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1

WHAT IS BOOKKEEPING?

1.1

Why do we prepare accounts?


If you invest in a business (whether by buying shares in a company or by
putting money into your own business), you need to know how well or badly that
business is doing.
In particular you need to be updated periodically with answers to two equally
important questions:
a)

Is the business making a profit?

b)

Has it got enough funds to pay its debts?

Accounts are the means by which these questions are answered.

1.2

Form of accounts
A set of accounts consists of two principal statements, usually amplified by
detailed notes.
These statements are:
(a)

the statement of financial position: a statement of the financial position


of a business at a given date;

(b)

the income statement: a summary of the results of a businesss


transactions for a period ending on the date of the statement of financial
position.

The amount of detail in a set of accounts will vary according to the type of
accounts and the people who will be using them. But the same principles will
still apply.

1.3

Types of business
There are 3 types of businesses which we will consider in Accounting and a
brief description of these types of business is given below. What is important to
remember is that regardless of the type of business we are looking at, all
businesses will produce an Income Statement and a Statement of Financial
Position periodically (usually annually).

Sole Trader
A sole trader is usually a small business, such as a plumber or plasterer, the
owner and the manager are the same person.

The sole trader is legally responsible for all of the losses that their business
makes.
Sole traders produce accounts which are not heavily regulated. The sole trader
will usually employ a firm of accountants to prepare the businesss accounts.

Partnership
This is a business owned and managed by two or more people examples of
such are Accountancy and Law firms. Each Partner in this business is a sole
trader for accounting purposes and a Partnership is a collection of sole traders
acting together in one business.
Partnerships produce special Partnership accounts.

Company
A company is not owned by the managers of the business (the directors) but
instead is owned by Shareholders who buy shares in the company and who
elect the Directors to run the company.
A company has limited liability which means that unlike a sole trader, the
owners (i.e. the shareholders) are not responsible for the losses of the
company. The company is its own legal entity.
Companies must produce company accounts and these are heavily regulated
by Company Law and Accounting Standards.

1.4

The purpose of bookkeeping


If accounts are to be produced periodically, the transactions which are being
accounted for (eg. purchases and sales of goods, expenses, receipt and
payment of cash) must be recorded as and when they happen.
As we said in the Introduction, bookkeeping is the recording of a businesss
commercial transactions. Its purpose is to enable those transactions to be
summarised at the end of a period so that accounts can be produced.

1.5

Types of accounting records


The expression books survives from the days before the invention of
accounting machines and computers, when everything was written up in
leather-bound books. You will see some handwritten records, but much of what
we still call books of account or accounting records will take the form of
computer print-outs. The same information is being given nonetheless.

1.6

Revision questions
(a)

What are the two basic questions which an investor in a business


should ask?
(i) ....
(ii) ....

(b)

What are the two principal statements in a set of accounts?


(i) ....
(ii) ....

(c)

Fill in the missing words:


Bookkeeping is the _____________ of a businesss _____________
____________________ .

1.7

Answers
(a)

(b)

(c)

(i)

Is the business making a profit?

(ii)

Has the business got enough funds to pay its debts?

(i)

Statement of financial position

(ii)

Income Statement

Bookkeeping is the recording of a businesss commercial


transactions

THE STATEMENT OF FINANCIAL POSITION

2.1

Introduction
In Chapter 1 we saw that the Statement of Financial Position is one of the
principal statements of our financial accounts.
Lets consider what we mean by position: the SOFP considers what the
business OWNS which we refer to as ASSETS and what the business OWES
which we refer as LIABILITIES.
In this chapter we will look at Assets and Liabilities in the Statement of Financial
Position (SOFP) in more detail.

2.2

Assets
As above, Assets are defined things which the business OWNS and can be
broken down into two types:
Non-current assets, and
Current assets.
Non-current assets
Non-current assets can be defined as assets acquired for use within a business
over more than one year (usually several years) with a view to earning profits,
but not for resale.
Without looking at the answer, try to think of some types of assets which a
business would be likely to keep over several years which might help them to
make profits.
Target

about 10.

Answer:

Land, buildings, plant and machinery, patents, motor vehicles, tools, fixtures
and fittings, office equipment, computers, long-term investments, ships, works
of art, locomotives.
Current assets
Current assets are defined as assets acquired for conversion into cash in the
ordinary course of business. These are any assets which are not non-current
assets.
In other words, non-current assets are those which a business keeps and uses
in the long term (usually more than 12 months), and current assets are those
which pass through the business as part of the normal trading process.
Just as people or animals cannot live without blood constantly moving through
their bodies, so a business cannot exist without the constant movement of
current assets.
a)
b)

Inventories
Cash

Receivables these occur when we sell goods to our customers on credit (i.e
they pay us later). When our customer will pay us depends on the credit terms
we offer them but it will usually be within 3 6 months.

