the
account as a guide for future credit.
2. When cash received
DR Cash/Bank
CR Receivables

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At the year end, the credit balance on the bad debt recovered account should be
netted against the bad debt account and the net figure transferred to the income
statement.

Example
A business had always made a provision for bad debts at the rate of 5% of
receivables. On 1st January 200X, the provision for this, brought forward from the
previous year, was €260. During the year ended 31st December 200X, the bad
debts written off amounted to €540. On 31st December 200X, the remaining debt-
ors totalled €6200 and the usual provision for bad debts is to be made.
Prepare the:
(i) Bad debt account for the year ended 31st December 200X;
(ii) Extract from the income statement for the year ended 31st December 200X;
and
(iii) Relevant extract from the balance sheet as at 31st December 200X.
(i) Bad Debts Accounts
€ €
31/12 Bad Debts % 540 IS 590

31/12 Provision 50
590 590
Provision of Bad Debts
€ €
1/1 Bal B/d 260
31/12 Bal c/d 310 *Bad Debts (IS) 50
*(6,200⫻5%) 310 310
Bal b/d 310
(ii) Charge to income statement is €590.
(iii) Balance Sheet Extract €
Trade receivables 6,200
Less: Bad Debt Provision 310
5,890

Non Current Liabilities:

In the pro forma balance sheet shown previously there is only one non current liability,
the 10% loan. Any liability which is not a current liability should be classed as a long term
liability, i.e. typically any liability which is not due to be paid until after more than a year.

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Examples of long term liabilities are:

n loans which are not repayable for more than one year;
n mortgage, which is specifically secured against a freehold property; and
n debentures - these are types of loans which are common in limited companies.
They are securities issued by a company which give a fixed rate of interest.
The holder of a debenture has effectively loaned money to the company for an
agreed length of time.

Current Liabilities:

n These are amounts owed by the business which must be paid within one year.
Examples of current liabilities are:
n loans which are repayable within one year;
n bank overdraft;
n trade payables; and
n accrued charges (accruals).

Trade payables relate to creditors/people to which the business owes money in

respect of a supply of goods.
Accrued charges, commonly referred to as ‘accruals’, are amounts owed by the
business in respect of expenses for which the business has made no payment at the
balance sheet date e.g. rent, electricity or telephone charges which are paid for in
arrears.

Proprietor’s Interest:

As we know from previous sections, the proprietor’s interest is made up of capital

plus profit less drawings and represents the extent of his investment in the business.
Capital is money introduced by the proprietor to start up the business plus any
amounts that he has introduced in subsequent periods.
Profit is the profit earned in a period plus any profits which were retained in the
business from previous periods. This accumulated profit is often referred to as
‘reserves’.
Drawings are amounts taken out of the business by the proprietor.
Bear in mind that the income statement is intended to show all revenue and
expenditure relating to the period. (This will rarely be the same as receipts and pay-
ments in the period).

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The Income Statement in Detail

We will look again at the pro forma income statement and explain the categories
of revenue and expenditure in a little more detail.
Income statement for the Year Ended 31st December 200Z
€ €
Sales x
Less: Cost of Goods Sold
Opening inventory x
Purchases of goods x
x
Less: Closing inventory (x) (x)
Gross Profit x
Less Expenses:
Rent x
Rates x
Lighting and Heating x
Stationery x
Insurance x
Salaries x
Accountancy charges x
Bank charges x (x)
Net Profit for the Year x

Sales:

This may also be shown as ‘revenue’, and represents the value of the sales made
during the period excluding any VAT charged. This figure will be made up of both cash
sales and credit sales and may well include sales made to people who have not yet
paid the business for the items sold to them.

Cost of Goods Sold:

This is sometimes called ‘cost of sales’. In a retail business, the cost of the goods
sold is their purchase price (the price that the business had to pay to acquire the
goods). In a manufacturing business, the cost of the goods sold will include the cost
of converting raw materials into the finished product as well as the purchase price of
the raw materials themselves.
It is important to realise that the figure we wish to arrive at for Cost of Goods Sold
must represent the cost of the goods actually sold by the business in the period. If the

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business has not sold all the goods it has purchased in the period it will have inventory
left at the end of the period. This is called ‘closing inventory’ and the purchase price
of this closing inventory will not be charged to the cost of sales. The purchase price
of the closing inventory must be carried forward into the next period so that when
the goods are sold their cost can be included in the figure for ‘cost of goods sold’ in
the same period as that in which the sale took place.
This may be easier to see if we look at a simple example.
Mr Sneeze started a business selling boxes of handkerchiefs. In his first year of
trading he bought 60 boxes for €1 each (the purchase price). He sold 40 boxes dur-
ing the year for €1.25 each. His cost of goods sold will be the cost (purchase price)
of the 40 boxes of handkerchiefs that he sold during the year.
i.e. 40 x €1 = €40
From this information we can produce his income statement for the first year:

€ €
Sales (40 boxes sold at €1.25) 50
Less: Cost of Goods Sold:
Opening inventory (He started with nothing) –
Purchase of goods (He bought 60 boxes for €1 each) 60
60
Less: Closing inventory (He had 60 - 40 = 20 boxes left
which had cost him 20 x €1) (20)
(40)
Gross profit 10

In the second year of trading, although Mr Sneeze still had the 20 boxes of hand-
kerchiefs that he had not sold in the first year, he decided to buy 30 more boxes. He
still bought them for €1 per box and charged his customers €1.25 per box. At the end
of the second year, as Mr Sneeze had managed to sell 45 boxes of handkerchiefs,
he had 5 boxes left (20 + 30 – 45 = 5). We can show his income statement for the
second year:
As you can see, the cost of the 20 boxes of handkerchiefs which were ought during
the first year, but sold in the second year, has been included in the figure for ‘cost of
goods sold’ in the second year. This is because they were sold in the second year and
revenue and expenditure must be ‘matched’.

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€ €
Sales (45 boxes sold at €1.25) 56.25
Less: Cost of Goods Sold:
Opening inventory 20
Purchase of goods (30 boxes for €1 each) 30
50
Less: Closing inventory (5 boxes at €1 each) (5) (45)
11.25
Gross profit

Example 1:
Suppose that Perry P. Louis, trading as the Umbrella Shop, ends his financial
year on 30th September each year. On the 1st October 200X, he had no goods in
inventory. During the year to 30th September 200Y, he purchased 30,000 umbrel-
las costing €60,000. He resold the umbrellas for €5 each, and sales for the
year amounted to €100,000. At 30th September 200Y, there were 10,000 unsold
umbrellas left in inventory, valued at €2 each.
What was Louis’ gross profit for the year?
Solution
€ €
Sales (20,000) 100,000
Purchases (30,000) 60,000
Less: Closing inventory (10,000 at €2) 20,000
Cost of Sales 40,000
Gross profit 60,000

Example 2:
During the year 1st October 200Y to 30th September 200Z, Louis purchased 40,000
umbrellas at a total cost of €95,000 and sold 45,000 umbrellas for €230,000. At
30th September 200Z, he had 5,000 umbrellas left in inventory, which had cost
€12,000.
What was his gross profit for the year?
Solution
€ €
Sales (45,000) 230,000
Opening inventory (10,000) 20,000
Add: Purchases (40,000) 95,000
115,000
Less: Closing inventory (5,000) 12,000
Cost of Sales 103,000
Gross Profit 127,000

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Gross Profit:

The difference between the value of sales and the cost of the goods sold.

Expenses:

This section of the income statement will show all the expenditure incurred by the
business which is not a direct cost of goods sold. For example, rent, rates, electricity
(lighting and heating) are included in this part of the income statement. The figures
shown under each category of expense will be the charge for that type of expense
for the period.
If the business has already paid an expense in advance, it should not be included
as an expense of the current period. It will be an expense of the next period. For
example:
Mr Shake ran a business with an accounting period running from 1st January to 31st
December each year. His rent was €200 per year. In the first year of the business he
paid rent on the business premises for two years as a sign of good faith to his land-
lord. At the end of his first year he would only include one year’s rent i.e. €200 as an
expense in his income statement. The second year’s rent would be an expense of the
next period even though it was paid for in the first period.
This concept will be developed at a later stage when we look at ‘Accruals’ and
‘Prepayments’. At this stage, a useful definition of an income statement is:
‘A income statement is both a financial statement and a ledger account which
matches against the revenues of a period of time the expenses of obtaining those
revenues and the expenses of the facilities used during the period with a view to
showing the net excess of the revenues of the period over those expenses, such
excess being called net profit’.

Example:
The following trail balance was extracted form the books of B Jackson on 30th
April 200W. From it, and the notes, prepare his income statement for the year
ended 30th April 200W, and a balance sheet as at that date.
Dr. Cr.
€ €
Sales 18,600
Purchases 11,556
(Continued overleaf )

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Inventory 1st May 200V 3,776

Carriage outwards 326
Carriage inwards 234
Returns inwards 440
Returns outwards 355
Salaries and wages 2,447
Motor expenses 664
Rent 576
Sundry expenses 1,202
Motor vehicles 2,400
Fixtures and fittings 600
Receivables 4,577
Payables 3,045
Cash at bank 3,876
Cash in hand 120
Drawings 2,050
Capital 12,844
34,844 34,844
Inventory at 30th April 200W was €4,998.
Solution
B Jackson
Income Statement for the Year Ended 30th April 200W
€ €
Sales (€18,600 – €440) 18,160
Opening inventory 3776
Purchases (€11,556 + €234 = €335) 11,435
Closing inventory (4,998)
Cost of goods sold 10,213 10,213
Gross profit 7,947

Expenses:
Carriage outwards 326
Salaries and wages 2,447
Motor expenses 664
€ €
Rent 576
Sundry expenses 1,202 5215
Net profit 2732
(Continued overleaf )

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B Jackson
Balance Sheet as at 30th April 200W
€ €
Non Current Assets
Motor vehicles 2,400
Fixtures and fittings 600
3,000
Current Assets
Inventory 4,998
Receivables 4,577
Cash at bank 3,876
Cash in hand 120
13,571
16,571
Capital at beginning of year 12,844
Plus: Net profit for year 2732
Less: drawings (2,050)
13,526
Current Liabilities
Payables 3,045
13526

Summary of Section Three

Section Three has examined the Trial Balance and considered whether the balances
belong in the balance sheet or the income statement. This section has also introduced
some book keeping notation and looked at the balance sheet and income statement
in more depth.
It is not essential, at this stage, to understand all the detail about the balance sheet
and income statement. It is sufficient to remember that the balance sheet carries bal-
ances representing assets and liabilities and that the income statement contains the
revenue and expenditure relevant to the period in question. You should, however, be
able to extract balances for a Trial Balance and decide whether those balances belong
in the balance sheet or income statement.
You should now try the Self Test Questions which follow the Glossary of Terms.

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Glossary of Terms
Trial balance: A list summarising all debit and credit balances from the
ledger accounts.
Income statement: Both a financial statement and a ledger account which
matches against revenues of a period of time the
expenses of obtaining those revenues in that period. From
this matching the net profit to be transferred to the balance
sheet is established.
Non current assets: Assets acquired for use within the business on a perma-
nent basis.
Current assets: Assets such as cash, receivables and inventory that can
be easily realised. They are acquired with the intention of
turning them into cash in the ordinary course of the busi-
ness within one year.
Current liabilities: Amounts owed by a business which are payable within
one year.
Working capital: The excess of current assets over current liabilities (i.e.)
the amount that remains for the running of a business.
Non current liabilities: Amounts owed by a business which are payable after
more than one year.
Sales: The total of cash and credit sales made during the period
excluding any VAT charged.
Cost of goods sold: Also called cost of sales. This is the cost to the business
of the goods actually sold during the period.
Gross profit: The excess of the value of sales over the cost of goods
sold.
Expenses: The costs incurred in earning revenues for the period.
Net profit: The excess of gross profit over expenses.

SELF TEST QUESTIONS – SECTION THREE

1. A list summarising all debit and credit balances from the ledger accounts is
called a .................

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2. Items of an expense and revenue nature are matched in the ........... ........ All
other balances are carried forward to the next period and appear in the .......
.......
3. Give a brief definition of a balance sheet.
4. Give a brief definition of an income statement.
5. Profit is calculated in two stages: the first stage being calculated as the differ-
ence between sales and cost of goods sold when the difference is called ........
....... .
The second stage is the deduction of expenses in the income statement to give
a final figure called .... ......... .
6. If revenues exceed expenses for a period the net result will be a ......... .
If expenses exceed revenues the net result will be a ....... .
7. State whether the following balances would be shown in the income statement
or in the balance sheet.

(a) €1,000 debit balance on the Van a/c

(b) €10,000 credit balance on the Sales a/c
(c) €1,500 credit balance on the Payables a/c
(d) €5,000 credit balance on the Capital a/c
(e) €200 debit balance on the Rent a/c
(f) €2,000 debit balance on the Receivables a/c
(g) €7,000 debit balance in the Purchases a/c.

8. Close off the following ledger accounts stating the type of balance (debit bal-
ance or credit balance) and indicating by your narrative in the ledger account
whether the balance has been transferred to the income statement or whether
it has been carried forward in the balance sheet.

