Daf1102 Fundamentals of Accounting I

DEPARTMENT OF MANAGEMENT
COURSE CODE: DBM 114
COURSE TITLE: FUNDAMENTALS OF ACCOUNTING I
MANUAL PREPARED BY: Mr. MBURU PETER
Cell phone No.: 0723135375
Email address: mbgipe@yahoo.com

COURSE CONTENT
DBM 114: FUNDAMENTALS OF ACCOUNTING I
Purpose: - The major aim of this course is to develop the learners understanding of the
principles of book-keeping and accounts and the ability to maintain books of accounts and
preparation of financial statements.
Course objectives:- By the end of the course unit the student should be able to;
 Compile accounting data
 Prepare financial statements
 Interpret accounting information
 Use accounting information in decision making
Course structure
 Introduction to accounting – purpose of accounting, basic principles; concepts and
convention underlying accounting reports, accounting equation, accounting terminology,
users of financial statements and their information needs.
 Double entry: - booking keeping and books of original entry.
 Distinction between and treatment of capital revenue and expenditure accounts
 Types of ledgers and their uses
 Petty cash book: - Analysis petty cash book; imprest system.
 Re conciliation of bank and cash balances
 Types of errors and their correction
 Control ledger accounts
 Provisions
 Preparation of final accounts:- preparation of the trading, profits and loss accounts;
balance sheet.
Reference
Honrgren and sundem, G L, Introduction to Financial Accounting, (6th Edition), New York;
Prentice Hall.
Larson, K M. and Pyre, D, Fundamentals of Accounting Principles, ( 12th Edition), prentice Hall
Wood, Frank, Business Accounting (17th Edition), International Thompson
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Contents
COURSE CONTENT .................................................................................................................................... i
INTRODUCTION TO ACCOUNTING (WEEK 1) ..................................................................................... 1
1.0 What is accounting? ............................................................................................................................ 1
1.1 The objectives of accounting .............................................................................................................. 2
1.2 Basic principles ................................................................................................................................... 2
1.3 Users of financial statements and their information needs ................................................................. 5
1.4 Characteristics of useful information .................................................................................................. 7
1.5 Chapter review questions .................................................................................................................... 8
THE ACCOUNTING EQUATION AND FINANCIAL STATEMENTS (WEEK 2) ................................. 9
2.1 The accounting equation ......................................................................................................................... 9
2.1.1 Component of accounting equations .......................................................................................... 10
2.2 Financial statements .......................................................................................................................... 11
2.2.1 Income statement ....................................................................................................................... 11
2.2.2 Balance sheets ............................................................................................................................ 12
2.2.2.1 Classification of balance sheet items ...................................................................................... 12
2.2.2.2 Current assets and current liabilities ....................................................................................... 14
2.2.2.3 Noncurrent assets and noncurrent liabilities ........................................................................... 15
2.2.3 Form of the balance sheet .............................................................................................................. 17
2.3 Chapter review questions .................................................................................................................. 21
RECORDING OF BUSINESS TRANSACTIONS (WEEK 3) .................................................................. 22
3.0 Introduction ....................................................................................................................................... 22
3.1 The t-account .................................................................................................................................... 22
3.2 Debits and credits .............................................................................................................................. 23
3.3.1 Recording changes in assets, liabilities and owner’s equity ...................................................... 23
3.3.2 Recording changes in revenues and expenses ................................................................................ 25
3.3.3 Recording withdrawals by the owner............................................................................................. 25
3.3.4 Determining the balance of an account .......................................................................................... 26
3.4 Rules of debit and credit summarized. .............................................................................................. 27
SOURCE DOCUMENTS AND BOOKS OF ORIGINAL ENTRY (WEEK 4) ......................................... 33
4.1 Source documents ............................................................................................................................. 33
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4.2 Books of original entry ..................................................................................................................... 35
4.2.1 Format of books of original entry .............................................................................................. 35
4.4 Ledger ............................................................................................................................................... 36
4.4.1 Major kinds of ledger ................................................................................................................. 37
4.4.2Classification of accounts ........................................................................................................... 38
CONTROL ACCOUNTS (WEEK 5) .......................................................................................................... 43
5.1 The benefits of accounting controls .................................................................................................. 43
5.2 Principles of control accounts ........................................................................................................... 44
5.3 Information for control accounts....................................................................................................... 45
5.4 Form of control accounts .................................................................................................................. 46
BANK RECONCILIATION STATEMENTS (WEEK 6) .......................................................................... 49
6.0 Introduction ....................................................................................................................................... 49
6.1 Among the reasons for the difference in the balances in the cashbook and that in the bank statement
are: .......................................................................................................................................................... 49
6.2 Steps in preparing the bank reconciliation statement ........................................................................ 54
6.3 Overdraft balances .......................................................................................................................... 59
CAPITAL EXPENDITURE AND REVENUE EXPENDITURE (WEEK 8) ............................................ 63
7.1 Capital expenditure ........................................................................................................................... 63
7.2 Revenue expenditure ......................................................................................................................... 63
7.3 Joint expenditure ............................................................................................................................... 64
7.6 Capital and revenue receipts ............................................................................................................. 65
ERRORS NOT AFFECTING TRAIL BALANCE AGREEMENT (WEEK 8) ......................................... 66
8.1 Types of error.................................................................................................................................... 66
8.2 Corrections of errors ......................................................................................................................... 67
BAD DEBTS AND PROVISIONS FOR DOUBTFUL DEBTS (WEEK 9) .............................................. 70
9.0 Bad debts........................................................................................................................................... 70
9.1 Provisions for doubtful debts ............................................................................................................ 71
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9.2 Accounting entries for provisions for doubtful debts. ...................................................................... 72
9.3 Chapter review question ................................................................................................................... 73
DEPRECIATION OF FIXED ASSETS: NATURE AND CALCULATIONS (WEEK 10) ...................... 74
10.1 Depreciation of tangible fixed assets .............................................................................................. 74
10.2 Causes of depreciation .................................................................................................................... 74
10.3 Provision for depreciation as an allocation of cost ......................................................................... 75
10.4 Methods of calculating depreciation charges .................................................................................. 75
10.7 Choice of method ............................................................................................................................ 76
10.8 Chapter review questions ................................................................................................................ 76
Model questions for revision ...................................................................................................................... 77
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INTRODUCTION TO ACCOUNTING (WEEK 1)
Chapter’s Objectives
By the end of this chapter, the student should be able to:-
 Define accounting
 Highlight objectives of accounting
 Explain main characteristics of accounting principles
 Discuss accounting concepts and conventions
 Explain users of financial statements and their information needs.
 Explain characteristics of useful information.
1.0 What is accounting?

Accounting can be defined as the process of identifying, measuring and communicating
economic information to permit informed judgments and decisions by users of the information.
Every element of society – from the individual to an entire industry or government branch – has
to make decisions on how to allocate its resources. Accounting is the process that aids these
decisions by recording, classifying, summarizing, and reporting business transactions and
interpreting their effects on the affairs of the business entity.
Business transaction is an event which involves the transfer of money or money’s worth of
financial events. The following summarizes the business transaction that a firm might have:-
 Acquisition of assets from owners and other creditors

 Investing resources in assets to produce goods or services
 Using resources to produce goods and services
 Selling goods or services of the firm
 Paying those to whom money is owed
 Returning assets to owners.
Accounting is often confused with bookkeeping. Bookkeeping involves the routine recording of
economic activities and is a mechanical process. Accounting includes bookkeeping but goes well
beyond it in scope. Accountants analyze and interpret financial information, prepare financial
statements, conduct audits, design accounting systems, prepare forecasts and budgets, and
provide tax services.
Specifically, the accounting process consists of the following groups of functions.
i. Accountants observe many events and identify and measure in financial terms those
events considered evidence of economic activity. These three functions are often
collectively referred to as analyze.
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ii. Next, the economic events are recorded, classified into meaningful groups and
summarized for conciseness.
iii. Accountants report on business activity by preparing financial statements and special
reports. Accountants are often asked to interpret these statement and reports for
various groups such as management and creditors. Interpretation may involve
determining how the business in performing compared to prior years and other similar
businesses.
1.1 The objectives of accounting

Accounting has many objectives, including letting people and organizations know:-
i. If they are making profit or a loss.

ii. What their business is worth
iii. What a transaction was worth to them
iv. How much cash they have
v. How wealthy they are
vi. How much they are owed
vii. How much they owe to someone else
viii. Enough information so that they can keep financial check on the things they do.
However, the primary objective of accounting is to provide information for decision making.
The information is usually financial, but can also be given in volumes, e.g. the number of cars
sold in a month by a car dealership.
1.2 Basic principles

Accounting is the language of business. In order to make the language convey the same meaning
to all people, accountants all over the world have developed certain rules, procedures and
conventions which are known as accounting standards. Accounting statements are prepared in
conformity with these standards in order to place more relevance on them.
Accounting standards refers to fundamental beliefs which once established do not change.
Main characteristics of accounting principles
i. Accounting standards are manmade so they do not have the authoritativeness as

universal principles like the principle of natural sciences have. They represent the
best possible guidelines based on reasons and observations and have been developed
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by accountant to enhance the usefulness of accounting data in an ever changing
society.
ii. Science of accounting is not in finished form; it is in the process of evolution.
Consequently, accounting standards are fast developing. These are influenced by
business practices and customs, government agencies and other business group.
iii. The general acceptance of an accounting standard usually depends on how well it
meets three criteria.
(a) Relevance – a standard is relevant to the extent that it resultsin information that is
useful to those who want to know something about a certain business
(b) Objectivity – a standard is objective to the extent that the accounting information
is not influenced by personal bias of those who furnish the information.
(c) Feasibility – a standard is feasible to the extent that it can be applied without
undue complexity or cost.
Accounting concepts and conventions
Accounting concepts are broad basic assumptions that underlie the periodic financial accounts of
business enterprises. Example of concepts include:-
(a) Going concern
The enterprise is normally viewed as a going concern that is as continuing in operarion for the
foreseeable future. It is assumed that the enterprise has neither the intention nor the necessary of
liquidation or of curtailing material the scale of its operations.
(b) Consistency
This states that in preparing accounts consistency should be observed in two respects
 Similar items within a single set of accounts should be given similar accounting
treatment.
 The same treatment should be applied from one period to another in accounting for
similar items. This enables valid comparison to be made from one period to the next.
(c) Accrual
Revenues and costs are accrued, that is, recognized as they are earned or incurred (and not as
money is received or paid) and recorded in the financial statements of the periods to which they
relate.
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(d) Prudence
Uncertainties inevitable surround many transactions. This should be recognized by exercising

prudence in preparing financial statements. Prudence does not, however, justify the creation of
secret or hidden resources.
The prudence concept states that where alternative procedures or alternative valuations are
possible, the one selected should be one that gives the most cautious presentation of the
business’s financial position or results. Therefore, revenue and profits are not anticipated but are
recognized by inclusion in the profit and loss account only when realized in the form of either
cash or of other assets the ultimate cash realized of which can be assessed with reasonable
certainty. Provision is made for all liabilities (expenses and loses) whether the amount of these
is known with certainty or is best estimate in the light of the information available.
Assets and profits should not be overstated but a balance must be achieved to prevent the
material overstatement of liabilities or losses.
A profit can be considered to be a realized when it is in the form of
 Cash
 Another asset that has a reasonable certain cash value. This includes amounts from
debtors, provided that there is a reasonable certainty that the debtors will eventually pay
up what they owe.
(e) Business entity
The concept is that accountants regard a business as separate entity, distinct from its owners or
managers. The concept applies whether the business is a limited company or a sole
proprietorship.
(f) Substance over form
Transactions and other events should be accounted for and presented in accordance with their
substance and financial reality and not merely with their legal form.
(g) Materiality
Financial statements should disclose all items which are material enough to affect evaluations or
decisions.
(h) Money measurement concept
The money measurement concept states that accounts will only deal with those items to which a
monetary value can be attributed.
(i) Separation of valuation principle
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The separate valuation principle states that, in determining the amount to be attributed to an asset
or liability in the statement of financial position, each component item of the asset or liability
must be determined separately.
Accounting bases
Bases are the methods that have been developed for expressing or applying fundamental
accounting concepts to financial transactions and items. Examples include:-
 Depreciation of non-current assets (e.g. by straight line or reducing balance)

 Treatment and amortization of intangible assets (patents and trademarks)
 Stock and work in progress (FIFO, LIFO and AVCO)
1.3 Users of financial statements and their information needs

Accounting information is produced in form of financial statement. These financial statements
provide information about an entity financial position, performance and changes in financial
position, performance and changes in financial position.
Financial position of a firm is what the resources the business has and how much belongs to the
owners and others.
Financial performance reflects how business has performed, whether it has made profit or losses.
Changes in financial positions determine whether the resources have increased or reduced.
The following are users of financial information:-
1. The equity investor group
Essentially this group consists of existing and potential shareholders. This group is considering
whether or not to invest in a business or alternatively, whether or not to disinvest, to sell shares
in the business. Equity investors look for one or a combination of two things:-
 Income – a money return by way of dividend

 Capital – a money return by way of selling shares at more than their purchase price
Investors, both existing and potential, need information about future profits. The emphasis in
published accounting information is almost wholly on past or more-or-less present profits. These
may or may not be a good guide for the future. Accounting statement reported should be made as
suitable as possible for the investor to make their estimations.
2. The loan creditor group
This group consists of long, medium or short-term lenders of money.
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The crucial question an existing or potential loan creditor wishes to consider is obvious i.e. will
he or she get their money back?
A short-term loan creditor will primarily be interested, therefore, in the amount of cash a
business has got or will soon get. As a safeguard, they will also be interested in the net realizable
value (NRV) of all the assets, and the priority of the various claims, other than own, on the
available resources.
Longer-term lenders will clearly need a correspondingly longer-term view of the firm’s future
cash position. Their needs are thus similar to the needs of the equity investor group i.e. they need
to estimate the overall strength and position of the business some way into future.
3. The employee group
Employees or their representatives need financial information about the business for two main
reasons.
 Fair and open collective bargaining (i.e. wage negations)

