FINANCIAL ACCOUNTING 1

BA1012

TOPIC 3
ACCOUNTING CYCLE
(FOR TRADE & SERVICES)
ACCOUNTING CYCLE

COLLECT
SOURCE
DOCUMENTS
PREPARE
FINANCIAL ANALYZE
STATEMENTS TRANSACTIONS

POST RECORDS
TRANSACTIONS TRANSACTIONS
ACCOUNTING EQUATION

• In business, all transaction must be recorded.

• Transaction occurred is defined as economic event that will affect the
business.
• Every time that a business transaction occurs, it will also affect the financial
position of the business.
DOUBLE ENTRY SYSTEM AND RULES OF THE
ACCOUNTING EQUATION
• Is the application of what as dual or two sided effects.
• Each transactions will involve 2 accounts & made in pairs
- Debit (Dr) & credit (Cr)
• An accountants use the double-entry bookkeeping system to keep the
accounting equation in balance and to double –check the numerical accuracy
of transaction entries.
SINGLE ENTRY SYSTEM.

• Means small sole proprietorships or home based businesses only maintain a

single record as opposed to double records in double entry system.
• When a business entity maintains a single record for their transactions, it is
called as single entry system.
• Single entry system means only one record of the transaction is made, and
another effect of the transaction is not recorded.
• The business transaction is only recorded once which is either a debit or
credit entry.
SINGLE ENTRY SYSTEM.
• A single entry system does not provide a complete set of records for small
business.
• The effect of this can be seen on the accounting equation, which will cause
imbalance to the accounting equation as only element in the accounting equation is
recorded.
• Therefore, the complete set of accounts cannot be prepare.
• It is simply not possible to prepare a statement of profit or loss and a statement of
affairs or financial position.
• Due to single entry, the owner would not be able to determine with sufficient
accuracy the profitability and financial affairs of the business, that are essential in
determining its future direction and prospect and for making financial decisions.
DISADVANTAGES OF A SINGLE ENTRY SYSTEM
a) Unsystematic system
- The recording of financial transactions in a single entry form, does not
have any set of specific rules and guidelines for recording and reporting
the financial transactions.
b) Incomplete System
- The single entry system is an incomplete system because it does not
record both sides of the relevant accounts for all the financial transactions of
the business.
- It does not maintain any record of the transaction relating to the nominal
and real accounts except cash account.
DISADVANTAGES OF A SINGLE ENTRY SYSTEM
c) Lack of Accuracy
- The system fails to provide the arithmetical accuracy of the books of accounts
as it is not based on the principles of double entry.
d) Does not reflect true profit or loss
- The single entry system does not provide sufficient information on revenues
and expenses.
- Hence, the profit or loss of the business is only the best estimate of the figure.
e) Does not reflect true financial affairs.
- The real accounts are not maintained under the single entry system except the
cash book.
-Difficult to determine the present financial affairs due to incomplete information. o
DISADVANTAGES OF A SINGLE ENTRY SYSTEM
d) Fraud and errors
- The single entry system is incomplete, inaccurate and unsystematic.
- Therefor it is a possibility of committing frauds and errors in the books of
accounts.
e) Unacceptable for tax purpose.
- The single entry system has incomplete records of the financial transactions of the
business.
- Hence, the tax office cannot accept the account maintained under this system for
the purpose of tax assessments.
ACCOUNTS AFFECTED BY DOUBLE ENTRY IN BUSINESS
ACTIVITIES
❑ Information obtained from all the transactions for a business will be
recorded in journals and later posted to the ledger using the doublr-entry
system.
❑Double –entry system generates the accounting equation as follows:
ASSET= LIABILITIES + CAPITAL
❑The ledger accounts will be closed in order to obtain the ending balance of
each account for a certain accounting period (either monthly, quarterly, half-
yearly or yearly).
❑ Therefore, all accounts must be recorded in double entry correctly in
order to ensure the correct preparation of financial statements.
❑The financial statements are the assessment of the company’s overall
ACCOUNTS AFFECTED BY DOUBLE ENTRY IN BUSINESS
ACTIVITIES
❑ The financial statements are the assessment of the company’s overall
performance.
i) Statement of Profit and Loss (Statement of Comprehensive Income)
- Shows the operational results (profit or loss) for a business for a certain
accounting period.

ii) Statement of Changes in Equity

- Shows the changes in the operating capital either profit or loss, or from the
drawings of the capital in the form of cash or goods by the owner.

iii) Balance Sheet (Statement of Financial Position)

- Shows the financial position (assets,liabilities and owner’s equity) of the business
on a given date at the end of the accounting period.
SOURCE DOCUMENTS

• Every business transactions is usually recorded in a document.