Cash Account
€ €
Bal. b/d 3,000 Purchases 1,000
Sales 1,500 Electricity 100
Purchases Account
€
Cash 1,000
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Sales Account
€
1,500
Cash Electricity Account
€
Cash 100
Capital Account
€
Bal. b/d 3,000

9. If the ledger accounts shown in Question 8. were the complete set of ledger
accounts of a business complete the Trial Balance below.
Dr Cr
€ €
Cash account
Purchases account
Sales account
Electricity account
Capital account
10. Using the Trial Balance that you have completed identify the items which
should be shown in an income statement and complete the one below.

Income Statement for the Period Ended XXXX

€ €
Sales
Less: Cost of Goods Sold
Opening inventory
Purchases
Less: Closing inventory
Gross profit
Less: Expenses
Electricity
Net profit for the period
11. Using the Trial Balance from Question 9. and the net profit from Question 10.
complete the balance sheet.
Balance Sheet as at XXXX
€
Current Assets
Cash
Representing:
Capital
Profit for the period

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The following question is more difficult than the previous questions. Do not attempt
it until your answers to the previous are consistently correct. Have a serious attempt
at this next question before working through the answers. If you get a correct answer
at the first attempt you are doing well with the material covered in Section Three and
can move on to Section Four.

12. Mr Saddle started in business as a typewriter spares retailer on 1st January

with a capital in cash of €5,000.
During January the following transactions took place.
On 3rd January, Mr Saddle:

(a) visited a local wholesaler and purchased €1,000 worth of typewriter parts
for which he paid cash;
(b) rented a shop and paid his first months rent of €100 in cash;
(c) called in at a firm of shop fitters and purchased a display cabinet for €500
in cash;

On 4th January, Mr Saddle’s first customer arrived and bought some spare
parts for €75 for which he paid cash.

Mr Saddle’s other sales in January were: €

(d) week ending 14th January cash sales 200
(e) week ending 21st January cash sales 500
(f) week ending 28th January cash sales 1,050

His other purchases in January were:

(g) 14th January typewriter parts for cash 250

His shop expenses during the month in addition to his rent were:
(h) week ending 7th January, stationery paid in cash 25
(i) week ending 14th January, sundries paid in cash 15
(j) week ending 21st January, advertising paid in cash 50
(k) week ending 28th January, shop furniture paid in cash 200
(l) 28th January, telephone installation charge paid in cash 25

Write up the ledger accounts for Mr Saddle’s business for the month of January and
extract a Trial Balance at 31st January.

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Then prepare the income statement and balance sheet assuming a sales price of
€2.50 per unit and a purchase price of €1 per unit.

Self Test Questions – Section Three Answers

1. Trial Balance
2. Income statement, balance sheet
3. A statement of assets and liabilities at a point in time.
4. A statement matching revenue and expenses relating to a period of time.
5. Gross Profit, Net Profit (or Net Loss)
6. Profit, Loss
7. a) Balance sheet
b) Income statement (Revenue, cost of sales and gross profit section)
c) Balance sheet
d) Balance sheet
e) IS
f) Balance sheet
g) IS (Revenue, cost of sales and gross profit section)

8.
Cash Account
€ €
Bal. b/d 3,000 Purchases 1,000
Electricity 100
Sales 1,500 Bal. c/d 3,400
4,500 4,500
Bal. b/d 3,400
(a debit balance)
Purchases Account
€ €
Cash 1,000 Trfr. to Cos 1,000
1,000 1,000
(a debit balance)
Sales Account
€ €
Trfr. to Cos 1,500 Cash 1,500
1,500 1,500
(a credit balance)
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Electricity Account
€ €
Cash 100 Trfr. to Cos 100
100 100
(a debit balance)
Capital Account
€ €
Bal. c/d 3,000 Cash 3,000
3,000 3,000
Bal. b/d 3000
(a credit balance)

9.
Dr. Cr.
€ €
Cash Account 3,400
Purchases Account 1,000
Sales Account 1,500
Electricity Account 100
Capital Account 3,000
4,500 4,500

10.
Income Statement for the Period Ended XXXX

€ €
Sales 1,500
Less: Cost of Sales
Opening inventory –
Purchases 1,000
1,000
Less: Closing inventory (–)
(1,000)
Gross Profit 500
Less: Expenses
Electricity (100)
Net Profit for the Period 400

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11.

Balance Sheet as at XXXX

€
CURRENT ASSETS
Cash 3,400
NET ASSETS 3,400
Representing:
Capital 3,000
Profit for the period 400
PROPRIETOR’S INTEREST 3,400

12.

Capital Account (Mr Addle)

€ €
Jan 31 Bal. 5,000 Jan 1 Cash 5,000
5,000 5,000
Cash Account
€ €
Jan 1 Capital 5,000 Jan 3 Purchases 1,000
Jan 4 Sales 75 Jan 3 Rent 100
Jan 14 Sales 200 Jan 3 Shop fittings 500
Jan 21 Sales 500 Jan 7 Stationery 25
Jan 28 Sales 1,050 Jan 14 Purchases 250
Jan 14 Sundries 15
Jan 21 Advertising 50
Jan 28 Shop Furniture 200
Jan 28 Telephone 25
Jan 31 Balance 4,660
6,825 6,825
Purchases Account
€ €
Jan 3 Cash 1,000
250 Jan 1 Balance 1,250
1,250 1,250
Rent Account
€ €
Jan 3 Cash 100 Jan 31 Balance 100
100 100
Shop Fitting Account
€ €
Jan 3 Cash 500 Jan 31 Balance 500
500 500
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Stationery Account
€ €
Jan 3 Cash 25 Jan 31 Balance 25
25 25
Sales Account
€ €
Jan 4 Cash 75
Jan 14 Cash 200
Jan 21 Cash 500
Jan 31 Balance 1,825 Jan 28 Cash 1,050
1,825 1,825
Sundries Account
€ €
Jan 14 Cash 15 Jan 31 Balance 15
15 15
Advertising Account
€ €
Jan 21 Cash 50 Jan 31 Balance 50
50 50
Shop Furniture Account
€ €
Jan 28 Cash 200 Jan 31 Balance 200
200 200
Telephone Account
€ €
Jan 28 Cash 25 Jan 31 Balance 25
25 25

Trial Balance as at 31st January

€ €
Dr Cr
Capital (Mr Addle) 5,000
Cash 4,660
Purchases 1,250

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Rent 100
Shop Fittings 500
Stationery 25
Sales 1,825
Sundries 15
Advertising 50
Shop Furniture 200
Telephone 25
€6,825 6,825

Mr Addle
Income statement for month of January € €
Sales 1825
Cost of Sales:
Opening Inventory Nil
Purchases 1250
Closing Inventory (520) (730)
Gross Profit 1095

Expenses:
Rent 100
Stationery 25
Sundries 15
Advertising 50
Telephone 25 (215)
Net Profit 880

Mr Addle Balance Sheet at 31 January € €

Non Current Assets:
Shop Fittings 500
Shop Furniture 200
700
Current Assets:
Inventory 520
Cash 4660 5180
5880
Financed By:
Capital 5000
Net Profit 880
5880

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SECTION FOUR: ADJUSTMENTS FOR FINANCIAL STATEMENTS

Introduction

This Section examines the recording of credit transactions and some of the sub-
sidiary books kept by a business. It also looks at the common types of accounting
documents that are used by a business as well as some of the reconciling statements
that a business will have to prepare.

Credit Transactions

A business which buys goods on credit will receive the goods and pay for them at a
later date. The amount owing to the supplier of the goods is a liability and is described
as a trade payable in the balance sheet. Sales may also be made to customers on
credit. The customer will take the goods and pay for them at a later date. The amount
that the customer owes the business is an asset and is described as a receivable in
the balance sheet.
To record a purchase of €100 on credit the entries required are:

Dr Purchases €100
Cr Trade payables €100

To record a sale of €200 on credit the entries required are:

Dr Trade receivables €200

Cr Sales €200

(The entries that would have been to cash in a cash purchase or sale are now to
payables or receivables.)
At a later date when cash is paid for the credit purchase the entries will be:

Dr Trade payables €100

Cr Cash €100

And when money is received in respect of the credit sale the entries will be:

Dr Cash (or Bank) €200

Cr Trade receivables €200

If we record each purchase a business makes on credit in a trade payables

account we will know how much the business owes at any time to its creditors. But
how will we know to whom the business owes the money?

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For example:

Mr White bought goods on credit from Mr Green for €100. He also bought goods on
credit from Mr Brown for €300.
If we record these transactions in the ledger accounts we will have:

Purchases Account Payables Account

€ € €
Payables 100 Purchases 100
Payables 300 Balance 400 Purchases 300
____ ____
400 400

By ruling off the payables account we can see that Mr White’s business owes €400
to creditors but we cannot see which particular creditors. One solution would be to
have two creditors accounts, one for amounts owing to Mr Green and one for amounts
owing to Mr Brown, both being part of the double-entry ledger system.

Purchases Account Payables Account (Mr Green)

€ €
Payables Purchases 100
(Green) 100
Payables
(Brown) 300

Payables Account (Mr Brown)

€
Purchases 300

If Mr White only buys goods from a few suppliers this solution would be a feasible
one. If he buys goods from hundreds of different suppliers you can see we would have
far too many individual ledger accounts forming part of our double-entry system to
cope with. Also, there would be a huge number of entries in the purchases account.
A similar situation arises for sales on credit. For example:
Mr White sells goods on credit to Mr Smith for €150 and also to Mr Jones for €350.
The ledger accounts would look like this.

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Receivables Account Sales Account

€ € €
Sales 150 Receivables 150
Sales 350 Balance 500 Receivables 350
___ ___
500 500

The ruled off receivables account shows a debit balance of €500. This is an asset
to the business. If Mr White does not know who owes him money he will not be able
to collect it unless the two debtors decide to pay of their own accord.
Again, a solution might be to have a separate receivables account for each customer
but there is still the potential problem of hundreds of individual ledger accounts in our
double-entry system as well as hundreds of separate entries to the sales account.
In circumstances where a business enters into many transactions SUBSIDIARY
BOOKS (or books of prime entry) will be used.

Subsidiary Books

Although every transaction must find its way into a ledger account eventually, it may
not be practicable to enter each transaction directly into the ledger accounts individu-
ally. Any business with a large number of transactions will need to use subsidiary
books to aggregate ‘like’ transactions and periodically transfer the totals into the
ledger accounts. It will also need to keep ‘memorandum’ accounts for its receivables
and payables. Consequently, the ledger accounts will contain a few entries which sum-
marise all the transactions that have taken place.
The subsidiary books and ‘memorandum’ accounts are not part of the double-entry
but will be used to aggregate transactions to give a total figure which will be used as
part of the double-entry book keeping system of the business. Examples of subsidi-
ary books are:

(a) Sales Day Book (SDB);

(b) Purchase Day Book (PDB);
(c) Sales Returns Day Book;
(d) Purchase Returns Day Book; and
(e) Cash Book.

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As well as the books listed above, a business with many credit transactions will
keep a Receivables Ledger and a Payables Ledger to keep track of who owes the
business money and to whom the business owes money.
It is important to realise that none of the subsidiary books are part of the dou-
ble-entry system but only a means of summarising transactions. By the end of this
Section, you should have a clear picture in your mind of:

n The ledger – which contains all the ledger accounts forming the double entry book
keeping system. This is often called the ‘Nominal Ledger’ or ‘General Ledger’. In
the Ledger, you will find an account for total receivables which is usually called
the ‘Receivables Control Account’. Similarly, there will be a ‘Payables Control
Account’ for total payables. There will also be an account summarising cash and
bank transactions. Amounts recorded in these accounts will be totals which have
come from the subsidiary books.
n Subsidiary books – where each individual transaction is listed and totaled and
the total used to make debit entries and corresponding credit entries in the ledger
accounts as part of the double-entry book keeping system.

Accounting Documents

There are a variety of source documents which give rise to accounting entries. The
two most common documents are invoices and credit notes.
Invoices are documents which set out the particulars of a sale. An invoice will
describe the goods sold, the price for which they were sold, the date of the sale and,
where applicable, the VAT charged on the sale. The invoice will usually show the trade
name and address of the vendor and may have instructions as to the method of pay-
ment required. A specimen invoice is shown below.

MUFC Limited
INVOICE
Deliver To: Invoice To:
UUJ QUB
1 OLD STREET 2 NEW STREET
BELFAST LONDON
AB2C 6DE FG2H 6IJ

Terms Territory Invoice No. Account No. Invoice Date & Tax point Page
Net cash 30 days 1320 251351 07560751 02/07/0U 1

Order Your Our Delivery Method

Date Reference Reference
27/06/0U A00520 151496 POST

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Inventory Codes Quantity Unit Description VAT Code Value

2713-27 40 EACH PRINTOUT CARTRIDGE 1.1/2’ GRN 2 152.00
2713-32 30 EACH PRINTOUT CARTRIDGE 1.1/2’ DBL 2 114.00
2713-22 30 EACH PRINTOUT CARTRIDGE 1.1/2’ BL 2 114.00

PRICES INCLUDE AGREED DISCOUNT

V.A.T Reg. No. 14 06 1964 Goods Total 380.00
V.A.T Code Vatable Percentage VAT
2 380.00 17.50 66.50
VAT 66.50
_______
Invoice Total 446.50

In the event of non delivery, or if any of these goods are in a damaged condition, please advise us
AT ONCE so that we may take immediate action. For Terms of Sale see over.

