DAC 100 - Fundamental of Accounting Notes

ST.
PAUL’ S UNIVERSITY
DAC I: FUNDAMENTALS OF ACCOUNTING I
COURSE INSTUCTURE’S NAME: JOHN KIARIE
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SPU Distance & e - Learning Program
© 2012
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© Module Author’s : JOHN KIARIE]
CONTACT INFORMATION
John Kiarie. Ass Dean of Students/PHD Candidate]

0727-496213 and hours of availability:Tue to Frid from 2-4pm]
jkiarie@spu.ac.ke]
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TABLE OF CONTENTS
CHAPTER ONE: FINANCIAL ACCOUNTING ------------------------------------------------------------------------------------- 1
1.1 INTRODUCTION AND OVERVIEW -------------------------------------------------------------------------------------------------- 1

1.2 LEARNING OUTCOMES ------------------------------------------------------------------------------------------------------------ 1
1.3 DEFINITION OF ACCOUNTING---------------------------------------------------------------------------------------------------- 1
1.3.1 ACCOUNTING CYCLE ----------------------------------------------------------------------------------------------------------- 1
1.4 CONCEPTUAL FRAMEWORK OF ACCOUNTING ----------------------------------------------------------------------------------- 2
1.4.1: CHARACTERISTICS OF ACCOUNTING INFORMATION -------------------------------------------------------------------------- 2
1.4.2 BASIC ACCOUNTING ASSUMPTIONS AND PRINCIPLES ------------------------------------------------------------------------- 4
1.4.3: ACCOUNTING PRINCIPLES ----------------------------------------------------------------------------------------------------- 4
1.4.4: THE CONSTRAINTS (LIMITATIONS) ------------------------------------------------------------------------------------------- 5
1.5 ROLE OF ACCOUNTING IN BUSINESS -------------------------------------------------------------------------------------------- 6
1.6 NEEDS FOR ACCOUNTING RECORDS --------------------------------------------------------------------------------------------- 7
1.7 USERS OF ACCOUNTING INFORMATION ------------------------------------------------------------------------------------------ 8
1.7.1 MANAGERS --------------------------------------------------------------------------------------------------------------------- 8
1.7.2 OTHER USERS OF FINANCIAL INFORMATION ---------------------------------------------------------------------------------- 8
1.8 KEY TERMS USED IN ACCOUNTING --------------------------------------------------------------------------------------------- 9
1.9 ACCOUNTING STANDARDS ------------------------------------------------------------------------------------------------------- 9
1.9.1 MAINTAINING CONFIDENCE IN THE ACCURACY OF ACCOUNTING INFORMATION -------------------------------------------- 9
1.9.1.1 FREE FROM MATERIAL ERRORS -------------------------------------------------------------------------------------------- 10
1.9.1.2 THE ACCOUNTING STANDARDS BOARD ----------------------------------------------------------------------------------- 10
1.9.1.3 THE INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB) -------------------------------------------------------- 11
1.9 SUMMARY OF THE TOPIC ------------------------------------------------------------------------------------------------------- 11
1.10 REVIEW QUESTIONS ---------------------------------------------------------------------------------------------------------- 12
CHAPTER TWO: BUSINESS TRANSACTIONS AND BOOK KEEPING EQUATION ------------------------------------- 13
2.1 INTRODUCTION AND OVERVIEW ----------------------------------------------------------------------------------------------- 13

2.2 LEARNING OUTCOMES ---------------------------------------------------------------------------------------------------------- 13
2.3 DEFINITION OF TRANSACTION -------------------------------------------------------------------------------------------------- 13
2.4 CLASSIFICATIONS OF BUSINESS TRANSACTIONS ------------------------------------------------------------------------------- 14
2.5 BASIC ACCOUNTING TERMS ----------------------------------------------------------------------------------------------------- 14
2.5.1 ASSETS AND LIABILITIES------------------------------------------------------------------------------------------------------- 14
2.5.1.1 ASSETS ---------------------------------------------------------------------------------------------------------------------- 14
2.5.2 LIABILITY----------------------------------------------------------------------------------------------------------------------- 16
2.5.2.1 CLASSIFICATION OF ACCOUNTING LIABILITIES ----------------------------------------------------------------------------- 17
2.5.3 OWNER’S EQUITY ------------------------------------------------------------------------------------------------------------ 17
2.6 ACCOUNTING EQUATION ------------------------------------------------------------------------------------------------------ 18
2.7 UNDERSTANDING BALANCE SHEET -------------------------------------------------------------------------------------------- 20
2.7.1 BALANCE SHEET STRUCTURE ------------------------------------------------------------------------------------------------- 20
2.7.2 ILLUSTRATION OF A SIMPLE BALANCE SHEET -------------------------------------------------------------------------------- 21
2.7.2 EFFECT OF TRANSACTIONS ON BALANCE SHEET --------------------------------------------------------------------------- 22
2.9 REVIEW QUESTIONS------------------------------------------------------------------------------------------------------------- 25
CHAPTER THREE: BOOKS OF ORIGINAL ENTRY----------------------------------------------------------------------------- 26
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3.3 BOOKS OF ORIGINAL ENTRY OR JOURNALS ------------------------------------------------------------------------------------- 26
CHAPTER FOUR: CASH BOOK --------------------------------------------------------------------------------------------------- 41

4.2 LEARNING OUTCOMES --------------------------------------------------------------------------------------------------------- 41
4.3 DEFINITION OF CASH BOOK ----------------------------------------------------------------------------------------------------- 41
4.4 TWO-COLUMN CASHBOOK ----------------------------------------------------------------------------------------------------- 42
4.5 THE THREE COLUMN CASH BOOK ---------------------------------------------------------------------------------------------- 43
4.4 THE ANALYTICAL PETTY CASH BOOK ----------------------------------------------------------------------------------------------- 45
4.5 THE IMPREST SYSTEM ---------------------------------------------------------------------------------------------------------- 46
4.6 SUMMARY OF THE TOPIC ----------------------------------------------------------------------------------------------------------- 48
4.7 REVISION QUESTIONS ---------------------------------------------------------------------------------------------------------- 49
CHAPTER FIVE: LEDGER ACCOUNTS ------------------------------------------------------------------------------------------- 50
5.1 INTRODUCTION AND OVERVIEW ------------------------------------------------------------------------------------------------ 50

5.3 LEDGER -------------------------------------------------------------------------------------------------------------------------- 50
5.4 THE CONCEPT OF DOUBLE ENTRY --------------------------------------------------------------------------------------------- 52
5.4.1 ACCOUNT AND DOUBLE ENTRY ----------------------------------------------------------------------------------------------- 53
5.4.2 DOUBLE EFFECT OF TRANSACTION ------------------------------------------------------------------------------------------- 54
5.4.3 SUMMARY OF DOUBLE ENTRY CONCEPT ------------------------------------------------------------------------------------ 56
5.5 RULES OF DEBIT & CREDIT ---------------------------------------------------------------------------------------------------- 57
5.5.1 PURCHASES ------------------------------------------------------------------------------------------------------------------- 57
5.5.2 INCOMES --------------------------------------------------------------------------------------------------------------------- 58
5.5.3 EXPENSES --------------------------------------------------------------------------------------------------------------------- 58
5.5.4 RETURNS INWARDS AND RETURNS OUTWARDS----------------------------------------------------------------------------- 59
CHAPTER SIX: TRIAL BALANCE -------------------------------------------------------------------------------------------------- 63
6.1 INTRODUCTION AND OVERVIEW ------------------------------------------------------------------------------------------------ 63

6.3 TRIAL BALANCE ------------------------------------------------------------------------------------------------------------------ 63
6.4 PURPOSE OF A TRIAL BALANCE ------------------------------------------------------------------------------------------------- 63
6.5 PROCEDURE OF PREPARING A TRIAL BALANCE -------------------------------------------------------------------------------- 64
6.6 BALANCING THE ACCOUNTS AND EXTRACTING A TRIAL BALANCE ------------------------------------------------------------ 64
6.7 TRIAL BALANCE ERRORS -------------------------------------------------------------------------------------------------------- 67
6.8 SUSPENSE ACCOUNT ------------------------------------------------------------------------------------------------------------ 68
6.9 SUMMARY ----------------------------------------------------------------------------------------------------------------------- 69
6.10 --------------------------------------------------------------------------------------------------------------------------- R
EVIEW QUESTIONS -------------------------------------------------------------------------------------------------------------- 70
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CHAPTER SEVEN: FINAL ACCOUNTS ------------------------------------------------------------------------------------------- 71

7.3 TRADING PROFIT AND LOSS ACCOUNT/INCOME STATEMENT --------------------------------------------------------------- 72
7.3.1 THE GROSS PROFIT ---------------------------------------------------------------------------------------------------------- 72
7.3.2 THE NET PROFIT ------------------------------------------------------------------------------------------------------------- 72
7.3.3 OTHER CONSIDERATIONS ----------------------------------------------------------------------------------------------------- 73
7.3 EFFECTS OF CREDIT OR LOSS ON CAPITAL ------------------------------------------------------------------------------------- 74
7.4 EFFECTS OF PROFIT OR LOSS ON CAPITAL -------------------------------------------------------------------------------------- 74
7.5 DRAWINGS ---------------------------------------------------------------------------------------------------------------------- 75
7.6 REVENUE AND DOUBLE ENTRY ------------------------------------------------------------------------------------------------- 76
7.7 BALANCE SHEET ----------------------------------------------------------------------------------------------------------------- 76
7.8 SUMMARY OF THE TOPIC ----------------------------------------------------------------------------------------------------------- 80
CHAPTER EIGHT: ADJUSTING ENTRIES --------------------------------------------------------------------------------------- 83
8.1 INTRODUCTION AND OVERVIEW OF YEAR END ADJUSTMENT ENTRIES------------------------------------------------------- 83

8.3 FUNDAMENTAL ACCOUNTING CONCEPTS -------------------------------------------------------------------------------------- 83
8.4 ACCRUALS AND PREPAYMENTS ------------------------------------------------------------------------------------------------- 84
8.5 BAD AND DOUBTFUL DEBTS --------------------------------------------------------------------------------------------------- 85
8.5.1 CALCULATION OF PROVISION FOR BAD AND DOUBTFUL DEBTS ------------------------------------------------------------ 86
8.5.2 ACCOUNTING FOR BAD & DOUBTFUL DEBTS ------------------------------------------------------------------------------- 86
8.5.3 BAD DEBTS RECOVERED----------------------------------------------------------------------------------------------------- 88
8.5 PROVISION FOR DISCOUNTS ALLOWABLE ---------------------------------------------------------------------------------------- 89
8.6 PROVISION FOR DISCOUNT RECEIVED ------------------------------------------------------------------------------------------ 90
8.6 DEPRECIATION OF FIXED ASSETS ACCOUNTS --------------------------------------------------------------------------------- 93
8.6.1 PROVISION FOR DEPRECIATION ---------------------------------------------------------------------------------------------- 95
8.8 REVIEW QUESTIONS ------------------------------------------------------------------------------------------------------------ 98
CHAPTER NINE: CONTROL ACCOUNTS ------------------------------------------------------------------------------------- 100
9.1 INTRODUCTION AND OVERVIEW --------------------------------------------------------------------------------------------- 100

9.2 LEARNING OUTCOMES -------------------------------------------------------------------------------------------------------- 100
9.3 CONTROL ACCOUNTS -------------------------------------------------------------------------------------------------------- 100
9.3.1 SALES LEDGER CONTROL ACCOUNT --------------------------------------------------------------------------------------- 101
9.3.2 PURCHASES LEDGER CONTROL ACCOUNT -------------------------------------------------------------------------------- 102
9.4 PURPOSE OF CONTROL ACCOUNTS------------------------------------------------------------------------------------------ 103
9.5 SUMMARY OF THE TOPIC --------------------------------------------------------------------------------------------------------- 104
9.6 REVIEW QUESTIONS ---------------------------------------------------------------------------------------------------------- 105
CHAPTER TEN : BANK RECONCILIATION STATEMENT ------------------------------------------------------------------ 106
10.1 INTRODUCTION AND OVERVIEW ------------------------------------------------------------------------------------------- 106

10.2 LEARNING OUTCOMES ------------------------------------------------------------------------------------------------------ 106
10.3 DEFINITION OF BANK RECONCILIATION STATEMENT----------------------------------------------------------------------- 106
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10.2.1 FACTORS CONTRIBUTING TO THESE DIFFERENCES ARE ------------------------------------------------------------------ 107
10.3 PROCEDURE OF BANK RECONCILIATION STATEMENT --------------------------------------------------------------------- 108
10.3.1 STEPS INVOLVED IN PREPARATION OF THE BANK RECONCILIATION STATEMENT --------------------------------------- 108
10.4 SUMMARY OF BANK RECONCILIATION PROCEDURE ----------------------------------------------------------------------- 110
10.4.1 ERRORS OF THE BANK STATEMENT (MADE BY THE BANK) ------------------------------------------------------------ 111
10.5 THE PURPOSES OF A BANK RECONCILIATION STATEMENT ------------------------------------------------------------------- 111
10.6 SUMMARY OF THE TOPIC------------------------------------------------------------------------------------------------------- 111
10.7 REVIEW QUESTIONS ---------------------------------------------------------------------------------------------------- 112
CHAPTER ELEVEN: COMPANY ACCOUNTS -------------------------------------------------------------------------------- 113
11.1 INTRODUCTION AND OVERVIEW OF THE CHAPTER ------------------------------------------------------------------------- 113

11.2 LEARNING OUTCOMES ----------------------------------------------------------------------------------------------------- 113
11.3 DEFINITION OF COMPANY ACCOUNTS -------------------------------------------------------------------------------------- 113
11.4 FORMATION OF A COMPANY------------------------------------------------------------------------------------------------ 114
11.4.1 MEMORANDUM OF ASSOCIATION -------------------------------------------------------------------------------------- 114
11.4.2 ARTICLE OF ASSOCIATION ----------------------------------------------------------------------------------------------- 114
11.4 TYPES OF SHARES ----------------------------------------------------------------------------------------------------------- 115
11.4.1 ORDINARY SHARES ------------------------------------------------------------------------------------------------------- 115
11.4.2 PREFERENCE SHARES ----------------------------------------------------------------------------------------------------- 115
11.5 CLASSES OF SHARE CAPITAL ----------------------------------------------------------------------------------------------- 116
11.5.1 TERMS OF ISSUE OF SHARES ---------------------------------------------------------------------------------------------- 116
11.5.2 DEBENTURES ------------------------------------------------------------------------------------------------------------- 117
11.6 FORMAT OF COMPANY FINAL ACCOUNTS--------------------------------------------------------------------------------- 118
11.7 DIVIDENDS ------------------------------------------------------------------------------------------------------------------ 122
11.8 CAPITAL RESERVES----------------------------------------------------------------------------------------------------------- 123
11.9 REVENUE RESERVES--------------------------------------------------------------------------------------------------------- 124
11.10 BONUS SHARES------------------------------------------------------------------------------------------------------------ 124
11. 11 RIGHTS ISSUE -------------------------------------------------------------------------------------------------------------- 124
11.12 BENEFITS OF A LIMITED COMPANY --------------------------------------------------------------------------------------- 129
11.13 SUMMARY OF THE TOPIC ------------------------------------------------------------------------------------------------- 130
11.14 REVIEW QUESTIONS------------------------------------------------------------------------------------------------------- 131
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FINANCIAL ACCOUNTING
Introduction and Overview
Accounting is a system meant for measuring business activities, processing of

information into reports and making the findings available to decision-makers. The
documents, which communicate these findings about the performance of an organization
in monetary terms, are called financial statements. Accounting is referred to as the
language of the business. However, a business may have a lot of aspects which may not
be of financial nature. The better the understanding of the language, the better is the
management of financial aspects of living.
Many aspects of our lives are based on accounting, personal financial planning,
investments, income-tax, loans, etc. We have different roles to perform in life-the role of
a student, of a family head, of a manager, of an investor, etc. The knowledge of
accounting is an added advantage in performing different roles. However, we shall limit
our scope of discussion to a business organization and the various financial aspects of
such an organization. When we focus our thoughts on a business organization, many
questions may arise such as: is our business profitable? Should a new product line be
introduced? Are the sales sufficient? etc. strike our mind. To answer questions of such
nature, we need to have information generated through the accounting process. The
people who take policy decisions and frame business plans use such information.
All business organizations work in an ever-changing dynamic environment. Any new

programme of the organization or of its competitor will affect the business. Accounting
serves as an effective tool for measuring the financial pulse rate of the company. It is a
continuous cycle of measurement of results and reporting of results to decision makers.
Just like arithmetic is a procedural element of mathematics, book keeping is the
procedural element of accounting
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Purpose of the course
The purpose of accounting is to provide the information that is needed for sound
economic decision making. The main purpose of financial accounting is to prepare
financial reports that provide information about a firm‘s performance to both internal
parties and external parties, such as creditors, investors, employees etc. Financial
accounting is performed according to Generally Acceptable Accounting Principles
(GAAP) guidelines.
Instructional Goals:
By the end of this course, the learner should be able to:

a. Prepare accounting records systematically
b. To maintain control of business properties
c. Ascertain the results of operations during a period
d. Ascertain the financial position of a business enterprise.
e. Providing information to tax authorities and other government agencies.
f. To properly match income with expenses.
g. To provide a reliable set of data with which to prepare financial reports for
analysis purposes (for owners, lenders, investors, etc).
h. To provide a reliable set of data with which to report income for tax purposes.
In this Unit, the course will cover: the meaning of accounting, transaction and their
effects on balance sheet, Ledger accounts, Trial balance, trading, profits and loss
accounts, adjustment of final accounts, control accounts, bank reconciliation
statement and company accounts
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Course outcomes:
At the end of this course, the learner should be able to:

(i) Use accounting and business terminology, and understand the nature and purpose
of generally accepted accounting principles (GAAP).
(ii) Explain the objective of financial reporting, the elements of the financial
statements, and the related key accounting assumptions and principles.
(iii) Define and distinguish between cash basis and accrual basis accounting and the
impact of each on the financial statements.
(iv) Recognize the information conveyed in each of the four basic financial statements
and the way it is used by investors, creditors, regulators, and managers.
(v) Identify and illustrate how internal controls are used to manage and control the
firm‘s resources and risk.
(vi) Explain the nature of current assets including the measuring and reporting of
items such as short-term investments, receivables and bad debts, inventory and
costs of goods sold, and prepaid expenses.
(vii) Explain the valuation and reporting of current liabilities, estimated liabilities, and
contingencies.
(viii) Identify and illustrate issues relating to the acquisition, use, depreciation, and
disposal of long-lived assets.
Required Background: To successfully complete this course you must [Insert bulleted
prerequisite skills, know, able to. understand...instruction or information.
Required Materials: To successfully complete this course, you will need [Insert bulleted
list of required reading materials, including textbook name and authors, technology
accessible & availability]. Additional Print Resources [Insert bulleted list of helpful
books, journal articles etc]. Online resources [Insert bulleted list of helpful Web sites]
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COURSE OUTLINE:
Week Topics Subtopics Reference Assessment
1 -2 Benedict. A & Elliott. Refer page

Introduction  Definition of financial B (2008).Financial 12
Financial accounting. Accounting
accounting  Needs for accounting
 Users of financial accounting
 Accounting standards
3 Transactions  Definition of transaction Kimmel.D.P,Weyganl Refer pg 25

and  Accounting terms .J &Kisoi.D.E(2010)
bookkeeping  Effects of transactions on Financial Accounting.
equation assets, liabilities and capital Cengage Learning.
4 Books of  Definition of books of original Benedict. A & Elliott. Refer pg 38

original entries entry B (2008).Financial
 Types of books of original entry Accounting
4 Cash book  Definition of a cash book Nasee CAT 1-refer
 Two-column cashbook Ahmed,(2008).Finan pg 12 no.3,pg
 Three column cash book cial Accounting 25
 Petty cash book Simplified.Atlantic no.2,pg38.no.
 Imprest system Publisher.New D 1 and pg47 no
 Balancing off the cash books 3
5 Ledger  Definition of accounts Kimmel.D.P,Weyganl Refer pg 47
accounts  Format of accounts .J &Kisoi.D.E(2010)
 Recording transactions on Financial Accounting.
ledger accounts Cengage Learning.
 Double entry system
6 Trial balance  Definition of trial balance Benedict. A & Elliott. Refer pg 59
 Preparation of a trial balance B (2008).Financial &60
 Errors affecting a trial balance Accounting
7 Final accounts  Preparation of final accounts: Kimmel.D.P,Weyganl Refer pg 68
financial statement and .J &Kisoi.D.E(2010)
Statement of affairs Financial Accounting.
Cengage Learning.
8  Adjustment for depreciation, Benedict. A & Elliott. Refer pg 96
Adjustment for provision for doubtful debts, B (2008).Financial &80
final accounts accrual and prepayments Accounting
9 Control  Uses of control accounts ‘ Benedict. A & Refer pg 103
Accounts  Debtors control account Elliott. B
 Creditors control accounts (2008).Financial
Accounting
10 Bank  Definition  CAT 2.Refer
reconciliation  Causes for differences between pg80 no.3,pg
statements cash book and bank statement 96 no.2
&pg103 no.2
11 Company  Introduction Benedict. A & Elliott. Refer pages
Accounts  Final accounts for company B (2008).Financial 129 &130
accounts Accounting
12 Final Exam wk  Final Exam week Final Exam week
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CHAPTER ONE: FINANCIAL ACCOUNTING
1.1 Introduction and Overview
In this topic, it covers the meaning of financial accounting, needs for accounting, users of financial
account and accounting standards and principles.
1.2 Learning Outcomes
At the end of the topic, the learner should be able to:
a. Explain what is financial accounting

b. Explain why business keeps accounting records
c. Describe the need of accounting information
d. Explain what International Accounting and Financial Reporting Standards are
1.3 Definition of Accounting
Accounting is the process of collecting, recording, summarizing, interpreting and communicating

financial information to permit informed decisions. Accounts are records in which financial
information is contained. Accounting is a process which involves the art of recording, classifying
and summarizing in a significant manner and in terms of funds, transactions, and events, which
are, in part at least, of financial character and interpreting the results thereof. All organizations
require written records which the management uses for day-day actions, decision making and
setting up procedures and relationships with other organizations and individuals. Money matters
of the business are one of the most important aspects of records.
1.2.1 Accounting Cycle
The process of accounting involves records drawn at successive stages and typically involves
four levels as follows.
Transaction Journal Ledgers Financial

documents book Statements
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1.3 Conceptual Framework of Accounting
Recognition of measurement concepts