• The document is known as the source document.

• The purpose of source documents is to identify and describe the transactions, thus, it can
provide a reliable source of evidence for the business transactions.

• The source documents in the form of paper or in electronic format.

a) Invoice d) Receipt

b) Credit Note e) Cheque

c) Debit Note
RECORDING PROCESS
a) Invoice
- issued by a seller to a buyer.
- to inform the buyer about the goods and /or services that have been supplied by seller.
- Normally describes the goods or services supplied, quantities and agreed prices.

b) Credit Note
- A document sent from the seller to the buyer.
- To inform that some amount has been credited to the buyer’s account.
- It is issued to correct items that were wrongly invoiced before.

c) Debit Note
- A document sent by the seller to the buyer.
- To inform if there is an undercharged amount in the invoice.
SOURCE DOCUMENTS
d) Receipt
- A document from the seller to acknowledge that the buyer has paid for the goods
received or services made.
- A receipt normally has the information of the name of the player, the amount and the
date.

e) Cheque/ Online banking transfer

- Is another important source document for recording transactions.
- The information that is usually available from the cheque is the date,the signature of the
payer, the name of the payee, and the amount of money both in figures and words.
THE DOUBLE ENTRY SYSTEM

• Every transaction affects two

items.

• These effects need to be shown

in the accounting books.

• This is double entry

bookkeeping.
A DOUBLE ENTRY ACCOUNT
HOW RECORDING IN AN ACCOUNT
AFFECTS ITEMS
OR, TO SEE THIS IN THE ACCOUNTS
ACTIVITY
The owner starts the business with £10,000 in cash on 1 August 2012.
ACTIVITY (CONTINUED)

A van is bought for £4,500 in cash on 2 August 2012.

ACTIVITY (CONTINUED)
ACTIVITY (CONTINUED)

Fixtures (e.g. shelves) are bought on credit from Shop Fitters for £1,250 on
3 August 2008.
ACTIVITY (CONTINUED)

Paid the amount owning to Shop Fitters in cash on 17 August 2012.

ACTIVITY (CONTINUED)
Combining all four of these transactions, the accounts now
contain:
ACTIVITY
Activity (Continued)
Activity (Continued)
THE NATURE OF PROFIT OR LOSS
• Profit means the amount by which revenue is greater than expenses for a set of
transactions, where:
• Revenue means the sales value of goods and services that have been supplied to
customers.
• Expenses means the cost value of all the assets that have been used up to obtain
these revenues.
CALCULATING PROFIT

If we supplied goods and services valued for sale at £100,000 to customers, and
the expenses incurred by us in order to supply those goods and services
amounted to £70,000, the result would be a profit of £30,000:
Revenue £100,000
Less expenses (£70,000)
Profit £30,000
THE EFFECT OF PROFIT AND LOSS ON CAPITAL

• The accounting equation we have used is:

Capital (C)= Assets (A)-Liabilities (L)

• When profit has been earned, this increases capital :

Capital + Profit = New Capital

• Or when a loss has been earned, the capital figure decreases:

Old Capital − Loss = New Capital
 RECORDING EXPENSES

In order to calculate profit, expenses must be entered into appropriate accounts. A

separate account is opened for each type of expense:

Bank interest account Subscriptions account Rent account

Overdraft interest Motor expenses Postages
account account account
Audit fees account Telephone account Stationery
account
Insurance account General expenses Wages account
account
DEBIT (DR) OR CREDIT (CR)

• Assets and expenses involve expenditure by the business and are shown as debit
entries because they must ultimately be paid for.

• Revenue is the opposite of expenses and therefore revenue entries appear on the
credit side of the revenue accounts.
DEBIT OR CREDIT (CONTINUED)
DOUBLE ENTRIES FOR EXPENSES
AND REVENUES
Rent of £200 is paid in cash:

Debit the rent account with £200

Credit the cash account with £200
DOUBLE ENTRIES FOR EXPENSES
AND REVENUES (CONTINUED)
Motor expenses of £355 are paid by cheque:

Debit the motor expenses account with £355

Credit the bank account with £355
 DOUBLE ENTRIES FOR EXPENSES
AND REVENUES (CONTINUED)
£60 cash is received for commission
earned by the business:

Debit the cash account with £60

Credit the commissions received account with £60
 ACTIVITY
June 1 – Paid for postage stamps by cash £50
June 2 – Paid for electricity by cheque £229
June 3 – Received rent in cash £138
June 4 – Paid insurance by cheque £142
June 5- Bought goods in credit from supplier £200
June 5- Sold goods in cash £300