You should appreciate that the document which is a sales invoice to the vendor will
be a purchase invoice to the buyer. This point may seem obvious but you should not
be confused when people refer to sales invoices and purchase invoices. The ‘invoice’
is the same and the prefix depends from whose point of view you are looking at the
transaction. Particulars of all sales invoices issued will be entered in the sales day
book and particulars of purchase invoices received will be entered in the purchase
day book.
A credit note is a document issued by the vendor when goods are returned by his
customer or when some other allowance needs to be made (e.g. to adjust for an
amount over charged.). A credit note is like an invoice in reverse. Instead of stating the
amount which must be paid by the customer, it tells the customer how much allowance
he may make against invoices already issued or against future invoices from the ven-
dor. Credit notes often closely resemble invoices but are frequently written in red type
and overprinted with the words ‘CREDIT NOTE’. Particulars of all credit notes issued
in respect of goods returned will be entered in the sales returns book. Particulars of
all credit notes received for goods returned will be entered in the purchase returns
books.

Recording of Accounting Documents

We will now look at how invoices and credit notes will be recorded in the-subsidiary
books of a business and how the totals are used to make the double-entry in the
ledger accounts.

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When a CREDIT SALE takes place the business will raise an invoice and will send
one copy to the customer. The business will always keep at least one copy itself so
that it can record the transaction and also to form part of its records (which is a legal
requirement). From the copy invoice kept by the business, the details will be recorded
in the Sales Day Book before the invoice is filed away. The type of details necessary
will be the: date; customer’s name; customer’s account number; invoice number; net
amount of the sale; VAT amount; and invoice total. At the end of the day, week or
month (depending on the number of transactions the business has) the amount of
the sales will be totaled and posted to the sales account and the-receivables control
account (the double-entry for a credit sale being Dr.-Receivables and Cr. Sales).
This is shown by the diagram below.
Sales Sent to the customer
Invoice
Copy

SALES DAY BOOK

Date Customer A/c Invoice Net Vat Total

Name No. No. € € €
Jan 3 Brown 110 1 100.00 – 100.00
Jan 3 Smith 152 2 250.00 – 250.00
Jan 3 Jones 133 3 175.00 – 175.00
Jan 3 Smith 152 4 50.00 – 50.00
Jan 3 Donald 125 5 165.00 – 165.00
Jan 3 Gerrard 131 6 22.00 – 22.00
TOTAL FOR DAY 762.00 – 762.00

CR. SALES DR. RECEIVABLES

Sales Account Receivables Control A/C

Jan 3 €762.00 Jan 3 SDB €762.00

In the example, it has been assumed that this business records its totals daily and
that VAT is not applicable for the type of goods sold.
When a customer returns goods which were bought on credit, the business will
raise a credit note. They will again send one copy to the customer and keep at least
one for their own records. Details from the credit note will be recorded in the Sales
Returns Day Book. At the end of the day, week or month the amount of sales returns
will be totaled and posted to the sales account and the receivables control account
(The double-entry will be exactly the reverse of a credit sale i.e. Dr. Sales and Cr.
Receivables).

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If we look at the receipt of a purchase invoice and how that is recorded we will
see how similar it is to the treatment of a sales invoice. The invoice is received from
a supplier and is recorded in the Purchase Day book. At the end of the day, week or
month the amount of purchases will be totaled and posted to the purchases account
and the payables control account (the double-entry for a purchase on credit being Dr.
Purchases and Cr. Payables).
A diagram showing a credit purchase is shown below.

Invoice
from
Supplier

PURCHASE DAY BOOK

Date Suppliers A/C Goods Net Vat Total

Name No. Inwards € € €
Jan 3 White 263 1 20.00 – 20.00
Jan 3 Green 232 2 156.00 – 156.00
Jan 3 White 263 3 135.00 – 135.00
Jan 3 Black 205 4 201.00 – 201.00
Jan 3 Daffy 220 5 350.00 – 350.00
Jan 3 Parker 251 6 39.00 – 39.00
Jan 3 Shake 254 7 242.00 – 242.00
TOTAL FOR DAY 1,143.00 – 1,143.00

DR. PURCHASES CR. PAYABLES

Purchases Account Payables Control A/C

€ €
Jan 3 PDB 1,143.00 Jan 3 PDB 1,143.00

Again, it has been assumed that this business records its total daily and that VAT is
not applicable on the type of goods purchased. You will notice a column for a ‘Goods
Inwards No.’. Usually businesses will number the invoices they receive in numerical
order or raise an internal voucher which is pre-numbered and called a ‘Goods Inwards
Note’. The column in the Purchase Day Book will refer to this number.
When a business returns goods to its supplier it will expect to receive a credit note
from the supplier. Details from credit notes received in respect of goods returned to
the supplier will be recorded in a Purchase Returns Day Book. At the end of the day,
week or month the amount of purchase returns will be totaled and posted to the pur-
chases account and the payables control account (the double-entry will be exactly the
reverse of a credit purchase i.e. Dr. Payables and Cr. Purchases).

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In order to consider what happens when VAT is involved, we will look at an example
of both a day’s totals in the Sales Day Book and a day’s totals in the Purchase Day
Book when sales and purchases are subject to VAT.

Example 1:
If the totals on the Sales Day Book for the day were:
Net Sales VAT Total Sales
€ € €
5,000 750 5,750
Sales A/C VAT Control A/C Receivables Control A/C
€ € €
SDB 5,000 SDB 750 SDB 5,750

The double-entry has three parts to it, but the total debited to the ledger accounts equals the total
credited. Summarising these entries:
€ €
Dr. Receivables Control A/C 5,750
Cr. Sales A/C 5,000
Cr. VAT Control A/C 750
You can see clearly here that we have debited the same amount as we have credited.

Example 2:
If the totals on the Purchase Day Book for the day were:
Net Purchases VAT Total Purchases
€ € €
2,000 300 2,300
Purchase A/C VAT Control A/C Payables Control A/C
€ € €
PDB 2,000 PDB 300 PDB 2,300

Again the double-entry has three parts to it but the total debited to the ledger account equals the
total credited. Summarising these entries:
€ €
Dr. Purchases A/C 2,000
Dr. VAT Control A/C 300
Cr. Payables Control A/C 2,300

The balance on the VAT Control A/C will be shown in the balance sheet and will
reflect the amount of VAT which is owed to the business by Customs & Excise (i.e. an
asset – a debit balance) or the amount that is owed to Customs & Excise by the busi-
ness (i.e. a liability – a credit balance).
We have now seen how invoices and credit notes are recorded in the relevant day
books and how the totals are used as part of the double-entry book-entry system.

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The areas we have not covered in respect of credit sales and credit purchases is the
Receivables Ledger and Payables Ledger – the ‘memorandum’ accounts.

Receivables Ledger

The Receivables Ledger is used to keep a record of exactly who owes the business
money and how much each person owes. It may take various different forms in differ-
ent businesses but is likely to be a book full of individual T accounts or a set of cards
with a T account on each card. Because receivables arise through making sales it is
often referred to as the ‘Sales Ledger’.
When the total of the Sales Day Book is posted it is also necessary to go through
each entry in the Sales Day Book and enter the transaction for each customer in
their individual T account in the Receivables Ledger. This is time consuming and tedi-
ous but is necessary for information purposes. As with the receivables accounts in
the double-entry ledger accounts, the credit sales transaction will be debited to the
individual debtor’s account. As this is only a memorandum entry (we have already
recorded the total of the receivables in the receivables control a/c) it has only one
side. This is not part of the double-entry system.
All the separate entries made to each individual’s account will, if no errors are
made, be equal to the total amount posted to the receivables control a/c and the sum
of the balances on the individual accounts will be equal to the balance on the receiva-
bles control a/c. To make sure that this is, in fact, the case a business will perform a
reconciliation of the balance on the receivables control a/c with the sum of the indi-
vidual balances on the Receivables Ledger.

Payables Ledger

The Payables Ledger is used to keep a record of exactly who is owed money by the
business and how much is owed to each supplier. It works in exactly the same way
as the Receivables Ledger except that the entries come from the Purchase Day Book
and are credited to each supplier’s T account. Because creditors arise through mak-
ing purchases the Payables Ledger is often referred to as the ‘Purchase Ledger’ or
‘Bought Ledger’. The entries made to the accounts in the Payables Ledger are of a
memorandum nature and are not part of the double-entry system.
All the separate entries made to each individual’s account will be equal to the
total amount posted to the Payables Control a/c and the sum of the balances on the

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individual accounts will be equal to the balance on the Payables Control a/c. A busi-
ness will perform a reconciliation of the balance on the Payables Control a/c with the
sum of the individual balances on the Payables Ledger.

The Cash Book

All businesses need to keep a cash book. The extent to which cash payments and
receipts are analysed will depend on the complexity of the day-to-day transactions.
It is quite common for the cash book itself to be used as the cash account for the
purposes of double-entry book keeping. The alternative is to have some sort of Cash
Control a/c and post the total receipts and total payments to this control account at
the end of each day, week or month. Whether a cash control account is kept or not
will not affect the layout or the entries in the cash book itself and a typical analysed
cash book is shown below:

Debit Side:
Date Narrative Total Receivables Cash Sundry
Ledger Sales Income

€ € € €

Credit Side:
Date Narrative Total Payables Cash Sundry
Ledger Purchases Expenses
€ € € €

As you can see, the total cash received or paid is entered in the ‘Total’ column and
then an analysis is made to indicate the reason for the receipt or payment.
At the end of the day, week or month each column will be totaled and posted to the
relevant ledger account.
On the debit side of the cash book there will be a column for receipts relating to the
receivables ledger. Entries analysed to this column will be receipts for credit sales made
in the past. The total analysed to this column will be posted, as part of the double-entry,
to the credit side of the receivables control a/c and each individual entry will have to
be recorded (as a memorandum entry remember) on the credit side of the customers
individual receivables ledger account.
Also, on the debit side of the cash book, there will be a column for ‘Cash Sales’
and the total of this column will be posted to the credit side of the sales a/c. Similarly
‘Sundry Income’ will be posted to the credit side of the sundry income a/c. Sundry
income is often analysed further into such things as capital, dividends received, etc.

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The total of the ‘Total’ column will represent the amount of cash received (for
whatever reason) in the day, week or month and, if a cash control a/c is kept, will be
debited there. (If the cash book is used as the cash account and is, therefore, part of
the double-entry book keeping system there will be no need to make another debit
entry because writing the item in the cash book will be the debit entry).
Looking at the credit side of the cash book, the column called ‘Payables Ledger’
will have all the amounts paid to suppliers from whom the business has made credit
purchases. The total of the Payables Ledger column will be debited to the payables
control a/c and all the individual items will be recorded in the individual supplier’s
accounts on the payables ledger.
The total of the ‘Cash Purchases’ column will be debited to the purchases a/c
and the total of ‘Sundry Expenses’ will be debited to the relevant expense account.
Sundry expenses will usually be analysed into much more detail (e.g. rent, rates,
electricity, wages, etc.). The total of the ‘Total’ column will represent the amount of
cash paid (for whatever reason) in the day, week or month and, if a cash control a/c
is kept, will be credited there.
Let us look at a short example.
Mr Thumb had cash at the beginning of January of €5,000. He had no receivables
and no payables. He than made the following transactions:

1. Bought goods from Mr Smith, a supplier, for €1,000 on credit;

2. Bought goods from Mr Left, another supplier, for €1,500 on credit;
3. Sold goods to Mr Right, a customer for €2,000 on credit;
4. Sold goods for cash €300;
5. Paid Mr Smith €1,000 for the goods he had had on credit terms;
6. Received €2,000 from Mr Right;
7. Bought €3,000 of goods on credit from Mr Smith;
8. Sold goods on credit to Mr Wrong €2,500;
9. Mr Thumb paid the rent on the business premises €500 cash; and
10. Bought €200 of goods for cash.