2.3

Liabilities
Above we defined a liability as an amount owed by the business. This means
that the business has an obligation to pay money at some future date. As with
assets, there are two types of Liability: Non-Current Liability and Current
Liability.
Non-current liabilities
These are amounts owed by the business, payable in more than one year
after the date of the statement of financial position. Long-term bank loans are
much the common example.
Current Liabilities
A current liability is simply a short-term liability
business, payable within one year.

i.e. an amount owed by the

The commonest examples of current liabilities are:

2.4

(a)

trade payables; - these occur when we buy goods on credit and owe
our supplier money. When we will pay our supplier depends on how
long they give us to pay but this will usually be less than 12 months.

(b)

bank overdraft we owe the bank the money back

The Business Entity Concept


We saw in Chapter 1 that a Sole Trader is a business which is owned and
managed by the same person. However, from an accounting perspective, the
Owner and the Manager are two different people. Therefore if the business
owner puts anything into the business, the business OWES this back to the
owner. This concept is known as the Business Entity Concept.
For Example, Joe the plumber has his own sole trader business. Joe uses his
own money to buy a van for the business which costs 10,000. The plumbing
business now has a Non Current Asset in their accounts (a Van). Per the
Business Entity Concept, this plumbing business owes Joe 10,000 as the
business and Jo are separate people. Anything which Joe puts into the
business is owed back to him. The amount which the business owes back
to the business owner is known as Capital.

2.5

Capital
The term capital represents the total amount which the business owes to its
owner, or proprietor. On our SOFP we need to show at that particular date how
much capital there is in the business.
How we calculate capital:

Opening
capital

the amount which the proprietor has invested in


the business to the start of the year

plus

Capital
injections

any money the proprietor put into the business


during the year

plus

Profits

funds generated by the business (we will see


how to calculate this in the next chapter).

(or) minus

Losses

funds lost by the business (we will see how to


calculate this in the next chapter).

minus

Drawings

any amounts taken out of the business by the


business owner e.g the sole trader takes 1,000
per month out of the business as his/her salary.

So:
Opening capital
+
+/

2.6

Capital injections
Profits / Losses

Drawings

Capital owed to proprietor

Layout of the statement of financial position


Below is an example of what a Statement of Financial Position (SOFP) looks
like.
Remember that the SOFP gives the position at a given date which in this
example is 31 January 20X1.
Therefore this SOFP shows what the sole trader P PILBEAM owns and owes at
this date.

P PILBEAM:

Statement of financial position as at 31 January 20X1

ASSETS
Non-current assets
Motor vehicles

4,000

Current assets
Inventories

2,000

Trade receivables
Cash

6,300
8,300

Total assets

12,300

CAPITAL AND LIABILITIES


Capital
As at 1 January

10,000

Profit for the period

800

Less drawings

(500)

At 31 January

10,300

Non-current liabilities
Current liabilities
Trade payables

2000
2000

Total capital and liabilities

12,300

As you can see from the illustration, when we prepare a SOFP we present Noncurrent assets separately from current assets and Non-current liabilities
separately from current liabilities.
If you look at the numbers in the SOFP you can see that
Total Assets = Capital + Total Liabilities.
The above equation is known as the Accounting Equation - we will look more
closely at this in chapter 3.
6

2.7

Revision questions
(1)

Define non-current assets.

(2)

Define current assets.

(3)

Are the following non-current or current assets?


(a)

Buildings

(b)

Receivables

(c)

Cash

(d)

Fixtures & fittings

(e)

Long-term investments

(4)

Define a current liability?

(5)

Name two types of current liability.


(a)
(b)

(6)

How do we calculate capital?

2.8

Answers
(1)

Non-current assets are assets bought by the business for use over a
number of years, with the aim of earning profits, but not for resale.

(2)

Current assets are assets acquired for conversion into cash in the
ordinary course of business.

(3)

(a)

non-current

(b)

current

(c)

current

(d)

non-current

(e)

non-current

(4)

A current liability is an amount owed by the business which is payable


within one year.

(5)

(a)

Trade payables

(b)

Bank overdraft

(6)

A opening capital + capital injections + profit drawings.

3.