How
Assumptions principles constraints
Characteristic Elements of
s of account Accounting or Bridge
information Financial statements
Why of accounting
Objectives
The main objective of accounting is to provide useful and sufficient information to meet the
needs of various users at the lowest possible cost.
1.3.1: Characteristics of Accounting Information
They can be grouped into two categories;

a) Primary characteristics
b) Secondary characteristics
A. Primary Characteristics
They are two characteristics for accounting information to be useful.
(i) Relevance
(ii) Reliability
(i) Relevance
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For accounting information to be relevant;
a) It must be able capable of making a difference in decision making e.g. a shareholder
needs to be able to decide whether to sell or buy more shares.
b) Relevant information has a predictive value, i.e. it should help users predict the ultimate
outcome of present, past and future events.
c) Relevant information helps users confirm or correct their prior expectation i.e. it has to
have a feedback value.
d) Relevant information should be available to decision makers before it loses is capacity to
influence their decision i.e. it has to be timely.
(ii) Reliability
a) Verifiable: verifiability occurs when independent measures using the same methods
yields similar results i.e. it allows for information to be comparable.
b) Representation fairness: the numbers and descriptions in the financial statement should
match what really happens or existed e.g. inventory and assets on the balance sheet
should reflect the value and the actual presence of these assets.
c) Unbiased or neutral information: the selected information to be reported on financial
statement should not favour one set of interested parties over the other e.g. a tobacco
company, suppressing or failing to disclose information about law suits.
B. Secondary Characteristics
(i) Comparability:
Information that has been measured and reported in a similar manner for different
enterprises is considered to be comparable e.g. when companies use the same
depreciation methods, or some inventory valuation methods.
(ii) Consistency
When a company applies the same accounting treatments to similar events from
period to period, the company is said to show consistency in the use of accounting
standards.
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1.3.2 Basic Accounting Assumptions and Principles
There are four basic accounting assumptions
1. Economic Entity Assumption
The activities of an accounting entity should be kept separate and distinct from its owners and
any other accounting entities. NB: The entity assumption does not necessarily refer to a legal
entity.
2. The going concern assumption
Assume that the business will continue long enough to recover the cost of its assets.
3. The monetary assumption
It states that only those transactions capable of being expressed in terms of money should be
included in the accounting records of an entity i.e. it assumes that transactions and events can be
measured in terms of a common denominator i.e. the unit of money.
4. Periodicity assumption
Assumes that the economic life of a business can be divided into artificial time periods e.g. the
business life can be divided into quarters, months or into an annual period.
1.3.3: Accounting Principles
(a) Historical Cost Principle
It states that assets should be recorded at the acquisition costs. In addition the cost of an asset
should include all the cost necessary to acquire the item and to get it in place and condition for
its intended use.
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(b) Revenue Recognition Principle
It states that revenue should be recognized (recorded) when
(i) It is realized or realizable

(ii) It is earned.
(c) ) The matching principle
It requires that expenses should be recognized in the same period as the related revenue is
recognized.
(d) The full disclosure principle
It states that circumstances and events that make a difference to decision making should be
disclosed to the interested users. The notes to the financial statements should explain or give
additional information to the items presented in the body of the statements.
1.3.4: The Constraints (Limitations)
1. Cost-benefit Relationship
It states that the cost of providing information must be weighed against the benefits that can be
derailed for using the information when the perceived cost exceeds the perceived benefits a
measurement or a disclosure may be foregone because it is not practical.
2. Materiality constrain
It states that an immaterial or less significant item need not be given strict accounting treatment.
3. Conservation constrain
When in doubt or uncertain, the accountant should choose the option or the solution that will not
over state the assets or the income of the company.
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1.4 Role of Accounting in Business
1. Record-keeping. One of the main functions of accounting is to record business

transactions, such as sales and expenses. Record-keeping is also known as bookkeeping,
which is a specific way to capture and organize data. If a business does not capture
proper business data, it cannot effectively use an accounting system. Many times sales
and other data are presented in paper form, which is manually entered and recorded in an
account system.
2. Classification. Business transactions are classified in a systematic way. A sale could be
classified as income and a paid bill could be classified as expense. They are not all
bunched together in a listing; they must be classified to make sense. Consistency in
classification is a must. For example, if you paid rent in March, when you pay rent again
in April, the amount should be classified the same way as the one in March.
3. Summarizing. After data are recorded and classified, the next step is to summarize them
in reports or queries. Summarizing accounting data in reports is called "compilation" and
accounting software helps this process immensely. If you want to know if you have had a
profit or a loss last month, you look at a "profit and loss statement,‖ which summarizes
all transactions for that month. You will not see all transactions that make up the rent
expense, for instance, you will see only one line item summarizing and adding up all rent
expense transactions for that month.
4. Analysis and Interprets: This is the final function of accounting. The recorded financial
data is analyzed and interpreted in a manner that the end-users can make a meaningful
judgment about the financial condition and profitability of the business operations. The
data is also used for preparing the future plan and framing of policies for executing such
plans.
5. Communicate: The accounting information after being meaningfully analyzed and
interpreted has to be communicated in a proper form and manner to the proper person.
This is done through preparation and distribution of accounting reports, which include
besides the usual income statement and the balance sheet, additional information in the
form of accounting ratios, graphs, diagrams, funds flow statements etc.
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6. Ascertainment of profit and loss. This requires accurate and complete recording of all
business transaction as this information is used to find out if the business is making profit
or losses. A business cannot survive in the long run without making reasonable profit.
7. To facilitate the credit transaction. Sometimes business transaction is carried on credit
on the basis of promise to make payment in future. If goods are bought such supplies on
credit basis, the supplier is regarded to as creditor. On the other hand, if goods are sold on
credit, then the buyer is regarded as debtor. Accounting records facilitates such credit
transactions as the record helps in determining the amount due to creditors and due from
debtors.
8. Others
Evaluating of asset and liabilities
Base for further planning
A tool for counting
1.5 Needs for accounting records
There are many reasons depending on the nature of the business i.e. sole proprietor, partnership
or a company. This includes;
i. To prevent cash and other items owned e.g. properties, vehicle, stock etc from being
stolen or improperly used.
ii. To monitor the cash available to the business, checking whether the amount available is
sufficient to pay bills as they fall due.
iii. To keep checking whether the business is doing well i.e. if there is sufficient reasons for
continuing to carry on the business.
iv. To satisfy the tax inspector
v. To know how much to pay to creditors and receive from debtors
vi. For partnership business, accurate accounts are essential to avoid dispute and possible
litigation.
vii. For company, it is a legal requirement for the directors to keep proper accounting records
and to report financial information to those who have invested their cash in the company.
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1.6 Users of Accounting Information
1.6.1 Managers
Managers within the business require accounting information to:-

i. Ensure that business resources (including cash) are protected and applied in the best
manner possible.
ii. Plan the business activities with the resources available.
iii. Establish target such as how much they hope to earn and the amount of exposure they are
likely to incur.
iv. Control cash, a task which is essential for survival in a competitive market.
v. Establish business strategies on day to day basis and for this reason requires accounting
information tailored to meet specific needs.
1.6.2 Other Users of Financial Information
i. Banks and creditors need to assess the ability of the business to pay what is due to them.
These groups also include suppliers who are yet to be paid for the goods supplied on
credit.
ii. Employees of the business; they are interested in whether thy are being paid fairly and
also want to assess whether the business will survive and continue to provide
employment and pension benefits.
iii. The government and its agencies need the information for collecting appropriate taxes
and for regulating the activities of the business in the interest of the whole community.
iv. The public: both the customers are interested in the continuation of the goods & services,
that the business supplies and as penetrated investors.
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1.7 Key Terms used in Accounting
Accounting: process of identifying, measuring and communicating economic information to

permit informed judgments and decisions.
Bookkeeping: routine records from daily transactions in a prescribed form and according to set
rules, of all events, which affect the financial state of a business.
Accounting system: an arithmetic model of the organization‘s financial state at a given point in
time and designed to register change in that state over time.
Accounting equation: an arithmetic formula used to prepare a balance sheet based on the logic,
Asset- liabilities= owner‘s equity
Accounting policy: the principles, bases, conventions, rules and practices applied by an entity
that specifies how the effects of transactions and other events are to be presented in its financial
statements.
Accounting postulates: Fundamental ideas upon which the whole intellectual structure of
accounting discipline rest, and are not susceptible to proof within the framework thereof.
Accounting principles: fundamental ideas and assumptions that guide the preparation of
accounting information and therefore underlie the construction of financial statements.
1.8 Accounting Standards
In an ideal world, a business would prepare different financial statements to meet the needs of
each user group. In real life, this would be costly and time consuming, hence need for
compromise.
The compromise adopted by the accounting profession is to accept that there is a sufficient
overlap in the information requirements of the different user groups and therefore make the
financial statements prepared for the investors reasonably suitable for the other groups.
1.8.1 Maintaining confidence in the accuracy of accounting information
Investors, lenders and suppliers do not have access to the records of the business. They make
their decisions based on information provided by the business. It is essential if they are to
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continue to be available to invest and make credit available, that they should have confidence
that the accounting information provided to them is:-
i. Free from material errors.

ii. Treat similar transactions in the same way.
iii. Complies with statutory requirements
1.8.1.1 Free from material errors
It can be too expensive to require all information to be 100% accurate, as it requires every detail
to be cross checked. However emphasis is on the information being free from material errors.
What checks is there that information is free from material error.
Sole proprietor and partnership are assumed to be too close to their business and hence know
what is happening. However, for limited companies, where the owners do not manage the
business, there is a statutory requirement for the record and financial statement to be audited by
an independent qualified auditor. Similar transactions treated in same way by all companies.
It is important that managers and directors are not allowed to manipulate the way in which
information is reported in the financial statements to tell a favorable but unfair story.
For shareholders in limited companies it‘s achieved by companies being required to prepare
financial statement that are in line with Financial Reporting Standards (FRSs)
Statement of Standard Accounting Practice (SSAPs) and Financial Reporting Standards (FRSs)
are issued in the UK by the Accounting Standards Board and for companies that apply
international financial reporting standards; these are issued by the International Accounting
Standard Board.
1.8.1.2 The Accounting Standards Board
In 1970, the accounting standards committee was formed in UK with responsibility for
developing accounting standard. The standard which were issued are known as Statements of
Standards Accounting Practice (SSAPs)
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Since 1990, their responsibility has been taken over by the Accounting Standards Board (ASB)
and the standards which the ASB issues are known as Financial Reporting Standards (FRSs).
Accounting standards are authoritative statements of how particular types of transactions and
other events should be reflected in financial statements and accordingly compliance with
accounting standards will normally be necessary for financial statements to give a true and fair
view.
1.8.1.3 The International Accounting Standards Board (IASB)
Internationally, there has been a growing trend, towards the globalization of trade and the
movement of investment across national boundaries. This has meant that there is a need for all
countries to apply the same accounting treatment if accounting information is to be compared.
Complying with statutory requirement

Each country has its own statutory requirement, for example, Company Act, 2006 in UK which
requires to keep accounting records, publish financial statement and when necessary to appoint
auditors to check these records and financial statements.
1.9 Summary of the Topic
Financial accounting involves recording business transactions and preparations of financial

statement.
Book keeping is the process of classifying transactions and recording them in a systematic
manner.
Accounting is the process of preparing and explaining financial statements
Two of the financial statements are balance sheet and an income statement may not be 100%
accurate but, as they are relied on by the owners of a business and other interested parties, need
to be free from material error. The ASB and IASB are enjoyed in continuous effort to ensure that
continuous effects to ensure that financial statement are comparable by issuing financial
reporting standard and International Financial Reporting Standard.
11
Refrences
1. Benedict. A & Elliott. B (2008).Financial Accounting.Cengage Learning
2. Kimmel.D.P,Weygan.J $ Kisoi.D.E. (2010).Financial Accounting.Cengage Learning
3. Frankwood (2009) financial accounting for business decision. Prentice l.UK
1.10 Reflection Questions
1. Using practical EXAMPLES demonstrate the purpose and the usage of accounting
information:
a) By shareholders
b) By creditors
2. Explain the limitations of accounting information?
3. Who are the users of accounting information and which accounting reports do they
normally use?
4. Discuss some of the conflicts of interest that arises between prepares users and the
accounting professions?
12
CHAPTER TWO: BUSINESS TRANSACTIONS AND BOOK KEEPING EQUATION
This topic covers the meaning of a business transaction, book keeping, defines an accounting
equation, the basic accounting terms. It helps the learner understanding the balance sheet and the
effect of business transactions on the balance sheet.
At the end of this topic, the learner should be able to:
a) Define a business transaction and bookkeeping equation.

b) Understand the basic accounting terms and their classifications
c) Prepare a balance sheet.
d) Show the effects of business transactions on the balance sheet.
2.3 Definition of Transaction
A transaction is an exchange of value between the business and another entity. Transactions
include such events such as sales, purchases and payment of salaries and wages. The evidence of
the transaction is usually supported by a source document. A source document is any written or
printed evidence of a business transaction. Source documents are also known as transaction
documents and includes the following:
 Cash receipt-used for recording all cash received
 Invoice-used for recording all purchases
 Goods received notes
 Cheque
 Salary slip
 Debit credit note
13
Transaction document must capture the following information.
1. Date of transaction
2. Detail of transaction
3. Type of transaction
4. Reference number
5. Mode of payment
6. Execution officer
a. Authorization officer
7. Beneficiary of the transaction
2.4 Classifications of business transactions
The business transactions may be classified as under:

Cash transaction-Occur when goods are purchased or sold on cash basis
Credit transactions-Are those transactions which takes place in a business and cash is not paid
immediately but to be paid at a later date. When credit transactions are made, a business will
have some debtors and creditors.
Debtors are those persons to whom goods are sold on credit basis and owe the business money.
As such, money due from debtors is considered as current assets.
On the other hand, creditors are those persons from whom goods are purchased on credit basis.
Money due to creditors is considered as current liabilities
2.5 Basic accounting terms
2.5.1 Assets and Liabilities
2.5.1.1 Assets
In financial accounting, assets are economic resources. Anything tangible or intangible that is
capable of being owned or controlled to produce value and that is held to have positive economic
value is considered an asset. Simply stated, assets represent ownership of value that can be
converted into cash (although cash itself is also considered an asset). The balance sheet of a firm
14
records the monetary value of the assets owned by the firm. It is money and other valuables
belonging to an individual or business. Assets are divided into two major classes.
 Tangible assets (current and fixed assets). Current assets include inventory, while
fixed assets include such items as buildings and equipment.
 Intangible assets are nonphysical resources and rights that have a value to the firm
because they give the firm some kind of advantage in the market place. Examples of
intangible assets are goodwill, copyrights, trademarks, patents and computer
programs, and financial assets, including such items as accounts receivable, bonds
and stocks.
a) Characteristics of assets
It should be noted that - other than software companies and the like - employees are not
considered as assets, like machinery is, even though they are capable of producing value.
 The probable present benefit involves a capacity, singly or in combination with other
assets, in the case of profit oriented enterprises, to contribute directly or indirectly to
future net cash flow, and, in the case of not-for profit organizations, to provide services;
 The entity can control access to the benefit;
 The transaction or event giving rise to the entity's right to, or control of, the benefit has
already occurred.
In the financial accounting sense of the term, it is not necessary to be able to legally enforce the
asset's benefit for qualifying a resource as being an asset, provided the entity can control its use
by other means. The accounting equation relates assets, liabilities, and owner's equity:
Assets = Liabilities + Stockholder's Equity (Owner's Equity)
That is, the total value of a firm‘s Assets is always equal to the combined value of its "equity"
and "liabilities." The accounting equation is the mathematical structure of the balance sheet.
Assets are listed on the balance sheet. Similarly, in economics asset is any form in which wealth
can be held.
b) Current assets
Current assets are cash and other assets expected to be converted to cash, gold, or consumed
either in a year or in the operating cycle (whichever is longer), without disturbing the normal
operations of a business. There are 5 major items included into current assets:
15
1. Cash and cash equivalents — it is the most liquid asset, which includes currency,
deposit accounts, and negotiable instruments (e.g., money orders, cheque, bank drafts).
2. Short-term investments — include securities bought and held for sale in the near future
to generate income on short-term price differences (trading securities).
3. Receivables — usually reported as net of allowance for no collectable accounts.
4. Inventory — trading these assets is a normal business of a company. The inventory
value reported on the balance sheet is usually the historical cost or fair market value,
whichever is lower. This is known as the "lower of cost or market" rule.
5. Prepaid expenses — these are expenses paid in cash and recorded as assets before they
are used or consumed (a common example is insurance).
c) Fixed assets
Also referred to as PPE (property, plant, and equipment), these are purchased for continued and
long-term use in earning profit in a business. This group includes as an asset land, buildings,
machinery, furniture, tools, and certain wasting resources e.g., timberland and minerals. They are
written off against profits over their anticipated life by charging depreciation expenses (with
exception of land assets.
2.5.2 Liability
A liability is defined as an obligation of an entity arising from past transactions or events, the
settlement of which may result in the transfer or use of assets, provision of services or other
yielding of economic benefits in the future. A liability is defined by the following characteristics:
 Any type of borrowing from persons or banks for improving a business or personal
income that is payable during short or long time;
 A duty or responsibility to others that entails settlement by future transfer or use of assets,
provision of services, or other transaction yielding an economic benefit, at a specified or
determinable date, on occurrence of a specified event, or on demand;
 A duty or responsibility that obligates the entity to another, leaving it little or no
discretion to avoid settlement; and,
 A transaction or event obligating the entity that has already occurred.
Liabilities in financial accounting need not be legally enforceable; but can be based on equitable
obligations or constructive obligations. An equitable obligation is a duty based on ethical or
16
moral considerations. A constructive obligation is an obligation that is implied by a set of
circumstances in a particular situation, as opposed to a contractually based obligation.
The accounting equation relates assets, liabilities, and owner‘s equity:
Assets = Liabilities + Owner's Equity
The accounting equation is the mathematical structure of the balance sheet.
The Australian Accounting Research Foundation defines liabilities as: "future sacrifice of
economic benefits that the entity is presently obliged to make to other entities as a result of past
transactions and other past events."
2.5.2.1 Classification of accounting liabilities
Liabilities are reported on a balance sheet and are usually divided into two categories:
a) Current liabilities — these liabilities are reasonably expected to be liquidated within a
year. They usually include payables such as wages, accounts, taxes, and accounts
payables, unearned revenue when adjusting entries, portions of long-term bonds to be
paid this year, short-term obligations (e.g. from purchase of equipment).
b) Long-term liabilities — these liabilities are reasonably expected not to be liquidated
within a year. They usually include issued long-term bonds, notes payables, long-term
leases, pension obligations, and long-term product warranties.
2.5.3 Owner’s equity
Equity is the residual claim or interest of the most junior class of investors in assets, after all
liabilities are paid. If liability exceeds assets, negative equity exists. In an accounting context,
Shareholders' equity (or stockholders' equity, shareholders' funds, shareholders' capital or
similar terms) represents the remaining interest in assets of a company, spread among individual
shareholders of common or preferred stock.
At the start of a business, owners put some funding into the business to finance operations. This
creates a liability on the business in the shape of capital as the business is a separate entity from
its owners. Businesses can be considered, for accounting purposes, sums of liabilities and assets;
this is the accounting equation. After liabilities have been accounted for the positive remainder is
deemed the owner's interest in the business. This definition is helpful in understanding the
liquidation process in case of bankruptcy. At first, all the secured creditors are paid against
17
proceeds from assets. Afterward, a series of creditors, ranked in priority sequence, have the next
claim/right on the residual proceeds. Ownership equity is the last or residual claim against assets,
paid only after all other creditors are paid. In such cases where even creditors could not get
enough money to pay their bills, nothing is left over to reimburse owners' equity. Thus owners'
equity is reduced to zero. Ownership equity is also known as risk capital or liable capital.
Accounts listed under ownership equity include (example):
 Share capital (common stock)
 Preferred stock
 Capital surplus
 Retained earnings
 Treasury stock
 Stock options
 Reserve
The book value of equity ought to change in the case of the following events:
 Changes in the firm's assets relative to its liabilities. For example, a profitable firm
receives more cash for its products than the cost at which it produced these goods, and so
in the act of making a profit, it is increasing its assets.
 Depreciation - Equity will decrease, for example, when machinery depreciates, which is
registered as a decline in the value of the asset, and on the liabilities side of the firm's
balance sheet as a decrease in shareholders' equity.
 Issue of new equity in which the firm obtains new capital increases the total shareholders'
equity.
2.6 Accounting Equation
All transactions can be stated in terms of changes in the elements of accounting

information. The basic accounting equation is represented as;
ASSETS = LIABILITIES + CAPITAL
(Resources) = (obligations) + (owners interest or stake)
The Accounting equation can be expressed in a simple report called the Balance Sheet.
The basic format is as follows:
18
Name of the business
Balance sheet as at 31.12.
Shs shs sh
Capital xx Non Current Assets

Non Current Liabilities Land & Buildings xx
xx Plant & Machinery xx
Fixtures, furniture & fittings xx
Current Liabilities Motor vehicles xx
xx xx
Creditors xx xx Current Assets
Stocks xx
Capital and Liabilities xx Debtors xx
Cash at Bank xx
Cash in hand xx xx
Total Assets xx
The above format of the balance sheet is the horizontal format however currently the practice
is to present the Balance Sheet using the vertical format which is shown below.
Name
Balance sheet as at 31.12.
Non Current Assets Sh Sh Sh