These transactions would be recorded in the Cash Book, Purchase Day Book and
Sales Day Book as follows:

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Purchase Day Book

Date Supplier A/C GIN Net Vat Total
Name No. No. € € €
Jan Smith 213 1000 1,000 – 1,000
Jan Left 201 1001 1,500 – 1,500
Jan Smith 213 1002 3,000 – 3,000
Total for Month 5,500 – 5,500

DR. Purchases A/C CR. Payables A/C

Sales Day Book

Date Customer A/C Invoice Net Vat Total
Name No. No. € € €
Jan Right 112 200V 2,000 – 2,000
Jan Wrong 152 200X 2,500 – 2,500
Total for Month 4,500 – 4,500

CR. Sales A/C DR. Receivables A/C

Cash Book
Debit Side:
Date Narrative Total Receivables Cash Sundry
Ledger Sales
€ € € €
Jan Cash sale inv. 200W 300 300
Jan Right 2,000 2,000 ______ ______
Total for Month 2,300 2,000 300 –

Dr. Cash Cr. Receivables Cr. Sales A/c

Control A/C

Cash Book
Credit Side:
Date Narrative Total Payables Cash Sundry
Ledger Purchases
€ € € €
Jan Mr Smith Chq. No. 123 1,000 1,000
Jan Rent Chq. No. 124 500 500
Jan Goods Chq. No. 125 200 200
Total for Month 1,700 1,000 200 500

Cr. Cash Dr. Payables Dr.Purch. Dr.Rent

Control A/C A/C A/C

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Writing up the memorandum entries:

Mr Smith’s A/C (in payables ledger)

€ €
Jan Cash Book 1,000 Jan PDB 1,000
Jan PDB 3,000
Jan 31 Bal c/d 3,000
4,000 4,000

Feb 1 Bal b/d 3,000

Mr Left’s A/C (in payables ledger)

€ €
Jan PDB 1,500
Jan 31 Bal c/d 1,500
1,500 1,500

Feb 1 Bal b/d 1,500

Mr Right’s A/C (in receivables ledger)

€ €
Jan SDB 2,000 Jan Cash Book 2,000
2,000 2,000

Mr Wrong’s A/C (in receivables ledger)

€ €
Jan SDB 2,500 Jan 31 Bal c/d 2,500

2,500 2,500
Feb Bal b/d 2,500
Writing up the ledger accounts (the double-entry for the totals):

Receivables Control A/C

€ €
Jan SDB 4,500 Jan Cash Book 2,000
Jan 31 Bal c/d 2,500

4,500 4,500
Feb 1 Bal b/d 2,500
Payables Control A/C
€ €
Jan Cash Book 1,000 Jan PDB 5,500
Jan 31 Bal c/d 4,500

5,500 5,500
Feb 1 Bal b/d 4,500

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Purchases A/C
€ €
Jan PDB 5,500
Jan Cash Book 200 Jan 31 Bal c/d 5,700
_____ _____
5,700 5,700
Feb 1 Bal b/d 5,700

Sales A/C
€ €
Jan SDB 4,500
Jan Cash Book 300
Jan 31 Bal c/d 4,800
_____ _____
4,800 4,800
Feb 1 Bal b/d 4,800

Rent A/C
€ €
Jan Cash Book 500 Jan 31 Bal c/d 500
___ ___
500 500
Feb 1 Bal b/d 500

Cash Control A/C

€ €
Jan 1 Bal b/d 5,000 Jan Cash Paid 1,700
Jan Cash Rec’d 2,300 Jan 31 Bal c/d 5,600
_____ _____
7,300 7,300
Feb 1 Bal b/d 5,600

If we list the accounts (memorandum remember) making up the Payables Ledger we have:
Balance
€
Mr Smith 3,000
Mr Left 1,500
Total per Payables Ledger 4,500

This should be (and is in this case) equal to the balance on the Payables Control A/C.
Similarly, if we list the accounts making up the Receivables Ledger:
Balance
€
Mr Right –
Mr Wrong 2,500
Total per Receivables Ledger 2,500

This is equal to the balance on the Receivables Control A/C.

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Note that only credit sales and credit purchases were recorded in the SDB and
PDB. Cash sales and cash purchases were recorded in the cash book and at the end
of the month were posted to the sales a/c and purchases a/c as part of the double-
entry procedure.
The purchases a/c and sales a/c were not closed off at the end of the month in this
example since it was not the end of Mr Thumb’s accounting period. The balances on
these accounts were carried forward to the next month. When further purchases and
sales are made by him next month and the month after and all through his account-
ing period these will accumulate to give a total purchases and total sales figure to be
transferred at the end of the accounting period to his income statement.

Control Account Reconciliations

We have seen that the balance on the Receivables Control A/C should be equal to the
sum of the balances on the Receivables Ledger. Also the balance on the Payables
Control A/C should be equal to the sum of balances on the Payables Ledger. If this
is not the case we will have to investigate to see why the difference has arisen. Some
reasons for differences arising are:

1. Adding up the day book incorrectly (overcasting or undercasting);

2. Transactions with a customer being recorded in a supplier’s individual ledger
account in error (this might happen if both people have the same name);
3. Balances on the Receivables or Payables Ledger being missed out when adding
them up to compare the total to the control account balance;
4. Contra entries being made between the individual ledger accounts with no entries
to the control account (a contra entry is an entry to transfer an item between
accounts); and
5. Correct recording of an invoice in the day book but a transposition error occurring
when the entry is entered in the individual ledger account.

Another common error is that an invoice has not been recorded in the day book.
This will not cause the sum of the individual ledger account balances to differ from the
control a/c balance but is nevertheless an error. (Remember we mentioned errors of
omission when we looked at the Trial Balance).
Control Account Reconciliations are a necessary control over the accuracy of the
recording of the credit transactions of a business. To be able to make the required
adjustments you must first have a good understanding of the double-entry involved in

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recording credit transactions using day books which we looked at earlier in this Section.
There is no short cut to understanding this and now would be a good time to go back
and re-read the section on recording of accounting documents if you do not feel you
understand it.
We will look at one example of a Receivables Ledger reconciliation and one exam-
ple of a Payables Ledger reconciliation. Try to understand the implications of the
errors in double-entry terms and follow through the way in which the adjustments
have been made.

Example 1:
The balance on the Receivables Control Account at 31st December was €13,500.
The balances on the individual accounts in the receivables ledger were extracted
and totaled €13,165. On investigation the following errors were discovered:
1. The Sales Day Book was overcast by €300;
2. An invoice for €120 was correctly recorded in the Sales Day Book but posted to
the individual’s ledger account as €210;
3. The debit balance of €75 on Mr Mint’s individual ledger account was not
included in the list of balances;
4. A contra entry of €50 had been made between Mr Strong’s individual receiva-
bles ledger account and his individual payables ledger account to settle an
amount owing to him for goods purchased by the business on credit. No entry
had been made to account for this in the control accounts.

First let’s look at the errors which will affect the Receivables Control Account.
These will be errors 1. and 4.
For error 1., we know that the total of the Sales Day Book was €300 more than
it should have been. This means that €300 too much will have been debited to the
Receivables Control Account (and credited to the sales account). To correct the
error we need to make entries which are the reverse of this, i.e.
Dr. Sales €300
Cr. Receivables Control Account €300
For error 4., we know that an entry has been made to the individual ledger
accounts but no entry has been made to the control accounts. First what has been
done to the individual accounts? The amount the business owed to Mr Strong of
€50 has been set against the amount he owed the business. The entries made to
Mr Strong’s individual accounts would have been:
Dr. Mr Strong’s Individual Payables Account €50
Cr. Mr Strong’s Individual Receivables Account €50
(The reason for this may be clearer if you think about personally owing someone
money when they also owe you money. If you owed me €150 and I owed you €50
you would give me €100.)
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We then have to record this in the control accounts:

Dr. Payables Control Account €50
Cr. Receivables Control Account €50
So our Receivables Control Account adjusted for the errors 1. and 4. would be:
Receivables Control Account
€ €
Balance b/d 13,500 Overcast of SDB (1.)
300
Contra with payables
control a/c (4.) 50
Balance c/d 13,150
13,500 13,500
Balance b/d 13,150
N.B. The other sides of these entries would be made to the relevant accounts
(sales account and payables control account) to complete the double-entry.

Next let’s look at the errors affecting the extracted list of balances (the sum of the
balances of the individual ledger accounts).
For error 2., we know that the invoice for €120 was correctly dealt with in the
Sales Day Book but posted as €210 in the customers individual ledger account.
So €90 too much has been debited to his individual account. This was only a
memorandum entry so it does not affect any other account but must be changed
on the customer’s individual account and deducted from the total of the bal-
ances.
For error 3., the person adding up the balances on the individual accounts missed
a debit balance of €75. This should have been included so we must add it to the total
of the balances.
When we have made the adjustments for 2. and 3. the corrected total list of balances
should equal our corrected Receivables Control Account balance.
€
Original total of list of balances 13,165
Transposition error (2.) (90)
Debit balance omitted (3.) 75

Corrected total of list of balances 13,150

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Example 2:
The balance on the Payables Control Account at 30th June was €15,033.
The balances on the individual accounts in the payables ledger were extracted
and totaled €14,363.
The following errors had been made:
1. A credit balance of €340 had been omitted from the list of balances;
2. The creditors ledger column of the cash book had been undercast by €100;
3. No entry had been made to Mr Can’s individual ledger account in respect of an
invoice for €230 which was correctly recorded in the Purchases Day Book;
4. An invoice from Mr Able for €70 had not been recorded in the Purchases Day
Book;
5. An invoice from Mr Will for €150 had been recorded twice in error in the
Purchases Day Book.
Looking first at the Payables Control Account. The errors affecting the control
account are 2., 4. and 5.
For error 2., the payables ledger column of the cash book being undercast will
mean that €100 more cash should have been posted, i.e.
Dr. Payables Control A/C €100
Cr. Cash €100
For error 4., Mr Able’s invoice had not been recorded in the Purchases Day Book
so it would not have been included in the total debited to purchases and credited
to the payables control a/c (it will also not be in his individual ledger a/c). To correct
the control account we need to
Dr. Purchases A/C €70
Cr. Payables Control A/C €70
For error 5., if the invoice was recorded twice the total posted to the payables
control account would be too much by the amount of the invoice. We need to
reverse this entry so:
Dr. Payables Control A/C €150
Cr. Purchases A/C €150
(Also, it will have been posted to Mr Will’s individual ledger account twice).
Showing these adjustments in the Payables Control Account:
Creditors Control Account
€ €
Undercast CB (2.) 100 Balance b/d 15,033
Invoice recorded Invoice not recorded (4.) 70
twice (5.) 150
Balance c/d 14,853
15,103 15,103
Balance b/d 14,853
Errors affecting the list of balances are 1., 3., 4. and 5.:
Error 1. – a credit balance was missed out so should now be added in.
Error 3. – Mr Can’s account needs to be credited with €230 to record the invoice.
(Continued overleaf )

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Error 4. – Mr Able’s account needs to be credited with €70 to record the invoice.
Error 5. – Mr Will’s account has two credit entries relating to the same invoice of
€150. One of these needs to be reversed so we must debit his account with €150.
Showing these adjustments to the original list of balances:
€
Original total of list of balances 14,363
Credit balance omitted (1.) 340
Invoice not recorded (Mr Can) (3.) 230
Invoice not recorded (Mr Able) (4.) 70
Invoice recorded twice (Mr Will) (5.) (150)
Corrected total of list of balances 14,853
This is now equal to the control account balance.

Note that if we had not discovered error (5.) the control account would still have bal-
anced with the total of the list of balances since equal errors were made to both accounts.
Likewise, error 4. caused both the control account and list of balances to be wrong by
an equal amount. In these cases a business will use ‘statements’ sent to them by their
creditors to act as a check on each individual account balance to help detect errors. A
statement is a summary of all the invoices issued to a business by its supplier.
Receivables and payables control account reconciliations act as a check to ensure
that all totals posted to the control accounts have been individually posted to the cus-
tomers’ and suppliers’ individual ledger accounts and that a substantial amount of the
double-entry made in respect of credit transactions has been properly carried out.

Bank Reconciliations

These are another type of reconciliation carried out by a business to test the accuracy
of the entries in the cash book by reconciling the cash book balance with the bank
statement balance. If a cash control account is used it will be this balance (which
should be equal to the cash book balance) which is reconciled.
At any point in time it is unlikely that the cash book balance will agree with the bal-
ance on the bank statement (as you probably know if you keep your cheque book
stubs up to date). The reasons for this are usually:

1. cheques paid have not yet cleared through the bank;

2. receipts (cheque or cash) have not yet cleared through the bank;
3. errors have been made (by the bank or by you); and
4. amounts charged or credited by the bank directly have not been recorded in the
cash book (e.g. bank charges, interest, standing orders etc.).

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There are two separate parts of a bank reconciliation to perform. Firstly cor-
recting the cash book for errors made and secondly adjusting the bank statement
balances for timing differences and bank errors (if applicable).
Before we look at an example of a bank reconciliation it is important to realise that
when a business deposits money with the bank (a receipt) it will debit its cash book
but the bank will show that receipt as a credit. This is quite logical if you consider that
the business has more money, an increase in an asset, and must therefore make a
debit entry while from the bank’s point of view they debit their cash book and credit
the account of the business. The bank owes the business more money and the busi-
ness is a creditor as far as the bank is concerned. Similarly when a business has an
account which is overdrawn it will owe money to the bank so the cash book will show
a credit balance but the bank will have a debtor.
When you are told that a bank account is ‘in credit’ it means there is money in the
account since you are being told the position from the bank’s point of view.
To see how a bank reconciliation is done let’s look at an example.
At 31st December the balance on Mr Stone’s cash book was a €2,162 debit bal-
ance. His bank statement showed a credit balance of €1,638.
On investigation you find that:
(a) unpresented cheques totaled €353;
(b deposits made with the bank on the 31 December of €626 had yet to be
cleared;
(c) the debit side of his cash book had been overcast by €200;
(d) a payment of €213 had been recorded in the cash book as €312; and
(e) a payment of €150 made by Mr Rock had been charged in error by the bank to
Mr Stone’s account.
Firstly we must correct the Cash Book (or Cash Control Account).

