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CHAPTER ONE
THE ROLE OF ACCOUNTING
1.0 Learning Objectives………………………………………………………………..
1.1 Introduction………………………………………………………………………..
1.2 The Historical Development of Accounting……………………………………
1.2.1 Regulatory Framework…………………………………………………………...
1.3 The Purpose of Accounting………………………………………………………..
1.3.1 Financial Transactions…………………………………………………………
1.3.2 Types of Business………………………………………………………………….
1.4 Bookkeeping and Accounting……………………………………………………
1.5 Scope of Accounting………………………………………………………………
1.5.1 Financial Accounting………………………………………………………………
1.5.2 Cost Accounting……………………………………………………………………
1.5.3 Management Accounting…………………………………………………………..
1.5.4 Auditing…………………………………………………………………………….
1.5.5 Government Accounting ……………………………………………………………
1.5.6 Accounting for Taxation……………………………………………………………
1.6 The Need for Accounting Information…………………………………………….
1.7 Qualities of a Good Accounting Information………………………………………
1.8 Users of Accounting Information…………………………………………………..
1.9 The Work of an Accounting………………………………………………………..
1.9.1 Members in Public Practice………………………………………………………
1.9.2 Members Not in Public Practice……………………………………………………
1.10 Summary…………………………………………………………………………..

CHAPTER TWO
FORMS AND STRUCTURES OF BUSINESS ORGANISATION
2.0 Learning Objectives……………………………………………………………….
2.1 Forms of Business Organisations………………………………………………….
2.1.1 Sole-Proprietorship……………………………………………………………….
2.1.1.1 Advantages and Disadvantages…………………………………………………
2.1.2 Partnership…………………………………………………………………………
2.1.2.1 Contents of Partnership Agreements……………………………………………
2.1.2.2 The Main Advantages of Partnership Over Sole-Proprietorship………………
2.1.3 Limited Liability Company………………………………………………………
2.1.3.1 Formation Procedure……………………………………………………………….
2.1.3.2 Statutory Books…………………………………………………………………….
2.1.3.3 Issued Share Capital………………………………………………………………...
2.1.3.4 Reserves and Provisions……………………………………………………………
1.3.5 Advantages and Disadvantages…………………………………………………….
2.1.4 Public Enterprise……………………………………………………………………
2.2 Summary and Conclusion…………………………………………………………..

CHAPTER THREE
ACCOUNTING CONCEPTS AND CONVENTIONS
3.0 Learning Objectives……………………………………………………………….
3.1 Accounting Concepts and Conventions……………………………………………
3.1.1 Entity Concept……………………………………………………………………
3.1.1.1 Accounting Equation……………………………………………………………
3.1.1.1.1Assets…………………………………………………………………………
3.1.1.1.1.1 Non-Current Asset………………………………………………………
3.1.1.1.1.2 Current Asset………………………………………………………………
3.1.1.1.2 Liabilities…………………………………………………………………..
3.1.1.1.2.1 Non-Current Liabilities……………………………………………………
3.1.1.1.2.2 Current Liabilities………………………………………………………
3.1.2 Money Measurement Concept…………………………………………………….
3.1.3 Going Concern Concept……………………………………………………………
 3.1.4 Periodicity Concept………………………………………………………………..
3.1.5 Prudence Concept………………………………………………………………….
3.1.6 Substance Over Form………………………………………………………………
3.1.7 Consistency Concept……………………………………………………………….
3.1.8 Accrual Concept……………………………………………………………………
3.1.9 Matching Concept………………………………………………………………….
3.1.10 Materiality Concept………………………………………………………………..
3.1.11 Historical Cost Concept……………………………………………………………
3.1.12 Objectivity Concept……………………………………………………………….
3.1.13 Fairness……………………………………………………………………………
3.1.14 Realisation Concept………………………………………………………………
 3.2 Summary………………………………………………………………………….

CHAPTER FOUR
SOURCE DOCUMENTS AND BOOKS OF ORIGINAL ENTRY
4.0 Learning Objectives………………………………………………………………..
4.1 Introduction………………………………………………………………………..
4.2 The Need for Source Documents………………………………………………….
4.3 Main Source Documents……………………………………………………………
4.3.1 Sales Invoices………………………………………………………………………
4.3.2 Purchases Invoice…………………………………………………………………..
4.3.3 Credit Note…………………………………………………………………………
4.3.4 Debit Note………………………………………………………………………….
4.3.5 Payment Vouchers………………………………………………………………
4.3.6 Bank Pay-in-Slips………………………………………………………………….
4.3.7 Cheque Counterfoils………………………………………………………………
4.3.8 Receipts……………………………………………………………………………
4.3.9 Purchase Order…………………………………………………………………….
4.3.10 Delivery Note……………………………………………………………………
4.3.11 Goods Received Note (GRN)……………………………………………………
4.3.12 Bin Card…………………………………………………………………………
4.4 The Need for Books of Original Entry…………………………………………
4.4.1 Sales Day Book……………………………………………………………………
4.4.2 Trade Discount…………………………………………………………………….
4.4.3 Purchases Day Book……………………………………………………………….
4.4.4 Analysis of Purchases Day Book………………………………………………
4.4.5 Sales Returns Book……………………………………………………………
4.5 The Journal………………………………………………………………………
4.5.1 Uses of The Journal………………………………………………………………..
4.5.2 The Layout of the Journal………………………………………………………….
4.5.3 Opening Entries……………………………………………………………………
4.5.4 Transfer from One Account to the Other Through the Journal……………………
4.5.5 Other Uses of the Journal………………………………………………………….
4.6 Summary…………………………………………………………………………


CHAPTER FIVE
APPLICATION OF DOUBLE ENTRY BOOKKEEPING AND THE TRIAL BALANCE
5.0 Learning Objectives………………………………………………………………
5.1 Introduction……………………………………………………………………….
5.2 Principle of Double Entry…………………………………………………………
5.3 Ledger Account……………………………………………………………………
5.3.1 Importance of the Ledger Account………………………………………………..
5.3.2 Types of Account………………………………………………………………….
5.3.3 Types of Ledger……………………………………………………………………
5.4 Application of the Double Entry Principle………………………………………
5.4.1 Debit and Credit Entries……………………………………………………………
5.4.2 The General Rules for Recording in the Ledger…………………………………..
5.4.3 Cash Transactions…………………………………………………………………
5.4.4 Transactions Made on Credit……………………………………………………
5.4.5 Balancing a Ledger Account…………………………………………………
5.4.6 Interpretation of the Balances……………………………………………………..
5.4.7 Comprehensive Illustration……………………………………………………….
5.5 Trial Balance……………………………………………………………………
5.5.1 Uses of the Trial Balance…………………………………………………………
5.5.2 Errors not Affecting Trial Balance Agreement…………………………………..
5.5.3 Errors that Affect the Trial Balance………………………………………………
5.6 Correction of Errors……………………………………………………………
5.6.1 Suspense Account…………………………………………………………………
5.6.2 Location of Errors…………………………………………………………………
5.6.3 Steps Involved in Correcting Errors……………………………………………
5.7 Comparing Manual and Computer Based Accounting System……………………
5.7.1 Recording in Computer-Based System…………………………………………….
5.8 Summary……………………………………………………………………………

CHAPTER SIX
CONTROL OR TOTAL ACCOUNTS
6.0 Learning Objectives……………………………………………………………….
6.1 Introduction……………………………………………………………………….
6.2 The Nature and Functions of Control Accounts…………………………………..
6.2.1 Merits of Control Accounts………………………………………………………
6.2.2 Sources of Information for Control Accounts……………………………………
6.2.3 Receivables or Sales Ledger Control Accounts…………………………………..
6.2.4 Trade Payables or Purchases Ledger Control Accounts………………………….
6.2.5 Trade Receivables Statements or Statement of Account…………………………
6.3 Summary…………………………………………………………………………..

CHAPTER SEVEN
ACCOUNTING FOR CASH TRANSACTIONS
7.0 Learning Objectives………………………………………………………………
7.1 Introduction……………………………………………………………………….
7.2 The Need for Control Over Cash…………………………………………………. .
7.2.1 How to Handle Cash………………………………………………………………
7.3 Definition of Some Terms Relating to Control Over Cash………………………
7.4 Trade Discounts and Cash Discounts…………………………………………….
7.4.1 Cash Discount……………………………………………………………………..
7.4.2 Accounting Treatment of Cash Discount…………………………………………
7.5 The Main Cash Book………………………………………………………………
7.5.1 Double Column Cash Book………………………………………………………
7.5.2 Three Column Cash Book…………………………………………………………
7.6 The Petty Cash Book………………………………………………………………
7.6.1 Control Over Petty Cash Imprest…………………………………………………
7.6.2 Advantages of the Imprest System………………………………………………
7.7 Summary……………………………………………………………………………

CHAPTER EIGHT
BANKING SYSTEMS AND SERVICES
8.0 Learning Objectives………………………………………………………………..
8.1 Introduction……………………………………………………………………….
8.2 Current Account………………………………………………………………….
8.2.1 Opening a Bank Current Account…………………………………………
8.2.2 Cheques……………………………………………………………………………
8.2.3 Pay-in-Slip…………………………………………………………………………
8.2.4 Dishonoured Cheques……………………………………………………………..
8.2.5 Stop Payment Order……………………………………………………………….
8.3 Interest Bearing Accounts…………………………………………………………
8.3.1 Savings Accounts………………………………………………………………….
8.3.2 Fixed Deposit Account…………………………………………………………….
8.4 Inter-Bank Transfers……………………………………………………………….
8.4.1 Mode of Operation of Electronic Banking Products………………………………
8.5 Credit Cards……………………………………………………………………….
8.6 Bank Statement…………………………………………………………………….
8.6.1 Example of a Bank Statement……………………………………………………
8.7 Bank Reconciliation Statement……………………………………………………
8.7.1 Steps Involved in the Recognition of Discrepancies……………………………
8.7.2 Preparation of the Bank Reconciliation Statement………………………………

CHAPTER NINE
PAYROLL ACCOUNTING
9.0 Learning Objectives………………………………………………………………..
9.1 Introduction………………………………………………………………………..
9.2 Payroll……………………………………………………………………………...
9.3 Gross Pay…………………………………………………………………………..
9.4 Methods of Calculating Gross Pay ……………………………………………......
9.4.1 Time-Based System……………………………………………………………
9.4.2 Performance Related Systems…………………………………………………….
9.4.3 Straight Salary……………………………………………………………………..
9.4.4 Bonus Schemes…………………………………………………………………….
9.4.5 Types of Bonus Schemes…………………………………………………………..
9.4.5.1 Halsey Premium Plan……………………………………………………………
9.4.5.2 Rowan Plan………………………………………………………………………
9.4.5.3 Comparison of Halsey Plan and Rowan Plan……………………………………
9.5 Allowable Deductions and Reliefs…………………………………………………
9.6 Net Pay…………………………………………………………………………….
9.7 Accounting Entries………………………………………………………………...

CHAPTER TEN
ACCOUNTING FOR NON-CURRENT ASSETS
10.0 Learning Objectives………………………………………………………………
10.1 Introduction………………………………………………………………………
10.2 The Determination of the Cost of Non-Current Assets………………………….
10.2.1 Land……………………………………………………………………………
10.2.2 Cost of Building………………………………………………………………
10.2.3 Cost of Equipment……………………………………………………………
10.3 Capital Expenditure Versus Revenue Expenditure……………………………
10.3.1 Differences Between Capital and Revenue Expenditure……………………
10.4 Depreciation……………………………………………………………………
10.4.1 Causes of Depreciation………………………………………………………
10.5 Methods of Calculating Depreciation…………………………………………
10.5.1 Straight Line Method…………………………………………………………
10.5.2 Reducing Balance Method……………………………………………………
10.6 Double Entry Records for Depreciation…………………………………………
10.7 Disposition of Non-Current Assets………………………………………………
10.8 Summary…………………………………………………………………………

CHAPTER ELEVEN
END OF PERIOD ADJUSTMENT
11.0 Learning Objectives………………………………………………………………..
11.1 Introduction………………………………………………………………………..
11.2 Deferred Revenue and Prepayments……………………………………………….
11.3 Accrued Expenses………………………………………………………………….
11.4 Accrued Revenue………………………………………………………………….
11.5 Other Adjustments…………………………………………………………………
11.5.1 Depreciation Expenses……………………………………………………………
11.5.2 Bad Debts…………………………………………………………………………
11.5.3 Provision for Doubtful Debts………………………………………………………
11.5.4 Bad Debt Recovered……………………………………………………………….
11.5.5 Provision for Discount on Trade Receivables……………………………………..
11.6 Summary………………………………………………………………………….

CHAPTER TWELVE
PREPARATION OF SIMPLE FINAL ACCOUNTS
12.0 Learning Objectives………………………………………………………………
12.1 Introduction………………………………………………………………………
12.2 The Trial Balance…………………………………………………………………
12.3 The Statement of Comprehensive Income………………………………………..
12.3.1 The Movement of Inventories …………………………………………………
12.3.2 Carriage Inwards and Outwards…………………………………………………
12.3.3 Goods Taken By the Proprietor…………………………………………………
12.3.4 The Accounting Treatment of Inventories………………………………………
12.4 The Income Statement……………………………………................................
12.4.1 Adjustments in the Final Accounts……………………………………………
12.5 The Statement of Financial Position………………………………………………
12.5.1 Non-Current Assets………………………………………………………………
12.5.2 Current Assets…………………………………………………………………….
12.5.3 Liabilities………………………………………………………………………….
12.5.4 Capital Account…………………………………………………………………..
12.6 Manufacturing Account…………………………………………………………..
12.6.1 Prime Cost………………………………………………………………………..
12.6.2 Factory Overhead………………………………………………………………..
12.6.3 Production Cost………………………………………………………………….
12.6.4 Work-in-Progress…………………………………………………………………
12.6.5 Transfer Pricing…………………………………………………………………..
12.7 Summary………………………………………………………………………….

CHAPTER THIRTEEN
SINGLE ENTRY AND INCOMPLETE RECORDS
13.0 Learning Objectives……………………………………………………………….
13.1 Introduction……………………………………………………………………….
13.2 The Ascertainment of Profit from Incomplete Records…………………………..
13.3 Preparation of Detailed Final Accounts from Incomplete Records………………
13.3.1 Preparation of Statement of Affairs……………………………………………….
13.3.2 Preparation of Cash and Bank Summary………………………………………….
13.3.3 Analysis of unbanked Cash Sales…………………………………………………
13.3.4 Posting from the Cash and Bank Summary……………………………………….
13.3.5 Preparation of Trade Receivables and Payable Schedule…………………………
13.3.6 Extraction of Trial Balance……………………………………………………….
13.4 Summary………………………………………………………………………….

CHAPTER FOURTEEN
ACCOUNTING FOR NOT-FOR-PROFIT ORGANISATION
14.0 Learning Objectives……………………………………………………………….
14.1 Introduction……………………………………………………………………….
14.2 Receipts and Payments Accounts………………………………………………….
14.3 Income and Expenditure Account…………………………………………………
14.4 Membership Subscription………………………………………………………….
14.5 Bar Income Statement …………………………………………………………….
14.6 Life Membership…………………………………………………………………..
14.7 Accumulated Fund………………………………………………………………..
14.8 Summary………………………………………………………………………….  
CHAPTER ONE
THE ROLE OF ACCOUNTING

1.0 Learning Objectives
At the end of this chapter, candidates should be able to:
 Narrate the historical development of accounting
 Explain the purpose and scope of accounting
 Identify users of accounting information and the need for such information
 Explain the qualities of accounting information
 Describe the range of services provided by accountants

1.1 Introduction
Accounting is concerned basically with „accountability‟. The underlying purpose of accounting is to provide financial information about an economic entity. The information is provided periodically, to shareholders and others connected with the organization to enable them decide the extent to which they want to continue to associate with the organization. The need for accounting is more pronounced in a business where a lot of finance, risk and energy have been involved. Financial information is needed to plan and control the finance and operation of a business.

Every other person such as the owner, creditor, government, employee and other parties need financial information of a business for one purpose or the other; details of which would be discussed later in this chapter.

1.2 The Historical Development of Accounting
Rudimentary form of accounting started with book-keeping by Lucia Pacioli, an Italian monk. In his book titled “Summa de Arithmetical, Geometrica, proportioni et proportionalita,” published in 1494 on Arithmetic, Geometry and Proportion.  He devoted a chapter to expound the principles of the double entry system. It became necessary for managers to report to the owners of businesses during the period under review. Such report would include mainly the following:
 How the financial resources of the business have been invested during the period
 The profit earned or loss incurred during the period and
 The assets, liabilities and the owners‟ equity at the end of the period under review. After this initial development, a lot of changes have been witnessed in accounting. These changes were informed by sophistication and complexity of businesses, industrial and political environments which placed more responsibilities on management of business to disclose more information to owners and other interested parties.

For instance, a lot of Generally Accepted Accounting Principles (GAAPs) have been developed to be followed in the preparation of financial statements. Also, accounts have to be „audited‟ and reported on as presenting a „true and fair‟ position. Accounting has also gone beyond mere reporting for managerial decisions, to include tax management, government accounting and social responsibility accounting.
The GAAPs are developed from time to time to keep pace with changes in the economic and political environments. The GAAPs are also codified into what is known as Accounting Standards. Therefore, accounting is not a fixed set of rules but a constantly evolving body of knowledge.

Most countries have their own Local Accounting Standards Board but the body responsible for developing and issuing International Accounting Standards is the International Accounting Standards Board (IASB) based in the United Kingdom. In Nigeria, the Nigerian Accounting Standards Board (NASB) now Financial Reporting Council (FRC) is charged with the responsibility of developing and issuing local accounting standards for use by all preparers and users of financial statements in Nigeria. Accounting has changed from manual records alone; it now also makes use of computer and video displays.






1.2.1 Regulatory Framework
Due to the increasing changes in the economic and political environments, statutory and other regulations have been put in place to ensure the reliability, relevance and comprehensiveness of financial information, and to narrow areas of differences.

The main statutory document for the regulation of business in Nigeria is the Companies and Allied Matters Act 1990 (as amended in 2004). The company laws are enforceable in the court of law.

Other legislations relate directly to specific industry such as:
 Banks and Other Financial Institutions Act (BOFIA) 1991
 Insurance Act 2003
Other regulations consist of the following accounting standards:
 Statements of Accounting Standards (SAS) issued by NASB(now Financial Reporting  Standards (FRS) issued by Financial Reporting Council FRC)
 International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) issued by IASB from time to time

1.3 The Purpose of Accounting
Accounting is the art of recording, classifying, summarizing and analyzing financial transactions of a business.

Accounting transactions are classified into related groups or categories. The transactions are then recorded in the books of original entry. Thereafter, the transactions are analyzed and posted to accounts in the ledger. The accounts are then summarized into financial statements. Finally, the financial statements are interpreted through the development of significant relationship and by way of explanations.

The accounts of companies contained in their Annual Reports and Accounts are examples of the product of accounting and they are called financial statements.

1.3.1 Financial Transactions
These are transactions on which monetary values can be placed and measured objectively. They consist of cash transactions, credit transactions or contra. A financial transaction must be able to cause a change to assets or liabilities or capital; or a combination of them. It is the exchange of goods and services for cash or a promise to pay in future for goods or services.

1.3.2 Types of Business
A business is a commercial outfit which sells goods or provides services. There are three main types of business enterprises; the sole traders, the partnerships and the limited liability companies.

The commonest form of business entity is the sole trader who owns and manages his business.

Partnerships are formed by two or more persons who contribute finance and technical knowledge in order to share the risks and rewards of the business together. Limited liability companies are those that are incorporated under the company laws of a country. The owners take advantage of the fact that their liability is limited to the amount payable on their shares.

Details, characteristics and operations of these various business enterprises shall be dealt with later in this study pack.

1.4 Bookkeeping and Accounting
Bookkeeping is the recording phase of accounting. It is the classification and recording of business transactions in the books of account. The recording of the transactions is a routine task, therefore it tends to be repetitive. Accounting, on the other hand, includes not only the keeping of accounting records, but also the design of efficient accounting systems, the interpretation of accounts and the development of forecast.

The processes involved in bookkeeping are as follows:
(a) Classification of business transactions using source documents;
(b) Recording of transactions in appropriate subsidiary books or books of prime entry;
(c) Posting of entries from subsidiary books to the ledger  and  (d) Extraction of the Trial Balance.

1.5 Scope of Accounting
The starting point in the study of accounting is financial accounting; others are cost Accounting, Management Accounting, Auditing, Government Accounting and Tax Management.

1.5.1 Financial Accounting
Financial accounting involves an accounting process that starts with bookkeeping and ends with the preparation and interpretation of financial statements. The components of financial statements are comprehensive income statement, income statement and statement of financial position.

For limited liability companies other statements required by the company laws or standards are; Chairman’s Report, Directors Report, Auditors Report, Group Financial Statements, Statement of Accounting Policies, Notes on the Accounts, Value added received flow Statement and a Five year Financial Summary. (Value added statement and five years summary are no longer required under IFRS and cash flow is now fund flow).

The financial statements enable owners of the business to assess how efficiently management has run the business. The information needs of other parties who are interested in the business are satisfied to a large extent by the financial statements.

For instance, the Statement of Accounting Standard (SAS 2) states that „all accounting information that will assist users to assess the financial liquidity, profitability and viability of a reporting entity should be disclosed and presented in a logical, clear and understandable manner.
You shall come across the details of each of these issues as you progress in the study of accounting.

1.5.2 Cost Accounting
Cost accounting is the procedure for accumulating data to provide information for managerial action. Cost accumulation is the collection of cost data in some organised ways by means of accounting systems. The cost accumulated will be related to specific products and departments for planning, control and decision making by management.
 
1.5.3 Management Accounting
Management accounting provides information to management of a business to help them take better decision and to improve upon the efficiency and effectiveness of existing operations.  It is concerned with providing accounting information to management for the purpose of planning, decision making and control. Management accounting uses various quantitative analysis tools to forecast the future. It is sometimes referred to as “managerial accounting”.

1.5.4 Auditing
Only complete and reliable financial statements can be of any use to the creditors, investors, government agents and other interested parties. To guarantee these, the accounts must be audited by an independent person called an Auditor. Auditing is the independent examination of the books of accounts and records of the company. The professional accountant will gather various forms of audit evidence before he forms an opinion on the financial statements. At the end of the audit exercise, he will write a report on the „true and fair view‟ of the financial statements and the scope of work he carried out before arriving at his opinion.

1.5.5 Government Accounting
Government accounting is the process of recognising and reflecting in the appropriate books of accounts and records government generated revenue and disbursed expenditure in such a way as to extract with ease relevant financial information vital for appropriate decision making from time to time, and in compliance with the laws regulating government finances.

It is a class of Accounting in the Public Sector where government has some executive responsibility. Public sector consists of the ministries and parastatals.

Government accounting is concerned with planning, control and appraisal of government activities and in effect, accountability.

1.5.6 Accounting for Taxation
The accounting profits generated in the financial statements provide the basis for determining the taxable profits of a company. The taxable profits are different from the accounting profits because certain expenses and income are allowable for accounting purpose but disallowable for tax purpose. A good understanding of the knowledge of these taxable incomes and expenses and non-taxable incomes and expenses would help a business in its tax management.

1.6 The Need for Accounting Information
The need for accounting information can be summarized as follows:
 It provides information useful for making economic decisions
 It provides information to users for predicting, comparing and evaluating the earnings power and financial strength of a business
 It is used to judge the ability of management to utilize the entity‟s resources effectively in achieving the goal of the entity
 It provides information to creditors for predicting and evaluating the cash flows of the entity
 It provides management with detailed accounting data for use in planning and controlling the daily operations of the business
 It provides information to government for determining the tax payable on the profit and/or other incomes of an individual or company and for formulating fiscal policies
 It forms the basis of reporting on the activities of an enterprise as they affect the society
 It serves as the basic instruments by which investors decide the securities in which to invest.

1.7 Qualities of a Good Accounting Information
Accounting information should possess the following qualities before users can rely on it:
(a) Relevance: The accounting information must include enough facts to satisfy the need of the user. For instance, management accounting information should be relevant to the decision to be taken with it. Financial accounting information should disclose enough information to satisfy the various users.
(b) Reliability: The source of information must be verifiable and one source of evidence must corroborate the other.
(c) Comparability: There should be no change in the basis for the preparation of the accounting information from period to period so that it will be easy to compare the result of operations over some accounting periods.
(d) Timeliness: Accounting information must be made available early enough for its use. For instance, management requires certain information on daily basis or weekly basis for effective running of the business; if it comes late it would be useless. Annual reports and accounts must be published not long after the year end.
(e) Objectivity: There must be no bias, window dressing or subjective judgement in the presentation of accounting information. Objectivity includes ability to trace transactions to documentary evidence and complying with required regulations in its presentation.
(f) Comprehensiveness: Accounting information must contain enough details for good understanding. The details must neither be too little nor too much.

1.8 Users of Accounting Information
Accounting information is of interest to various groups of people. The following people are likely to be interested in accounting information.
(a) Owners of the business/investors: These are sole traders, partners and shareholders. They need accounting information to assess how efficiently the management is performing – they want to know how profitable the business is and how much of this profit they can withdraw for their own use. It will also allow shareholders to make appropriate investment decision such as buying and selling of shares.
(b) Management: These are the people who manage the affairs of the business for the owners. In a limited liability company, they are the members of the board of directors and other management staff. They need accounting information to ascertain the efficiency of the policy they formulate and to plan and control the resources of the business.
(c) Trade Creditors: These are the people who supply goods to the business on credit. The trade creditors want to know the ability of the business to pay for the goods supplied to the business promptly. They will be interested in the liquidity of the business.
(d) Customers: These are the people who purchase the goods or services provided by the business. The customers want to know whether the business will continue to be a reliable source of supply; though they will also be interested in the quality of the products of the business.
(e) Tax authority: Profits determine the basis of computing tax. The tax authority wants to determine the tax payable by the company and its employees.
(f) Employees of the entity: They need accounting information to enable them decide how secure their job is and the ability of the business to pay good salaries and provide good welfare facilities.
(g) Lenders: These include the banks and other loan creditors. Financial statements enable them to decide whether more credit facility can be granted and whether the company will be able to pay interest and principal when they fall due. They are interested in the liquidity, profitability and reliability of underlying assets.
(h) Government: Government needs accounting information to enable it formulate fiscal policies.
(i) Financial Analysts: They analyze financial statements for their clients in order to help them make informed decisions. Financial analysts include stock brokers, credit agencies and financial reporters.


1.9 The Work of an Accountant
A professional accountant performs various types of work for an organization either as an employee of the organisation or as a consultant to the organisation. For instance, members of the Institute of Chartered Accountants of Nigeria (ICAN) are classified into two broad categories; members in public practice and members not in public practice.

1.9.1 Members in Public Practice
These are accountants working in accounting firms which offer a variety of accounting services to their clients. Their principal functions are:
(i) Auditing: They examine the books and records of the company, obtain reliable, relevant and sufficient audit evidence and then issue a report on the true and fair view of the financial statements. The report issued by the auditor enables users to rely on the financial statements.
(ii) Tax Services: They engage in tax planning for a company or an individual with a view to minimizing the tax payable. Their services are also engaged by government in the investigation of the adequacy of tax paid by companies and individuals.
(iii) Management advisory services: Firms rely on the extensive knowledge of accountants to provide a range of management consulting services. They could render advice in the area of mergers and acquisition, whether an organisation should enter a new line of business or divest. They could also offer advice on asset replacement policy, the best Computer based accounting system to adopt, setting up and operating the accounting system..
(iv) Insolvency Services: They could act as receiver manager in the process of winding up a company.
(v) Investigation Services: They investigate fraud or any other matter for which investigation services are required.

1.9.2 Members not in Public Practice
These are accountants in the employment of government ministries and parastatals or private business concerns. Their main functions include the following:
(i) They prepare the financial statements and the annual reports of the organisation on behalf of management.
(ii) They provide relevant management accounting information to management for decision making.
(iii) They set up and run an efficient system of accounting and internal control.
(iv) They act as treasury managers.

1.10 Summary
In this chapter we have looked at the nature and scope of accounting. We have also considered the importance of accounting information to management, investors, creditors and the other users.

We also discussed the development of accounting from the rudimentary form to modern form.  We also discussed the regulatory framework of accounting.

CHAPTER TWO

FORMS AND STRUCTURES OF BUSINESS ORGANISATIONS

2.0 Learning Objectives
After studying this Chapter, readers should be able to understand the forms and structures of business organizations, their characteristics, advantages and disadvantages.

2.1 In an economy, in which free-enterprise is allowed and encouraged by the government, business organizations take different forms in this situation, we discuss four different forms of business organizations: sole-proprietorship, partnership, Limited Liability Company and public enterprise.

            2.1.1 Sole-proprietorship
It is a business owned by an individual.  He bears the responsibility for running the business and he alone takes the profits or loss. The sole-proprietorship is not regulated by special rules of law.

2.1.1.1 Advantages and disadvantages

Advantages

(a) The individual provides the capital and employs a handful of people, if and when necessary.
(b) He takes decisions quickly without consulting anybody.
(c) He is highly committed because the profit is entirely his own in case of   success and he depends on the business for his livelihood.
(d) There is privacy
(e) It is not regulated by special rules of law.

Disadvantages

(a) The finance available for expansion is limited to that which the sole trader can raise.
(b) The owner has unlimited liability because all his assets might be seized if the business goes bankrupt.
(c) It lacks continuity because the death of the owner automatically leads to the collapse of the business.

Sole-proprietorship is common in retailing, farming, personal services such as hairdressing, fashion designing etc.

 
2.1.2 Partnership

Partnership Formation
Partnership is the relationship which exists between two or more persons, commonly referred to as partners, carrying on a business in common with a view to making profit.  The business may also result in a loss although the purpose is that of profit.  Coming together is voluntary and exit of a partner may also be voluntary.

The Partnership Act 1890 and the Limited Partnership Act 1907 contain the provisions which govern the relationship between persons carrying on a business with the intention of making profit.

The maximum number of partners in a firm is twenty. There is no maximum limit for professional firms such as accountants and solicitors who have received the approval of the law for this purpose.  A firm with more than twenty members would normally be incorporated as a Limited Liability Company.

Most partnerships are formed under a formal agreement.  In the absence of an agreement, the Partnership Act 1890 provides among other things, that:
(a) All profits and losses are to be shared equally between the partners   (b) No interest is allowed on capital and current account.
(c) No remuneration will be paid to a partner.
(d) Any advance or loan made by a partner in excess of his agreed share of capital will attract interest at 5% per annum.
An agreement is most important, if it is intended that partners should be rewarded according to their differing contributions made to the firm in form of capital, expertise, experience or effort.  Resulting from this, an agreement would necessarily contain provisions regarding the following, to ensure as far as possible, that there is an equitable distribution of profits or losses.

(a) The amount of capital to be provided and maintained by each partner.
(b) The rate of interest (if any) to be paid on capital.
(c) The extent to which drawings are allowed and the rate of interest (if any) to be charged on drawings.
(d) The remuneration (if any) to be paid to partners for their services.
(e) The interest to be paid on any advance or loan made to the firm by a partner over and above his agreed capital.
(f) The proportions in which profits and losses are to be shared after taking account of any adjustments as a result of the above.

Decisions regarding the distribution of profits can be quite interesting in practice due to the search for an equitable relationship among partners.  If all partners provide equally in all respects, an equal distribution of profits might adequately represent each interest.  But differing amounts of capital, all other contributions to the firm being equal, would usually be compensated for by allowing interest on capital at an agreed rate.  In this way; each partner would be given a return on his capital before distribution of the remaining profit. Differences in partners‟ contributions in the form of expertise, experience or effort could be taken into account by salaries and/or differential distribution of profits.

The problems inherent in determining a just and equitable distribution of profits are not usually a concern of examination students.  A question will normally indicate:
(a) Whether salaries are to be paid.
(b) Whether interest is to be allowed on capital
(c) Whether interest is to be charged on Drawings, and
(d) How the remaining profit should be distributed.

Students‟ problems are usually technical, arithmetical and presentational.

A partnership will often maintain a fixed amount of capital.  Under these circumstances, it is preferable that only an agreed capital ratio should be credited to a separate capital account for each partner.  All other transactions involving partners such as share of profits, interest, salary, drawings, should be dealt with in their current accounts rather than through the capital accounts. It is simple in this way to keep a constant check on the current accounts; provided a partner’s Current Account is not overdrawn, the agreed capital at least must remain with the firm.  Of course, profits (or losses) are accruing over the whole of the year, and not just when the final accounts are prepared.  It follows therefore that an overdrawn current account is not necessarily an indication that a partner is not maintaining his agreed capital.  It is up to the partners to agree on the extent to which drawings are allowed and whether the drawings may exceed the current account balance at the beginning of the year.


  Partnership Agreements
  Since the essence of partnership is mutual agreement, it is desirable for the partners to come to some understanding before entering into partnership as to the conditions upon which the business is to be carried on and their respective rights and powers.

 The Partnership Act 1890 provides certain rules to be observed in the absence of any agreement.  The circumstances must determine whether these rules are applicable in the particular case and since many matters should be decided which are not included in these rules, it is desirable that a formal agreement be entered into with a view to preventing disputes in the future.  The advantages of written agreements need no emphasis and it is preferable that it should be under seal, since the character of a deed precludes contradiction by any party of the terms which have been agreed.