 Assessment of present and future jobs security.
In these respects they too need to be able to assess the economic stability and vulnerability off
the business in the future.
4. The analyst – advisor group
In one sense this is not a separate group. It is a collection of experts who advise other groups.
Stockbrokers and investment analysts will advise shareholders, trade union advisors will advise
employees, government statisticians will advise the government and on. The needs of the
analyst –advisors group are obviously essentially the needs of the particular group they are
advising.
5. The business contact group
This consist in effect, of all those who have or may have dealing with the business, but who are
not included in any other group. It can usefully be divided into two three subgroups:
 Suppliers and trade creditors need similar information to that required by short-term
loan creditors. But they will also need to form a longer-term impression of the business’s
future. Regular suppliers are often dependant on the continuation of the relationship.
 Customers will wish to assess the reliability of the business both in the short-term sense
and in the long-term sense. Where long-term contracts are involved, the customer will
need to be particularly on his or her guard to ensure that the business appear able to
complete the contract successfully.
 Competitors will wish to increase their own effectiveness and efficiency by finding out as
much as possible about the financial, technical and marketing structure of the business.
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The business itself will naturally not be keen for this information to become generally
available within the industry, and it is generally recognized that businesses have a
reasonable rights to keep the causes of their own competitive advantage secret.
The government
Governments require financial information for purposes of taxation. This may be the most
obviously apparent use by the governments, but it is not necessarily the most important.
Governments also need information for decision-making purposes. Governments today take
many decisions affecting particular firms or particular industries, both in a control sense and in
government’s capacity as purchaser or creditor. Also, governments need information on which to
base their economic decisions as regards the economy as a whole.
6. The public
Economic entities, i.e. business in the broadest and most general sense, do not exist in isolation.
They are part of society at large and they react and interact with society at every level. At the
local level, there will be concern at such things as employment, pollution and health and safety.
At the wider level, there may be interest in, for example, energy usage, effective use of subsidies
etc. much of this of formation is non financial. Indeed some of it cannot be effectively measured
at all.
1.4 Characteristics of useful information

Desirable attributes which financial information should have if it is likely to be useful:-
i. Relevance
A report must give the user what he or she wants. This presupposes that we as the accountants
preparing the report know:-
 Who the user is

 What their purpose is
 What information he or she requires for this purpose.
Clearly this requirement may change as time goes by.
ii. Understandability
Different users will obviously have different levels of ability as regards understanding
accounting information. Understandability does not necessarily mean simplicity. It means that
the reports must be geared to the abilities and knowledge of the users concerned.
iii. Reliability
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The user should be able to have a high degree of confidence in the information presented to him
or her. Preferably, it should be independently verified, e.g. by an independent qualified auditors.
iv. Completeness
The user should be given a total picture of the reporting business as far as possible.
v. Objectivity
The information presented should be unbiased in that it should meet all proper user needs and
neutral in that the perception of the measurer should not be biased towards the interest of any one
user group.
Report should not be biased by the personal perception, the personal opinion, of the preparer of
these reports.
vi. Timeliness
This means that information should be provided to the user in time for use to be made of it.
Information presented should be up-to-date as possible. Approximate information, made
available in time to assist with some decision or action, is likely to be more useful than precise
and accurate information presented after the decision has already been made.
vii. Comparability
Information about any one business for any one period should be presented so that:
 It can be easily compared with information about the same business for a different
period
 It can be easily compared with information about a different business for the same, or
even a different, period.
1.5 Chapter review questions

1. Define accounting.
2. Highlight objectives of accounting
3. Explain any six accounting concepts and conventions.
4. Discuss any five users of financial statements and their information needs
6. Explain characteristics of useful information.
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THE ACCOUNTING EQUATION AND FINANCIAL STATEMENTS (WEEK 2)
Chapter’s objectives
By the end of this chapter, the student should be to:-
 Discuss clearly accounting equation

 Explain clearly financial statements
2.1 The accounting equation

A business can be set in two ways:
 Owners supplying all the resources

 Owner supplying some of the resources and the rest being supplied by outside parties
The two cases bring out the accounting equation also called book-keeping equation.
By adding up what the accounting records say belongs to a business and deducting what they say
the business owes, you can identify what a business is worth according to those accounting
records. The whole of financial accounting is based upon this very simple idea (accounting
equation).
It can be explained by saying that if a business is to set up and start trading, it will need
resources. Let assume first that it is the owner of the business who has supplied all of the
resources. This can be show as below:
Resources supplied by the owner = Resources in the business
In accounting, special terms are used to describe many things. The amount of the resources
supplied by the owner id called capital. The actual resources that are then in the business are
called assets.
Capital = Assets
Usually, however, people other than the owner have supplied some of the assets. Liabilities is the
name given to the amounts owing to those people for those assets. The accounting equation has
now changed to:
Capital = Assets -Liabilities
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It can be seen that the two sides of the equation will have the same totals. This is because we are
dealing with the same thing from two points of view (the value of the owner’s investment in the
business and the value of what is owned by the business and the value of what is owned by the
owners.
Unfortunately, with this form of the accounting equation we can no longer see at a glance what
value is represented by the resources in the business. You can see this more clearly if you switch
assets and capital around to produce the alternate form of accounting equation:
Assets = Capital + Liabilities
This can then be replaced with words describing the resources of the business.
Resources: what they are = Resources: who supplied them
(Assets) (Capital + Liabilities)
2.1.1 Component of accounting equations

Assets – an asset is a resource controlled by a business entity/ firm as a result of past events for
which economic benefits are expected to flow to the firm. An example is a business sells goods
on credit then it has an asset called a debtor. The past event is the sale on credit and the resources
is a debtor. This debtor is expected to pay so that economic benefits will flow towards the firm
i.e. in form of cash once the customers pays
Liabilities – these are obligations of a business as a result of past events settlement of which is
expected to result to an economic outflow of amounts from the firm.
Capital/ owners’ equity – this is the residual amount on the owners’ interest in the firm after
deducting liabilities from assets.
NOTE
 It is a fact that no matter how you represent the accounting equation, the totals of both
sides will always equal each other, and this will always be true no matter how many
transactions there may be. Actual assets, capital and liabilities may change, but the total
of the assets will always equal to total of capital plus liabilities.
 Assets consist of property of all kinds, such as buildings, machinery, stocks of goods and
motor vehicles. Other assets include debts owed by customers and the amount of money
in the organization’s bank account.
 Liabilities include amounts owed by the business for goods and services supplied to the
business and for expenses incurred by the business that has not yet been paid for. They
also include funds borrowed by the business.
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 Capital is often called the owners equity or net worth. It comprises the funds invested in
the business by the owner plus any profits retained for use in the business less any profits
paid out of the business to the owner.
2.2 Financial statements

The owner of a business is concerned with how well he or she is doing financially. One measure
of performance is the net income (profit) earned for the reporting period. This is shown in the
income statement. Another measure is the owners’ capital (the difference between the equity’s
total assets and total liabilities) at the end of the period. Assets, liabilities, and capital are
reported in the balance sheet (statement of financial position). The income statement and
balance sheet summarize the voluminous data contained in the detailed accounting records of the
business.
The profit as shown in the income statement is derived by subtracting total expenses from total
revenue (income). A detailed listing showing the source and amount of revenue and expenses is
provided in the income statement. This breakdown is needed, among other reasons so that the
owner can determine the trend in revenue and expense items e.g. the owner like to know if a
given expenses item is disproportionately great so that he/she can determine the reason why and
possibly control that expenses item.
The balance sheet lists the type and amount of each asset, liability, and the capital account
existing as of the last day of the reporting period. This listing is necessary so that the proprietor
knows the specific items he/she owns (i.e. cash, inventory, machinery), what is owed (accounts
payable), and the amount of ending equity in the business (capital account). The equity at the
end of the period consists of the capital investments made plus the profits earned less any
withdrawals.
2.2.1 Income statement

The income statement measures performance over a specific period of time, say, a year. The
accounting definition of income is
Income = Revenue – Expenses
Income statement is like a video recording of what the people did between two snapshots. It
shows the revenue, expenses, and net income (or net loss) for a period of time.
 Revenue is the increase in capital arising from the sale of merchandise or the
performance of services. When revenue is earned it results in an increase in either cash or
accounts receivable.
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 Expenses decrease capital and result from performing those functions necessary to
generate revenue. The amount of an expense is either equal to the cost of the inventory
sold, the value of the service rendered (e.g. salary expenses) or the expenditures
necessary for conducting business operations (e.g. rent expenses) during the period.
 Net income is the amount by which total revenue exceeds total expenses for the reporting
period. The resulting profit is added to the owner’s capital account. However, if total
expenses are greater than total revenue, a net loss ensues and decreases the capital
account.
NOTE
Revenue does not necessarily mean receipt of cash and expense does not automatically imply a
cash payment. Net income and net cash flow (cash receipts less cash payments) are different.
For example, taking out a bank loan will generate cash but this is not revenue since merchandise
has not been sold nor have services been provided. Further, capital has not been altered because
of the loan.
2.2.2 Balance sheets

The balance sheet is an accountant’s snapshot of the firm’s accounting value on a particular date,
as though the firm stood momentarily still. The balance sheet has two sides: on the left are the
assets and on the right are the liabilities and stockholder’s equity. The balance sheet states
what the firm owns and how it is financed. The accounting definition that underlies the balance
sheet and describes the balance is
Assets = Liabilities + Stockholder’s equity
Stockholders’ equity is defined to be the difference between the assets and liabilities of the firm.
In principles, equity is what the stockholders would have remaining after the firm discharge its
obligations.
By analyzing the relationships among these items, investors, creditors, and others can assess a
firm’s liquidity, i.e. its ability to meet short-term obligations, and solvency, i.e., its ability to pay
all current and long-term debts, as they come due. The balance sheet also shows he composition
of assets and liabilities, the relative proportion of debt and equity financing, and how much of
a firms earnings have been retained in the business.
Collectively, this information can be used by external parties to help assess the financial states
of a firm at a particular date.
2.2.2.1 Classification of balance sheet items
Balance sheet items are generally classified in a manner that facilitates analysis and
interpretation of financial data. Information of primary concern to all parties is the business
unit’s liquidity and solvency. Assets and liabilities are classified as:-
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 Current or short-term items
 Non-current or long-term items
When assets and liabilities are so classified, the difference between current assets and current
liabilities may be determined. This is referred to as the company’s working capital i.e. the liquid
buffer available in meeting financial demands and contingencies of the future.
The importance of an adequate working capital position cannot be minimized. A business may
not be able to survive in the absence of a satisfactory relationship between current liabilities.
Ability of business to prosper is largely determined by the composition of the current asset pool.
There must be a proper balance between liquid assets in the form of cash and temporary
investments, and receivables and inventories.
Cash and temporary investments, representing immediate purchasing power, are used to meet
current claims and purchasing, payroll, and expense requirements.
Receivables are the outgrowth of sales effort and provide cash in the course of operations.
Inventory is also a source of cash as well as the means of achieving a profit.
Although there are no standard categories that must be used, the following general framework
for a balance sheet is representative.
ASSETS
Current assets
Cash XX
Notes receivables XX
Inventories XX
Total current assets XXX

Non-current assets
Investments XX
Land, buildings, and equipment XX
Intangible assets XX
Other non-current assets XX
Total non-current assets XXX

Total assets XXXX
LIABILITIES
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Current liabilities
Notes payables XX
Creditors XX
Short-term loans XX
Total current liabilities XXX

Non-current liabilities
Long-term debts XX
Long-term lease obligations XX
Deferred income taxes XX
Other noncurrent liabilities XX
Total non-current liabilities XXX

Total liabilities XXX
Owners’ equity
Contributed capital XX
Retained earnings XX
Total owners’ equity XXX

Total assets and owners’ equity XXXX
2.2.2.2 Current assets and current liabilities

Current assets include cash and resources that are reasonably expected to be converted into cash
during the normal operating cycle of a business or within one year, whichever period is longer.
Normal operating cycle

Normal operating cycle is the time required for cash to be converted to inventories, inventories
into receivables, and receivables ultimately into cash.
Current assets are normally listed on the balance sheet in the order of their liquidity.
Current liabilities are those obligations that are reasonably expected to be paid using current
assets or by creating other current liabilities. Generally, if a liability is reasonably expected to be
paid within 12 months, it is probably classified as current. Payables arising from the normal
operating activities may be classified as current even if they are not to be paid with 12 months.
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Items commonly included as current liabilities include:-
 Short-term borrowings
 Accounts payable
 Accrued salaries and wages
 Accrued rental expense
 Accrued interest expense
 Accrued taxes
 Current portion of long-term obligation
Note
Classification problems can arise when an obligation is callable by a creditor because it is
difficult to determine exactly when the obligation will be paid. A callable instrument is one that
is either
i. Payable on demand (has no specific due date)
ii. Has a specified due date, but is callable if the debtor violates the provisions of the
debt agreement.
Any obligation that is due on demand or will become due on demand due on demand within one
year form the balance sheet date (or operating cycle if longer) should be classified as current.
2.2.2.3 Noncurrent assets and noncurrent liabilities

Assets and liabilities not qualifying for presentation under the current headings are classified
under number of noncurrent headings such as:-
Noncurrent assets
1. Investments
Investments held for such long-term purposes as regular income, appreciation, or ownership
controls are reported under the heading investments. For example, stocks, bonds and sinking
fund assets consisting of cash and securities held for the redemption of bonds or stocks.
2. Land, Buildings, and Equipment.

