Fundamental

Book Cover Here

Accounting
7th edition
Chapter 4: Accounting as a system
Objectives
By the end of this chapter, you should be able to:
• Introduce and apply the recording process in the
accounting system.
• Define the output of accounting in the presentation of
financial statements.
• Introduce the examples of input of accounting.

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Introduction
• The objective of accounting is to provide
information about the business in order to
make the necessary economic decisions.
• Management uses the information to
determine whether the business is performing
as well as expected and whether the financial
position is sound.
• Other users???

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The systems approach to accounting
• The accounting process can only be developed
once the required output is determined, i.e
what the accounting system aims to achieve.
In this way the accounting system is similar to
any system.

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Output: Reports on financial position
and financial performance
• In order to develop a system, we first need to
determine what the system should achieve.
• Two fundamental aspects:
1. To determine the net value of the business
(present financial information).
2. To provide a statement of past profits to predict
future benefits (past financial information)

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1. Present financial information
• Determine what the business entity owns – its assets as
well as who has claims over the asets.
• Record assets on the cost basis.
• Other alternative basis on determining the value of assets:
– Historic cost – the rand value is arrived at by deducting a
proportion i.e depreciation.
– Replacement cost – the cost of replacing the asset at present
time
– Realisable/market value – the amount the assets could be sold
for in the market
– Economic value – adding all future expected profits that the
asset will generate.
– Liquidation value – net disposal value of assets and settlements
(liabilities) when a business is not considered a going concern.

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Present financial information (cont.)
• The historical cost concept is therefore fundamental to
the accounting system being used.
 Who will get claims against the assets of the
business?
 When the business closes down, who will receive the
money?
• Owners vs liabilities. The creditors/liabilities have first
claim on the assets of the business.
• Only after all debt has been paid is the owner entitled
to the remainder of the net assets (money).

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Present financial information (cont.)
• The Statement of Financial Position (S.O.F.P.) is
used as a proper tool to show the present
financial information.
• A financial position is the output that informs
users about the assets held by a business and
the persons who have claims against those.
• It distinguishes between outsiders (liabilities)
and owners, their claim known as owners
equity.

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Statement of financial
position…Example 4.1

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2. Past financial performance
• We need to know how well the business has
performed during the previous year.
• Past performance therefore holds valuable
information for the users.
• The statement of financial performance (i.e
statement of comprehensive income) is a
report on what happened during a specific
period of time.

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Statement of Comprehensive
Income….Example 4.2

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Usefulness of Financial Statements
• From the financial statements, users can obtain more
meaningful information
• E.g Return on investment (equity)
ROE = (Profit for the year/Investment at the
beginning of the year)x 100
= {(E1 000x12 months)/E38 000}x100
=31.6%
• Investors/potential investors can use this to evaluate if
it’s a favourable return considering other alternative
investments
• Other ways to interpret financial information???

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Input: source documents
• Each time a transaction takes place, it is
recorded on a document (storage device).
• It usually includes the following facts:
– The type of transaction
– Details of the other party involved
– The date of the transaction
– The amount of money involved

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Types of source documents
• Receipts – to record cash received in payment of debt.
• Cash sales/register slip – to record cash or cheques
received from sale of goods or service rendered.
• Cheque – to pay amounts owing or to pay goods or
services purchased.
• Invoice – to record goods or services purchased on
credit.
• Debit/credit notes – used by credit customers and
suppliers
• Others????

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The process: the accounting equation
• The data now needs to be transferred into
accounting information.
• It is therefore based on understanding and a
mathematical equation
• Assets = Owner’s equity + Liabilities
• A = OE + L
The equation holds that because a business is not a person and therefore cannot possess
wealth, the assets that the business is using must belong to one of the 2 categories of
either owners or liabilities

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The system

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Adjusting entries
• Apart from the business’ interaction and other
parties (e.g suppliers, customers, receivables),
there are additional entries that do not have
source documents but are necessary to apply the
matching concept.
• They are not interactions with third parties but
are important to incorporate for more accurate
financial records
• E.g unused material purchased, depreciation of
assets, accounting for those credit customers
who may not be able to pay

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Practice exercises
• Go through chapter illustrative example
• Attempt all end of chapter exercises

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 Fundamental
Book Cover Here
Accounting
7th edition
Chapter 5: Fundamentals of the recording
process
Objectives
By the end of this chapter, you should be able to:
• Introduce the second step in the recording process (general
ledger accounts).
• Explain the concept of the general ledger (GL).
• Name the three primary accounts.
• Classify and explain how to enter transactions in the GL.
• Explain how to balance off the GL account.
• Distinguish between mathematical and accounting
concepts.
• Understand how accounting principles link to mathematical
principle.