 Even though a formal agreement is made, this does not preclude subsequent variation where changing circumstances demand it; such variation can always be effected with the consent of all the partners, which may be evidenced by an amended agreement.

2.1.2.1 Contents of Partnership Agreements
 
The provisions affecting partnership accounts are as follow:
(a) Capital Contribution
The agreement states whether each partner should contribute a fixed or a flexible amount.
 
(b) Division of Profits and Losses
The basis as to how profits and losses shall be shared among the partners.

(c) Fixed or Flexible Capital
Whether the Capital Accounts are to be Fixed Account, or if drawings and profits are to be adjusted in the current accounts, or in the capital accounts.
 
(d) Interest on Capital and/or Drawings
Whether interest on any of the two or both, is to be allowed or charged before arriving at the profits divisible in the agreed proportions, and if so, at what rate.
(e) Current Accounts
Whether current accounts (if any) are to bear interest, and if so, at what rate.

(f) Partners‟ Drawings
Whether partners‟ drawings are to be limited in amount in order to prevent a negative balance against the capital account, and/or whether interests are to be charged on drawings and at what rate.
 
(g) Partners‟ Remuneration
Whether partners are to be allowed remuneration for their services before arriving at divisible profits, and if so, the amount of the remuneration.
 
(h) Accounting Records
Proper accounts shall be prepared at least once a year and that these shall be audited by a professional accountant and signed by all the partners.

(i) Signed Accounts
The accounts, when prepared and duly signed, shall be binding on the partners, but shall be capable of being reopened within a specified period on an error being discovered.

(j) Valuation of Goodwill
The method by which the value of Goodwill shall be determined in the event of admission, retirement or death of any of the partners.

(k) Compensation to the Estate of Deceased Partner
The method of determining the amount due to the estate of a deceased partner and the manner in which the liability to his payment within a specified period, by instalments of certain proportions and the rate of interest to be allowed on outstanding balances.
 
(l) Insurance Premiums
In the event of any partnership insurance policies, the method of treating the premiums thereon and the division of the policy must be stated.
 
       2.1.2.2 The main advantages of partnership over sole-proprietorship are:

(a) More finance is available
(b) Higher performance may be achieved since two heads are better than one.
(c) Decision-making is also swift since partners are friends and they are not many.

The disadvantages are:
(a) The major disadvantage is that the liability of members of the partnership is unlimited.

(b) The amount of capital the partners can raise is still too small to enable them carry out large investments.

(c) The death and bankruptcy of a partner may lead to the dissolution of the firm.

(d) Disagreement may occur between the partners.  They may find out that they are not compatible which may lead to the dissolution of the partnership.

2.1.3 Limited Liability Company

  Nature, Formation and Statutory Books Of Limited Liability Companies

 A limited liability company is a form of business organization that has a personality distinct from those of its owners.  The attraction of this form of business enterprise is its access to capital larger than what its promoters can provide.  Because of its distinct legal personality, it can sue and be sued in its name and enter into contracts for which it is solely liable.

 The following are different types of companies:
(a) Private Limited Liability Company;
(b) Public Limited Liability Company;
(c) Company Limited by Guarantee and
(d) Unlimited Liability Company.

Companies derive their existence under the provisions of the Companies and Allied Matters Act, Cap. C 20 LFN 2004.  The rules and procedures guiding the incorporation or formation of limited liability or unlimited liability companies are contained in Sections 18 – 49 of the Companies and Allied Matters Act, Cap. C 20 LFN 2004.

      2.1.3.1 Formation Procedure

(a) The name proposed by the promoter of the Company has to be searched for and approved by the Corporate Affairs Commission, which must be utilized within 60 days, otherwise the name has to be revalidated.
(b) A limited liability company, private or public, may be brought into existence when the documents enumerated below and appropriate fees are paid to the Registrar, Corporate Affairs Commission:

(i) A Memorandum of Association signed by at least two subscribers, dated and witnessed by Chartered Accountant, Chartered Secretary and a Lawyer facilitating the registration of the Company. Each subscriber must agree to subscribe for at least one share.

(ii) A minimum of 25% of the authorized share capital must be taken up at incorporation.

(iii) Articles of Association will be similarly signed, dated and witnessed by the Professionals involved in the registration of the Company as mentioned above.

(iv) A statement of nominal capital (unless the company is to have no share capital) must be stated.  Stamp duty varying with the amount of authorized share capital is payable. Rate is at present N3 for every N200 worth of shares.

(v) There is no upper limit to the amount of the authorized share capital, although the minimum is currently N10,000 for a private company while that of a public limited liability company is N500,000 (except in cases of special companies such as, banks and insurance companies).

(vi) A statutory declaration by a solicitor engaged in the formation of the company or by one of the persons named as a director or secretary that the requirements of the Companies and Allied Matters Act 2004 in respect of registration have been complied with.

(vii) A statement (in the prescribed form) of the particulars of the first directors and secretary and the first address of the company’s registered office. The persons named as directors and secretary must sign the form to record their consent to act in the relevant capacity and when the company is incorporated; these persons are automatically appointed.

(c) When the Registrar General, Corporate Affairs Commission is satisfied that all the documents are in order and that the objects specified in the memorandum are lawful he issues a certificate of incorporation.
(d) The purpose of the memorandum and articles of association is to define the constitution of the company.  The memorandum sets out basic elements of the constitution while the articles are mainly internal rules, but of interest to outsiders since they define the powers of the directors to enter into contracts on behalf of the company.  The memorandum prevails if there is any inconsistency between it and the articles.

(e) A private company may do business and exercise its borrowing powers from the date of its incorporation but a public company (incorporated as such) may not do business or borrow until it has obtained a trading certificate (not a statutory expression) from the Registrar General.

(f) The memorandum of every company limited by shares must include:
(i) The company’s name, which if the company is “limited” by shares or by guarantee, should end with the word limited.  A limited company may in some circumstances omit the word “limited” from its name.  An unlimited company does not end its name with the word “Limited”.
(ii) The country (not the address) in which the company’s registered office is to be situated.  This determines the nationality and the place of domicile of the company which cannot be changed.

(iii) The objects of the company contained in an “objects clause” which, because of the developments of company law over time, specifying both alternative business activities and express powers to engage in every kind of business which the company might wish to undertake.
The objects stated in the opening paragraphs are treated as „main objects‟ while the others are ancillary to them, unless the contrary is stated.  
(iv) The liability of members: If the company is one limited by guarantee, this is followed by a second clause which states the maximum amount that each member undertakes to contribute in a winding-up to enable the company pay its debts.  The authorized share capital (of a company limited by shares) must disclose the amount of the share capital with which the company proposes to be registered and specify shares of stated value into which that amount is divided.  For example, the share capital of the company is  N100,000 divided into 200,000 shares of 50k each‟.  The amount of the authorized share capital may be increased (or reduced) in the manner provided by the articles, usually by passing an ordinary resolution.  The authorized share capital is the maximum amount in shares which the company may issue.

(g) The articles of association deal mainly with the internal conduct of the company’s affairs, e.g. the issue and transfer of its shares, alterations of its capital structure, conduct of general meetings, members voting rights, powers of directors and board meetings, dividends, accounts and notices.

(h) The articles of association usually delegate the power to allot and issue shares to the directors as one of their management functions. The formal procedure is that the subscriber applies for shares (often in response to an invitation by the company) and the directors accept his offer by deciding at a board meeting to allot shares to him. His name is entered in the register of members, a share certificate is issued and within one month of allotment; a return is submitted to the Registrar General.

2.1.3.2   Statutory Books
(a) Once the company has been formed and it commences trading it has a statutory obligation to prepare financial statements showing a true and fair view of the company’s operations and statement of affairs and keep accounting records sufficient to show and explain the company’s transactions.
(b) Redeemable Preference Shares
Under section 122 and 158 of the Companies and Allied Matters Act Cap C20 LFN 2004, a company so authorized by its articles may issue redeemable preference shares, provided that:
(i) There are in issue other shares which are not redeemable.
(ii) The redeemable shares may not be redeemed unless they are fully paid.
(iii) The terms of redemption provide for the company to make payment at the time shares are redeemed.  The redemption may be effected on such terms and in such manner as may be provided by the articles as long as the provisions of the Act are complied with.
(iv) Redemption is made out of the:
- Distributable profits of the company
- Proceeds of a fresh issue of shares made for the purposes of the redemption.
(v) Any premium payable on redemption is payable out of the company’s distributable profits, except: the premium payable on the redemption of redeemable preference shares which were issued before the appointed day may be paid out of the share premium account or partly out of the distributable profits (section 158(4) of the Companies and Allied Matters Act, Cap. C20, LFN 2004).
(vi) Where the redemption is made out of the proceeds of a fresh issue of shares made for the purpose of the redemption and the shares to be redeemed were originally issued at a premium, any premium payable on their redemption shall be paid out of the share premium account up to an amount equal to the lower of:
 The aggregate of the premium received by the company on the issue of the shares redeemed, or

 The current amount of the company’s share premium account (including any sum transferred to that account in respect of premium on the new shares).

Where specific provision is made in the articles, preference shares may be participating preference shares.  This type of shares entitles the holders to share in any remaining profits after the preference shares and ordinary shares have received specified dividends.

(c) Ordinary shares
The ordinary share capital of a company is often termed the „equity capital.‟ Ordinary shares may be divided into preferred and deferred ordinary shares, in which case the balance of the profit is shared between the two types of ordinary shares in some prescribed proportions.

  2.1.3.3 Issued Share capital

A company does not necessarily issue all its authorized share capital immediately, or indeed ever.  The amount of capital that it does issue, whether for cash or otherwise, is known as its Issued Share capital.

Both the authorized share capital and the issued share capital must be shown in a company’s statement of financial position.
 
  2.1.3.4 Reserves and Provisions

Reserves are grouped under a separate heading in the statement of financial position with „opening reserves‟ shown first and ending with the balance carried forward on the income statement, i.e. retained profit.

It is important that reserves are distinguished from provisions.  The expressions „Reserves‟ and „Provisions‟ are defined in the Companies and Allied Matters Act, Cap. C20 LFN 2004, as follows:

(a) „Provision‟ means any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.

(b) „Reserves‟ include any amount written off or retained by way of providing for depreciation, renewals or diminution in the value of assets or retained by way of providing for any known liability, or any sum set aside for the purpose of its being used to prevent undue fluctuations in charges for taxation.

(c) Any excess of the amount retained by way of providing for any known liability which in the opinion of the directors is reasonably necessary for the purpose, shall be treated as a reserve and not as a provision.

It should be noted, particularly, that the expression „provision‟ should be used only to indicate known depreciation, renewals or diminution in the value of assets and known liabilities, the amount of which, however, cannot be estimated with substantial accuracy.  It follows that the provisions will generally be deducted from the assets to which they relate.

  2.1.3.5 Advantages and disadvantages of Limited Liability Company
 
Advantages
(a) The liability of the shareholders is limited to the amount they have subscribed to the firm’s capital if the company goes bankrupt.

(b) It can raise substantial amount of capital from the numerous shareholders or from financial institutions.

(c) The chance of survival is high because the company is controlled and managed by highly skilled professional management team appointed by the Board of Directors who are elected by and answerable to the shareholders.

(d) The limited company is a separate legal entity distinct from its members.  It can sue and be sued in its name.

(e) Unless it is wound up, a limited company has perpetual succession so that it is not affected by the death, bankruptcy, mental disorder or retirement of its members.

(f) Floating charges can be created by a limited company.

(g) Shares in a public company can be transferred without the consent of other members.    

  Disadvantages
(a) Formation of Limited Liability Company requires costly legal expenses
(b) Decision making may be delayed due to bureaucratic bottlenecks.
(c) The members of the company have no power to manage its affairs.
(d) Much legal and publicity formalities are observed e.g. filing of annual returns, annual general meeting etc.
 
2.1.4 Public Enterprises

The public corporation is an enterprise owned by and controlled by the government.  The government provided the capital for the company.  The Commissioner (Minister) acting on behalf of the State or Federal government appoints the members of the Board of Directors who in turn formulate policies within the enabling Act establishing the Corporation and the framework.  Examples of public corporation are Ghana Airways, the Nigerian Railway Corporation, the Nigerian Ports Authority and the Nigerian National Petroleum Corporation.

Advantages
(a) Some activities such as the generation of electricity, provision of port facilities and rail transport services involve huge financial considerations which the private entrepreneurs cannot provide.  These facilities must be provided to quicken the pace of economic development and industrial growth.

(b) It enables some natural resources, especially minerals to be efficiently exploited and effectively managed.

(c) Some essential goods or services if left in the hands of private business may not be sufficiently provided or may be provided at exorbitant prices.  Thus, the common people will not be able to afford them as a result of which their conditions of living will worsen.

(d) The public company can borrow money externally by issuing bonds or debentures.  This is not possible for the private company.

The major disadvantage of public enterprises is that members of the Board of Directors are political appointees to control and manage the corporation.  At times, they  may not possess the relevant skills to manage such organization efficiently.  Some members of staff are appointed on political grounds and quota basis, resulting in low quality of labour.

The performance of public enterprise is poor when compared with the private sector.  Most of the public enterprises are being run at a loss as the motive for establishing them is not for profit. They receive subventions from the government.

2.2 Summary and Conclusions

Chapter 2 dealt with the forms and structures of business organizations covering their characteristics, advantages and disadvantages.

At the end of the chapter, students would have sufficiently familiarized themselves with;  - advantages and disadvantages of Sole Trader.
- Procedure for the formation and drafting of Partnership Deed.
- Procedure for the formation of limited liability company, the required statutory books and sources of capital
- Advantages and disadvantages of Public Enterprises.











CHAPTER THREE

ACCOUNTING CONCEPTS AND CONVENTIONS

3.0 Learning Objectives
At the end of this chapter candidates should be able to:
 Identify and explain the relevance of accounting concepts.
 Explain the relationship between a business entity and its owner.
 Explain the relationship between accounting equation and statement of financial position.
 Differentiate between assets, liabilities and Owner’s equity.

3.1 Accounting Concepts and Conventions
Accounting concepts and conventions are the basic assumptions that underlie the preparation of the periodic financial statements of a business entity. They are rules regulating the manner in which transactions are recorded. They are deemed to be in existence though not actually stated or referred to. The concepts and conventions give reasons why accounting data are prepared in a typical manner.

We shall now discuss some of the fundamental concepts and their importance in the preparation of financial statements. (SAS 1)

3.1.1 Entity Concept
In the strict legal sense, only limited liability companies are regarded as legal entities separate from their owners. It can acquire assets and incur liabilities. It can enter into contract on its own and can owe debt. It can sue and be sued.
In accounting, however, all forms of businesses are regarded as being separate from their owners. The assets (such as cash) contributed by the owner to the business is regarded as the liability of the business to the owner, which is called capital or owners‟ equity.

The essence of the entity concept is to distinguish the income and costs of the business from the private income and costs of the proprietor or his drawings from the business. For instance, if the owner of a business draws cash from the business bank account to repair delivery vans, it would be regarded as business expenses. But if he pays his child’s school fees with the cash, the amount will be treated as drawings of the owner rather than expenses of the business. The entity concept also gives rise to what is called the Accounting Equation.

3.1.1.1 Accounting Equation
The cash or other assets invested in a business by the owner are liabilities of the business to the owner. Therefore, assets = capital (liability to owner) at the commencement of the business.

As the operation progresses the owner may obtain goods on credit from suppliers or borrow additional loan from the bank to finance the business. The value of the goods supplied and the cash received as loan would increase the assets of the business, while liabilities to third parties (not owners) would increase. The accounting equation becomes Assets = Capital + Liabilities.

Let us illustrate the two scenarios.
(a) Ade, a proprietor of Adisco Enterprises started business with cash of N50,000
The accounting equation is
Assets = Capital + Liabilities
N50,000 (cash) = N50,000 +  0

(b) Assuming that in addition to the cash invested, Ade introduced N25,000, borrowed from a friend into the business. The cash position is now  N75,000, made up of Owner’s capital of N50,000 and liability N25,000
  Assets = Capital + Liability
  N75,000 (Cash) = N50,000 + N25,000

We shall now consider the effect of different transactions on the Assets, Capital and Liability of a business.

(c) Adisco Enterprises spent N20,000 to rent an office and bought furniture for N10,000. He also purchased for cash some textile materials for resale at the cost of N30,000.

The accounting equation will remain as in (b) above but the composition of the assets has changed. Assets = Capital + Liability
Furniture + Inventories of Goods + Rent + Cash = Capital + Liability N10,000 + N30,000 + N20,000 + N15,000 = N50,000 + N25,000 i.e. N75000 = N50,000 + N25,000

(d) If the goods above have been purchased on credit the accounting equation would be Assets = Capital + Liability
Furniture + Inventories of Goods + Rent + Cash = Capital + Loan + Supplier
N10,000 + N30,000 + N20,000 + N45,000 =  N50,000 + N25,000 + N30,000
N105,000  =  N50,000 + N55,000
We shall now consider the effects of profits and drawings on Owner’s equity and the accounting equation.

Profits will increase the Owner’s equity/capital while drawings will reduce it.
(e) Assuming that in illustration (d) above, Adisco Enterprises sold all the textile     materials for N52,000 and made a profit of N22,000 (N52,000 – N30,000). The cash from the sale would increase cash balance by N52,000 while capital is increased by N22,000 profit.
  Assets = Capital + Liability
Furniture + Rent + Cash =  Capital + Profit + Loan + Supplier
N10,000 + N20,000 + N97,000 = N50,000 + N22,000 + N25,000 + N30,000
  i.e.Assets = Capital + Liability        N127,000 = N72,000 + N55,000 (f) In addition to the information in (e) above, Ade withdrew N16,000 cash for private use. The accounting equation will become  Assets = Capital + Liability will be:
  127,000 – N16,000 = N72,000 – N16,000 + N55,000
  N111,000 = N56,000 + N55,000
You will notice that though capital is described as a sort of liability, it is not described with the word „liability‟. It is only the amount owed to third parties by the business that is described as liability. In the event that the business ceases to exist, the liabilities to third parties are settled first from the business assets.  

Other examples on accounting equation are
Transactions     Effects on Assets and Liabilities
1. Buy goods on Credit for N1,200,000   Assets (Inventories) is increased Liabilities (Creditors) is increased by N1,200,000  by N1 ,200, 000
2. Buy goods in Cash for N300,000                  Asset (Inventories) is increased by
 Asset (Cash) is also decreased by N300,000  N300,000
3.  Pay Creditors for N1,200,000          Asset    (Cash) is decreased by
Liability (Creditors) is decreased by N1,200,000 N1,200,000
4. Proprietor takes N400,000 for private use Asset (Cash) is decreased by
Capital decreases by N400,000 N400,000
         Let us now see how the above four transactions affect the accounting equation.
1. Buy goods on Credit N1,200,000  Inventories N1,200,000
2. Buy goods in Cash N300,000     Inventories N300,000)
3. Pay Creditors          (N1,200,000)         Cash (N1,200,000)
4 Proprietors‟ drawings           N400,000)           Cash N400,000
Grand total effect N400,000         = N400,000 Creditors
Cash
Creditors
Capital
Assets = Liabilities
All figures in brackets denote decrease while others denote increase.

The two sides of the equation are equal, that is (N400,000) both ways. This confirms that for any transaction, the effect is of equal weight on the two sides of the accounting equation i.e. Asset = Liability


Explanation of some of the terms used in the Accounting Equation

The accounting equation: assets = capital plus liability represents the two sides of a statement of financial position; Assets on one side and capital and liabilities on the other side. The capital and liabilities are claims against the assets. The net worth of the business is the capital. The net worth is the original capital plus the profits earned (or less the losses incurred) during the period less the proprietor’s drawings during the same period.

3.1.1.1.1 Assets
Assets are the economic resources of a business that are expected to bring immediate and future benefits to the business. They are classified into non-current and current assets.

3.1.1.1.1.1 Non-current Assets
These are the economic resources that aid income generation for more than one accounting period. They include land and buildings, motor vehicles, equipment, machinery, furniture etc.

3.1.1.1.1.2 Current Assets
These are the economic resources of the business which are easily converted to cash or can be consumed within an accounting period or operation cycle, whichever is longer. Examples are cash in hand and at bank, receivables and other receivables, prepaid expenses and inventories of goods meant for resale.

3.1.1.1.2 Liabilities
Liabilities are claims against the assets of the business. Liabilities give rise to creditors. Some of the liabilities may arise from the use of the services or goods of another person on credit basis; some other liabilities may arise from financing the organization i.e. loan creditors. They are divided into current liabilities and longterm liabilities.

3.1.1.1.2.1 Current Liabilities
These are the liabilities of the business that are meant to be paid within twelve months. Examples of current liabilities are trade creditors (supplier of goods on credit), and other payables such as outstanding bills on electricity, salary and wages, taxation etc. and bank overdraft.

3.1.1.1.2.2 Non-current liabilities: These are liabilities that will take more than one year before repayment is due. They are long-term loans.
We have discussed the entity concept much because it is fundamental to the principle of double entry. We shall now consider the other concepts and conventions.

3.1.2  Money Measurement Concept
Money serves as the common denominator for measuring the various assets and liabilities of an organization, therefore accounting transactions are expressed in monetary values. The Naira and the Cedi represent unit of value which have the ability to command goods and services in Nigeria and Ghana respectively.
Apart from the fact that money serves as a common unit, accountants also believe that it is stable in value.

There are some limitations in the use of money as measure of value in accounting.
(a) The value of money does not always remain stable particularly in an inflationary economy.
(b) Apart from inflation, the time value of money today is greater than the time value of money in any future time, due to the cost of funds.
(c) There are some activities of an organization that are not recorded because monetary value cannot be attached to them. Examples are good management, employees‟ morale, strength of competition etc.

Thus, accounting does not provide all the information about a firm, it provides only economic information that can be expressed in monetary terms.
We may then understand why limited liability companies are required to disclose a lot of non-accounting information in their annual reports.

3.1.3    The going concern concept
Unless otherwise stated, it is always assumed that a business entity will continue in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or curtailing significantly the scale of operation.

The going concern concept will help investors, creditors, employees, customers and other stakeholders to determine the extent to which they want to continue to patronize the business. The going concern concept may be more justified in a limited liability company where the death or withdrawal of any member (shareholder) may not affect its scale of operation.

Assets and liabilities of a going concern enterprise are valued on historical cost basis. When the going concern is in doubt the assets are valued on break-up value basis i.e. forced sale values.

3.1.4    Periodicity concept
Notwithstanding the going-concern assumption, the operations and performance of a business entity should be subjected to periodic review, for instance limited liability companies are required to present their financial statements to members of the company annually. Management accounting information is even prepared more frequently.

The periodic review would help to assess management efficiency and the planning and control of future operations.

3.1.5    Prudence
The prudence concept requires that an accountant should not recognize income until the income has been earned and that losses should be fully written off. The essence of the principle is that profits are not overstated in any accounting period.

The prudence concept is most useful when matters of judgement or estimates are involved. For instance, if the credit policy of a business requires a customer to pay for the goods sold to him in 60 days and he has not paid after 120 days, it may be reasonable to make provision for the entire amount as bad and doubtful debt. Another example is when inventories becomes obsolete and its net realizable value falls below cost, the difference between the cost and the net realizable value will be written off to income statement.

Failure to write foreseeable losses off or the recognition of unrealized income will produce a misleading result which will eventually lead to losses to creditors and shareholders.

3.1.6    Substance Over Form
Business transactions are usually governed by legal principles; nevertheless they are accounted for and presented in accordance with their financial substance and reality and not merely by their legal form.

Examples are found in; sales and re-purchase agreements, lease contracts and consignment of goods.

3.1.7    The Consistency concept
Consistency concept requires that when a method has been adopted in treating an item in the financial statements, the method should not be changed but used consistently from period to period. For instance, there are many methods of depreciating a non-current assets; straight line, reducing balance, sum of the digits. If straight line is chosen to depreciate building in year one, the company should continue to depreciate building on straight line basis from year to year.

The essence of this principle is to make it easy for users of financial statements to compare the result of one period to another. Constant change in method will distort profits and make comparison difficult.

Occasionally there may be justification to change from one method to another. If the change is made, adequate disclosure must be made about the nature of the change and the effect of the change on profits.

3.1.8    Accrual concept
The accrual concept states that income should be recognized when they are earned and not when they are received. Expenses should be recorded when they are incurred and not when they are paid. The application of this concept gives rise to prepayments and accrued expenses. An accrued expense occurs when it has been incurred but has not been paid. Prepaid expenses occur when payment has been made for services but benefits have not been derived from them. They give rise to liabilities and assets respectively. Prepaid expenses and outstanding receivables are assets while income received in advance and outstanding expenses are liabilities of the business.

All expenses due but not yet paid should be added to the expenses paid in order to determine the total expenses for the period. All expenses prepaid should not be included in the amount to be deducted in the income statement. All income due and receivable should form part of the income for the period. While all income received in advance should be excluded.

3.1.9     Matching Concept
This is related to the accrual concept in a way. The concept holds that for any accounting period, the earned revenue should be matched with the cost that earned them. If revenue is deferred from one period to another, all elements of cost relating to them will be carried forward.

The concept is important in measuring the cost of goods sold or services rendered in a period. It is also useful in determining when the cost of an item becomes expenses (that is expired cost). The matching concept is applied to products where the costs can be related directly to them. It is applied in relation to time period where the cost incurred cannot be related to the product.

For instance, if a trader bought 50 pairs of shoes for N50,000 and sold 35 pairs for N70,000 at the end of a period. The cost of goods sold would be measured on the 35 pairs sold. That is 35/50 x N50,000 = N35,000. N15,000 would be deferred to the next period.

Some cost that cannot be related to specific transactions are depreciation, electricity bill, insurance cost etc. When the matching concept is not properly applied profits are either overstated or understated.

3.1.10     Materiality Concept
The principle of materiality holds that financial statements should separately disclose items which are significant enough to affect evaluation or decisions. It refers to the relative importance of an item; therefore some level of judgement may be required in determining what is material to an organization; as what is material to a sole trader may be immaterial to a large company.

In any event the amount (size) of an item would affect materiality. For instance, stapler, perforator, waste basket are expected to be used for more than one period, so that their costs should be measured over the period of use. However, because of the insignificant amount involved, the concept of materiality permits the immediate write off of these costs as expenses.

The nature of an item and type of a business entity will also affect materiality.

3.1.11 Historical Cost Concept
The basis for initial recognition of an asset‟s acquisition, service rendered or received and an expense incurred is cost. The concept also holds that after acquisition cost values are retained throughout the accounting process except to allocate a portion of the original cost to expense as the assets expire (see matching concept). The justification for the historical cost principle is its objectivity; that is, the cost can be traced to source documents and that other measures of value would be based on the subjective judgement of management.

The main criticism against the historical cost concept is that with the passage of time, cost would no more represent the fair value of an asset. For instance, the value of a building constructed ten years ago might have appreciated considerably over the period. In periods of inflation, the use of historical cost instead of fair values, normally leads to the recognition of „holding gain‟ because cost would significantly understate the value of the resources being consumed. Recognizing holding gain may lead to the distribution of the profits that would have been retained in the business for further expansion.
 
3.1.12 Objectivity Concept
Objectivity concept holds that financial statements should not be influenced by personal bias of management. The use of historical cost for asset valuation is an attempt to be objective, because it can be backed up by vouchers, invoices, cheques, bills etc.

A change in the value of an asset should be recognized when it can be measured in objective terms.

Objectivity is useful in accounting in the following ways:
(a) Auditing is made possible
(b) Accounting data are standardized.
(c) Fraud and falsification of accounts are minimized.
(d) Data is available for independent party to cross-check.

In spite of the goals of objectivity concept some personal opinion and judgement are brought into accounting information in few instances. For instance, estimates are required to determine the useful life of a non-current asset, the net realizable value of inventories or the amount to be provided for bad and doubtful debts.

However, figures built into financial statements should rely as little as possible on estimates or subjectivity.



3.1.13     Fairness
This is an extension of the objectivity principle. In view of the fact that there are many users of accounting information, all having differing needs, the fairness principle requires that accounting reports should be prepared not to favour any group or segment of society.

3.1.14     Realisation Concept
Under accrual concept, revenue should be recorded when it is earned. The realisation concept is concerned with determining when revenue is earned.
The realisation concept holds that revenue should be recognised at the time goods are sold and services are rendered; that is the point at which the customer has incurred liability.

Before revenue can be realised and recorded, it must have met the following two conditions
(a) The revenue is capable of objective measurement
(b) The value of asset received or receivable is reasonably certain.

The realisation concept may be difficult to apply in hire purchase transactions, lease transactions, contract jobs, advertisement agencies etc.

You will learn the rules that are applied in recognising revenue as you progress in the accounting profession.

3.2     Summary
In this chapter we have discussed the fundamental accounting concepts including entity, going-concern, historical cost, periodicity, monetary measurement, realisation, matching, consistency, prudence, materiality, accrual, substance over form and fairness concepts.

We discussed the usefulness of these concepts in accounting information and their limitations.

The chapter also treated the importance of accounting equation in the preparation of the statement of financial position.

 
CHAPTER FOUR

SOURCE DOCUMENTS AND BOOKS OF ORIGINAL ENTRY

4.0 Learning Objectives
At the end of this chapter candidates should be able to:
 Know the role of source documents
 Know the nature and functions of books of original entry
 Prepare day books and Journals
 Transfer from the books, of original entry to the relevant ledgers
 Know the effect of trade discount and value added tax (VAT) on sales and purchases.

4.1 Introduction
In the last chapter we said that the historical cost concept makes financial transactions to be objective because they can be traced to source documents. In this chapter, we shall explain those source documents, their importance and the books of original entry to which they relate. The book of original entry is the accounting record in which transactions are first recorded from source documents.

4.2 The Need for Source Documents
Source documents constitute the source of all original information on the financial transactions of a business.

They perform the following functions:
 They serve as evidence of financial transactions thereby guiding against fraud
 They serve as evidence of financial transactions thereby making audit possible
 They are usually signed by the parties to the transaction therefore they are not usually denied
 They are usually signed by the parties to the transaction, therefore it is almost impossible to alter or collude in order to defraud.
 In some cases, there could be more than one source document for a transaction but they would complement one another.
4.3 Main Source Documents
The main source documents that are used for recording in the books of original entry are:
 Sales Invoices
 Purchases Invoices
 Credit notes
 Debit notes
 Payment vouchers
 Petty cash vouchers
 Bank Pay-in-slips
 Cheque counterfoils
 Receipts
 Monthly bank statements
Others which may not contain full information to make recording possible in the books of original entry are
 Purchase order
 Delivery note
 Goods Received Note
 Bin Card

4.3.1 Sales Invoices
A sales invoice serves as the source document to record in the sales day book. This is a document sent by the seller to the buyer (usually for credit sales) requesting the buyer to pay for the amount stated on the invoice for goods or services rendered to him. Usually bills are sent for service rendered while invoices are sent for goods sold.

A Sales invoice would contain the following particulars
 Name and address of the seller and purchaser
 Date of the sales
 Description and quantity of goods sold
 Unit price and total amount of invoice
 Amount charged for value added tax (VAT)
 Conditions and terms of sales such as trade discount, cash discount and the date payment fall due.
 Signature of the parties

Sales Invoices are pre-numbered and prepared in duplicate. The original is sent to the buyer while the duplicate provides what is recorded in the sales day book.

SPECIMEN SALES INVOICE
Grace Enterprises Iludun Street
               Ado-Odo
 
Invoice No.: 7491
  Date: 2 June, 2006
  Your Order No S/K/158

To: Ajala Ventures
  11 Ajala Street
  Idimu

 
The goods underlisted have been delivered in line with your request
 
    N
500 pairs of shoes at N200 per pair                                    100,000
128 silk shirts at N250 each                        32,000
                                                                                              132,000
As you will learn laless 10% discountter,
the 10% discount is a trade discount                                           13,200.
 Trade discount
Sales amount due                                                             118,800
           Please arrange for the payment immediately. A cheque drawn on the firm’s name is acceptable.
 

 -----------------------------    -----------------------------      Accountant             Sales Manager


 
Trade Discount does not form part of the double entry. It is deducted from the gross sales to arrive at the net amount of sales that would be recorded in the ledger.

4.3.2 Purchases Invoice
A purchase invoice serves as the source document to record in the purchases day book. As explained in the last paragraph, the purchases invoice is the original of the sales invoice sent by the supplier to the customer. Therefore, the sales invoice and the purchases invoice contains the same details. The only difference is that purchases invoices are in the books of buyer and are received from various customers and therefore will not be re-numbered because goods are purchased from different sources.

4.3.3 Credit note
A credit note is a document relating to goods returned by the buyer or refunds to him when the buyer has been overcharged.

Goods may be returned by a customer for any of the following reasons:
 Damage to the goods before delivery
 Wrong specification from the one ordered by the customer.

The purpose of credit note is to inform the buyer that his indebtedness has been reduced by the amount stated on the credit note.

Credit note issued represents returns on sales while credit note received represents returns on purchases. A credit note is made out in red to distinguish it from an invoice.
 