Properties of a tangible and relating permanent character that are used in the normal business
operations are reported under land, buildings and equipment or other appropriate headings such
as property and equipment.
Land, buildings, machinery, tools, furniture, fixtures, and vehicles are included under this
heading. Most tangible properties except land are normally reported at cost less accumulated
depreciation.
3. Intangible assets
The long-term rights and privileges of a nonphysical nature acquired for use in business
operations are often reported under the heading intangible assets. For example, goodwill, patents,
trademarks etc.
15
Intangible assets are normally reported at cost less amount previously amortized.
4. Other non-current assets

These noncurrent assets not suitably reported under any of the previous classification may be
listed under the general heading other noncurrent assets. For example, long-term advances to
officers and deposits made with taxing authorities and utilities companies.
Noncurrent liabilities
i. Long – term debt.
Long- term loans, bonds, mortgages, and similar obligations not requiring the use of current
funds for their retirement are generally reported on the balance sheet under the heading long—
term debt.
When amount borrowed is not the same as the amount ultimately required in settlement of the
debt, and the debt is stated in the accounts at its maturity amount, debt discount or premium is
reported.
When a note, a bond issue, or a mortgage formerly classified as a long-term obligation becomes
payable within a year, it should be reclassified and presented as a current liability, except when
the obligation is to be refinanced, or is to be paid out of a sinking fund.
ii. Long – term lease obligations

Some leases of land, buildings, and equipment are financially structured so that they are in
substance a debt- financed purchase. The present value of the future minimum lease payments is
recorded as a long-term liability. That portion of the present value due within the next year, or
normal operating cycle, whichever is longer, is classified as a current liability.
iii. Deferred income taxes

The credit balance in this account indicates that book income has exceeded taxable income due
to timing differences in recognizing revenues and expenses. Generally, the tax regulations permit
a faster write-off than is allowable for financial reporting purposes
iv. Other noncurrent liabilities

Those noncurrent liabilities not suitably reported under the separate headings may be listed under
separately under special descriptive headings e.g. long- term obligations to company officers or
affiliated companies, matured but unclaimed bond principle and interest obligations.
Owners’ Equity
The method of reporting the owners’ equity varies with the form of the business unit. Business
units are typically divided into three categories:-
 Proprietorships
 Partnerships
 Corporations
16
In the case of a proprietorship, the owner’s equity in assets is reported by means of a single
capital account. The balance in this account is the cumulative results of the owner’s investments
and withdrawals as well as past earnings and losses.
In a partnership, capital accounts are estimated for each partner. Capital account balances
summarize the investments and withdrawals and share of the past earnings and losses of each
partner, and thus measure partners’ individual equities in the partnership assets.
In a corporation, the difference between assets and liabilities is referred to as owners’ equity,
shareholders’ equity, or simply capital.
In presenting the owners’ equity on the balance sheet, a distinction is made between the equity
originating from the stockholders’ investments, referred to as contributed capital or paid-in
capital, and the equity originating from earnings, referred to as retained earnings.
2.2.3 Form of the balance sheet

The form of the balance sheet presentation varies in practice. Its form may be influenced by the
nature and size of the business, by the character of the business properties in presenting key
relationships. The balance sheet is prepared in one of two basic forms:
 The account form with assets been reported on the left hand side and liabilities and
owners’ equity on the right-hand side.
 The report form with assets, liabilities, and owners equity sections appearing in vertical
arrangement.
The order of asset and liability classifications may vary, but most businesses emphasize working
capital position and liquidity, with assets and liabilities presented in the order of their liquidity.
An exception to this order is generally found in the land, buildings, and equipment section where
the more permanent assets with longer useful life are listed first.
Illustration 1
Using information below which was obtained from Smile Enterprise, prepare a classified balance
sheets as of December 31, 2009 .
Accounts payable 2,500
Accounts Receivable 3,000
Capital, December 31, 2009 8,000
Cash $ 6,000
Equipment 14,000
Mortgage payable 12,000
Notes payables 1,500
Supplies 1,000
17
SOLUTION (balance sheets in account form)
Smile Enterprise balance sheet as at 31 December, 2009

ASSETS LIABILITIES AND OWNERS’ EQUITY
Current assets Current liabilities
Cash $6,000 Notes payable $ 1,500
Account receivables 3,000 Account payable 2,500
Supplies 1,000 Total Current liabilities $ 4,000
Total current assets $ 10,000 long-term/non-current liabilities

Non-current/fixed assets Mortgage payable 12,000
Equipment 14,000 Total liabilities 16,000
Total assets 24,000 Capital 8,000
Total liabilities & owners’ equity $ 24,000
Illustration 2
Using the following information obtained from metropolitan, Inc. prepare a classified balance
sheet in account form.
Accrued expenses 86,300
Additional paid-in capital 120,000
Bond payable 365,000
Buildings and equipment 732,900
Cash $52,650
18
Common stock 300,000
Current portion of long-term debt 62,000
Deferred income taxes 126,700
Intangible assets 165,000
Inventories 436,100
Investments 128,000
Land 76,300
Long-tem loan 75,000
Long-term lease obligations 135,000
Marketable securities 67,350
Other current liabilities 28,600
Other non-current liabilities 72,500
Others noncurrent assets 37,800
Preferred stock 125,000
Prepaid expenses and other 32,900
Receivables 363,700
Retained earnings 308,900
Short-term loan 75,000
SOLUTION (Balance sheet in report form)

Metropolitan Inc. Balance sheet as at 31 December, 2009
ASSETS
Current assets
Cash $52,650
Marketable securities 67,350
Receivables 363,700
Inventories 436,100
19
Prepaid expenses and other 32,900
Total current assets $952700

Investments 128,000
Land 76,300
Buildings and equipment 732,900
Intangible assets 165,000
Others noncurrent assets 37,800
Total noncurrent assets $1,140,000

Total assets $2,192,700
LIABILITIES AND OWNERS' EQUITY
Current liabilities
Short-term loans 75,000
Accrued expenses 86,300
Current portion of long-term debt 62,000
Other current liabilities 28,600
Total current liabilities $564,600

Non-current liabilities
Long-term debt
Long-term loan 75,000
Bond payable 365,000
Long-term lease obligations 135,000
Deferred income taxes 126,700
Other non-current liabilities 72,500
Total noncurrent liabilities $774,200

Total liabilities $1,338,800
Owners’ equity
Preferred stock 125,000
20
Common stock 300,000
Additional paid-in capital 120,000
Retained earnings 308,900
Total owners’ equity $853,900

Total liabilities and owners equity $2,192,700

1. State two ways in which a business can be started
2. Discuss accounting equation
3. Differentiate between income statement and balance sheet
4. Discuss the classification of balance sheets items
5. Define operating cycle
6. State two basic form in which balance sheet can be prepared
7. Using information below which was obtained from XYZ Enterprise, prepare a classified
balance sheets as of December 31, 2010.
Cash $ 60,000
Equipment 140,000
Supplies 10,000
21
RECORDING OF BUSINESS TRANSACTIONS (WEEK 3)
 Explain what is a T-account, differentiate between debiting and crediting

 Explain what is double entry procedure
 Explain recording changes in assets, liabilities and owner’s equity.
 Explain recording changes in revenues ad expenses
3.0 Introduction
A business may engage in thousands of transactions during a period of time. The data in these
transactions must be classified and summarized before becoming useful information. Making
the accountant’s task somewhat easier is the fact that most business transactions are repetitive in
nature and can be classified into groups having common characteristics. For example, there
may be thousands of receipts or payments of cash. As a result, a part of every cash transaction
can be recorded and summarized in a single place called an account.
An account is an element in an accounting system that is used to classify and summarize

measurements of business activity. An account will be set up whenever it is necessary to provide
useful information about a particular business item. Thus, business will have a cash account in its
accounting system simply because knowledge of the account of cash owned is useful
information.
Accountants may differ on the account title they give for the same items e.g. one person might
name an account notes payable and another might call it loans payable. Both accounts title refer
to the amounts borrowed by the company.
The number of accounts in a company’s accounting system depends on what information is

needed by those interested in the business. The main requirement is that each account provides
useful information.
3.1 The t-account

To understand how the increases and decreases in an account are recorded, T-account is
normally used. It derives its name from the fact that it looks like the letter T. The title of the item
accounted for, such as cash, is written across the top of the T. increase are recorded on one
side of the vertical line of the T and decreases on the other side, depending on the type of
account. E.g.
22
Cash account
Note
Each business transaction affects at least two items e.g. if you invest cash into your business,
your assets would increase and your owner’s equity would increase.
3.2 Debits and credits

The accountant uses the term debit to say placing an entry on the left side of the T-account and
credit for placing an entry on the right side of the T-account. Debit (Dr) simply means left side,
while Credit (Cr) means right side. A debit entry is an entry on the left side of an account while
a credit entry is an entry on the right side of an account.
3.3 Double entry procedure
Once a business event is recognized as a business transaction, it is analyzed to determine its

increase or decrease effect on the assets, liabilities, owner’s equity, revenues, or expenses of
the business. These increase or decrease effects are then translated into debits and credits.
In each business transaction that is recorded, the total dollar amount of debits must equal the
total dollar of credits. This means that when one account (or accounts) is debited for $100,
another account (or accounts) must be credited for total of $100. The requirement that each
transaction must be recorded by an entry that has equal debits and credits is called double
entry procedure, or duality. This double entry procedure keeps the accounting equation in
balance.
The dual recording process produces two sets of accounts. That is, those with debit balance and
those with credit balances. When the totals of these two groups of accounts are equal, the
accountant has some assurance that the arithmetic part of the transaction recording process has
been properly carried out.
3.3.1 Recording changes in assets, liabilities and owner’s equity

Recall the basic accounting equation
Assets = Liabilities + Owner’s Equity
When you begin to record transactions into the T-accounts of the accounting equations, think
first of the equal sign, then you must remember that assets, to the left side of the equal sign, are
increased on the left side of the T-accounts. Liabilities and Owner’s equity, to the right side of
the equal sign, are increased on the right side of the T-accounts. You already know that the left
side of the T-account is the debit side and the right side is the credit.
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ASSETS = LIABILITIES + OWNERS EQUITY
Debit for Credit for Debit for credit for Debit for credit for
Increases decreases decreases increases decreases increases
Note
i. Assets are increased by debits on the left side of the T-account and decreased by
credits on the right side of the T- account.
ii. Liabilities and owner’s equity are decreased by debits on the left side of theT-
account and increased by credits on the right side of the T-account and increased
by credits on the right side of the T-account.
Illustration
Assume that John Stevens invested $ 10,000 in his company. The company records the receipt of
$10,000 as follows.
(Dr) Cash (Cr) (Dr) John Stevens, Capital (Cr)
(1) 10,000 (1) 10,000
The transaction involves an increase in the assets, cash, which is recorded on the left side of the
cash account, and an increase in owner’s equity, which is recorded on the right side of the John
Stevens, capital account.
Assume John Stevens went to the bank and borrowed $5,000 on a note. A note is written promise
to pay to another party (in this case the bank) the amount owed either when demanded or at a
certain specified date. The transaction is recorded as follows.
(Dr) Cash (Cr) (Dr) Notes payable – Bank (Cr)
(2) 5,000 (2) 5,000
Note that liabilities, in this case notes payable to bank, are increased by an entry on the right
(credit) side of the account.
24
3.3.2 Recording changes in revenues and expenses
Since the amounts of revenues and expenses are needed to prepare the income statement, a
separate account should be kept for each revenue and expenses. Expenses account s are treated as
if they were sub-classifications of the debit side of the owner’s Capital account, and revenue
accounts as if they were sub-classification of the credit side.
Revenue and expense recording rules are:
i. Increases in revenue are recorded on the right (credit) side of the T- account and
decreases on the left (debit) side. This is because revenues increases owner’s equity
and increases in owner’s equity are recorded on the right side.
ii. Increases in expenses are recorded on the left (debit) side of the T-account and
decreases on right (credit) side. This is because expenses decrease owner’s equity.
Decreases in owner’s equity are recorded on the left side.
Assume a company received $ 800 cash from a customer for services rendered. The cash
account, which is an asset, is increased on the left (debit) side of the T-account, and the services
revenue account, which is an increase in owner’s equity, is increase on the right (credit) side.
(Dr) Cash (Cr) (Dr) Services revenue (Cr)
(3) 800 (3) 800
Assume a company paid $ 600 wages to employees. The cash account, which is an asset, is
decreased on the right (credit) side of the T-account and the wages expenses account, a decrease
in owner’s equity is increased on the left (debit) side.
(Dr) Cash (Cr) (Dr) Wages Expenses (Cr)
(4) 600 (4) 600
3.3.3 Recording withdrawals by the owner

Owner withdrawals are a distribution of assets to the owner. Just as an owner investment
increases owner’s equity, owner withdrawals reduce it. Since owner’s withdrawals reduce the
owner’s equity in the business, they have the same effects on owner’s equity as an expense.
Owner withdrawals could be shown directly as a reduction of the owner’s capital account
balance by entering the amount on the left (debit) side of that account. But a clearer record of
withdrawals is available if a separate drawing account is used to record all amounts withdrawn.
A drawing account acts like sub-classification of the owner’s capital account.
25
A withdrawal of $100 cash by John Stevens would be as follows
(Dr) Cash (Cr) (Dr) John Stevens, Drawing (Cr)
(5) 100 5) 100
There comes a time when a business owner looks at the company accounts with all the debits and
credits, and asks where the firm is financially? The only way the owner can determine this is to
balance the accounts.
3.3.4 Determining the balance of an account

The balance of any T-account is obtained by totaling the debits to the account, totaling the credit
to the account, and subtracting the smaller sum from the larger. If the sum of the debits exceeds
from the credits, the account has a debit balance.
Example
(Dr) Cash (Cr)
(1) 10,000 (4) 600
(2) 5,000 (5) 100
(3) 800 bal. c/f 15100
15,800 15,800
Bal. c/d 15,100
If, on the other hand, the sum of the credits exceeds the sum of the debit the account will have a
credit balance. For instance assume that a company has an accounts payable account with a total
of $ 10,000 in debits and $13,000 as shown in the following T-account.
(Dr) Accounts payable (Cr)
10,000 7,000
Bal. c/f 3,000 6,000
13,000 13,000
26
Bal. c/d 3,000
3.4 Rules of debit and credit summarized.