THE INCOME STATEMENT

3.1

Introduction
As mentioned in chapter 1, the Income Statement is a summary of the results
of a businesss transactions for a period ending on the date of the statement of
financial position.
The income statement summarises sales that a business has made and
expenses a business has incurred over a period of time. This leads us to
determine whether the business has made a profit (more sales than expenses)
or if they have made a loss (more expenses than sales).

3.2

Income statement format


The pro forma Income Statement below shows you the items which most
businesses are likely to have in their accounts.
Income Statement for the year ended 31 December 20X1

Revenue
Less cost of sales
Opening inventories on 1 January 20X1
Purchases
Less closing inventories on 31 Dec 20X1

X
X
(X)
____

(X)
____

Gross profit

Less expenses
Rent
Rates
Lighting and heating
Telephone
Postage
Insurance
Stationery
Office salaries
Accountancy and audit fees
Bank charges and interest
Delivery costs
Van running expenses
Advertising

X
X
X
X
X
X
X
X
X
X
X
X
X
____

(X)
____

Net profit

X
____

3.3

Revenue
Revenue includes sales made for cash and sales made on credit.

3.4

Cost of sales
As the pro forma shows, the way to find the cost of the goods actually sold
during a period is to take:
(a)

the cost of goods in stock at the beginning of the period known as


opening inventories
and add

(b)

the cost of goods bought during the period purchases.


and then deduct

(c)

the cost of goods in stock at the end of the period: closing inventories.

What this does is to take the cost of goods available for sale during the period
(opening inventories plus purchases) and deduct the cost of the goods which
werent sold during the period (closing inventories). This results in the cost of
the goods which were actually sold.
The thing to remember here is that, whereas revenue should be a larger
amount than cost of sales, the actual number of units of goods concerned will
be the same. Cost of sales or cost of goods sold means exactly that: the cost
of the goods actually sold during the year or period. Revenue thus means
the selling price of the goods during the same period.

3.5

Gross Profit
The first part of the income statement (down as far as gross profit) is known in
many businesses as the core profit, since it shows the results of the actual
buying and selling operations of a business (sales we have made compared to
how much it costs us to buy the things which we have sold i.e. the cost of
sales).
As you can see from the pro forma, the gross profit arrived at is the result of
subtracting cost of sales from revenue.
The resulting gross profit is a very useful figure, since it shows how successful
the main activity of the business has been (i.e. the buying and selling of goods,
as opposed to incidental expenses). You would have to be supremely
incompetent to achieve a large loss.
3

3.6

Net Profit
After arriving at gross profit, we must show other items of income and
expenditure (mainly expenditure) which are relevant to the business but are
incidental to it and not part of the buying, selling or manufacturing of the
goods.
After we have taken off all other expenditure of the business the result is Net
Profit as we can see in the Income Statement.

3.7

Relationship between Statement of Financial Position and the


Income Statement
If you remember from the previous chapter, we included in the SOFP what the
business owes back to the business owner, this being called Capital.
Capital is calculated as:
Capital at the start of the year + capital injections in the year + Profit or loss
Drawings.
The net profit/loss from the Income Statement is therefore included in the
calculation of capital in the SOFP.
If a business makes a profit (sales are higher than expenses) then capital will
increase. If the business makes a loss (expenses are higher than sales) then
capital will decrease.
We can therefore see that making sales or incurring expenses can have an
effect on Capital.
We will explore this further in the next chapter.

3.8

Revision questions

(1)

(a)

What is revenue less cost of sales?

(b)

The final figure in the income statement is called what?

(2)

A businesss sales for a year amount to 120,000. Only 100,000 of


these have been paid for by customers. What will revenue be?

(3)

How is cost of sales calculated?

(4)

A business has opening inventories of 20,000 and closing inventories


of 30,000. During the year it bought goods costing 70,000 of which
10,000 have not yet been paid for.
What is the cost of sales for the year?

(5)

Using the numbers from (4), assuming sales of 100,000, calculate


gross profit.

(6)

Following on from (4) and (5), if the business has rental expenses of
5,000 and telephone expenses of 3000,
How much net profit have they made?

3.9

Answers
(1)

(2)

(a)

Gross profit

(b)

Net profit

120,000 (includes sales where customer has not yet paid).

(3)
Opening inventories
Add
Purchases
Less
Closing inventories
Cost of sales

X
X
(X)
_____
X
_____

We are determining the cost of goods sold in the period. Closing


inventories will be sold next year.

(4)
Opening inventory
Add
Purchases
Less
Closing inventories
Cost of sales

20,000
70,000
(30,000)
_____
60,000
_____

(5)

100,000
(60,000)
_______
40,000
_______

Sales
Cost of sales
Gross profit

(6)
Gross profit
Less

40,000
(5,000)
(3,000)
______
32,000
______

Rent
Telephone

Net profit

CALCULATIONS MADE EASY


Contents
1

Percentages the quick way

Rearranging equations some simple rules using typical exam


examples

1.