4.3.4 Debit note
The buyer normally issues a debit note to a supplier to request for a credit note. The buyer may not debit the account of the supplier until his request is approved by him as evidenced by the issue of the credit note to the buyer.
A debit note is also prepared whenever it becomes necessary, for one reason or the other, to increase the amount due from a debtor. An example is where the seller has undercharged a customer on an invoice.

Generally, any expenses that should have been charged to the customer but were erroneously omitted when the invoice was made out would be charged subsequently by means of a debit note prepared by the supplier.



4.3.5 Payment Vouchers
In an organization every payment must be supported by a payment voucher. Examples are payment vouchers for salary and wages, and petty cash vouchers etc.
Payment voucher is an authorising document for payment for a particular expense or service. The voucher must be checked and authorised by a responsible or authorising officer before cash can be paid.

4.3.6 Bank Pay-in-slips
This serves as evidence of cheque and cash paid into the bank by an organization and individuals. It is the major source documents for recording in the bank column of cash book (debit side).

Pay-in-slip contains the following information:
• Name of branch where the account number is operating
 Name of the business and the account number
 Phone number of the depositor.
 Name of the person paying in the cheques or cash
 If it is cash, the total amount of each cash denomination is stated
 If it is cheque, cheque number, name of bank, amount on each cheque and branch for each of the cheques being lodged
  Column for signature of the person paying in
 Column for signature of the bank official receiving the cheques with the bank‟s official stamp
 Date of lodgement


4.3.7 Cheque Counterfoils
Cheque counterfoils serve as evidence of payment to creditors through the bank and withdrawals made for office or personal use.
In most organizations all cash received must be paid to the bank and all cash payments must be made through the bank, (except petty cash that is operated through the imprest system). Therefore for many businesses, cheque counterfoils have become major source documents for recording in the bank column of the cash book (Credit side).

4.3.8 Receipts
Receipts are issued for cash and cheques received from a customer for goods sold or service rendered to him. The original is issued to the buyer, it represents the document for recording cash paid in his cash book. The seller retains the duplicate, which is the document for recording cash received in the cash book of the seller.
Receipts contain the following information:
-Name of customer
-Date of receiving cash/cheque
-Amount of cash/cheque received (In words and figures)
-Signature of the Receiver

4.3.9 Purchase Order
A purchase order is issued by a customer requesting the seller to supply certain quantities of goods of specified description. The purchase order will also state the agreed price and the delivery point and date.

Invoices are compared with the purchase order when invoices are received. The goods received note is issued after it has been ascertained that the goods supplied meet the specification in the purchase order. An example of a purchase order is the Local Purchase Order (LPO).

4.3.10 Delivery Note
Delivery note accompanies the goods dispatched to the customer. Delivery note protects the dispatch driver from harassment on how he comes about the goods and serves as evidence of goods received by the purchaser when it is signed by him.






4.3.11 Goods Received Note (GRN)
The good received note shows the evidence that the goods dispatched to an organization are received in good condition and meet the specifications. The account department will require seeing the relevant GRN before paying a supplier’s invoice. The GRN is also used to update the Bin Card.

4.3.12 Bin Card
Bin card records movement of inventories. When inventories are added to the store or warehouse bin card is debited and when inventories is issued to production, the bin card is credited.

4.4 The Need for Books of Original Entry
These books are also referred to as books of prime entry or subsidiary books or day books or journals. They are the books in which transactions are first recorded. Transactions can be recorded directly to the ledger but the books of original entry are in use because they have the following advantages which the ledger does not have.
(i) They record the total of transactions in one place rather than the individual accounts.
(ii) They provide an explanation of the transactions recorded. For instance the journal shows the complete story of a transaction. You will not need to look at the debit and credit for a transaction in different accounts/folio.
(iii) They provide records of transactions in chronological order.
(iv) They help to prevent error. The total in the book of original entry can be reconciled with the total in the individual accounts. Main Books of Original Entry
(i) Sales day book
(ii) Purchases day book
(iii) Sales returns book/Returns inward book
(iv) Purchases returns book/Returns outward book
(v) Journal
(vi) Cash book (described in chapter 7)
(vii) Petty cash book (described in chapter 7)

In a computerized accounting system the books may not be in printed form but stored in a computer memory.

4.4.1 Sales Day Book
Sales day book is the book of original entry that records credit sales. The source document is the duplicate of the invoice issued to the customer. The volume of daily sales normally demands that it is issued first to collate a period’s sale before being transferred to sales ledger accounts.

The sales day book shows the following information:
(i) A list of the sales invoices in the order in which they are issued
(ii) The date of issue
(iii) The name of the customer
(iv) The number of the invoice
(v) The sales ledger number to which the individual accounts are posted
(vi) The net amount of the invoice after deducting trade discount and VAT

The sales day book does not show the description of the goods. These are contained in the invoice. Illustration 4.1
Baba Olu Enterprises made the following credit sales with invoice numbers 072 – 079 respectively. Baba Olu trades in textile materials
  N
    2006, March 1:     Addo Enterprises 1,500,000
     ,, 2: Moslad & Sons 800,000
    ,, 3: Kanfo Ltd. 2,500,000
    ,, 4: Aburi & Sons 900,000
   ,, 5: Akapo Enterprises 1,500,000
   ,, 6: Nwosu Ventures 400,000
   ,, 7: Bamiro Enterprises 600,000
  ,, 7: Adeolu Ventures 700,000
Record the above sales in the sales day book.

Solution to Illustration 4.1
Baba Olu Enterprises
Date   Customer   Invoice Sales Reference Total Amount
           No             Ledger
2006                  N
            March 1 Addo Enterprises     072    SL     18                                   1,500,000
 ,,   2 Moslad & Sons        073    SL      11                                     800,000
 ,,   3 Kanfo Ltd.               074    SL      15                                   2,500,000
 ,,   4 Aburi & Sons          075    SL       7                                       900,000
 ,,   5 Akapo Enterprises   076   SL     16                                    1,500,000
 ,,   6 Nwosu Ventures      077   SL     10                                       400,000
 ,,   7 Bamiro Enterprises  078   SL       8                                       600,000
 ,,   7 Adeolu Ventures     079   SL      5                                       700,000
               “       7 Transfer to sales a/c                   14                                   18,900,000

The sales ledger reference means the ledger folio to which the sales to each customer are posted. At the end of the period the total of N8,900,000 is posted to the sales account.
Each customer’s transaction is also posted to the debit side of the subsidiary ledger.

A business entity may trade in more than one type of products. The periodic sales may be analyzed according to each product in the sales day book.

Illustration 4.2
In the first week of September 2006 Victor Enterprises issued the following invoices to his customers. The invoice numbers are 1182 to 1187. He trades in wooden chairs and wall clocks.
Date   Description of goods                N
2/09/06 Jacobs & Sons
  12 wooden chairs at N500 6,000
  4 wall clocks at N650 2,600
  8,600

3/09/06   Moruf Enterprises  
  25 wooden chairs at N500   12,500
4/09/06   Sago Ventures  
  40 wooden chairs at N500   20,000

  50 wall clocks at N650
  32,500
52,500

  Trade discount at 5%
  2,625
49,875
4/09/06   Koku Emmanuel  
  2 wall clocks at N650   1,300
5/09/06   Solola and Co.  
  10 wall clocks at N650   6,500
7/09/06   Annan Enterprises  
  100 wooden chairs at N500   50,000

  80 wall clocks at N650
  52,000
102,000

  Trade discount at 8%
  8,160
93,840

Prepare the analytical sales day book of Victor Enterprises for the week ending 7 September, 2006.

Solution to Illustration 4.2
Date
  Customer Invoice Number Sales Ledger Wooden Wall Chairs             Clock
  A M O U N T
  N       N   N
2/9/06
3/9/06
4/9/06
4/9/06
5/9/06 Jacobs & Sons
Moruf Enterprise
Sago Ventures
Koku Emmanuel
Solala & Co 1182
1183
1184
1185
1186 SL 114
SL 83
SL 68
SL 101
SL 94 8,600 6,000 2,600
12,500 12,500 -
49,875 19,000 30,875
1,300 - 1,300
6,500 - 6,500
7/9/06 Anna enterprises 1187 SL 71



Notes
(i) The analysis would help managers to assess the rate at which each class of inventories is sold for efficient management of the business.
(ii) Where trade discounts were given, the effects were distributed on a pro-rata basis between the two classes of goods sold. For instance in the sales to Sago Venture the amount on wooden chairs and wall clocks were calculated as follows
Wooden chairs N20,000 – (20,000 x 5%)
Wall clocks        N32,500 – (32,500 x 5%)

4.4.2 Trade Discount
A. Trade discount is a discount given to a trader buying in large quantity. The invoice price would be the same for all customers but the net selling price may be different for customers depending on the quantity purchased by them.
B. Trade discount is not recorded in the books of accounts. It is only a means of calculating the net selling price of goods. Only the net amount of goods sold is transferred to the books.

We shall discuss cash discount in the next chapter.

4.4.3 Purchases Day Book
The purchases day book is the book of original entry used to record all credit purchases. The total therein is transferred to the debit of the purchases ledger at regular intervals. Each supplier’s account is credited in the subsidiary ledger. The period may be daily, weekly or monthly depending on the volume of purchases transactions. The details on purchases day book are got from incoming invoices. Each supplier’s account is credited in the subsidiary ledger.
Illustration 4.3
Maomao Enterprises made the following purchases on credit
1/8/2006 Mrs B. Kent ¢ 150,000 with invoice N0.1062
I. Akolade Ltd. ¢ 108,000 with invoice No. 083
4/8/2006 Saidi Ojo ¢ 60,000 with invoice   No. 003
  Wasiu Stars ¢ 82,800 with invoice    No 288
  Akala & Co ¢ 98,250 with invoice  No. 1124
7/8/2006 Onuo Paul & Sons   ¢120,000 with invoice   No. 002
J. Mfon Ltd. ¢  67,500 with invoice    No. 116
  Festac Enterprises ¢  337,500 with invoice  No. 644
Enter the transactions in the purchases day book of Maomao Enterprises. Solution to Illustration 4.3
Maomao Enterprises
Purchases day book
Date   PL ref. Supplier                    Amount
  ¢
1/8/2006 PL 22 Mrs. B. Kent 150,000
  PL 132 I. Akolade 108,000
4/8/2006 PL 08 Saidi Ojo 60,000
  PL 042 Wasiu Stars 82,800
  PL 015 Akala & Co 98,250
7/8/2006 PL 06 Onuo Pan & Co 120,000
  PL 04 J. Mfon Ltd. 67,500
  PL 105 Festac Enterprises 337,500
7/8/2006 Transfer to purchases ledger 1,024,050

Note
(i) PL reference is the reference to the Purchases Ledger
(ii) The invoice number column is excluded in the Purchases day book because the numbers are erratic. Remember that the purchases day book records invoices coming from different suppliers.

4.4.4 Analyzed Purchases Day Book
Like the sales day book, the purchases day book can be analyzed, but unlike the case of sales day book, it may contain columns for goods meant for resale, goods not meant for resale and bills received for services.





Illustration 4.4
Benard Carena, a sole trader, made the following transactions which relate to the month of July, 2006.
2006                                   ¢
July1 Bought goods in credit from J. Leye Ltd.                                                       1,500,000
  ,, 2 Bought goods on credit from Bala & Sons                                                  850,000
  ,, 6 Bought stationery on credit from Suzie Ltd.                                               750,000
  ,, 9 Bought goods on credit from Sasa & Sons                                                 640,000
  ,,12 Received invoices for carriage on goods from Samcol                              940,000
  ,,14 Bought goods on credit from Bala & Sons                                              1,050,000
  ,,15 Received invoice for electricity from NEPA                                              750,000
  ,,18 Bought goods on credit from Mike Essien & Co                                        645,000
  ,,25 Bought stationery on credit from Suzie Ltd.                                              874,000
  ,,26 Received invoice from Babs motors for vehicle repair                               682,000
  ,,28 Bought goods on credit from Bala & Sons                                              1,200,000
  ,,30 Bought goods on credit from Nana & Co                                                  450,000
  ,,31 Received invoices for gas consumed from Owusu Ltd.                            894,500

Prepare the Analyzed purchases day book for the month of July, 2006 in the books of Benard Carena.

Solution to Illustration 4.4
Date

2006

J  July 1
,,  2
,,  2
,,  9
,,  12
 ,, 14
,, 15
,, 18
 ,, 25
,,  26
,,  28
,,  30
,,  31

  Names of   PL
Supplier Folio
 
 
J. Leye   PL 40
Bala & Sons   PL 36
Suzie Ltd.   PL 48
Sasa & Sons   PL 16
Samcol   PL 12
Bala & Sons   PL 36
NEPA   PL 18
Mike Essien & Co         PL 06
Suzie Ltd.    PL 48
Babs Motors      PL 64
Bala & Sons    PL 36
Nana & Co    PL 72
     
Owusu Ltd.    PL 04 Total
Transfer

  Analyzed Purchases Day Book Carriage

 Inwards

¢





940,000







       
______
940,000
       
GL 43 Motor

Expenses


¢










682,000


           
______
682,000
         
GL 68 Electricity
Total


¢
1,500,000 850,000
750,000
640,000
940,000
1,050,000
750,000
645,000
874,000
682,000
1,200,000
450,000
894,500
11,225,500
  Purchases


  ¢

1,500,000
850,000

640,000

1,050,000

645,000


1,200,000
450,000
       
________
6,335,000
     GL 28
55 Stationery

 

¢



750,000





874,000



         
_______
1,624,000
       
GL 30













  & Gas

¢
750,000
   894,500
 1,644,500
GL 46


Notes
(i) The goods that are to be resold are called purchases
(ii) The analysis shows all invoices for transactions that will not be paid for immediately.
(iii) The sum of the row totals should be equal to the sum of the column totals. This is useful for control purposes.
(iv) The total in each column will be debited to the purchases account, stationery account, carriage inwards account, motor expenses account and electricity and Gas account in the general ledger.

4.4.5  Sales Returns Book
The sales returns book or returns inward book is the book of original entry that records returns on goods sold to customers.

The sales returns book analyses what goods were returned.

Illustration 4.5
Refer to Illustration 4.2
Victor Enterprises
Sept. 10, 2006 Jacobs and Sons returned 3 wooden chairs
Sept. 12 2006 Annan Enterprises returned 2 wall clocks
Sept. 14 2006 Moruf Enterprises returned 1 wooden chair

Prepare the Sales returns book for Victor Enterprises.

Solution to Illustration 4.5
Victor Enterprises Sales Returns Day Book
Date   Particulars Sales ledger ref Amount
2006      N
Sept. 10 Jacobs & Sons
 
  3 wooden chairs          SL 114                 1,500
Sept. 12 Annan Enterprises
  2 wall clocks            SL 71                          1,196

Sept 14 Moruf Enterprises
  1 wooden chair          SL 83                             500
                        Transfer to sales return         GL12                               3,196
Benard Carena
Returns Outwards Book
Date   Supplier Purchases ledger ref Amount
2006 ¢
Aug 3 J. Leye Ltd.           PL40                                 200,000
Aug 5 Bala & Sons               PL36                                 150,000
Aug 10 Mike Essien & Co     PL06                                   40,000
Aug 10 Nana & Co          PL72                                        45,000
Transfer to returns outward account GL 180                                  435,000
 
The relevant purchases ledger reference would be transferred from the purchases day book.

4.5 The Journal
The journal is used as the book to record transactions that do not fit into other subsidiary books. The information recorded in the journal about each transaction includes:
 The date of the transaction
 The debit and credit changes in specific ledger accounts
 A brief explanation of the transaction, referred to as narration or narrative.

The narration is required to indicate the purpose and authority of the transaction. For efficient use of the journal, candidates must be able to analyse the effect of a transaction on assets, liabilities, and Owner’s equity.

4.5.1 Uses of the Journal
The journal is used for the following:-
 Opening and closing entries
 Transfer from one account to the other
 Purchases and sales of non-current assets on credit.
 End of period adjustments  Correction of errors.

4.5.2 The layout of the Journal
Journal
Date   Particulars Folio   Dr Cr
  The name of account to debit   XX
  The name of account to credit XX
  The Narration

The name of the account to be debited is always shown first. The name of the account to credit is inset to the right hand side. The narration is not indented. A blank space should be left after each entry to make each set of journal entries stand out clearly.

4.5.3 Opening Entries
When the journal is used for opening entries the aim is to determine the value of the opening capital.

Illustration 4.6
N. Gyan‟s business affairs on 1 January, 2006 stood as follows:
             ¢
Cash in hand 66,000
Cash at bank 366,000
Inventories  375,000
Furniture and fittings   180,000
Creditors 150,000









 
Record these transactions in a Journal.
Solution to Illustration 4.6
N. Gyan
Journal
Date Dr Cr
2006 ¢                 ¢
1 Jan Cash in hand 66,000
  Cash at bank 366,000
  Inventories 375,000
Furniture and fittings 180,000
Creditors 150,000
Capital (difference) 837,000
Being assets and liabilities of  N. Gyan at 1 January, 2006.

4.5.4 Transfer from one account to the other through the journal
Only the journal can readily explain the transferring from one account to the other, what happens will be narrated and any doubt will be set aside.

Illustration 4.7
Record through the journal entry transfer of N600,000 from Wasobia & Co‟s account in the bought ledger to their account in the sales Ledger, to set off purchase against sales. The transaction took place on 31 January, 2007.

Solution to Illustration 4.7
Wasobia and Co
Journal
  Dr Cr
31/01/07 Bought ledger control account 600,000
    Sales ledger control account 600,000
  Balance on bought ledger transferred   to sales ledger on contra basis.

4.5.5 Other uses of the Journal
The use of journal for other purposes is shown in the following illustration:
Illustration 4.8
The following transactions took place in the books of Orire Ltd. in June, 2006
(i) A machine is bought on credit from Jerry Enterprises for N186,000 on June 1
(ii) A motor vehicle is sold to Jebeleje on credit for N360,000 on June 8
(iii) Bobo. T a debtor owed N160,000. He offers a motor car in full settlement of the debt on June 16 and the offer was accepted.
(iv) Ilemobayo is a creditor. On June 25, his business is taken over by Prospect Ventures to which the debt of N45,000 is now to be paid.
Show the journal entries to record the transactions.

Solution to Illustration 4.8
Orire Ltd.
Journal
Date             Dr.       Cr.
2006 N        N
June 1 Machinery 186,000
  Jerry Enterprises 186,000

  Recording machinery brought on credit.
June 8 Jebeleje 360,000
  Motor vehicle 360,000

  Recording motor vehicle sold on credit
June 16 Bobo T 160,000
  Motor vehicle 160,000
  Recording acceptance of motor car in  

  full settlement of debt.
June 25 Ilemobayo 45,000
  Prospect Ventures 45,000
  Debt owed to Ilemobayo to be paid
  to Prospect Ventures.

The use of journal for end of period adjustments and correction of errors would be examined in detail later.



4.6 Summary
In this chapter we have discussed source documents, their uses and their relationship to the books of original entry. We also examined the importance of the books of original entry and illustrated how they are to be transferred to the ledger accounts.
The Journal, as a means of recording unusual transactions, was also examined.


CHAPTER FIVE
APPLICATION OF DOUBLE ENTRY BOOKKEEPING AND THE TRIAL BALANCE

5.0 Learning Objectives
At the end of this chapter candidates should be able to:
 Understand the double entry principle
 Use the principle of double entry to post transactions to the relevant ledger accounts
 Differentiate between various classes of accounts
 Balance the  ledger accounts  Extract the Trial Balance.

5.1 Introduction
From our discussion of the accounting equation in chapter two, you will discover that every transaction has a dual effect. That is when there is a transaction that is recorded twice in form of a balancing equation. This principle of dual effect called the double entry principle is applied in recording every transaction in the ledger accounts.

5.2 Principle of Double Entry
Double entry principle states that for every debit entry, there must be a corresponding credit entry and vice versa. If the principle is properly followed, the total of the debit entries in the accounts must be equal to the total of the credit entries.

Before we go into the application of the double entry principle, let us discuss the nature, types and functions of ledger accounts.

5.3 Ledger Accounts
A ledger is the book containing a group of accounts. It contains the permanent records of the assets, liabilities, income, expenses and capital of a business entity. The accounts in a ledger are those to which entries are posted from the subsidiary books.



5.3.1 Importance of the ledger accounts
(i) They serve as the means of keeping permanent records of assets, liabilities, income and expenses.
(ii) They provide relevant information that is required to prepare the income statement and the statement of financial position.
(iii) They give the origin of every transaction and the parties involved.
(iv) They show the details of the movement in each account. For instance, a bank account will show what amount had been deposited or how much had been withdrawn and for what purpose.
(v) The Trial Balance is extracted from the ledger accounts at the end of the accounting period.

5.3.2 Types of Accounts:
Accounts can be grouped under three main headings
 Real Accounts
 Personal Accounts
 Nominal Accounts

Real Accounts: These are accounts relating to tangible things that can be seen, felt, touched and moved in most cases e.g. cash, cars, goods etc. The rule of double entry to these types of accounts is Debit, when there are additions, that is, when more of these items are acquired. Credit, when these items are disposed off, either by selling them off, when damaged beyond use or when given out as gift.
Personal Accounts: These are accounts dealing with persons, corporate bodies or even partnership. Before these accounts can exist, there must be credit transactions unlike the real accounts where both cash and credit transactions are involved.

In personal accounts, the accounts are opened only if the persons concerned purchase goods or services on credit or if they sell goods or services on credit. There is no need of writing or recording the names of persons who have purchased on cash basis. This amounts to waste of resources since the company has nothing to do with the persons again.

The case will be different if payment is deferred till a future date, it will be necessary to know those who owe and those who are owed as the case may be.
Nominal Accounts: These are the accounts opened for gains or losses. They are not real or personal but are for profits and losses items. We only talk of benefit arising from these accounts as a result of the services rendered. Examples are rent, salaries, electricity, discounts, drawings etc.

5.3.3 Types of Ledgers
Ledgers can also be classified into the following four groups:-
(a) Sales Ledger or Trade Receivables Ledger
This contains all the personal accounts of customers otherwise referred to as trade receivable.

(b) Purchases Ledger or Payables Ledger
This contains the personal accounts of suppliers of goods and services, otherwise referred to as trade payables.

(c) Private Ledger
The Private ledger contains details of capital accounts, drawings account, loan account and investment account. Usually only the senior managers have access to these accounts in order to prevent office staff from seeing details of the items contained therein.

(d) General Ledger
The general ledger, also referred to as the nominal ledger, contains the remaining accounts such as:-
 Nominal accounts, relating to expenses, wages, rent, sales, purchases, bad debts accounts; and
 Real accounts; relating to assets such as land and buildings, motor vehicles, inventories, plant and machinery.

5.4 Application of the double entry principle
To record a transaction using the double entry principle the following steps must be taken.
(i) Ensure that a transaction has actually taken place. That is at least two parties are involved and the transaction can be measured in monetary terms.
(ii) Identify the two main accounts involved. That is, under which two main subject matters the transaction can be divided.

For example: Adeolu Enterprises purchased a motor car for N750,000 cash.
 The transaction can be measured monetarily and it involves at least two parties
 Two main subject matters can be identified
(a) Motor car was purchased
(b) Cash was paid
(iii) Identify the one that receive value. In the above example motor car has increased, therefore it has received value.
(iv) Identify the one that has given value – cash has been reduced, in this case it has given value
(v) Debit the account that has received value with N750,000 (i.e. debit motor car) and credit the account that has given value (i.e. credit cash)

5.4.1 Debit and Credit Entries
(a) An account consists of two sides; the debit side to the left hand side and the credit side to the right hand side. By the time it is ruled a T – account is formed.
Debit side Title of the account                          Credit side  

(b) On both sides of the accounts we have column for date, particulars (details of the transaction), the folio and the amount.
(c) An amount recorded on the debit side is called debit entry while an amount recorded on the credit side is called the credit entry.
(d) The corresponding entry of the debit entry is found on the credit side of another account and the corresponding entry for the credit entry is found on the debit side of another account.
(e) The folio is the ledger page on which the corresponding debit or credit entry could be found.




What is explained above can be summarized as follows
Asset Account

Capital Account


Revenue Account


Expenses Account


5.4.2 The general rules for recording in the ledger are as follows:
A. An account that receives is debited
(i) An increase in an asset or in an expense is debited. That is there is addition to assets and expenses.
E.g. Office rent is paid. The rent is an expense and has increased by the transaction; therefore the rent account should be debited.
(ii) A decrease in revenue or a decrease in liability is debited. Examples
(a) Returns on sales is a decrease of sales revenue, therefore the return on sales/returns inwards account should be debited.
(b) When creditors are paid, the liability due to the suppliers will reduce, therefore the creditors account is debited with the amount paid.
B. An account that gives is credited:
(i) Any decrease in an asset or in an expense account is credited. E.g.
when a machine is sold, the amount in the account will decrease, therefore machine account is credited.
(ii) Any increase in liabilities or income is a credit. E.g. when goods are sold the revenue of the company increases, therefore sales account is credited.

5.4.3 Cash Transactions
The simplest way to look at the application of the double entry is through cash transactions.
a. When cash is received, debit cash and credit the corresponding accounts
b. When cash is paid, credit cash account and debit the corresponding account.

Illustration 5.1
The following transactions took place in the books of Olu Aina Enterprises in 2006
2006
(i) January 4, 2006 Cash sales of N900,000
(ii) January 10, 2006 Payment of office rent N250,000 in cash
(iii) January 18, 2006 Purchased N200,000 goods for cash
(iv) January 25, 2006 Purchased stationery for N40,000 cash.

Prepare the necessary ledger Accounts for each of the transactions.
Solution to Illustration 5.1
i. Cash is received for goods sold
Debit cash with N900,000
Credit sales with N900.000

          Cash Account
                 

Sales Account
 

Note the narration/particulars: in the cash account the particulars is Sales Account because the corresponding credit entry is found in the Sales Account. Following the same logic, the particulars in the Sales Account is stated as Cash because the corresponding debit entry is in the Cash Account.

ii Cash is paid for office rent   credit cash account and debit rent
Cash Account
 

Office Rent Account
  2006

iii Purchased goods for cash N200,000
  Cash is given, therefore credit cash account and debit purchases account.
  Purchases Account
Cash Account
 
 

iv. Purchased stationery for cash – cash is given, therefore credit cash and debit stationery account
Cash Account
 

Stationery Account
 
Note
You will notice that for each of the four transactions of Olu Aina Enterprises cash account is affected. The four cash Accounts can be combined as shown below
Olu Aina Enterprises
Cash Account
  2006 N 2006 N
Jan 4 Sales   900,000 Jan 10  Office rent             250,000
  Jan 18   Purchases             200,000
  Jan 25   Stationery              40,000

This is not different from how a firm’s purchases and sales of different dates will be combined in one purchases account and sales account respectively.

5.4.4 Transactions made on credit
(i) When cash is not received immediately for goods sold then it is sold on credit. Therefore the receivables/customers account receives instead of cash, there the receivables account is debited and sales account is still credited.
(ii) When cash is not paid immediately for goods, then it is purchases on credit, therefore, the creditor gives. Creditors account will be credited and purchases account debited.

Illustration 5.2
R. Okonkwo is a sole trader. The following transactions took place in his books.
     N
(i) Bought goods on credit from Jaja Ltd.    85,000
(ii) Sold goods on credit to Sule I & Co 176,000
(iii) Purchased some office machines on credit from
Apala Engineering Ltd. 150,000

Show the double entries for each of the transactions.





Solution to Illustration 5.2
(i)
R. Okonkwo
Purchases Account
 

Creditors Account (Jaja Ltd.)
 
(ii)

Apala Engineering Account
 

Note the following
We just decided to post the transactions to the ledger accounts for demonstration only. In real life situation, the amount recorded in the sales ledger, purchases ledger and office machines would have been accumulated in the relevant books of original entry, only the totals would be transferred to the different Ledger accounts.

5.4.5 Balancing a ledger Account
At the end of every period, all ledger accounts must be balanced off. Balancing  means to find the difference between the debit side and credit side of one account.
(i) Balance carried down (bal c/d): This is the figure that is used to force the lesser side to agree with the higher side, because the total of the two sides of an account must be equal.
(ii) Balance brought down (bal b/d): This is the closing balance (bal c/d) of the period that becomes the opening balance at the beginning of the next period.

5.4.6 Interpretation of the balances
(i) In a trade receivables account, the debit side is expected to be greater than the credit side, therefore the balance c/d would be on the credit side of the trade receivable account but when it is brought down (bal b/d) in the next period, it is debit balance. Therefore a debit balance in trade receivables account and other assets account represents an asset.
(ii) In a trade payables account, the credit side is usually greater than the debit side. Balance c/d is on the debit side and balance b/d on the credit side. This is a liability.
(iii) The cash account will always be a debit balance, except where it is a bank account when it can be a credit balance (bank overdraft).
(iv) The capital account will always be a credit balance.

5.4.7 Comprehensive Illustration
We shall now take a comprehensive question to demonstrate all the principles we have explained in this chapter.

Illustration 5.3
Mensa Joe Enterprises started a retail business, selling cement on retail basis. On 1st of March 2006, he introduced the following into the business:

(i) Motor van valued at N480,000
(ii) Cash from his salary account N330,000
(iii) Money borrowed from a friend N66,000




The following transactions took place in March
      N
March 3 Purchased cement on credit from Fola Ltd.   189,000
,,         3 Paid carriage on cement to warehouse    16,456
,,         6 Sold goods on credit to Aburi & Co   190,000
,,         8            Sold cement for cash    26,280
,,       11 Paid sundry expenses    16,278
,,       15 Purchased cement on credit from Fola Ltd.      60,000
,,       17 Bought some Dunlop tyres from Okechukwu
  Enterprises on credit          10,852
,,       20   Paid cash to Fola Ltd. on account   167,500
,,       22 Aburi & Co paid cash on account   125,000
,,       25 Paid Salaries and wages    77,958
,,       25 Paid electricity bill      6,000
,,       27
  Sold cement on credit to K. Opobo      68,000
(i) Open the ledger accounts and post the above transactions (ii) Balance the ledger accounts.

Solution to Illustration 5.3
Mensah Joe Enterprises
Capital  account
2006 N 2006           N
March 31 Bal c/d           810,000 March 1 Cash                           330,000
        March 1 Motor vehicle             480,000
  810,000                   810,000
  April 1  Bal b/d                   810,000
Loan account
2006 N 2006        
March 31 Bal c/d     66,000 March 1 Cash Account             66,000
    April 1    Bal b/d        66,000
Cash  account
2006   N                    2006                                       N
March 1 Capital        330,000          March 3    Carriage inward 16,456
  ,,      1 Loan              66,000                         „‟   11    Sundry expenses   16,278
  ,,     8  Sales             26,280                     ,,   20    Fola Ltd.            167,500     ,,    22  Aburi & Co   125,000                        ,,   25   Electricity bill              6,000
             “    31   Bal c/d          263,088
   547,280                                  547,280
April  Bal b/d              263,088

                                     Aburi & Co-Debtor
2006 N 2006 N
March 6 Sales                             190,000      March 22 Cash       125,000
                       March 31 Bal c/d        65,000
    190,000         190,000
April 1 Bal b/d  65,000



Sundry Expenses Account





Salaries & Wages account





Okechukwu Enterprises – Accounts payable
2006 N    2006                                   N
March 31 Bal c/d                 10,852   March 17 M/V expenses       10,852
                    April1 Bal b/d                  10,852

K. Opobo Account – Debtor
2006 N 2006 N
March 27 Sales      68,000 March 31   Bal c/d            68,000   April1 Bal b/d                  68,000

Notes
(i) The balance carried down on 31 March 2006, the end of March became the balance brought down on 1st of April, the beginning of the next period.
(ii) (a) All assets accounts, i.e. cash account, motor vehicle account and receivables account, have debit balances.
(b) All liabilities accounts, i.e. loan account and creditors   account have credit balances.
(c) Capital accounts have credit balances
(iii) In our illustrations in this chapter, the transactions are posted  directly to the ledger accounts. In real practice the transactions would first pass through the books of original entry.

5.5 Trial Balance  
A Trial Balance is a list of balances extracted from the ledger accounts at a given date, arranged according to whether they are debit balances or credit balances. The total of the debit and credit balances should agree if the double entry rules have been properly followed. Though a Trial Balance can be drawn at any time, it is usual practice to prepare it at the end of an accounting period before preparing the entity‟s final accounts.





Illustration 5.4
We can now draw up the Trial Balance  to our illustration 4.3
Mensah Joe Enterprises
Trial Balance at 31 March 2006
               Dr                                                  Cr
Capital 810,000
Loan 66,000
Cash                                                           263,088
Motor vehicle                                             480,000
Carriage inwards                                          16,456
Debtor – Aburi & Co                                    65,000
Creditors                                                       81,500
Sundry expenses                                           16.278
Motor van expenses                                      10,852
Salaries and wages                                        77,958
Electricity bill                                                 6,000
Purchases                                                     249,000
Sales     284,280
Account payable       10,852
Debtor – Opobo                                            68,000                                    _______
                                                                 1,252,632  1,252,632


NOTE
(i) The two receivables (i.e. Aburi & Co and Opobo) accounts could have been summed up in the General Ledger but they are shown separately here for convenience.
(ii) The balances brought down represent the position of the items in the Trial Balance . For instance, the balances brought down for capital, loan, creditors, sales and accounts payable are on the credit side, this is also their position in the Trial Balance.