Cash Book

€ €
Balance b/d 2,162 Receipts overcast (c) 200
Transposition Error (d) 99 Balance c/d 2,061

2,261 2,261

Balance b/d 2,061

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Error (c) has been credited to the cash book since we must reverse the overcasting
of the debits.
Error (d) has been debited to the cash book since we had previously recorded €99
too much as a payment and must reverse that.
Next we prepare the actual bank reconciliation statement:
€ €

Balance per bank statement 1,638

Less: Unpresented cheques (a) (353)
Add: Deposits not credited (b) 626
Bank error (e) 150
776
Balance per cash book 2,061

We took off the unpresented cheques since these were cheques that the business
had paid before the date we were looking at.
We added the deposits made by the business since this was money which should
have been in the bank account but had not been processed by the bank.
We also added the amount of the bank error since the cheque of €150 which was
recorded on the bank statement was not drawn by Mr Stone so he should have had
€150 more in the bank.
Having done this the adjusted bank statement balance is equal to the corrected
cash book balance.
Note that:

n deposits are often called ‘lodgments’; and

n it is the amount of cheques drawn and deposits made by the date in question that
should be accounted for. It would be incorrect to adjust the cash book for items
which have not cleared the bank.

Prepayments and Accruals

The next area which we look at is the concept and treatment of prepayments and
accruals. We have already come across the concept of accrual accounting in the
income statement. Accrual accounting is the matching of the income and expenditure
which is relevant to an accounting period rather than what has been received and paid
in the period.

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ACCRUALS are amounts which are charged against the profit for a particular
period even though they are not paid for until after the end of the period.
PREPAYMENTS are amounts paid in the period which should not be charged to
that period because they relate to a subsequent period.
All expenditure should be matched against the period to which it relates look at the
following examples.

Example 1 – Accruals:
Mr Spare operated as a retailer of motor parts and had an accounting period
ending on 31st March each year. He receives his electricity bills quarterly just after
the end of each quarter has elapsed. He received the following bills during his
last year which he paid on the dates shown.
Amount Date bill Date bill
From To € received paid
1st Jan X5 – 31st Mar X5 190 10th Apr X5 29th Apr X5
1st Apr X5 – 30th Jun X5 180 10th Jul X5 1st Aug X5
st
1 Jul X5 – th
30 Sept X5 160 th
9 Oct X5 31st Oct X5
1st Oct X5 – 31st Dec X5 220 12th Jan X6 1st Feb X6
st
1 Jan X6 – st
31 Mar X6 200 th
13 Apr X6 2nd May X6
Calculate the amount to be charged to his income statement for the year ending
31st March 20X6 and the accrual that would need to be made on that date.
Solution
The income statement should be charged with the cost of the electricity used
from 1st April 20X5 to 31st March 20X6. This will be:
€
st th
1 April X5 – 30 Jun X5 180
1st Jul X5 – 30th Sep X5 160
1st Oct X5 – 31st Dec X5 220
1st Jan X6 – 31st Mar X6 200
760
As at 31st March 20X6, he had not paid for the electricity that he had used in the
last quarter but it is an expense of the year to 31st March 20X6 and so must be
accrued. The accrual is therefore €200.

Example 2 – Accruals:
Mr Spare also had a telephone and received bills each quarter paying for them about
a month later. During the year to 31st March 20X6 he received the following bills.
Amount Date paid
From To €
1st Dec X4 – 28th Feb X5 200 1st Apr X5
st
1 Mar X5 – st
31 May X5 210 1st Jul X5
1st Jun X5 – 31st Aug X5 220 30th Sep X5
(Continued overleaf )

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1st Sep X5 – 30th Nov X5 230 28th Dec X5

1st Dec X5 – 28th Feb X6 190 2nd Apr X6
1st Mar X6 – 31st May X6 180 28th Jun X6
Calculate the amount to be charged to his income statement for the year ending
31st March 20X6 and the accrual that would need to be made at that date.
Solution
To find the amount that should be charged to the income statement we would need
to see how much the telephone had cost between 1st April 20X5 and 31st March
20X6. This would be:
€
1st April – 31st May (2/3 x €210) 140
1st June – 31st Aug 220
1st Sept – 30th Nov 230
1st Dec – 28th Feb 190
1st March – 31st March (1/3 x £180) 60
840
To find the necessary accrual we need to know how much of the amount to be
charged to the profit and loss had not been paid for at 31st March 20X6.
Mr Spare had not paid for the bills:
€
1st Dec X5 – 28 Feb X6 190
1st Mar X6 – 31 May X6 180
But only 1/3 of the last bill relates to the year ending 31 March 20X6. So the accrual
needs to be:
€
The whole of the bill from 1st
Dec X5 – 28th Feb X6 190
Plus 1/3 of the bill from 1st Mar X6 – 31st May X6 60
250
The T account for telephone charges would look as follows:
Telephone Account
€ €
(3 mths to 28th
Feb) Cash 200 Balance b/d 270
(3 mths to 31st May) Cash 210
(3 mths to 31st Aug) Cash 220 Trfr to
(3 mths to 30th Nov) Cash 230 IS 840
Balance c/d 250
1,110 1,110
Balance b/d 250

The balance on the account at the beginning of the period is his accrual at 31st March
20X6 (the bill to 28th Feb X6 plus 1/3 of the bill to 31st May X6). During the year from 1st
April 20X5 to 31st March 20X6 he paid the four bills shown on the debit side. We can
then balance the account in one of two ways:

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(i) find the charge to the income statement (€840) and the balance carried down is
then our accrual at 31 March 20X6; or
(ii) find the amount we need to accrue at 31st March 20X6 (€250) and the balancing
figure is transferred to our income statement for the year.

Example 1 – Prepayments:
Mr Trip is a retailer whose accounting period runs from 1st January to 31st December
each year. He pays his rates six monthly in advance for the periods 1st April to 30th
September and 1st October to 31st March each year. The following transactions
occurred in respect of his rates:

1st October 200S paid €600 for rates to 31st March 200T;
1st April 200T paid €700 for rates to 30th September 200T;
1st October 200T paid €750 for rates to 31st March 200U.

Calculate:
(i) the amount of rates prepaid as at 31 December 200S;
(ii) the amount of rates prepaid as at 31 December 200T; and
(iii) the charge for rates in his income statement for the year ending 31 December
200T.

You are also required to draw up his rates account for 200T.

Solution
As at 31st December 200S Mr Trip had paid €600 for rates for the 6 months ended
31st March 200T. He has therefore prepaid 3 months rates i.e. 3/6 x €600 = €300
(being rates for Jan – March 200T).
As at 31st December 200T Mr Trip had paid €750 for rates for the 6 months
ended 31st March 200U. Again 3 months of this is prepaid i.e. 3/6 x €750 = €375
(being rates for Jan – March 200U).
The charge for rates for the year ended 31st December 200T will be:
€
1st Jan – 31stMarch (3/6 x€600) 300
1st April – 30th Sept 700
1st Oct – 31st Dec (3/6 x €750) 375
Charge for rates for the year 1,375
The rates account will be:

Rates Account
200T € €
1st Jan Balance b/d 300
1st Apr Cash 700 Trfr to IS 1,375
1st Oct Cash 750 Balance c/d 375
1,750 1,750
200U
1st Jan Balance b/d 375

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Example 2 – Prepayments:
Mr Fall runs a business whose accounting period runs from 1 st March to 28 th
February each year. He leases his shop fittings and pays for them in advance
each quarter. He made the following payments in respect of the shop fit-
tings:

(i) On 1st January 200T €420 for the 3 months ending 31st March 200T.
(ii) On 1st April 200T €430 for the 3 months ending 30th June 200T.
(iii) On 1st July 200T €440 for the 3 months ending 30th Sept 200T.
(vi) On 1st October 200T €440 for the 3 months ending 31st Dec 200T.
(v) On 1st January 200U €450 for the 3 months ending 31st March 200U.

Calculate:
(a) the prepayment at 28th February 200T;
(b) the prepayment at 28th February 200U; and
(c) the charge for shop fittings for the year ending 28th February 200U.
Also draw up the account showing charges for shop fittings for the year ending
28th February 200U.

Solution
The prepayment at 28th February 200T is the amount relating to the month of
March 200T i.e. 1/3 x €420 = €140.
The prepayment at 28 February 200U is the amount relating to the month of March
200U i.e. 1/3 x €450 = €150.
The charge for the year ending 28 February 200U is:

€
1st March – 31st
March (1/3 x £420) 140
1st April – 30th June 430
1st July – 30th September 440
1st October – 31st December 440
1st Jan – 28th February (2/3 x £450) 300
1,750

Shop Fittings Charges

€ €
1st Mar 0T Balance b/d 140
1st Apr 0T Cash 430 Trfr to IS 1,750
1st Jul 0T Cash 440
1st Oct 0T Cash 440
1st Jan 0U Cash 450 28th Feb 0U bal. c/d 150
1,900 1,900
1st Mar 0U Bal. b/d 150

You should try the following more comprehensive examples before moving on.

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Example 1 – Prepayments and Accruals

The financial year of H. Saunders ended on 31st December 200X. Show the ledger
accounts for the following items, including the balance transferred to the necessary
part of the final accounts and the balances carried down to 200Y.
(a) Motor Expenses – paid in 200Y €744; and owing at 31st December 200Y €28.
(b) Insurance – paid in 200Y €420; and prepaid as at 31st December 200Y €35.
(c) Stationery – paid during 200Y €1,800; owing as at 31st December 200X €250;
and owing as at 31st December 200Y €490.
(d) Rent – paid during 200Y €950; prepaid as at 31st December 200X €220; and
prepaid as at 31st December 200Y €290.
(e) Saunders sub-lets part of the premises, receiving €550 during the year ended
31 December 200Y. The tenant owed Saunders €180 on 31st December 200X
and €210 on 31st December 200Y.
Solution
Motor Expenses
€ €
Bank 744
Bal c/d 28 IS 772
772 772
Bal b/d 28
Insurance
€ €
Bank 420 IS 385
Bal c/d 35
420 420
Bal b/d 35
Stationery
€ €
Bank 1800 Bal b/d 250
Bal c/d 490 IS 2040
2290 2290
Bal b/d 490
Rent
€ €
Bal b/d 220 IS 880
Bank 950 Bal b/d 290
1170 1170
Bal b/d 290
Rent Received
€ €
Bal b/d 180 Bank 550
IS 580 Bal c/d 210
760 760
Bal b/d 210

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Example 2 – Prepayments and Accruals

J Owen’s year ended on 30th June 200Y. Write up the ledger accounts showing the trans-
fers to the final accounts and the balances carried down to the next year for the following:
(a) Stationery – paid for the year to 30th June 200Y €855; inventory of stationery
at 30th June 200X €290 and at 30th June 200Y €345.
(b) General expenses – paid for the year to 30th June 200Y €590; owing at 30th
June 200X €64; and owing at 30th June 200Y €90.
(c) Rent and Rates (combined account) – paid in the year to 30th June 200Y
€3,890; rent owing at 30th June 200X €160; rent paid in advance at 30th June
200Y €250; and rates owing at 30th June 200Y €360.
(d) Motor expenses – paid in the year to 30th June 200Y €4,750; owing as at 30th
June 200X €180; and owing as at 30th June 200Y €375.
(e) Owen earns commission from the sale of one item. He received for the year to 30th
June 200Y €850; owing at 30th June 200Y €80; and owing 30th June 200Y €145.
Solution
Stationery
€ €
Bal b/d 290 *IS 800
Bank 855 Bal c/d 345
1,145 1,145
Bal b/d 345
General Expenses
€ €
Bank 590 Bal b/d 64
Bal c/d 90 *IS 616
680 680
Bal b/d 90
Rent & Rates
€ €
Bal b/d Rent 160
Bank 3,890 Rates 205
*IS 3,635
Bal c/d 360 Bal c/d 250
4,250 4,250
Bal b/d 250 Bal b/d 360
Motor Expenses
€ €
Bank 4,750 Bal b/d 180
Bal c/d 375 *IS 4,945
5,125 5,125
Bal b/d 375
Commission
€ €
Bal b/d 80 Bank 850
*IS 915 Bal c/d 145
995 995
Bal b/d 145

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Summary of Section Four

This section has covered a lot of fairly detailed accounting procedures which take
a while to understand properly. They are all essential procedures and you should
do your best to get to get to grips with them at this stage. A-section of Self Test
Questions follows the Glossary of Terms.