Percentages the quick way


First, youll save time if you dont use the % button on your calculator.
Just convert the % given in the question to a decimal, and put that decimal into
your calculator directly.

Examples
5%

= 0.05

15%

= 0.15

One half
percent

of

a = 0.5% = 0.005

125%

= 1.25

3.894%

= 0.03894

Just remember to move the decimal point two places to the left

Second, dont waste time by writing down separate numbers!

Example
A sales value of 150,000 will increase by 5% next year. What is next years
value?

The slow way:


This year

150,000

5% of this is 0.05 x 150,000

7,500

Add together

157,500

The quick way:


150,000 x 1.05 =

157,500

Examples to try

40,000 with a 3% increase =

___________

40,000 with a 23.75% increase =

___________

Example

A sales value of 150,000 will decrease by 10% next year. What is next years
value?

The slow way:

This year

150,000

10% of this is 0.10 x 150,000

15,000

Subtract decrease

135,000

A 10% decrease means that the new figure is 90% of the old value.
A 15% decrease would be 85%, a 3% decrease 97% and so on..

The quick way:

150,000 x 0.90 =

135,000

Examples to try

40,000 with a 30% decrease =

___________

40,000 with a 6.40% decrease =

___________

2.

Rearranging equations some simple rules using typical exam


examples
The rules:
You must do the same thing to both sides of an equation
When you move an item to the other side of the equation by adding or
subtracting, it changes its sign [ positive (+ve) to negative (ve) and vice versa].
When you move an item to the other side of the equation by multiplying or
dividing, it changes from underneath a fraction to on top [and vice versa]
If you know any numbers, and they are separate from the unknown youre trying
to find; just write the numbers down it can make life easier.
Proceed step by step, and leave a trail for a marker to follow

Example 1

Y = a + bx
If Y = 100,000; b = 4 per unit; and x = 2000 units: What is a?

Solution
100000 = a + 4 x 2000
100000 = a + 8000
100000 8000 = a
a = 920000

Example 2

D0
P0 =
Divi yield

If P0 = 20 million and D0 = 1 million; what is Divi yield?

Solution

20m = 1m/divi yield


Divi yield x 20m = 1m
Divi yield = 1m/20m
Divi yield = 0.05m

Example 3

Assets = Liabilities + Capital


Cash = 3000, Inventory = 7000, Loans = 1000
What is capital?

Solution

Assets are cash + inventory = 3000 + 7000 = 10000


Loans are liabilities = 1000
10000 = 1000 + capital
Capital = 10000 - 1000
Capital = 9000

Example 4

Closing capital = opening capital + capital injected + profit drawings


A sole trader business has closing capital of 30000, opening capital of 10000.
The sole trader took drawings out of the business of 5000.
How much profit did he make?
6

Solution

30000 = 10000 + 0 + profit 5000


30000 = 5000+ profit
Profit = 30000 - 5000
Profit = 25000

Have a go

1. A business has Cash of 5000 and receivables of 6000, Payables of 4000 what is capital?
2. A sole trader has capital of 100000, inventory of 60000, loans of 40000 what is cash?
3. A sole trader has Assets of 50000, Liabilities of 20000, opening capital of
5000 - how much profit did the business make?

Answers

1. Assets = liabilities + capital

Cash + receivables = loans + capital


5000 + 6000 = 4000 + Capital
11000 = 4000 + Capital
Capital = 11000 - 4000
Capital = 7000

2. Assets = Liabilities + Capital


Assets = 40000 + 100000
Assets = 140000

Inventory + cash = 140000


60000 + cash = 140000
Cash = 140000 - 60000
Cash = 80000

3. Assets = Liabilities + Capital


Assets = Liabilities + Capital
50000= 20000 + capital
Capital = 50000-20000
Capital = 30000

Capital = opening capital + capital injected + Profit Drawings

30000 =5000 + 0+ Profit 0


Profit = 30000 - 5000
Profit = 25000
9

THE ACCOUNTING EQUATION


If you recall from chapter 2, the Accounting Equation is defined as:
Assets = Liabilities + Capital
This equation will always hold true and the assets of a business will always be
equal to the liabilities of a business plus what the business owes back to the
business owner (capital).

4.1

Dual Effect
A consequence of the Accounting Equation is that every transaction will have
two effects (a dual effect).
Lets think about how we can apply that to an example.
Suppose you are in business as a shopkeeper.
(a)

You start up the business by putting 10,000 into the business.