Recall asset accounts are increased on the debit side, while liabilities and owner’s equity
accounts are increased on the credit side. When the account balances are totaled, they will
confirm to the following two independent equations.
Assets = Liabilities + Owner’s equity
Debit = Credit
The arrangement of these two formulas gives the first three rules of debit and credit:
(1) Increase in assets accounts are debits while decrease are credits
(2) Decreases in liability accounts are debits while increases are credits
(3) Decreases in owner’s equity accounts are debits increases are debits.
The debit and credit rules for expense and revenues accounts follow if you remember that
expenses are decrease in owner’s equity and revenues are increases in owners’ equity.
Since owner’s equity accounts decrease on the debit side, expenses accounts increase on the
debit side, and since owners equity accounts increase on the credit side, revenue accounts
increase on the credit side, revenue accounts increase on the credit side.
(4) Decreases in revenue accounts are debits while increases are debit
(5) Increases in expense accounts are debits while decreases are credits.
A table showing the double entry rules for bookkeeping
Accounts To record Entry in the account
Assets An increase Debit
27
A decrease Credit
Liabilities An increase Credit
A decrease Debit
Capital An increase Credit
A decrease debit
Looking again at the accounting equation, the following table summarizes the rules.
CAPITAL = Assets -
Liabilities
To increase each item credit Debit Credit
To decrease each item debit Credit Debit
The double entry rules for liabilities and capital are the same, but they are the opposite of those
for assets.
NB
In a real business, at least one full page would be taken for each account in the accounting books.
Debits Credits
increase assets Decrease assets
Decrease liabilities Increase liabilities
Decrease owner’s equity Increase owner’s equity
Decrease revenues Increase revenues
Increase expenses Decrease expenses
Worked examples
1 The owner starts the business with $ 10,000 in cash on 1 August 2009.
The effects of this transaction are entered as follows:
28
Effects Action
1 Increases the assets of cash Debit the cash account
2 Increases the capital Credit the capital account
(Dr) Cash (Cr)
2009 $
Aug 1 10,000
(Dr) Capital (Cr)
2009 $
Aug 1 10,000
The date of the transaction has already been entered. Never forget to enter the date of each
transaction. Now there remains the description which is to be entered alongside the amount. This
is completed by a cross-reference to the title of the other account in which the double entry is
completed. The double entry to the item in the cash account is completed by an entry in the
capital account. Therefore the word Capital will appear as the description in the cash account.
(Dr) Cash (Cr)
2009 $
Aug 1 Capital 10,000
Similarly, the double entry to the item in the capital account is completed by an entry in the cash
account, so the word Cash will appear in the capital account.
(Dr) Capital (Cr)
2009 $
Aug 1 Cash 10,000
29
2 A van is bought for $ 4500 cash on 2 August 2009.
Effects Action
1 Increases the assets of cash Debit the van account
2 decreases the capital Credit the Cash account
(Dr) Van (Cr)
2009 $
Aug 2 Cash 4,500
(Dr) Cash (Cr)
2009 $
Aug 2 Van 4,500
3 Fixtures (e.g shelves) are bought on credit from shop fitters for $1,250 on 3 August 2009
Effects Action
1 Increases the assets of fixtures Debit the fixtures account
2 Increases the liability to shop fitters Credit the shop fitters account
(Dr) fixtures (Cr)
2009 $
Aug 3 shop fitters 1,250
(Dr) shop fitters (Cr)
2009 $
Aug 3 fixtures 1,250
30
4 Paid the amount owing to shop fitters in cash on 17 August 2009
Effects Action
1 Decreases the liability to shop fitters Debit the shop fitters account
2 Decreases the asset of cash Credit the cash account
2009 $
Aug 17 cash 1,250
(Dr) cash (Cr)
2009 $
5 Combining all four of these transactions, the accounts now contain:
(Dr) cash (Cr)
2009 $ 2009 $
Aug 1 Capital 10,000 Aug 2 Van 4,500
(Dr) capital (Cr)
2009 $
Aug 1 cash 10,000
(Dr) van (Cr)
2009 $
Aug 2 cash 4,500
31
2009 $ 2009 $
Aug 17 cash 1,250 Aug 3 fixtures 1,250
(Dr) fixtures (Cr)
2009 $
NOTE
Note how you enter each transaction in an account in date order and how, once you open an
account e.g. cash, you continue to make entries in it rather than opening a new account for every
entry.

i. Write brief notes about T-account
ii. Differentiate between debits and credits
iii. Explain double entry procedure
iv. Explain how to:-
 Record changes in assets, liabilities and owners’ equity

 Record changes in revenue and expenses
 Record withdrawal by the owner
 Determine the balance of account
32
SOURCE DOCUMENTS AND BOOKS OF ORIGINAL ENTRY (WEEK 4)
 Explain source documents

 Discuss book of original entry
 Explain what is a ledger and major kinds of ledgers
 Discuss classification of accounts
4.1 Source documents

All the entries in books of accounts must be supported by documentary evidence. The documents
which provide the accounting information are called source documents. These include:-
1. Invoice
Invoice is a document which gives the quantity, quality, unit price, total value of the goods
dispatched, any discount allowed, transport changes if any. Depending on the size of the firm,
several copies are prepared. When the goods have been received, the buyer checks them against
the invoice to make sure the quantities and quality are in order. There may be two kind of
invoice:-
 Incoming invoices- these are received from the creditors.

 Outgoing invoices- these are sent to the debtors
The purchases journal/day book is written up from the incoming invoices and the sales journals/
day book from the outgoing invoices. The entries made in the purchase and sale journals are
posted in the ledger accounts at the end of every month. The term ―posting’ means to record a
transaction in a ledger account from a book of original entry.
2. Cash sale
Cash sale is a document which is issued by the seller to the buyer. It shows the description of
goods bought their prices and total amount paid to the seller. The name and address of the seller
is printed on the cash sale but the name of the buyer is not in most cases. Cash sales simply
indicate the total amount payable by a customer.
Cash receipts are of two kinds:-
33
 Incoming cash receipts- these are received from the sellers or creditors. These receipts
indicate the purchase of goods.
 Outgoing cash receipts- these are issued to the customers or purchasers of goods. These
receipts indicate the sale of goods.
From these receipts, the entries are made into cash regarding the cash received or cash paid.
3. Credit note
This document shows the decrease on a claim of money. It is issued when part of goods sold or
purchased are returned or prices over-charged is reduced at a later stage. It is usually printed in
red to distinguish it from other documents. It notifies the buyer of the reduction in the amount
owing by him to the seller. Credit note may be of two kinds:-
 Incoming credit notes- sent by creditors

 Outgoing credit notes -sent to the debtors
The returns outwards journal/ day book is written up from the incoming credit notes and returns
inwards journals/ day books from the outgoing credit notes.
4. Debit note
This document is sent by the seller to the buyer to correct for an under charge on the original
invoice. It is issued because it is better to issue another document rather than to do the alterations
on the original invoice. A debit not is also issued when the buyer has failed to return containers
or packing cases not charged for in the invoice. Debit note may be also of two kinds:
 Incoming debit note- received from creditors

 Outgoing debit note- sent to the debtors.
5. Statement of account
The statement of account is sent by the seller to the buyer at the end of the every month and it
indicates the amount due from the buyer. This statement is sent to remind the buyer for the
payment of his outstanding amount.
6. Remittance advice note.
This note is sent by the buyer to the seller together with a cheque at the end of the month and
shows the details of the items against which that payment is made.
7. Authority to incur expenditure
Authority to incur expenditure means the powers which are delegated by the top management to
a committee or some personnel in the organization to issue orders to spend money. These powers
34
may be given by the board of directors of a company to the chief accountant or budget
committee. When such powers are delegated the written documents or letters are issued.
8. Minutes and resolutions
A committee may be set up by the management to perform some specific duties. A committee is
a body of persons with delegated functions. Various points which are discussed in a specific
meeting of a committee are produced in written form and these are called minutes. The decisions
made by a committee are called resolutions. These minutes and resolutions are the source
documents relating to financial aspects of any organization.
4.2 Books of original entry

The entries made in the ledger accounts are first recorded in some other books which are known
as subsidiary books, or books of original entry. These books are used to reduce the bulk of the
work in the ledger. This procedure also enables to the different staff members to work
simultaneously as they can work on different books. The transactions record in the subsidiary
books are posted to the ledger accounts at the end of every month and in case of some
transactions, any total amount is posted.
The books of the original entry are the following.
i. Purchase day book/ journal- This book records the details and amounts of all goods
purchased on credit.
ii. Sales day book/journal-this book records the details and amounts of all goods sold
on credit.
iii. Purchases return book or returns outward journal-this book records the details
and amount of good returned to the creditors.
iv. Sales return book or returns inward journal- this book records the details and
amounts of goods returned by the debtors
v. Petty cash book- this book records the small cash receipts or payments. This book is
also used to analyze the expenses paid in cash.
vi. General journal/ diary – the journal is that day book in which we can record the
details of any transaction that cannot be recorded in any other subsidiary book.
4.2.1 Format of books of original entry

Books of original entry are ruled specifically to record the details relating to different types of
business transactions. Sales, purchases, return inwards and return outwards books are ruled as
follows.
Date Particulars Invoice or credit Folio Amount

Note No.
35
Journal is ruled as follows:
Date Particulars Folio Debit Credit
Note
i. In the column of date, the date on which transaction took place is entered here. The
transactions should be shown in date order.
ii. Details relating to sale are entered in a detail column.
iii. A folio column entry is made cross-referencing back to the source document e.g.
invoices
iv. The monetary amounts are entered in columns included in the books of original entry
for that purpose.
4.4 Ledger
The book required for a proper record of the transactions is called the ledger. Entries are made in
the books of original entry. The entries are then summarized and the summarized and the
summary information are entered, using double entry, to accounts kept in the various ledgers of
the business. One reason why a set of ledgers is used rather than just one big ledger is that this
makes it easier to divide the work of recording all the entries between different bookkeepers.
A ledger has two sides i.e. left hand and right hand. Left hand side is used for debit entry and
right hand side is used for credit entry. The ledger is ruled as follows:
1 2 3 4 1 2 3 4
36
Each page of a ledger is divided in two equal parts and there are four columns on each side.
Column 1 is used for date
Column 2 is used for particulars or details
Column 3 is used for folio. It gives users the page number where the corresponding
double entry is made
Column 4 is used for the amount of the transactions
4.4.1 Major kinds of ledger

1. General ledger
This ledger contains the accounts relating to proprietor and other normal transactions like
purchases, sales, expenses etc. All nominal accounts are maintained in this ledger.
2. Purchases ledger or creditor’s ledger.
This ledger is used to maintain the personal accounts of all creditors.
3. Sales ledger or Debtor’s ledger
This ledger is used to maintain the personal accounts of all debtors.
A diagram of the books commonly used
All business transaction
Classify- put some types of transactions together
Cash receipts
Credit sales Credit Returns Returns Other types
and payments
purchases inwards outwards
Enter in Enter in Enter in returns Enter in returns Enter in Enter in

sales day purchases inwards day outwards day cash book journal
book day book book book
37
Enter in double entry accounts in various ledgers
 Sales ledgers
 Purchases ledger
4.4.2Classification of accounts
General ledger
An account may be defined as a record of transactions of a particular type or with a particular
person usually expressed in financial terms and maintained in a ledger. Each page of a ledger is
given a heading or title and it is used to record transactions of similar nature.
All purchases of goods are recorded on one particular page and it is known as purchases account.
In ledger various accounts are opened according to the requirements of the business.
i. Personal accounts
These account contains the name of the business, person or firm. In a ledger, there may be three
types of personal accounts:-
(a) Capital account
This account records the transactions between the proprietor and the business. Any amount
invested or withdrawn by the proprietor is recorded in this account.
(b) Creditor’s account
The persons to whom money is owed by a business are called creditors. The goods purchased on
credits basis from the suppliers create a liability of the business. These amounts owing to
creditors are recorded in their personal accounts which are opened separately for each creditor.
© Debtor’s account
Debtors are the persons owing money to the business. This money is owed to the business
against the goods sold to the customers on credit basis. A separate account is opened for each
debtor.
ii. Impersonal accounts
The accounts which do not contain the name of any person or business are called impersonal
accounts. They are of two kinds.
(a) Real accounts
38
These relate to tangible items. The accounts of assets like land and building, plant and
machinery, motor vehicles, furniture and fittings and cash are real accounts.
(b) Nominal accounts
These relate to intangible items. These accounts record transactions for which we have nothing
tangible to show e.g. wages and salaries, electricity, purchases, sales, rent, printing and
stationary.
Accounts and double entry
The classification of accounts enables us to establish rules for making double entry in case of
different transaction. When faced with any transaction, the following three points must be
considered.
 What two accounts are affected?