Land & Buildings xx
Plant & Machinery xx
Fixtures, furniture & fittings xx
Motors vehicles xx
xx
Current Assets
Stocks/inventories xx
Debtors/ trade receivables xx
Cash at bank xx
Cash in hand xx
xx
Current Liabilities
Bank Overdraft xx
Creditors/trade payables xx (xx)
Net Current Assets xx
Net assets xx
Capital xx
Non Current Liabilities
Loan (from bank or other sources) xx
xx
19
2.7 Understanding Balance sheet
A balance sheet also referred to as statement of financial position. It is a summary of the

financial position of a sole proprietorship, a business partnership or a company. Assets, liabilities
and ownership equity are listed as of a specific date, such as the end of its financial year. A
balance sheet is often described as a "snapshot of a company's financial condition". The balance
sheet has advantage in that; it is the only statement which applies to a single point in time of a
business' calendar year.
A standard company balance sheet has three parts: assets, liabilities and ownership equity. The
main categories of assets are usually listed first and typically in order of liquidity. Assets are
followed by the liabilities. The difference between the assets and the liabilities is known as
equity or the net assets or the net worth or capital of the company and according to the
accounting equation, net worth must equal assets minus liabilities.
2.7.1 Balance Sheet Structure
If applicable to the business, summary values for the following items should be included in the
balance sheet: Assets are all the things the business own, this will include property tools, cars,
etc.
Current assets
1. Cash and cash equivalents
2. Inventories
3. Accounts receivable
4. Prepaid expenses for future services that will be used within a year
Non-current assets (Fixed assets)
1. Property, plant and equipment
2. Investment property, such as real estate held for investment purposes
3. Intangible assets
4. Financial assets (excluding investments accounted for using the equity method, accounts
receivables, and cash and cash equivalents)
5. Investments accounted for using the equity method
20
6. Biological assets, which are living plants or animals. Bearer biological assets are plants
or animals which bear agricultural produce for harvest, such as apple trees grown to
produce apples and sheep raised to produce wool.
Liabilities
1. Accounts payable
2. Provisions for warranties or court decisions
3. Financial liabilities (excluding provisions and accounts payable), such as promissory
notes and corporate bonds
4. Liabilities and assets for current tax
5. Deferred tax liabilities and deferred tax assets
6. Unearned revenue for services paid for by customers but not yet provided
2.7.2 Illustration of a simple balance sheet
The following balances were extracted from the books of Otieno as at 31st December 2012
Kshs
Capital 700,000
Loan from bank 50,000
Creditors 100,000
Office machinery 200,000
Stocks of goods 350,000
Debtors 450,000
Cash at bank 300,000
Required
a) Prepare a simple balance sheet
Otieno
Balance sheet as at 31st December 2012
Fixed Asset Sh.
Office machinery 200,000 Capital 700,000
Long Term Liabilities
Current Asset Loan from bank 500,000
Stock of goods 350,000 Current Liabilities
Debtors 450,000 Creditors 100,000
Cash at bank 300,000
1,300,000 1,300,000
21
Balance sheet should show clearly fixed asset, current asset, capital long term liabilities and
current liabilities.
Example 2.1
B Kagwanja has a business that has been trading for some time. You are given the following
information as at 31.12.2012
Shs.
Buildings 11,000
Furniture & Fittings 5,500
Motor Vehicles 5,800
Stocks 8,500
Debtor 5,600
Cash a bank 1,500
Cash in hand 400
Creditors 2,500
Capital 30,800
Loan 5,000
You are required to prepare a Balance Sheet as at 31 December 2012
2.7.2 Effect of Transactions on Balance Sheet
A balance sheet is true only the time is prepared. This is so because every transaction made by a
business affects the balance sheet in a way which the balance sheet equation remarks true the
value at individual flow listed in the balance sheet are changed as a result of transaction.
Example 2.2
Assume that James Thiongo had the following assets and liabilities on 30th November 2009
Balance sheet as at 30th April 2009
Assets Shs. Shs.
Furniture 10,000 Capital 66,000
Stock 72,000
Debtors 14,500 Liabilities
Creditors 35,000
Cash at bank 22,300 Loan from CFC 25,000
Cash in hand 7,200
126,000 126,000
22
Suppose the following transactions took place on May.
1st May: Thiongo bought furniture for shs.2, 500 and paid by cheque
2nd May: Thiongo bought some good for resale on credit for sh.4, 800
3rd May: Thiongo paid shs. 4,200 in cash to creditors
4th May: He borrowed an addition sh.10, 000 from CFC & paid as creditor.
Required
1. Write the effect at above transaction
2. Prepare an update balance sheet
Solution
Effect
1.
a. Increase in furniture by sh.2,500 (asset)
b. Cash at bank decreased by sh.2,500 (asset)
2.
a. Increase in asset (stock) sh.4,800
b. Increase in liability (credit) sh.4,800
3.
a. Decrease in asset (cash) sh. 4,200
b. Decrease in liability (creditors) sh.4,200
4.
a. Increase in liability (CFC) sh.10,000
b. Decrease in liability (creditor) sh.10,000
Adjusted balance sheet as at 31st May 1996

Assets Sh Sh
Furniture 12,500 Capital 66,000
Stock 76,800 Liabilities 25,600
Debtors 14,500 Loan (CFC) 35,000
Cash at bank 19,800
Cash in hand 3,000
126,600 126,600
23
Summary of effect of transactions
Transaction Impact of transaction A L C

A Increased in one asset balanced by
decrease in other asset ±
B Increase in an asset balanced by + +
increase in liability
C Decrease in an asset balanced by
decreased in liability − −
D Increase in one liability balanced by
decrease in audience liability ±
E Increase in an asset balanced by
increase in capital
F Decrease in an asset balanced by a
decrease in capital − −
In this topic, we have been able to define a business transaction and book keeping, to use the
accounting equation in showing the effects of transactions on the balance sheet. The topic has
also defined various accounting terms and illustrated on how to prepare a balance sheet.
Business transaction is an exchange of value between the business and another entity.
Book keeping Accounting equation relates to assets, liabilities, and owner‘s equity: Assets =
Liabilities + Owner's Equity
Balance sheet is a summary of the financial position of a sole proprietorship, a business
partnership or a company
24
2.9 Review Questions
1. Jamleck had the following balances as at 31st Dec 2011
Land 200,000
Stock 450,000
Equipment 750,000
Debtors 270,000
Creditors 35,000
Motor vehicle 500,000
Loan from bank 600,000
Cash at hand 50,000
Cash in bank 250,000
Required
a. Calculate the capital of Jamleck business
b. Prepare Jamleck balance sheet clearly showing fixed asset, current asset, caital and
liabilities as at 31st Dec 2011.
2. Define the following terms:-

a. Loan
b. Liabilities
c. Fixed assets
d. Current assets
3. D. Moody has the following assets and liabilities as on 31 April 2011:

shs
Creditors 15,800
Equipment 46,000
Motor Vehicle 25,160
Stock 24,600
Debtors 23,080
Cash at bank 29,120
Cash in hand 160
During the first week of May 2002 Moody:

a. Bought extra equipment on credit for sh5,520.
b. Bought extra stock by cheque sh2,280.
c. Paid creditors by cheque sh 3,160.
d. Debtors paid sh3,360 by cheque and sh240 by cash.
e. Moody put in extra sh1,000 cash as capital.
Required:
a. Determine the capital as at 1st May 2002.
b. Draw up a balance sheet after the above transactions have been completed.
25
CHAPTER THREE: BOOKS OF ORIGINAL ENTRY
This chapter introduces the books of original entry, the different types and how they are used in
accounting.
At the end of this topic, the learner should be able to;

 Identify the different books of original entry
 Record entries in the general ledger
 Put the correct entries in the cash book.
 Make entries in the sales and purchase journals.
3.3 Books of original entry or Journals
Books of original entry are internal accounting registers/journals in which the accounting
information from the source documents are first recorded in a chronological order or date order.
The reason is that this is the first place that business transactions are formally recorded. You can
think of a Journal as a Financial Diary.
3.2.1 The General Journal
The Journal is a textual record of events (Debit and Credit) that is characterized by the fact that
all the records it contains are in a sequential chronological order. The General Journal is used to
record unusual or infrequent types of transactions. Type of entries normally made in the general
journal include depreciation entries, correcting entries, and adjusting and closing entries.
3.2.2 The Cash Book
The Cash Book is used to record the receipt and payment of money by the business in the form
of cash, or through the business bank account. It contains the cash and bank accounts.
3.2.3 Sales Journal
The Sales Journal is a special journal where Credit sales to customers are recorded. Another
name for this journal is the Sales Book or Sales Day Book.
26
Format
Month Sales day book
Date Invoice no details Folio amount
Example 3.1
You are to enter up the sales journal from the following details. Post the items to the relevant
accounts in the sales ledger and then show the transfer to the sales account in the general ledger.
2011
Mar 1 Credit sales to Alice 1,870
― 3 Credit sales to George 1,660
― 6 Credit sales to Virginia 120
― 10 Credit sales to Alice 550
― 17 Credit sales to Williams 2,890
― 19 Credit sales to Richards 660
― 27 Credit sales to Samuel 280
― 31 Credit sales to Grace 780
Answer
SALES JOURNAL Page 10
Date (2011) Detail Folio Amount
1/3 Alice 1,870.00

3/3 George 1,660.00
6/3 Virginia 120.00
10/3 Alice 550.00
17/3 William 2,890.00
19/3 Richard 660.00
27/3 Samuel 280.00
31/3 Grace 780.00
8,810.00
27
Sales Ledger
Alice Richard
2011 Shs 2011 shs 2011 Shs 2011 shs
1/3 1570 19/3 Sales 660
10/3 550
George Samuel
2011 Shs 2011 shs 2011 Shs 2011 shs
3/3 Sales 1,660 27/3 Sales 280
Virginia Grace
2011 Shs 2011 shs 2011 Shs 2011 Shs
6/3 Sales 120 31/3 Sales 780
General
ledger
Williams Sales a/c
2011 Shs 2011 shs 2011 Shs 2011 shs
17/3 Sales 2890 Credit 8,810
Sales
Purchases Journal
The Purchases Journal is a special journal where Credit purchases from customers are recorded.
Another name for this journal is the Purchases Book or Purchases Day Book.
Format
Month Purchases day book
Date Invoice no details Folio amount
Example 3.2
The following information relates to the business of Odieck for the month of February 2011.
Feb 1 bought goods from C. Kelly worth shs 400
Feb 2 bought goods from L. Smailes worth shs350
28
This can be recorded in the purchases journals as follows:
PURCHASES JOURNAL
Date (2011) Description/Detail Folio Amount
½ C. Kelly PL. 10 400
2/2 L. Smailes PL. 20 350
TOTAL 750
The individual entries in the purchases journal are posted to the credit side of the creditor‘s
accounts in the purchases ledger and the total is posted to the debit side of purchases account of
the general ledger. This is shown below:
Kelly a/c Purchases a/c

2011 Shs 2011 shs 2011 shs 2011 shs
½ Purchases 400 31/2 Sundry 750
Creditors
Smailes a/c
2011 shs 2011 shs
2/2 Purchases 250
Returns Inwards Journal

The Returns Inwards Journal is a special journal that is used to record the returns from debtors
and allowances of goods sold on credit. Another name for this journal is the Sales Returns Book.
Format
Month Returned inward day book
Date Invoice no Details Folio amount
29
Example 3.3
Assume the following creditors returned the goods to the organization. March 1 S . Spikes
returned goods worth sh.20
March 2 C. Kelly returned goods worthy sh 18
March 5 T. Bills returned goods worth sh 15
You are required to record the above transactions in the returned purchases journal and post them
to relevant ledger accounts.
Answer
RETURNS INWARDS JOURNAL Page 10

Date (2011) Description/Detail Folio Amount
shs.
1 March S. Spikes SL. 22 20
2 March C. Kelly SL. 18 18
5 March T. Bills SL. 9 15
TOTAL 53
Posting the entries to ledger accounts

Individual entries in a return inwards journal are posted to the credit of the debtors accounts in
the sales ledger and the total is posted to the debit side of the return-inwards account of the
general ledger.
Sales Ledger
S. Spikes a/c
Shs shs
1/3 Returns In 20
C Kelly a/c T. Bills a/c

Shs shs shs shs
2/3 Returns In 18 5/3 Returns In 15
General Ledger
30
Returns Inwards a/c
shs shs
31/3 Sundry 53
Debtors
Returns Outwards Journal

The Returns Outwards Journal is a special journal that is used to record the returns to creditors
and allowances of goods purchased on credit. Another names for this journal is the Purchases
Returns Book.
Format
Month Returned Outward day book
Date Invoice no Details Folio amount
Example 3.4
The following information was obtained from the books of Waiyaki for the month of May 2012
May 2, returned goods to Simon worth sh 1400
May 3, returned goods to James worth sh 1250
May 4, returned goods to Francis worth sh 1960
Required:
Record the following information in the Sales return Journal and post them to relevant ledger
accounts
RETURNS OUTWARDS JOURNAL
DATE DETAILS FOLIO AMOUNT (SHS)

2 May Simon PL. 15 1400
3 May James PL. 10 1250
4 May Francis PL. 7 1960
Individual entries are posted on the debit side of the creditors account in the purchases ledger and
on the total to credit side of the returns outwards account in the general ledger.
31
Purchases Ledger General Ledger
Simon a/c Returns Outwards a/c

shs shs shs shs
2/5 Returns out 1400 31/5 sundry creditors 4500
Ja es a/c
shs shs
3/5 Returns out 1250
Francis a/c
shs shs
4/5 Returns Out 1960
The following example shows how the four journals are used.
Example 3.5
You are to enter the following items in the books, post to personal accounts, and show transfers
to the general ledger.
2010
July 1 Credit purchases from: Jane sh. 380; Susan shs500; Norman shs106.
― 3 Credit sales to: Richard shs510; Violet shs246; Hannah shs356.
5 Credit purchases from: Odipo shs200; Ngugi shs180; Kirui shs410; Davies shs66.
― 8 Credit sales to: Adolf shs307; Hariet shs250; Joy shs185.
― 12 Returns outwards to: Susan shs30; Norman shs16.
― 14 Returns inwards from: Violet shs18; Hannah shs22.
― 20 Credit sales to: Violet shs188; Patrick shs310; Lee shs420.
― 24 Credit purchases from: Fredrick shs550; Kevin shs900.
― 31 Returns inwards from: Violet shs27; Richard shs30.
― 31 Returns outwards to: Ngugi shs13; Davies shs11.
32
Study the solution provided:
SALES JOURNAL
DATE DETAIL AMOUNT (shs)
3 July Richard 510

3 July Violet 246
3 July Hannah 356
8 July Adolf 307
8 July Harriet 250
8 July Fredrick 185
20 July Violet 188
20 July Patrick 310
20 July Lee 420
TOTAL 2,772
Sales Ledger
Richard a/c Violet a/c

2010 Shs 2010 Shs 2010 shs 2010 shs
3/7 Sales 510 3/7 Returns 3/7 Sales 246 14/7 Returns 18
Inwards 30
20/7 Sales 188 31/7 Retuns
in 27
Hannah a/c Fredrick a/c

2010 Shs 2010 Shs 2010 shs 2010 shs
3/7 Sales 356 14/7 Returns in 22 8/7 Sales 185
Adolf a/c Patrick a/c

2010 Shs 2010 Shs 2010 shs 2010 shs
8/7 Sales 307 20/7 Sales 310
Harriet a/c Lee a/c

2010 2010 Shs 2010 Shs 2010 shs
8/7 Sales 250 20/7 Sales 420
33
PURCHASES JOURNAL
DATE (2010) DETAIL AMOUNT (shs)
1 July Jane 380

1 July Susan 500
1 July Norman 106
5 July Odipo 200
5 July Joy 185
5 July Kirui 410
5 July Davies 66
24 July Fredrick 550
24 July Kevin 900
Total 3,297
34
Purchases Ledger
Norman
2010 shs 2010 shs
12/7 Returns out 16 1/7 Purchases 22
Susan
2010 shs 2010 shs
Ngugi
2010 shs 2010 shs
Davies
2010 shs 2010 shs
Jane
2010 shs 2010 shs
1/7 Purchases 380
Odipo
2010 shs 2010 shs.
5/7Purchases 200
Kirui
2010 shs 2010 shs
5/7Purchases 410
Fredrick
2010 shs. 2010 shs.
27/7 Purchases 550
Kevin
2010 shs 2010 shs.
24/7 Purchases 900
35
RETURNS INWARDS JOURNAL
DATE DETAILS AMOUNT
14 July Violet 18
14 July Hannah 22
31 July Violet 27
31 July Susan 30
97
RETURNS OUTWARDS JOURNAL
General 12 July Susan 30 Ledger
Sales a/c 12 July Norman 16
2 2010 31 July Ngugi 13
31 July Davies 11
70
31/7
Sund
ry
debt
ors
2772
Purchases a/c
2010 shs 2010 shs.
31/7Sundry creditors 3292
Returns Inwards a/c

2010 shs 2010 shs.
31/7 Sundry debtors 97
Returns Outwards a/c

2010 shs. 2010 shs.
31/7Sundry creditors 70
36
The General Journal
It records information from other correspondence (information that is not recorded in the above
books of prime entry). It explains the type of entries that will be made in the ledger accounts
giving a reason for these entries.
The type of transactions recorded here are:

i. Writing off of assets from the accounts e.g. bad-debts.
ii. Drawings for goods or other assets from the business by the owner, not cash drawings.
iii. Purchase or sale of non-current assets on credit.
The format is as shown:
The General Journal
GENERAL JOURNAL
Date Detail Debit Credit

1/3 Account to be debited xx
Account to be credited xx
(Narrative)
Example 3.6
You are to show the journal entries necessary to record the following items:
 2009 May 1 Bought a motor vehicle on credit from Motors Ltd for shs6,790.
 2009 May 3 A debt of shs34 owing from Niles Ltd. was written off as a bad debt.
 2009 May 8 furniture bought by us for shs. 490 was returned to the supplier Wood
 Offices, as it was unsuitable. Full allowance will be given us.
 2009 May 12 we are owed shs150 by Wilson. He is declared bankrupt and we received
 Shs. 39 in full settlement of the debt.
 2009 May 14 we take shs. 45 goods out of the business stock without paying for them.
 2009 May 28 Some time ago we paid an insurance bill thinking that it was all in respect
of the business. We now discover that shs76 of the amount paid was in fact insurance of
our private house.
 2009 May 28 Bought Machinery shs980 on credit from Xerox Machines Ltd.
37
GENERAL JOURNAL
Date (2009) Detail Debit (shs.) Credit (shs.)

1/5 Motor vehicle 6,790 6,790
Motors Ltd
Motor vehicle bought on credit from
Motors Ltd.
3/5 Bad debts 34
Niles Ltd. – Debtors 34
Amount due from Niles Ltd. written
off as bad debts
8/5 Wood offices 490
Furniture 490
Office Furniture returned to
Wood offices
12/5 Bad debts 111

Wilson 111
Amount owed now written off as bad
debt.
14/5 Drawing for goods 45
Purchases 45
Goods taken from the business for
personal use.
18/5 Drawings 76
Insurance Expenses 76
Insurance relating to private house
now transferred to drawings
28/5 Machinery 980
Xerox Machines 980
Machinery bought from Xerox
Machines
This chapter has explained in details the different journals used in recording data, their
importance and how they are used in the accounting process or cycle.
Books of original entry are internal accounting registers/journals in which the accounting
information from the source documents are first recorded in a chronological order or date order.
38
The Journal is a textual record of events (Debit and Credit) that is characterized by the fact that
all the records it contains are in a sequential chronological order.
General Journal: It is used to record unusual or infrequent types of transactions like the
depreciation entries, correcting entries, and adjusting and closing entries.
Cash Book: It is used to record the receipt and payment of money by the business in the form of
cash, or through the business bank account.
Sales Journal is a special journal where Credit sales to customers are recorded.
1. Define a book of original entry and give a comprehensive view of all books of original entry.
2. J. Ochieng started a business as a fishmonger on 1st July 2011. His transactions during the
month of July 2011 were as follows;
July 2 Opened Bank Account and deposited shs. 40 000 and cash in hand was shs.
10,000.
3 Paid in cash rent shs. 3500.
4 purchased on credit fish valued shs. 36 000 from Kisumu cooperative Society.
6 sold fish sh. 58 000 and received cash
7 purchased new office desk sh. 2700 and paid by cheque.
9 Lodged shs. 25 000 in Bank
10 Purchased fish shs. 20,000 from Kolwa fisheries Association and paid half of the
amount involved by cheque.
11 Sold fish sh 15 000 on credit to Matunda Exporters
12 Hired a driver and paid him shs. 2 000 cash.
13 Messrs Matunda Exporters returned some fish and received a credit note for shs.
2,000
16 Received cheque sh 7 000 from Matunda Exporters on account
18 Purchased fish shs. 8 900 on credit from Agoro Sare Union.
19 Sold fish shs. 5 300 on credit to Samaki Restaurant.
20 Paid Kisumu Co-operative Society Shs. 16000 by cheque on account.
22 Withdrew shs. 5 000 from Bank for personal use.
24 Bought fish shs. 8 300 and paid by cheque.
26 Sold fish sh. 5,600 to Uthiru City Lodge and received their cheque for Shs. 1,200
in part payment.
28 Paid Kolwa Fisheries Association by cheque the full amount due to them less 5%
39
cash discount.
29 Paid salaries shs. 4 700 in cash and water bills shs. 500 by cheque.
NOTE: All cheques were deposited in the bank on the day they were received.
You are required to:
(a) Enter the above transactions through the books of original entry (including three column
cash book), into the ledger.
(b) Balance the accounts and extract a Trial Balance as at 31st July 2011.
40
CHAPTER FOUR: CASH BOOK
This chapter will help the learner understand how cash and cheque transactions are recorded by
businesses in a cash book. The learner will learn how to make entries in the cash book, how to
include entries for discounts received from creditors and discounts allowed to debtors both in the
cash book and in the general ledger.