What are the two effects of this?

(i)

The businesss cash goes up by 10,000. (Assets )

(ii)

The businesss capital goes up 10,000 (Capital )

Expressed as an equation, this shows:

Cash

Total assets = Liabilities + Capital

10,000
Capital 10,000

The business then has the following transactions:

(b)

You buy goods from a wholesaler for 4,000 cash. What are the two
effects of this?
(i)

The business gains more inventories 4,000 (Assets )

(ii)

The businesss cash falls by 4,000. (Assets )

Accounting equation:

Inventories
Cash

(c)

Assets

4,000
6,000

= Liabilities + Capital

Capital 10,000

________

________

10,000

10,000

________

________

You buy goods from another wholesaler for 2,000, who says he will
send you a bill later. What are the two effects of this?
(i)

The business gains more inventories of 2,000. (Assets )

(ii)

The business now has a payable to the wholesaler of 2,000


(Liabilities )

Accounting equation:

Inventories
Cash

(d)

Assets

6,000
6,000

= Liabilities

Payables 2,000

+ Capital

Capital 10,000

________

________

12,000

12,000

________

________

You sell goods to a customer for 4000 and allow them to pay you at
the end of the month. What are the two effects of this?
(i)

The customer now owes the business money ( i.e. a receivable


of 4,000). (Assets )

(ii)

The business inventories fall by 4,000. (Assets )

Inventories
Cash
Receivables

Assets

2,000
6,000
4,000

= Liabilities

Payables 2,000

+ Capital

Capital 10,000

________

________

12,000

12,000

________

________

There is nothing that a business can do which will not have this dual effect not
even right at the beginning, when you first started up the business and put your
money in as capital.
3

4.2

Inventory
You will consider Inventory a lot in future studies but for now we need to be
happy that Inventory is a current asset. However, when we are considering the
Accounting Equation and the Dual Effect we do not need to consider whether
Inventory has gone up or down.
This is because Inventory is something called a year end adjustment and
therefore is only thought about at the end of the year when the accounts are
being completed. You will see a lot of year end adjustments later in your
studies.
When looking at the dual effect and Inventories are involved we consider
buying Inventory to be a Purchase, which is an expense in the Income
Statement and this will reduce profit. The sale of Inventories is regarded as
Income in the Income Statement which will increase profits.
Remember that if we make a profit then Capital goes up and if we make a loss
Capital goes down.

4.3

Impact on the Accounting Equation


Let us now consider the above example again
(a)

You start up the business by putting 10,000 into the business. What are
the two effects of this?
(i)

The businesss cash goes up by 10,000. (Assets )

(ii)

The businesss capital goes up 10,000 (Capital )

Expressed as an equation, this shows:

Assets
Cash

10000
10000

Liabilities

0
=

Capital
Capital

10000

10000

The business then has the following transactions:


(b)

You buy goods from a wholesaler for 4,000 cash. What are the two
effects of this?

(i)

The business has a purchases expense of 4,000 (Expenses ,


therefore Profit hence Capital )

(ii)

The businesss cash falls by 4,000. (Assets )


4

Assets

Cash

Liabilities

6000
6000

(c)

0
=

Capital

Capital

10000
4000 =
6000

6000

You buy goods from another wholesaler for 2,000, who says he will
send you a bill later. What are the two effects of this?
(i)

The business has a another purchase expense of 2,000


(Expenses , therefore profit hence Capital )

(ii)

The business has a liability (a payable) of 2,000. ( Liabilities)

Accounting equation:

Assets

Cash

Liabilities

Payable
2000

6000
6000

(d)

Capital

Capital

6000
2000 =
4000

6000

You sell goods to a customer for 4000 and allow them to pay you at
the end of the month. What are the two effects of this?
(i)

The customer now owes the business money ( i.e. a receivable


of 4,000). (Assets )

(ii)

The business has income from a sale (income therefore profit


, hence Capital)
Assets

Cash
Receivables

6000
4000
10000

Liabilities

Payable 2000 +
=

10000

Capital

Capital

4000 +
4000 =
8000

Test your understanding so far Part 1

This was the activity that we asked you to complete. The answers are set out below.
Record the accounting equation for Doras business after each of the following
transactions:
(1)

Dora starts her business with 20,000 paid into a new business bank
account.

(2)

Goods for resale are bought on credit for 2,000.

(3)

A new motor van is purchased for 5,000. Dora pays by cheque.

(4)

Stock which had cost 2,000 is sold for 3,500 on credit.