 What type of accounts are they?
 Which account is to be debited and which credited
The following figure gives an idea of making double entry in case of different transactions:-
Accounts
Impersonal accounts Personal accounts
Nominal accounts Real accounts Dr Cr
The receiver The giver
Dr Cr Dr Cr
Expenses & Income & What comes in What goes out
Losses gains
Note
The business transactions are recorded in the ledger. For each transaction, two ledger accounts
are affected.
Illustration
Mr. Salim begins to deal in furniture with capital of sh. 50,000 in cash as on January 1, 2009. He
makes the following transaction during the month of January, 2009.
39
Jan 5- He purchases two sofa sets at sh.2, 000 each, paying cash down.
Jan 7-He purchases one dining table with six chairs for cash shs.1, 000.
Jan 10- He sells one sofa set for sh. 3, 000.
Jan 15 – He sells one dining table and six chairs for sh.1750.
Jan 20 – He sells the remaining sofa set for sh. 2800.
Jan 30 – He pays sh.300 for advertisement and other sundry expenses.
Required
Make the necessary entries to record these transactions in Mr. Salim ledger
Answer
1. Mr. Salim separates from his private funds a sum of sh. 50,000 for business purposes.
This amount will be debited in the business cash account (Dr: what comes in) and
credited in the capital account (Cr: the giver)
2. The purchases of furniture for resale purposes will be debited to the purchase account
(Dr: Expenses and losses)and credited to cash account (Cr: what goes out)
3. The sales of furniture will be debited to cash account (Dr: what comes in) and credit to
sales account (Cr: income and gains).
4. The advertisement and other expenses will be debited to sundry expenses account and
credited to cash account.
These transactions will appear in the in the ledger accounts as follows
Dr Cash account Cr CB-1
Date Particulars folio amount date particulars folio amount

2009 Sh. 2009 Sh.
Jan. 1 Capital L-1 50,000 Jan 5 Purchases L-2 4,000
Jan. 10 Sales L-3 3,000 Jan 7 Purchases L-2 1,000
Jan. 15 Sales L-3 1,750 Jan Sundry L-4 300
Jan. 20 Sales L-3 2,800 30 expenses
Dr Capital account (Mr. Salim) Cr L-1
Date Particulars folio amount date particulars folio Amount

2009 Sh.
Jan.1 Cash CB-1 50,000
40
Dr Purchases account Cr L-2
Date Particulars folio amount date particular folio Amou

s nt
2009 Sh.
Jan. 5 Cash CB-1 4,000
Jan. 7 cash CB-1 1,000
Dr Sales account Cr L-3
Date Particulars folio amount date particulars folio amount

2009 Sh. 2009 Sh.
Jan. 1 Capital L-1 50,000 Jan 10 Cash CB-1 3,000
Jan. 10 Sales L-3 3,000 Jan 15 Cash CB-1 1,750
Jan. 15 Sales L-3 1,750 Jan 20 Cash CB-1 2,800
Jan. 20 Sales L-3 2,800
Dr Sundry expenses account Cr CB-1
Date Particulars folio amount date Particulars folio amount

2009 Sh.
Jan. 30 Cash CB-1 300
Note
Credit transactions
All transactions in a business are not made on cash basis. Most of these transactions are made on
credit basis. It means goods are purchased and sold on credit. The credit period may vary from
30 days to 90 days.
41
i. The documents which provide the accounting information are called source documents. State
and explain source documents.
ii. State and explain books of original entry.
iii. Discuss major kinds of ledger
iv. Explain classification of accounts
v. Using the following information open the relevant accounts.
 May 1 started a domestic machine business putting $25,000 into a business bank account.
 May 3 bought equipment on credit from house supplies $12,000.
 May 4 withdrew $150 cash from the bank and place it in the cash box.
 May 7 bought a van paying by cheque $6800.
 May 10 sold some equipment that was not
42
CONTROL ACCOUNTS (WEEK 5)
 Explain benefits of accounting controls

 Discuss principles of control accounts
 Prepare control accounts
5.1 The benefits of accounting controls

In any but the smallest business, the accounting information system is set up so as to embed
controls that help ensure that errors are minimized and that nothing occurs that shouldn’t such as
the cashier embezzling funds.
One of the tasks undertaken by auditors is to check the various controls that are in place to
ensure they are working satisfactorily and one of the things they will look out for is segregation
of duties e.g. the will same person will not both invoice customers and act as cashier when
payment is received.
The example of control above is organizational, that is, it does not directly impose controls over
accounting data, nor do they ensure that accounting entries are correct.
When all the accounts were kept in one ledger a trial balance could be drawn up as a test for the
arithmetical accuracy of the accounts. If the trial balance totals disagree, the books of a small
business could easily and quickly be checked so as to find the errors. Using a trial balance
ensures that all the double entries appear, at least, to have been recorded correctly.
When the business has grown and the accounting work has been so divided up that there are
several ledgers, any errors could be very difficult to find if a trial balance was the device used to
detect errors. Every item in every ledger may be checked just to find one error that caused the
trial balance not to balance. What is required is s type of trial balance for each ledger, and this
requirement is met by control accounts.
Control account is a summary account that enables you to see at glance whether the general
ledger balance for the ledger to which that control account belongs agrees with the total of all the
individual accounts held within that ledger.
43
Using control accounts means that it is only the ledger whose controls accounts do not balances
that need detailed checking to find errors.
5.2 Principles of control accounts

If the opening balance of an accounting is known, together information of the additions and
deductions entered in the account, the closing balance can be calculated.
Applying this to a complete ledger, the total of opening balances together with the additions and
deductions during the period should give the total of closing balances. This can be illustrated by
references to a sales ledger for entries for a month.
Total of opening balances, 1 January, 2009 $ 3,000
Add total of entries which have increased the balances $9,500
$ 12,500
Less total of entries which have reduced the balances ($8,000)
Total closing balance should be $ 4,500
Because totals are used, control accounts are sometimes known as total accounts: thus a control
account for a sales ledger could be known as either a sales ledger control or as total debtors
account. Similarly, a control account for a purchases ledger could be known either as a purchases
ledger control account or as a total creditors account.
Format of a control account
Title
2009 $ 2009 $
Jan 1 balance b/d x,xxx Jan 31 returns Inwards Day Books (totals
Jan 31 Sales Day Book (total of sales of all goods returned from debtors in
Invoiced in the period xx,xxx the period) xx,xxx
Jan 31 Cash Book (total of all Cash received
from debtors in the period xx,xxx
Jan 31 Cash Book (total of all cheques

recorded from debtors in the period) xx,xxx
Jan 31 balances c/d x,xxx
44
xxx,xxx xxx,xxx
5.3 Information for control accounts

The following tables show list from where information is obtained with which to draw up control
accounts.
Sales ledger Source

control
Opening List of debtors’ balances drawn up at the end of the previous period
debtors
Credit sales Total from the sales day book.
Returns Total of the returns inwards day book

inwards
Cheques Cash book: bank column on received side. List extracted or the total of a
received special for cash which has been included in the cash book.
Cash received Cash book: cash column on received side. list extracted or the total of a special
column for cash which has been included in the cash book.
Discounts Total of discounts allowed column in the cash book column in the cash book.
allowed
Closing List of debtors’ balances drawn up at the end of the period.

debtors
Purchases Sources
ledger
Opening List of creditors’ balances drawn up at the end of the previous period
creditors
Credit Total from purchases day book

purchases
Return Total of returns outwards day book.

outwards
Cheque paid Cash book: bank column on payments side. List extracted or total of a special
45
Cash paid Cashbook: cash column on payments side. list extracted or total of special
Discounts Total of discounts received column in the cash book

received
Closing List of creditors’ balances drawn up at the end of the period

creditors
5.4 Form of control accounts

Control accounts kept in the General Ledger are normally prepared in the same form as an
account, with the totals of the debit entries in the ledger on the left-hand sides of the control
accounts, and the totals of the various credit entries in the ledger on the right-hand side. Taking
the sales ledger as an example, the following process if is followed.
i. Individual amounts received from debtors are transferred from the cash book into the
personal accounts in the sales ledger (the double entry is completed automatically in
the normal way, because the cash book is, in itself, a ledger account)
ii. Individual invoice amounts are transferred from the sales day book into the personal
accounts in the sales ledger. (you would complete the double entry in the normal way,
by crediting the sales account.)
iii. The sales ledger control account would open each period with the total of the debtor
balances at the start of the period.
iv. Then, post the total of the returns inwards day book to the credit side of the sales
ledger control account.
v. At the end of the period, you post the totals of all the payments from debtors’
received during the period from cash book to the credit side of the sales ledger control
account.
vi. This is followed by posting to the debit side of the sales ledger controls account the
totals of all new sales during the period shown in the sales day book.
vii. Balance off the control account.
viii. Check whether the balance on the control account is equal to the total of all the
balances in the sales ledger.
46
If the balance is not the same as the total of all the balances in the sales ledger, there is an error
either in the total entered in the control account from the books of original entry or, more likely,
somewhere in the sales ledger.
An example of a sales ledger control account for a sales ledger in which all the entries are
arithmetically current and the totals transferred from the book of original entry are correct.
Sales ledger control account data $
-debit balances on 1st January, 2009 1,894
-total credit sales for the month 10,290
-cheques received from customer in the month 7,284
-cash received from customers in the month 1,236
-return inwards from customers during the month 296
-debit balances on 31st January as extracted from the sales ledger 3,368
Sales ledger control account
2009 $ 2009 $
Jan 1 balance b/d 1,894 Jan 31 bank 7,280
Jan 31 sales 10,290 Jan 31 cash 1,236
Jan 31 returns inwards 296
Jan 31 balances c/d 3,368
12,290 12,184
We have proved the ledger to be arithmetically correct, because the control account balances
with the amount equaling the total of the balances extracted from the sales ledger.
An example where an error is found to exist in a purchase ledger, the ledger will have to be
checked in detail, the error found, and the control account corrected.
Purchase ledger control account data $
-credit balances on 1st January 2009 3,890
-cheques paid to suppliers during the month 3,620
47
-returns outwards to suppliers in the month 95
-bought from supplier in the month 4,936
-credit balances on 31st January as extracted from the purchase ledger 5,151
Purchases ledger control
2009 $ 2009 $
Jan 31 bank 3,620 Jan 1 balance b/d 3,890
Jan 31 return outwards 95 Jan 31 purchases 4,936
Jan 31 balances c/d 5,151
8,866 8,826
Note
Provided all the totals transferred into the purchases ledger control from the books of original
entry were correct, there is a $ 40 difference between debit and credit entries in the purchase
ledger.
We will have to check the purchases ledger in details to find the error. You need to be sure that
the totals transferred from the books of original entry were correct before assuming that an out-
of- balance control account means that the ledger is incorrect.