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Introduction
• This chapter introduces the most frequently used
terminology in the accounting process.
• The general ledger allows us to summarise
accounting data.
• For efficient recording, we need to understand
three conceptual steps:
– The accounting equation and the effect on
transactions (chapter 3&4)
– The general ledger accounts (this chapter and 6)
– Subsidiary journals and how it allows us to cope with
large amounts of data (later chapters)

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The general ledger
• In the prior chapter, mathematical concepts were
used to explain the accounting process.
• The general ledger on the other hand uses the
‘debit’ and the ‘credit’ side (account) to process
an entry.
• Where we used (+)/(-) before, we now say
debit/credit.
• However, the increase or decrease could be on
either the debit or the credit side. This is
dependent on the type of account.
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Three primary accounts
• The primary accounts can be stated as follows:
– Asset accounts
– Owner’s equity accounts
– Liability accounts
• While the accounting terms ‘debit’ and ‘credit’
will be used more frequently, it does not
remove the mathematical element as
introduced in Chapter 3.

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Tips when recording debit and credit
entries
• Assets accounts
– Asset accounts increase on the debit side and decrease on
the credit side.
– However, if the account is a negative asset, the opposite will
apply. This will be further discussed in Chapter 14 (PPE).
• Owner’s equity (OE) accounts
– This represents the owner’s claim against the business.
– In essence, every transaction that increases the owner’s
claim against the business will be credited, whereas
transactions that decrease the owner’s claim, will be debited.
– Example: Expense accounts may increase on the debit side,
but the owner’s claim decreases on the debit side.

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Tips when recording debit and credit
entries (cont.)
• Liability accounts
– Liability accounts decrease on the debit side and
increase on the credit side.
• Importantly, one should not forget the accounting
equation principle which states:
Assets = Owner’s equity + Liabilities
• Now that we are dealing with the general ledger,
we should notice that for every debit, a
corresponding credit exists (double entry
principle).
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Tips when recording debit and credit
entries (cont.)

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Balancing off the general ledger
account
• Balancing accounts:
– Add up the debit side.
– Add up the credit side.
– Find the difference or balancing figure between
the debit and credit side.
– Add the difference to the side with the lower
total. This balance is referred to as the balance
carried down (c/d).

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Balancing off the general ledger
account (cont.)
• Chapter 4 illustrative example

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Practice Questions
• Attempt all end of chapter exercises.

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 Fundamental
Book Cover Here
Accounting
7th edition
Chapter 6: Expanding the set of accounts
Objectives
By the end of this chapter, you should be able to:
• Explain the second step in building up a general
ledger.
• Show how the three basic elements of the
accounting process can be expanded and subdivided
into separate general ledger accounts.
• Demonstrate how to prepare financial statements.

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Introduction
• The main aim of processing accounting data is
to provide information that will be used to
make decisions.
• The two most important types of information
relate to:
– Present financial condition of the business
(statement of financial position)
– Profit or loss made over a period (statement of
profit or loss & other comprehensive income)
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Accounting: a system approach
• Fig 6.1

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Modifying output
• Since accounting aims at providing information
for users decision making, it is important
ascertain whether the acc. system developed
provides the quality & quantity of info. Needed
by users
• In modifying the process, questions like what
information is provided by the process, what
useful information is not provided by the process,
what kind of statements would be most useful
(example of financial statements???)

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Modifying output (cont’.)… examples of
financial statements Fig 6.3

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 Modifying the process
• The previous chapter distinguished between the three
primary accounts.
• This chapter merely takes the three primary accounts
and divides it into the specific types of accounts,
whether it be an asset, owner’s equity or liability
account.
• E.g. The owner opened a bank account in the name of
the business and deposited E50 000.
Questions to ask: what is the effect on the acc.equation?
which (asset, owners equity or liability
increases/decreases? Why?

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Financial reporting
• Prior to drawing up the statement of financial
position and statement comprehensive income
there is need to check if no errors were made in
processing the equation
• A trial balance is prepared from the balances
from the general ledger accounts.
• What is a trial balance?
• The trial balance is a good way of checking if the
double entry has been done correctly and also to
identify any errors or omissions that may not
have been identified.
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Financial reporting (cont.)
• All accounts appearing in the trial balance will be
categorised into nominal accounts and real
accounts.
• Real accounts form part of the statement of
financial position while the nominal accounts
form part of the statement of profit or loss.
• Even though the nominal accounts form part of
the statement of profit or loss, the difference
between income and expenses (profit) will affect
the financial position through the owner’s equity
account.