(5)

1,800 is paid to a credit supplier.

(6)

Dora borrows 5,000 from Explorer Bank plc.

(7)

A cheque of 2,700 is received from a credit customer.

(8)

Rent of 300 for the past month is paid by cheque.

(9)

250 wages are paid by cheque.

(10)

Dora withdraws 200 from her business.

Answers
(1) Cash
Capital
Assets
Cash

(2) Purchases
Trade Payables
Assets
Cash

20,000
20,000
=

Liabilities
20,000

20,000

2,000
2,000
=
Liabilities
20,000Trade payables

20,000

(3) Cash
5,000
Non-current assets
5,000
Assets
Cash

=
Liabilities
15,000Trade payables

+ Capital
Capital

+ Capital
2,000 Capital
Profit / (loss)

2,000

+ Capital
2,000 Capital

20,000

20,000

20,000
(2,000)

18,000

20,000

Test your understanding so far Part 1


(20,000 5,000)
NCA

(4) Trade receivables


Revenue

Assets
Cash
NCA
Trade receivables

(5) Cash
Trade payables

Profit / (loss)
5,000

20,000

3,500
3,500

= Liabilities
15,000Trade payables
5,000
3,500

23,500

1,800
1,800

Assets
Cash
(15,000 1,800)
NCA
Trade receivables

=
Liabilities
13,200Trade payables
(2,000 1,800)
5,000
3,500

21,700

(6) Non-current liabilities


5,000
Cash
5,000
Assets
Cash
(13,200 + 5,000)
NCA
Trade receivables

(7) Cash
Trade receivables
Assets
Cash
(18,200 + 2,700)
NCA
Trade receivables
(3,500 2,700)

(8) Rent expense

2,000

+ Capital
2,000Capital
Profit/(loss)
(3,500 2,000)

2,000

+
200

= Liabilities
18,200Trade payables
NCL
5,000
3,500

26,700

2,700
2,700

Capital
Capital
Profit / (loss)

200

(2,000)

18,000

20,000
1,500

21,500

20,000
1,500

21,500

+ Capital
200Capital
5,000Profit / (loss)

20,000
1,500

5,200

21,500

=
Liabilities
20,900Trade payables
NCL
5,000
800

+ Capital
200Capital
5,000Profit / (loss)

20,000
1,500

26,700

300

5,200

21,500

Test your understanding so far Part 1


Cash
Assets
Cash
(20,900 300)
NCA
Trade receivables

(9) Wages expense


Cash
Assets
Cash
(20,600 250)
NCA
Trade receivables

(10) Cash
Drawings
Assets
Cash
(20,350 200)
NCA
Trade receivables

300
=
Liabilities
20,600Trade payables
NCL
5,000
800

26,400

+ Capital
200Capital
5,000Profit / (loss)
(1,500 300)

20,000
1,200

5,200

21,200

+ Capital
200Capital
5,000Profit / (loss)
(1,200 250)

20,000
950

5,200

20,950

250
250
=
Liabilities
20,350Trade payables
NCL
5,000
800

26,150

200
200
=
Liabilities
20,150Trade payables
NCL
5,000
800

25,950

+ Capital
200Capital
5,000Profit / (loss)
Drawings

20,000
950
(200)

5,200

20,750

Double Entry

5.1

Introduction
In the previous chapter we considered the impact of transactions on the Accounting Equation.
In this chapter we take this a step further and think about the impact of transactions using the
terminology debit and credit to show the dual effect of each transaction.

5.2

Debit and credit entries


The first thing we need to consider is what type of account the transaction we are looking at
will impact. There are 6 types of account which we consider
expenses (e.g purchases, gas bill, phone bill, electricity bill, salaries)
assets (e.g cash, receivables, factory, cars, remember that we no longer consider
inventory when looking at the dual effect)
drawings (arise whenever a sole trader takes something out of the business).
liabilities (e.g payables, loans)
income (e.g sales, interest income)
capital (what the business owes back to the business owner).

To increase expenses, assets or drawings we say we Debit the account.


To increase liabilities income and capital we say we Credit the account.
We can use the handy acronym DEAD CLIC:

DEBIT (increase)

CREDIT (increases)

Expense (income statement)

Liability (balance sheet)

Asset (balance sheet)

Income (Income statement)

Drawings (balance sheet)

Capital (balance sheet)

It follows that:
a decrease in an expense, asset or drawings is a credit, and
a decrease in a liability, income or capital is a debit

Note that by convention we sometimes abbreviate Debit to Dr and Credit to Cr

33

The acronym DEADCLIC is fundamental to Accounting and therefore will be used


throughout your studies. Write the acronym down and keep it beside you throughout this
chapter.