i. Discuss the benefits of accounting controls
ii. Explain the principle of control account
iii. Taking the sales ledger as a example, explain the process followed when preparing control
account.
48
BANK RECONCILIATION STATEMENTS (WEEK 6)
 Discuss reasons for the difference in the balances in the cashbook and that in the
cashbook and that in the banks statement
 Be able to prepare bank reconciliation statement
6.0 Introduction
In the books of a business, funds paid into and out of the bank are entered into the bank columns
of the cash book. At the same time, the bank will also be recording the flows of funds into and
out of the business bank account.
If all the items entered in the cash book were the same as those entered in the records held by the
bank, the balance on the business bank account as shown in the cash book and the balance on the
account as shown by the bank’s records would be the same.
Generally balances reported are not the same. There may be items paid into or out of the business
bank account which have not been recorded in the cashbook. And there may be items entered in
the cash book that are yet been entered in the bank’s records of the account.
To see if any of these things have happened, the cash book entries need to be compared to the
record of the account held by the bank. Banks usually send a copy of that record, called a bank
statement, to their customers on a regular basis.
6.1 Among the reasons for the difference in the balances in the cashbook and that in the
bank statement are:
6.1.1 Transactions recorded in the bank statement but not in the cashbook
a) Credit Transfer
The bank may receive deposits to the firms account from a source other than the firm itself. This
is also called a bank giro transfer, and would be shown as a credit entry on the bank statement.
49
b) Interest Earned
Some banks pay an interest on the closing balance in the firm’s current account, provided that
they will write a limited amount of cheques. This is usually done to discourage excessive
withdrawal from the account.
c) Bank Charges
The bank will charge a fee for holding the firm’s account, and for other services rendered e.g. for
an overdraft arrangement
d) Standing Order
The firm may instruct the bank to make regular payments from its account. This may include
payments for insurance premium, mortgage, or loan.
e) Direct Debit
The firm may make an arrangement with someone to make withdrawals from the account at
the bank. This includes open cheque payments, or post dated cheques.
f) Dishonoured Cheque
A cheque that was previously deposited to the firms account may be subsequently cancelled or
dishonoured by the bank. This may be due in part to insufficient funds in the drawer’s account,
or an apparent error in the preparation of the cheque.
6.1.2 Transactions recorded in the cashbook but not in the bank statement
a) Late Lodgements
Money received by the firm and deposited to the bank may not appear on the bank statement.
This could be due to the timing of the lodgement, or a delay in posting it to the firm’s account. It
is also known as a deposit in transit
b) Unpresented Cheques
Cheques drawn by the firm may not be shown as being cashed on the bank statement. Cheques
may remain as being unpresented for a period of six months.
c) Errors
Aside from the bona fide transactions recorded in both the cashbook and the bank statement,
there may be several entries that are made in error. Those that are located in the cashbook may
50
be easily corrected. However, errors made in the bank statement may take some time before they
are corrected.
All the errors should be taken into consideration when preparing the bank reconciliation
statement.
Example of a cash book and a bank statement
Cash Book (bank columns only: before balancing on 31.12.2009)
Date particulars amount Date particulars amount
2009 $ 2009 $
Dec 1 balance b/d 250 Dec 5 J Gordon 65
Dec 20 P Thomas 100 Dec 27 K Hughes 175
Dec 28 D Jones 190
Bank Statement
Date particulars withdrawals deposit balance
2009 $ $ $
Dec 1 Balance b/d 250
Dec 8 10625 65 185
Dec 21 Deposit 100 285
Dec 28 Deposit 190 475
Dec 29 10626 175 300
Dec 30 bank Giro credit: P Smith 370
Dec 31 bank charges 50 320
Two items are not shown in cash book:
51
 Bank Giro credit: P Smith $70
 Bank charges $50
P Smith had paid $70 but, instead of sending a cheque, he paid the money by bank giro credit
transfer direct into the business bank account. The business did not know of this until it received
the bank statement.
The bank has charged $50 for keeping the bank account and all the work conducted with it.
Instead of sending an invoice, the bank has simply taken the money out of the bank account.
A complete write up by entering the two items we have identified.
Cash Book (bank columns only: after balancing on 31.12.2009)
2009 $ 2009 $
Dec 1 balance b/d 250 Dec 5 J Gordon 65
Dec 20 P Thomas 100 Dec 27 K Hughes 175
Dec 28 D Jones 190 Dec 31 Bank charges 50
Dec 30 P Smith 70
610 610
2010
Jan 1 balance b/d 320
Both the bank statement and cash book closing balances are now shown as being $ 320.
Where closing balances differ
Although a cash book may be kept up to date by a business, it obviously cannot alter the bank’s
own records. Even after writing up entries in cash book, there may still be a difference between
the cash book balance and the balance on the bank statement.
52
Example
Cash Book (bank columns only: after balancing on 31.12.2009)
2009 $ 2009 $
Jan 1 balance b/d 320 Jan 10 C Morgan 110
Jan 16 R Lomas 160 Jan 20 M McCarthy 90
Jan 24 V Verity 140 Jan 28 Cheshire CC rates 180
Jan 31 J Soames 470 Jan 30 M Peck 200
Jan 31 R Johnson 90 Jan 31 balance c/d 600
1,180 1,180
Feb 1 balance b/d 600
Bank Statement
2009 $ $ $
Jan 1 balance b/d 320
Jan 12 10627 110 210
Jan 16 Deposit 160 370
Jan 23 10628 90 280
Jan 24 Deposit 140 420
53
Jan 28 Direct debit: Cheshire CC 180 240
Jan 31 bank Giro credit: R Johnson 90 330
Two items are in the cash book but shown on the bank statement. These are:
 A cheque had been paid to M Peck on January 30. He deposited it in his bank on January
31 but his bank didn’t collect the money from the business’s bank until February 2. This
is known as an unpresented cheque.
 Although a cheque for $ 470 was received from J Soames on January 31 and the business
deposited it with the bank on that date, the bank did not receive the funds from Soames’
bank until February. This is known as a bank lodgement not yet credited to the business
bank account.
The cash book balance on January 31 was $ 600, whereas the bank statement shows a balance of
$ 330. To prove that although the balances are different they can be reconciled with each other, a
bank reconciliation statement is prepared. It will either start with the bank statement balance and
then reconcile it to the cash book balance, or it will start with the cash book balance and then
reconcile it to the bank statement balances.
6.2 Steps in preparing the bank reconciliation statement

1. Compare the cashbook with the bank statement, indicating those transactions that are
recorded in both of them. Also, identify those items that are recorded in the cashbook or
the bank statement only, as well as items recorded in error.
2. Use the items that are recorded in the bank statement only to update the cashbook. Starting
with the closing balance in the cashbook, the general entries would be as follows:
Updated Cashbook
DA DETAILS F AM DAT DETAILS F AMT

TE O T E O
L L
Bal b/d A Standing Order
Credit Transfer Direct Debit
Interest Earned Bank Charges
54
Dishonoured Cheque
Bal c/d B
Items of errors reported in the bank statement may also be treated as bona fide entries in the
cashbook, for the sake of completing the reconciliation. Later when they are corrected, the
reversed entry must be made in the cashbook. Errors located in the cashbook may be correction
immediately.
Note that the location of the bal b/d and the bal c/d may not always be as shown
above, since these are determined by the status of the account.
3. Complete the process of reconciliation as follows:
Balance as per updated cashbook $ 600
Add Unpresented Cheques $ 200
$ 800
Less bank lodgements not on statement ($ 470 )
= Balance as per bank statement $ 330
=====
The process above could be done in the inverse, i.e. starting with the balance in the bank
statement, adding late lodgements, deducting unpresented cheques, and resulting with the
balance as per cashbook.
Illustration
Gary Allen started a peanut project in Montego Bay. The following is a summary of his bank
transactions for the month of May 2007:
55
CASHBOOK
DATE. DETAILS AMT DATE DETAILS AMT
May 1 Bal b/d 40,000 May 1 Insurance (0001) 4,000
May 15 Sales (0167) 30,000 May 8 Rent (0002) 5,000
May 22 D. Mattis (3164) 20,000 May 9 Purchases (0003) 10,000
May 30 G. T. Taylor (5186) 35,000 May 16 K. Owen (0004) 20,000
May18 M. Price (0005) 15,000
May 24 C. Francis (0006) 12,000
May 31 Bal c/d 59,000
---------- ----------
125,000 125,000
====== ======
June 1 Bal b/d 59,000
However, the statement received from the bank showed the following details
DATE DETAILS With Deposits BALANCE

drawals
56
May 1 Balance 40,000
6 0001 4,000 36,000
11 0002 5,000 31,000
14 0003 10,000 21,000
19 0167 30,000 51,000
25 3164 20,000 71,000
26 Cr. Transfers 15,000 86,000
28 81924 8,000 78,000
30 Standing Order 15,000 63,000
31 Interest 2,000 65,000
Now to prepare the bank reconciliation statement
Step No.1 Compare the cashbook with the bank statement
A careful examination of both the cashbook and the bank statement reveals the following:
a) Cheque 5168 received from G. Taylor was recorded in the cashbook but not yet
recorded in the bank statemnent. This is a late lodgement
b) Cheques 0004-6 paid out from the cashbook have not yet been cashed. These
are unpresented cheques
c) On May 26 the bank added 15,000 to our balance. This is recorded as a credit
transfer
d) On May 28 the bank paid out 8,000 by way of cheque # 81924. This is
obviously an error since our cheques are numbered 0001-6
e) On May 30 the bank paid out 15,000 from our account. This is recorded as
57
a standing order
f) On May 31 the bank added 2,000 to our account as interest.
Step No. 2 Update the cash book with entries made in the bank statement only
UPDATED CASHBOOK
DATE DETAILS AMT DATE DETAILS AMT
June 1 Bal b/d 59,000 June 1 Error (81924) 8,000
Cr. Transfer 15,000 Standing Order 15,000
Interest 2,000 Bal c/d 53,000
------------- -------------
76,000 76,000
========= ========
Step No. 3 Complete the reconciliation with the items from the cashbook only
Balance as per Updated Cashbook 53,000
Add Unpresented Cheques 0004 20,000
0005 15,000
0006 12,000 47,000
100,000
Less Late Lodgement 5186 ( 35,000)
Balance as per bank statement 65,000
58
6.3 Overdraft balances
In the event of an overdraft situation, the same procedures may be followed, provided that
the overdraft amount is shown as a negative figure. The adjustment needed to reconcile a bank
overdraft according to the firms books, shown by a credit balance in the cash book, with that
shown in the bank’s records are the same as those needed when the account is not overdrawn.
An example below is the cash book and bank statement both showing an overdraft. Only the
cheque for Cumberbatch (A) $ 106 and the cheque paid to J Kelly (B) $ 63 need adjusting.
Because the balances shown by the cash book is correct, you can use the form of bank
reconciliation statement as shown below.
Cash Book
2009 $ 2009 $
Dec 5 I Howe 308 Dec 1 balances b/d 709
Dec 24 L Mason 120 Dec 9 P Davies 140
Dec 29 K King 124 Dec 27 J Kelly (B) 63
Dec 31 G Cumberbatch (A) 106 Dec 29 United Trust 77
Dec 31 balance c/d 380 Dec 31 Bank charges 49
1,038 1,038
Bank Statement
2009 $ $ $
Dec 1 balance b/d 709 O/D
Dec 5 cheque 308 401 O/D
Dec 14 P Davies 140 541 O/D
Dec 24 Cheque 120 421 O/D
Dec 29 K King: Credit transfer 124 297 O/D
59
Dec 29 United Trust 77 374 O/D
Dec 31 Bank charges 49 423 O/D
NB An overdraft is often shown with the letters O/D following the amount.
Bank Reconciliation statement as at 31 December 2009
Overdraft as per cash book (380)
Add unpresented cheque 63
(317)
Less Bank Lodgement not on bank statement (106)
(423)

1. Discuss the need for the bank reconciliation statement
2. Explain the following terms: credit transfer, dishonoured cheque, standing order
3. Discuss the benefits of the bank reconciliation statement
60
4. The following is the bank account for Tony Rebel for the month of June 1994:
--------------------------------------------------------------------------------------------------------------
DATE DETAILS AMT DATE DETAILS AMT
--------------------------------------------------------------------------------------------------------------
June June
1 Bal b/d 25,000 3 NHT 6,000
7 T. Cowan 15,000 6 Farels 5,000
9 Devon House 7,000 17 HILO Supermarket 4,500
21 Babsy Grange 10,000 19 Court’s Ja Ltd 12,000
24 Boscobel Beach 20,000 22 Vandel 4,000
29 Club Inferno 20,000 26 Pagoda 15,000
30 Tuff Gong 25,000 27 Bob Andy 4,000
28 Derrick Morgan 3,500
29 Marcia Griffiths 10,000
30 Bal c/d 58,000
-------------- ------------
122,000 122,000
========== ========
July
1 Bal B/d 58,000
However, his bank statement from National Commercial Bank showed the following details
61
-------------------------------------------------------------------------------------------------------------
DATE DETAILS DR CR BAL
-------------------------------------------------------------------------------------------------------------
2 Direct Debit 4,000 21,000
10 Farels 5,000 16,000
12 T. Cowan 15,000 31,000
17 Devon House 7,000 38,000
21 HILO Supermarket 4,500 33,500
22 Courts (Ja) Ltd 12,000 21,500
26 Boscobel Beach 20,000 41,500
29 Vandel 4,000 37,500
29 Boscobel Beach (refer to drawer) 20,000 17,500
30 Derrick Morgan 3,500 14,000
30 Bank Charges 2,000 12,000
30 Credit Transfer 17,000 29,000
Prepare Tony Rebel’s updated cashbook and his bank reconciliation Statement for the
month of June.
62
CAPITAL EXPENDITURE AND REVENUE EXPENDITURE (WEEK 8)
 Differentiate capital expenditure, revenue expenditure and joint expenditure and to give
example in each type of expenditure.
 Explain the effect of incorrect treatment of expenditure.
7.1 Capital expenditure

Capital expenditure is incurred when a business spends money either to:
 Buy fixed assets, or

 Add to the value of an existing fixed asset.
Included in such amounts should be spending on:
 Acquiring fixed assets

 Bringing them into the business
 Legal costs of buying buildings
 Carriage inwards on machinery bought
 Any other cost needed to get a fixed asset ready for use.
7.2 Revenue expenditure

Expenditure which is not spent on increasing the value of fixed assets, but on running the
business on a day-to-day basis, is known as revenue expenditure.
The difference between revenue expenditure and capital expenditure can be seen clearly with the
total cost of using a van for a business. Buying a van is capital expenditure. The van will be in
use for several years and is, therefore, a fixed asset.
Paying for petrol to use in the van is revenue expenditure. This is because the expenditure is used
up in a short time and does not add to the value of the fixed asset.
Example of different types of capital and revenue expenditure
Expenditure Types of
63
expenditure
Buying van Capital
Petrol costs for van Revenue
Repairs to van Revenue
Putting extra headlights on van Capital
Buying machinery Capital
Electricity costs of using machinery Revenue
We spent $ 1,500 on machinery: $ 1000was for an item (improvement) added Capital $1000
to the machine: and $ 500 was for repair Revenue $500
Painting outside of new building Capital
Three years later-repainting outside of building in 8 Revenue
Note
Revenue expenditure is chargeable to the trading and profit and loss account, while capital
expenditure will result in increased figures for fixed assets in the balance sheet. Getting the
classification wrong affects the profits reported and the capital account and assets values in the
financial statements.
7.3 Joint expenditure

Sometimes one item of expenditure will need to be divided between capital and revenue
expenditure. For example, from the table above, item 7, $ 1500 spent on machinery was splint
between capital and revenue.
$ 1,500
$ 1,000 capital $ 500 revenue
Machinery Account Repair account
General ledger General Ledger
Balance sheet profit and loss account
(add to existing total value of (shown as an expense)
the machinery)
7.4 Incorrect treatment of expenditure
If one of the following occurs
 Capital expenditure is incorrectly treated as revenue expenditure or
 Revenue expenditure is incorrectly treated as capital,
64
Then both the balance sheet figures and trading and profit and loss account figures will be
incorrect.
7.5 Treatment of loan interest
If money is borrowed to finance the purchase of a fixed asset, interest will have to paid on the
loan. The loan interest is not a cost of acquiring the asset, but is simply a cost of financing its
acquisition.
7.6 Capital and revenue receipts