5.5.1 Uses of the Trial Balance  
 The main uses of the Trial Balance are:
(i) To check the arithmetical accuracy of entries in the ledger
(ii) To detect such errors of posting that can easily be identified by the Trial Balance
(iii) To facilitate easy preparation of the final accounts.



5.5.2 Errors not affecting Trial Balance  Agreement
The preparation of a Trial Balance does not prove that transactions have been completely and correctly recorded in the proper accounts. There are errors that do not affect the agreement of the Trial Balance and they include the following:
(i) Error of omission: This is a complete omission of a transaction from the ledger. Both the debit entry and the credit entry were not recorded.
(ii) Error of principle: This is the correct posting of a transaction in the correct side of the ledger but in a wrong account. For instance a repair of motor vehicle is posted to motor vehicle account.
(iii) Error of commission: This is an error within the same class of account but affecting different persons. It is the posting of entry to the account of a person other than the one intended.
(iv) Compensating errors: This is where one or more errors are cancelled out by one or more errors elsewhere. For instance, sales account may be understated by N800 and wages and salaries account also understated by N800.
(v) Complete reversal of entries: This involves error in which, for a transaction, the account that ought to be debited is credited and the one to be credited is debited. For instance, cash paid to creditors is debited in cash account and credited in creditor account.
Errors of original entry: double entry is correctly observed but the original figure that is posted from the subsidiary books is incorrect

5.5.3 Errors that affect the Trial Balance
The total of the debit side and credit side of the Trial Balance may not agree which means that one or more errors have been committed. Some of these errors are:
(i) Arithmetic errors in balancing ledger accounts
(ii) Using one figure for the debit entry and another figure for the credit entry in respect of one transaction.
(iv) Errors of extracting the wrong figure from the ledger to the Trial Balance
(v) Listing a debit balance to the credit side of the Trial Balance   (vi) Listing a credit balance to the debit side of the Trial Balance.
(vii) The posting of debit as credit or vice versa while the other entry is correctly made.
(viii) Making an entry on only one side of the accounts, omitting the second entry.

5.6 Correction of Errors
There are two approaches to the correction of errors. This is dependent on the effect of the error on the Trial Balance. For errors which do not affect the agreement of Trial Balance totals, there will always be two affected accounts in between which the error will be corrected, while errors which affect the agreement of the Trial Balance will affect only one ledger account, thereby requiring one other account, which is the Suspense Account for correction to be effected.

5.6.1 Suspense Account
The suspense account is an account in which the net difference in Trial Balance totals is recorded pending the location and correction of the errors causing the difference.

5.6.2 Location of Errors
Errors which affect the agreement of the Trial Balance totals are more easily discovered than those which do not affect Trial Balance totals. In most cases errors not affecting the Trial Balance will come to light through complaints from affected third parties such as customers or suppliers.
An error of either type can be located by taking the following steps:
(i) Re-cast the addition of the Trial Balance
(ii) Check for any omission of the Trial Balance
(iii) Make sure that the ledger balances appear on the correct side of the Trial Balance i.e. Income, Liabilities, capital and sales for the credit side while Expenses, Assets, Drawings and Purchases should be on the debit side.
(iv) Check for correct transfer of ledger balances to the Trial Balance.
(v) Take a general look at the entries in the ledger to see if a figure close to the difference sought is in them.
(vi) Check the double entries in the ledger.
(vii) Check the arithmetic in the ledger.

5.6.3  Steps involved in correcting Errors
In correcting errors which are not revealed by the Trial Balance the following steps should be taken:
(i) Read the question well and try to understand the transaction involved.
(ii) When the transaction is understood, determine the accounts involved and the entry which ought to be passed.
(iii) Compare the entries which ought to be passed with what has been done, as reported in the question.
(iv) On the basis of the observed difference, effect the correction of error.

Illustration 5.5
After extracting the Trial Balance of Giringori Enterprises on 31 March, 2006 a difference of N6,180 was discovered. A review of the ledger revealed the following errors:
1. A sum of N720 on a creditor’s account was omitted from the balance of creditors.
2. An item of furniture purchased for N5,760 had been debited to repairs.
3. The payments side of the cash account had been undercast by N3,900
4. The total of one page of the sales day book had been carried forward as N12,924, whereas the correct amount was N15,084.
5. A debit note of N1,260 received from a customer had been posted to the wrong side of his account.
6. Mr. Laku whose debts of N3,120 to the business had been written off, paid during the year. His personal account was credited but no corresponding entry was made.

You are required to:
(i) Prepare Journal entries to correct the errors.
(ii) Write up the Suspense account.

Solution to Illustration 5.5
GIRINGORI ENTERPRISES
(i) Journal Entries on 31 March, 2006
          DR   CR
                N     N
(a) Suspense Account D                                             720
To Creditors Account               720
(Being entry in respect of omitted  

  Creditors balance)
(b) Furniture Account Dr 5,760
To Repairs Account             5,760
(Being correction of the purchase of  

  Furniture earlier debited to repair Account)
(c) Suspense Account Dr 3,900
To Cash Account           3,900
(Being correction of the undercasting

  of cash book payment)
(d) Suspense Account   2,160
Sales Account          2,160
(Being correction of wrong amount

  c/f on one page of the sales daybook)
(e) Suspense Account 2,520
Receivables Account         2,520
(Being correction of posting a

  debit note to the page of the Sales day book)
(f) Cash Account 3,120
To Suspense Account        3,120
(Being entry of recovered debt
 
  omitted from cash account)
(ii) Suspense Account
     N   N
  Creditors   720              Trial Bal diff             6,180
  Cash 3,900   Cash 3,120
  Sales              2,160  
  Receivables 2,520     9,300  
                           9,300



5.7 Comparing manual and computer based accounting system
Computers are programmed to perform mechanical tasks with great speed and accuracy. The computer can re-arrange accounting data in a required format and can add and balance accounting data programmed into it automatically. Therefore they eliminate the need for copying and re-arranging what has already been entered into the computer system. They also eliminate most of the paper work required in a manual accounting system.

However, the procedure and principles involved in the operation of manual and computer based accounting system are usually the same.

The human aspects in the processing of transactions through the computer are as follows:
(i) Determine which transactions to be recorded in the accounting records. (ii) Determine which accounts to debit or credit

5.7.1 Recording in computer-based system
The manner in which accounting data is recorded in a manual based accounting system is different from how it is recorded in the computer based system.
(i) Accounting data are not handwritten but entered through the keyboard, optical scanner and other input devices.
(ii) Accounting data are entered in a data base instead of the books of original entry.
(iii) Therefore data posted to the ledger accounts in a computer-based system come directly from the data base and not from the books of original entry.
(iv) The information required for the preparation of the Trial Balance is already contained in the data base; they are automatically extracted by the computer.

5.8 Summary
In this chapter we have discussed the double entry system. We also described the ledger accounts and the rules of debits and credits in these accounts.

We prepared the Trial Balance and extracted the Trial Balance. We discussed the uses of the Trial Balance and touched on possible errors. We also discussed briefly the use of the computer to record accounting transactions.


CHAPTER SIX

CONTROL OR TOTAL ACCOUNTS

6.0 Learning Objectives
         At the end of this chapter candidates should be able to:
• Explain control accounts and know their usefulness
• Know the main types of control accounts
• Prepare control accounts from given information
• Describe trade receivable statement or statements of account
• Prepare trade receivables statement or statement of accounts.

6.1 Introduction
In a small organisation it may be possible for one person to maintain all the ledger accounts. Where a business maintains a large number of accounts it will become necessary to divide the ledger into sections and to assign the recording of each section to different persons. The main areas to which such ledgers can be divided are in the subsidiary ledger, trade ledger, trade receivables ledger, trade payables ledger and general ledger.
In very large organisations, the sub-division may further be divided among employees.
Where this type of divisions takes place, it will be necessary to institute controls on the accuracy of the postings made to each ledger. This is achieved by maintaining total accounts for trade receivables and payables in the general ledger. These total accounts are referred to as control accounts.

6.2 The Nature and Functions of Control Accounts
A control account is an account, the balance of which reflects the aggregate balances of many related subsidiary accounts which are part of the double entry system.

It is a memorandum record only, it does not form part of the double entry system but it is kept using double entry principle. Control accounts can be kept in respect of customers (sales ledger) accounts, suppliers (bought ledger) accounts and expenses.  Control accounts are maintained to facilitate easy detection of errors because they act as a check on the entries in the various ledgers. Where the Trial Balance totals are not equal, balances in each ledger can be added together and compared with the balance in the respective control accounts. Ordinarily the two should be equal, where there is a difference, such ledger that fails to reconcile with the control account will be investigated rather than all the ledger accounts.

Control accounts are also called self-balancing ledgers because the total trade receivables and total trade payables in the general ledger should be equal to the aggregate of the balances in the respective individual accounts in the subsidiary ledger.

6.2.1    Merits of Control Accounts
The merits of using control accounts can be summarized as follows:
• They can be used to locate errors more easily
• They make it difficult to commit fraud because they are normally under the control of responsible officers and their preparation is separate from the clerks who maintain the individual ledger accounts.
• They provide information about the total trade receivables and total trade payables thereby making management of the receivables and payables accounts easy.
They allow for account set-off

6.2.2 Sources of Information for Control Accounts
Information recorded in control accounts are obtained from:
• Receivables and Payables accounts
• Returns inwards and outwards accounts
• Bills payable and receivable accounts
• Dishonoured cheques
• Cash paid to payables and cash received from receivables (obtained from the cash book).
• Discount received and discount allowed accounts • Sales day book and purchases day book.

6.2.3 Receivables or Sales Ledger Control Account
Sales ledger control account is the account containing the summary of all trade receivables or customers‟ accounts. What is posted to the debit side of this account is the aggregate of all the items recorded on the debit side of the receivables accounts.
The same thing applies to the credit side of the account.
Summary of Entries
(i) Debit – (a) Credit Sales from sales day book
(b) Dishonoured cheques from customers
(c) Debit notes issued
  Credits :( a)      Cash received from receivables as recorded in the cash book.
(b) Discount allowed as recorded in the cashbook
(c) Returns inwards as recorded in the sales return day book.
(d) Set off between sales ledger control and purchases ledger control accounts
(e) Bad debts written off

6.2.4 Trade payables or Purchases Ledger Control Account
This is the account containing the summary of all the accounts of the creditors or suppliers in the purchases ledger.

Summary of entries in the Purchases Ledger Control Accounts
Debit entries
(a) Payment to customers obtained from the cash book
(b) Returns outwards
(c) Cheques paid to suppliers from the cash book
(d) Discount received from the memorandum column on the credit side of the
(e) cash book
(f) Credit notes
(g) Transfer between sales ledger control and purchases ledger control accounts.

Credit entries
(a) Credit purchases obtained from the purchases day book
(b) Cash refund from suppliers (c) Dishonoured bills payable

NOTE
Cash sales should not be debited to the sales ledger control account rather, cash sales should be debited to the cash book. Cash purchases should also not be credited to purchases ledger control account but should be credited to the cash book.
Illustration 6.1
Extracts from the books of JK Ltd. shows the following balances for the month of
June 20X6
       N
Sales ledger balances – 1 June 20X6 4,702
Purchases ledger balances – 1 June 20X6  2,757
Sales journal balances – 30 June 20X6       37,437
Purchases journal balances – 30 June 20X6 40,800
Returns Inwards     910
Returns Outwards     749
Receipts from Customers – Cash 38,529
Discount allowed  1,345
Payment to Customers 35,415
Discount received       746
Bad debt written off     115
Sales ledger set off     209
Purchases ledger set off     110
On 30 June 20X6, it was discovered that a supplier was paid twice in error for N157.
The amount was refunded on that date.
You are required to determine the sales and purchases ledger balances at 1 July 20X6.
  (Adapted from ATS ICAN)


Solution to Illustration 6.1
JK Ltd.
Sales Ledger Control Account
20X6               N   20X6                N
June    June
1 Bal b/f 4,702 30              Cash                        38,529
30              Sales 37,437 30             Returns inwards         910
  30             Discounts allowed            1,345
  30             Bad debts                      115
  30              Set-off                         209
  ______ 30              Bal c/d                      1,031
  42,139                                                42,139
1 July   Bal b/d 1,031

Purchases Ledger Control Account
20 x 6
June                                                N         20X6                N
                                                                                June
30   Returns outwards 749 1 Bal b/f                 2,757
30     Cash   35,415 30   Purchases            40,800
30   Discount received 746 30   Cash refund             157
30   Set-off 110
30 Bal c/d 6,694                           _____
  43,714                                               43,714
                                                                July 1    Balance b/d                                 6,694 Illustration 6.2
Aji Father Enterprises controls his Trade payables accounts by drawing up monthly, a Trade Payables Ledger Control Account in two parts A and B.
The following figures are available at January 31 2006 when there is a difference on the Trial Balance  of N2,000.

                                            A                             B
                              N                             N
Jan 1 Balances on Trade Payables (credit side)                    18,400             13,600
Jan 1 Balances on Trade Payables Ledger (debit side)                      150                   184
Jan 1 – 31 Purchases                                                                   114,512                        17,372
Jan 1 – 31 Returns                                                                     11,000                                 1,652
Jan 1 – 31 Sundry charges by suppliers                                 1,200            144
Jan 1 – 31 Cheques paid to suppliers                                            17,980       13,420
Jan 1 – 31 Discount received from suppliers                                  1,420         1,180
Jan 31       Balances carried down to debit side                                  150                          132
The book-keeper in charge of the A Ledger makes his accounts total N103,712 while the clerk in charge of the B Ledger makes his Ledger balances total N16,812.

Draw up the two Control Accounts and draw any conclusion you can from them.







Solution to Illustration 6.2
AJI Father Enterprises
 Ledger Control Account A
2006   N 2006     N
Jan Balance b/d 150 Jan 1 Balance b/d                         18,400
1 – 31 Returns      11,000 1 – 31 Purchases                       114,512
1 – 31 Bank        17,980 1 – 31 Sundry charges                1,200
1 – 31 Disc. Received         1,420      31 Balance c/d                               150
      31 Balance c/d                103,712                                                           _______
     134,262                                          134,262
Feb 1 Balance b/d           150 Feb 1 Balance b/d                            103,712

 Trade Payables Ledger Control Account B
2006          N            2006         N
Jan            Balance b/d                   184 Jan 1 Balance b/d              13,600
1 – 31 Bank                         13,420 1 – 31 Purchases               17,372
1 – 31 Disc Received            1,180 1 – 31 Sundry charges                   144
1 – 31 Returns                       1,652 31 Balance c/d                         132
1 – 31 Balance c/d              14,812                                        _____
                                                        31,248                                                       31,248
Feb 1             Balance b/d                    132   Feb 1 Balance b/d                       14,812

The Control Accounts reveal that there is a difference of N2,000 between the Control Account for the B Ledger (N16,812 – N14,812) which is the total discovered by the book keeper in charge of that Ledger. The A Ledger seems to be correct. The obvious solution is to check the Ledger entries in the B Ledger very carefully.

6.2.5 Trade Receivables Statements or Statements of Account
Trade receivables statements are documents sent periodically, usually once a month, by a seller to his customers showing the position of their accounts up to a certain date. Each statement gives the particulars of the invoices, debit notes and credit notes that the seller has sent to the customer during a month, payment made and how much the customer owes the seller and when the amount will be due for payment. The statement is often a copy of the customer’s account in the seller’s books.

The statement may be kept for reference purpose or returned to the seller with the customer’s cheque. In either case neither the customer nor the seller records the statement in his books.

Illustration 6.3
The following transactions took place between Sisi Eko Enterprises of 2, Balinga Street, Lagos and her customer Ambrose & Co of 10 Dennis Avenue, Ikeja in January 20X1.

2 Jan 20X1 Invoiced goods worth N23,120 on invoice number 426
9 Jan 20X1 Invoiced goods worth N16,240 on invoice number 489
16 Jan. 20X1 Ambrose & Co paid a sum of N25,140 with cheques
22 Jan. 20X1 Invoiced goods worth N52,910 on invoice number 563
25 Jan. 20X1 Credit note number 1326 for N6,000 was sent Required:
Prepare a Trade Receivables Statement to show these transactions
(ATS ICAN)

Solution to Illustration 6.3
SISI EKO Enterprises
2, Balinga Street, Lagos
Ambrose & Co January 20X1
10, Dennis Avenue, Ikeja

Date of   Details Invoice/ Debits                    Credits                     Balances
Invoice Credit       Note No
January                 N                           N                          N
2 Goods 426         23,120                   23,120
9 Goods 489        16,240                                        39,360
16 Payment Cheque                                   25,140                     14,220
22 Goods 563        52,910                                                      67,130
25   Credit note 1326                                         6,000                     61,130
Amount due on January, 31                                            61,130 Cash discount terms: 5% for payment within 15 days

6.3 Summary
In this chapter we have explained the importance of control account in detection of error and in the management of the subsidiary accounts. We also showed, through illustration, how errors in a Trial Balance that does not “balance” can be detected easily through the control account. We also described the receivables statement and how they are prepared.


  CHAPTER SEVEN
ACCOUNTING FOR CASH TRANSACTIONS

7.0 Learning Objectives
At the end of this chapter candidates should be able to
• Know the need for control over cash
• Know basic requirements for internal control over cash
• Distinguish between trade discount and cash discount
• Know the need for the use of petty cash book
• Explain the importance of using the imprest system to control cash.

7.1 Introduction
Cash is defined to include cheques, money order, coins and paper money that a bank will accept for immediate deposit from a customer.

Cash is the asset most susceptible to loss through theft and other means; therefore there is a need for proper internal control over cash to minimize the loss of cash.

7.2 The need for Control over Cash
A good internal control over cash will help management to achieve the following objectives:
(i) There will be accurate accounting for cash transactions.
(ii) Management will maintain sufficient amount of cash at all times
(iii) Management will not keep excessive cash rather they will invest idle cash in profitable ventures.
(iv) It will prevent losses of cash from fraud or theft.
(v) It will save employees from unnecessary suspicion and harassment that result from losses of cash through fraud and theft.

7.2.1 How to Handle Cash
In order to have good internal control over cash, the following steps should be taken in handling cash:
(i) Cash must be deposited daily in the bank
(ii) All payments (except for petty cash transaction) should be made by cheques.
(iii) The function of receiving cash should be separated from that of maintaining records of cash. Each function should be performed by different persons.
(iv) All cash receipts must be recorded in a cash register. At the end of each day the amount in the register should be compared with the physical cash.
(v) All payments must be checked and approved in writing by responsible officers before payments are made.
(vi) The function of approving payment must be separated from the function of signing cheques.
(vii) Carbonized receipts must be issued for all cash sales and cash received.
(viii) When payment is made for a transaction the invoice and other supporting documents relating to that transaction should be stamped paid with date so that payment will not be made for a transaction twice.

7.3 Definition of Some Terms Relating to Control Over Cash
(i) Voucher System: A voucher system involves a written authorization called a voucher that is prepared for every cash payment transaction. It requires that every transaction be verified, approved and recorded before payment is made.
(ii) Voucher: A voucher is a written authorization used in approving a transaction for payment.
(iii) Voucher register: This is a special journal used to record the payment of cash.
(iv) Cash over or short: This is the account in which errors in making change to a cash customer would be recorded.

 7.4 Trade Discounts and Cash Discounts
In chapter four we describe the trade discount as a reduction in the invoiced price for goods and that it is usually given for bulk purchase. We also explain that only the net amount of purchases or sales would be recorded in the books. This means that trade discount is not part of the double entry.

7.4.1 Cash Discount
A cash discount is also called a settlement discount. It is given for prompt payment. The cash discount on sales is referred to as discount allowed and the cash discount on purchases is referred to as discount received.

A cash discount is not recorded until the customer has fulfilled the terms of payment specified in the invoice. When cash is paid promptly the customer will deduct the discount from the amount due.

Illustration 7.1
Appiah Enterprises sold goods to Sule Ventures for N250,000. A trade discount of 10% was granted and cash discount of 5% if payment is made within 60 days.

Required:
Calculate (i) The net sales value (ii) the cash discount and the amount received by Appiah Enterprises if it paid within 60 days.

Solution to Illustration 7.1
Immediately the goods were sold a trade discount of 10% is deducted i.e.
  N
              Invoiced price 250,000
  Less: 10% trade discount   25,000
  Net sales value 225,000

Assuming the customer paid within 60 days the amount due, the settlement discount of 5% would be deducted from N225,000. i.e.
                                                 N              
Net sales value   225,000
Less: Cash discount of 5%   11,250
Amount received by Appiah Enterprises 213,750

7.4.2 Accounting Treatment of Cash Discounts
(a) Cash discounts are recorded in a memorandum column in the cash book.  Discount allowed is recorded in a column on the debit side of the cash book, the same side in which receipts from cash sales are recorded. Discount received is recorded on the credit side, the same side in which payments for cash purchases are recorded in the cash book.
(b) The sales and purchases would be recorded in the books at their invoice value less trade discount.
(c) Discount allowed is debited in discount allowed account and credited in the receivables account. When the income statement is being prepared the amount
will be transferred from the discount allowed account to Income statement as expenses.
(d) Discount received is debited to trade payable account and credited to discount received account. When the income statement is being prepared, it is transferred from discount received account to statements of comprehensive income as addition to income.

We shall illustrate the treatment for cash discount later in this chapter.

7.5 The Main Cash Book
We have seen in chapter five that cash book records only cash receipts and payments. Another thing is to note that cash book is a book of original entry as well as a ledger account for cash transactions.

In this chapter we shall consider the double column and three column cash book.

7.5.1 Double Column Cash Book
The double column cash book has two columns on both sides of the accounts namely; cash and bank columns.

The cash column records the cash transactions that involve cash in hand. The bank column records cash transactions that involve cash in bank. Supporting documents for these bank transactions are mainly cheques and pay-in-slips.

Contra entries
When related to the cash book, contra entry refers to either the lodgement of cash into the bank account or the withdrawal of cash from the bank for office use.

Illustration 7.2
Mallam Ture has been in business for many years as a sole trader. His cash at hand was N75,000 but there was no bank account.

The following transactions took place during the month of June 20X6.
        N
June 1 Opened bank account and paid in cash   75,000
 ,, 4 Rented premises and paid for 2 months by cheque                                    3,000
 ,, 7 Bought furniture and fitting by cheque      9,000
 ,, 11 Purchased goods for sale by cheque   12,000
 ,, 14 Cash sales to date     22,500
 ,, 16 Received cheque from Kojo on account of May Sales                             12,300
 ,, 19 Paid Cash into bank   19,000
 ,, 20 Purchased goods for resale from Shuaib and Sons                                   15,000
 ,, 25   Cash Sales   11,250
 ,, 26 Paid cash into bank   11,250
 ,, 28 Sold goods to Stephens & Co    2,700
 ,, 29 Withdrew Cash for office use   10,000
 ,, 29 Paid Shuaib and Sons on account by cheque    7,500
 ,, 30 Paid Salaries by cash    8,155
 ,, 30 Paid electricity bill by cheque    1,350
 ,, 30 Paid sundry expenses by cash       600
Required: Prepare the two column cash book of Malam Ture Enterprises   Solution to illustration 7.2
Mallam Ture
Dr.                    Cash book          Cr NOTES
(i) When cash was paid into the bank we debited bank account and credited cash account and indicated by „C‟ in the ledger folio column that it is a contra entry.
(ii) When cash was withdrawn from the bank for office use, it was also a contra entry. We debited cash account and credited bank account.
(iii) The transactions of June 20 and June 28 did not pass through the cash book because they were not cash transactions.
(iv) The cash book will normally show a debit balance but the bank column may show a credit balance when the business enjoys overdraft facility from the bank, otherwise a person cannot spend more than what he has.

7.5.2 Three Column Cash Book
The three column cash book has three main columns for discount, cash and bank. The only additional column is the discount column. Discount allowed is shown as a memorandum column on the debit side of the cash book. Discount received is shown as a memorandum column on the credit side of the cash book.

As explained earlier, memorandum records do not form part of the double entry.
Illustration 7.3
Solo Enterprises started a business with N96,000 on July 20X6 and paid the money into the bank on 4 July, 2006. His transactions for the rest of the month were as  follows:
20X6 N
4/7 Purchases by cheque 32,760
 7/7 Credit purchases 30,240
 ,, Electricity paid by cheque 600
 ,, Rent paid by cheque 840
10/7 Sales  - on credit 51,024
     - cheque 60,000
     - by cash 576
  ,, Drew cash for office use 2,400
11/7 Paid trade payables by cheques 18,120
  ,, Cash discount recorded from creditors 384
12/7 Cash Sales 20,538
  ,, Wages paid by cash 600
14/7 Cheques received from customers 47,040
   ,, Discount allowed to customers     960
17/7 Drew cash for Office use     300
18/7 Paid cash for repairs     144
  Purchases – credit 54,000
  - cheques    6,000
  - cash 23,000
22/7 Sales – cash 45,000
  - cheques 20,400
24/7 Paid trade payables by cheques 32,400
  Discount received from trade payables     120
  Cash Sales immediately paid into bank  2,400
26/7 Paid rent by cheque  1,800
  Paid Wages & Salaries by cheques  6,720
31/7 Cash paid into bank 12,000
  Drew cheque for petty cash     240
Required:
(a) Enter the above transactions in the cash book of Solo Enterprises (b) Show the double entry for discount on sales and discount on purchases (c) Show also the receivables account and the creditors account.
 SOLUTION TO ILLUSTRATION 7.3



                                Trade Payables Account


20X6       N      20X6    N
July 11 Discount received 384 July 7 Purchases 30,240
July 11 Bank 18,120 July 18 Purchases 54,000
July 26 Discount received 120
July 31 Bank 32,400
July 31 Bal c/d 33,216 _____
  84,240 84,240
  Aug 1 Bal b/d 33,216

Cash Book Analysis
The cash book may be analyzed to columns according to the nature of transactions.
For instance, the debit side of cash book with analysis columns can be as follows
Cash Book (Receipts)
Date   Particulars            L/F     Total           Receivables    Cash sales  Others
20X7                              N                    N               N       N
Jan 1 Bal b/d                  5,400
,,  5 Cash Sales                         1,440                     1,440
,,  9 Receivables – Ajayi          6,840         6,840
,, 12       Receivables Sannie      12,960       12,960
,, 19 Loan – Dangote               32,400                                32400
,, 22 Cash sales                          2,700                         2,700
,, 27 Sales of assets                      3,600                                                  3,600
    29 Receivables Kabir               2,520                 2,520        _____     _____
                              67,860         22,320       4,140      36,000

           
 
                              Cash Book Payments
Date  Particulars        L/F   Total Creditors     Petty cash    Salaries      Others
20X7                                      N         N               N          N        N
Jan 2      Credit – Ade              2,160              2,160
  ,, 4      Credit – Ola               5,580              5,580
  ,, 7      Salaries & Wages       13,320               13,320
  ,, 12     Telephone                  7,200                               7,200
  ,, 17   Petty cash                   1,800             1,800
  ,, 24   Furniture                   27,000                                                 27,000
 ,,  27     Office rent                   5,040                                                   5,040
 ,,  31     Bal c/d                         5,760   _____          _____          ______          ____
                                     67,860    7,740          1,800            13,320        39,240


Note
The total of receipts is N67,860 while the total of payments is N62,100. Therefore the balance carried down is N5,760 (i.e. N67,860 – N62,100).

7.6 The Petty Cash Book
The petty cash book is used for recording expenses of a smaller size than those recorded in the main cash book.
The petty cash book is usually operated on the imprest system in which cash float is maintained. The cash float is reimbursed by the amount spent at the end of a specific period.
The only source of cash inflows to the petty cash is the imprest. The expenses are spread on various items which are separately analyzed. At the end of specific periods the columns are added and posted to the debit side of the ledger accounts to which they relate.

7.6.1 Control over Petty Cash Imprest
A petty cash voucher must be filled and approved before the disbursement of any expenditure. The petty cash voucher shows the date, the amount paid, the purpose of the expenditure, the signature of the person who approved the payment and the signature of the person receiving the money.
A surprise count of the imprest should be done occasionally so that the fund can always be kept intact.

 
7.6.2 Advantages of the Imprest System
(a) It trains young staff (the petty cashier) to be responsible about money and accurate in accounting for it.
(b) It saves the time of the main cashier, who is a person with great responsibilities.
(c) The main cash book will not be overloaded with payment of items with low amount.
(d) It makes expense analysis and monitoring easy.
(e) It reduces the number of accounts to be opened in the ledger accounts thereby facilitating balancing of periodic accounts with ease

Illustration 7.4
Rasak Ventures maintains an imprest of N10,000 per month. The transactions for the month of February, 20X7 are as follows:
     N
Feb. 1 Petty cash in hand 2,500
  Received cash to make up the imprest
Feb. 3 Bought postage stamps 650
  Transport fare 400
Feb 6 Telephone bills 1,500
  Paid carriage 650
  Taxi fares 850
Feb 7 Paid for repairs to computer keyboard 1,600
  Paid carriage 2,500
  Office entertainment (beverages) 1,000
  Purchase of envelopes 550
 prepare the petty cashbook for the period.
 
Solution to Illustration 7.4
Rasak Ventures


7.7 Summary
In this chapter we have explained the need for control over cash, the internal control required for the security of cash transactions and the operation of the petty cash system.
The chapter also discussed the nature of cash discounts and the accounting entries for cash discounts. We also explained how to prepare double column cash book and three column cash book.


CHAPTER EIGHT
BANKING SYSTEMS AND SERVICES

8.0 Learning objectives
At the end of this chapter candidates should be able to
 Know the types of accounts a business can open with the bank
 Understand interbank transfers
 Understand the role and operations of the electronic fund transfer (EFT).
 Recognize the causes of discrepancy between bank statement and cash book balances.
 Determine the cash available to a business for inclusion in the end of period statement of financial position.
 Prepare a bank reconciliation statement.

8.1 Introduction
In the last chapter we said that one of the ways to guide against loss of cash through theft and fraud is to open and maintain a bank account. Apart from guiding against theft a business entity or customer can also enjoy some credit facilities and professional advice from its/his bank. There are two main types of account a customer may keep with the bank. These are current accounts and savings accounts.

8.2 Current Account
A current account is operated by the use of cheques. Money can be withdrawn from the account anytime without giving prior notice to the banker. For this reason it is called “Demand Deposit.” The customer usually does not enjoy any interest on current account balances. In a few cases, little interest may be given by the bank. A current account customer may be granted an overdraft.

A Cheque book is issued to the account holder when a current account is opened. Each cheque is assigned with identification number that is serially numbered. The holder of the account can issue cheques for payment to any person he has done business with. However, the cheques must be duly signed by the drawer and the signature, which must be regular or identical to the signature on the mandate card.

Money is deposited into the bank account through pay-in-slip. The number assigned to the cheques and pay-in-slip is printed in magnetic ink to make processing of transactions possible by the computer.
At intervals, usually every month, the banker will send bank statement to its customers, detailing all cash lodgement, payment cheques, dishonoured cheques, bank charges, direct payments, dividend warrants received on behalf of the customer etc.

8.2.1 Opening a Bank Current Account

Every business entity is required to open a current account to transact its business. The bank requires the customer to provide the following items /information for opening a current account.
(a) A written application to open an account, stating the type and purpose of the account.
(b) Two or more reference letters from people who maintain current accounts with any branch of the bank or other banks.
(c) Completed mandate cards.
(d) Two or more passport photographs.
(e) Copy of the Article and Memorandum of Association if it is a corporate organization or deed of partnership for partnership firms and constitution in respect of un-incorporated body.
(f) An extract of the minutes of the meeting in which the decision to open the account was taken.
(g) An initial deposit as may be stipulated by the bank from time to time.
(h) In some countries evidence of payment of tax by the sole trader, partner or the limited liability company.
(i) The specimen signature by the authorized person must be signed on the mandate card. The signature on cheques is compared with the specimen signature each time the customer wants to make withdrawal.

8.2.2 Cheques

A cheque is a written order upon a particular banker to pay a certain sum of money to a specified person or organization. There are three parties to a cheque namely
 i. The drawer- issues the cheque
ii. The drawee- The bank on which the cheque is written and
iii.   The payee- the person to whom the cheque is payable.

One of the means by which a bank customer can know the balance in his/her account is to record on the cheques‟ counterfoils the amount of money drawn and the amount of money deposited. Another means of knowing the balance is through the amount recorded in the bank columns of the cash book.

8.2.3 Pay-In-Slip
A bank customer fills out pay-in-slip for each deposit usually in duplicate or triplicate.
Some pay-in-slips are carbonized.

Items to be found on a pay –in-slip or cash lodgements teller are:-
i. Date
ii. Bank and branch
iii. Account number
iv. Account name
v. Note and coin denomination
vi. Amount in words
vii. Amount in figures
viii. Total amount
ix. Payer’s name and signature
x. Payer’s telephone number
 xi. Mothers‟ maiden name

Details of cheques are analyzed on the reverse side of the pay-in-slip, if the latter is not the carbonized type.

The bank teller will sign the duplicate copy of the pay-in-slip. This will serve as documentary evidence of the amount deposited. The pay-in-slip can be compared with the amount debited in the cash book.