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Trial Balance…example
Kibo Cleaners Figure
TRIAL BALANCE AS AT 31 MARCH 20x9 6.5
Details Fol. Debit Credit
Real accounts
Bank B2 24 900 00
Equipment B3 11 500 00
Vehicles B4 36 200 00
Accounts receivable B5 3 800 00
Cleaning material inventory B7 600 00
Capital B1 38 000 00
Accounts payable B6 38 000 00
Nominal accounts
Rent expense N1 1 500 00
Cleaning materials expense N2 300 00
Cleaning revenue N3 9 400 00
Wages and salaries N4 5 200 00
Depreciation N5 1 400 00
85 400 00 85 400 00

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Statement of Comprehensive
Income

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Statement of Financial Position

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Analysing the figures
• ROE = (E12 000/E38 000)x100
• = 31.6%
• The proportion of expenses to income?
• (Expenses/Income)x100
• (E8 900/E9 400)x100 = 89.4%
• The proportion of net profit to income?
• (Net profit/expenses)x100
• (E1 000/E8 400)x100 = 11.9%
• The proportion of rent to expenses?
• (Rent/Expenses)x100
• (E1 500/E8 400)x100 = 17.9%
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Recording in subsequent periods
• In cases where the business has been
operating in previous years, there will be
opening balances
• Ledger accounts will have opening balances
before transactions are effected
• I.e. if records are to be made for the month of
April, the closing balances for March will be
the opening baalances

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Practice Exercises
• Go through chapter illustrative example
• Attempt all end of chapter exercises

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 Fundamental
Book Cover Here
Accounting
7th edition
Chapter 7: The general ledger and general
journal
Objectives
By the end of this chapter, you should be able to:
• Complete the final step in preparing a general ledger
(GL).
• Introduce and prepare the general journal (GJ).
• Introduce the additional information recorded in the
general ledger.
• Process closing entries in both the GJ and GL.
• Distinguish between real and nominal accounts.
• Record transactions that the owner has with the
business.
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Introduction
• The accounts we have looked at only had figures
as entries on either the debit or credit side
• As businesses deal with many transactions, there
is need for more information like the date on
which the transactions took place will be needed
• This information is in the source documents but
there will be a need to have a record of such
information
• A general journal may be used to capture all the
information in source documents
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Introduction
• The general journal is a first book of entry
where transaction information is first captured
before it is posted to the general ledger
• The entry in the general journal will state
which account is to be debited or credited as
well as the other information in the source
documents
• The source document can then be filed safely
as evidence that the transaction took place

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Procedure for recording
• Recording:
– Obtain source document.
– Ask questions about the effect (=/-) the
transactions have on the accounting model.
– Prepare the journal entry in the general journal.
• The general journal merely provides more
information for reference purposes than
would have been provided by the general
ledger.

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Example: General journal
• Transaction
Kibo Cleaners opened a bank account and
deposited E38 000 (source document: original
deposit slip)

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General ledger
• After recording in the general journal, the details
need to be recorded in the general ledger (as
accounts).
• This is know as posting from general journal to
general ledger.
• Because the accounting process was followed in
recording in the general journal, the posting in
the general ledger becomes much simpler.
• Separate real from nominal accounts, posting real
accounts first and nominal accounts later.
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Posting to the general
ledger….example

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Flow of data

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Closing entries
• After balancing nominal accounts or accounts related
to profit or loss, a new account will be opened.
• This account is referred to as the profit and loss
account, which is also a nominal account that all
balances of norminal accounts are collected together
• The balance of this account will be the profit or loss
• Simply stated, this account is like a statement of
comprehensive income that shows expenses on the
debit side and income on the credit side.
• So all nominal accounts will be closed off to the profit
and loss account instead of balancing them up using
balance b/d and balance c/d

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Closing entries
• Journal entries are done to close off all
nominal accounts to the profit and loss
account
All expenses:
Dr - profit and loss account
Cr - expense account
Check Fig7.6; Fig7.7; Fig7.8

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Transactions between the owner
and the business
• After the initial capital investment, the owner
often has different interactions with the business.
• Some of it may relate to a withdrawal of cash or
even items for personal use.
• These items should be recorded in a drawings
account.
• A drawings account is used for withdrawals from
the owner, rather than debiting the capital
account.
• Example 7.1

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Summary

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Practice Exercises
• Go through chapter illustrative example
• Attempt all end of chapter exercises

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