Steps to record a transaction


Identify the two accounts that are affected.
Consider whether they are being increased or decreased.
Decide whether each account should be debited or credited.
Check that a debit entry and a credit entry for equal amounts have been made

Let us now consider the example which we saw in the previous


chapter:

You start up the business by putting 10,000 into the business. What are the two effects of this?
The businesses cash goes up by 10,000. (Assets )
The businesss capital goes up 10,000 (Capital )

(i)
(ii)

An increase in the value of an asset is a debit entry


So we make a debit entry in the cash account.
Capital is the amount owed by the business to its proprietor.
An increase in the value of capital is a credit entry.

Double Entry

Dr Cash 10000
Cr Capital 10000

The business then has the following transactions:


Buy goods from a wholesaler for 4,000 cash. What are the two effects of this?
(i)
(ii)

The business has a purchases expense of 4,000 (Expenses , hence Capital )


The businesss cash falls by 4,000. (Assets )

Although expenses have an ultimate impact on Capital, Expenses are one of the 6 types of account which
we consider so we dont need to look just at the impact on capital but can consider expenses on their own.
Therefore, as purchase expenses have increased we debit purchases.

Cash is an asset and cash has fallen. We debit to increase assets an conversely we credit to reduce assets
and we need to reduce cash by 4,000

34

Double Entry
Dr Purchases Expenses 4000
Cr Cash 4000

You buy goods from another wholesaler for 2,000, who says he will send you a bill later. What are the
two effects of this?
(i)

The business has a another purchase expense of 2,000 (Expenses , hence


)

(ii)

Capital

The business has a liability (a payable) of 2,000. ( Liabilities)

Again, we have a purchase expense and to increase our total purchases expenses we
need to debit purchases expenses another 2,000.
We have bought the goods on credit but this time we have not paid cash and
therefore we do not need to reduce cash. Instead we have paid on credit and created
a liability. Therefore we want to increase liabilities. To increase a liability we credit.

Double Entry
Dr Purchases Expenses 2000
Cr Payables (Liabilities) 2000

You sell goods to a customer for 4000 and allow them to pay you at the end of the month. What are
the two effects of this?
(i)
(ii)

The customer now owes the business money ( i.e. a receivable of 4,000). (Assets )
The business has income from a sale ( profit, Capital)

Here we have made a sale which means that we will have income in our income statement. To increase
income we credit. The customer has not paid us yet, they still owe us money and therefore we have a
receivable which is an asset. To increase assets we debit.
Double Entry
Dr Receivables 4000
Cr Sales 4000 (income)

You must always have an equal and opposite debit and credit.

35

5.3

Double Entries - examples

Lets assume that we are in business selling fruit and vegetables.


Consider the double entries for the following transaction:
(1)

Sold all the vegetables 2,500 cash.

Dr Cash 2500
Cr Sales 2500
Since cash is an asset and we debit to increase assets and Sales are income and we credit to
increase income.

(2)

Bought 6,000 worth of fruit from Wooster Wholesalers on credit.

Dr Purchases 6000
Cr Payables 6000
Since purchases are an expense and we need to increase expenses to do so we Debit. As we
now owe our supplier money, we have a payable which is a liability. To increase liabilities we
credit.

(3)

Bought 3,000 worth of vegetables for cash.

Dr Purchases 3000
Cr Cash 3000
As above, purchases are an expense and we need to increase expenses therefore we debit
expenses. This time we have paid in cash and therefore we need to reduce the cash of the
business and to reduce an asset, which is what cash is, we credit.

(4)

Sold all the fruit bought in (2) above for 7,500 on credit to R Glossop.

Dr Receivables 7500
Cr Sales 7500
Whenever we make a sale we will have income in our income statement and to increase
income we credit. When we make a sale on credit the customer owes us money which for us
is an asset (called a receivable) and to increase an asset we Debit.

36

(5)

Paid Wooster Wholesalers 3,500.

Dr Payables 3500
Cr Cash 3500

Remember in (2) above we bought the goods from Wholesalers on credit. Therefore we had a
payable which is a liability.
If we are now paying some of that Liability off we are reducing how much we owe. To reduce
a liability we Debit the liability. Also, we are paying out cash and therefore cash is falling.
Cash is an asset and to reduce an asset we Credit.

(6)

R Glossop paid for his fruit in full.