8.2.4 Dishonoured Cheques
A business may deposit a cheque received from a customer into its bank account but the bank may refuse to honour the cheque for various reasons. A cheque that is so treated is referred to as a dishonoured cheque.

A cheque may be dishonoured for any of the following reasons:-
i. The cheque is not dated
ii. The amount in words does not correspond to the figure written on the cheque
iii. The balance in the drawer’s account is not sufficient to accommodate the amount to be drawn with the cheque.  
iv. The cheque has been mutilated
v. The cheque has become stale
vi. Signature on the cheque is irregular
vii.   The cheque is post-dated viii.   The cheque is not signed.
ix. Suspicion that the cheque has been stolen from the drawer and there is a need to seek further confirmation from the drawer.

8.2.5 Stop Payment Order

When a cheque is lost or stolen, the owner of the cheque should issue a stop payment order on the bank. He should identify the missing cheque by its serial number and amount if the cheque had been issued and signed. The stop order is issued to prevent payment to a wrong person.

8.3 Interest Bearing Accounts
Some business organisations transact a large volume of business through their current accounts every month, and they may not be able to earn any interest on their current account balances. Therefore some businesses usually open some other accounts on which they can earn interests; these could be referred to as interest-bearing accounts. These consist of savings account and fixed deposit account. They will transfer surplus cash from the current account to these accounts to earn interests

8.3.1 Savings Account
This type of account is meant for the small savers to keep their surplus funds. This account is usually opened by individuals such as clubs, associations, salary earners, petty traders etc. A prospective customer who is a salary earner should bring a letter of introduction from his/her employer, upon which he/she will be given the bank’s application forms to complete and supply the following information:
(i) His full names and address (Not P. O. Box)
(ii) Business or Occupation
(iii) Specimen signature or thumb print
(iv) Three (3) recent passport photographs, and
(v) Customer’s identity card or international passport or driver’s license.
(vi) The initial deposit. This varies from bank to bank. The bank then issues the paying-in-booklet to the customer to enter the initial deposit and every subsequent deposit.

Some other distinguishing features of savings account are:
(i) No cheques are required for withdrawal
(ii) Customers may not be granted overdraft facilities on this type of account
(iii) Interest is payable on the sum standing to the customer’s credit
(iv) The balance standing to a customer’s credit on savings account is repayable on demand. Although, there is a dormant rule, which requires at least 7 days notice before withdrawal is made.
(v) Customer must be present physically when withdrawal is made.
(vi) In some years back, passbooks were issued to the customer to show both the credit and debit entries of the account. But nowadays, paying-in-slips and withdrawal booklets are issued to customers to make payments to and withdrawals from their accounts.
(vii) No reference is required for this type of account except where cheques will be paid into the account in the future, but a letter of introduction is required where the account will be used to receive the customer’s salary.

8.3.2 Fixed Deposit Account
In this situation, an account is kept with the bank in form of investment for a specific period of time usually 30 days, 60 days, 90 days or 180 days. A fixed rate of interest is paid by the bank on such bank deposits. The banker needs to be adequately informed before cash can be withdrawn from this account.
The features of this type of account are as follows:
(i) The balance standing to a customer’s credit on deposit account is repayable or rolled-over upon a written application after a stated or agreed period.
(ii) The customer is not issued with cheque book but with a receipt or certificate indicating the terms and conditions of the deposit e.g. amount fixed, interest rate, date of maturity etc.
(iii) Both the bank and the customer agree on the terms and conditions of the relationship, such as interest rate, amount and duration of the account.
(iv) No bank statement is issued to the customer.
(v) No reference is taken since the account requires cash transaction. But where lodgement of cheque is anticipated in the future, bank must ensure that references are taken and all the necessary account opening procedures are followed.
(vi) No commission is charged by the bank.

8.4 Inter-Bank Transfers
Through the use of computer and the internet, a lot of electronic equipment is now available which enables banks to transfer funds from the account of one customer to another without the need for exchange of paper document. This electronic equipment is turning the monetary system to a cashless society.

At present in Nigeria, some of the available Electronic banking products are AutoTeller Machine (ATM), Electronic Fund Transfer (EFT) and Electronic devices such as the Magnetic Ink Character Recognition (MICR).

Apart from the foregoing, there are some other forms of electronic banking which are yet to be available in Nigeria. These include: Electronic Fund Transfer At Point of Sales (EFTPOS), Debit Cards and Smart Cards.

We shall now discuss the mode of operation of some of these products.

8.4.1  Mode of Operation of Electronic Banking Products

i) Auto-Teller Machines (ATM)
ATM is a cash dispenser which is designed to enable customers enjoy banking services without coming in contact with the Bank Teller (Cashier). The machine, therefore, performs the function traditionally reserved for cashiers. It is electronically operated and as such response to request by customers is done instantly.
(a) ATM is user-friendly and it guides users through the instructions that have been pre-programmed into it for easy operation.
(b) Access to the ATM is through the use of Personal Identification Number (PIN) and a plastic card that contains magnetic strips with which the customer is identified. Banks usually handover the PIN personally to the customer who is usually instructed not to disclose the number to a third party.
(c) It is essential for users to ensure the safety of the ATM card as well as to ensure that its surface is not mutilated. Otherwise, the machine may reject it, even where the PIN has been correctly entered.
(d) The first step to take while using the ATM is to insert the Card and thereafter the PIN. Then the customer can select the service required e.g. withdrawal, in which case the „Withdrawal‟ Key is depressed, and then presses the number keys for the amount of money required as well as the denominations wanted. It is not enough to punch the amount required, it is also necessary to press “ENTER” for the ATM to work.

Other functions that the machine is capable of performing are:
 Printing of statements
 Provision of account balances
 Transfer of funds
 Payment of bills
 Cash Advances and
 Display of Promotional messages

The objective of introducing the ATM in Nigeria is to decongest the counter; hence these ATM can only perform withdrawal functions.

ii) Electronic Fund Transfer (EFT)
EFT system allows customers account to be credited electronically instantly anywhere in the country especially in banks where there is on-line service. It provides a more suitable and cost-effective way of transferring funds when compared with the traditional modes such as Mail/Telegraphic transfers. It is more secure and time saving when money is transferred through EFT. Such money is transferred electronically by the bank through their branches or accredited agents.

iii) Electronic Fund Transfer At Point of Sale (EFTPOS)
This is a system which enables a customer’s account to be debited instantly with the cost of purchase in an outlet. The system requires the customer to be an ATM Card holder.

iv) Electronic Card Products (DEBIT CARD)
At present, most banks in Nigeria issue electronic debit cards. Debit Cards are like the EFTPOS that are supposed to be passed to a customer’s account immediately.

There are two popular debit cards; the Pass Card and the Smart Card.
(a) Pass Card
This product is processed in an IBM machine by debiting a customer’s bank account.

(b) Smart Card
This is a debit card whose micro-chips contain additional information on bio-data and financial position of the holder.

8.5 Credit Cards
A credit card is a convenient method of payment which embodies two essential aspects of basic banking functions; the transmission of payment and the granting of credits.

A credit card is similar to a cheque which is drawn upon the funds of the credit card company rather than upon the personal account of the customer. The credit card company would pay cash promptly to the creditor to redeem the credit card.

At the end of the month, the credit card company bills the credit card holder for all the drafts it has redeemed during the month. Making sales through credit cards, suppliers receive cash more quickly from credit sales and avoid problems of bad debts.

There are bank credit cards and non-bank credit cards.
(a) Bank Credit Cards: - Some widely used credit card is the master card. A business may deposit bank credit card draft directly in its bank account together with cash and cheques received from a customer. The bank accepts the credit cards for immediate deposit. Therefore sales to bank customers using credit cards are treated immediately as cash sales. The banker deducts some service charges from the customer‟s balances for handling the credit cards.

(b) Non bank credit cards: - Non bank credit cards drafts are not deposited directly into the bank. Therefore non bank credit cards drafts received from customers are not treated as cash sales but amount receivable from them.

The credit cards are sent to the credit cards company at periodic intervals. The credit cards company will now send cheques to the holder of the credit card draft. The amount received by this holder would not be the face value of the sales made or services rendered. The credit card company would have discounted the amount say by 5% to pay him for handling the credit cards.

Illustration 8.1
Ossei Ltd. based in Ghana, sold some goods for N65,400 to a customer who uses Bafo Ltd.. Credit card. After seven days Ossei Ltd. sent the credit card drafts to Bafo Ltd.
which redeems the draft after deducting 7.5% discount.

Show the entries in the book of Ossei Ltd.

Solution to Illustration 8.1
(1) When the sales is made             DR CR
   N  N
Receivables 65,400
Sales 65,400
To record sales to a customer using Bafo  Ltd.. credit cards
 

(2) When Bafo Ltd. redeems the draft
  DR CR
    N  N
Cash                                                                          60,495
Discount expenses on credit cards                              4,905
Receivables Account                         65,400
To record the collection of Amount due  from Bafo Ltd. less 7½% discount.

Note: The credit card expenses will be treated as part of the operating expenses in the income statement.

8.6 Bank Statement
The bank usually sends a bank statement to its customer at the end of every month. The statement contains details of the receipts and payments by and on behalf of the customer for that period. Receipts will include cash paid into the customer‟s account and those paid by third parties direct into the bank. Until the customer receives the bank statement or a credit advice transaction alert in respect of the direct credit to his bank account, the business may not be aware of it or the amount involved.

Payment or withdrawal will also include details of cheques issued by the customer, bank charges and payments made on behalf of the customer to third parties by the bank ( if the customer so directs the bank, this is called a standing order).

The balance at the end of the period represents the balance as per bank statement. This balance can be a credit balance (favourable) or a debit balance (overdraft). Remember though that in the cash book of the customer, a favourable balance is a debit balance and a credit balance is an overdraft.

8.6.1 Example of a Bank Statement
Illustration 8.2 below is used as an example of a bank statement.

Illustration 8.2
Mr.  K. A. Afolabi maintains a current account No. 000023456 with XYZ Bank Ltd..
The balance on the account as at 31/12/2001 was N15,500 credit.

Mr. Afolabi‟s transaction with the bank in the month of January 2002 were as follows
(i) N10,000 cash deposited on 2/1/2002.
(ii) A cheque of N2,500 issued to Mr. Afolabi by one of his receivables was lodged into his bank account on 6/1/2002.
(iii) He drew a „cash‟ cheque number 000062 for N4,000 on 7/1/2002. The cheque was presented to the bank and payment received on that date.
(iv) He issued a cheque No.000063 for N5,000 to one of his creditors, Mr. S. O. Babalola on 10/1/2002. Mr. Babalola presented the cheque to XYZ Bank Ltd. on 13/1/2002 and received payment.
(v) Received cheques totalling N22,000 from various customers and lodged them into the account on 14/1/2002. All cheques matured for credit to the account on 19/1/2002.
(vi) There was a standing agreement between the bank and Mr. Afolabi that his monthly life assurance premium of N2,150 should be paid direct to the insurance company by the bank. The bank remitted this on 25/1/2002
(vii) A customer living upcountry deposited a cash sum of N9,500 into Mr.
Afolabi‟s account No 000023456 with the local branch of XYZ Bank Ltd..  on 27/1/2002. The bank credited Mr. Afolabi‟s Account the same day.
(viii) On 31/1/2002 XYZ Bank Ltd. debited Mr. Afolabi‟s account with a service charge of N420.50.

You are required to prepare a statement as it would have been prepared by XYZ Bank Ltd reflecting the above transactions

Solution to Illustration 8.2
XYZ Bank Limited
202 Marina, Lagos Statement In respect of:
Account No:   000023456
Customer: Mr. K. A. Afolabi
Period covered: 01/01/2002 – 31/01/2002
Date issued: 05/02/2002



Date Transaction   Debit N      Credit N        Balance N
01/01/2002 Balance b/f                  15,500
02/01/2002 Cash deposit                   10,000                           25,500
06/01/2002 Cheque deposit        2,500                            28,000
07/01/2002 Cheque No 000062 –cash                   4,000            24,000
13/01/2002 Cheques No 000063-                          5,000            19,000
19/01/2002 Cheque deposit        22,000                          41,000
25/01/2002 Standing Order                                     2,150          38,850
27/01/2002 Cash deposit                  9,500                           48,350
31/01/2002
  service charge                      420.50                     47,929.50
Opening Balance 15,500.00
Total Debit 11,570.50
Total credits 44,000.00
Closing balance 47,929.50

8.7 Bank Reconciliation Statement
The bank and its customer (e.g. a business entity) maintain independent records in respect of the transactions taking place between them. Therefore it is necessary to reconcile the bank statement balance with the bank balance in the cash book to be assured that the two are in agreement on the amount of money deposited and cheques drawn.

Usually the bank column balance and bank statement balance are not always in agreement and they need to be reconciled.
The disagreement between the two may be traced to the following factors:-
(a) Unpresented cheques: - These are the cheques drawn on the bank and given to the payees but they have not been presented for payment to the bank. The cash book of the business has been credited (that is it has been treated as payment through the bank by the business) this transaction would appear on the credit side of the cash book but missing from the debit side of the bank statement.
(b) Uncredited cheques: - these are cheques deposited in the business bank account and not yet recorded in the bank statement until three or four days thereafter, whereas it would have been recorded on the debit side of the cash book.
The transaction will appear on the debit side of the cash book but missing from the credit side of the bank statement.

(c) Bank charges:- These are charges made by the bank to cover the expenses in handling bank account. The major charges are based on the volume (i.e. turnover) of the transactions on the account. It is sometimes called commission on turnover (COT). Other charges are charges for cheque book, interest charges on bank overdraft facilities from the bank, administration expenses etc.
These charges would have been recorded in the bank statement but will be missing on the credit side of the cash book.

(d) Direct Debits: These are direct payments of expenses on behalf of the business. These have the same effect as the bank charges.
(e) Direct Credits: These are amounts received on behalf of the business directly by the bank. The bank statement would have been credited but the entry will be missing from the debit side of the cash book.
(f) Error of the customer or of the bank

8.7.1 Steps Involved In the Recognition of Discrepancies

(a) Tick items on the debit side of the cash book against items on the credit side of the bank statement. Outstanding items on the debit side of the cash book but missing on the credit side of the bank statement are uncredited cheques. List them.
(b) Tick items on the credit side of cash book against items on the debit side of the bank statement. Items outstanding on the credit side of the cash book but missing on the debit side of the bank statement are unpresented cheques. List them.
(c) The remaining items on the debit side of the bank statement are bank charges and standing order. List them.
(d) The remaining items on the credit side of the bank statement are amounts paid into the bank directly for the benefit of the business entity by its customers (i.e. direct credits).
(e) After all these have been adjusted, it should be possible to reconcile the cash book balance with the balance on the bank statement. If it is not, then there are some errors which further investigation would reveal and be traced to their sources.

8.7.2   Preparation of the Bank Reconciliation Statement

Two main steps are involved in the preparation of a bank reconciliation statement.
(1) Determine the adjusted cashbook balance. This adjustment will not be         affected by items (a) and (b) above. The adjustment will be affected mainly by items (c) and (d).
(2) Reconciling the adjusted cash book balance with the bank statement    balance.

Step 1 - Determining the adjusted Cash Balance
Format
Cash Book (with Adjustment)
    N N
Balance b/d x Standing order                                  x
Direct debit                                x       Cheque earlier lodged
            now dishonoured                     x
Add: - Direct Credit x Bank charges                               x
  Understatement x Overstatement of cash               x
  _ Adjusted cash balance       x
  xx                                                        xx
           

The adjusted cash book balance is the amount that will be shown in the statement of financial position




Step 2 - Reconciling the adjusted cashbook with the bank statement
   N
  Adjusted Balance as per cash book xx
  Add: Unpresented cheques xx
        Error of overstatement by bank xx   xx
  Less: Uncredited cheques xx
  Error reducing the business balance
  committed by bank xx   xx
  Balance as per bank statement xx
            Using an Alternative Method
                 N
  Balance as per bank statement xx
  Add: Uncredited cheques xx
  Bank error reducing cash balance xx
  Less:
  Unpresented cheques                        xx
  Bank error overstating cash balance  (xx)
  Adjusted Balance as per cash book     xx

Illustration 8.3
The following bank account and bank statement relate to the firm of Mohammed and Sons for the period of 1 to 12 September, 2007
Bank Account
2007                               N 2007   N
Sept 1 Bal b/f               6000     Sept 2 Cheque Owen          400
     3 Cash                   500 2  Cheque Peter            150
     5 Cheque Kuku            85 6  Cheque Ringo           105
     7 Cheque Labe           220 8  Cheque Smith         365
    9  Cheque Michael      155            10 Cheque Thomas                         1,120
   11  Cheque Ndidi         360 12  Balance c/d                   5,180
                                                7,320                                            7,320
  Balance b/d       5,180
Bank statement as at 12 September, 2007

2007  Debit Credit Balance
     N  N    N
          Sept 1 Balance 6,000
  2 Cheque no. 98876 400 5,600
  3 Cash 500 6,100      
      4 Charges  20 6,080
  5 Cheque deposits 85 6,165
  6 Cheque no.98877 150 6,015
  7 Cheque deposit 220 6,235
  8    Cheque deposit (by Umoru) 600 6,835
  9 Cheque dishonoured 85 6,750
  10 Standing order
  (Insurance Premium) 560 6,190
  11 Cheque 98878 105 6,085

You are required to:
(a) Effect the necessary adjustment to the bank account and prepare the adjusted balance.
(b) Prepare a Bank Reconciliation Statement

Solution  to Illustration 8.3

(A) Adjusted Bank Account
Date                                 N                            N
Sept 2007   Balance b/d                   5,180     Bank charges                   20
            Direct credit (Umoru)         600     Standing Order                       560
                                                        Dishonoured cheques        85
                                           _____    Bal c/d                           5,115
                                            5,780                                       5,780
         Balance b/d                5,115






(B) Bank Reconciliation Statement at 12 September, 2007        
N
Adjusted balance as per cash book
Add:- unpresented cheques:- 5,115
  Smith 365
  Thomas         1,120 1,485
  less:- Uncredited cheques: 6,600
  Micheal 155
  Ndidi 360 515
Balance as per Bank statement   6,085

Illustration 8.4
The following is the summary of the cash book of Akintola Enterprises for the month ended 31/12/20X5

  Cash Book
      N     N
Balance b/d         2,110 sundry payment   23,280
Sundry receipt   22,610 bal. c/d  1,440
24,720 24,720
Balance b/d 1,440

On investigation the following errors were discovered.
i. Bank charges of N53 showed on the bank statement had not been entered in the cash book.
ii. A cheque drawn for N27 had been returned by the bank marked “Returned to Drawer” but this had not been recorded in the cash book.
iii. The opening balance in the cash book was wrongly brought down as N2,110 instead of N2,205.
iv. The last page of the pay-in-slip book showed a deposit of N2,178 which had not yet been credited to the account by the bank.
v. The bank had debited a cheque for N108 in error to the entity‟s account.
vi. The bank statement showed an overdrawn balance of N50
vii. A payment of N70 cheque was treated as a receipt in the cash book.
viii. Three cheques issued to suppliers for N321, N555 and N45 had not been presented for payment.

You are required to
(a) Write up the cash book.
(b) Prepare a bank reconciliation statement.

Solution to Illustration 8.5
Akintola Enterprises
(a) Adjusted Cash Book
         N N
Balance b/d 1,440 Bank Charges 53
Difference in opening bal. 95 Error in cheques drawn 140
Dishonoured cheque 27
_____ Balance c/d 1,315
1,535
Balance b/d 1,315
  1,535
(b) Bank Reconciliation Statement at 31 December 1996
  N N
Adjusted balance as per cash book
Add: unpresented cheques 321
  555 1,315
                                      45 921

Less: Uncredited cheque 2,178 2,236
        Debit in error by the bank 108 2,286
Balance as per Bank Statement (Overdraft)                                         50

Note: Payment of N70 cheque recorded in error as receipt gave a correction of N140 in the cash book because the error will be cancelled first before the N70 is reinstated on the credit side.



Illustration 8.5
The following information was extracted from the records of a petty trader as at 30th of June 20X9.

Balance as per Bank Statement was N1,000 credit. Cash Book balance showed N37,000 credit in the Bank Account column.
The following had been reflected in the Bank Statement but not in the Cash book.

Bank charges                         N5,000
Bank loan interest                               N1,000
Interest from investments     N2,000
Dividends from shares                       N12,000

In addition a cheque for N20,000 issued to Kete was dishonoured because of insufficient fund. Another cheque for N30,000 issued to Jimoh remained unpresented.
A cheque for N20,000 from Kudiratu was yet to be credited
You are required to produce an adjusted Cash Book and then a Bank Reconciliation as at 30th June 20X9.        

Solution to Illustration 8.5Adjusted Cash Book Account
        N    N
Interest on Investments  2,000       Balance b/f 37,000
Dividends 12,000       Bank charges  5,000
Kete (dishonoured Cheque)                   20,000       Interest on loan      1,000
Balance c/f  9,000                            ___    
                                           43,000                                              43,000
Balance c/d                                               9,000
Bank Reconciliation Statement as at 30th June 20X9
 N
Adjusted Cash Book Balance (9,000)
Add: unpresented cheques 30,000
  21,000
Less: Uncredited cheque 20,000
Balance per Bank statement                           1,000








CHAPTER NINE

PAYROLL ACCOUNTING

9.0   Learning Objectives

After you have studied this chapter, you should be able to:
• Define and explain payroll
• Explain the difference between gross salary, net salary and take-home pay
• Explain and calculate the difference between employee‟s and employer‟s social security contributions
• Calculate the net salary or pay of an employee where his or her gross pay, statutory and other deductions and personal income tax schedule are given
• State the control procedures required in the management of payroll
• Demonstrate ability to record payroll activities in the accounting records of a business organisation

9.1   Introduction
In this chapter you will learn how to calculate the salary or pay of employees and the various deductions that are made from the gross pay before calculating the income tax. You will also learn how to use the progressive personal income tax schedule to calculate the income tax of an employee. You will learn why statutory deductions like social security contributions are made and how they are calculated. Finally you will learn what types of reliefs are available to employees and how they are adjusted before the employees‟ net pay is calculated.

9.2   Payroll

Payroll may be defined as a record showing the names of employees, rates of pay, hours worked, bonuses, allowances, gross earning (salaries), statutory deductions and other contributions withheld during a given pay period.  In simple terms, payroll may be understood as a document showing for each worker his gross earning, any deductions (statutory and otherwise) made from his gross earning and the net amount payable to him in a particular pay period.

The objectives of payroll accounting are to process information such as; Hours Worked, Pay Rate, Gross Earning, Deduction and Net Pay (salary). Business organisations record information relating to employees‟ pay due to the following:

1) Payroll usually constitutes the most significant or material obligation or expense in most business establishments.

2) Business organisations are required by law to send returns on their payroll including the amount of income tax deducted at source to the tax authorities.

3) It is used for cost control purposes, usually in the form of variance analysis.
4) It is also the basis upon which most tax clearance certificates are prepared.

Employees are usually paid either a wage or a salary. Wages refer to the type of employee remuneration package that is time based. In this situation the rate of pay is given as a fixed amount per hour for number of hours actually worked or of those who reported for duty. Salary, though time based, is quoted on an annual basis.

In Ghana and Nigeria all employees are taxed under the PAYE (Pay-as-You Earn) system. This is a form of withholding tax system where the employer is legally required to deduct at source the income tax and social security contributions from the wages or salaries of employees and pay the same to the tax authorities. This therefore means that the employee will not have to wait till the end of the year for him to personally pay his tax liabilities to the state. The PAYE tax is a monthly phenomenon which is seen as an estimate and as such may result in overpayment or underpayment of an employee‟s income tax liability.      

9.3 Gross pay or earning is the total amount of wages or salaries that employees earn in a particular period before statutory deductions and others are made.  In Ghana, gross pay is the consolidated income of an individual earned from employment. The consolidated salary of an employee may consist of the following components:
• Basic Salary
• Leave allowance
• Responsibility allowance
• Transport allowance
• Overtime allowance
• Risk allowance
The two main remuneration methods often used are:  Time based system and Piecework system.  Others include:  Straight salary, bonuses, commission and allowances.
 
9.4.   Methods of calculating Gross pay
Methods of remuneration refer to the basis used in calculating wages of workers.  In the preparation of payroll, the organisation must initially determine the employee‟s Gross Salary or wages using the most appropriate remuneration plan adopted by the firm.

9.4.1  Time Based System
In this system of remuneration, employees are paid according to number of hours actually worked multiplied by a fixed amount or rate.  This simply means that the longer the period for which an employee works, the larger his or her gross pay will be. This method of remuneration is usually employed in the manufacturing industries.
The payment to the employees is based on this formula:

Earnings = Clock hours x Rate per hour

Advantages
• It is simple to understand and administer
• Wage negotiations (changes) can be easily affected
• It has stood the test of time
• It provides incentive for longer period of work
• It facilitates cost control Disadvantages
• There is no incentive to improve productivity and efficiency
• It is not a sound accounting practice to pay all employees in the grade the same rate irrespective of performance.
• Cost of supervision under this method is very high • It is not a very good basis for cost control.
• It does not encourage innovation.

9.4.2   Performance related Systems
Under this system, the remuneration in terms of wages or salaries that is paid to each employee is dependent on his or her level of output, performance or services rendered.  Workers are normally given a fixed sum per unit of output so that the higher one‟s output the larger his gross pay or salary.  Casual labour, cooks, painters, contractors etc. are often paid by this method. The payment to the employee is based on the formula below:

Earnings = Number of units produced x rate per unit

Advantages
• It attracts higher grade worker (scholars and “macho” men).
• It provides direct incentive for innovations, efficiency and high productivity without any difficulty of individual piecework rates.
• It is simple to understand and administer.
• It facilitates cost control.
• It has stood the test of time.

Disadvantages
• Output may exceed target if proper supervision is not carried out.
It results in competition for higher grade workers thereby increasing the cost per output.
• Shoddy work or inferior goods will be made, if proper supervision is                                                      not put in place.  
• It does not take into account individual disabilities.

9.4.3    Straight Salary
Under this method of remuneration, employees are paid a fixed amount annually with a constant increase per annum. This is usually referred to as the notch system and is usually stated as follows:
Gross Pay = ¢10,000,000 x¢ 2,000,000 – ¢18,000,000.
The above statement means that this employee will receive ¢10,000,000 for the first year of his engagement. Thereafter his gross pay will increase by ¢2,000,000 every subsequent year following the date of his employment. This increment will not continue when it gets to ¢18,000,000 until he or she is promoted to the next grade.  It must however be noted that the gross pay under this method does not depend on the number of hours worked or output produced.  

9.4.4   Bonus Schemes
These are schemes which are used to reward exceptional employees by   paying bonuses on top of these normal earnings mentioned above. Such incentives vary from one company to the other. The main purpose of providing these incentives is to encourage workers to produce their best for the company.  

9.4.5 Types of Bonus Schemes
9.4.5.1  Halsey Premium Plan

This plan was introduced by F. A. Halsey in 1891. The plan simply combines the time and piece rate systems. The main features of this plan are as follows:
a. Workers are paid at a rate per hour for the actual time taken to perform a task.
b. A standard time is set for each piece of work, job or operation.
c. If a worker takes standard time or more than the standard time to complete his work, he is paid wages for the actual time taken by him at the time rate.
d. If a worker takes less than the standard time, he is paid a bonus equal to 50 % of the time saved at the time rate fixed.
Under this system, total earnings of a worker are equal to wages for the actual time taken by him plus a bonus. The formula for calculating bonus and total earnings under this incentive plan is:
Bonus = 50% of [Time saved x Time rate]
Total earnings = Time rate x Time taken + 50% of [Time saved x Time rate]
    Illustration 9.1
            Standard time (or Allowed time) = 250 hours.
            Wages rate per hour                     = ¢15
Actual time taken                         = 220 hours

Thus time saved = 250hrs – 220hrs = 30hrs.
Bonus = 50% [30hrs x ¢15] = ¢225
Total earnings = ¢15 x 220hrs + 50% [30hrs x ¢15] = ¢3,525
   

Advantages of Halsey Plan.
1. It is easy to understand.
2. It guarantees a minimum time wages to all the workers. This means that slow or lazy and relatively inefficient workers have nothing to fear on the plan.
3. The benefits resulting from saving in time is equally divided between workers and the employer.
4. Bonus is separately calculated for each job. As a result any time saved by a worker on a particular job is not adjusted against excess time taken by him on another job.

Disadvantages of Halsey Plan
1. Workers do not like the employer to share the benefits of time saved by them.
2. It does not provide the employer with full protection against high rate setting.
3. Extra efficiency of a worker is not fully recognised and rewarded.

9.4.5.2 Rowan Plan

This plan is similar to the Halsey incentive plan mentioned above. The difference lies in the calculation of bonus. The main features of Rowan Plan are as follows:
a. Wages are paid on time basis for the actual time worked by the worker
b. A standard time is determined for each piece of work or job.
c. If a worker completes his work in standard time or in more than the standard    time, he is paid wages for the time actually taken by him.
d. If a worker completes his work in less than the standard time, he is entitled to a bonus.
e. The Bonus is calculated as the proportion of wages of actual time taken which     the time saved bears to the standard time.

The formula for calculating bonus and total earnings under this incentive plan is:

 Bonus =    Time saved      x Time taken x Time rate
Time allowed

Total earnings = (Time taken x Time rate) + Bonus

Illustration 9.2
            Standard time (or Allowed time) = 250 hours.
            Wages rate per hour                     = ¢15
Actual time taken                         = 220 hours

Bonus = 30 hrs    x 220 hrs x ¢15 = ¢396
250 hrs

Earnings = (220 hrs x ¢15) + ¢396 = ¢3,696


Advantages of Rowan Plan
1. Just like Halsey plan, it provides guaranteed minimum wages to workers.
2. It protects the employers against loose rate setting.
3. It pays a higher bonus than that under the Halsey plan up to 50% of the standard time saved.
4. The worker is not induced to rush through the work if time saved is more than 50% of the standard time, the bonus increases at a decreasing rate.
5. It provides good incentives for comparatively slow workers and beginners.

Disadvantage of Rowan Plan
1. The calculation of bonus is complicated and may not be easily understood by workers who may suspect the employers‟ motives.
2. In case of extra efficient workers, bonus is less than under Halsey Plan. This is true when the time saved is more than the time taken.

9.4.5.3  Comparison of Halsey Plan and Rowan Plan

1. Bonus. When time saved increases, bonus under Halsey Plan also keeps increasing. But under the Rowan Plan, when time saved increases, bonus increases only when time saved is up to 50% of the standard time allowed. Thereafter the amount of bonus begins to decline. Bonus under the two plans is the same when time saved is exactly 50%. Before 50% of standard time saved, bonus under Rowan Plan is higher than that of Halsey Plan and after 50% of the time saved, bonus under Rowan plan is lower than that of Halsey Plan. For example under Rowan plan, a person who has saved 60% of time allowed earns the same amount of bonus if he saves 40% of the time allowed.
2. Earnings per hour. Under both plans earnings per hour of workers keep on increasing. But the rates of earnings under the two plans differ. When time saved is less than 50% of time allowed , the rate of increase in per hour earnings is higher in Rowan Plan whereas when time saved is more than 50% of time allowed , the rate increase in per hour earnings is higher in Halsey Plan. At 50% time saved, earnings per hour under both schemes are the same.

3. Effect on labour cost. Labour cost per unit decreases as production increases up to the standard time allowed; thereafter, it continues to decrease but not at a faster rate.
Rowan plan cost per unit is higher than under Halsey Plan until time saved is 50% of time allowed .Thereafter it is lower and soon becomes significantly lower. At 50% time saved, labour cost per unit is the same under both plans.

9.5       Allowable deductions and reliefs
These are statutory deductions and others that are expected to be deducted from the gross salary of an employee at the end of a given period. In Ghana these deductions include the following:

a. Income Tax  
b. 5% employee‟s Social Security Contributions
c. employees‟ provident fund
d. Any percentage contribution towards a Special retirement fund by an employee
e. Medical Insurance
f. Union/Senior Staff Dues or Welfare Fund Contributions
g. Repayment of Employees Advances or Loan from Employers
h. Hire Purchase Deductions
i. Others

The first two deductions (income tax and social security contribution) are compulsory in Ghana. However, the other deductions will depend on the regulations of the company in question and the employees own preferences.

9.6 Net Pay
This is the excess of the gross pay or salary over statutory deductions and income tax.
It is often called disposable income or “take home pay”.  It is the pay the worker actually takes home for a given period.

At the beginning of each Government fiscal year (1st January in the case of Ghana), the Minister of Finance presents the Budget to Parliament. In Nigeria, the President presents the Appropriation bill to the National assembly a few months before the commencement of a fiscal year (1st January). After due processes the bill is passed into law and becomes the Appropriation Act.