When an item of capital expenditure is sold, the receipt is called a capital receipt. Suppose a van
is bought for $ 5000, and sold five years later for $750. The $ 5,000 was treated as capital receipt
and credited to the fixed asset account in the general ledger.
Revenue receipts are sales and other revenue items that are added to gross profit, such as rent
receivables and commission receivables.
EXAMPLE
For the business of J charlse, wholesale chemist, classify the following between capital and
revenue expenditure.
i. Purchase of an extra van capital
ii. Cost of rebuilding warehouse wall which had fallen down

revenue
iii. Building extension to the warehouse capital
iv. Painting extension to the ware house when it is first built capital
v. Repainting extension to warehouse three years later than that done in (d) revenue
vi. Carriage costs on bricks for new warehouse extension capital
vii. Carriage costs on purchases revenue
viii. Carriage costs on sales revenue
ix. Legal charges on acquiring new premises for office capital
x. Fire insurance premium revenue
xi. Costs of erecting new machine capital

i. With the aid of example explain the concept of capital expenditure and revenue expenditure.
65
ii. What is a joint expenditure? Give examples
ERRORS NOT AFFECTING TRAIL BALANCE AGREEMENT (WEEK 8)

 Discuss types of errors not affecting trial balance agreement

 Explain correction of errors
8.1 Types of error

If we followed the rules:
 Every debit entry needs a corresponding credit entry.
 Every credit entry needs a corresponding debit entry
and entered transactions in our ledgers using these rules then, when we extract the trial balance,
the totals of the two columns would be the same, i.e. it would balances.
The following are some of the errors which don’t affect the agreement of the trial balance totals.
i. Error of omission
This is where a transaction is completely omitted from the books. If we sold $ 90 goods to J
Brewer, but did not enter it in either the sales or brewer’s personal account, the trial balances
would still balance.
ii. Error of commission
This type of error occurs when the correct amount is entered but in the wrong person’s account,
e.g. where a sale of $ 11 to C Green is entered in the account of K Green. It will be noted that the
correct class of account was used, both the accounts concerned being personal accounts.
iii. Errors of principle
Where an item is entered in the wrong class of account e.g. if purchase of a fixed asset, such as a
van, is debited to an expenses account, such as motor expenses.
66
iv. Compensating errors
This is where errors cancel each other out. If the sales account was added to be $ 10 too much
and the purchases account was also added up to be $10 to much, then these two errors would
cancel out in the trial balances.
v. Error of original entry
This is when the original figure is incorrect, yet double entry is still observed using this incorrect
figures. An instance of this could be where there were sales of $ 150 goods but an error is made
in calculating the sales invoice. If it were calculated as $ 130, and $130 were credited as sales
and $130 were debited to the personal account of the customer, the trial balance would still
balance.
vi. Complete reversal of entries
This is where the current accounts are used but each item is shown on the wrong side of the
account. Suppose we had paid a cheque to D Williams for $ 200, the double entry of which is Cr
Bank $200, Dr D Williams $ 200. In error it is entered as Cr D Williams $ 200, Dr Bank $ 200.
The trial balane totals will still agree.
vii. Transposition errors
This where the wrong sequence of the individual characters within a number was entered. For
example, $ 142 instead of 124. This is quite a common error and is every difficult to spot when
the error has occurred in both the debit and credit entries, as the trial balances would still
balance.
8.2 Corrections of errors

Most errors are found at a date later than the one on which they are first made. When we correct
them we should not do so by crossing out items, tearing out accounts and throwing the away. We
make corrections to double entry accounts by preparing journal entries. We should:
 Show the correction be means of journal entries
 Then show the corrections in the double entry set of accounts, by posting these journal
entries to the ledger accounts affected
1. Error of omission
The sale of goods, $59 to George, has been completely omitted from the books. We must correct
this by entering the sale in the books. The journal entries for the correction are as shown.
The journal Dr Dr
67
$ $
E George 59
Sales Account 59
Correction of omission of sales invoices number xxxx from sales journal.
2. Error of commission
A purchase of goods, $ 44 from C Simons, was entered in error in C Simpson’s account. To

correct this, it must be cancelled out of C Simpson’s account, and then entered where it should
be in C Simon’s account. The double entry will be:
C Simpson
2009 $ 2009 $
Sept 30 C. simpson error corrected 44 sept 30 purchases 44
C. Simons
2009 $
Sept 30 purchase: Entered originally in C. Simpsons account 44
The journal entry will be:
The journal
Dr Cr
C Simpson $ 44
C Simsons $ 44
Purchase invoice number xxxx entered in wrong personal account now corrected.
3. Error of principle
The purchase of a machine, $ 200, is debited to the purchases account instead of being debited to
a machinery account. we there cancel the item out of the purchases account by crediting that
account. It is then entered where it should be by debiting the machinery account.
The journal
68
Dr Cr
Machinery account $ 200
Purchase account $ 200
Correction of error: purchase of fixed asset debited to purchases account.
4. Compensating error
The sales is overcastted by $200, as also is the wage account. The trial balance therefore still
balances. This assumes that these are the only two errors found in the books.
The Journal
Dr Cr
Sales account $ 200
Wages account $ 200
Correction of overcasts of $200 each in the sales account and the wages account which
compensated for each other.
5. Error of original entry
A sale of $38 to A Smailes was entered in the books as $28.it needs another $10 f sales entry
now.
The Journal
Dr Cr
A Smailes $ 10
Sales account $ 10
Correction of error whereby sales were understated by $ 10.

i. State and explain errors which don’t affect the agreement of the trial balance totals
ii. With hypothetical example, explain how to correct those errors.
69
BAD DEBTS AND PROVISIONS FOR DOUBTFUL DEBTS (WEEK 9)
 Define bad debts and highlight possible scenarios that may exist concerning a bad debt.
 Explain why provisions for doubtful debts are needed.
 Make accounting entries for provisions for doubtful debts
9.0 Bad debts

Business normally take the risk that some of the customers may never pay for the goods sold to
the on credit. This is normal business expenses. They must be charged to profit and loss as an
expense when calculating the profit or loss for the period. The other thing that needs to be done
is to remove the bad debt from the asset account.
When a debt is found to be bad, the asset as shown by the debt in the debtor’s account is
worthless it must be eliminated from the account. This is done by crediting the debtor’s account
to cancel the asset and increasing the expense account of bed debt by debiting it there.
Possible scenarios that may exist concerning a bad debt
i. The debtor may be refusing to pay one of a number of invoices

ii. The debtor may be refusing to pay part of an invoice
iii. The debtor may owe payment on a number of invoices and has indicated that only a
portion of the total amount due will ever be paid because the debtor’s business has
failed.
iv. The debtors’ business has failed and nothing is ever likely to be received.
Whatever the reason, once a debt has been declared bad; the journal entry is the same. You debit
the bad debt account with the amount of the bad debit and credit the debtor’s account in sales
ledger to complete the double entry. At the end of the period, the total of the bad debts account is
transferred to the profit and loss. An example of debts being written off as bad
C Bloom
70
2009 $ 2009 $
Jan 8 sales 520 Dec 31 Bad debts 520
R Show
2009 $ 2009 $
Feb 16 sales 375 Aug 17 Cash 125
Dec 31 Bad debts 250
375 375
Bad debts
2009 $ 2009 $
Dec 31 C Bloom 520 Dec 31 profit and loss 770
Dec 31 R Show 250
770 770
9.1 Provisions for doubtful debts

Why provisions are needed?
When we are drawing up financial statements, we want to achieve the following objectives:
I. To charge as an expenses in the profit and loss account from that year an amount
representing debts that will never be paid.
II. To show in the balance sheet a debtors figure as close as possible to the true value of
debtors at the balance sheet date.
Debts declared bad are usually debts that have existed for some time, perhaps even from earlier
accounting periods. It is impossible to determine with absolute accuracy at the year end, what
true amount is in this respect of debtors who will never pay their accounts. In order to arrive at a
71
figure for doubtful debts, a business must first consider that some debtors will never pay any of
the amounts they owe, while others will pay a part of amount owing only, leaving the remainder
permanently unpaid. The estimated figure can be made:
(a) By estimating, on the basis of experience, what percentage of the total amount due from
the remaining debtors will ultimately prove to bad debts
(b) By looking at each debt, and deciding to what extent it will be bad.
It is well known that the longer a debt is owing, the more likely it is that will become bad debt.
Some businesses draw up an ageing schedule, showing how long debts have been owing. Old
debtors need higher estimates of bad debts than do newer debtors. The percentages chosen
should reflect the actual pattern of bad debts experienced in the past.
Most businesses don’t go this level of details. Instead, they apply a percentage to the overall
debtors balance after deducting the bad debts. The percentage will be one this business has
established over the years as being the most appropriate.
9.2 Accounting entries for provisions for doubtful debts.

The accounting entries needed for the provision for doubtful debts are:
Year in which provision is first made:
i. Debit the profit and loss account with the amount of the provision (i.e deduct it from
gross profit as an expenses)
ii. Credit the provision for doubtful debts account.
Example
At 31 December 2009, the debtors figure after deducting bad debts was $ 10,000. It is estimated
that 2 per cent of debts (i.e. $200) will eventually prove to be bad debts, and it is decided to
make a provision for these. The account will appear as follows:
Profit and loss account (extract) for the year ended 31 December 2009
Gross profit $ XX,XXX
Less expenses:
Provision for doubtful debts ($ 200)
Provision for doubtful debts
72
2009 $
Dec 31 profit and loss 200
In the balance sheet, the balance on the provision for doubtful debt will be deducted from the
total of debtors.
Balance sheet (extract) as at 31 Dec 2009
Current assets $
$
Debtors 10,000
Less provision for doubtful debts (200) 9,800
Note
Two different accounts are used to make the two debtor adjustments. This is done in order to
make it clear how much is:
 Being written off as bad,

 and how much is being treated as a provision for doubtful debts
i. bad debts accounts – this expenses account is used when a debt is believed to be irrecoverable
and is written off.
ii. provision for doubtful debts account – this expenses account is used only for estimates of
the amount of the debtors remaining at the year end after the bad debts have been written off that
are likely to finish up as bad debts.
9.3 Chapter review question

i. What is meant by bad debt?
ii. Highlight possible scenarios that may exist concerning a bad debt.
iii. Explain why provisions for doubtful debts are needed
iv. What is meant by:-
 bad debts account
73
 provision for doubtful debts account
DEPRECIATION OF FIXED ASSETS: NATURE AND CALCULATIONS (WEEK 10)

By the end of this chapter, the student should able to:-
 define depreciation and discuss depreciation as an expense

 Explain causes of depreciation
 Discuss provision for depreciation as an allocation of cost
 Discuss methods of calculating depreciation charges
10.1 Depreciation of tangible fixed assets

Tangible fixed assets such as machinery do not last forever. If the amount received (if any) on
the disposal of a fixed assets is deducted from the cost of buying it, the value of the fixed asset
can be said to have depreciated in value by that amount over its period of usefulness to be the
business. One can only estimate what it should be the depreciation of each year while the fixed
asset continues to be used.
Depreciation is an expense.
Depreciation is that part of the original cost of a fixed asset that is consumed during its period of
use by the business. It needs to be charged to profit and loss every year. The amount charged in a
year profit and loss for depreciation is based upon an estimate of how much of the overall
economic usefulness of a fixed asset has been used up in that accounting period. It is an expense
for services consumed in the same way as expenses are incurred for items such as wages, rent
etc.
Because it is charged as an expense to the profit and loss account, depreciation reduces net profit.
10.2 Causes of depreciation

i. Physical deterioration.
 Wear and tear- when fixed assets are used they eventually wear out.
74
 Erosion, rust, rot and decay-land may be eroded by the wind or water, metals will rust
away and wood will rot eventually.
ii. Economic factors
These may be said to be the reasons for an asset being put out of the use even though
it is in good physical condition. The two main factors are usually obsolescence and
inadequacy.
 Obsolescence- this is the process of becoming out of date.