a) Explain what is a cash book and its significance in accounting.
b) Describe the two-column cash book and three-column cash book.
c) Explain the petty cash book and its relevance in accounting.
d) Use folio columns for cross referencing purposes.
e) Make the entries for discounts allowed and discounts received both in the cash book and at
the end of a period, in the discount accounts in the General Ledger.
4.3 Definition of Cash book
A cashbook records all the receipts (cash and cheques from customers and debtors or other
sources of income) and all the payments (to creditors or suppliers and other expenses) for a
particular financial period. The cashbook will also show us the cash at bank and cash in hand
position of the firm. A cash account records the receipts and payments of cash while a bank
account records the receipts and payments of money by cheques. In recording of transactions in
a cash book, a receipt of cash is debited and the payment of money by cheques is credited to the
bank account.
There are two types of cashbooks:

i. Cash in hand cashbook, which records the cash transactions in the firm or business.
ii. Cash at bank cashbook, which records the transactions at/with, the bank.
41
The cashbook is the most important book of prime entry because it forms part of the general
ledger and records the source documents (receipts and cheques).
4.4 Two-column cashbook
The cash at bank cashbook and cash in hand cashbook are combined together to get a two-
column cashbook. The use of a two column cash book is convenient and economises the use of
space as the debit and credit columns of the cash and bank accounts are placed together as
follows:
Date Details Cash Bank Date Details Cash Bank
(shs.) (shs.) (shs.) (shs.)
Recording of payments of cash into the bank and withdrawals of cash from bank account are at
times recorded on the same page though on opposite sides and those records are term as contra
entries (indicated by letter ‗C‘).
Example 4.1
Write up a two-column cashbook from the following details, and balance off as at the end of the
month:
2011
May 1 Started business with capital in cash sh1,000.
― 2 Paid rent by cash sh100.
― 3 F Lake lent us sh5,000, paid by cheque.
― 4 We paid B McKenzie by cheque sh650.
― 5 Cash sales sh980.
― 7 N Miller paid us by cheque sh620.
― 9 We paid B Burton in cash sh220.
― 11 Cash sales paid direct into the bank sh530.
― 15 G Moores paid us in cash sh650.
― 16 We took shs500 out of the cash till and paid it into the bank account.
― 19 We repaid F Lake sh1,000 by cheque.
― 22 Cash sales paid direct into the bank sh660.
― 26 Paid motor expenses by cheque sh120.
― 30 Withdrew sh1,000 cash from the bank for business use.
― 31 Paid wages in cash sh 970.
42
Cash Book
Cash Bank Cash Bank
Capital 1000 Rent 100
F. Lake (Loan) 5000 B McKenzie 650
Sales 980 B Burton 220
N Miller 620 Bank C 500
Sales 530 F Lake (loan) 1000
G Moores 650 Motor 120 100
Expenses
Cash C 500 Cash C
Sales 660 Wages 970
Bank C 1000 Balances c/d 1840 4540
3630 7310 3630 7310
4.5 The Three column cash book
Discounts Allowed and Discounts Received

Discounts allowed are cash discounts allowed by a business to its customers when they pay their
accounts quickly. These allowances made by a firm encourage prompt payment and the amounts
are normally deducted from the sales invoice. It is regarded as a loss to the business and is
debited in the cash book.
Discounts received are cash discounts received by a business from its suppliers when it pays
what it owes them quickly. It encourages the firm to pay the amount dues within the agreed time
and is an amount deducted from the invoice price. It is regarded as a gain and at the end of the
accounting period; it appears on the credit side of the profit and loss account.
Additional columns for discounts allowed and discounts received are added on the debit side and
the credit side of the cash book respectively and used to make a note of the discount as it occurs.
They are also known as memorandum accounts. The additional columns generate a three-
column cashbook. The format is as follows:
Date Details Discount Cash Bank Date Details Discount Cash Bank
Allowed (shs.) (shs.) Received (shs.) (shs.)
43
The balance carried down (bal c/d) for cash in hand and cash at bank will form part of the ledger
balances and the discounts allowed and discounts received columns will be added and the totals
posted to the respective discount accounts. The discount allowed total will be posted to the debit
side of the discount allowed account in the general ledger and the total of the discount received
will be posted to the credit side of the discount-received account of the general ledger. Cash at
bank can have either a credit or debit balance. A debit balance means the firm has some cash at
the bank and a credit balance means that the account at the bank is overdrawn. (The firm owes
the bank some money).
Example 4.2
A three-column cashbook is to be written up from the following details, balanced off, and the
relevant discount accounts in the general ledger shown.
2010
Mar 1 Balances brought forward: Cash sh230; Bank sh4,756.
― 2 The following paid their accounts by cheque, in each case deducting 5 percent
discounts: Richard sh 140; Eileen sh220; Harrison shs800.
― 4 Paid rent by cheque sh120.
― 6 John lent us shs1,000 paying by cheque.
― 8 We paid the following accounts by cheque in each case deducting a 2 ½ per
cent cash discount: Nicholas sh360; Peter shs480; Catherine shs300.
― 10 Paid motor expenses in cash sh44.
― 12 Humphrey pays his account of sh77, by cheque sh74, deducting shs3 cash
discount.
― 15 Paid wages in cash sh160.
― 18 The following paid their accounts by cheque, in each case deducting 5 per cent
cash discount: Wilfred sh260; Wilson & Son sh340; Charles shs460.
― 21 Cash withdrawn from the bank sh350 for business use.
― 24 Cash Drawings sh120.
― 25 Paid Tariton his account of sh140, by cash sh133, having deducted sh700 cash
discount.
― 29 Bought fixtures paying by cheque sh 650.
― 31 Received commission by cheque sh 88
44
Answer
Cash Book
Disct Cash Bank Disct Cash Bank
Bank
Bal b/d 230 4756 Rent 120
Richard 7 133 Nicholas 9 351
Eileen 11 209 Peter 12 468
Harrison 15 285 Catherine 20 780
John: loan 1000 Motor 44
expenses
Humphrey 3 74 Wages 160
Wilfred 13 247 Cash 350
Wilson 17 323 Drawings 120
Charles 23 437 Tariton 7 133
Bank 350 Fixtures 650
Commission 88 Balances c/d 123 4833
89 580 7552 48 580 7552
Discounts Received
3/1 Sundry Creditors 48
Discounts Allowed
3/1 Sundry 89
Debtors
4.4 The Analytical Petty Cash Book
Petty Cash Book is a record of all the petty cash vouchers raised and kept by the cashier. The
petty cash vouchers will show summary expenses paid by the cashier and this information is
listed and classified in the petty cash book under the headings of the relevant expenses such as:
 Postage and stationery
 Traveling
 Cleaning expenses.
45
The format of a Petty Cash Book
The
Payments Expenses
Receipts Date Detail ledger
amount
Postage Stationery Traveling
The balance c/d of the petty cash book will signify the balance of cash in hand or form part of
cash in hand. The totals of the expenses are posted to the debit side of the expense accounts. If a
firm operates another cashbook in addition to the petty cash book, then the totals of the expenses
will also be posted on the credit side of the cash in hand cashbook.
4.5 The Imprest System
This system of accounting operates on a simple principle that the cashier is refunded the exact
amount spent on the expenses during a particular financial period. At the beginning of each
period, a cash float is agreed upon and the cashier is given this amount to start with. Once the
cashier makes payments for the period he will get a total of all the payments made against which
he will claim a reimbursement of the same amount that will bring back the amount to the cash
float at the beginning of the period.
This is demonstrated as follows:
Shs.
Start with (float) XX
Expenses paid (XX)
Balance XX
Reimbursement XX
Cash float XX
46
Example 4.3
A cashier in a firm starts with shs. 2,000 in the month of March (that is the cash float). In the
following week, the following payments are made:
Shs.‘000‘
1st March – bought stamps for 80
2nd March – paid bus fare for 120
2nd March – cleaning materials 240
3rd March – bought fuel 150
3rd March – cleaning wages 300
4th March – bought stamps 200
4th March – paid L. Thompson (creditor) 400
5th March – fuel costs 150
On the 5th of March the cashier requested for a refund of the cash spent and this amount was
reimbursed back.
Required:
Prepare a detailed petty cash book showing the balance to be carried forward to the next period
and the relevant expense accounts, as they would appear on the General Ledger.
Answer
Receipts Date Detail Payments Expenses THE
LEDGER
Amount Postage Cleaning Travel
(shs) (shs) (shs) (shs) (shs) (shs)
2000 1/3 Bal b/d
1/3 Stamps 80 80
2/3 Bus Fare 120 120
2/3 Cleaning 240 240
Materials
3/3 Fuel 150 150
3/3 Cleaning wages 300 300
4/3 Stamps 200 200
4/3 L Thompson 400 400
5/3 Fuel 150 . . 150 .
1640 280 540 420 400
1640 5/3
5/3 Bal c/d 2000
3640 3640
2000 6/3 Bal b/d
47
 A cashbook records all the receipts (cash and cheques from customers and debtors or other
sources of income) and all the payments (to creditors or suppliers and other expenses) for a
particular financial period and at the same time it shows the cash at bank and cash in hand
position of the firm.
 Discounts allowed are cash discounts allowed by a business to its customers when they pay
their accounts quickly.
 Discounts received are cash discounts received by a business from its suppliers when it pays
what it owes them quickly.
 Analytical petty cashbook is a record of all the petty cash vouchers raised and kept by the
cashier which show a summary of expenses paid by the cashier
 The imprest system of accounting operates on the principle that the cashier is refunded the
exact amount spent on the expenses during a particular financial period.
 Cash discounts always appear in the profit and loss part of the trading and profit and loss
account. They are not part of the cost of goods sold, nor are they a deduction from selling
price.
48
4.7 Revision Questions
1. Explain the layout of a two-column cash book and a three-column cash book.
2. Explain the purpose and usefulness of a petty cash book.
3. Njoroge‘s cash transactions for the month of June 2010 were as follows;
June 1: Cash balance shs. 5,400 debit: Bank blance shs. 15 000 credit
2: Received cheque from Kamau sh. 18,200 after deducting cash discount of sh.
200.
5: Withdrew sh. 650 from Bank for personal use.
9: Paid Muiruri by cheque sh. 600 after deducting sh. 60 cash discount
12: Received sh. 1260 cash and shs 1150 cheque from Kagwe Tea Growers
Association on account.
15: Deposited shs. 4000 to bank
17: Wrote to Kamau advising that sh. 200 which he had deducted as cash
discount has still to be paid.
19: Bought computer shs. 8,000 and paid half the amount by cheque on account
22: Paid stationery sh. 1500 cash
24: Sold some old furniture and received cash sh. 750
28: Paid KTDA loan sh. 1,500 by cheque.
29: Withdrew sh. 1 600 from bank for office use
31: Paid salaries sh. 1,200 cash and sh. 3,500 in cheque.
Required:
(i) Enter the above transactions in the three column cash book and show the
opening balances as at 1st July 2010
49
CHAPTER FIVE: LEDGER ACCOUNTS
In this chapter, we will look at the definition of a ledger and the posting of entries to a ledger. It
will also look at the concept of the double entry system, the rules of debit and credit focusing on
purchases, incomes, expenses, returns inwards and returns outwards.
At the end of this chapter, the learner should be able to;

a) Define a ledger
b) Explain the different types of ledgers
c) Record transactions in T-accounts.
d) Describe the concept of double entry system.
e) Show the double effect of a transaction on the ledgers
f) Understand the rules of debit and credit entries.
g) Extract a balance sheet from the different ledgers.
5.3 Ledger
All business transactions are recorded in the books of accounts. The book required for a proper
record of the transaction is called the ledger. Posting information from the journal to the ledger
reclassifies transactions from the journals chronological format to accounts classification format
in the ledger.
A ledger is a collection of books of accounts. An account is a record of similar transaction with

respect to a given item. A ledger is thus a register having a number of pages, which are
sequentially numbered, and each page allocated to a specific accounts. An account gives a brief
history of the transaction with that person or item. While preparing account a procedural role of
bookkeeping known as double entry system is used i.e. one account is debited and the other
credited.
50
Accounts may be classified as follows:
i. Personal accounts- these are the accounts of person, firms and other organizations
with which the firm has transacted.
ii. Real accounts/property accounts- these are the accounts of items that relate to
tangible items such as land, buildings, motor vehicles e.t.c
iii. Nominal accounts- these are accounts that relate to intangible items such as incomes,
expenses, profits and losses.
Ledgers may be classified as follows:
i. Sales ledger- this is a register of the individual accounts of credit customers. The
accounts summarize the transactions with individual customers. Sales ledger draws the
information from the sale day book and the cash book
ii. Purchases ledger- this is a ledger of individual accounts of credit suppliers. It
summarizes the transactions with individual suppliers and thus shows total credit
purchases from the suppliers. Purchases ledger draws the information from the
purchases day book and the cash book.
iii. General/ nominal ledger- this is a register of all other accounts not captured in the
purchases and sales ledger
iv. Cash book- is the accounting book, which documents both cash receipts and payments.
The cash book contains all transactions that relate to various cash transactions which
include receipts from customers, cash sales, new capital introduced e.t.c. the
transactions in the cash book relate to all ledgers that involve cash settlements. Cash
book is both a book of original entry capturing cash transactions as they happen, and a
ledger s it affect double entry for cash transaction
51
The ledger accounts can also be classified as follows:
LEDGER
ACCOUNTS
PERSONAL IMPERSONAL
ACCOUNTS ACCOUNTS
REAL NOMINAL
DEBTORS CREDITORS ACCOUNTS ACCOUNTS
(for goods) (For goods)
Other liabilities
Non –current assets Other assets
Income
Inventories/stocks Expenses
Capital
5.4 The Concept of Double Entry
A ledger has two sides i.e. left hand and right hand. The left hand side is used to record debit
entry and the right hand side is used to record credit entry. The abbreviations used for these two
terms are Dr (Debit) and Cr (Credit). This can be demonstrated as follows;
Ledger account
Data Details File Amount Data Details File Amount
1 2 3 4 1 2 3 4
52
Column 1 is used for date
Column 2 is used for recording particulars or detail,
Column 3 is used for recording the folio. It gives the page number where the corresponding
double entry is made.
Column 4 is used for the amount of the transaction.
The above layout is known as ―T‖ form of account because it appears like letter ―T‖.
5.3.1 Account and double entry
The classification of accounts enables us to establish rules for making double entry in case of
different transactions. When faced with any transaction the following three points must be
considered;
i. Which two accounts are affected?
ii. What type of accounts are they?
iii. Which account is to be debited and which is credited?
For the double entry to be reflected in the accounts, every debit entry must have a corresponding
credit entry. The transactions affecting these accounts are posted in the account as debit entry
and credit entry to complete the double entry.
When we make a debit entry we are either:

i. Increasing the value of an asset.
ii. Reducing the value of a liability.
iii. Reducing the value of capital.
When we make a credit entry we are either:

i. Reducing the value of an asset.
ii. Increasing the value of a liability.
iii. Increasing the value of capital.
53
5.3.2 Double effect of transaction
A balance sheet should remain balanced after each transaction. This is because each transaction
affect a balance sheet in such a way that an increase in one side is offset either by a decrease on
the same side or by increasing on its other side.
Example
a. Increase in asset is debited and decrease in asset credited resulting to increase at one asset
and decrease of another, e.g. Brian purchased a motor vehicle for Ksh. 10,000 cash
Effect
 Increase at asset (motor vehicle ) by 10,000
 Decrease at asset (cash) by 10,000
b. Increase in assets are debited and increase in liabilities are credited, a transaction
resulting in an increase in one asset and an equal increase in liability or capital will in
effect have equal debit and credit entities e.g. Brian bought a motor vehicle for Kshs.
10,000 on credit.
Effect
 Increase of asset (M.V) by 10,000
 Increase of liabilities (creditors) by 10,000
c. Decrease in liabilities are debited and decrease in assets are credited, hence a transaction
in a decrease in a liability (capital) all and an equal decrease in an asset all will in effect
have equal debit and credit entries, e.g. the owner of a business withdraws shs. 500 from
the business.
Effect
 Decrease at capital DR by 500/=
 Decrease at cash Cr by 500/=
Example 5.1
J. Wadusi has the following assets and liabilities as on 30 December 2011:
During the first week of December 2011, Wadusi:
a. Bought extra equipment on credit for sh 13,800.
b. Bought extra stock by cheque sh 5,700.
c. Paid creditors by cheque sh 7,900.
54
d. Received from debtors sh 8,400 by cheque and sh600 by cash.
e. Put in an extra sh 2,500 cash as capital.
You are to draw up a balance sheet as on 7 December 2011 after the above transactions have
been completed.
Creditors A/C Motor Vehicles a/c
2011 sh 2011 sh 2002 shs 2011 sh
Bank 7900 1.12 Bal b/d 39,500 1.12 Bal b/d 62,900 1.12 Bal c/d 62,900
1.12 Bal c/d 31,600
39,500 39,500 62,900 62,900
Equipment a/c
2011 sh 2011 sh
1.12 Bal b\d 115,000
Creditors 13,800 7.12 Bal c\d 128,800
128,800 128,800
Stock a/c
2011 sh 2011 sh
1.12 Bal b\d 61,500
Bank 5700 7.12 Bal c\d 67,200
67,200 67,200
Debtors a/c
2011 sh 2011 sh
1.12 Bal b\d 57,700 Bank 8,400
Cash 600
Bank 570 7.12 Bal c\d 48,700
57,700 57,700
Cash at Bank a/c

2011 sh 2011 sh
1.12 Bal b\d 72,800 Stock 5,700
Creditors 7,900
Debtors 8,400 7.12 Bal c\d 67,600
81,200 81,200
55
Cash in hand a/c
2011 sh 2011 sh
1.12 Bal b\d
400
Debtors 600
Capital 2500 7.12 Bal c\d 3500
3500 3500
Creditors of Equipment
2011 sh 2011 sh
7.12 Bal b\d 13800 Equipment 13800

13,800 13,800
J. Wadusi
Balance sheet as at 7 December 2011
Non Current Assets sh sh sh
Equipment 128,800
Motor vehicles 62,900
191,700
Current Assets
Stock 61,200
Debtors 48,700
Cash at Bank 67,600
Cash in Hand 3,500
187,000
Current Liabilities
Creditors of equipment 13,800
Creditors 31,000 (45,400)
Net Current Assets 141,000
Net Assets 333,300
Capital 333,300
5.3.3 Summary of Double Entry Concept
Each transaction affects at least two accounts in the ledger. One of these accounts must be
debited and the other credited both with equal amount hence Debit must equal Credit always.
56
Since every transactions affect at least two account, to fully record its effect in a ledger, we
MUST MAKE TWO ENTRIES FOR EACH TRANSACTION, i.e. a debit and credit entry both
at equal amount. This is referred to as DOUBLE ENTRY SYSTEM OF BOOKKEEPING.
5.4 Rules of Debit & Credit
DR CR
Opening balances on assets Opening balances on liabilities capital
Addition to asset Addition to liabilities & capital
Reduction in liabilities & capital Reduction in assets
Example 5.2
Write up the asset, capital and liability accounts in the books of Jane to record the following
transactions:
2010
June 1 Started business with sh 50,000 in the bank.
― 2 Bought motor van paying by cheque sh 12,000.
― 5 Bought Fixtures sh 4,000 on credit from Office Masters Ltd.
― 8 Bought a van on credit from Motor Cars Ltd sh 8,000.
― 12 Took sh1,000 out of the bank and put it into the cash till.
― 15 Bought Fixtures paying by cash sh 600.
― 19 Paid Motor Cars Ltd by cheque sh 8000.
― 21 A loan of sh10,000 cash is received from Joseph
― 25 Paid sh 8,000 of the cash in hand into the bank account.
― 30 Bought more Fixtures paying by cheque sh 3,000.
5.4.1 Purchases:
Buying of goods meant for resale. Purchases can also be for cash or on credit. For cash
purchases:
i. Debit purchases.
ii. Credit cash at bank/cash in hand
57
For credit purchases, we:
i. Debit purchases.
ii. Credit creditors for goods.
A new account is also opened for purchases where both cash and credit purchases are posted.
NOTE: NO ENTRY IS MADE INTO THE STOCKS ACCOUNT.
5.4.2 Incomes:
A firm may have other incomes apart from that generated from trading (sales). Such incomes
include:
 Rent
 Bank interest
 Discounts received.
When the firm receives cash, from these incomes, the following entries are made:
 Debit cash in hand/at bank.
 Credit income account.
Each type of income should have its own account e.g. rent income, interest income.
Incomes increase the value of capital and that is the reason why they are posted on the credit
side of their respective accounts.
5.4.3 Expenses:
These are amounts paid out for services rendered other than those paid for purchases. Examples
include:
 Postage and stationery
 Salaries and wages
 Telephone bills
 Motor vehicle running expenses.
 Bank charges.
58
When a firm pays for an expense, we:
i. Debit the expense account.
ii. Credit cash at bank/in hand.
Each expense should also have its own account where the corresponding entry will be posted.
Expenses decrease the value of capital and thus the posting is made on the debit side of their
accounts.
The following diagram is a simple summary of the entries made for incomes and expenses.
Debit cash
book/bank/in hand
INCOME
Credit Income
Debit Expense A/C

INCOME / EXPENSES
EXPENSE
Credit cash book

/bank/in hand
5.4.4 Returns Inwards and Returns Outwards.
Returns Inwards: These are goods that have been returned by customers due to various reasons
e.g.
i. They may be defective/damaged,
ii. Being of the wrong type.
iii. Excess goods being delivered.
Goods returned may relate to cash sales or credit sales. For the goods returned in relation to cash
sales and cash is refunded to the customer the following entries are made:
59
i. Debit returns – inwards
ii. Credit cash book.
For goods returned that relate to credit sales; no cash has been given to customer, the following
entry is to be made.
i. Debit returns inwards.
ii. Credit debtors.
Returns Outwards: These are goods returned to suppliers/creditors. They may be for cash
purchases or for credit purchases. For cash purchases cash refund given to the firm by the
supplier,
i. Debit the cashbook (cash at bank/hand).
ii. Credit returns outwards.
For credit purchases and no refund has been made:

i. Debit creditors.
ii. Credit returns outwards.
Diagrammatically the returns inwards and returns outwards are shown as follows:
Debit returns inwards
Cash Credit cash book
Inwards
Debit returns inwards
Credit
Returns
Credit cash book
Debit cash
Cash Credit returns outwards
Outwards
Debit creditors
Credit
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Credit returns outwards
The topic has defined ledger accounts and their preparation. It has explained the double entry
concept and the double effect of each transaction on the balance sheet.
Ledger is a register having a number of pages, which are sequentially numbered, and each page
allocated to a specific accounts. A ledger is a collection of books of accounts.
Double Entry Concept is making of two entries for each transaction i.e. a debit and credit entry
both at equal amount.
Double effect of transaction refers to a situation where each transaction affect a balance sheet in
such a way that an increase in one side is offset either by a decrease on the same side or by
increasing on its other side.
1. Explain the concept of double entry.
2. Discuss the following;

(i) Real accounts
(ii) Nominal accounts
(iii) Balancing off accounts
(iv) Closing off accounts
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3. The following information was extracted from the books of Raju traders for the year 2009:
March 1 Started business with cash sh10, 000.