The budget statements contain the rates of income tax and any deductible reliefs for the following year. Due to the annual changes in rates and reliefs, the rates of income tax used in the computations in this book are for illustration purposes only. The calculation of income tax and net pay is as follows:
Income tax:
  ¢
Basic Salary xxxxx
Add Other Cash allowances   xxxxx
Total Consolidated Salary xxxxx
Less Statutory deductions and reliefs xxxxx
Taxable Pay or Salary xxxxx
Income Tax = (Taxable pay x rate of tax)
Net Pay: xxxxx
Total Consolidated Salary xxxxx
Less Statutory deductions xxxxx
Taxable pay or salary xxxxx
Income Tax xxxxx
Net Pay or Salary xxxxx

Illustration 9.3
Mr Victor Kakapo has been in the employment of Pacheco Limited since January, 1 2005 on a salary scale of ¢50,000,000 per annum. For the year 2005 his entitlements were as follows:
  ¢
Inconvenience allowance 5,000,000
Leave allowance 3,000,000
Risk allowance 4,000,000

He is married with two children attending secondary schools in Ghana. He contributes to the social security scheme. He qualifies for the following reliefs:
  ¢
Marriage                                                       300,000
Child education       480,000
Aged dependent for two 400,000

You are required to calculate Mr. Victor Kakapo‟s Income tax and Net pay in 2005 using the income tax rates below.

 Income Tax rate
 ¢
First     1,800,000 0 %
Next     1,800,000 5 %
Next     4,800,000 10 %
Next   27,600,000 15 %
Next   33,000,000 20 %
Exceeding   69,000,000
  28%
Computation of Mr. Victor Kakapo‟s Taxable Pay
¢ ¢
Basic Salary (2005)  50,000,000
Inconvenience allowance    5,000,000
Leave allowance    3,000,000
Risk allowance    4,000,000 Consolidated Salary  62,000,000
Less Statutory deductions & reliefs:
5% Social security   2,500,000
Marriage      300,000
Child education      480,000
Aged dependent      400,000    3,680,000
Taxable Pay  58,320,000




Computation of Mr. Victor Kakapo‟s Income Tax
 Income Tax rate  Tax amount
¢ ¢
First     1,800,000 0%              -
Next     1,800,000 5%        90,000
Next     4,800,000 10%      480,000
Next   27,600,000 15%   4,140,000
Next   22,320,000 20%   4,464,000
Total   58,320,000   9,174,000
 


Therefore Victor Kakapo‟s Net Pay for 2005 is:

Basic Salary   50,000,000
Add Cash allowances   12,000,000 Total Consolidated Salary   62,000,000
Less:
5% Social security 2,500,000
Less Income tax
Net Pay or Salary


9.7 Accounting Entries

For the purpose of Accounting, the entries in the pay slips are passed in the general journal to record the payments made at the end of the given pay period.

1. When Liabilities/Expenses are due
• Debit Wages/Salaries Account with the Gross Salary.
• Credit Provident Fund Account.
• Credit Income Tax Account.
• Credit Medical Insurance Account
• Credit Union Dues Account
• Credit any Other Deduction Account
• Credit Payroll Payable Account with Net Salary or Wages.
• Credit 12.5% Employer‟s Social Security Fund Account
• Debit Employer‟s Social Security expenses Account (i.e. contribution)

2. When Expenses or Liabilities are Paid

• Debit provident fund account and credit Cash/Bank account with the amount paid • Debit Income tax account and credit cash/bank with the sum paid.
• Debit any other deduction account and credit cash/bank account with the amount paid.
• Debit payroll payable account and credit cash/bank account with the amount paid.
• Debit 12.5% Employer‟s Social Security Fund Account and credit cash or bank account with the amount paid.





CHAPTER TEN

ACCOUNTING FOR NON-CURRENT ASSETS

10.0  Learning objectives
After you have studied this chapter, you should be able to:
• State the types and characteristics of non-current assets
• Differentiate between capital and revenue expenditure
• Define depreciation and explain why accountants provide  for depreciation in final accounts
• Calculate depreciation using the straight line and the reducing balance methods
• Calculate any profit or loss made on the sale of non-current assets
• Explain the significance of maintaining non-current assets register
 
10.1 Introduction
In this chapter we are going to learn how non-current assets are recorded and valued in the books of accounts of a business organisation. We are also going to learn why depreciation should be provided for and also calculate depreciation using the two most popular methods. Finally we shall learn how to compute any profit or loss that may arise from the sale of non-current assets.
The Ghana National Accounting Standards (GNAS 9) defines Property, Plant and Equipment as tangible assets that:
(a) are held by an enterprise for use in the production or supply of goods or services for rental to others or for administrative purposes and (b)      are expected to be used during more than one accounting period.

The statement of Accounting Standard (SAS) No. 3 issued by the Nigerian Accounting Standard Board (NASB) defines Property, Plant and Equipment as tangible assets that:
(c) have been acquired or constructed and held for use in the production          or supply of goods and services and may include those held for maintenance or repair of such assets and;
(d) are not intended for sale in the ordinary course of business.
From the above definition you must understand that an asset is classified as a non-current asset by its function rather than by its type.  Generally speaking a non-current asset is held for use in the production and supply of goods and services. The asset should have been bought for use on a continuing basis rather than for sale in the ordinary course of business. Any asset, which does not satisfy these general criteria, would be classified as a current asset. Therefore it is not possible to state whether an asset is current or non-current until we know its function.  The classification of an asset as fixed or current has to be done with care; this is because an asset may indeed change with changing circumstances.  For instance, a company that manufactures and sells cars would normally expect to see such cars classified as current assets.  If, however, the company were to use one of their manufactured cars within their own business, then the classification would change from “current” to “non-current”
Examples of non-current assets include land, building structures (offices, factories, warehouses), and equipment (machinery, furniture, tools).
10.2 The determination of the cost of non-current assets
Almost every business enterprise of any size or activity uses assets of a durable nature in its operations. Such assets are not acquired for resale but rather they are used in the business to increase the earning capacity or productivity in the organization.

An item of expenditure, which qualifies for recognition as a non-current asset, should be initially recorded at its historical cost. Historical cost is measured by the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use. The purchase price, freight costs, and installation costs of a productive asset are considered as part of the assets cost. You must remember that any trade discount and rebates are deducted in arriving at the historical cost of the noncurrent asset.  

The concept of including all incidental expenses necessary to put the asset in use is illustrated by the following examples:
Illustration 10.1
Slopworks (Ghana) Ltd. Orders a machine from a Nigerian tool manufacturer at an invoice price of ¢100,000,000. Payment will be made in 48 monthly instalment of ¢2,500,000 which include ¢20,000,000 interest charges.  Value Added Tax of ¢12, 500,000 must be paid, as well as freight charges of ¢10,250,000.  Installation and other start-up costs amount to ¢4,000,000.  The cost of this machine to be debited to the machinery Account is ¢126,750,000. It is computed as follows:
¢
Invoice Price    * 100,000,000
VAT   12,500,000
Transportation charges     10,250,000
Cost of Installation     4,000,000
Total 126,750,000

• The ¢20,000,000 interest charges on the instalment purchase will be recognised as interest expense over the next 48 months and written-off in the statement of comprehensive income.

10.2.1 Land
When land is purchased, certain incidental costs are generally incurred, in addition to the purchase price. These incidental costs may include commissions to real estate brokers, legal fees for examining and insuring the title and fees for surveying, draining, clearing and grading the property. All these expenditures are part of the cost of the land since they are intended to get the assets ready for use. Any proceeds obtained in the process of getting the land ready for its intended use, such as the sale of cleared timber, are treated as reduction in the price of the land.
Special case is made for the treatment of local improvements, such as pavements, streetlights, sewers, drainage system and land-scaping. These are usually charged to the land account because they are relatively permanent in nature. However expenditures on land such as private driveways, fences, and car parks are recorded separately as land improvements. These expenditures should be recorded as land improvements and depreciated over their estimated useful lives because they have limited useful lives.
10.2.2 Cost of building
The cost of building should include all expenditures related directly to their acquisition or construction. These costs include materials, labour, overheads costs incurred during construction, professional fees and building permit. An organisation may engage the services of contractors to have its building constructed. All costs incurred by the contractors from excavation to completion, are considered part of the building costs.

There are occasions where land purchased as a building site has on it an old building which is not suitable for the buyer‟s use.  In this case, the only useful “asset” being acquired, is the land. Where this happens, any cost incurred in demolishing the old building should be debited to the land account together with the purchase price of the land. This is because the cost of demolition less its salvage value is a cost of getting the land ready for its intended use.
10.2.3 Cost of equipment
The term “equipment” in accounting includes delivery equipment, office equipment, machinery, furniture and fittings, factory equipment and similar assets. The costs of these assets include the purchase price, freight and handling charges incurred, insurance on the equipment while in transit and costs of conducting trial runs. Costs therefore include all expenditures incurred in acquiring the equipment and preparing it for use.

10.3     Capital expenditure versus Revenue Expenditure

Capital expenditure may be defined as the cost of acquiring a non-current asset for use in an organization. The earning potential or capacity of such assets will certainly last for more than one accounting period. In addition capital expenditure includes such costs that are incurred in adding value to existing non-current assets in order to improve their earning capacity.

Examples of capital expenditure are:
a) Purchase price of non-current assets such as motor vehicles, buildings, furniture and fittings, plant and machinery
b) Extension or any improvement of a permanent nature made to any structure
c) Legal fees of acquiring land or buildings
d) The cost incurred in bringing any non-current asset to its present location
e) Any other cost that must be incurred in getting the non-current assets ready for its intended use.

Revenue expenditure on the other hand is incurring of any cost in which its earning potential is exhausted within one accounting period. Such expenditures are not made to increase or improve the value of non-current assets but rather, are made for the maintenance and day-today running of the business.

Examples of revenue expenditure are:
1) The cost incurred in acquiring trading inventories for sale
2) Cost of repairing any non-current assets
3) Discount allowed on credit sales
4) Expenses in connection with rent, insurance, telephone and electricity.

10.3.1 Differences between capital and revenue expenditure
Differences due to time:
Where the benefit that is derived from an item of expenditure is used up or exhausted within one accounting period, then such expenditure is revenue expenditure. However if the benefit derived from an item of expenditure extends to more than one period of account, it should be referred to as capital expenditure.

Differences due to type of account:
An increase in capital expenditure is recorded or debited to a non-current asset account, which eventually finds its resting place in the statement of financial position.
All revenue expenditures are charged to the Statement of comprehensive income.
 
You should be careful not to incorrectly classify capital and revenue expenditure. As you can see from the above, the classification of capital and revenue expenditure has a direct impact on the resulting profit figure in the Trading and Statements of Comprehensive Income and also the assets values in the Statement of Financial Position. This is true because if you wrongly classify revenue expenditure as a capital expenditure, the total expenses figure in the income statement will be understated. This will result in overstating the net profit of the business. Should the owner appropriate the profit for his personal use, it might lead to the collapse of the business since the owner is spending his capital instead of the profits or gains from the business.    

10.4  Depreciation
Capital expenditure like building, plant, fixtures and fittings do normally last for more than one year. It is obviously possible that these assets may deteriorate with the passage of time due to its usage. There is therefore the need to recognise the loss in the value of non-current assets in the books of accounts.  If this is not done, the value of non-current assets in the statement of financial position will be mis-stated.
The process of recognising the loss in the value of non-current assets as a result of using such assets is called depreciation. The Ghana National Accounting Standards
(GNAS 10) defines depreciation as: “the allocation of the depreciable amount of an asset over its estimated useful life.” The Nigerian SAS No. 9 states that depreciation “represents an estimate of the portion of the historical cost or re-valued amount of a non-current asset chargeable to operations during an accounting period”. The standard also recognises the fact that depreciation for the accounting period is charged to income either directly or indirectly. This definition implies that depreciation is effectively an accrual technique, which matches the cost of a non-current asset with the benefits, which are derivable from the asset.

Non-current Assets produce revenue through use rather than through resale. They can be viewed as quantities of economic service potential to be consumed over time in the earning of revenues. Depreciation recognition transfers a portion of acquisition cost and capitalised post-acquisition cost of non-current to an expense account called depreciation expense. The corresponding credit is the provision for depreciation, a contra non-current assets account that reduces gross assets to net book value. This expense is recorded as an adjusting entry at the end of each accounting period. Depreciation expense could be classified as a selling or administrative expense, depending on the assets function.  Manufacturing firms include depreciation of plant and machinery or factory building in the cost of goods produced. When the goods are sold, depreciation becomes part of cost of goods sold.
Certain types of non-current assets have unlimited useful economic lives, and so do not require depreciation. This is usually true of land unless the land is an agricultural land or land acquired for extractive purposes. By contrast, buildings will normally have limited useful economic life, and therefore, will normally be subjected to depreciation.
You must note that the Provision for Depreciation account does not represent cash set aside for replacement of non-current assets; nor does its recognition imply the creation of reserves for asset replacement.
 
10.4.1 Causes of depreciation
There are several factors that contribute to depreciation of non-current assets. These factors or causes can be classified as follows:
1)   Physical deterioration
This is where the fall in value of a non-current asset is due to wear and tear as a result of its constant use. Natural occurrences such as erosion, rust and decay will certainly reduce the value of any non-current asset.
 
2)   Economic factors
This is where an asset is put out of use even though it is in good working condition. This occurs where an asset becomes out of date as a result of new inventions or technological advancement. For example bakers use claymolded oven in baking bread. The invention of gas-molded oven will certainly render the former out of date. This factor of depreciation is known as obsolescence.  
Another situation closely linked with economic factors is where a noncurrent asset is rendered useless as a result of the growth and changes in the size of business. A fisherman who uses canoe may have to acquire a large fishing boat when the demand for fish increases beyond the capacity that the canoe can cope with. In this situation you can clearly deduce that it would be more efficient and economical to operate a large fishing boat than the canoe, and as a result the canoe will be put out of use, though it is in good working condition. This factor of depreciation is known as inadequacy.  
 
3) Depletion
Natural resources such as mines, quarries, oil, coal and gas deposits become worthless when the deposits or resources are depleted. These assets are called wasting assets. The process of providing for the consumption of such assets is called depletion.

4) Time factor
There are certain assets that have specific period of legitimate life span. Assets such as patent, copyrights, finance leases have a legal life fixed in terms of years. As and when the years elapse, the value of these assets reduces. The cost of these assets must be spread over their legal lives. The term used in recognising the fall in value of these assets is termed amortisation.  

10.5 Methods of calculating depreciation
Depreciation is an attempt to allocate the cost of a non-current asset to each accounting period that the asset is used to generate income or earnings. Depreciation may be calculated simply by deducting the amount receivable when the asset is either sold or put out of use by the business from the cost of the non-current asset. The amount that will be received when the asset is sold or put out of use is technically termed the salvage value or the residual value of an asset. The cost less the salvage value is called depreciable value or amount. It is this depreciable value that the accountant seeks to spread over the useful life of a non-current asset.
There are several methods of calculating depreciation. These include:
1) Straight Line Method
2) Reducing Balance Method
3) Sum-of- the-Years‟-Digits Method
4) Units-of-Output Method
5) Revaluation Method
6) Machine Hour Method
7) Depletion of Unit Method

The purpose of this manual is to explain into details only two of the methods mentioned above. The straight Line or fixed instalment method and the reducing balance or diminishing balance method will be discussed; the remaining methods will be treated in the next stage of the course.
In order to calculate the depreciation charge for a period, we need to know four factors:
• The cost of (or revalued amount) of the non-current asset.
• The estimated residual value of the non-current asset.
• The estimated useful economic life of the non-current asset.
• The method of depreciation that is appropriate for the business.

All the factors mentioned above involve a certain amount of subjectivity. As a result of the subjective nature of the depreciation computation, GNAS 10 requires that the estimates that are used in the depreciation calculation should be kept under constant review and, where appropriate, revised. Where the estimate is revised during the period of depreciation, then the existing net book value should be written down over the remaining estimated useful economic life of the asset in question. The depreciation method should be reviewed periodically. When a change in depreciation method materially changes the annual depreciation charge, then the effect of the change should be accounted for as a change in accounting policy which will necessitate the restatement of the beginning balance of the income surplus account. It must be noted that the revision of the useful life of a non-current asset does not constitute a change in accounting policy but rather a change in accounting estimate.  This type of change will not have retroactive effect on the income statement.
10.5.1 Straight Line Method
The straight line method is the most widely used method of computing depreciation charge for financial statement purposes. Under this method, an equal amount of depreciation is recorded for each accounting period over the useful life of the noncurrent asset. The depreciation amount is computed by dividing the original cost of the non-current asset less estimated salvage value by the useful life of the asset. A mathematical formula can be deduced as follows:
Annual Depreciation = Original cost of Asset – Salvage Value
  Useful Life of Asset
Illustration 10.2
On January 1, 2000 Hyde Limited purchased a motor vehicle for ¢250,000,000. The motor vehicle has an estimated useful life of five years with a salvage value of ¢5,000,000.
You are required to calculate the depreciation charge and accumulated depreciation for each of the years and show the net book value as at the end of 2004 accounting period using the straight-line method.
Solution to Illustration 10.2
Annual Depreciation   = ¢250,000,000 – ¢5,000,000
  5
= ¢49,000,000
Beginning Depreciation Accumulated Closing
Year Book value for the year Depreciation Book value
¢ ¢ ¢ ¢
2000 250,000,000        49,000,000            49,000,000 201,000,000
2001 201,000,000        49,000,000            98,000,000 152,000,000
2002 152,000,000        49,000,000          147,000,000 103,000,000
2003 103,000,000        49,000,000          196,000,000   54,000,000
2004   54,000,000        49,000,000          245,000,000     5,000,000

10.5.2 Reducing Balance Method
Under this method of depreciation, the book value of a non-current asset at the beginning of the year is multiplied by a fixed percentage to determine the depreciation for the accounting year. This procedure is repeated in subsequent accounting periods so as to reduce the depreciable value of the non-current asset to zero (i.e. reduce its cost to its residual value).
Illustration 10.3
On January 1, 2000 John Kay Limited purchased plant for ¢250,000,000. It is the policy of John Kay to depreciate Plant at 20%. You are required to calculate the net book value as at the end of 2004 accounting period using the reducing balance method.

Solution to Illustration 10.3
Beginning Depreciation Depreciation Accumulated Closing
Year Book value Rate for the year Depreciation Book value
¢ ¢ ¢ ¢
2000 250,000,000 20%        50,000,000            50,000,000 200,000,000
2001 200,000,000 20%        40,000,000            90,000,000 160,000,000
2002 160,000,000 20%        32,000,000          122,000,000 128,000,000
2003 128,000,000 20%        25,600,000          147,600,000 102,400,000
2004 102,400,000 20%        20,480,000          168,080,000   81,920,000

When a non-current asset is purchased during the year, depreciation is calculated to the nearest month. In some organisations, a full year’s depreciation charge is provided on noncurrent assets acquired during the year irrespective of the period in which they were purchased. Where this is the case any asset sold in the year will also not attract depreciation in the year of sale irrespective of the time of sale within the accounting period.

10.6  Double Entry Records For Depreciation
After calculating the depreciation charge for the accounting year, you must record the amount in the books of account. It is important for you to remember that the process of providing for depreciation is recording for the use of non-current assets during the accounting period. This therefore means that depreciation is revenue expenditure and as such must be recorded in the same manner that accountants record normal business expenses.
There are two main ways of recording depreciation in the books of account of a business organisation. The old method and the modern method of recording depreciation. In the case of the former, depreciation charges are recorded in the noncurrent asset account. It is important to note that this method is no longer used in practice. The double entry of depreciation is as follows under the old method:
Dr. Depreciation Expense Account
                        Cr. The non-current asset Account in question  
Dr. Income statement
                        Cr. Depreciation Expense Account
Illustration 10.4
On January 1,2000 Brown Kay Limited purchased Equipment for ¢450,000. It is the policy of John Kay to depreciate Plant at 20%. You are required to show the Equipment account in the books of Brown Kay Limited as at the end of 2004 accounting period using the reducing balance method.


Solution to Illustration 10.4
Equipment account

¢                                             ¢
01/01/2000 Bank                  450,000     31/12/2000 Depreciation expense      90,000
                                                             31/12/2000 Balance c/f                 360,000
                                          450,000                                                                450.000

01/01/2001 Balance b/d      360,000   31/12/2001 Depreciation expense      72,000
                                                           31/12/2001 Balance c/f                  288,000
                                            360,000                                                        360,000

01/01/2002 Balance b/d      288,000   31/12/2002 Depreciation expense      57,600
                                                            31/12/2002 Balance c/f          230,400
                                            288,000                                                    288,000

01/01/2003 Balance b/d      230,400   31/12/2003 Depreciation expense      46,080
                                                            31/12/2003 Balance c/f          184,320
                                            230,400                                                        230,400

01/01/2004 Balance b/d      184,320   31/12/2004 Depreciation expense      36,864
                                                            31/12/2004 Balance c/f            147,456
                                            184,320                                                        184,320

Balance b/d      147,456

Depreciation Expense Account
                                                                               ¢             ¢
31/12/2000 Equipment account        90,000   31/12/2000 Profit and loss      90,000
31/12/2001 Equipment account        72,000   31/12/2001 Profit and loss      72,000
31/12/2002 Equipment account        57,600   31/12/2002 Profit and loss      57,600
31/12/2003 Equipment account        46,080   31/12/2003 Profit and loss      46,080
31/12/2004 Equipment account        36,864   31/12/2003 Profit and loss      36,864


 
The modern practice of recording depreciation treats depreciation as a contra to the noncurrent asset account. The non-current asset account is maintained at its original cost. A ledger account called “Accumulated Provision for Depreciation account” is opened and all depreciation calculations are credited to that account, the corresponding entry being passed into the Depreciation charge Account as a debit. The double entry is as follows:  
Dr. Depreciation charge Account
                       Cr. Accumulated Provision for Depreciation Account  
Illustration 10.5
On January 1, 2000 Amoroso Limited purchased Equipment for ¢800,000. It is the policy of the Company to depreciate all equipment at 20% per annum. You are required to show the Equipment account in the books of Amoroso Limited as at the end of 2004 accounting period using the reducing balance method.
Solution to Illustration 10.5
31/12/2000 Balance c/f      160,000                                                 31/12/2000 Deprecitioin expense    160,000
31/12/2001 Balance c/f      288,000                                                 01/01/2001 Balance b/d    160,000
                   31/12/2001 Deprecitioin expense    128,000
     288,000                                                                                           288,000
31/12/2002 Balance c/f      390,400                  01/01/2002 Balance b/d    288,000
                   31/12/2002 Deprecitioin expense    102,400
     390,400    390,400
31/12/2003 Balance c/f      472,320                   01/01/2003 Balance b/d    390,400
                                                                                                     31/12/2003 Deprecitioin expense      81,920
     472,320                                                                                        472,320
31/12/2004 Balance c/f      537,856                                                    01/01/2004 Balance b/d    472,320
                      31/12/2004 Deprecitioin expense      65,536
     537,856                                                                                           537,856
                     01/01/2005 Balance b/d    537,856


Depreciation Expense A ccount
¢ ¢
31/12/2000 Equipment account      160,000 31/12/2000 Profit and loss       160,000
31/12/2001 Equipment account      128,000   31/12/2001 Profit and loss    128,000
31/12/2002 Equipment account      102,400   31/12/2002 Profit and loss    102,400 31/12/2003 Equipment account        81,920   31/12/2003 Profit and loss      81,920
31/12/2004 Equipment account        65,536   31/12/2004 Profit and loss      65,536


 

The balance on the equipment account will be shown on the statement of financial position at the end of the accounting year less the balance on the Accumulated Provision for Depreciation Account as follows:
 
10.7 Disposition of non-current assets
An organisation can dispose of its non-current assets by either selling it for cash, exchanging it for a similar asset or a different one, or merely by discarding the asset. In all these three situations you must remember to take out the disposed asset from the main non-current asset account. This is done by opening an account for the purpose of the disposal. Into this account is entered the cost of the non-current asset and its associated accumulated depreciation provision. A profit or loss may arise from the disposal of the non-current asset depending on the outcome of the non-current asset disposal account.
On the disposal of non-current asset, the following entries must be passed:
1) Transfer the cost of the non-current asset sold to a named non-current asset disposal account as follows:
Dr. Non-current asset disposal Account
                        Cr. Non-current asset Account  
2) Transfer the accumulated depreciation on the asset sold to the non-current asset disposal account as follows:
Dr. Accumulated provision for depreciation Account
                        Cr. Non-current asset disposal Account  
3) The amount realized from the sale of the non-current asset must be recorded as follows:
 Dr. Cash, Bank or Sundry receivables Account
                        Cr. Non-current asset disposal Account  
Where the balance on the non-current asset disposal account is credit, it means that the amount received from the sale is more than the net book value of the non-current asset, hence a profit is the resulting figure.
Dr. Non-current asset disposal Account  
                        Cr. Income statement  
Where the balance on the non-current asset disposal account is debited, it means that the amount received from the sale is less than the net book value of the non-current asset sold, hence, the loss must be recorded.
Dr. Income statement
                       Cr. Non-current asset disposal Account  
The entries above can be illustrated by assuming that the equipment purchased by Amoroso in Illustration 10.5 was sold for cash amounting to ¢295,000 at 2nd January 2005. The cost of the equipment as at January, 2 2005 was ¢800,000, its associated accumulated depreciation amounted to ¢537,856 leaving a net book value of ¢262,144 (¢800,000-¢537,856). Since the equipment was sold for ¢295,000 it means that a profit amounting to ¢32,856 will be calculated as follows:
 
If one again assumes that the equipment purchased by Amoroso in Illustration 10.5 was sold for cash amounting to ¢200,000 on January2 2005. The balance on the equipment account as at January, 2 2005 will show cost of ¢800,000, with its associated accumulated depreciation recording ¢537,856 leaving a net book value of ¢262,144 (¢800,000-¢537,856). Since the equipment was sold for ¢200,000 it means that a loss amounting to ¢62,144 will be calculated as follows:
Calculation of loss on sale of equipment ¢
cost of equipment       800,000
Less Accumulated depreciation       537,856
Net book value       262,144

Proceeds from sale of equipment       200,000
Less Net book value       262,144
Loss on disposalof equipment       (62,144)

The transaction involving the sale of assets at a profit as per Illustration  .5 will be recorded as:
 




CHAPTER ELEVEN

END OF PERIOD ADJUSTMENTS

11.0  Learning Objectives
After you have studied this chapter, you should be able to:
• Differentiate between capital expenditure and revenue expenditure
• Explain the effect on profit if a revenue expenditure has been wrongly
classified as a capital expenditure, and vice versa
• Explain prepayments and accruals
• Pass adjusting entries in respect of prepayment and accruals
• Explain and pass entries in respect of bad debts and provision for doubtful debts
• Record increases and decreases in the provision for doubtful debts
• Calculate and make entries with respect to provisions for discount on receivables and creditors
Prepare Income statement and statement of financial position (extracts) showing the treatment of bad debts provision for doubtful debts, depreciation and provision for discount on trade receivables and payables and provision for doubtful debts, depreciation and provision for discount on trade receivables and payables

11.1  Introduction
Many changes in a company’s economic resources and obligations occur continuously. For example, interest accrues daily on debts, as does rent expense on an office building. Other resources and obligations such as employee salaries originate as service is rendered, with payment to follow at specified dates. The end of the accounting period generally does not coincide with the receipts or payment of cash associated with all the types of resource changes. Adjusting entries are therefore, used to record such resource changes to ensure the accuracy of the financial statements. This chapter will consider some of the adjustments most commonly used in the preparation of the final accounts.  As well as discussing why such adjustments are required, their treatment in both the Income statement and statement of financial position will be reviewed in detail.
Accountants rely on two principles in the adjusting process – revenue recognition and matching principles. The revenue recognition concept requires that revenue be reported when earned, not before and not after. Revenue is earned for most firms when services and products are delivered to customers. If a firm sells goods in 2003 to a customer, the revenue was earned in 2003 and as such should be reported in the 2003 Income statement, even if the customer paid for the goods in a period other than 2003.
The matching principle aims to report expenses in the same accounting period as the revenues that are earned as a result of incurring these expenses. The matching of expenses with revenue is a major part of the adjusting process. As an example if a business earns monthly revenue while operating out of rented store space, the matching concept stipulates that rent must be reported on the income statement for December, even if rent is paid in a month either before or after December. This ensures that the rent expense for December is matched with December revenue.
At the end of an accounting period it is likely that an organization will find that some expenses have been paid which relate to the next accounting period, whilst other amounts, which relate to the current period remain outstanding. In order that the account shows a true and fair view of the firm’s financial performance, adjustments for such items are necessary.  Adjustments are classified into three categories:
(1) Deferrals and prepayments
(2) Accruals
(3) Other adjustments

11.2  Deferred Revenue and Prepayments
Deferrals or prepayments refer to transactions where cash is paid or received before a related expense or revenue is recognized.  These transactions are recorded when cash is paid for expenses that apply to more than one accounting period or when cash is received for revenue that relates to more than one accounting period.  The portion of the expense or revenue that applies to the future periods is deferred as a prepaid expense (asset) or unearned revenue (liability).  If we do not make adjustments for prepayments and unearned revenues, profit for the current period will be understated or overstated respectively. Items, which normally need to be prepaid, include rates, insurance and road licensing fee.
The accounting entry requires the prepayment to reduce the relevant expense in the Income statement thereby increasing profit.  The same applies to the unearned revenue, where the adjusting entry reduces the relevant revenue in the Income statement thereby increasing profit.  Since conceptually the prepayment represents an amount owing to the firm from a third party and unearned revenue represents amounts owed by the business to third party, it is included under current assets and current liabilities respectively in the statement of financial position. The accounting entries are as follows:
Debit:  Prepayments (Statement of financial position)
Credit: Expenses (Income statement)
Debit:  Revenue (Income statement)
Credit: Unearned revenue (Statement of financial position)
Illustration 11.1
As an illustration let us assume that Santo Ltd. paid ¢240,000 for two years insurance protection beginning on December 1, 2000.
The cash payment of ¢240,000 will be debited to the insurance account. With the passage of time, the benefit of the insurance protection gradually expires and a portion of the unexpired insurance is transferred to the next accounting period as a prepaid expense.  For instance, one month‟s insurance coverage expires by December 31, 2000.  This expense is ¢10,000, or 1/24 x ¢240,000 and will be as follows:
Insurance Account
¢ ¢
1/12/2000 Cash    240,000 31/12/2000 Profit and loss        10,000
Prepaid c/f      230,000
    240,000        240,000
1/1/2001 Prepaid b/f    230,000   31/12/2001 Profit and loss (12/24  x  240,000)      120,000
31/12/2001 Prepaid c/f      110,000

    230,000        230,000

1/1/2002 Prepaid b/f     110,000


The balance carried forward of ¢230,000, and ¢110,000 represents insurance prepaid to be shown under current assets in the statement of financial position for the years 2000 and 2001 respectively.

The adjusting entries will be journalized as follows:
2000
Debit: Insurance Prepaid ¢230,000
Credit: Insurance expense   ¢230,000
2001
Debit:  Insurance Prepaid ¢110,000
Credit: Insurance expense   ¢110,000
Let us now illustrate the treatment of deferred revenue as follows: Illustration 11.2
Assume that Santo Ltd rented a small office in its building to a customer on January 1, 2001.
The rental agreement required the payment of ¢180,000 cash in advance for 18 months rent.

This transaction is recorded as a debit to cash and a credit to rent received account.  On December 31, 2001, the unadjusted Trial Balance will report ¢180,000 as rent received, which is overstated by ¢60,000 (6/18 x ¢180,000) relating to 2002.  The rent received account will be as follows:
 

The balance carried forward of ¢60,000 in 2001 represents unearned revenue which will be recorded under current liabilities in the statement of financial position for the financial statement for the year 2001. The adjusting entry will be journalised as follows:

Debit: Rent receivable A/c                        ¢460,000
Credit: Deferred Rent Revenue ¢460,000
11.3 Accrued Expenses
Accrued expenses and accrued revenues reflect transactions where cash is paid or received after a related expense or revenue is recognized. It represents an item, the use of which the firm has already benefited from during the current accounting period, but which will not be paid for until the next accounting period. If we do not make an adjustment the profit for the current period will be overstated.  Examples of items that need to be accrued for include electricity, since it is not likely that these bills will exactly coincide with the firm’s accounting year-end. The accounting entry for accrued expense is:
Debit: Expense (Income statement)
Credit: Accrued expense (Statement of financial position)

In this case, the relevant expense in the Income statement is increased by the accrued amount whilst in the statement of financial position, accruals appear under current liabilities, reflecting an amount owing by the business.

Illustration 11.3
As an example, let us assume that Santo Ltd’s Trial Balance  recorded electricity expenses of ¢600,000 which cover the period up to 31st October 2000.  A careful examination of the previous electricity bills of Santo Ltd shows that the company’s consumption of energy is even throughout the period.

The above example tells us that the electricity charge in the Trial Balance does not cover the entire year. This means that an accrual is required for the period of November to 31 December 2000. Since electricity is used evenly throughout the year, we can estimate the outstanding amount based on the bills received to date. The ¢600,000 recorded in the Trial Balance  represents 10 months of electricity charge, therefore the accrual is estimated as follows:
Accrual = ¢600,000 x 2/10 = ¢120,000
The electricity expense recorded as follows:
 

The balance carried forward of ¢120,000 in 2000 represents accrued expense and will be recorded under current liabilities in the statement of financial position . The adjusting entry will be as follows:

Debit: Electricity expense A/c                       ¢120,000
Credit: Accrued Expense A/c   ¢120,000
11.4 Accrued Revenue
Accrued revenue refers to transactions where cash is received after related revenue is recognized. It represents an item, the use of which the firm has already dispensed with during the current accounting period, but which will not be received until the next accounting period. If we do not make an adjustment the profit for the current period will be understated.  Examples of items that need to be accrued for include interest earned on treasury bills of which payment has not been received, since it is not likely that the maturity of these bills will exactly coincide with the firm’s accounting yearend. The accounting entry for accrued revenue is:

Debit: Accrued income (Statement of financial position)
Credit: Interest Receivable (Income statement)

In this case the relevant income in the Income statement is increased by the accrued amount.  Whilst in the statement of financial position the accrued income will appear under current assets, reflecting an amount owned by the business.