GLOSSARY OF TERMS
Subsidiary Books: Books of ‘prime’ or original entry such as the Sales Day
Book, Purchases Day Book etc. Totals from subsidiary
books are posted to the Ledger.
The Ledger: A ‘book’ containing all the accounts of a business which
form the double-entry system.
Sales Day Book: The book recording all sales transactions made on
credit.
Purchase Day Book: The book recording all purchase transactions made on
credit.
Receivables Ledger: Sometimes called the Sales Ledger, this contains the
debtors’ individual personal accounts.
Payables Ledger: Sometimes called the Purchase Ledger or Bought Ledger,
this contains the creditors’ individual personal accounts.
Invoice: The document sent by the seller to the buyer showing
details of the quantity, price and value of goods supplied
in a transaction.
Credit Note: The document sent by the seller to the buyer showing
allowances against invoices.
Accruals: Amounts charged against the profit for a particular period
but not paid for until after the end of the period.
Prepayments: Amounts paid in a period which relate to charges of a
subsequent period.

SELF TEST QUESTIONS – SECTION FOUR

1. Pair up the following subsidiary books with the transactions they will record:
(i) Sales Day Book will record (a, b, c or d)
(ii) Purchases Day Book will record (a, b, c or d)
(iii) Sales Returns Day Book will record (a, b, c or d)
(iv) Purchases Returns Day Book will record (a, b, c or d)

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(a) The business sends back two cartons of goods previously purchased.
(b) The business invoices €100 of sales.
(c) A customer returns goods relating to two invoices issued to him by the busi-
ness.
(d) The business receives an invoice relating to goods purchased from a sup-
plier.
2. Using the Sales Day Book as a book of prime entry the total will be posted as the
following double-entry.
Debit ........ and Credit Sales a/c.
3. The ......... Day Book will be used as a book of prime entry from which the follow-
ing double-entry will be made.
Debit Purchases a/c and Credit Payables (control) a/c.
4. Sales made on credit by Mr Wall in week 13 were as follows:
€
Goods to customer A (15) 50
Goods to customer B (16) 15
Goods to customer C (17) 30
Goods to customer D (18) 45

Invoice numbers 153 – 156 inclusive were used and the number in brackets is
the customers account number.
Record these transactions in the relevant day book, find the total and state the
double-entry to be made (there is no VAT).

......DAY BOOK
Date Customer A/C No. Invoice No. Net Vat Total
€ € €
Total for Week 13
The required double-entry is:
€ €
Dr ..................... a/c
Cr ..................... a/c

5. Using the details given in question (4) write up the individual ledger accounts (the
memorandum accounts) for customers A, B, C and D.
A B

C D

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6. If customer B paid Mr Wall €15 in week 15 update B’s individual ledger account
for this transaction.

7. Assuming no transactions other than those described in questions (4) to (6)

extract a list of balances at the end of week 15.

Customer €
A
B
C
D _________

Try the following longer and more difficult questions when you have successfully com-
pleted the Questions 1 – 7.

8. A business makes all its sales and purchases of goods on credit and during
September the following transactions occurred.

a) Sold goods to Mr Ask €100

b) Sold goods to Mr Tell €250
c) Bought goods from Mr But €70
d) Sold goods to Mr Question €300
e) Bought goods from Mr Why €425
f) Bought goods from Mr But €210
g) Sold goods to Mr Ask €125

During October there were further transactions as follows:

A. Sold goods to Mr Tell €175
B. Received money from Mr Ask €100
C. Paid money to Mr But €70
D. Bought goods from Mr Why €50

You are required to:

(i) write up the Sales Day Book and Purchases Day Book (in as much detail
as you can with the given information) and show the relevant double-entry
postings in T account format for the month of September;

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(ii) show the memorandum entries to the customers and suppliers individual
accounts for the month of September in T account format;
(c) write up the Sales Day Book, Purchases Day Book and Cash Book for the
month of October and show the relevant double-entry posting in T account
format (bringing forward any relevant balances from September);
(d) show the memorandum entries to the customers and suppliers individual
accounts for the month of October in T account format (bringing forward any
relevant balances from September);
(e) balance the Receivables Control Account and Payables Control Account
at the end of October and extract a list of balances from the Receivables
Ledger accounts and Payables Ledger accounts at that date.

9. The balance on Mr What’s Sales Ledger Control Account (Receivables Control

Account) at the end of the month of June was €14,586.
Mr What extracted a list of balances from his Sales Ledger (Receivables
Ledger) and found that they totaled €14,383.
On investigation he found the errors listed below has asked you to tell him
the action required to correct each error, to write up an adjusted Sales Ledger
Control Account and reconcile this to the corrected total list of balances.

(a) Sales to Mr Who of €125 have been mistakenly entered on Mr Who’s indi-
vidual account in the payables ledger;
(b) An invoice for €220 in respect of sales to Where Limited was not recorded
in the Sales Day Book;
(c) A contra entry of €55 has been made on Mr When’s individual account in
the sales ledger against his account in the payables ledger. This has not
been recorded in the control accounts;
(d) A debit balance of €371 has been omitted from the list of balances;
(e) An invoice for €315 has been correctly entered in the Sales Day Book but
posted to the customer’s individual account as €351;
(f) Cash received from Mr Why of €412 has not been recorded on his indi-
vidual ledger account;
(g) The Sales Day Book total was overcast by €100.

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Note that an alternative name has been used for the Receivables Control Account and
Receivables Ledger. This will be the name used by some business for those accounts
and you should learn to recognise the use of either name.

10. The balance on Mr Glove’s Purchase Ledger Control Account (Payables Control
Account) at the end of December was €12,832.

Mr Glove’s extracted list of balances from his Purchase Ledger (Payables

Ledger) totaled €13,177.
He found that he made errors during the year and wants you to amend his
Purchase Ledger Control Account and list of balances for him so that they
agree.
The errors identified were:

(a) the Purchases Day Book had been undercast by €500;

(b) €265 owing to Mr Hat had been settled by a contra entry to his individual
receivables ledger account. No entry had been to the control accounts;
(c) the amount of an invoice from Mr Coat for goods bought from him had been
illegible and could not be entered in the Purchases Day Book. The amount
is now known to be €135;
(d) cash paid to Mr Scarf of €640 had been recorded in the cash book but not
in his individual ledger account;
(e) A credit balance of €530 had been omitted from the list of balances.

Note that ‘Purchase Ledger’, ‘Bought Ledger’ and ‘Payables Ledger’ are alterna-
tive names for the same ledger. ‘Purchase Ledger Control Account’, ‘Bought Ledger
Control Account’ and ‘Payables Control Account’ are also alternative names for the
same control account.

11. The cash book of Stoke, a retailer, showed a debit balance of €323 at 31st July.
His bank statement showed that he was overdrawn by €637.

He asked you to prepare a bank reconciliation statement for him.

You look at the cash book and bank statement for the period since the last
reconciliation was performed and find the following items which need to be
adjusted for.

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(a) Cheques from customers totaling €1,054 were entered in the cash book
on 31st July but did not clear the bank until the following day.
(b) Cheques issued by Mr Stoke to pay his creditors on 29 July which totaled
e241 did not appear on the bank statement until August.
(c) A standing order for rates of €300 had been paid by the bank on 24 July
but no entry had been made for this in the cash book.
(d) A credit transfer had been received by the bank on 28 July in settlement of
one of Stoke’s customers accounts of €153. Stoke had not entered this in
his cash book.

Adjust the cash book as necessary and prepare a bank reconciliation state-
ment for Mr Stoke at 31st July.

SELF TEST QUESTIONS – SECTION FOUR ANSWERS

1. (i) (b)
(ii) (d)
(iii) (c)
(iv) (a)
2. Receivables (control) a/c
3. Purchases
4.

Sales Day Book

Date Customer A/C No. Invoice No. Net VAT Total
€ € €
Wk 13 A 15 153 50 – 50
Wk 13 B 16 154 15 – 15
Wk 13 C 17 155 30 – 30
Wk 13 D 18 156 45 – 45
Total for Week 13 140 – 140

The required double entry is:

€ €
Dr. Receivables Control a/c 140
Cr. Sales a/c 140

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5.
A B

€ €
wk 13 SDB 50 wk 13 SDB 15
C D

€ €
wk 13 SDB 30 wk 13 SDB 45
6.
B

€ €
wk 15 SDB 15 wk 15 CB 15
7.
Customer €
A 50
B –
C 30
D 45
125
8. (i)

Sales Day Book

September €
Mr Ask (a) 100
Mr Tell (b) 250
Mr Question (d) 300
Mr Ask (g) 125
Total for September 775
Purchases Day Book
September €
Mr But (c) 70
Mr Why (e) 425
Mr But (f) 210
Total for September 705

The double-entry postings in T account format:

Receivables Control A/C Sales A/C

€ €
Sept SDB 775 Sept SDB 775

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Purchases A/C Payables Control A/C

€ €
Sept SDB 705 Sept PDB 705

(ii) The memorandum entries to the customers and suppliers individual accounts in
T account format for September.
Receivables Ledger Accounts (customers):
Mr Ask Mr Tell
€ €
Sept SDB 100 Sept 250
Sept SDB 125
Mr Question
€
Sept SDB 300
Payables Ledger Accounts (Suppliers):
Mr But Mr Why
€ €
Sept PDB 70 Sept PDB 425
Sept PDB 210

(iii)

Sales Day Book

October €
Mr Tell (A) 175
Total for October 175
Purchase Day Book
October €
Mr Why (D) 50
Total for October 50
Cash Book
October Total Receiv. October Total Payables
Ledger Ledger
€ € € €
Mr Ask (B) 100 100 Mr But (C) 70 70
100 100 70 70

The double-entry postings in T account format:

Receivables Control A/C Sales A/C

€ € €
1 Oct Bal. b/d 775 1 Oct Bal. b/d 755
Oct SDB 175 Oct CB 100 Oct SDB 175

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Purchases A/C Payables Control A/C

€ € €
1 Oct Bal. b/d 705 1 Oct Bal. b/d 705
Oct PDB 50 Oct CB 70 Oct PDB 50

Cash (Control) A/C

€ €
Oct CB 100 Oct CB 70

(iv) The memorandum entries to the customers and suppliers individual accounts in
T account format for October.

Receivables Ledger Accounts (Customers):

Mr Ask Mr Tell
€ € € €
1 Oct Bal. b/d 225 Oct CB 100 1 Oct Bal. b/d 250
Bal. c/d 125 Oct SDB 175 Bal. c/d 425
225 225 425 425
Bal. b/d 125 Bal. b/d 425

Mr Question
€ €
1 Oct Bal. b/d 300 Bal. c/d 100
300 300
Bal. b/d 300

Payables Ledger Accounts (Suppliers):

Mr But Mr Why
€ € € €
Oct CB 70 1 Oct Bal. b/d 280 1 Oct Bal. b/d 425
Bal. c/d 210 Bal. c/d 475 Oct PDB 50
280 280 475 475
Bal. b/d 210 Bal. b/d 475

(v) Reproducing the Receivables Control Account and Payables Control Account
and balancing them.

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Receivables Control A/C

€ €
1 Oct Bal. b/d 775
Oct SDB 175 Oct CB 100
Bal. c/d 850
950 950
31 Oct Bal. b/d 850

Payables Control A/C

€ €
1 Oct Bal. b/d 705
Oct CB 70 Oct PDB 50
Bal. c/d 685
775 755
31 Oct Bal. b/d 685

List of Balances from Receivables Ledger:

Customer €
Mr Ask 125
Mr Tell 425
Mr Question 300
850 (agrees with the Receivables Control Account balance)

List of Balances from Payables Ledger:

Supplier €
Mr But 210
Mr Why 475
685 (agrees with the Payables Control Account balance).

9. The action required to correct the errors are:

€ €
(a) Dr. Mr Who’s individual sales ledger a/c 125
Cr. Who Limited’s individual payables ledger a/c 125

being the memorandum entries required to correct the misposting (adjust the list of
balances for this).

(b) Dr. Sales Ledger Control a/c 220

Cr. Sales Account 220

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being the double-entry required to record the omitted invoice.

Also, Dr. Where Limited’s individual Sales Ledger a/c €220 which is a memorandum
entry and adjust the list of balances for this.
(c) Dr. Payables Control a/c 55
Cr. Sales Ledger Control a/c 55

being the double-entry required to reflect the contra entry to Mr When’s accounts.
(d) Add in the debit balance of €371 omitted from the list of balances.
(e) Deduct €36 from the list of balances and make a credit entry to this amount on
the relevant customer’s individual account.
(f) Credit Mr Why’s individual ledger account with the €412 cash received from him
and take this amount away from the list of balances.
(g) Dr. Sales Account 100
Cr. Sales Ledger Control Account 100

being the double-entry required to reverse the €100 too much previously posted due
to an overcast SDB.
The adjusted Sales Ledger Control Account is:

Sales Ledger Control Account

€ €
Bal. b/d 14,586
Invoice omitted (b) 220 Contra to
Payables Ledger (c) 55
Overcast SDB (g) 100
Bal. c/d 14,651
14,806 14,806
Bal. b/d 14,651

The corrected total list of balances:

€
Original total list of balances 14,383
Sales to Mr Who (a) 125
Invoice omitted (b) 220
Omitted debit balance (d) 371
Transposition error (e) (36)
Cash not recorded (f) (412)
Corrected total list of balances 14,651

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Purchase Ledger Control Account

€ €
Bal. b/d 12,832
Contra to Undercast PDB (a) 500
Receivables ledger (b) 265 Invoice: Coat (c) 135
Balance c/d 13,202
13,467 13,467
Balance b/d 13,202

€
Original total list of balances 13,177
Invoice not recorded (c) 135
Cash paid not recorded (d) (640)
Credit balance omitted (e) 530
Corrected total list of balances 13,202

Cash Book
€ €
Bal. b/d 323 Standing order 300
Credit transfer 153 Bal. c/d 176
476 476
Bal. b/d 176
€
Balance per bank statement (overdrawn) (637)
Add: Deposits not cleared 1,054
Less: Unpresented cheques (241)
Balance per cash book 176

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SECTION FIVE: INCOMPLETE RECORDS

Introduction

This final Section begins by dealing with Suspense Accounts before concentrating
upon incomplete records.