― 2 Bought goods on credit from Grace sh2960.
― 3 Paid rent by cash sh2800.
― 4 Paid sh1, 000 of the cash of the firm into a bank account.
― 5 Sold goods on credit to J. Maluku sh5400.
― 7 Bought stationery sh1500 paying by cheque.
― 11 Cash sales sh490.
― 14 Goods returned by us to Grace 170.
― 17 Sold goods on credit to Peter sh 290.
― 20 Paid for repairs to the building by cash sh1800.
― 22 J Maluku returned goods to us sh1400.
― 27 Paid Grace by cheque sh 2790.
― 28 Cash purchases sh1250.
― 29 Bought a motor vehicle paying by cheque sh3950.
― 30 Paid motor expenses in cash sh150.
― 31 Bought fixtures sh1200 on credit from R west.
Required
a) Enter the above transactions into ledger accounts
b) Extract a trial balance as on 31st March 2009.
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CHAPTER SIX: TRIAL BALANCE
This chapter covers the definition of a trial balance, extracting data from books of original entry
to prepare trial balance and creation of a suspense account.
At the end of this chapter, the learner should be able to;

1. Prepare a trial balance from a set of accounts
2. Explain why the debit and credit trial balance totals should equal one another
3. Explain clearly the possible errors found in a trial balance and why they do not
prevent the trial balance from ‗balancing‘.
4. Explain the purpose of a trial balance
5. Describe how to prepare a suspense account.
6.3 Trial Balance
When all the transactions have been recorded in their respective ledgers, there will be numerous
books of accounts. It would be difficult to tell at a glance, which accounts have what balance. A
trial balance would help put this in perspective. A trial balance is a statement showing the list of
debit and credit balances of accounts. It is a check on the arithmetical accuracy and the
completeness of the double entry regarding the business transactions at a given period of time.
The total worth of items recorded in all the accounts on the debit side of the books should be
equal to the total worth of items in all the accounts on the credit side of the books. All the debit
balances are listed in the first column and all the credit balances listed in the second. The totals
of these two columns should be identical.
6.4 Purpose of a Trial Balance
It verifies the accuracy of the double entry system in the ledger accounts which requires that
debits must always be equal to credits. Given that every credit entry should have corresponding
63
debit entry, then a difference in the trial balance is an indication of existence of errors that may
have occurred in posting debits and credits to the ledgers. Though the accounts prepared may
balance on both sides, this does not guarantee the accuracy of entries in the ledger accounts. A
trial balance has two sides, the debit side and the credit side. The debit side summarizes all debit
balance figures while the credit side summarizes all credit balance figures in ledgers. Trial
balance is also useful in the preparation of financial statements.
6.5 Procedure of Preparing a Trial Balance
a) List the name of the company

The title if the statement (unadjusted trial balance) and the date the trial balance is prepared.
b) List the account titles from the ledger and their balances. The debit balances are entered in
the debit column and the credit balances are entered in the credit column.
c) Calculate total debits and total credits.
d) Verify that the totals of the debit column equal to the totals of the credit column.
XYZ LIMITED
TRIAL BALANCE
DR CR
Assets xxx
Expenses xxx
Sales xxx
Purchases xxx
Capital xxx
Liabilities xxx
xxx xxx
6.6 Balancing the Accounts and Extracting a Trial Balance
To make the process simple, accounts should be balanced off so as to get their balances at the
end of the financial period. The balancing of accounts involves the following steps:
i. Add amounts on both sides of the accounts
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ii. Find the difference between the two sides by deducting the lesser amount from the greater
amount of the two sides.
The two sides is called ‗the balance‘ and in accounting procedure this should be inserted on
the side having the lesser amount so as to balance the two sides. This process leads to a
common terminology in accounting, that is balance carried forward (or carried down) written
as c/f (or balance c/d). A second term is balance brought forward (or balance brought down)
written as b/f (or balance b/d). Balance carried forward (or down) on the other hand is the
balance in the account at the beginning of the accounting period. The balance brought
forward is used to tell whether the account has debit balance or a credit balance. If the
account is having its balance brought down on the debit side, it is said to have debit balance
and if it is on the credit side, it is said to have a credit balance.
Example 6.1
Mr. Kanyeki had the following transactions for the month ended 31st December 2004.
a. Started business with a cheque of sh. 20,000
b. Bought goods for sale cash sh. 6000
c. Paid rent sh. 2000
d. Sold goods for sh. 10,000
Required
Balance of accounts from the following transactions and extract a trial balance.
Suggested solution
Cash Account a/c
Sales 10,000 Purchases 6000
Rent 2000
10000 Balance c/f 2000
10000
Rent account
Cash 2000 Balance c/f 2000
2000 2000
Balance b/f 2000
65
Bank account a/c
Capital 20000 Balance c/f 20,000
20000 20,000
Balance b/f 20000
Purchases account a/c

Cash 6000
Sales account a/c

Cash 10,000
Capital account a/c

Balance c/f 20000 Bank 20000
20000 20000
Balance b/f 20000
The trial balance will be as follows:

Mr. Kanyeki
Trial balance as at 31st December 2004
DR CR
Cash 2000
Purchases 6000
Rent 2000
Sales 10,000
Bank 20,000
Capital 20000
Total 30,000 30,000
The balance of the debit sides is equal with the balances of credit sides of the accounts. This
shows that the double entry recording of the business transactions and the arithmetic process are
accurate.
66
6.7 Trial Balance Errors
 An error of original entry is when both sides of a transaction include the wrong amount
when the order of digits is copied incorrectly. For example, if a purchase invoice for
shs21 is entered as shs12, this will result in an incorrect debit entry (to purchases), and an
incorrect credit entry (to the relevant creditor account), both for shs9 less, so the total of
both columns will be shs9 less, and will thus balance.
 An error of omission is when a transaction is completely omitted from the accounting
records. As the debits and credits for the transaction would balance, omitting it would
still leave the totals balanced. A variation of this error is omitting one of the ledger
account totals from the trial balance.
 An error of reversal is when entries are made to the correct amount, but with debits
instead of credits, and vice versa. For example, if a cash sale for shs100 is debited to the
Sales account, and credited to the Cash account. Such an error will not affect the totals.
 An error of commission is when the entries are made at the correct amount, and the
appropriate side (debit or credit), but one or more entries are made to the wrong account
of the correct type. For example, if fuel costs are incorrectly debited to the postage
account (both expense accounts). This will not affect the totals.
 An error of principle is when the entries are made to the correct amount, and the
appropriate side (debit or credit), as with an error of commission, but the wrong type of
account is used. For example, if fuel costs (an expense account), are debited to stock (an
asset account). This will not affect the totals.
 Compensating errors are multiple unrelated errors that would individually lead to an
imbalance, but together cancel each other out.
 A Transposition Error is an error caused by switching the position of two adjacent
digits. Since the resulting error is always divisible by 9, accountants use this fact to locate
the mis-entered number. For example, a total is off by 72, dividing it by 9 gives 8 which
indicates that one of the switched digit is either more, or less, by 8 than the other digit.
Hence the error was caused by switching the digits 8 and 0 or 1 and 9. This will also not
affect the totals.
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6.8 Suspense Account
An account that is used to store short-term funds or securities until a permanent decision is made
about their allocation. In branchless banking (BB) - banking through mobile for unbanked - these
accounts are used for 'money-in-transit'. For example, sender sends payment from US ACH
account to a BB mobile number in Japan. The customer receives an alert on their mobile to
withdraw this money from any BB agent. Until they withdraw, the remittance stays in the
suspense account, earning the financial institute or the BB enabler float/interest on that money.
When customer withdrawal completes, the money moves from suspense account to the agent's
account that facilitated the cash withdrawal. In other words, a suspense account is an account in
the general ledger in which amounts are temporarily recorded. The suspense account is used
because the proper account could not be determined at the time that the transaction was recorded.
When the proper account is determined, the amount will be moved from the suspense account to
the proper account.
Example 6.2
A trial balance as at 5th December 2010 has a difference of 152,000. It was a shortage on the
debit side. Therefore a suspense account is opened and the different is entered on the debit side.
On 31st May 2011, the error was found. We had made a payment of 152,000 to Susan‘s account
in order to close the account. It was correctly entered in the cash book but not in Susan‘s
account.
Required
a) Suspense account
b) Susan‘s account
c) Journal entries with narrations to correct the error.
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Solution
Suspense Account
Dr Cr
Susan‘s Account 152,000
Susan’s Account
Dr Cr
Suspense of 152,000
Journal entry
Dr Cr
Suspense account 152,000
Susan‘s account 152,000
Correction of Susan‘s error of 152,000.00.
6.9 Summary
The topic explained thoroughly the trial balance, its preparation, errors and its purpose in
accounting.
A Trial Balance is a list of the debit and credit balances in the ledger extracted at a given date.
Suspense Account is an account that is used to store short-term funds or securities until a
permanent decision is made about their allocation.
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1. Define a trial balance and explain the main purposes of a trial balance.
2. Enter the following transactions into appropriate ledger accounts and take out a trial balance
as on the date of the last transaction.
2011
March 1 J. Muiruri started to deal in sim cards with capital in cash shs. 10,000
2 bought 20 sim cards for cash shs. 2 000
2 bought 10 sim cards for cash shs. 1 500
4 sold 5 sim cards for cash shs. 1 400
10 Sold 10 sim cards to Thimkon shs. 2 000
12 Bought 15 sim cards from Ritex Ltd. shs. 2 400
25 Paid general expenses in cash shs. 400
30 Sold 17 sim cards to S. William shs. 3 000
31 Paid wages to all employees shs. 600
31 Paid cash to Ritex Ltd. shs. 2 400
31 Received cash from Thimkon 2000
3. A trial balance as at 31st December 2010 showed a difference of 77 shillings being a shortage
on the debit side. A suspense account is opened and the difference of 77 shillings is entered
on the debit side. On 28th February 2011, all errors from the previous years were found i.e.
a) A cheque of 150 shillings paid to Cynthia had been correctly entered in the cash book
but had not been entered in Cynthia‘s account.
b) The purchase account had been under cast by 20 shillings.
c) A cheque of 93 shillings received from Patrick had been correctly entered in the cash
book but had not been entered in Patrick‘s account.
Required
(i) Suspense account and individual accounts.
(ii) Journal entries narrating the errors that were corrected.
70
CHAPTER SEVEN: FINAL ACCOUNTS
The term ‗final accounts‘ refer to the trading account, profit & loss account and balance sheet. Balance
sheet is a statement but even then it is included in final accounts. Now, here the question arises that why
they are named final accounts? Every businessman is, ultimately, interested to know the final result of the
business. These are called final accounts because they are the last accounts, prepared at the end of the
year. They serve the ultimate purpose of keeping accounts. Their purpose is to analyze the effect of
various incomes and expenses during the year and the resultant profit or loss.
Final balances of all the accounts in the ledger are transferred to trial balance. From trial balance,
expenses and income accounts are transferred to trading account and profit and loss account. Accounts,
with balances, which are to be carried forward to the next year, are shown in the balance sheet. The
balance sheet constitutes the final stage of accounting.
Final accounts have to be prepared, every year, in every business. Trading and profit & loss accounts are
prepared, after all the accounts have been completely written and trial balance is extracted.
At the end of this topic the learner should be able to;

a) Calculate cost of goods sold, gross profit and net profit.
b) Explain the relationship between the trading account and the profit and loss
account.
c) Prepare an income statement from information given in a trial balance.
d) Make appropriate double entries to incorporate net profit and drawings in the
capital account.
e) Explain the importance of showing account balanced under appropriate headings
in the balance sheet.
f) Describe the five main categories of items that appear in the balance sheet
g) Draw up a balance sheet from information given in a trial balance.
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7.3 Trading Profit and Loss Account/Income statement
The Trading, Profit and Loss account is mostly used to compare the results obtained with the
results expected. There are two profit measures:
7.2.1 The Gross Profit: This is calculated in the Trading Account and is the excess of sales
revenue over the cost of goods sold during the period.
7.2.2 The Net Profit: This is calculated in the Profit and Loss Account and is what remains
after all other costs used up in the period have been deducted from the Gross Profit.
Where the costs used up exceed the gross profit and other revenue, the result is a net
loss.
It is now usual for the trading and the Profit and Loss accounts to be shown under one combined
heading, The Trading Account being the top section and the Profit and Loss account being the
lower section. It would be unusual for a trader to have sold all the goods at any particular date.
So in most cases there would be stock in hand at the end of the trading period. So it is normal
practice for this stock to be counted and valued at the price for which it could be sold. The figure
for this is normally called the closing stock and the details are given as a note at the end of the
Trial Balance. This amount is in fact entered as a debit in a new account called the Stock
account, which is an asset account and as a credit in the Trading account.
The Trading Account also shows any items of expenditure which can properly be allocated to
expenses connected with the purchase, manufacture or stage of goods, i.e. rent of warehouse,
wages of store men, carriage inwards, etc.
72
Format for the trading account:
Name
Trading Account for the year ended 31 Dec…
shs shs shs
Sales x
Less: Returns Inwards (x)
x
Less: Cost of Sales
Opening stock x
Purchases x
Add: Carriage Inwards x
x
Less: Returns Outwards x x
Cost of stock available for sale x
Less: Closing stock x (x)
Gross Profit x
7.2.3 Other considerations
Returns Outwards - Goods returned to suppliers, so this reduces the cost of purchases.
Returns Inwards - Goods returned to the company by the customers who bought them,
so this reduces the sales figure.
Carriages Inwards - Is the cost of transport of goods into the firm and are therefore
added to the purchases figure.
Carriage Outwards - Is the cost of transport of goods out of the firm to its customers, it
is not part of the firm's expenses in buying the goods and is always entered in the Profit
and Loss Account as an expense not the Trading Account.
Depreciation - This is discussed later, but generally the provision for depreciation for
the accounting period is considered an expense to the business is entered on the Profit
and Loss Account. (The total depreciation of the asset is taken account of on the Balance
Sheet).
73
7.3 Effects of Credit or Loss on Capital
For the accountant, profit means the amount by which revenue exceeds expenses for a set of
transactions for a period.
Revenue is the cash value of goods and or services consumed by the customers. It shows the
inflows of asset or an entity or settlement of liability during a period from delivering or
producing goods, rendering services or other activities that constitutes the entities ongoing major
operations.
An expense is the value of the asset used up to obtain revenue. It is the outflow or incurrence of
liabilities during a period from delivering or producing goods, rendering services or carrying out
other activities that constitute the entities ongoing major or central operations.
Therefore:
(a) ) Revenue less expenses = profit
(b) Expenses > revenue = loss
7.4 Effects of Profit or Loss on Capital:
 Profit increases capital: Opening capital + profit = new capital.

 Loss decreases capital: Opening capital - loss = new capital
Profit or Loss and Expenses: There are costs associated with the selling of goods - known
as expenses. Every dollar spent for expense reduces profit. We, therefore, have to open an
expense account for each type of expense.
Therefore:
a) Gross profit - expenses = net profit
b) Expenses - gross profit = net Loss
74
Format for a Trading, Profit and Loss Account
Name
Trading, Profit and Loss Account for the year ended 31/12/-------
shs. shs. shs.

Sales x
Less: Returns Inwards x
x
Less: Cost of sales

Opening stock x
Purchases x
Add: Carriage Inwards x
x
Less: Returns Outwards x x
Cost of goods available for sale x
Less: Closing stock x (x)
Gross Profit x
Discount received x
Rent received x
Interest received x
Other incomes x
x
Less: Expenses
Carriage Outwards x
Discounts allowed x
Postage & stationary x
Salaries & wages x
Rent paid x
Insurance & rates x
Bank charges x
Other expenses x (x)
Net profit/ (loss) x/(x)
7.5 Drawings
Whenever the owner of a business takes out money or goods out of the business for personal use
it is known as drawings. Drawings reduce capital. A drawings account is prepared and each
entry made in this account. The total is posted to the capital A/C
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7.6 Revenue and Double Entry:
Just as we have to record expenses we have to record revenues. Therefore, if a part of the
business premises is sublet, the money you receive is known as rent receivable and must be
recorded in a revenue account. Therefore, if the business sublet a part of the premises to Mr.
James for $50,000 per month and he pays his rent by cheque, the two accounts will be:
Bank - Which you debit.
Rent receivable - Which you credit.
Example 7.1
The accountant of Yummy Products has compiled the following information from the companies
records as a basis for preparation of an income statement for the year ended 31st December 2011.
Details Shs
Sales revenue 970,000
Cost of goods sold 422,000
Beginning inventory on 1/1/2011 82,000
Purchases 421,000
Closing inventory 81,000
Dividends declared 14,400
Wages and salaries in sales 95,000
Advertising expenses 20,000
Supplies expense sales dept 11,400
Depreciation sales van 42,000
Mailing expense for sales 6,000
Administrative sales expenses 135,900
Depreciation expense building 28,000
Other administrative expenses 46,700
Required
Prepare an income statement for the period ending 31st December 2011.
7.7 Balance Sheet
Balance sheet shows the resources (assets) that remain at the end of the period and available for
use in the next period(s). It also shows claims (liabilities) to those resources that remain unpaid
at the end of the period and the difference which is capital presented in the various forms are
constituted. Resources are described as assets. Assets can either be fixed or current. Fixed assets
76
are acquired for use over a long period of time. They are also referred to as non-current assets.
They include land, buildings, motor vehicles etc. the balances for such assets are obtained from
the general ledger. Current assets are short term assets such as stock, debtors and cash liabilities
and may be classified as short term or long term. Short-term liabilities are the ones expected to
be settled within the next one financial year such as creditors. Long term liabilities are payable
over a long period of time and include such liabilities as bank loans.
According to the International Financial Reporting Standards (IFRS), the balance sheet is
classified into;
1. Owners capital + Reserves (retained earnings)
2. Liabilities
3. Assets
Balance sheet as at a given date

Non-current assets
Land and buildings xxx
Plant and machinery xxx
Motor vehicles xxx
Xxx
Current assets xxx
Stock xxx
Debtors xxx
Cash xxx xxx
Current liabilities
Creditors xxx
Bank overdraft xxx [xxx]
Net assets xxx
Financed by:
Capital xxx
Net profit xxx
Total capital xxx
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Notice that capital structure depends on the business organization as well as the various forms of
financing used by the firm. The net assets figure must equal that of total capital. The example
below illustrates the construction of financial statements from figures listed in the trial balance.
The Trial balance of Ms Konde as at 31st December 2010 is as follows;

DR CR statement
Sh. ‘000’ sh. ‘000’
Sales 252500 T
Purchases 148800 T
Advertising 5400 P&L (expense)
Telephone P&L (expense)
Stock 1st January 2004 12350 T
Salaries and wages 46000 P&L (expense)
Electricity 3000 P&L (expense)
Rent 2000 P&L (expense)
General expenses 4700 P&L (expense)
Land and buildings 100000 BS(fixed asset)
Furniture 30000 BS(fixed asset)
Motor vehicles 21500 BS(fixed asset)
Debtors 23850 BS(current asset)
Cash 125 BS(current asset)
Creditors 12041 BS(current asset)
Capital 136884 BS(capital)
401425 401425
Note: The stock as at December 2004 was valued at sh. 16,300,000.

Required;
Draw the trading, profit and loss account for the year ended 31st December 2004 and the balance
sheet as at 31st December 2004.
T= trading; P & L= profit and loss accounts; BS = balance sheet
78
Suggested solution
MS KONDE
TRADING AND PROFIT AND LOSS ACCOUNT
FOR THE YEAR ENDED 31ST DECEMBER 2004
Sh.’000’ sh. ‘000’
Sales 252500
Opening stock 12350
Purchases 148800
Less closing stock [16300]
Cost of goods sold [144850] [144850]
Gross profit 107650
Less expense:
Advertising 5400
Telephone 3700
Salaries and wages 46000
Electricity 3000
Rent 2000
General expenses 4700 [64800]
Net profit 42850
MS KONDE
BALANCE SHEET
AS AT DECEMBER 31ST 2004
Sh. ‘000’ sh. ‘000’ sh. ‘000’
Non-current assets:
Land and buildings 100000
Furniture 30000
Motor vehicles 21500
151500
Current assets:
Stock 16300
Debtors 23850
Cash 125
40275 40275
Current liabilities
Creditors 12041 12041
28234 28234
NET ASSETS: 179,734
FINANCED BY:
CAPITAL 136884
NET PROFIT 42850
TOTAL CAPITAL 179,734
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In this chapter the final accounts which are the trading account, profit & loss account and balance sheet
have been discussed at length. The chapter has summarized the accounting cycle.
Nominal Accounts shown in the trial balance are taken in the trading account and profit and loss account.
Trading Account summarizes the trading activities (sale and purchase of goods/stocks) of the
business and tries to determine the gross profit for the relevant financial period.
Profit & Loss Account shows the net profit or net loss that the business has made from all the
activities during a financial period.
Net Profit is added to the capital figure brought forward and drawings a re deducted to find the
adjusted capital figure. These adjustments are shown in the balance sheet.
Balance sheet is a simple report that shows the assets and liabilities of the business and the
capital of the owner as at a certain point in time.
The balances appearing in the balance sheet are taken as balances brought forward in the
respective ledger accounts opened on the first date of the following accounting period.
80
1. What are the components of final accounts?