Illustration 11.4
As an illustration, assume that the Trial Balance of Sky Ltd. shows interest receivable of
¢855,000. Excluded from the Trial Balance  is a 182 days Bank of Ghana Bond purchased on
August,  1 2001 at an interest rate of 15% per annum at a cost of ¢12,000,000. Sky Ltd Prepares account to December, 31 each year.

From the illustration above, Sky Ltd. will receive a total of ¢900,000 (15% x ¢12,000,000 x 6/12) representing interest that will be earned on the bond for the period August, 1 2001 to January, 31  2002. Since five months interest amounting to ¢750,000 (5/6 x ¢900,000) relates to 2001 financial year, it must be accrued in the Income statement for 2001 though the amount will be received after 2001. The interest receivable account will be recorded as follows:

 
The adjusting entry will be as follows:
Debit: Interest accrued A/c                          ¢750,000
Credit: Interest receivable A/c ¢750,000
11.5 Other adjustments
11.5.1 Depreciation Expense
Non-current assets are the statement of financial position classification used to account for many productive assets with useful lives exceeding one year. The capital expenditures for these assets are matched against the revenues that the assets help to generate in an accounting period.  Depreciation is the process in which we spread the cost of a non-current asset over the accounting periods that benefited from its use.  Irrespective of the method of depreciation used, the accounting treatment is always the same:

Debit: Depreciation expenses (Income statement)
Credit: Provision for Depreciation (Statement of financial position)

The effect of the entry is to show depreciation as a business expense in the income statement, thereby reflecting the proportion of cost or valuation attributable to the current period. It should be cautioned that depreciation is a non-cash item. This means it is a book adjustment, which does not involve the physical movement of cash.

Illustration 11.5
The example below illustrates depreciation recorded for Santo Ltd.. at the end of 2002 under the straight-line method.

                         Assets Cost   Residual Estimated Proportionate use by function
                          Value             Useful live Selling         Administrative
        ¢                   ¢ Function       Function
Building 1,600,000     100,000            15 yrs             46%           54%
Equipment         910,000       10,000            10 yrs        

Computation:       40%          60%  
Total ¢ ¢
Selling Administration
Building [(¢1,600,000-¢100,000)÷15yrs]      100,000        46,000             54,000
Equipment[(910,000-10,000)÷10yrs]            90,000        36,000             54,000
Totals                                                          190,000        82,000           108,000


The adjusting entry for these two assets is:
Dr Cr
¢ ¢
Depreciation Selling expense    82,000
Administration expense  108,000
          Provision for Depreciation: Building  100,000
Equipment    90,000


The adjusting entry reduces the net book value of the building and equipment accounts.  The provision for depreciation is a contra account that has a balance opposite that of the assets account to which it relates.  Thus, the provision for depreciation is subtracted from the gross building and equipment accounts, leaving the net undepreciated account balances of ¢1,500,000 (¢1,600,000-¢100,000) and ¢820,000 (¢910,000-¢90,000) for building and equipment respectively in the statement of financial position.
11.5.2  Bad Debts
Where a business sells its goods on purely cash basis, does not have to worry about customers not paying for such goods. This is however not always the case. Goods and services are usually sold or rendered on credit, giving rise to trade receivables.  The business is therefore taking the risk of some customers defaulting in the payment of their receivables. Trade receivables that are not collected are called bad debts, which is a risk of doing business on credit terms.

Where a customer‟s debt is found to have gone bad, steps must be taken to remove such debts from the list of customers owing the business. This is done by completely writing off the debt from the receivables account. Writing off of a particular debt from the list of receivables accounts means that the value of the assets of the business has reduced or diminished. This in effect means that the business has incurred losses that must be accounted for by increasing the expense account of bad debt, which will eventually reduce profit and also reduce assets of receivables, which will also result in the reduction of the net assets of the business.

Where an account containing a debt is declared „bad‟ you must pass a journal entry as follows:
Debit: Bad debts expense account (Income statement)
Credit: Trade receivables‟ account (Statement of financial position)
It is important for companies to review its receivables periodically and identify those debts from which full payment is unlikely. These bad debts may then be written-off in the statement of financial position.  This practice prevents overstatement of both profit and assets and is required if bad debts are probable and can be estimated. At the end of the accounting period the total debt written off is transferred from the bad debt account to the Income statement as follows:
Debit: Income statement
            Credit: Bad debt account

Illustration 11.6
Jack Terror has been in business for several years dealing in the sale of second hand cloths. During the three years ended October, 31 2005, he presented the following information relating to receivables:
  Receivables
(including bad debts)
¢ Bad Debt
¢
October, 31 2003 4,500,000 1,200,000
October, 31 2004 8,750,000 3,850,000
October, 31 2005 12,200,000 6,300,000
 
You are required to show the above information for the year ended October, 31 2003, 2004, 2005 in the following accounts:
(a) Trade receivables
(b) Bad debt
(c) Income Statement (extracts)
Solution to Illustration 11.6
 
  Trade Debtors Account
¢ ¢
31/10/2004 Sales  8,750,000 31/10/2004 Bad debt   3,850,000
31/10/2004 Balance c/f   4,900,000
   8,750,000

11/01/2005 Balance b/f

Trade Debtors Account
¢ ¢

¢
2003 Gross profit xxxxxx
Less bad debts     1,200,000
2004 Gross profit xxxxxx
Less bad debts     3,850,000
2005 Gross profit xxxxxx
Less bad debts       6,300,000

11.5.3  Provision for doubtful debts
This refers to the possibility of a debt going bad in the future but for which the amount cannot be calculated with substantial accuracy. In the case of doubtful debts, the amount or estimate still remains in the list of receivables and is not cancelled from the receivables account as in the case of debts that have actually gone bad. Doubtful debt does not relate to any specific debtor, but the business recognizes the fact that not all the existing debts will be collected and as such, it is prudent that such uncertainty is reflected in the Income statement and the statement of financial position.  The accounting treatment necessary to make a provision for doubtful debts is:

1. When a provision is made for the first time: Debit: Income Statement
                        Credit: Provision for doubtful debts Account With the initial provision.

In this way the current year’s profit is reduced, whilst in the statement of financial position the provision is clearly shown and deducted from trade receivables.

2. In subsequent accounting period’s new estimate must be made in respect of debt that may be considered doubtful. The new provision should be compared with the existing one and where the current provision is greater than the previous one, the difference representing an increase in provision for doubtful debts should be accounted for as: Debit: Income statement
                        Credit: Provision for doubtful debts
                        With the increase in provision (i.e. the difference)
If the current provision is less than the previous one, the difference representing a decrease in provision for doubtful debts should be accounted for as: Debit: Provision for doubtful debts account
                        Credit: Income statement
With the decrease in provision (i.e. the difference)
Illustration 11.7
Viscosity Ltd. has been in business since 2003 dealing in the sale of mobile phones. During the three-years period ended December, 31 2005 the company presented the following information relating to receivables:
        Date   Trade
Receivables(excluding bad debts)
¢ Bad Debts
     ¢
31 December 2003 7,000,000 1,000,000
31December 2004 18,250,000 2,500,000
31December 2005 10,000,000 4,300,000
 
Viscosity Ltd. makes provision for doubtful debts at the rate of 6% on receivables. There was no balance on the provision for doubtful debt at the beginning of 2003 financial year.   You are required to show the above information for the year ended 31October, 2003,2004, 2005 in the following accounts:
(d) Bad debt
(e) Provision for doubtful debt
(f) Income Statement extracts
(g) Statement of financial position  (extracts)
Solution to Illustration 11.7
Bad debts Account
¢ ¢
31/12/2003 Trade debtors   1,000,000 31/12/2003 Profit and loss     1,000,000
31/12/2004 Trade debtors    2,500,000   31/12/2004 Profit and loss      2,500,000
31/12/2005 Trade debtors    4,300,000   31/12/2005 Profit and loss      4,300,000
Provision for doubtful debt
¢ ¢
31/12/2003 Balance c/f     420,000   31/10/2003 Profit and loss    420,000

31/12/2004 Balance c/f   1,095,000              01/01/2004 Balance b/f     420,000
                                       31/10/2004 Profit and loss     675,000
  1,095,000   1,095,000
31/12/2005 Profit and loss      495,000   01/01/2005 Balance b/f  1,095,000
31/12/2005 Balance c/f      600,000   31/10/2005
  1,095,000   1,095,000

/01/2006 Balance b/f     600,000


Income Statement (extract) for the year ended 31 December xxxxxxx
¢
2003 Gross profit xxxxxx
Less bad debts   1,000,000
           Increase in Provision for doubtful debt      420,000     1,420,000
2004 Gross profit xxxxxx
Less bad debts   2,500,000
           Increase in Provision for doubtful debt      675,000     3,175,000
2005 Gross profit xxxxxx
Add  Decrease in Provision for doubtful debt     495,000
Less bad debts (4,300,000)   (3,805,000)


 
11.5.4 Bad Debts Recovered
It normally occurs that a debt, which has previously been written off in past accounting periods, may be repaid or recovered. When this is the case it is usually advisable that such recovered debt be reinstated. The debt is reinstated in the sales ledger account to ensure that a detailed and concise history and behaviour of the debtor or customer is available to serve as a guide for future granting of credit in respect of the same customer. It will therefore assist the company in its credit rating of all customers that buy goods from them on credit.
The accounting entries when a debt is recovered are:
   Debit: Trade Receivables account
                           Credit:Bad debts recovered account                With the amount of debt reinstated
   Debit: Cash or bank account
                           Credit:Trade Receivables account
With the amount recovered from receivables in settlement of all or part of the debt.

At the end of the accounting period the balance in the bad debt recovered account will either be transferred directly to the Income statement or to the main bad debt account. Either mode of transfer will produce the same result since the dab debt account will eventually be transferred to the Income statement with the net value.

11.5.5 Provision for Discount on Trade Receivables

In certain businesses provision is made for cash discount that is expected to be offered to customers on the trade receivables balance at the statement of financial position date. Proponents of this concept argue that since companies allow discounts from credit sale for prompt payment recording net realisable value of receivables as the balance on receivables account less provision for doubtful debt will not give the best estimate of the amount expected to be collected from trade receivables. They argue that to estimate the realisable value of receivables, consideration should be given to the impact or effect of cash discount, hence the determination of provision for discount on receivables.
The manner in which provision for discount on receivables is calculated is almost the same as that obtained when calculating provision for doubtful debts. You must however remember to apply whatever rate or percentage on the net amount of trade receivables less provision for doubtful debts. This is so because discounts are allowed on debts expected to be paid and not bad debts.      

Illustration 11.7
Mahatma Ltd. has been in business since 2003 dealing in the sale of Italian executive shoes. During the three years ended 31December 2005 the company presented the following information relating to receivables:
  Trade
Receivables Provision for doubtful debts Provision for cash discount allowed
  ¢ ¢ %
31st December 2003 17,000,000 1,000,000 4
31st December 2004 28,550,000 4,500,000 4
31st December 2005 22,000,000 2,800,000 4


You are required to show the above information for the years ended 31 October, 2003, 2004, and 2005 in the following accounts:
Provision for discount on receivables
Income Statement extracts
Statement of financial position extracts
Solution to Illustration 11.8

 
Income Statement (extract) for the year ended 31 December xxxxxxx
¢
2003 Gross profit
Less  Provision for doubtful debt    1,000,000 xxxxxx
            Provision for discount on debtors       640,000     1,640,000
2004 Gross profit
Less  Provision for doubtful debt    3,500,000 xxxxxx
            Provision for discount on dereceivables       322,000     3,822,000
2005 Gross profit
Add  Decrease in provision for doubtful debt   1,700,000 xxxxxx
            Decrease in provision for discount on debtors       194,000

Statement of Financial Position (extract) as at 31 December xxxxxxx
                                                         ¢             ¢         ¢
Debtors                                                                     17,000,000
Less  Provision for doubtful debt    1,000,000
            Provision for discount on debtors      640,000    1,640,000    1,894,000

                                                                                                                       15,360,000
Debtors                                                                   28,550,000
Less  Provision for doubtful debt    4,500,000
            Provision for discount on debtors      962,000    5,462,000
   23,088,000
Debtors                                                                   22,000,000
Less  Provision for doubtful debt   2,800,000
      768000           3,568,000
      18,432,000

11.6 Summary
In this chapter we have considered some of the adjustments that are often made to improve the quality of the year-end accounts used to prepare the financial statements.  We should also understand that these adjustments are needed in order to record the actual expenses incurred and the actual revenue earned for the accounting year. It must be remembered that each of the adjustments considered will impact upon the Income statement and the statement of financial position.  

We have also learned that depreciation is a business expense that must be charged in the Income statement of any period that a non-current asset has been in use. In addition we learned that any business debt that an organization is unable to collect is called a bad debt and that there is the need to also record provision for bad debts so that the receivable figures in the statement of financial position  will reflect the amount that the business is likely to collect from receivables.

Finally we have also learnt how to record bad debts, provisions for doubtful debts, provision for cash discount in the ledger, Income statement and the statement of financial position.  It is hoped that, students will have a better understanding of the purpose and accounting treatment for depreciation, bad debts provision and accruals and prepayments.
























CHAPTER TWELVE

PREPARATION OF SIMPLE FINAL ACCOUNTS

12.0 Learning Objectives
After you have studied this chapter, you should be able to:
• define, explain and record returns inwards, returns outwards, carriage inwards and carriage outwards.
• identify items that will appear in the Comprehensive Income Statement, Income statement and statement of Financial Position  of a sole trader
• explain why carriage inwards is recorded in the Income Statement and also why carriage outwards is recorded in the Income statement
• prepare the inventories account and show how the opening and closing inventories are treated in the Comprehensive Income Statement
• prepare an Income statement and statement of Financial Position
• pass the necessary adjustment in respect of accruals, prepayments and provisions that affect the Income statement
• explain and calculate cost of goods sold taking into consideration the appropriate adjustments such as returns inwards and outwards, carriage inwards and outwards, and inventories
• prepare Manufacturing Account  

12.1 Introduction
In this chapter, you are going to learn how to prepare a simple Comprehensive Income Statement and a statement of financial position   for a sole trader who deals in the buying and selling of goods. You will also learn how to prepare final accounts of a sole trader who is involved in the manufacturing process. New terminologies such as returns inwards, returns outwards, carriage inwards and carriage outwards will also be introduced. The chapter will also consider the treatment and recording of trading inventories that were purchased in the accounting period but the trader was not able sell all.

12.2  The Trial Balance
The first step in the preparation of the final accounts is the compilation of a Trial Balance, with a view to:
(a) confirms the arithmetical accuracy of the postings, and
(b) Providing in one statement a concise summary of the items, which are to be included in the Comprehensive Income Statement, Income Statement and the Statement of Financial Position.

Debit balances recorded in the Trial Balance normally represent either assets, or losses and expenses. The assets are entered in the Statement of Financial Position, while losses and expenses are debited to the Comprehensive Income Statement or to the Income statement.

Likewise, the credit balances represent liabilities, provisions, reserves, or revenues and gains. The liabilities are entered in the Statement of Financial Position  as deductions from assets of the firm, while income and gains are credited either to the Comprehensive Income Statement or to the Income statement.

Students must remember to carefully distinguish between balances, which appear in the Comprehensive Income Statement, Income statements, and those that appear in the Statement of Financial Position.  The trading and Income statement essentially closes off all the nominal account balances during a particular accounting period. Any account, which remains in the Trial Balance after the trading and Income statement have been prepared, represents either assets or liabilities that must be recorded in the Statement of Financial Position. The balance on the Income statement will finally be transferred to the capital account in the statement of Financial Position.

12.3  The Statement of Comprehensive Income
The main objective of this Statement is the determination or calculation of the gross profit for the period. It is also in this account that the cost of obtaining the goods, usually referred to as cost of goods sold or simply as cost of sales is calculated.

 Another important function of this Statement is that it enables the owner of a business to compare the gross and net profit of a current period with the results attained in previous periods. It is pertinent that, the component items in the Income Statement do not vary in any material effect from previous and subsequent accounts, as this will make it impossible for any analyst to make meaningful approximate comparison. This therefore means that the Income Statement should be standardized so that the same items should appear in similar form in the successive final accounts so that an effective comparison may be made of one trading period with another.

The actual items in the Income Statements of different classes of enterprises or businesses will necessarily vary depending on the nature of the nominal accounts in the respective business; for example, customs duty, licenses, and freight and insurance on inward shipments of raw materials will be essential items in the Statement of a cigarette manufacturer, but these particular items would not appear in the Comprehensive Income Statement of a retail tobacconist.

The following is the usual method of preparing the Statement of Comprehensive Income.

On the debit side are recorded:
(1) Inventories at commencement of the period, which is usually, called opening inventories.
(2) Purchases during the period (less returns outwards).
(3) All purchasing and expenses, such as wages, carriage inwards, and other items which are incurred in putting the product in a saleable condition or location.

The account is credited with-
1. Sales during the period (less returns inwards).
2. Inventories at end of period (it is the usual practice of deducting the closing inventories figure from the sum total of opening inventories and net purchases on the debit side of the Comprehensive Income Statement so as to show on the face of the account the cost of goods sold).

Where the balance remaining on the Statement is credit then the business has recorded a gain, which is referred to as gross profit and will be transferred to the Income statement as a credit entry by debiting the Comprehensive Income Statement.

Before we attempt to prepare the Statement of Comprehensive Incomes of a business in detail; we need to understand the following accounting terminologies:

12.3.1 The movement of inventories
Organisations usually maintain four different accounts for the inventories function.
The accounts involved are:
• Sales account
• Returns inwards account
• Purchases account and
• Returns outwards account

The sales and the returns inwards accounts are accounts in which are recorded the respective goods sold and goods returned by customers. The purchases account and the returns outwards account contain transactions involving goods bought for resale and goods returned to suppliers respectively.

The usual practice is to maintain the sales account separately and not to deduct directly any goods that have been returned by customers during the accounting period. The returns inwards account serves as a contra to the sales account by recording all sales that have been returned by customers. Being a contra account to the sales account means that it has a debit balance which when transferred to the sales account at the end of the accounting period will show the net sales or turnover of the organisation.

The accounting entries will be recorded as follows:
Dr. Bank or Receivables Account
            Cr. Sales Account
            With goods sold for cash or on credit

Dr. Returns inwards Account
            Cr. Bank or Receivables Account
            With goods sold but returned by customers

Dr. Sales Account
            Cr. Returns inwards Account
            With the balance on the return inwards account

Similarly the purchases account is maintained separately by recording all goods bought for the sole purpose of resale relating to the accounting period. The returns outwards account serves as a contra to the purchases account. In to this account is recorded all purchases that were returned to suppliers. Being a contra account to the purchases account means that it has a credit balance which when transferred to the purchases account at the end of the accounting period will show the net purchases of the organisation.

The accounting entries will be recorded as follows:
Dr. Purchases Account
             Cr. Bank or Payables Account
              With goods bought for cash or on credit

Dr. Bank or Payables Account
            CR. Returns outwards Account
            With goods bought but returned to suppliers
 
Dr. Returns outwards Account
            Cr. Purchases Account  
            With the balance on the return outwards account

12.3.2  Carriage inwards and outwards
Carriage is an accounting terminology that refers to the cost of transport that a trading concern incurs in moving goods meant for resale into or out of a firm. Where the carriage is charged for delivering goods purchased, it is called carriage inwards.
Carriage of goods upon sale out of a firm is called carriage outwards.

Carriage inwards is a cost that is incurred in order to bring the goods into a condition that is necessary for its sale and as such should be charged to the Income Statement. This is done by adding the carriage inwards to the purchases figure in the Income Statement. This ensures that the true cost of buying goods for resale is taken into account in calculating the gross profit of a business.

 Carriage outwards, however, is not considered as a relevant cost the purpose of which is to put the asset into a saleable condition. It is therefore worthy to note that carriage outwards is an Income statement item and for that reason is not included in the calculation of gross profit. This is because carriage outwards is seen as expenses on sales and as a result is debited in the Income Statement.


12.3.3  Goods taken by the Proprietor
It is common in a one man business to find the proprietor making use of the products that he is selling for his own benefit. The use of products or goods by a proprietor is usually termed inventories drawings. The accounting effect of inventories drawings is that it reduces the amount of cost of goods available for sale since the total goods bought for resale have been reduced by the inventories drawings and as such the inventories drawings account must be debited and the purchases account credited.

  Illustration 12.1
  From the following Trial Balance of Jack Terror after his first year‟s trading, you are       required to prepare Income Statement for the year ended 30 June 2007.

 


 Solution to Illustration 12.1
The Income Statement will be compiled as follows:
Trading Account for the year ended 30 June 2007
¢'000 ¢'000
Purchases   20,000 Sales   28,000
Add carriage inwards        650 Less returns inwards        450
  20,650   27,550
Less returns outwards        745
Cost of sales   19,905
Gross Profit c/f     7,645
   27,550    27,550

Gross Profit c/f      7,645

12.3.4  The accounting treatment of inventories
From the above Income Statement one can deduce that the business is a new one and also was able to sell the goods that were purchased during the year. This means that the business had no opening and closing inventories during the accounting period ended 30 June 2007. The usual practice is for business organisations to hold certain minimum level of inventories to meet future demand.

If this practice is accepted to be normal, then it should be expected that in most situations a business would certainly have closing inventories that might have been bought in the current accounting period but have not been sold. Goods that were bought for the purpose of resale in an accounting period but have not been sold in that particular period and carried forward to the next accounting year constitute what is referred to in accounting terminology as closing inventories.

It must be noted that the closing inventories of an accounting period is brought forward as the opening inventories of the next accounting period. This is handled in the Income Statement by adding the opening inventories to the purchases figure which gives rise to cost of goods available for sale and deducting the closing inventories figure resulting in cost of goods sold.

Illustration 12.2
The following is the Trial Balance of Victorosky Trading Enterprise who has been in business for several years. You are required to draw up the Income Statement for the year ended 31 December 2006.
 

Solution to Illustration 12.2
 

12.4  The Income Statement
The main function of the Statement of Comprehensive Income is to ascertain the net Income statement resulting from the trading operations of the accounting period.

It is debited with the gross loss and with the General, Selling, Distribution and Administration expenses for the period, and is credited with the gross profit (if any)  and any miscellaneous gains made, such as interest and discounts received.

There is no established arrangement or order in which items should be set out in an Income Statement, but a sequence frequently adopted in practice and which is recommended for examination purposes is as follows:

Debits-
1. Gross loss from the Comprehensive Income Statement (if any).
2. Establishment charges, e.g., rent, rates, electricity. etc.
3. Administration expenses, e.g., clerical wages, salaries, director fees, etc.
4. Selling and Distribution expenses, e.g., advertising, travelling expenses; salaries and commission, carriage outwards, packing materials, etc.
5. Other expenses, e.g., loss by fire, loss by defalcations.
6. Finance Charges, e.g., loan interest and bank charges.
7. Personal Income tax
Credits-
1. Gross Profit (if any)
2. Investment income, e.g., interest earned on treasury bills and dividend receivable
3. Miscellaneous Income, e.g., rents received, discounts received.

In examination setting, students may be required to prepare the Income Statement and Statement of Financial Position, from a Trial Balance, which already contains the gross profit figure. The inventories that appear in the Trial Balance in this situation are the closing inventories, which must be recorded in the Statement of Financial Position as a current asset and should not be treated as an adjustment in the Income Statement. The opening inventories will not be recorded because it has already been accounted for in the inventories prior to the extraction of the Trial Balance.

The balance on the Income statement represents net profit or loss of the business or the firm. Where the resulting balance in the statement is a credit, a transfer will be made by debiting the Income statement and crediting the capital account of the proprietor. The effect of this entry is to close off the Income statement to the capital account.

12.4.1  Adjustments in the Final Accounts
The ultimate objective of preparing the Income statements and the Statement of Financial Position, is to enable the management of an organisation determine:

(a) The result of its operations during a given period; and (b) Its financial position at the end of that period.

It must also be noted that, in order to obtain these results accurately, it is necessary to make adjustments for:

(1) Expenses incurred but not paid and as a result have not been recorded in the books of account.
(2) Expenses paid in advance, a proportion of which relate to subsequent accounting period.
(3) Income earned in respect of the current accounting period but has not yet been received.
(4) Income received during the current accounting period but will affect the next accounting period.
(5) Provisions for possible losses, e.g., bad debts, and discounts on receivables.
(6) Necessary adjustments for depreciation in the values of the assets at the end of the trading period.

12.5  The Statement of Financial Position
This is a Statement that shows the Financial Position of a business as at the end of an accounting period. It is therefore a presentation of a concise summary of the assets and liabilities of an enterprise in a well-arranged form, so that the financial position of the firm or company on the date of the statement may be clearly ascertained.

  The arrangement of the Statement of Financial Position is nothing but the expression     of the accounting equation and as such must always agree or balance. This means the total book values of assets must be equal to the sum of the values of Capital and Liabilities. The assets of a business are usually arranged in order of their permanence and for this reason; they may conveniently be classified into non-current and current assets.

12.5.1  Non-current assets
These are assets which by their nature or the type of business in which they are employed, are held with the aim of earning revenue and not for the purpose of sale in the normal course of business. Non-current assets are generally valued at cost, less provisions for accumulated depreciation that is sufficient to reduce the carrying or book value of the asset to its salvage or scrap value by the end of its useful working life. Examples of non-current assets are land, buildings, motor vehicles and office equipment.

The amount at which non-current assets are shown in the Statement  does not reflect the amount that will be realised if sold or the cost that will be incurred when they are replaced, but rather is a historical record of their cost less amounts provided in respect of accumulated depreciation. Depreciation represents that part of the cost of a noncurrent asset to its owner, which is not recoverable when the asset is finally scrapped or sold. Provision against this loss of capital must be made before calculating the amount of profit or loss made by a business organisation.

12.5.2 Current assets
These are assets that are acquired and held for resale, and not as agents of production, but for the purpose of eventual conversion into cash. They are therefore not permanent in nature, but are continually changing in the ordinary course of business. Examples of current assets are cash, receivables, closing inventories and bills receivable. The professionally accepted basis of valuing inventories is “cost price or net realizable value, whichever is the lower.” The fundamental reason for this basis of valuation is that anticipated losses should always be provided for as far as possible, while anticipated profits should be ignored until actually realised.

Although examples of current and non-current assets have been mentioned above, it must be remembered that the dividing line between current and non- current assets is a thin one. This is due to the fact that what is considered as a non-current asset in one business may be a current asset in another, and any classification must depend upon the nature of the particular business carried on by the firm. For example a business that manufactures and sells furniture will certainly record a motor vehicle purchased as a non-current asset and furniture as a current asset but if he uses any of the furniture in the office such furniture will be classified as a non-current asset.

12.5.3 Liabilities
These are the obligations of a business enterprise to outsiders. The best method of arranging the liabilities in the case of a sole trader is in order of permanence. The usual groupings are as follows:
• Non-current liabilities.
• Current Liabilities

12.5.4 Capital Account
This represents the contribution of the proprietor of a business to the assets that the firm has acquired. It is made up of the following:
(1) The initial amount that the owner used in starting the business
(2) Any additional amount that he invested in the business during any accounting period
(3) The net profit from the Income statement, which has the effect of increasing the capital of the owner at the end of the accounting period
(4) The net loss from the Income statement that has the effect of reducing the capital account balance at the end of the period, and
(5) Drawings, which eventually results in the reduction of the capital balance.

12.6  Manufacturing Account
Though the Income statement is the acceptable means of determining the performance of a trading enterprise, it is not a sufficiently explanatory means of ascertaining the profit of a manufacturing concern.
Manufacturing firms usually prepare an additional account called Manufacturing Account, which shows the cost of goods produced or manufactured. The cost of goods manufactured, normally called the production costs is transferred from the Manufacturing Account into the Income Statement by crediting the Manufacturing Account and debiting the Income Statement. The production cost effectively replaces purchases found in the Income Statement of a retail enterprise. It must however be noted that where a manufacturing firm produces more than one product, a separate Manufacturing Account should be prepared for each product.  

The sequence and grouping of items in a Manufacturing Account depends on the costing system of the firm and is usually designed to yield the maximum amount of information on the composition of the total cost of production. The classification, sequencing and grouping of the Manufacturing Account is as follows:
• Prime cost
• Factory overhead
• Production cost
• Work-in-progress

12.6.1 Prime cost
(1) Cost of raw materials consumed. These consist of the cost of direct materials that the firm purchased and used in the manufacturing process. It is calculated as follows:
              ¢
Opening inventories of raw materials 500,000
Add Purchases of raw materials 2,500,000

  3,000,000
Less returns outwards of raw materials (200,000)

Cost of raw materials available 2,800,000
Less closing inventories of raw materials (600,000)
Cost of raw materials consumed 2,200,000

(2) Direct labour costs. These consist of the cost of labour such as wages of operatives and workers (both casual and regular) whose efforts are traceable directly to the manufactured product.

(3) Direct Expenses. These consist of all direct costs other that direct materials and direct labour. Examples include royalties and cost of hiring machine.
The summation of the items above show the sub-total for prime cost.
12.6.2  Factory Overheads:
This sub-heading is shown immediately below the prime cost figure and consists of all indirect costs in respect of materials, labour and expenses. They may include rent, rates, electricity, depreciation of plant and equipment, insurance, the wages of foremen in the factory and research and development cost.
Certain expenses may be common to the manufacturing process as well as to the general administration of the business. Such expenses should be apportioned between the Factory and Administration, Selling and Distribution. The method or basis commonly used in apportioning these common expenses is usually given in an examination question.

12.6.3  Production Cost:
This is the summation of the prime costs and factory overhead figures. This represents the total cost that a manufacturing firm incurs in the production process and is transferred to the Comprehensive Income Statement for that accounting period.  
Illustration 12.3
Kefir Enterprises is a manufacturing firm and has presented the following balances for the year ended 30 June 2006.
 


You are required to prepare the Manufacturing Account for the year ended 30 June 2006.

Solution to Illustration 12.3
The Manufacturing Account will be prepared as follows:
Kefir Enterprises

Manufacturing Account for the year ended 30 June 2006.
Raw materials: ¢ ¢
Opening inventories      30,000
Add Purchases      40,000
      70,000
Less Return outwards        2,000
Cost of raw materials available      68,000
Less closing inventories      26,000
Cost of raw materials consumed      42,000
Manufacturing wages      40,000
Prime cost
Factory Overheads:      82,000
Depreciation of Plant        5,600
Factory expenses      16,800
Rent and rates      12,800      35,200
Production cost    117,200




12.6.4  Work-in-progress

The time that manufacturing companies use to complete a unit or batch of production is not the same; it varies from company to company. It is therefore possible that by the time that the accounting period of a manufacturing firm ends there might be some product s that are not fully complete. Those products that have not been completed at the date of the statement of financial position date are called inventories of work-inprogress.
The cost of production must be adjusted for work-in-progress at the end and the beginning of the accounting period. This is due to the fact that the amount to be transferred to the Comprehensive Income Statement must contain the cost of only products that are fully complete. Any item or product that has not been fully processed cannot be sold; hence they must not appear in the Statement.
Illustration 12.4
Koki Enterprise is a manufacturing firm and has presented the following balances for the year ended 30 June 2007.

 

Required: Prepare the Manufacturing Account for the year ended 30 June 2007


Solution to Illustration 12.4
The cost of production taking into consideration work-in-progress would be prepared as follows:

Manufacturing Account for the year ended 30 June 2007.
Raw materials: ¢ ¢
Opening inventories         80,000
Add Purchases       240,000
         Carriage inwards         44,000
       364,000
Less Return outwards         35,000
Cost of raw materials available       329,000
Less closing inventories         48,000
Cost of raw materials consumed       281,000
Manufacturing wages    160,000
Royalties paid      72,000       232,000
Prime cost
Factory Overheads:       513,000
Depreciation of Plant      56,000
Insurance expenses -factory      28,000
Factory expenses
Work-in-progress:      66,000       150,000
       663,000
Add Opening inventories         58,000
       721,000
Less closing inventories         50,000
Cost of completed goods c/f       671,000



12.6.5 Transfer Pricing

The usual practice in the preparation of Manufacturing Account is to transfer the production cost to the Income Statement at historical cost. This means that the Manufacturing Account will not record any profit and for that matter one will not know whether the manufacturing process is profitable.

A technique is therefore devised with the purpose of ascertaining profit on the Manufacturing Account. This is done by transferring from the Manufacturing Account the market value of the goods produced for the period. The reason for the use of the market value as the transfer figure to the Income Statement is to ascertain the cost of the manufactured item had the firm decided to acquire those products in the open market instead of producing them.