Suspense Accounts

A Suspense Account is an account in which debits or credits are held temporarily until
sufficient information is available for them to be posted to the correct accounts. There
are two main reasons why Suspense Accounts may be created:

n On the extraction of a Trial Balance the debits are not equal to the credits and the
difference is put to a Suspense Account; and
n When a bookkeeper performing double entry is not sure where to post one side of
a double entry, he may debit or credit a Suspense Account.

In whatever circumstances a Suspense Account is set up it clearly should not

remain permanently in the books of account, but as it forms a ‘T’ account it should be
cleared by means of normal book keeping procedures.

Example:
Upon extracting a Trial Balance, the accountant discovered a Suspense Account
with a debit balance of €1,075 included therein. He also found that the debits
exceeded the credits by €957, and he posted this difference to the Suspense
Account before investigating the situation. He discovered:
(a) A debit balance of €75 on the postages account has been incorrectly extracted
on the Trial Balance as €750 debit.
(b) A payment of €500 to Creditor X had been correctly entered in the cash book,
but no entry had been made in the creditor’s account.
(c) When a motor vehicle had been purchased during the year, the bookkeeper did
not know what to do with the debit entry so he made the following entry:
DR Suspense €1,575
CR Bank €1,575
(d) A credit balance of €81 in the sundry income account had been incorrectly
extracted on the Trial Balance as a debit balance.
(e) A receipt of €5 from Debtor Y had been correctly posted to his account but had
been entered in the cash account as €625.
(f) The bookkeeper was not able to deal with the receipt of €500 from the owner’s
own Bank account, and he made the following entry:

(Continued overleaf )

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DR Bank €500
CR Suspense €500
(g) No entry has been made for a cheque of €120 received from debtor M.
(h) A receipt of €50 from debtor N had been entered into his account as €5 and
into the cash book at €5.

Required
Complete the Suspense Account, correcting the above errors.

Solution
Suspense
€ €
Balance b/d 1,075
Postages (TB only) 675 Trial Balance 957
Sundry Income X 500
(TB only) 162 Cost of Fixed Asset 1,575
Cash 620
Capital account 500
3,032 3,032

Incomplete Records

Some businesses may not maintain a full double entry set of accounts; however they
may keep sufficient records to enable full and accurate accounts to be prepared.
Since a full set of accounts is not maintained, preparing the final accounts is not a
simple matter of closing off accounts and transferring balances to the income state-
ment or showing outstanding balances in the balance sheet. The task of preparing
the final accounts involves determining what items are incomplete, determining their
value and then constructing the income statement and balance sheet.
Items which may be incomplete include:

(a) The opening balance sheet;

(b) Credit sales and receivables;
(c) Purchases & trade payables;
(d) Purchases, inventory & cost of sales;
(e) The cash book;
(f) Accruals and prepayments; and
(g) Drawings.

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The Opening Balance Sheet

This is normally available from the previous year’s set of accounts. However, an
examination problem might provide information about the assets and liabilities of a
Business at the beginning of the period but then leave the balancing figure – the pro-
prietor’s business capital – unspecified.

Example:
A client started the business on 1.1.WW. He introduced €1,000 into the business
which was immediately invested in a second hand van costing €900 and €100
worth of inventory. He introduced no further capital into the business during the
year but he withdrew €100 each week except for the week immediately after
Christmas and the week of his Easter holiday, when he withdrew nothing.
At the end of the year (31.12.WW): he still had his van (which he believes will last
him two more years and then be worth nothing); he was owed €95 (subsequently
received) by various customers; he owed various wholesalers €265 for inventory
bought on credit; the remaining inventory had cost him about €55; and he has a
cash float of €370.

Required
Calculate the profit earned for the period.

Solution
There was no opening capital, but there was an injection of capital of €1,000.
Drawings may be calculated as €5,000 (€100 x 50 weeks)
Capital = Assets – Liabilities
Assets €
Van 600
Inventory 55
Receivables 95
Cash 370
1,120
Liabilities
Payables 265
Capital 855
Therefore, profit for the year was:
€
Opening capital Nil
Capital introduced 1,000
1,000
Plus: Profit X
Less: Drawings 5,000
Closing Capital 855
Therefore profit must be €4,855.

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Credit Sales and Receivables

If a business does not keep a record of its sales on credit, the value of these sales
can be derived from the opening balance of trade receivables, closing balance of
trade receivables and payment received during the period.

Example
The business had trade receivables of €1,750 on 1.1.XX, and trade receivables of
€3,140 on 31.12.XX. Payments received during year amounted to 31.12.XX were
€28,490, and there were no bad debts. What were the credit sales?
Solution
Receivables
€ €
Balance b/d 1750 Receipts 28,490
* Sales 29,880 Balance c/d 3,140
31,630 Cl. Bal 31,630
Bal b/d 3,140

Purchases and Trade Payables

A similar relationship exists between purchases of inventory during a period, the

opening and closing balances for trade payables and amounts paid to payables dur-
ing the period.

Example
Trade payables were €2,500 at 1.1.XX and €4,200 at 31.12.XX. Payments to trade
creditors during the year amounted to €32,000. What were purchases during the
year?
(a) €30,000
(b) €31,600
(c) €33,700
(d) none of these
Solution
Trade Payables
€ €
Payments 32,000 Bal. b/d 2,500
Balance c/d 4,200 * Purchases 33,700
36,200 36,200
Balance b/d 4,200

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Purchases, Inventory and Cost of Sales

When the value of purchases is not known, a different approach might be required to
find out what they were, depending on the nature of information given to you. If you
are given information about opening and closing inventory and cost of goods sold,
purchases could be calculated using the ‘cost of goods sold’ formula
That is:

Opening inventory x
Plus: purchases x
Less: closing inventory (x)
Equals: cost of goods sold x

Example
The inventory held on 1.1.XX had a balance sheet value of €8,400, while the inven-
tory taking exercise at 31.12.XX showed inventory valued at €9,350. Sales during
the year amounted €80,000. The business makes a gross profit of 33 1/3 % on
cost for all items that it sells.
Required
Calculate cost of goods sold and the purchases during the ended 31.12.XX.
Solution
€
Sales 80,000 133.3%
Cost of good sold 60,000 100%
Gross Profit 20,000 33.3%
80,000 x 100
133.3
Opening inventory 8,400
+ Purchases ??
– Closing inventory (9,350)
= COGS 60,000
Therefore purchases = €60,950.

The Cash Book

The cash book contains details of all receipts and payments. Details of receipts and
payments may be needed to establish the amount of:

n purchases during period;

n credit sales during period;

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n cash sales;
n expenses; and
n drawings.

Therefore it is usually normal, if a business does not keep a cash book day to day,
to construct a cash book at the end of an accounting period.
Where there appears to be a sizeable volume of receipts and payments in cash,
then it is also helpful to construct a two column cash book. This is a cash book with
one column for the cash receipts and payments and another column for payments into
and out of the business bank account.

Example:
Jonathan Slugg owns and runs a shop selling fishing tackle, making a gross profit
of 25% on the cost of everything he sells. He does not does keep a cash book.
On 1.1.XX, the balance sheet of his business was:
€
Non current assets 20,000
Inventory 10,000
Cash at bank 3,000
Cash in till 200
33,200
Proprietor’s capital 32,000
Trade payables 1,200
33,200
In the year to 31.12.XX:
(a) There were no sales on credit;
(b) €41,750 in receipts were banked;
(c) The bank statements during the period show the following payments:
(1) Trade payables €36,000;
(2) Sundry expenses €5,600;
(3) Drawings €4,400.
(d) Payments were also made in cash out of the till to:
(1) Trade payables €800;
(2) Sundry expenses €1,500;
(3) Drawings €3,700.

At 31st December XX, the business has cash in the till of €450 and trade paya-
bles of €1,400. The cash balance in the bank was not known.
Required

A two-column cash book for the period

(Continued overleaf )

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Solution
Cash Book
Cash Bank Cash Bank
€ € € €
Bal b/f 200 3,000 Trade payables 800 36,000
Cash receipts banked – 41,750 Sundry expenses 1,500 5,600
Contra Drawings 3,700 4,400

*Sales 48,000 Cash receipts banked

Contra 41,750
*Bal c/f 1,250 Bal c/d 450
48,200 46,000 48,200 46,000
Bal b/d 450 Bal b/d 1,250

Accruals and Prepayments

Where there is an accrued expense or prepayments, the charge to be made in the

income statement for the item concerned should be found from the opening balance
brought forward, the closing balance carried forward and the payments for the item
during the period.

Accrual Account
€ €
Cash paid X Bal B/F X
Bal c/f (accrual) X *IS (bal figure)
X X
Bal b/d X
Prepaid Account
€ €
Bal b/d X
Cash paid X * IS (bal figure) X
Balance c/d (prepayment) X
X X
Bal b/d X

Example:
At 1.1.XX, the company had prepaid rent of €700 which relates to the next
accounting period. During the year to 31.12.XX, the company paid €9,300 in
rent and at 31.12.XX the prepayment of rent is €1,000. What is the charge to
the income statement?
(Continued overleaf )

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Rent Account
€ €
Bal b/d 700
Paid 9,300 *IS (bal figure) 9,000
Balance c/d (prepayment) ______
10,000 10,000
Bal b/d 1,000

Drawings

Where personal items of receipts or payments are made:

(a) Receipts should be set off against drawings:

DR Cash
CR Drawings
(b) Payments should be charged to drawings:
DR Drawings
CR Cash

Approach to Dealing with Incomplete Records Problems

Step 1 Establish opening balance sheet.

Step 2 Open up accounts for:
– Trading (sales less cost of sales);
– Cash book;
– Receivables; and
– Payables.
Step 3 Enter the opening balances in theses accounts.
Step 4 Work through the information you are given line by line. Each item should be
entered into the appropriate account if it is relevant to one or more of the
four accounts above.
Step 5 Look for the balancing figures in your accounts. Calculate these missing
figures and make any necessary double entry.
Step 6 Complete the income statement and balance sheet. Working T-accounts might
be needed where there are accruals or prepayments.

Finding the Value of Assets Lost

This arises where, for example, inventory has been stolen from a business which does
not maintain detailed and up to date inventory records. Under such circumstances the
inventory figure will not be available directly and would need to be deduced. Similarly,
cash stolen from a firm which does not keep a detailed record of cash transactions
will require some kind of estimate to be made.

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n Stolen goods or goods destroyed

When an unknown quantity of goods is lost, then the cost of goods lost is the
difference between the:
(a) cost of goods sold; and
(b) opening inventory of goods (at cost) plus purchases less closing inventory
of the goods (at cost).
In theory (a) + (b) should be equal. However if (b) is larger than (a) it follows that
the difference must be the cost of goods purchased and neither sold nor remain-
ing in inventory i.e. cost of goods lost.
n Stolen cash
This can usually be estimated by putting cash as the balancing figure on a bal-
ance sheet as at the day of the mishap.

Example:
The Carnaby Wholesale Clothing Co. was burgled on the night of 14th
December 200X. The raiders stole all that day’s cash takings together with the
petty cash and a selection of the most expensive clothing. On 30th November
200X, the owner had taken a physical inventory count for which the cost
was evaluated as €32,540. The inventory of clothing left after the burglary
amounted to €11,300 at cost. Deliveries from suppliers of further inventory
items between 1st December and 14th December 200X were invoiced at €5,784
after deduction of trade discounts of €732.

Sales to retails customers (at selling price) were:

Cash Credit
€ €
1–6th December 1,429.71 6,250.29
7–13th December 1,644.50 8,079.50
14th December 259.32 1200.68

The cash and bank accounts showed that during the period 1–14 December
200X:
1. The cash takings for the 1–13th December, inclusive had been banked intact.
2. Cheques for €168.92 and €192.67 had been drawn to pay staff wages.
3. Credit customers had paid cheques amounting to €15,867.11 (all of which
had been banked) in full settlement of accounts totalling €16,102.83.
4. The company had paid credit suppliers a total of €17,118.36 by cheque
after deducting cash discounts of €940.45.
5. The petty cash imprest account had been restored to its established level of
€25 on 1st December by a withdrawal from the bank of €9.74. Subsequent
disbursements to 14th December had amounted to €13.69.
(Continued overleaf )

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Account balances in the firm’s books on 30th November 200X were:

€
Bank €6,625.08 (DR)
Cash €129.60
Petty Cash €15.26

Gross profit on sales had been at the rate of 30% throughout 200X but on 7th
December, as part of a sales campaign, this was reduced to 25% for the remain-
der of the month.