2. Kimemia trial balance as at 30th September 2012 was as follows
Dr Cr
Shs. ‗000‘ Shs ‗000‘
Capital 30,955
Drawings 8,420
Cash at bank 3,115
Cash in hand 295
Debtors 12,300
Creditors 9,370
Stock 30th September 2012 23,910
van 4,100
Office equipment 6,250
Sales 130,900
Purchases 92,100
Returns inwards 550
Carriage inwards 215
Returns outwards 307
Carriage outwards 309
Motor expenses 1,630
Rent 2,970
Telephone charges 405
Wages and salaries 12,810
Insurance 492
Office expenses 1,377
Sundry expenses 284
171,532 171,532
Additional note:
Stock at 30 September 2012 was Shs. 27,457,000
Required
2.1 Prepare the trading, profit and loss account for the year ended 30th September 2012.
2.2 Prepare a balance sheet as at 30th September 2012.
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3. The following trial balance was extracted form the books of Evelyne a sole trader, at 31st
December 2011
Shs Shs.
Drawings/Capital 2,148 20,271
Debtors/Creditors 7,689 5,462
Purchases/Sales 62,101 81,742
Rent and Rates 880
Light and heat 246
Salaries and wages 8,268
Bad debts 247
Provision for bad debts 326
Stock in trade 31st Dec 2010 9,274
Insurance 172
General Expenses 933
Bank balances 1,582
Motor van at cost/Provision for 8,000 3,6000
depreciation
Proceeds on sale of van 250
Motor expenses 861
Freehold premises at cost 15,000
Rent received 750
Provision for depreciation on buildings 5,000
117,401 117,401
The following matters are to be taken into account:

1. Stock in trade at 31st December 2011 was Shs.9,884
2. Rates paid in advance at 31st December 2011, Shs.40
3. Rent receivable due at 31st December 2011, Shs.250
4. Lighting and heating due at 31st December 2011, sh.85
5. Provision for doubtful debts to be increased to Shs.388
6. Included in the amount for insurance Shs.172, is an item for Shs82 for motor insurance
and this amount should be transferred to motor expenses.
7. Depreciation has been and is to be charged on vans at an annual rate of 20% on cost.
8. Depreciate buildings Shs.500
9. On 1st January 2011 a van which had been purchased for Shs.1, 000 on 1st January 2009
was sold for Shs250. The only record of matter is the credit of Shs.250 to ―Proceeds of
sale on van‖ account.
Required:
A Trading Profit and Loss account for the year ended 31st December 2011 and a Balance Sheet
as at that date using vertical format.
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CHAPTER EIGHT: ADJUSTING ENTRIES
8.1 Introduction and Overview of Year End Adjustment Entries
Final Accounts are prepared, normally, for a complete period. It must be kept in mind that expenses and
incomes for the relevant accounting period are to be taken, while preparing final accounts. If an expense
has been incurred but not paid during the period, a liability for the unpaid amount should be created,
before finding out the operating result and financial position of a concern. In order to prepare the final
accounts on mercantile system of accounting, all expenses and incomes relating to the period, whether
incurred or not, received or not, should be brought into the books. For doing this, a concern is required to
pass certain entries at the end of the year to adjust the various items of incomes and expenses. Such
entries are called adjusting entries. Normally there are four main adjustments namely accruals,
expenses, prepaid expenses, accrued income, income received in advance.
8.2 Learning outcomes

a) Understand application of the accruals and prudence concepts in end of year adjustments.
b) Adjust expense accounts for accruals and prepayments and revenue accounts for amounts
owing.
c) Show accruals, prepayments and revenue debtors in the balance sheet.
d) Ascertain the amounts of expense and revenue items to be shown in the profit and loss
account after making adjustments for accruals and prepayments.
e) Explain and show how bad debts are written off and why provisions for bad and doubtful
debts are made.
f) Make the necessary entries in the profit and loss account and the balance sheet for bad debts
provisions for doubtful debts and provisions for cash discount.
8.3 Fundamental Accounting Concepts
One fundamental accounting concept namely prudence concept states that revenue and profits
are only earned when represented either by cash or some other asset with reasonable certain cash
value. In view of this concept all expected losses are taken into consideration while preparing
Trading a/c and Profit & Loss a/c.
83
The accrual concept means that revenue and cash are earned and incurred not as cash is received
or paid out but as they are reacquired as being applicable to a particular period. Hence all
expenses or income relating to any particular accounting period is taken into consideration while
preparing final account.
8.4 Accruals and Prepayments
When trading a/c and profit & loss a/c are prepaid for a specific period, we must bring into a/c
i. All expenses relating to the period whether we have actually paid them or not
ii. All items of income and gain whether we have actually received them or not.
This necessitates the need for adjustment at the end of the year relating to:-
1. Accrued Expenses
These are outstanding expenses incurred but not yet paid in cash or recorded in the books. An
adjustment for accrued expenses is done to record an obligation that exists during an accounting
period or at the balance sheet date. The entry is also made to recognize the expenses that apply
to the current accounting period.
Treatment
Dr: The relevant expenses A/C
Cr: Accrued expense account
Example 8.1;
Salaries and wages paid during the year amounted to sh.6, 200. Accrued wages as at 31 Dec
2009 amounted to sh.2, 250. Show the entries necessary.
2. Prepaid Expenses/Prepayments
Those which already have been paid but relatively to the following accounting period. They are
paid in cash and are recorded as assets before they are used, for example, prepaid rent, prepaid
insurance, prepaid advertising, and prepaid interest.
Dr: prepayment a/c
Cr: P&L a/c
They appear as correct asset in the balance sheet
84
Example 8.2:
Insurance paid during the year amounted sh.3, 800. Prepaid insurance during the year amounted
to sh.1, 200. Show the necessary end.
3. Accrued Income/Revenue
This is the income relating to the current accounting period earned but has not been received or
recorded.
Treatment
Dr: accrued income a/c
Cr: P&L a/c or respective income or gain a/c
It appears as current asset in the balance sheet.
Example 8.3
Rent received during the year amounted to sh.6, 500. Accrued or owned rent as at 31 Dec 2009
amounted to sh.700 show the entry.
4. Income in Advance/Unearned Revenue

This is the income which has already been received but relates to the following accounting
period. It is recorded as a liability before it is earned.
Dr: profits & Loss a/c
Cr: income in advance a/c
Example 8.4
Rent received during the year amounted to sh.8, 000,
Rent received in advance as at 31 Dec 2009 amounted to sh.800. Show the relevant entries.
8.5 Bad and Doubtful Debts
Most businesses sell goods on credit with the hope that the buyer (debtor) will pay within the
credit period. However, all debtors will pay the debt but those who do not pay are referred to as
Bad Debtors and the debt as Bad Debt. A bad debt is an amount owed to a business which it
considers or proves to be, irrecoverable, e.g. due to death, bankruptcy, insanity etc.
Irrecoverable debt is removed from the books such that the amount of debtors as shown in the
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books of account due to the business. However bad debt from customers, is considered as an
asset unless prove otherwise.
Treatment
Dr: bad debt acc

Cr: the debtor‘s personal a/c
8.4.1 Calculation of Provision for Bad and Doubtful Debts:
Normally, problem states the % of Provision for Bad and Doubtful Debts. On which amount of debtors,
this % of Provision for Bad and Doubtful Debts is to be calculated? From debtors, first deduct total bad
debts from debtors. Bad debts are that amount, appearing in the trial balance and any further provision
that may be required in the adjustment for bad debts.
On the balance amount of debtors only, Provision for Bad and Doubtful Debts is to be calculated. Reason
is simple. Once, debt becomes bad, it would be written off. So, bad debts amount is already excluded
from debtors. The balance amount of debtors is only good debts, expected to be realized. Even this
amount may not be totally recoverable and for this reason only, Provision for Bad and Doubtful Debts
would be created.
Provision for Bad and Doubtful Debts is to be calculated on that amount of debtors, after deducting
bad debts. Provision for Bad and Doubtful Debts is not to be calculated on the total amount of
debtors.
8.4.2 Accounting for Bad & Doubtful Debts:
Bad debts
When a debt becomes bad the following entries will be made:
Debit bad debts account
Credit debtors account with the amount owing.
At the end of the accounting period
Debit Profit and Loss Account.
Credit bad debts account to transfer the balance on the bad debts account to the Profit and
Loss Account.
86
Doubtful Debts
A provision for doubtful debts can either be for a specific or a general provision. A specific
provision is where a debtor is known and chances of recovering the debt are low. The general
provision is where a provision is made on the balance of the total debtors i.e. Debtors less Bad
debts and specific provision. The accounting treatment of provision for doubtful debts depends
on the year of trading and the entries will be as follows. If it is the 1st year of trading (1st year of
making provision):
i. Debit P&L a/c.
ii. Credit provision for doubtful debts (with total amount of the provision).
In the subsequent periods, it will depend on whether if it is an increase or decrease required on

the provision.
If it is an increase:
i. Debit P&L a/c.
ii. Credit provision for doubtful debts (with increase only).
If it is a decrease:
i. Debit provision for doubtful debts.
ii. Credit P&L a/c (with the decrease in provision only).
Format;
Debtors x
Bad debts (x)
x
Specific Provision (x)
x
General Provision (x)
x
Example 8.5
A firm started trading in the year 2010, the balance on the debtor‘s account was shs 400,000.
Bad debts amounting to shs. 40,000 were written off from this balance, there was a specific
87
provision of shs 5,000 to be made to one of the debtors and a general provision of shs5% was to
be made on the balance of the debtors. The ledger accounts of 2010 were as follows:
Debtors Provision for doubtful debts
2010 Shs 2010 Shs 2010 Shs 2010 Shs

Bal b/d 400 000 Bad debts 40 000 31/12 Bal c/d 22 750 31/12 22
Bal c/d 360 000 P&L 750
400 000 400000
Bad debts
2010 Shs 2010 Shs.
Debtors 40 000 31/12 P & L 40 000
shs
Debtors 400,000
Bad debts (40,000)
360,000
Specific Provision (5,000)
355,000
General Provision (5%) (17,750)
337,250
8.4.3 Bad Debts Recovered
A firm may be able to recover a debt that was previously written off. The following entries will
be made if this happens:
i. Debit – Debtors
Credit – credit bad debts recovered account – to restore the bad debt recoverable.
N/B: This should be the amount to be recovered.
ii. Debit – Cashbook
Credit – Debtors with the cash received.
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iii. Debit – bad debts recovered account.
Credit – P & L account with the same balance as bad debts account.
Example 8.6:
A firm recovers debts amounting to £10,000 that had been written off in the previous periods. In
the same financial period the firm writes off bad debts amounting £30,000. The ledger accounts
will be as follows:
Bad debts
shs. shs.
Debtors 30,000 Bad Debt Recovered 10,000
P\L 20,000
30,000 30,000
Bad debts recovered

shs. shs.
Bad Debt 10,000 Debtors 10,000
8.5 Provision for Discounts Allowable.
In some cases a firm may create a provision for discounts allowable in addition to provision for
doubtful debts. This happens where a firm anticipates that some of the debtors may take up cash
discounts offered by the firm. The accounting treatment is similar to accounting for provision
for doubtful debts. The provision should be made after creating a provision for doubtful debts
(debtors figure less either general/specific provision for doubtful debts) as shown below.
Debtors x
Bad debts (x)
x
Specific provision (x)
x
General provision (x)
x
Provision for discount allowed (on balance) (x)
X
89
In a Profit & Loss Account it would appear as follows;
shs shs
Incomes
Decrease in provision for D/Debts x
Decrease in provision for discounts allowed x
Expenses
Bad debts x
Increase in provision for D/Debts x
Increase in provision for discounts allowed x
In a Balance Sheet it would appear as follows.
Current Assets shs shs

Debtors x
Less: provision for Doubtful Debts (x)
Less: provision for discounts allowed (x) x
8.6 Provision for Discount Received
A discount received is an allowance by the creditors to the firm to encourage the firm to pay the
amount dues within the agreed time which is deducted from the invoice price. Provision for
discount received is created for the discount received from the creditors regarding the payments
to be made in the following month. It is considered a gain and the balance is shown as a
deduction from creditors in the balance sheet. It is treated as follows.
(i) DR: Provision for discount received a/c
Cr: Profit & Loss a/c
(ii) Incase of an increase
Dr: Provision for discount received ac
Cr: Profit & loss ac with increase
(iii) Incase of a decrease
Dr: Profit & Loss a/c
Cr: Provision for discount received a/c
90
Example 8.7
The following trial balance was extracted from the books of a trader 31 Dec 2011
Sh.
Capital 400,000
Gross profit 276,500
Salaries 89,4 00
Rates and insurance 17,2 00
Office expenses 11,7 00
Transport expenses 23,3 00
Bad debt w/o 46,0 00
Drawings 76,0 00
Stock 31 Dec 2011 72,5 00
Debtors 84,0 00
Provision for bad debt 2011 1,900
Machinery 220, 000
Motor vehicle 175, 000
Office appliances 30,4 00
Provision for depreciation on machinery 98,000
On motor vehicle 45,000
Creditors 70,700
Cash at bank 7,000
KDC loan 50,000
KDC loan interest 4,80 0
Freehold promise 170, 000
949,100 949,100
Additional Information
i. Machine has unfulfilled at 7yrs & scrap rate of sh.10, 000
ii. Motor Vehicle are to be w/o at 25% on book value
iii. Office appliance are to be valued at sh.25, 000
iv. Provision for bad debt is to be adjusted to 3% at debtors
Required
Prepare a profit & loss a/c for 2011 and a balance sheet at 31 Dec 2011
91
Profit & Loss ac for the year ended 31 Dec 2011
Sh. Sh.
Salaries Gross Profit 276,500
Rates & insurance 17,200
Office expenses 11,900
Transport expenses 23,300
Bad debt 4,600
Loan interest 4,800
Provision for bad debt (M1) 620
Depreciation on machine (M2) 30,000
Depreciation on M.V (M3) 620
Depreciation on office appliances (M4) 5,400
Net profit 56,780
276,500 276,500
Balance sheet as at 31 Dec 2011

Sh. Sh.
Capital 400,000 Freehold premise 170,000
Add: Net profit 56,000 Machine 220,000
456,000 Less provision for depreciation 128,000 92,000
Less: drawings 46,000 Motor vehicle 175,000
410,780 Less provision for depreciation 77,500 97,500
ICDC loan 50,000 Office appliances 30,400
Creditors 70,700 Less provision for depreciation 5,400 25,000
Overdraft 7,000 384,500
Stock 72,500
Debtor 84,000
Less provision for bad debt 2,520 81,480
538,400 538,400
Working
1. Provision for bad debt at 3% at 84,000
Less existing provision 1,900
Additional provision 620
220,000−10,000
2. Depreciation on machinery =
7
= 30,000
3. Cost of motor vehicle sh.175,000
Less accumulated depreciation b/f sh.45, 000
Book value on 1.1.2011 sh.130, 000
Depreciation @25% on 130,000 sh.32, 500
4. Value of office appliance given sh.30,400

Revalued at sh.25, 000
Depreciation for 2011 sh.5, 400
92
8.6 Depreciation of Fixed Assets Accounts
Depreciation is a fall in the value of a fixed asset due to usage, wear and tear, passage of time or
obsolescence. In other words, it is the decrease in the usefulness of fixed assets like office
equipment, motor vehicles, plant equipments which are used to generate revenue and unlike
supplies there is no visible reduction in the quantity of this assets and instead this assets loose
their ability to provide useful service. It is calculated only once in a year at the end of each
financial year.
Depreciation in accounting terms is the systematic process of allocating the cost of fixed assets
to expense in the periods an organization is expected to benefit from the use of the asset. In
other words, a fixed asset depreciates while being used to generate revenue thus a portion of the
cost should be recorded as an expense. This periodic expense is called depreciation expense.
An adjusting entry is necessary to record the depreciation expense for a specific period. While
preparing the adjusting entry, the depreciation expense account is debited for the amount of the
periodic depreciation, however, the fixed asset account is not credited (reduced) instead on
account entitled accumulated depreciation (provision for depreciation) is credit. This is because
both the historical cost of the fixed asset and depreciation since the asset was purchased are
normally reported on the balance sheet.
There are three (3) basic methods of calculating;
1. Fixed Investment/straight line method

Amount at depreciation each year is fixed and equal.
Applied where:-
a) Assets that give more or less the same services over their entire life and when their
useful life is over, they are of no value to owner e.g. leasehold property
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93
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2. Reducing Installment Method
Depreciation in each year is less than the amount provided for in the previous year. It is
calculated by applying a fixed percentage on the book value at the asset each year.
Illustration
Mr. Ogola bought a car for sh.120, 000 on January 2009 depreciation is at 20% per year.
Calculate the car depreciation for the year 2009, 2010 and 2011.
Solving
Cash Sh. 150,00

Rate 20%
Depreciation in
2009 = 20% × 150,000 =
2009 depreciation = 30, 000
2010 = 150,000- 30,000
=120,000 × 20%
2010 Depreciation = 24,000
2011 = 120,000 - 24,000
= 96,000
=20% × 96,000
2011 Depreciation = 19,200
Treatment for depreciation
Depreciation represents a loss on a fixed asset which is chargeable against profit made.
Treatment
Dr: Profit & Loss Acc
Cr: Assets Account or provisions for depreciation
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Example 8.8
A machine cost sh.10, 000 is to be depreciated at the rate of 15% on the straight line method
assuming that this machine was purchased on 1st Jan 2010. Show the entries to record this as at
31st Dec 2010, 2011 & 2012
c) Motor vehicle a/c
d) Provision for depreciation
e) Profit and loss a/c
f) Balance sheet extracted
Motor vehicle a/c

2010 Sh 2010 Sh
Jan 1st bank 10,000 Dec 31st Bal c/d 10,000
2011 2011
Jan 1st Balance c/d 10,000 Dec 31st Balance c/d 10,000
2012 2012
Jan 1st Balance c/d 10,000 Dec 31st Balance c/d 10,000
3. Revaluation method
The fixed asset concerned is valued by a competent person at the end of the each financial year
and depreciation arrived at by deducting the value at the end of the year from the value at the
beginning of the year. Revaluation method is particularly suitable for such assets that are smaller
in value have greater degree of breakage and are of various items e.g. loose tools, crockery and
cutlery, book etc.
8.6.1 Provision for Depreciation
This account is part of fixed assets account and is used to accumulate depreciation provided
against the asset. One provision for depreciation account is opened for every fixed asset e.g. is
there a motor vehicle a/c there will be opened a provision for depreciation on motor vehicle
account. The balances or provision for depreciation account is carried forward to the next
95
financial year hence balances increased every year. There are two main methods which are
followed to calculate depreciation for provision for assets bought or sold;
i. Year fully
ii. Half yearly
Profits & Loss a/c extract
2009 Sh
Depreciation 1,500
2010
Depreciation 1,500
2011
Depreciation 1,500
Provision for depreciation

2009 Sh 19-5 Sh
Dec 31st Balance c/d 1,500 Dec 31st P&L a/c 1,500
2010 19-6
Dec 31st Balance c/d 3,000 Jan 1st balance c/d 1,500
Dec 31st P&L a/c 1,500
3,000 3,000
2011 19-7
Dec 31st Balance c/d 4,500 Jan 1st Balance b/d 3,000
Dec 31st P&L a/c 1,500
4,500 4,500
Balance Sheet
2009 Sh Sh
Motor vehicle
Cost 10,000
Less provision for depreciation 1,500 8,500
2010
Cost 10,000
Less: provision for depreciation 3,000 7,000
2011
Cost 10,000
Less provision for depreciation 6,500 5,500
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The learner should have learnt the following at the end of this topic;
Prudence concept states that revenue and profits are only earned when represented either by cash
or some other asset with reasonable certain cash value.
Accrual concept means that revenue and cash are earned and incurred not as cash is received or
paid out but as they are reacquired as being applicable to a particular period.
Accrued Expenses are outstanding expenses incurred but not yet paid in cash or recorded in the
books.
Prepaid Expenses/Prepayments are expenses already paid but relatively to the following
accounting period.
Accrued Income is the income relating to the current accounting period earned but has not been
received or recorded.
Income in Advance is the income which has already been received but relates to the following
accounting period.
A bad debt is an amount owed to a business which it considers or proves to be, irrecoverable and
bad debtors are considered debtors who will not pay the debt.
The provision for bad debts & doubtful debts are needed to prevent a high value of debtors
showing on the balance sheet which could mislead someone looking at the balance sheet and to
give more accurate figures on profits and losses.
Provision for Discounts Allowable occurs where a firm anticipates that some of the debtors may
take up cash discounts offered by the firm.
Provision for Discount Received is created for the discount received from the creditors regarding
the payments to be made in the following month.
Depreciation is the systematic process of allocating the cost of fixed assets to expense in the
periods an organization is expected to benefit from the use of the asset. It is an expense of the
business which has to be charged against any accounting period during which a fixed asset has
been in use. There are several methods of calculating depreciation among them being the
straight line method, reducing installment method and the revaluation method.
97
1. Write short notes on;