In this situation, the Manufacturing Account will show a balance, which will reveal either a profit or loss on production. This will therefore inform management whether the production department is a profitable one. If the answer to this question is negative management may have to decide whether to close the production department or institute cost-cutting measures that will result in lower cost of production by means of strict supervision and economies to cheapen production.

Illustration 12.5
Given the same question in illustration 12.4 above, let us assume that the production department transfers the finished product from the factory to the marketing department at cost plus 25%.










The Manufacturing Account will be prepared in the horizontal format as follows:
Manufacturing Account for the year ended 30 June 2007.
Raw materials: ¢ ¢ ¢
Opening inventories     80,000 Market value of goods
Add Purchases   240,000 completed c/f   838,750
         Carriage inwards     44,000
   364,000
Less Return outwards     35,000
Cost of raw materials available   329,000
Less closing inventories     48,000
Cost of raw materials consumed   281,000
Manufacturing wages 160,000
Royalties paid   72,000   232,000
Prime cost
Factory Overheads:   513,000
Depreciation of Plant   56,000
Insurance expenses -factory   28,000
Factory expenses
Work-in-progress:   66,000   150,000
   663,000
Add Opening inventories     58,000
   721,000
Less closing inventories     50,000
Cost of completed goods c/f   671,000
Gross profit on manufacure c/f   167,750
   838,750   838,750




12.7  Summary
We have learned that the purpose of the Income statement of a sole proprietor is to determine his performance for the accounting period. The performance is determined by calculating the net profit or net loss as the case may be. Important terms such as carriage inward, carriage outward, returns inward and returns outward have also been explained. The statement of financial position was also mentioned and explained as a statement that shows the financial position of an enterprise as at a particular time or date.

We also saw that an enterprise that manufactures products for sale will need an additional account called Manufacturing Account to record the total cost incurred in producing the products


CHAPTER THIRTEEN

SINGLE ENTRY AND INCOMPLETE RECORDS

13.0 Learning Objectives

After you have studied this chapter you should be able to:

• Use accounting equation to calculate profit where only opening and closing net assets figures are available
• Convert single entry and incomplete records into double entry records
• Prepare detailed trading and statement of comprehensive Income from records that were not kept on double entry system
• Derive proprietor‟s cash drawings or additional capital as a missing figure where all other information relating to cash payments and receipts are known
• Determine the figures for purchases and sales from the purchases ledger control and the sales ledger control accounts
• Derive expenses incurred and revenue earned from incomplete records

13.1 Introduction

The term „single entry‟ is applied to any system, which does not provide for the two fold aspect of transactions; while the alternative term „incomplete records‟ is often applied to books of account kept on such a single entry or incomplete double entry system. Pure „single entry‟ recognises only the personal aspect of transactions, and, consequently, the only essential books are personal ledgers for recording transactions with receivables and creditors. In practice, however, a cashbook is invariably kept, but, with this exception, the impersonal aspect of transactions is usually left entirely unrecorded.  

In this chapter you will learn the procedure involved in preparing the statement of Comprehensive Income and statement of financial position for an enterprise that has only opening and closing net assets and perhaps capital as the only known figures.
You will also understand and learn how to ascertain the proprietor‟s drawings and any additional capital contribution during an accounting period from the scanty information provided by a cash book summary.

Questions on incomplete records and single entry are popular for examiners because they enable them to test techniques, which are also relevant for other topics such as ledger control accounts. It also provides the basic information necessary to prepare final accounts but without the examiner presenting it in the form of a Trial Balance .

13.2 The Ascertainment of Profit from Incomplete Records
Generally speaking, profits (or losses) are ascertained, under the single entry system, by a comparison of the values of the net assets at two specified dates, after taking into account additions to, or withdrawals from, capital during the period. The difference between these two values represents the profit or loss, according to whether there is an increase or decrease in the figures.
Remember the accounting equation, which states that:
Business Assets = Owner’s Capital + Business Liabilities

The equation above can be restated as:
Owner’s Capital = Business assets – Business Liabilities

If during an accounting period, the business realised an excess of income over expenditure, the additional cash or assets generated belong to the owner(s), thus increasing the capital. The accounting equation will now become:
Opening capital + profit = opening net assets + increase in net assets.

The introduction or withdrawal of resources by the owner will also increase or decrease the Owner’s capital respectively. As a result profit can be calculated using the format below:

  ¢
Closing capital XXX
Less opening capital   XXX
Increase in net assets XXX
Owners‟ Drawings XXX
Additional Capital (XXX)
Net profit for the year   XXX

Illustration to Illustration 13.1:
Calculate the net profit for the year ended 31 December 2001 from the following information:
  31/12/2000
          ¢     31/12/2001
                ¢
   
Property    200,000 200,000
Equipment  60,000 90,000
Trade Receivables      40,000 80,000
Cash      10,000 15,000
Overdraft      60,000 90,000
Trade Payables 50,000 30,000

Drawings during the year were ¢45,000 and additional capital introduced during the year was ¢50,000.
Solution:
  31/12/2000 31/12/2001
  ¢ ¢
Total Assets 310,000 385,000
Total Liabilities (110,000) (120,000)
Net Assets 200,000 265,000
  ¢
Closing capital 265,000
Less opening capital
200,000
Increase in net assets  65,000
Owners‟ Drawings  45,000
Additional Capital (50,000)
Net profit for the year
  60,000
 
13.3  Preparation of detailed final accounts from Incomplete Records
It is understandably certain that calculating the profit of an enterprise using the method as presented above is not satisfactory. It is important for you to note that the accountant does not only prepare the final accounts of an enterprise but also communicates accounting and financial information to stakeholders. It is therefore much more informative when statement of comprehensive Income is drawn. It is important for the accountant to convert these scanty and incomplete records into the acceptable double entry form.

For one to be able to prepare the Income statement and a statement of financial position from single entry and incomplete records, the procedures detailed below are recommended:

 13.3.1 Preparation of statement of affairs
One must first construct a statement of financial position at the beginning of the accounting year. This means that the assets and liabilities of the business must be ascertained and calculated. The statement prepared to show the financial position of the business at the beginning of the year is technically called „statement of affairs‟.

In most practical situations the owner of the business will provide lists of values of non-current assets that he uses in the business together with the dates of acquisition. It should therefore be easy for one to calculate the accumulated provision for depreciation of the non-current assets from the date of their purchase to the date of reporting. Values of such items as inventories in trade, receivables and liabilities may have to be estimated with the help of the owner.

From the above information a journal should be opened and accounting entries with the aim of achieving the dual purpose of recording accounting transactions should be effected. This means that appropriate debit entries must be posted into assets account and credit entries entered into capital or liabilities accounts.
 
The difference between the assets and liabilities, which usually ends up with the assets exceeding the liabilities may be assumed to be the initial amount that the owner used in starting the business and therefore will be recorded as the capital of the business. It is possible that the owner may be able to mention the initial amount he used in commencing the business. Where this is the case then, any difference between such capital and the net assets estimated may be recorded as the balance on the Income statement retained in the business.

13.3.2  Preparation of Cash and Bank Summary
Ascertain the cash position of the business. This is usually done by carefully examining any available bank statement, any pay-in-slip and the cheque counterfoil. The bank statement together with the cheque counterfoil could reveal information concerning purchases, payment of rent, bank charges, wages, insurance, interest earned, the acquisition of non-current assets, and any personal withdrawals. Information extracted from the pay-in-slip will help determine the amount of money paid in by customers to whom goods were sold on credit and also direct sales by cheque instead of cash. The above information may be used to prepare a cash summary or a receipts and payments account for the business.  
13.3.3 Analysis of unbanked cash sales
One must at this stage determine the amount of cash sales which have not been banked by the owner, but which might have been used by the owner to pay for business expenses, cash purchases, and personal drawings. It is possible that the owner might have made use of some of the physical inventories in trade for his or her personal use. In such a situation conducting an informal interview with the owner would confirm the existence of such occurrences and so will help the bookkeeper make an appropriate estimate for inventories drawings. Physical inventories taking by head counting of items in inventories at the close of business will give us the actual closing inventories figure and therefore may not need to be estimated.
13.3.4  Posting from the Cash and Bank Summary
After the analysis above has been made, one can now carry out the following postings into the ledger. Note that in step one opening entries were made through the ledger, and therefore some of these entries will be made into existing ledger accounts irrespective of how inaccurate they may be.

From the analysis of the debit side of the cash and bank summary and information obtained from the pay-in-slips:
a) All cash sales or takings should be credited to the trade receivables account in the sales ledger;
b) Any proceeds from the sale of non-current assets should be credited to the respective asset account;
c) Any interest or income from investment must also be credited to the appropriate revenue account;
d) Any other item should be posted to the credit of the relevant account;
 
From the analysis of the credit side of the cash and bank summary and information obtained from the cheque counterfoils:
a) All payments for goods purchased should be debited to the trade payables account in the purchases ledger account;
b) Payment of expenses should be debited to the relevant nominal account;
c) All purchases in connection with non-current assets should be debited to the appropriate asset accounts;
d) Any charges should be posted to debit of the bank charges account;
e) Any other item should be posted to the debit of the relevant account;

Where any difference exists on the cashbook summary entries should be posted to make it balance. If the difference is on the credit side then the cashbook should be credited and the proprietor‟s drawings account debited. If the difference is on the debit side then one can safely presume that the owner of the business has introduced additional capital. This difference should be debited to the cash and credited to the capital account of the business.    
13.3.5 Preparation of Trade receivables and payables Schedule
At this stage one will have to determine year-end adjustment and balances.
A schedule will have to be compiled detailing all customers who are owing the business, as a result of goods sold to them on credit. The total of the schedule of receivables therefore represent debts owed to the business and as such must be carried forward to the credit of the total sales ledger control account. There is likely to be a missing figure in the debit side of the total receivables account, which represent total sales on credit for the period and should be transferred to the credit of the Income Statement as sales or turnover.  

Another schedule that must be prepared is a list of amount owing by the business to its suppliers for goods purchased on credit. The total of this schedule represent total liabilities by way of trade payables outstanding at the end of the period and should therefore be carried forward to the debit of the purchases ledger control account. The total of purchases for the period will be derived from the credit side of the purchases ledger control account as a balancing figure and should be transferred to the debit side of the Income Statement.

Similarly accruals and prepayments will be carried forward as closing balances in the appropriate expense accounts. The actual expense amount which has been incurred for the accounting period being accounted for as a balancing figure.

13.3.6  Extraction of Trial Balance
This is the final stage since all the transactions would have been recorded and the double entry will now have been completed and for that matter the business will be able to extract a Trial Balance  which will form the basis for the preparation of the statement of comprehensive Income and statement of financial position.

Illustration 13.2
Boakye, a sole proprietor, trading as KKB Enterprise requested Oko & Associates, a firm of Chartered Accountants, where you are employed as a trainee Accountant, to prepare the accounts of his business for the year ended December 31st, 2006.
Your audit Manager assigned this work to you. Your interview with Boakye revealed the following:
(i) He did not maintain double entry book-keeping system.
(ii) All sales were on credit basis. During the year Boakye received ¢9,025,000 and  ¢475,000 in cheques and cash respectively from his customers.
(iii) Suppliers of goods during the year paid ¢6,840,000 by cheque.
(iv) Boakye rented 2 premises at Dansoman and High Street for residential and business purposes respectively. In July 2005, he paid ¢480,000 as one-year rent in advance for his residence. In July 2006, he again paid a cheque of ¢600,000 to cover one year advance for his residence. The rent for the premises at High Street was ¢60,000 per month in 2006. Boakye always paid all his rent by cheque. (v) General business expenses paid by cheque amounted to ¢106,200 (vi) He took cash of ¢38,000 every month for his private use.


Boakye provided you with the following additional information.
  31/12/06 31/12/06
  ¢ ¢
Trade Receivables 1,254,000 1,045,000
Trade Payables 617,500 380,000
Rent Owing 60,000 120,000
Bank balance 3,000,000 1,073,500
Cash in Hand 60,000 76,000
Inventories 1,700,500 1,510,500
Fixture & fittings - 920,000

(vii) Depreciation is provided annually at the rate of 20% on Fixture and Fittings.
(viii) Boakye agreed to pay ¢100,000 as accountancy fees.
(ix) Differences in cash and bank balances at the end of 2006 represents additional drawings and Capital respectively.
Required:
(a) Computation of the profit of Boakye using the net worth method
(b) Cash and Bank Summary for 2006
(c) Statement of comprehensive Incomes for the year ended 31st December 2006.
(d) Statement of financial position  as at 31st December 2006.

Solution to Illustration 13.2
You may like to try the question before reading this discussion.
The examiner has been fairly lenient with this question. Let us view the techniques to be used in answering it:

 (a)   Calculate opening net assets to arrive at opening capital
We need the opening capital to enable us calculate the closing balance in the nt in the statement of financial position.  All that is required is to pick up all opening balances not forgetting the opening cash balance. The information is presented clearly, and the examiner has even included the bank and cash opening balances in the tabulation of assets and liabilities.
 
Increase in net worth …………………….. ¢5,973,000 - ¢4,125,000 = ¢1,848,000

Computation of profit by the net worth method
¢
Increase in net worth       1,848,000
Add Drawings(456,000+600,000+35,000)       1,091,000
       2,939,000
Less Additional Capital       1,227,700
Net Profit       1,711,300



(b)   Construct a cash and bank summary
Even if some of the information in the question is given in the form of a cash or bank summary, it is usually necessary to build up one or both of these summaries to calculate a missing figure such as payment for purchases and Owner’s drawings

CASH BOOK SUMMARY
Cash Bank Cash Bank
¢ ¢ ¢ ¢
Bal  b/d    76,000   1,073,500 Suppliers -    6,840,000
Received from customers  475,000   9,025,000 Drawings  456,000 -
Capital(missing figure) -   1,227,700 Rent -       600,000
Gen. Bus. Exp.       106,200
Rent (w3) -       780,000
Drawings (missing figure)    35,000 -
Bal.  C/d    60,000    3,000,000
  551,000  11,326,200  551,000   11,326,200
Bal  b/d    60,000    3,000,000

(c)   Income statement for the year ended 31ST December 2006

¢ ¢
Sales / turnover       9,709,000
Cost of sales      (6,887,500) Gross profit       2,821,500
Less Expenses:
Depreciation       184,000
Rent       720,000
General Business expenses       106,200
Consultancy fees       100,000
       1,110,200
Net Profit       1,711,300


(d)   Statement of financial position  as at 31 December 2006

Current Assets
Inventories           1,700,500
Trade Receivabes           1,254,000
Cash                60,000
Bank           3,000,000
          6,014,500
Current Liabilities
Trade payables                617,500 Rent owing                  60,000
Accountancy fee owing                100,000
             777,500
             5,237,000
             5,973,000

Financed by
Capital at 1/1/06              4,125,000
Add Additional capital              1,227,700
             5,352,700
Add Profit for the year             1,711,300
             7,064,000
Less Drawings              1,091,000
             5,973,000




WORKINGS
(1) Construct sale and purchases ledger control accounts  
In a double entry- system, control accounts are used to confirm the arithmetical accuracy of the sales and purchases ledger system. This technique will be used to calculate sales and purchases as a missing figure.
Purchases Ledger Control Account
¢ ¢
Bank   6,840,000 Bal.  B/d     380,000
Purchases (missing figure)  7,077,500
Bal.   C/d      617,500
   7,457,500         7,457,500
Bal,  b/d         617,500
                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
(2) Workings for accruals and prepayments
In addition to these four techniques it will be necessary to construct figures for the Income statement by adjusting cash paid for expenses for opening and closing accruals and prepayment.

 


 
 
Computation of Depreciation ¢
Fixture and fittings at cost(1/1/06) 920,000
Less Depreciation  (20% @ ¢920,000) 184,000
Net book value (31/12/06) 736,000


Illustration 13.3
Damask is a retailer who deals in spare parts at Kokompe. He pays into his bank account the amount of his cash takings, after retaining ¢10,000 per week for personal use and after payment of wages and expenses, which for the accounting period of 31st December 2006, were as follows:
¢
Staff wages   1,200,000 Goods      220,000 Cleaning        75,000
Carriage        35,000
Others        20,000

The transactions in his Bank Account during the period were:
¢
Balance as at 1st January 2006   2,000,000
Lodgements:
from takings (cash) 30,100,000
Bulk sales account (cheques)   4,800,000
Interest on treasury bills        30,000
 36,930,000



Withdrawals: ¢
Goods 30,830,000 Rent      400,000
Rates in connection with store      345,000 Rates in connection with own house        55,000 Air conditioner expenses for store      200,000 Air conditioner expenses for house        20,000 Telephone and electricity      150,000 other expenses for store        70,000
Fire insurance        60,000
Life assurance policy        30,000
Repairs      150,000
Fixtures and fittings      600,000 Consultancy fees        70,000 Income tax      900,000
Owner's current account      180,000
Balance as at 31st December 2006   2,900,000
 36,960,000




The following information were also provided:
 
 

You are required to prepare statement of comprehensive Income for the year ended 31st December 2006 and a Statement of financial position as at that date.

Solution to Illustration 13.3

Calculate opening net assets to arrive at opening capital
You have to calculate the capital of the business by using the information on assets and liabilities at the opening and closing dates. This is done by preparing a statement of affairs of the business by picking up all opening balances and calculating the net asset of the business as at 31st December 2000. The information is presented clearly, and the examiner has even provided information on the bank and cash balances in the presentation of assets and liabilities.  The statement of affairs of Damask as at 31st December 2006 is as follows:
 
Construct sale and purchases ledger control accounts  
In a double entry- system, control accounts are used to confirm the arithmetical accuracy of the sales and purchases ledger system. This technique will be used to calculate sales and purchases by way of missing figure. This calculation will explore the horizontal format of determining the sales and purchases figures as missing figures instead of the usual „T‟ account that you are familiar with.
The sales figure will be determined as follows:
 
 The amount for Purchases is determined as follows:
 
Prepare the final accounts
Statement of comprehensive income for the year ended 31/12/2006
 









Statement of financial position as at 31/12/2006
 

Workings for accruals and prepayments
In addition to the above techniques it will be necessary to construct figures for the Income statement by adjusting cash paid for expenses for opening and closing accruals and

 

Drawings
¢ ¢
Bank   180,000 Bal.  c/d   775,000
Cash   520,000
Rates     55,000
Air condition exp     20,000
   775,000    775,000

Bal.  b/d    775,000

13.4  Summary  
In this chapter we have explained the difference between a double entry accounting system and single entry system. We have also learned how to use the closing and opening capital figures to calculate the net profit of a trader that is not keeping his books of accounts on the double entry system.

We have learnt how to convert from a single entry system to a double entry one and also the means by which statement of comprehensive income and statement of financial position are prepared from records that are kept on single entry basis. We mentioned that figures such as sales and purchases could be calculated as missing figures from the sales ledger control account and purchases ledger control account respectively.
It is imperative for students to note that as with all accounting topics, frequent practice of incomplete record questions is essential to develop speed and confidence. What is the cost of goods sold, given the sales figure as ¢800,000 with a mark-up of 25%?


CHAPTER FOURTEEN
ACCOUNTING FOR NOT-FOR PROFIT ORGANISATIONS

14.0  Learning Objectives

After you have studied this chapter, you should be able to:
• State the difference between a Receipts and Payments Account and an Income and Expenditure Account
• Explain the difference between the final accounts of not-for profit organizations and those of sole traders and partnerships  • Prepare Receipts and Payments Account
• Prepare Income and Expenditure Account
• Prepare subscription account making the necessary adjustment entries with respect to amounts in arrears and payments in advance.
• Prepare the accumulated fund of a not-for profit organisation

14.1 Introduction
There are many types of not-for profit organisations. They include government owned hospitals and voluntary health and welfare organizations. In Ghana and Nigeria most citizens depend heavily on such entities for religious, educational, social and recreational needs. Examples of other not-for profit organisations include the following:
• Private and community foundations
• Professional associations
• Research and scientific organisations
• Social and country clubs
• Trade associations
• Labour organizations • Political parties.

It is not only profit making organisations that need accounts.  Organisations set up for purposes other than profit, also need to tell their stakeholders how they have dealt with the funds they have contributed.
The legal status of such entities is usually spelt out in club rules or regulations. Students must however remember that external financial information provided by such organisations must be in conformity to generally accepted accounting principles.

The accounts of clubs, societies and charitable organisations may consist of the following:
• Receipts and Payment Account
• Income and Expenditure Account and
• Statement of Financial Position

14.2  Receipts and Payments Account
This is a statement of cash actually received and paid during a given period. Receipts being debited and payments credited. It is, in effect, a summary of the cashbook, and therefore shows the opening and closing balances of cash in hand, and receipts and payments of any kind and on any account made during the period.  Illustration 14.1
An example of a receipts and payments account is shown below:
Receipts ¢’000 Payments ¢’000
Bank balance 1/6/2001    118,000   Printing & stationary   228,000
Sponsored walk      23,000   Management expenses   109,000
Subscription    580,000   Caterer for president ball   113,250
Sundry income      57,000   Electricity and water     78,500
Sale of club’s manual    230,000   Bar creditors   278,500
Sale of equipment    254,000   Bank balance 31/5/2002   454,750
1,262,000 1,262,000

14.3  Income and Expenditure Account
Income and Expenditure Account of the club is the equivalent of the Income statement of a trading concern.  It contains only revenue items, being debited with all expenditure, and credited with all incomes of a period, whether or not it has actually been paid or received within that period. The final balance of an Income and Expenditure Account represents the excess of income over expenditure or the excess of expenditure over income, as the case may be, for the period. This balance is similar to the net profit or loss of a trading concern.

Readers must note that an Income and Expenditure Account differs from the Receipts and Payments Account. The latter records only cash movements, the former takes into consideration non-cash adjustments for amounts owing and owed at the period end and for depreciation. It also recognises the accounting distinction between revenue and capital expenditure. The important point that students must note is that the Income and Expenditure Account is prepared on an accrual basis.

14.4  Membership subscription:
A club or society receives payments from members for benefits, which members have enjoyed. Annual membership subscriptions of clubs and societies are usually payable one year in advance. Such payment in advance by members is shown as liability in the statement of financial position. This is because the year‟s membership has still to run as at the date of statement of financial position. A large number of club subscriptions in arrears may never be received and the statement could be distorted, since such amounts are usually shown as assets.

Illustration 14.2
The Mambo Youth Club presented the following Receipts and Payments Account for the period of 1st January 2001 to 31st December 2001.
 

Extracts from the membership subscription book revealed that subscriptions owing by members amounted to ¢80,000 on 31st December 2000 and ¢120,000 on 31st December 2001. The accounts clerk recorded subscription of ¢21,500 and ¢109,000 in respect of subscriptions that have been paid by members in advance for 2001 and 2002 respectively.



The subscription account will be prepared as follows:
Subscription Account for the year ended 31st Dec. 2001
¢,000 ¢'000
Balance b/f      80,000 Bal b/f        21,500
Income & Expenditure a/c    532,500 Receipts & Payment a/c      580,000
Balance c/f    109,000 Balance c/f      120,000
    721,500      721,500

Balance b/f    120,000   Balance b/f      109,000

By carrying forward subscription in advance, the accountant is applying the matching concept. This is because the payment of ¢109,000 in 2001 represents income meant for 2002 accounting year. This must therefore be removed from the current year‟s Income and Expenditure account, hence the debit carry forward.  
From the above solution subscription in arrears have been treated as an asset. This will hold true as a result of the accrual concept since the subscription in arrears are income that have been earned for the accounting year of 2001 but for which cash has not been received.
In practice however, subscriptions in arrears are often excluded from the statement of financial position on grounds of the prudence concepts. This is due to the fact that subscriptions that are owed by members for a long time end up not being paid eventually. In examination environment, however, readers are reminded to follow the policy of the club or society as provided by the examiner.
14.5  Bar Income Statement
It is not uncommon for clubs to engage in other income generating activities to raise additional revenue for the effective running of the club. These other activities are done with the sole aim of making profit. For instance the aim of a local trade union is not to make profit but the union may operate a bar alongside its activities with the object of making profit. The profit will not be distributed among the members but rather used for the purpose of the union.
If a club has a bar, a separate Income Statement will be prepared for its trading activities.  The net profit from the bar activities is then included as income in the Income and Expenditure Account. Any loss on the bar activities will be shown in the expenditure side of the Income and Expenditure Account.
14.6  Life Membership
Subscriptions are often received from life members.   Life members pay a once and for all subscription which entitles them to membership facilities for the rest of their lives. The once and-for-all payments from life members are not income relating to the year in which they are received by the club, because the payment is for the life of the members, which can of course last a very long time to come. In practice, if life member‟s subscriptions are small, they are credited to income as received but if they are significant in amount, then they should be credited in equal proportion over the estimated active club membership of such members.
14.7  Accumulated fund
This represents the opening capital of a not-for profit making organisation. It has the same meaning ascribed to the capital accounts of a sole trader and partnership and is calculated as the difference between total assets and liabilities. It is usually common to see most not-for profit organisations keeping accounts on single entry basis. For this reason the procedure for preparing the accumulated fund of a not-for profit organisation is the same as that of statement of affairs as obtained under incomplete records and single entry.
Illustrative 14.2
The following is the Receipts and Payments Account for the Victorosky Fun Club for the year ended 31st October 2005.
RECEIPTS ¢‟000 PAYMENTS ¢‟000
Subscription 1,643,560 Printing & stationery 59,160
Sponsored walk 478,802 Bar steward‟s salary 69,600
President‟s Ball collections 408,000 Caterer for President‟s ball 250,000
Sundry income 75,000 Light, cleaning etc. 32,640
Bar takings 510,000 Petty cash 65,000
Sale of equipment 7,923 Bar creditors 280,500
Raffle  183,030 Investment in ABC limited 450,000
  Donation  50,000
  Sundry President‟s ball exp. 5,275
  Prizes for raffle 21,600
  Building project (materials) 839,000
  Rent  360,000
  Secretary‟s salary 120,000
  Sundry bar expenses 3,360
  Bank charges 36,000
  Hiring of hall for Pres. Ball 20,000
  Building project (wages) 525,000
  Insurance 18,000
  New equipment 67,800 The following additional information has been given:
1. Current Assets and Liabilities were:
          2004 2005
  ¢‟000 ¢‟ 000
Bar inventories 27,000 36,000
Bar payables 18,000 33,000
Subscriptions in arrears 240,000 360,000
Subscriptions in advance 150,000 210,000
Light and cleaning owing 4,200 6,800
Insurance prepaid 4,200 5,200
Petty cash float 3,000 1,000
Cash in hand 15,565 14,340
Bank balance 246,500 281,105

2. The petty cash float is used exclusively for telephone and postages.
3. The club started constructing its club House during the year. The project will take four years to complete. Amount owed for building materials supplied at 31st October 2005 was ¢511,500,000. Wages owed for October 2005 was ¢175,000,000. Inventories of materials at the end was ¢220,500,000
4. Tickets for the President‟s Ball were sold at ¢300,000 each. The Club engaged the services of a caterer who agreed to charge on the number of plates served under the following conditions:
• Below 1,500 plates, amount to be charged per plate was ¢250,000.
• From 1,501 to 2,000 plates, amount to be charged per plate was ¢220,000.
• Above 2,000 plates, amount to be charged per plate was ¢200,000.  Of the 2,400 tickets sold, 90% attended the function and were served
5. Depreciation of equipment is to be calculated at 10% per annum on written down value. The
Club‟s equipment which was disposed of during the year had a net book value of ¢9,905,000 on 1st November 2004.
6. Subscriptions in arrears for more than one year are to be written off.
7. An amount of ¢1,000,000,000 is to be transferred from accumulated fund to building fund.
8. Investment in ABC limited is expected to be held for at least five years.
9. Included in subscription is an amount of ¢192,000,000 in respect of 2004.
10. Rent paid represents one and half years to 30th April, 2007.
Required:
(a) Accounts showing the profit or loss on Bar operation and President‟s Ball (b) The accumulated fund as at 1st November 2004.
(c) The Income and Expenditure Account of Victorosky Fun Club for the year ended 31st October 2005 and Statement of financial position as at that date.

Solution to illustration question
(a) Victorosky Fun Club
(i)President ball Income statement for the year ended 31st December 2005
  ¢'000 ¢'000
Sale of tickets (2,400@¢300,000) 720,000
Less: Cost of meals served [2,400x90%@¢200,000] 432,000

  288,000
Less Expenses:
Hiring of Hall 20,000  
Sundry Expenses 5,275   25,275
Profit to I & E a/c
(ii) Bar Comprehensive Income Statement for the Year Ended 31st October, 2005
  ¢'000 ¢'000
Takings 510,000
Less cost of sales:
Opening inventories 27,000
Add Purchases(w1) 295,500

  322,500
Less Closing Inventories 36,000 286,500

  223,500  
Less Expenses:
Stewards salary 69,600  
Sundry expenses 3,360   72,960  
Profit to I & E a/c

(b) ACCUMULATED FUND AS AT 1ST NOVEMBER, 2004
Assets ¢'000 ¢'000
Equipment 9,905
Cash in hand 15,565
Bank 246,500
Inventories 27,000
Subscriptions 240,000
Prepaid insurance 4,200
Petty cash 3,000
Less Liabilities 546,170
Bar creditors 18,000
Light & Cleaning owing 4,200
Subscriptions 150,000 172,200
ACCUMULATED FUND

Victorosky Fun Club
Income and Expenditure Account for the year ended 31st October 2005.
INCOME: ¢'000 ¢'000
Subscription W2 1,751,560
Sponsored walk 478,802
Sundry income 75,000
Raffle (¢183,030-¢21,600) 161,430
Profit on Bar Trading 150,540
Profit on President Ball 262,725
  2,880,057
Expenditure:
Bank charges 36,000
Insurance (¢4,200+¢18,000-¢5,200) 17,000
Printing & stationary 59,160
Light & cleaning (6,800+32,640-4,200) 35,240
Telephone & Postages W3 67,000
Depreciation (10% @¢67,800) 6,780
Donation 50,000
Secretary's Salary 120,000
Rent [12/18@¢360,000] 240,000
Bad debt W1 48,000
Loss on sale of equipment (¢7,923-¢9,905) 1,982 681,162
 

Victorosky Fun Club
Statement Of Financial Position As At 31st October, 2005
ASSETS EMPLOYED ¢'000 ¢'000 ¢'000
NON-CURRENT ASSETS:
Equipment at cost     67,800
Less depreciation       6,780      61,020
Building project (w 5)
   ,891,020
Investment in ABC Shares    450,000

   ,341,020
Current Assets:
Stock (¢220,500+¢36,000)   256,500
Debtors- President's ball  (w4)     312,000
Subscription in arrears   360,000
Insurance prepaid       5,200
Rent prepaid   120,000
Bank balance   281,105
Cash (¢14340+¢1,000)     15,340

  1,350,145 Current Liabilities:
Creditors: Building project 511,500
Bar 33,000
           Caterer (¢432,000-¢250,000) 182,000
Subscription in advance   210,000
Light & cleaning owing                       6,800
Wages outstanding 175,000  
Net current Assets
Net Assets
 
Financed by:
Accumulated Fund (6)    373,970
Excess of income over expenditure 1 ,198,895 WORKINGS
1 Bar Purchases:    ¢'000
Payables 2005 33,000
Receipts & Payment a/c 280,500

  313,500
Less creditors 2004 18,000
  295,500

2 Subscription Account
         ¢‟000                  ¢'000
Balance b/f                     240,000 Balance b/f                              150,000
Income & Expenditure a/c 1,751,560 Receipts & Payments               1,643,560             a/c
  - Bad debt (240-192) 48,000
Balance c/f 210,000 Balance c/f 360,000
                                             201,560


3 Telephone & Postages ¢'000
      Petty cash 2004    3,000
      Receipts & Payments   65,000

  68 ,000
      Petty cash 2005    1 ,000
     Income & Expenditure a/c   67 ,000
 
4    Receivables on President's Ball: ¢'000
      Tickets sold   720,000
      Less Amount Paid 408,000
      Amount to be collected 312,000
 
5 Work in progress- Club House ¢'000 ¢'000
    Payment for materials   839,000
    Add Amount owed (2005)   511,500

1,350,500
    Less Closing inventories   220,500

    Materials used on project 1,130,000
    Wages paid 525,000  
    Add Amount owed (2005) 175,000  

    Cost to date

6    Accumulated Fund        ¢'000
      Balance as at 1/11/2004    373,970
      Transfer from   I & E a/c 2,198,895

      2,572,865
   Amount transferred to building fund 1 ,000,000
  1,572,865


14.8  Summary

We have learned the difference between a Receipt and Payment account and an Income and Expenditure Account and have also explained that the Receipts and Payments Account does not show the true financial position of the organisation.

The Income Statement of a not-for profit organisation is called Income and Expenditure Account from which any surplus (profit) or deficit (loss) is calculated and also the accumulated fund is similar to the capital account of a trader.

We also learned that where the club or society engaged in any activity with the aim of earning income for the attainment of the objectives of the organization, a separate Income Statement should be prepared and the resulting profit or loss transferred to the income and Expenditure Account.

We also mentioned the treatment of subscription owing should be seen as part of the earnings of the organization for the period unless its accounting policy dictates otherwise. Similarly life membership and entrance fees should be accounted for bearing in mind the accounting policy of the organization.