Dr Cash 7500
Cr Receivable 7500

Remember from (4) above that we sold to R Glossop on credit and therefore we had a
receivable since he still owed us money. As he has now paid us we need to reduce this
receivable (asset) and to reduce assets we credit. Also, he has now paid us some cash and to
increase cash we debit cash since cash is an asset.

(7)

Paid 200 for his telephone bill.

Dr Phone Bill expense 200


Cr Cash 200
The phone bill is an expense and to increase expenses we Debit. Also, we have paid out cash
and cash is an asset. If we want to reduce and asset we credit the asset.

(8)

Drew 400 cash out of the business.

Dr Drawings 400
Cr Cash 400
If a sole trader takes anything out of the business this is called drawings.
Although Drawings will ultimately reduce capital, Drawings is an account which we keep
separate and is one of the 6 accounts which we can consider for the dual effect.
To increase Drawings we Debit. If the cash of the business has gone down then we need to
reduce cash. Cash in an asset and to reduce and asset we credit.

37

(9)

Bought a Van for 300 on cash

Dr Non current Asset (Van) 300


Cr Cash 300
The Van is an asset and to increase an asset we debit. Once again, cash has fallen. Cash is an
asset and to reduce cash we credit.

Hopefully you will see from the above illustration that there is always and equal debit and credit to every
transaction. Remember to always consider what are the two accounts which are being affected and then to
use DEAD CLIC.

38

Test your understanding so far Part 2

This was the activity that we asked you to complete. The answers are set out below.
Edward opened a bookshop. The following transactions took place:
(1)

Started business with 20,000 in a business bank account.

(2)

Paid rent of 1,500 cash.

(3)

Made purchases for 350 cash.

(4)

Bought stationery for 55 cash.

(5)

Made further purchases from Joe for 245 on credit.

(6)

Sold books to a school for 1,200 cash.

(7)

Paid Joe 150 cash.

(8)

Bought a second hand van for 3,500 cash from MV Ltd

(9)

Sold a book on credit to Christine for 150.

(10)

Took 250 from the business to pay for a holiday.

(11)

Bought more stationery for 30 cash.

(12)

Paid 120 cash for motor expenses.

(13)

Received 75 from Christine.

(14)

Paid electricity of 30 cash.

Write down the double entries for the above transaction.

Answers
1

Dr
Cr

Cash
Capital

20,000
20,000

Dr
Cr

Rent expenses
Cash

1,500
1,500

Dr
Cr

Purchases
Cash

350
350

Dr

Stationery

55

Test your understanding so far Part 2

Cr

Cash

55

Dr
Cr

Purchases
Trade payables

245
245

Dr
Cr

Cash
Sales

1,200
1,200

Dr
Cr

Trade payables
Cash

150
150

Dr
Cr

Motor vehicles
Cash

3,500
3,500

Dr
Cr

Trade receivables
Sales

150
150

10

Dr
Cr

Drawings
Cash

250
250

11

Dr
Cr

Stationery
Cash

30
30

12

Dr
Cr

Motor expenses
Cash

120
120

13

Dr
Cr

Cash
Trade receivables

75
75

14

Dr
Cr

Electricity expense
Cash

30
30

Preparing Financial Statements


If you remember back to the earlier chapters, we looked at our basic Financial Statements, the
Income Statement and the Statement of Financial Position. In this exercise we will return to these
statements thinking about how they look and attempt to produce them ourselves.

Task
Using the numbers provided, try to prepare an Income Statement and Statement of Financial
Position.

Hint:
It helps if you draw up an Income Statement and a Statement of Financial Position with no numbers
in it first. You can use the illustrations provided in Chapter 2 for the Statement of Financial Position
and Chapter 3 for the Income Statement.

You also need a complete Income Statement before you complete the Statement of Financial
Position as what we get for profit or loss from the Income Statement is included in the Capital part
of the Statement of Financial Position.

Cash
Capital
Rent expense
Purchases
Stationery
Trade payables
Sales
Motor vehicles
Trade receivables
Drawings
Motor expenses
Electricity expense

15,290
20,000
1,500
595
85
95
1,350
3,500
75
250
120
30

Answer
Income statement
Sales
Cost of sales
Opening inventory
Purchases
Closing inventory

1,350

595
(595)

755

Gross profit
Expenses
Rent
Stationery
Motor expenses
Electricity

1,500
85
120
30

(1,735)

(980)

Net loss

Balance sheet
Non-current assets
Motor vehicles
Current assets
Inventory
Trade receivables
Cash

3,500

75
15,290

15,365

18,865

Caital
Capital introduced
Loss
Drawings

20,000
(980)
(250)

18,770

Current liabilities
Trade payables

95

18,865