(a) ) Accrued expenses
(b) Prepaid expenses
(c) ) Accrued Income
(d) Unearned revenue
2. Explain the following terms;
a) Provision for bad debts
b) Provision for discount allowed
c) Provision for discount received
3. The following is a list of balances for Mr. Kamau which had been extracted from his ledger
as at 30th June 2011.
Shs. ‗000‘
Capital 83 887
Sales 259 870
Trade creditors 19 840
Returns out 13 407
Provision for bad debts 512
Discounts allowed 2 306
Discounts received 1 750
Purchases 135 680
Returns inwards 5 624
Carriage outwards 4 562
Drawings 18 440
Carriage inwards 11 830
Rent, rates and insurance 25 973
Heating and lighting 11 010
Postage, stationery and telephone 2 410
Advertising 5 980
Salaries and wages 38 521
Bad debts 2 008
Cash in hand 534
Cash at bank 4 440
Stock as at 1st July 2010 15 654
Trade debtors 24 500
Fixtures and fittings at cost 120 740
Provision for depreciation on fixtures and fittings as at 30th June 2011 63 020
Depreciation 12 074
98
The following additional information as at 30th June 2011 is available
(a) Stock at the end of year was valued at shs 17 750 000
(b) Insurances have been prepaid by shs. 1 120 000
(c) Heating and lighting is accrued by shs. 1 360 000
(d) Rates have been prepaid by shs. 5 435 000
(e) The provision for bad debts is to be adjusted so that it is 3% of trade debtors.
Required
(i) Prepare Mr. Kamau‘s trading and profit account for the year ended 30th June 2011
(ii) Prepare a balance sheet as at 30th June 2011.
99
CHAPTER NINE: CONTROL ACCOUNTS
This chapter will cover the benefits of control accounts, the process involved in preparing control
accounts and reconciling them to the ledgers. Accounting systems are set up so as to embed
controls that help ensure that errors are minimized and that nothing occurs that shouldn‘t e.g.
embezzling of funds. The control account is a summary account that enables one to see 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. It helps to identify or detect certain
errors that may not be detectable through the trial balance as it only looks at the details of the
ledgers whose control accounts do not balance to find errors.
9.2 Learning outcomes

a) Explain the usefulness of control accounts.
b) Prepare a sales ledger control account and a purchases ledger control account.
c) Reconcile the purchases ledger and the sales ledger with their respective control accounts.
9.3 Control Accounts
Control accounts are total accounts inserted in a ledger to make the ledger self balancing. By
control we mean that the total on the control accounts should be the same as the totals on the
ledger accounts which proof the arithmetical accuracy of the book keeping entries in the ledger.
Control accounts are balanced off at the end of every month. These accounts are based on the
principle that if the opening balances of an account is known, together with information of the
additions and deductions entered in the account, the closing balance can be calculated.
Control accounts for debtors and creditors are prepared from totals in subsidiary books which are
posted in the nominal ledger in the respective accounts and are also entered into control account.
There are two main types of control accounts:
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(i) Sales ledger control Account
(ii) Purchases Ledger Control Account
9.2.1 Sales Ledger Control Account
It is also referred to as total debtors account. The balance on the sales ledger control account
should be the same as the total of the balances in the sale ledger.
Format of a Sales Ledger Control
Sales Ledger Control a/c
1. Balance b/d of the total debit 1. Total credit balances of the sales ledger
balances from previous period brought forward
2. Total credit sales for the period 2. Total cash received from credit
(from the sales journal) customers/debtors (from cash book)
3. Refunds to customers (from 3. Total cheques received from credit
cashbook) customers/debtors (from cash book)
4. Dishonored cheques (from 4. Total returns-inwards (returns-inwards
cashbook) journal)
5. Bad debts recovered (from 5. Total cash discount allowed to
general journal) customers (from cash book)
6. Bad debtors written-off (from general
journal)
7. Cash received from bad debtors
recovered (cash book)
8. Purchases Ledger contra
9. Allowances to customers (price

reduction in excess to discounts
allowed)
6. Total credit balances of the sales 10. Total debit balance carried down to the
Ledger carried forward next period – to be derived after posting
all those transactions
Refunds to Customers
Sometimes a firm can refund some cash on the customers account. This takes place when there
is a credit balance on the debtor‘s a/c and the customer is not a creditor too.
The entry will be:
Dr. Debtor‘s a/c
Cr. Cashbook
101
Example:
Debtor A
Shs shs
Sales 1000 Cashbook 950
(Refunds) C/B 100 Discounts 50
Returns 100
1100 1100
If the firm has not paid this amount owed to the customer, then it‘s carried forward to the next
period then is a credit balance in the customer‘s a/c. Therefore, if a firm has several customer,
this information will be shown in the control a/c as total balance c/f (debit side).
9.2.2 Purchases Ledger Control Account
It is also referred to as Total Creditors Account. The balance carried down (bal c/d) on the
purchases Ledger Control Account should be the same as the total of the balances in the
purchases ledger.
Format of a Purchases Ledger Control Account

Purchases Ledger Control A/C
1. Total debit balances from purchases 1. Total credit balance brought
ledger brought forward from forward (of purchases ledger from
previous period the previous period)
2. Total cash paid to creditors 2. Total credit purchases for the period
(from cash book) (from purchases journal)
3. Total cheques paid to creditors 3. Refunds from suppliers
(from cash book) (from cash book)
4. Total cash discounts received
(from cash book)
5. Allowances by suppliers
6. Sales ledger contra
7. Total returns outwards

(from returns-outwards journal)
8. Total credit balance 4. Total debit balances (of the
(to be derived after posting entries) purchases ledger carried forward)
102
Contra against the purchases ledger balances:
Some debtors may also be creditors in the same firm and therefore, if the amount due to them as
creditors is less than what they owe as debtors, then the credit balance is transferred from their
creditors‘ a/c to their debtors‘ a/c as a contra entry.
Example:
Debtor (A)
Sales 2000 Contra- purchases 1000

Bal c/d 1000
2000 1100
Creditor (A)
Contra – Debtor 1000 Purchases 1000
9.3 Purpose of Control Accounts
1. Provide for arithmetical check on the postings made in the individual accounts (either in
the sales ledger or purchases ledger.)
2. To provide for a quick total of the balances to be shown in the trial balance as debtors and
creditors.
3. To detect and prevent errors and frauds in the customers and suppliers account.
4. To facilitate delegation of duties among the debtors and creditors clerks.
NOTES:
The following notes should be taken into consideration:
1) Cash received from CASH SALES should NOT be included in sales ledger control a/c.
2) Only cash discounts (allowable & receivables) should be included. Trade discounts
should NOT be included.
103
3) Provision for doubtful debts is NOT included in the sales ledger control a/c. i.e. increase
or decrease in provisions for doubtful debts will not affect this account.
4) Cash purchases are NOT posted to the Purchases Ledger Control A/C. However in some
cases it can be included especially where there are incomplete records (Topic to be
covered later).
5) Interest due that is charged on overdue customers‘ account may also be shown on the
debit side of the sales ledger control. However when trying to determine the turnover
under incomplete records then it is wise to omit it.
 Control accounts enable errors to be traced down to the ledger that does not balance and thus
there is no need of checking all the books in full to find an error.
 Total balances from the sales ledger are not entered in the control account, instead, balance
off the control account and check whether the balance c/d is the same as the total of all the
individual balances in the sales ledger.
 Like a trial balance, if the totals of a control account are not equal and the entries made to it
were correct (i.e. the amounts transferred to it from the books of original entry have been
correctly summed), this shows that there is an error somewhere in the ledger.
104
1. Explain the purposes for which control accounts are prepared.

2. Describe the procedures followed in the preparation of sales ledger control a/c and purchases
ledger control account.
3. The balances and transactions affecting the control accounts of Rafiki Enterprises for the
month of November 2010 are listed below:-
Sh.
Balances on 1 November 2010:
Sales ledger 9,123,000 (debit)
211,000 (credit)
Purchases ledger 4,490,000 (credit)
88,000 (debit)
Transactions during November 2010:
Purchases on credit 18,135,000
Allowances from suppliers 629,000
Receipts from customers by cheques 27,370,000
Sale on credit 36,755,000
Discount received 1,105,000
Payments to creditors by cheques 15,413,000
Contra settlements 3,046,000
Bills of exchange receivable 6,506,000
Allowances to customers 1,720,000
Customers cheques dishonored 489,000
Cash received from credit customers 4,201,000
Refunds to customers for overpayments 53,000
Discounts allowed 732,000
Balances on 30 November 2010
Sales ledger 136,000 (credit)
Purchases ledger 67,000 (debit)
Required:
The sales ledger and purchases ledger control accounts for the month of November 2010 and
show the respective debit and credit closing balances on 30 November 2010.
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CHAPTER TEN : BANK RECONCILIATION STATEMENT
In this chapter, you will learn how to prepare a bank reconciliation statement, the major causes
for differences between cash book and bank statement and how dishonoured cheques are dealt
with in accounting. The cashbook for cash at bank records all the transactions taking place at the
bank i.e. the movements of the account held with the bank and the bank sends information
relating to this account using a bank statement for the firm to compare. Ideally, the records as
per the bank and the cashbook should be the same and therefore the balance carried down in the
cashbook should be the same as the balance carried down by the bank in the bank statement.
However, this is not the case in practice and the two (balance as per the bank and firm) are
different. A bank reconciliation statement explains the difference between the balance at the
bank as per the cashbook and balance at bank as per the bank statement.

a) Explain reasons for bank reconciliation.
b) Reconcile bank statement balances with cash book balances
c) Reconcile ledger accounts to suppliers statements
d) Make the necessary entries in the accounts for dishonored cheques.
10.3 Definition of Bank Reconciliation Statement
A detailed statement reconciling at a given date the cash balance reported by the bank with that
shown in the records of a business. All the transactions in a bank account are recorded in the
cash book in the bank column. The bank account opened by businessmen is normally current
account. In this accounts, the customers can deposit or withdraw money. The relationship
between a bank and its customers is one of the debtor and the creditors, e.g. If the trader has
deposited sh.10,000 into his bank account then the bank is the Debtor of the trade and from the
bank point of view the trader is a Creditor.
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Transactions which take place between the bank and a trader who is a customer at the bank are
recorded in:-
a. Traders cash book
b. Banks books
In the trader‘s cash book:-
a. Cheques and cash paid into the bank are debited
b. Cheques issued are credited.
In the banks book:-
a. Cash received by the bank is debited to cash account
b. Credited to the personal account at the trader.
Hence credit balance in a bank statement will appears as a debit balance in the traders‘ cash
book. If there will be a debit balance in the bank statement then it will appear as a credit balances
in the traders cash book. The credit balances indicate that there is an over draft. Normally the
bank sends copies of the ledger account of trader as it appears in the books of the bank at
regulars internal, normally is days or 30 days; bank statement. The cash balances in the bank
balances shown by the cash book will often disagree with the balance show by the bank
statement at a given time. The purpose of a bank reconciliation statement is to explain the
difference that exists between the two.
10.2.1 Factors contributing to these differences are:-
a) Items Appearing in the Cashbook and not Reflected in the Bank Statement.
i. Outstanding Cheque
Cheque drawn and entries in cash book but not presented at the bank for payment until after the
relevant date. Also referred to as unpresented Cheques.
ii. Uncredited deposits/cheques
These are cheques received from customers and other sources for which the firm has banked but
the bank has not yet availed the funds by crediting the firm‘s account.
iii. Book errors
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Amount debited or credited incorrectly;
iv. Entries that have been made by the account holder in his cash book may not appear in
the bank statement.
1. Cheques that have been made by the account holder in his cash book may not
appear in the bank statement.
2. Cheque deposited, particularly on the last day of the month.
b) Items appearing in the bank statement and not reflected in the cashbook:
(i) Bank charges: These charges include service, commission or cheques.
(ii) Interest charges on overdrafts.
(iii) Direct Debits (standing orders): They are orders by the account holder to the bank to
make regular payment of fixed amount at stated dates to certain firms or persons. e.g.
to pay CIC insurance.
(iv) Dishonored cheques: A cheque would be dishonored because:
 Stale cheques
 Post – dated cheques
 Insufficient funds
 Differences in amounts in words and figures.
(v) Direct credits
(vi) Bills of exchange, dividends etc, collected or paid Interest Income/Dividend incomes
10.3 Procedure of Bank Reconciliation Statement
10.3.1 Steps involved in preparation of the bank reconciliation statement
1. Adjusting cash book

To update the cashbook with the items appearing in the bank statement and not appearing in
the cashbook except for errors in the bank statement. Adjustments should also be made for
errors in the cashbook. All those items that are presented in the bank statement but are
missing from the cash book are entered in the cash book on the last date of the month. The
cash book is then balanced. If still the cash book still shows a balance different from the one
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shown on the bank statement, (due to entries present in cash book but not in bank statement)
hence need for bank reconciliation statement.
2. Compare the debit side of the cashbook with the credit side of the bank statement to
determine the uncredited deposits by the bank.
3. Compare the credit side of the cashbook with the debit side of the bank statement to
determine the unpresented cheques.
4. Prepare the bank reconciliation statement which will show:
(ii) Unpresented cheques
(iii) Uncredited deposits
(iv) Errors on the bank statement
(v) The updated cashbook balance.
Example 10.1
On 31st December 2010, the balances at bank as shown by the cash book was sh.25,370, where
the bank statement showed a credit balance at shs.25,670. Comparison at the cash book with the
bank statement showed the following differences:-
a. Cheques not presented for payment sh.12,340
b. Cheques paid to the bank but not credited by bank sh.12,160
c. Items shown in the bank statement but not yet entered in the cash book
i. Bank charges sh.240
Standing orders sh.460
Dividends sh.820
Required;
a) Adjust cash book
b) Bank reconciliation statement
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Answers
Cash book
2011 Sh 2009 Sh
Dec 31 Balance b/f 25,370 Dec 31 Bank charges 240
Dec 31 Dividends 820 Dec 31 Standing order 460
Dec 31 Balance c/d 25,490
26,190 26,190
Dec 31 balance b/f: sh.25, 490
Bank reconciliation statement
Sh
Balance as per cash book (adjusted) 25,490
Add
Cheque not presented 12,340
37,830
Deduct
Cheque not credited 12,160
Reduce as per bank statement 25,670
Format
Sh Sh
Balances as per cash book (adjusted) xxx
Add
Cheques issued but not yet presented
Cheque No…… xxx
xxx xxx
Less
Cheques deposited but not yet credited xxx
Details xxx xxx
Balance as per bank statement xxx
10.4 Summary of bank reconciliation procedure
a. When starting with a debit balance on cash book or the bank statement.
Add: (i) Cheque issued but not presented for payment at the bank
(ii) Cheque or bill of exchange directly credited by the bank unless you are
required to adjust the cash book first
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Deduct: (i) Cheques deposited into bank but not credited by the bank
(ii) Bank charges, standing order unless you are required to adjust cash
book first
b. When starting with credit balances on cash book or the bank statement
Deduct: (i) Cheque not presented for payment at the bank
(ii) Amount directly credited by the bank (i.e. relevant)
Add: (i) Cheques not credited by the bank
(ii) Bank charges and standing orders
NB: the credit balances on cash book or debit balance on bank statement shows an over draft
10.4.1 Errors of the Bank Statement (Made By The Bank).
Such errors include:

 Overstating/understating.
 Deposits
 Withdrawals
10.5 The Purposes of a bank reconciliation statement.
1. To update the cashbook with some of the items appearing in the bank statement e.g. bank
charges, interest charges and dishonoured cheques and make adjustments for any errors
reflected in the cashbook.
2. To detect and prevent errors or frauds relating to the cashbook.
3. To detect and prevent errors or frauds relating to the bank.
 A bank reconciliation statement can be prepared either before or after updating the cash book
with the items omitted from it that are shown on the bank statement.
 The purpose of a bank reconciliation statement is to explain the difference that exists
between the cash book and the bank statement which is attributed by several factors.
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1. Explain the term ―bank reconciliation‖ and state the reasons for its preparation.
2. The bank statement of Gathoni for the month of June 2010 showed that the bank balance was
Sh. 706,500 whereas his cash book balance was Sh.2,366,500. His accountant investigated
the matter and discovered the following discrepancies:
1. Bank charges of Sh.3, 000 had not been entered in the cashbook.
2. Cheques drawn by Gathoni totaling Sh.22, 500 had not yet been presented to the
bank.
3. He had not entered receipts of Sh.26, 500 in his cashbook.
4. The bank had not credited Mr Gathoni with receipts of Sh.98, 500 paid into the bank
on 30 June 2010.
5. Standing order payments amounting to Sh.62, 000 had not been entered into the
cashbook.
6. In the cashbook Gathoni had entered a payment of Sh.74, 900 as Sh.79, 400.
7. A cheque for Sh.15, 000 from a debtor had been returned by the bank marked ―refer
to drawer‖ but had not been written back into the cashbook.
8. Gathoni had brought forward the opening cash balance of Sh.329, 250 as a debit
balance instead of a credit balance.
9. An old cheque payment amounting to Sh.44, 000 had been written back in the
cashbook but the bank had already honored it.
10. Some of Gathoni‘s customers had agreed to settle their debts by paying directly into
his bank account. Unfortunately, the bank had credited some deposits amounting to
Sh.832, 500 to another customer‘s account. However acting on information from his
customers Gathoni had actually entered the expected receipts from the debtors in is
cashbook.
Required:
i. A statement showing Gathoni‘s adjusted cashbook balance as at 30 June 2010.
ii. A bank reconciliation statement as at 30 June 2010.
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CHAPTER ELEVEN: COMPANY ACCOUNTS
11.1 Introduction and Overview of the Chapter
This chapter discusses the company as a legal person created by law in a given country. This
means that the company is a legal entity separate and distinct from its members. The chapter
will look on the formation of a company which is in three ways namely; by charter, by
legislation or by registration under the Companies Act. The chapter will look at the main
components of a company‘s final accounts which are trading account, profit & loss account,
appropriation of profit and loss account and the Balance sheet.

a) Define a company and explain how companies are formed citing the different types of
companies.
b) Explain the different classes of shares.
c) Calculate how profits available for dividends are distributed between the different classes of
shares.
d) Explain the difference between debentures and shares.
e) Prepare the trading, profit and loss account and appropriation account of a company.
f) Draw up a limited company balance sheet.
11.3 Definition of Company Accounts
A company may be defined as an association of persons binded together for some particular
object, i.e. carry business with a view of profits.
It has the following characteristics;
i. Its capital consists of several units called shares, each of small value which is sold to a
large number of people.
ii. Its liability of shareholders towards the debt of their company is limited to the face value
of the shares held by them.
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iii. A company is considered a legal person and has an entity of its own, quite separate from
its members or shareholders.
iv. The day to day management of a company is entrusted to people called directors who are
elected by shareholders to whom are answerable.
v. All the profits and losses belong to the company but can be distributed to the
shareholders in form of dividends.
11.4 Formation of a Company
People wishing to start a company are required to prepare certain legal documents and file them
with the registrar of joint stock companies. These documents are;
i. Memorandum of Associations (MOA)
ii. Article of Association (AOA)
If the registrar finds the documents in order, he issues a certificate of Incorporation which gives
the company a legal existence.
11.3.1 Memorandum of Association
The document defines the company to the outside world. It contains the following:
a) The name of the company with ‗limited‘ as the last word.
b) Its address or general area of operation.
c) The details of its share capital.
d) The aim and objects for which the company is been formed.
e) A statement to the effect that the liability of its members is limited.
11.3.2 Article of Association
It contains set rules that govern the internal memory of the company. It covers things like-
i. Classes and rights of shareholders.
ii. The issue and transfer of share.
iii. Methods of dealing with any alteration on the capital.
iv. Procedures of general meeting and rating rights.
v. Qualification, duties and power as direction.
vi. Borrowing, dividend and policies.
vii. Audition of the books. e. t. c.
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11.4 Types of shares
There are two types of shares commonly used by companies in East Africa.
a) Ordinary shares.
b) Preference shares.
11.4.1 Ordinary shares
Represent the ‗real‘ share capital of a company. They are entitled to whole of the company‘s
profit after the claims of other classes of shares have been satisfied. However it is not all profit
distributed as dividends. Some is retained in the business for its expansion.
N/B Only ordinary shareholders have a right to vet or make decisions that require shareholder
approval.
11.4.2 Preference shares
Form a part of the share capital, but their holders do not possess the same status as ordinary
shareholders. Preference shareholders cannot claim to be the ‗real‘ owner. They are
characterized by the following features:
a) Do not have any voting rights to influence any policy making.
b) Their claim on company‘s profit comes before ordinary shareholders but is limited to pre-
determined maximum.
Types of preference shares

a) Redeemable or irredeemable
A redeemable preference shares can be bought back by the issuing company after a specified
minimum and before a specified maximum. The period is stated at the time of issue, i.e. if shares
are not redeemed within this time the preferences shareholder attain the status of creditors and
can then sue the company for the recovery of their investment. An irredeemable preference share
is never redeemed during the life time at the company. Its principle is returned to shareholders
when the company is liquidated. The shares are transferable and can be sold to anybody else
accept issuing company if the shareholder want to convert them to cash.
b) Accumulative and Non-accumulative.
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An accumulative preference share gets dividend for every year. If it is not declared for a
particular year, it is accumulated till the date it is finally paid. Non-accumulative preference
shares get dividend only for the year for which it is declared.
c) Participating or Non-participating.
A participating preference share may get something in addition to the stated maximum if the
company records vary high profits and the ordinary shareholders have been adequately rewarded.
A non-participating preference share gets nothing more than the specified maximum rate of
dividend regardless of the value of profit made by the company in any year.
11.5 Classes of Share Capital
The capital of a limited company is divided into shares which are allotted to members for cash.
a. Registered or Authorized capital
This is the maximum amount of capital the company expects to raise from its shares and stated in
the memorandum of association. e.g. 100,000 shares @ sh. 10 = sh.1, 000,000-authorized capital.
b. Issued Capital
This is the company‘s capital authorized by directors for subscribing to the public and above =
50,000 shares × 10=500,000-isssue the reminder 50,000 is unissued capital called up capital.
Once the shares have been put to the public so as to stand applying for then the shareholder are
called upon to subscribe on to pay. If a certain fraction is only paid of what was issued is referred
to as called up
c. Paid-up Capital
This is the amount received from the subscribers by the company and of the called up capital.
The amount unpaid is called call in arrears.
11.5.1 Terms of issue of shares
The company can issue its shares either at discount or premium.