Requirement
(i) The amount of cash and value of inventory, which had been stolen; and
(ii) The balance on the bank account at close of business on 14th December
200X.

Solution
(i)
The amount of cash stolen (can be derived from a cash summary / cash account
i.e. how much was on premises on night of the theft).
€ €
Balance at 30th November 200X 129.60
Receipts
Cash sales 1–6 1,429.71
7–13 1,644.50
14 259.32
3,463.13
Payments into bank
6th December 1,429.71
13th December 1,644.50
(3,074.21)
Therefore balance on hand 14th December 388.92
Cash Account
€ €
Bal b/f 129.60
Cash sales 1–6 /12 1,429.71 Lodged to bank 6/12 1,429.71
Cash sales 7–13/12 1,644.50 Lodged to bank 13/12 1,644.50
Cash sales 14/12 259.32 * Bal c/f 388.92
3,463.13 3,463.13
* The petty cash balance as at 14/12 would be €25 – €13.69 = €11.31 (stolen).
Therefore the total amount of cash stolen is €388.92 and €11.31 = €400.23.
Amount of inventory stolen:
1–6th Dec 7–14th Dec
€ €
(1) Sales 7,680 100% 11,184 100%
Cost of Goods sold 5,376 70% 8,388 75%
Gross Profit 2,304 30% 2,796 25%
(Continued overleaf )

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Therefore goods sold = €13,764.

(2) Cost of goods sold
€
Opening inventory 32,540
+ purchases 5,784
– closing inventory (11,300)
= COGS & lost 27,024
(3)
€
COGS & lost 27,024
COGS 13,764
Cost of goods lost 13,260
(ii) Balance on bank a/c at 14th December € €
Bal at 30.11.0X 6,625.08
Takings banked
(€1,429.71 + €1,644.50) 3,074.21
Receipts from credit customers 15,867.11
18,941.32
25,566.40
Payments to suppliers 17,118.36
Staff wages
(€168.92 + €192.67) 361.59
Petty Cash 9.74
17,489.69
Balance at 14.12.0X 8076.71
Bank Account
€ €
Bal b/f 6,625.08 Suppliers 17,118.36
Takings banked 1,429.71 Wages 361.59
Takings banked 1,644.50 Petty cash 9.74
Credit receipts 15,867.11
_________ * Bal c/f 8,076.71
25,566.40 25,566.40
Bal b/d 8,076.71

Summary of Section Five

This section has covered a lot of fairly detailed accounting procedures which take a
while to understand properly. They are all essential procedures and you should do
your best to get to get to grips with them at this stage.

Conclusion
Now that you have worked through this chapter, you should have formed an under-
standing of how double-entry book keeping works and be familiar with the main books
of account. You should also be able to:

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n draw up and balance T accounts;

n extract a Trial Balance;
n identify income statement balances;
n identify balance sheet balances;
n draw up an income statement;
n draw up a balance sheet;
n reconcile control accounts;
n prepare bank reconciliation statements;
n calculate prepayments and accruals; and
n deal with incomplete records.

This knowledge will form a base from which you can learn how to prepare accounts
for limited companies, partnerships, clubs and many other types of organisation.
You may have found some parts of this chapter rather daunting but don’t despair it
will become clearer with practice and experience. The main thing to remember is that
‘for every debit, there is a corresponding credit’.

EXAM LEVEL QUESTIONS

(P2) QUESTION 4, SUMMER 2002
Alan Dickens runs his own business selling books and you are in the process of pre-
paring his accounts for the year ended 31st December 2001. Some of his accounting
books and records for the year were lost when he moved premises and he has only
been able to supply you with the following information:

(1) All sales, purchases and expenses made during the year included the standard
rate of VAT, which should be assumed at 20%. VAT owed as at 1st January 2001
was €570.
(2) Cheque payments recorded in the books and records during the year were as
follows:

€
Payments to suppliers 95,270
Payments for VAT due 5,946

(3) Bank receipts lodged during the year were as follows:

€
Receipts from customers 97,842
Receipts for VAT refunds 5,278

(4) Purchase invoices included rent invoices of €6,936 (inclusive of standard rate
VAT) and telephone invoices of €564 (inclusive of standard rate VAT).
(5) Personal cheques (drawings) were paid out of the bank account but there are no
details available.

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(6) Balances known are as follows:

31st December 31st December

2000 2001
€ €
Receivables 25,275 26,775
Payables 14,555 12,765
Bank overdraft 10,257 9,553

All sales and purchases are on credit.

(7) There was € 485 (exclusive of standard rate VAT) of rent paid during the previ-
ous year, i.e. year ended 31st December 2000, which related to the current year.
€ 523 of rent (exclusive of standard rate VAT) had been paid in advance as at
31st December 2001.
(8) € 125 (exclusive of standard rate VAT) of telephone charges had been accrued in
the accounts as at 31st December 2000. The telephone invoice relating to the quar-
ter ended 31st January 2002 was received on 14th February 2002 and amounted to
€ 255 (excluding standard rate VAT).
(9) A review of the receivables ledgers indicated that discounts given were € 378, bad
debts written off were € 780 and credit notes raised amounted to € 150. All these
amounts are inclusive of standard rate VAT.
(10) The capital account of Alan Dickens was € 253 (credit) as at 31st December
2000.

Requirement
(a) Prepare the following nominal ledger control accounts for Alan Dickens for the
year ended 31st December 2001:
(i) Receivables control account
2 Marks
(ii) Payables control account
2 Marks
(iii) Bank account
1 Mark
(iv) VAT account
2 Marks
(b) Prepare the following nominal ledger accounts for Alan Dickens for the year
ended 31st December 2001:
n Sales
n Purchases
n Discounts given
n Rent
n Telephone
n Bad debts written off

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n Prepayments
n Accruals
n Capital Account – Alan Dickens
n Drawings – Alan Dickens
8 Marks
(c) Prepare an income statement for the year ended 31st December 2001.
3 Marks
Presentation Marks
2 Marks
Total 20 Marks

(P2) QUESTION 1, AUTUMN 2002

You have received a telephone call from Mrs. Old, the Accountant of FIXIT Limited,
and a repair and maintenance company. Mrs. Old is preparing the company’s accounts
for the year ended 31st December 2001. Mrs. Old has discovered that she needs to
make a number of accounting entries, of which she is unsure.
She has asked you to assist by providing her with a list of the journal adjustments
necessary to complete the company’s accounts for the year ended 31st December
2001.
She has provided you with the following information:
(1) A van, which had cost € 5,000 and had a net book value of € 2,813 at 1st
January 2001, was traded in on 1st March 2001 as a part exchange for the pur-
chase of a new van which cost € 7,800. A cheque for € 5,800 was paid by the
company to complete the purchase.
Depreciation is charged on vans at 25% per annum on a straight line basis. A
full year’s depreciation is to be charged in the year of purchase and none in the
year of sale.
(2) During the year, a machine initially held in inventory for resale was installed in the
company’s workshop. The machine had cost € 50,000 and its selling price was €
75,000. No adjustment in the accounts has ever been made for this machine.
The machine was damaged during its installation and the cost of repairing
the damage amounted to € 4,500. This has been included in the accounts as
repairs. The cost of employees’ time to install the machine was € 3,250 and this
has been included in the wages account in the income statement. The directors
want all eligible expenditure in relation to the machine to be included at its cost
in accordance with IAS 16 Property, Plant and Equipment.
A government grant of € 10,000 has been received in respect of this machine.
This has been included in sales. The useful economic life of the machine is 4
years.
(3) A sales credit note for € 180 (including standard rate VAT) has been omitted
from the accounts. The receivables control account totals € 25,930. Assume that
the standard rate of VAT is 20%.

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The receivables’ listing includes a bad debt of € 750 (including standard rate
VAT), which is to be written off. VAT can be reclaimed on this bad debt.
The provision for bad and doubtful debts carried forward from 31st December
2000 of € 2,125 (including standard rate VAT) did not include the bad debt writ-
ten off. The provision for bad debts should be 5% of the remaining receivables
(i.e. receivables after adjusting for both the credit note and bad debt write-off
above).
(4) Interim dividends paid of € 15,000 have been included in general expenses. The
interim dividend was € 20 per share. On 31st December 2001, a final dividend was
declared and approved by the shareholders of € 25 per share. No adjustment has
yet been made for this final dividend.

Requirement

Prepare the journal entries necessary to correct the accounts in each case noted in
(1) to (4) above.
18 Marks

Presentation Marks
2 Marks
Total 20 Marks

EXAM LEVEL QUESTIONS – SOLUTIONS

(P2) QUESTION 4, SUMMER 2002

(a) Nominal ledger control accounts

Receivables Control account:

€
Balance as at 1st January 2001 25,275
Receipts (97,842)
Discounts (378)
Credit notes (150)
Bad debts (780)
Sales 83,875
VAT 16,775
Balance as at 31st December 2001 26,775
Payables Control account:
€
Balance as at 1st January 2001 (14,555)
Payments 95,270
Purchases (77,900)
VAT (15,580)
Balance as at 31st December 2001 (12,765)

(Continued overleaf )

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Bank Control account:

€
Balance as at 1st January 2001 (10,257)
Payments to creditors (95,270)
Receipts from debtors 97,842
Payments for VAT (5,946)
Receipts for VAT refunds 5,278
Drawings (1,200)
Balance as at 31st December 2001 (9,553)
VAT Control account:
€
Balance as at 1st
January 2001 (570)
Payments for VAT 5,946
Receipts for VAT refunds (5,278)
VAT on Sales (16,775)
VAT on purchases 15,580
VAT on discounts given 63
VAT on credit notes 25
VAT on bad debts 130
Balance as at 31st December 2001 (879)
(b) Nominal ledger accounts
€
Sales account:
Balance as at 1st January 2001 –
Receivables (83,875)
Credit notes 125
IS 83,750
Balance as at 31st December 2001 –

Purchases account:
Balance as at 1st January 2001 –
Creditors 77,900
Rent (5,780)
Telephone (470)
IS (71,650)
Balance as at 31st December 2001 –

Discounts given:
Balance as at 1st January 2001 –
Receivables 315
IS (315)
Balance as at 31st December 2001 –

Rent:
Balance as at 1st January 2001 –
From prepayments 485
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Purchases 5,780
IS (5,742)
To prepayments (523)
Balance as at 31st December 2001 –

Telephone:
Balance as at 1st January 2001 –
From Accruals (125)
Purchases 470
IS (515)
To accruals (170)
Balance as at 31st December 2001 –

Bad debts written off:

Balance as at 1st January 2001 –
Receivables 650
IS account (650)
Balance as at 31st December 2001 –

Prepayments:
Balance as at 1st January 2001 485
To Rent (485)
Rent 523
Balance as at 31st December 2001 523

Accruals:
Balance as at 1st January 2001 (125)
To telephone 125
Telephone (170)
Balance as at 31st December 2001 (170)

Capital Account – Alan Dickens:

Balance as at 1st January 2001 (253)
Drawings 1200
IS account (4,878)
Balance as at 31st December 2001 (3,931)

Drawings – Alan Dickens:

Balance as at 1st January 2001 –
Bank 1,200
To capital account (1,200)
Balance as at 31st December 2001 –

(c) Income Statement for Year Ended 31st December 2001

€
Sales 83,750
Purchases (71,650)
Gross Profit 12,100
(Continued overleaf )

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Fewer Expenses:
Telephone 515
Rent 5,742
Bad debts 650
Discounts given 315
(7,222)
Net Profit 4,878

(P2) QUESTION 1, AUTUMN 2002

Dr Cr
(1) € €
Van – Cost of Additions 5,800
Bank 5,800
Cheque payment for acquisition of new van
Van – Cost of Additions 2,000
Profit /loss on sale 2,000
Accumulated depreciation – Vans 2,187
Cost of disposals – Vans 5,000
Profit /loss on sale 2,813
Depreciation charge – Vans 1,950
Accumulated depreciation – Van 1,950

(2)
Plant & Machinery – Cost 50,000
Purchases 50,000
Machine transferred to non current assets as taken
from inventory
Plant & Machinery – Cost 3,250
Wages 3,250
Adjustment for employee wages to be included in
machine costs
Sales 10,000
Deferred income (balance sheet) 10,000
Reallocation of grant to deferred income
Deferred income (balance sheet) 2,500
Amortisation of grant 2,500
Release of grant over its useful economic life
Depreciation – plant & machinery 13,312.50
Accumulated depreciation – plant & machinery 13,312.50

(Continued overleaf )

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(3)
Sales 150
VAT control account 30
Receivables control account 180
Adjustment for credit note omitted.
Bad debts (IS) 625
VAT Control account 125
Receivables Control account 750
Adjustment for bad debts written off
Provision for bad and doubtful debts 875
Bad debts (IS) 729
VAT control account 146
Adjustment for reduction in the provision for bad and
doubtful debts

(4)
Dividends (IS) 15,000
General expenses 15,000
Transfer of dividend from general expenses to dividends
Dividends (IS) 18,750
Dividends payable (balance sheet) 18,750
Adjustment for dividend declared and approved.

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