 Inadequacy- this arises when an asset is no longer used because of the growth and
changes in the size of the business.
10.3 Provision for depreciation as an allocation of cost

Depreciation in total over the life of a fixed can be calculated quite simply as coast less the
amount receivable when the fixed asset is put out of use by the business. This amount receivable
is normally referred as residual value or scrap value of an asset.
When the asset is used for more than one accounting period: an attempt has to be made to charge
each period with the depreciation for that period. Accounting has developed some methods to
make the depreciation calculation that are considered to be acceptable. However, you will see
that none of them really manages to address these issues.
10.4 Methods of calculating depreciation charges

I. Straight line method
By this method, the number of years of use is estimated. The cost is then divided by the number
of years to give the depreciation charged each year.
Example
If a lorry was bought for $ 22,000 and we thought we would keep it for four years and then sell it
for $ 2,000 the depreciation to be charged each year would be:
–
Annual depreciation= = = $ 5,000
II. Reducing balance method.
In this method, a fixed percentage for depreciation is deducted from the cost in the first year. In
the second or later years the same percentage is taken of the reduced balance i.e. cost less
depreciation already charged. This method is also known as the diminishing balance method.
Example
75
If a machine is bought for $ 10,000 and depreciation is to be charged at 20%, the calculation for
the first three years would be as follows:
Cost 10,000
First: depreciation (20 %) (2,000)
8,000
Second: depreciation (20 % of 8,000) (1,600)
6,400
Third year: depreciation (20% of 6,400) (1280)
Cost not yet depreciated, end of year 3 5,120
10.7 Choice of method

The purpose of depreciation is to spread the total cost of fixed asset over the period in which it is
to be used. The method chosen should be that which allocates cost to each period in accordance
with the proportion of the overall economic benefit from using the fixed asset that was expanded
during that period.
If , therefore, the main value is to be obtained from the asset in its earliest years, it may be
appropriate to use the reducing balance method, which charges more in the early years. If, on the
other hand, the benefits are to be gained evenly over the years, then the straight line method
would be more appropriate.

i. define depreciation
ii. Explain causes of depreciation
iii. Discuss provision for depreciation as an allocation of cost
iv. A business has just bought a machine for Kshs. 8,000. It will be kept in use for four years,
when it will be disposed of for an estimated amount of Kshs. 500. The chief accountant has
asked you to prepare a comparison of the amounts charged as depreciation using both straight
line method and reducing balance method. Use 50 % for reducing balance method.
76
Model questions for revision
SECTION A
(a) Name and briefly explain 3 groups of function which accounting process
consists. (4.5 marks)
(b) Distinguish between capital and liability. (3 marks)
(c) At the beginning of the financial year the firm had assets of the value Kshs. 600,000
and owners’ equity of Kshs.300,000,calculate the obligation at that time. (2.5 marks)
(d) Using solution in (c) above, if at the end of the reporting period, the business derived
a net income of 80,000, show the value of assets and owners equity. (3 marks)
(e) In the table below, indicate whether the item is a debit or credit entry in
the account. (3marks)
Increases in revenue account

Increases in expenses account
Increases in liabilities
(f) What is the difference between a cash book and sales day book? (3 marks)
(g) The following table indicates some of the expenses incurred by a firm, show which one
77
is a capital expenditure and which one is a revenue expenditure. (3 marks)
Painting outside of new building

Cost of rebuilding warehouse wall which had fallen down
Carriage cost on sales
(h) i. What is meant by the term salvage value? (1 marks)
ii. An asset was bought at Kshs 20,000. After 4 years its scrap value was zero. Using straight
line method use, find the annual depreciation of the asset. (3 marks)
(i) After analyzing record of A & B Company, the following mistakes were discovered:
1. Sales of Kshs. 20,000 to C Yegon was entered in the account G Yegon.
2. An entry of Kshs 142,000 instead of 124,000.
Which two type of errors are these? (2 marks)
(j) Name 2 reasons why there exists a difference between cash book and bank statement
balance. (2 marks)
(k) List and explain any 2 accounting assumptions. (4 marks)
(m)Write brief notes about accounting equation. (5 marks)
(n) If a business has assets of Kshs. 630,000 and obligations of Kshs. 220,000, compute
the owners’ equity. (2 marks)
(o) List and explain briefly 2 users of financial statements and their information needs. (4 marks)
(p) What is meant by the term debit entry and credit entry? (2 marks)
(q) Complete the following table by indicating whether it is a debit entry or a credit entry.
(3 marks)
78
Decreases in assets
Increases in liabilities
Decreases in owners’ equity
(r) Name and explain briefly any 2 books of original entry (3 marks)
(s) Differentiate between capital expenditure and revenue expenditure, then show
which one of the following is a capital expenditure and which is a revenue
expenditure. (4 marks)
Repair to a van
Putting extra headlights on van
Spending Kshs. 2,500 on machinery: Kshs 2000 was for an item added to the
machine and Kshs. 500 was for repair.
(t) What is meant by the term depreciation of fixed assets? (1.5 marks)
If a fixed asset was bought at 22,000 and it is estimated to be disposed at 2000 at the end of
four years in use. Calculate annual depreciation using straight line method. (2.5 marks)
SECTION B
Question 2
(a) Differentiate between personal account and impersonal account. (2 marks)
(b) What is the meaning of balancing off accounts? (1 mark)
© Define the term trial balance. (1 mark)
(d) Write up the relevant accounts to record the following transactions in the records
of Mr. Salim which was obtained in 2009. (16 marks)
79
-June 1 started business with $ 15,000 in bank.
-June 2 bought office furniture by cheque $1,200
-June 3 bought machinery $1,400 on credit from Trees Ltd.
-June 5 bought a van paying by cheque $ 6010.
-June 8 sold some of the office furniture not suitable for the business, for $150 on credit
to D Twiga & Sons.
-June 15 paid the amount owing to Trees Ltd $ 1400 by cheque.
-June 23 received the amount due from D Twiga & Sons $ 150 in cash.
-June 31 bought more machinery by cheque $650
Question 3
(a) Define depreciation of fixed asset. (2 marks)
(b) Name and briefly explain any two cause of depreciation. (2 marks)
© A business has just bought a machine for Kshs. 8,000. It will be kept in use for four years,
when it will be disposed of for an estimated amount of Kshs. 500. The chief accountant has
asked you to prepare a comparison of the amounts charged as depreciation using both straight
line method and reducing balance method. Use 50 % for reducing balance method. (16 marks)
Question 4
(a) Define gross profit and net profit. (2 mark)
(b) Given the following information of Rashid enterprise:
Sales Kshs. 38,500
Purchases Kshs. 29,000
Closing stock Kshs.3, 000
80
Calculate the cost of goods sold, and hence the gross profit. (4 marks)
© Using answer in question (b) above and given that the total expenses for that
Period is Kshs. 4,000, find the net profit. (2 marks)
(d) Using information below which was obtained from Smile Enterprise, prepare a classified
balance sheets as of December 31, 2009 and compute the current ratio and working capital.
Make an interpretation of the ratio. (12 marks)
Kshs.
Cash $ 6,000
Equipment 14,000
Supplies 1,000
Question 5
(a) Distinguish between cash book and purchases day book. (3 marks)
(b) Differentiate between General Ledger and Sales Ledger. (3 marks)
© Mr. Robert starts business as at April 1, 2009 with cash Sh. 50,000. The following transactions
took place during April 2009. (14 marks)
-April 1 opened a bank account with Equity bank paying in Sh. 45,000.
-April 2 bought goods for cash Sh. 1000.
81
-April 3 bought motor vehicle and paid by cheque sh. 20,000.
-April 5 bought goods for sh. 5,000 and paid by cheque.
-April 7 sold goods for cash Sh. 2,000.
-April 10 paid expenses Sh. 500 in cash.
-April 15 sold goods and received a cheque for sh. 3,500.
-April 16 paid cash into bank sh.2,000
-April 17 bought goods for cash sh. 1,000.
-April 20 paid wages to an assistant sh. 1,000 in cash.
-April 22 cashed cheque for office cash sh. 1,500
April 30 paid expenses sh.800 in cash.
Required:- show entries into two column cash book format provided below. In the column of
folio show only where there is contra items.
Cash book (page 1)
date particulars folio cash Bank Date particulars folio cash Bank
82
Question 6
I. Distinguish between current assets and fixed assets and give an example in each case. (2 marks)
II. What is the difference between current liability and non-current liability? (2 marks)
III. Using the following information obtained from Mr. Habson limited books on 31 December
2009, prepare a classified balance sheet in either account form or reported form. (14 marks)
Kshs
Accounts payable------------------------------------------------------------------------------31,270
Accounts receivables--------------------------------------------------------------------------36,370
Accrued expenses-------------------------------------------------------------------------------8,630
Bond payable-----------------------------------------------------------------------------------36,500
Buildings and equipment---------------------------------------------------------------------73,290
Cash-----------------------------------------------------------------------------------------------5,265
Common stock---------------------------------------------------------------------------------30,000
Current portion of long-term debt------------------------------------------------------------6,200
Intangible assets-------------------------------------------------------------------------------16,500
Inventories/stocks-----------------------------------------------------------------------------43,610
Investments-------------------------------------------------------------------------------------12,800
Land-----------------------------------------------------------------------------------------------7,630
Long-term lease obligation-------------------------------------------------------------------13,500
Long-term loan----------------------------------------------------------------------------------7,500
Marketable securities---------------------------------------------------------------------------6,735
Notes payable------------------------------------------------------------------------------------7,500
Other current liabilities-------------------------------------------------------------------------2,600
83
Other non-current assets-----------------------------------------------------------------------3,700
Other non-current liabilities------------------------------------------------------------------19,920
Preferred stock---------------------------------------------------------------------------------24,500
Prepaid expenses--------------------------------------------------------------------------------3,290
Retained earnings------------------------------------------------------------------------------42890
VI. Using answer in (V), calculate current ratio. (2 marks)
Question 7
(a) Discuss any 3 reasons why the difference in the cash book and in the bank
statement occurs. (6 marks)
(b) The following are extracts from the cash book and bank statement of Mr. Rashid.
Cash book
2009 Kshs 2009 Kshs
Dec 1 Balance b/d 3,419 Dec 8 S Komora 462
Dec 7 M Fatuma 101 Dec 15 A Nyangweso 21
Dec 22 N Maritum 44 Dec 28 D Musyoka 209
Dec 31 M Terry 319 Dec 31 Balance c/d 3,437
Dec 31 A Omondi 246
4,129 4,129
Bank statement
Date Particulars Withdrawals Deposits Balance
Kshs Kshs Kshs
Dec 1 Balance b/d 3,419
84
Dec 7 Cheque 101 3520
Dec 11 S Komora 462 3,058
Dec 20 A Nyangweso 21 3,037
Dec 22 Cheque 44 3,081
Dec 31 Credit transfer: M Muriu 93 3,174
Dec 31 Bank charges 47 3,127
Required
i. Identify items which are in the bank statement and are not in the cash book. (1
mark)
ii. Identify items which are in the cash book and are not in the bank statement. (1
mark)
iii. Write the cash book up to date, and state the new balance as on
31 December 2009. (8 marks)
iv. Draw up bank reconciliation statement as on 31 December, 2009. (4

marks)
Question 8
(a) Name and explain 3 types of ledgers. (6 marks)
(b) Discuss any 2 source documents (3 marks)
(c) With the aid of cash book format below, write up a two-column cash book for a pine furniture
shop from the following details, and balance it off as at the end of the month. In the folio
column indicate only where there is contra item by letter C. (11 marks)
-June 1 started in business with capital in cash Kshs. 1,000.
-June 2 paid rent by cash Kshs. 230.
-June 3 G Broad lent us Kshs. 2,000, paid by cheque.
-June 4 We paid J fine by cheque Kshs. 860.
-June 5 cash sales Kshs 190.
-June 7 F love paid us by cheque Kshs 34.
85
-June 9 we paid A Moore in cash Kshs 92.
-June 11 cash sales paid direct into bank Kshs 151.
-June 15 P Hood paid us in cash Kshs. 96.
-June 16 we took Kshs. 100 out of our cash till and paid it into bank account.
-June 19 we paid R Onions Kshs. 500 by cheque.
-June 22 Cash sales paid direct into the bank Kshs122.
-June 26 paid motor expenses by cheque Kshs. 75
-June 30 withdrew Kshs. 200 cash from the bank for business use.
-June 31 paid wages in cash Kshs 320.
Cash book (page 1)
date particulars folio cash bank Date particulars folio cash Bank
86
Question 9
(a) Differentiate between bad debt account and provision for doubtful debts account. (4 marks)
(b) Distinguish between gross profit and net profit. (2 marks)
(c) From the following trial balance of Mr. Musee, extracted after one year’s trading, prepare a
trading and profit and loss account for the year ended 31 Decenber 2009. (14 marks)
Trial balance as at 31 December 2009
Dr Cr
Kshs Kshs
Sales 385,000
Purchases 290,000
Rent 24,000
Lighting expenses 15,000
General expenses 6,000
Fixtures and fittings 50,000
Debtors 91,000
Creditors 151,000
Bank 2000
Cash 70,000
87
Drawings 200,000
676,000 676,000
88

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DEPARTMENT OF MANAGEMENT

COURSE CODE: DBM 114

COURSE TITLE: FUNDAMENTALS OF ACCOUNTING I

MANUAL PREPARED BY: Mr. MBURU PETER

Cell phone No.: 0723135375

Email address: mbgipe@yahoo.com

By the end of this chapter, the student should be able to:-

1.0 What is accounting?

 Acquisition of assets from owners and other creditors

Specifically, the accounting process consists of the following groups of functions.

1.1 The objectives of accounting

i. If they are making profit or a loss.

1.2 Basic principles

Main characteristics of accounting principles

i. Accounting standards are manmade so they do not have the authoritativeness as

Accounting concepts and conventions

(a) Going concern

Uncertainties inevitable surround many transactions. This should be recognized by exercising

A profit can be considered to be a realized when it is in the form of

(f) Substance over form

(h) Money measurement concept

(i) Separation of valuation principle

 Depreciation of non-current assets (e.g. by straight line or reducing balance)

1.3 Users of financial statements and their information needs

The following are users of financial information:-

1. The equity investor group

 Income – a money return by way of dividend

2. The loan creditor group

This group consists of long, medium or short-term lenders of money.

3. The employee group

 Fair and open collective bargaining (i.e. wage negations)

4. The analyst – advisor group

5. The business contact group

1.4 Characteristics of useful information

 Who the user is

Clearly this requirement may change as time goes by.

1.5 Chapter review questions

2. Highlight objectives of accounting

3. Explain any six accounting concepts and conventions.

6. Explain characteristics of useful information.

By the end of this chapter, the student should be to:-

 Discuss clearly accounting equation

2.1 The accounting equation

 Owners supplying all the resources

Resources supplied by the owner = Resources in the business

Capital = Assets -Liabilities

Assets = Capital + Liabilities

Resources: what they are = Resources: who supplied them

(Assets) (Capital + Liabilities)

2.1.1 Component of accounting equations

2.2 Financial statements

2.2.1 Income statement

Income = Revenue – Expenses

2.2.2 Balance sheets

Assets = Liabilities + Stockholder’s equity

Total current assets XXX

Total non-current assets XXX

Total current liabilities XXX

Total non-current liabilities XXX

Total owners’ equity XXX

2.2.2.2 Current assets and current liabilities

Normal operating cycle

2.2.2.3 Noncurrent assets and noncurrent liabilities