a. Issue at par
This is the face value (nominal) ashore carrier if she is offered for scale at , the issue would be at
par.
b. Issue at premium
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If a company offers its share at more than the par value, the issue is said to be being made at a
premium.
Company trading profitability can take advantage and sell its shares above the par value.
However share premium is not treated as a normal trading profit of the company, but as a special
reserve belonging to ordinary shareholders.
The excess of issue price over nominal value of the share is called share premium or premium.
c. Issue at discount
If a company offers its share at less the par value, the issue is said to being made at a discount.
This affects a company which has failed to pay adequate dividend, hence to induce investors by
offering the share at less than the par value.
11.5.2 Debentures
This is money borrowed by a company from the public as a way to obtain more funds for
operation; represent company expenses. A debenture is a document that states that the company
is borrowed a specified amount at specified terms from the person named there. It carries a fixed
rate of interest, payable out of the company‘s revenue not out of profit.
Debentures differ in shares in the following;
i. They are not part of the share capital but loan capital.
ii. They earn interest not dividend
iii. The interest is paid before dividend
iv. Debenture holders are creditors to and not owners to the company.
v. Debenture holders have no control or voting right
vi. Debentures are usually secured by a cheque on the assets of the company.
Types of debentures
a) Secured debentures
They are secured against a change on the borrowed assets. The change signifies that the lender
has a first right over the property pledged in the event of the company‘s liquidation. This
proceeds of the sale of the property pledged should therefore be first used to satisfy the lender
holding the cheque, only the surplus can be used for other creditors claim.
b) Unsecured debenture
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Do not have any price claim on the company‘s assets and in event of it liquidation are treated as
ordinary creditors.
c) Redeemable debenture
These debentures are redeemed (i.e. their principle is refunded to the lender) by the company
after a specified minimum and before a specified maximum period which are stated in the
debentures i.e. 5-7 yrs. After maximum period the debenture holders can demand the payment of
their principle amount.
d) Perpetual or irredeemable
Have no date of redemption hence a person holding these claiming demand for repayment of his
principle from the company through the company rose the right of refunding at its own
convenience.
e) Convertible debenture
The holder of theses debenture are given a right to get them converted to ordinary share after a
specified period in accordance with pre-state conversion time.
f) In-covetable debenture
Cannot be converted into ordinary or any other types of shares.
11.6 Format of Company Final Accounts
The Profit & Loss account of a company is the same as that of a sole trader, but there are
additional expenses that are unique to the company and therefore, they should be included in the
Profit & Loss A/C. These expenses include;
 Director‘s fees/salaries and other expenses
 Audit fees
 Amortization e.g. goodwill
 Debenture interest
Under the profit and loss account is a sector known as the profit and loss appropriation account
which shows how the profits will be used or appropriated. Here the credit side will show the net
profit and the balances of the profit b/f or the retained profits. On the debit side there will be the
transfer of profits to the general reserve. If the directors decide that part of the profit will not be
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included in the calculation of how much his to be paid in dividends, these profits are transferred
to the reserved account and the asset reserve account.
The format for a profit and loss appropriation account may be shown as follows;
Net profit before tax xx
Corporation tax (xx)
Net profit after tax xx
Retained profit b/f xx
xx
Less: Transfers to general reserve xx
Ordinary dividend xx
Preference dividend xx
Goodwill written off xx
Preliminary expenses xx (xx)
xx
Director’s salaries
Salaries, fees and other expenses in relation to the directors are expenses as far as company
accounts are concerned. This is different from that of Partnerships & Sole traders which are
shown as appropriations – expenses.
Audit fees
All companies are required to prepare the accounts which should be audited and therefore any
fees paid in relation to audit and accountancy is an expense.
Debenture interest
Loans taken up by companies are called debentures. The interest paid on these loans are charged
as an expenses and unpaid amount are shown as current liabilities in the business.
The debenture is classified under non-current liability.
Corporation tax
Companies pay corporation tax on the profits they earn. This is shown in the accounts because a
company is a separate legal entity unlike for sole traders and partnerships whose tax is shown as
drawings. The tax is listed under those 3 items as shown in the appropriation (under/over
provision for previous period, transfer to deferred tax corporation tax for the year). The under
provision and corporation tax relate to direct liability to the government and therefore is a
deduction from the net profit for the period. Transfer to deferred tax is to cater for future
possible tax liability.
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Format for Company Accounts
XYZ Limited
Trading, profit and loss and Appropriation Account for the year ended 31.12
shs shs Shs
Sales x
Less Returns inwards (x)
x
Less Cost of Sales
Opening Stock x
Purchases x
Add Carriage in x
x
Less purchase returns (x) x
x
Less Closing stock (x) (x)
Gross Profit x
Add incomes x
Discount received x
Profit on disposal (sale of Assets) x
Income from investment (can also be shown below) x
Other incomes e.g. interest received from bank x
x
Less Expenses
Other expenses x
Directors salaries/fees/---- x
Audit fees x
Debenture Interest x
Amortization of good will x (x)
Operating profit for the period x
Add investment income x
Profit before tax x
Taxation: Corporation tax x
Transfer to deferred tax x
Under or over provision x (x)
Profit after tax x
Less: transfer to the general reserve (x)
x
Less: Dividends
Preference dividend: Interim paid x
Final proposed x
x
Ordinary dividend: Interim paid x
Final proposed x (x)
Retained profit for the year x
Retained profit b/f x
Retained profit c/d x
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B Limited
Balance sheet as at 31.12
shs shs shs

Noncurrent Assets
Land & Building x (x) x
Plant and Machinery x (x) x
Fixtures, Furniture & Fittings x (x) x
Motor vehicle x (x) x
x x x
Intangible Assets
Goodwill x (x) x
Copyrights, patents x (x) x
x x
(Longterm) Investments (mkt value sh x) x
x
Current Assets
Stock x
Debtors x
Less provision for bad debts (x) x
Prepayments x
(Short term) Investments x
Cash at bank x
Cash in hand x
x
Current liabilities
Bank overdraft x
Creditors x
Accruals x
Interest payable(debenture interest) x
Tax payable x
Dividends payable x (x) x
x
Financed by
Authorized share capital x
100,000 ordinary shares of shs1 each x
100,000 preference shares of shs1 each x
(x)
Issued and Fully paid x
80,000 ordinary shares of shs1 each
50,000 10% preference shares of shs1 x
each x
Capital Reserves x
Share premium x
Revaluation Reserve x x
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Capital Redemption Reserve
Revenue Reserves x
General Reserve x x
Profit and loss A/C x
x
Deferred tax A/C x
Non Current Liabilities x
10% debenture x x
Other Long term Loans x
Example 11.1
Assume that a firm had estimated that the corporation tax for the year ended 31.12.2011 is
shs150,000. In 2012, the liability is now agreed at shs160,000, which the company pays and at
the end of the year 2012, the company estimates that the tax liability is shs140,000.
Prepare a tax A/C and show the amount to be deducted as tax for the year (ignore deferred tax).
(e.g.) Taxation Account
Cashbook 160,000 Bal b/d 150,000

Bal c/d 140,000 Appropriation 150,000
300,000 300,000
Under provision 10,000 (160 -150)

Corporation tax 140,000
11.7 Dividends
Shareholders are also entitled to a share of profits made by the company and this is because the
shareholders do not make drawings from the company. A company may pay dividends in two
stages during the cause of the financial period:
Interim dividends
Is paid part way during the financial period (e.g.) after the 6 months
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Final proposed
Is paid after the completion to final accounts at the year-end. If a company pays in these two
stages then the dividend section of the Profit & Loss appropriation should disclose interim paid
and final proposed.
11.8 Capital Reserves
Amounts reflected in Capital reserves cannot be paid out or distributed to shareholders. The three
types of capital reserves are:
3. Share Premium: A share premium arises when accompany issues shares at a price that is
more than the par value. The share Premium may be applied in:
 Paying un issued shares.
 Writing off preliminary expenses.
 Write off discounts on shares.
Example 11.2
Rozwan Ltd wishes to raise capital by issuing 100,000 ordinary shares at shs1 each (per value)
and the issue price (selling price) is shs1.5 each.
The following are the entries to be made in the A/C.
Dr Cashbook (100,000 shs1.5) 150,000
Cr Ordinary shares capital (100,000 shs1) 100,000
Cr Share Premium A/C (100,000 shs0.5) 50,000
Issue of shares at a premium of shs0.5
4. Revaluation Reserve: Any gain made on revaluation of non current Assets especially
for Land and buildings. When company sills it‘s property to realize the gain, the
amount is transferred to the Profit and Loss Account.
5. Capital Redemption Reserve: A reserve created after redemption or purchase of

Preference shares without issuing new shares. The transfer is made from either the
share premium or the profit and loss account.
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11.9 Revenue Reserves
This can be distributed and includes the retained profits (P & L Accounts) and the General
Reserves. Transfers are made from the Profits to the General reserves to provide for expansion or
purchase of non current assets. The General Reserves can also be used to issue bonus Shares.
11.10 Bonus Shares
Shares issued to existing shareholders free of charge. They are paid out from either the share
premium, balance of retained profits of the General Reserves.
A scrip issue is similar to bonus issue only that a scrip issue gives the shareholder the choice of
receiving cash or stock dividends. In a bonus issue the shareholder has no choice but to take up
the shares.
Example 11.3
A company has 100,000 shares at shs1 each to form an ordinary share capital of shs100,000 and
a balance on the share premium A/C of shs50,000. It issues some bonus shares to existing
shareholders at a rate of 1 share for every 5 shares held. This amount is to be financed by the
share premium. The entries will be as follows:
Shares to be issued:
100,000 1 =20,000
5
Dr share premium A/C [20,000 shs1 ] 20,000

Cr ordinary share capital 20,000
A bonus issue of 20,000 shares
Balance sheet (extract)

Ordinary shares of shs1 120,000
Capital Reserves
Share premium 30,000
11. 11 Rights Issue
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A right issue is an option on the part of the shareholder given by the company to existing
shareholders at a price lower than the market price. It involves selling ordinary shares to existing
shareholders of the company on a prorata basis. When the rights are issued the shareholders have
three options available,
(i) Buy the new shares and exercise their rights or
(ii) Sell the rights in the market
(iii) Ignore the rights.
A rights issue therefore gives the shareholder the right (but not an obligation) to buy the new
shares issued by the company.
Example 11.4
The following is the trial balance of Thanjoh Ltd. at 31 September 2010
Shs Shs
Issued share capital (ordinary shares of shs1 each) 42,000
Leasehold properties, at cost 75,000
Motor vans, at cost (used for distribution) 2,500
Provision for depreciation on motor vans to 31 September 2010 1,000
Administration expenses 7,650
Distribution expenses 10,000
Stock, 31 September 2010 12,000
Purchases 138,750
Sales 206,500
Directors‘ remuneration (administrative) 25,000
Rents receivable 3,600
Investments at cost 6,750
Investment income 340
7% Debentures 15,000
Debenture interest 1,050
Bank interest 162
Bank overdraft 730
Debtors and creditors 31,000 24,100
Interim dividend paid 1,260
Profit and loss account, 31 September 2010 17,852
311,122 311,122
Additional Notes
 All the motor vans were purchased on 1 April 2007. Depreciation has been, and is to be,
provided at the rate of 20% per annum on cost from the date of purchase to the date of sale.
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 On 31 September 2010 one van, which had cost shs900, was sold for shs550, as part
settlement of the price of shs800 of a new van, but no entries with regard to these
transactions were made in the books.
 The estimated corporation tax liability for the year to 31 September 2010 is shs12,700.
 It is proposed to pay a final dividend of 10% for the year to 31 September 2010.
 Stock at the lower of cost or net realizable value on 31 September 2010 is shs16,700.
Required:
Prepare, without taking into account the relevant statutory provisions:
 A profit and loss account for the year ended 31 September 2010
 A balance sheet at that date.
NOTE: As you tackle this question remember that everything covered under double entry
bookkeeping and the presentation of year end accounts is valid in the context of companies,
subject only to the points we have added in this topic
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Solution:
Thanjoh Ltd.
Profit and Loss A/C for the year ended 31.9.2010
shs Shs
Gross profit 72,450
Profit on disposal of van 190
Rent Receivable 3,600
76,240
Less: Expenses
Depreciation on motor vans 500
Administration expenses 32,650
Distribution expenses 10,000
Debenture interest 1,050
Bank interest 162 (44,362)
Trading profit for the year 31,878
Add investment income 340
Profit before tax 32,218
Taxation (12,700)
Profit after tax 19,518
Less: Dividends
Interim paid 1,260
Final proposed 4,200 (5,460)
Retained profit for the year 14,058
Retained profit b/f 17,852
Retained profit c/d 31,910
127
Thanjoh Ltd.
Balance sheet as at 31.9.2010
Shs Shs shs

Non-Current Assets
Leasehold properties 75,000 - 75,000
Motor vans 2,400 (960) 1,440
77,400 960 76,440
Investments 6,750
83,190
Current Assets
Stock 16,700
Debtors 31,000
47,700
Current liabilities
Bank overdraft 980
Creditors 24,100
Tax payable 12,700
Proposed dividends 4,200 (41,980) 5,720
88,910
Financed by:
Authorized issued and fully paid
42000 ordinary share of shs1 42,000
Revenue Reserves
Profit and Loss A/C c/f 31,910
73,910
Non-Current liabilities
7% Debentures 15,000
88,910
Workings
Sales 206,500
Less: Cost of sales
Opening stock 12,000
Purchases 138,750
150,750
Less Closing stock (16,700) (134,050)
Gross profit 72,450
Motor Vehicle – Depreciation

Disposal 540 Bal b/d 1,000
Bal c/d 960 P&L 500
1500 1,500
128
Motor vehicle
Bal b/f 2,500 Disposal 900
Disposal 550
Cashbook 250 Bal c/d 2,400
3,300 3,300
Motor vehicle Disposal

Disposal 900 Motor Vehicle 550
P&L 190 Depreciation 540
1090 1090
11.12 Benefits of a Limited Company
a) Limited liability: This is where the liability of the members is limited by the number of
shares they hold. This means that in case of a company winding up, the shareholders will
only lose their shares, that is, personal belongings are not put at risk in case of business
failure.
b) Business network: Operating in a limited company always gives the suppliers and
customers a sense of confidence as opposed to dealing with unlimited company.
c) Continuity: A limited company is assured of continuity incase one of the shareholders or
directors die. This is because the directors and employees act as agents of the company.
d) Financing: It is easier for a limited company to obtain finances as opposed to unlimited
company. This is because the company can secure the loan using part of its assets.
129
 A company may be defined as an association of persons bided together for some particular
object, i.e. carry business with a view of profits.
 Certain legal documents are required when starting a company which are filed with the
registrar of joint stock companies. These documents are the Memorandum of Associations
(MOA) and the Articles of Association (AOA) on which the registrar issues a certificate of
Incorporation which gives the company a legal existence if the registrar finds the document
in order.
 The owner‘s interest in a limited company is represented by shares which are divided into
Preference shares and Ordinary Shares.
 Share capital may be classified into: Authorized share capital, Issued share capital Called up
share capital, Uncalled share capital and Paid-up share capital
 Capital Reserves are amounts that cannot be paid out or distributed to shareholders. They are
classified into Share Premium, Revaluation Reserve and Capital Redemption Reserve:
 Debentures refer to money borrowed from the public by a company as a way to obtain more
fund for operations. The different types of debentures are: Secured debentures, Unsecured
debenture, Redeemable debenture, Perpetual or irredeemable, Convertible debenture and In-
covetable debenture. They are treated as expenses in the company accounts.
 Revenue reserves are amounts which can be distributed as profits to the shareholders e.g.
retained profits, general reserve and asset replacement reserve.
 Corporation tax is paid on the profits earned by a company. It is a direct liability to the
government and therefore is a deduction from the net profit for an accounting period.
 Dividend are profits that the shareholders are entitled in a company they are paid in two
stages which are Interim dividends and Final proposed
 Bonus shares are issued to existing shareholders free of charge and they are paid out from
either the share premium, balance of retained profits or the General Reserves.
 Rights issue is an option on the part of an existing shareholder in a company to buy more
ordinary shares at a price lower than the market price. It involves selling ordinary shares to
existing shareholders of the company on a prorata basis.
130
1. Explain why it is better when a company is limited other than when it is an unlimited
company
2. The following trial balance was extracted from the books of Tena Ltd as at 31 December
2011:
Shs ‗000‘ Shs ‗000‘
Purchases/sales 20 640 38 200

Carriage inwards 580
Carriage outward 1 360
Discounts 560 1 460
Salaries and wages 2 920
Advertising expenses 880
Rent and rates 1 800
Electricity 940
Insurance 420
Salesmen‘s commission 850
Directors salaries 2 100
Repairs and maintenance 350
Interim dividend paid 600
Fixtures and fitting at cost 4 080
Provision for depreciation on Fixtures and fitting (1 January 2011) 660
Motor vehicle at cost 2440
Provision for depreciation on motor vehicle (1 January 2011) 1 020
Share capital (shs. 10 per value) 6000
Stock (1 January 2011) 6 300
Trade debtors/trade creditors 9 200
Profit and loss account balance (1 January 2011) 2 140
Share premium account 1 500
Balance at bank 840
General reserve 1000
56 020 56 020
Additional information:
1. Prepayment and accrual as at 31 December 2011 were as follows:
Prepayment accruals
Sh Sh
Wages 120,000
Insurance 80,000
Commission to sale men 20,000
Auditors remuneration 280,000
131
2. Depreciation is to be provided for as follows:
 Fixture and fittings- 10% per annum using the straight line method
 Motor vehicles- 25% per annum using the reducing balance method
3. Stock as 31 December 2011 was valued a sh 7,280,000
4. A financial dividend at sh 3 per share is proposed by the directors
5. Transfer to general reserve shillings 500,000
6. Corporation tax is to be charged at 30% on the reported profit for the year
7. A provision for doubtful debts is to be made as at 2.5%of the debtors balance.
Required:
(i) Trading and profit and loss and appropriation account for the year ended 31
December 2011
(ii) Balance sheet as at 31 December 2011.
Refrences
1. Benedict. A & Elliott. B (2008).Financial Accounting.Cengage Learning
2. Kimmel.D.P,Weygan.J $ Kisoi.D.E. (2010).Financial Accounting.Cengage Learning
3. Frankwood (2009) financial accounting for business decision. Prentice l.UK
4. Albrecht.W &Stice.K,(2010) Financial Accounting. Cengage Learning
5. Journals of Financial Accounting
6. International Journal of Accounting and Financial Reporting
132

DAC 100 - Fundamental of Accounting Notes

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ST.

DAC I: FUNDAMENTALS OF ACCOUNTING I

COURSE INSTUCTURE’S NAME: JOHN KIARIE

Reviewed & Edited by:

© Module Author’s : JOHN KIARIE]

John Kiarie. Ass Dean of Students/PHD Candidate]

SPU Course Instructor’s Signature:

SPU Distance Learner’s Signature:

CHAPTER ONE: FINANCIAL ACCOUNTING ------------------------------------------------------------------------------------- 1

1.1 INTRODUCTION AND OVERVIEW -------------------------------------------------------------------------------------------------- 1

CHAPTER TWO: BUSINESS TRANSACTIONS AND BOOK KEEPING EQUATION ------------------------------------- 13

2.1 INTRODUCTION AND OVERVIEW ----------------------------------------------------------------------------------------------- 13

CHAPTER FOUR: CASH BOOK --------------------------------------------------------------------------------------------------- 41

4.1 INTRODUCTION AND OVERVIEW ----------------------------------------------------------------------------------------------- 41

CHAPTER FIVE: LEDGER ACCOUNTS ------------------------------------------------------------------------------------------- 50

5.1 INTRODUCTION AND OVERVIEW ------------------------------------------------------------------------------------------------ 50

CHAPTER SIX: TRIAL BALANCE -------------------------------------------------------------------------------------------------- 63

6.1 INTRODUCTION AND OVERVIEW ------------------------------------------------------------------------------------------------ 63

7.1 INTRODUCTION AND OVERVIEW ----------------------------------------------------------------------------------------------- 71

CHAPTER EIGHT: ADJUSTING ENTRIES --------------------------------------------------------------------------------------- 83

8.1 INTRODUCTION AND OVERVIEW OF YEAR END ADJUSTMENT ENTRIES------------------------------------------------------- 83

CHAPTER NINE: CONTROL ACCOUNTS ------------------------------------------------------------------------------------- 100

9.1 INTRODUCTION AND OVERVIEW --------------------------------------------------------------------------------------------- 100

10.1 INTRODUCTION AND OVERVIEW ------------------------------------------------------------------------------------------- 106

CHAPTER ELEVEN: COMPANY ACCOUNTS -------------------------------------------------------------------------------- 113

11.1 INTRODUCTION AND OVERVIEW OF THE CHAPTER ------------------------------------------------------------------------- 113

Introduction and Overview

Accounting is a system meant for measuring business activities, processing of

All business organizations work in an ever-changing dynamic environment. Any new

By the end of this course, the learner should be able to:

At the end of this course, the learner should be able to:

Week Topics Subtopics Reference Assessment

1 -2 Benedict. A & Elliott. Refer page

3 Transactions  Definition of transaction Kimmel.D.P,Weyganl Refer pg 25

4 Books of  Definition of books of original Benedict. A & Elliott. Refer pg 38

1.1 Introduction and Overview

1.2 Learning Outcomes

At the end of the topic, the learner should be able to:

a. Explain what is financial accounting

1.3 Definition of Accounting

Accounting is the process of collecting, recording, summarizing, interpreting and communicating

1.2.1 Accounting Cycle

Transaction Journal Ledgers Financial

Recognition of measurement concepts

1.3.1: Characteristics of Accounting Information

They can be grouped into two categories;

There are four basic accounting assumptions

1. Economic Entity Assumption

2. The going concern assumption

3. The monetary assumption

1.3.3: Accounting Principles

(a) Historical Cost Principle

It states that revenue should be recognized (recorded) when

(i) It is realized or realizable

(c) ) The matching principle

(d) The full disclosure principle

1.3.4: The Constraints (Limitations)

1. Record-keeping. One of the main functions of accounting is to record business

1.5 Needs for accounting records

Managers within the business require accounting information to:-

1.6.2 Other Users of Financial Information

Accounting: process of identifying, measuring and communicating economic information to

1.8 Accounting Standards