bookkeeping: introduction to bookkeeping

V3.0.1 June 2020

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Bookkeeping: Introduction to

Bookkeeping

0013843

Self-study Manual

Bookkeeping: Introduction to Bookkeeping Self-study manual

0013843 of 277 PROTECT

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Contents

About this Manual ................................................................................. 7

Chapter 1 Financial Accounts Overview ........................................... 11

Introduction .............................................................................................. 11

Learning outcomes and study objectives ................................................ 11

Study advice ............................................................................................ 12

1.1 Types of Business Entity ............................................................................ 13

1.1.1 Sole traders .................................................................................... 13

1.1.2 Partnerships ................................................................................... 14

1.1.3 Limited company ............................................................................ 15

1.1.4 Limited liability partnership ............................................................. 16

1.2 Types of Accounts ..................................................................................... 20

1.2.1 Management accounts ................................................................... 20

1.2.2 Financial accounts .......................................................................... 20

1.3 Users of Financial Accounts ...................................................................... 24

1.4 Form and Content of Sole Trader Accounts ............................................... 27

1.4.1 Trading and profit and loss account................................................ 28

1.4.2 The trading account ........................................................................ 30

1.4.3 The profit and loss account ............................................................ 36

1.4.4 The balance sheet .......................................................................... 39



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1.4.5 Different types of business expenditure .......................................... 48

Review..................................................................................................... 52

Learning check ........................................................................................ 54

Learning check – answers ....................................................................... 56

Before moving on .................................................................................... 60


Chapter 2 Accounting Standards ...................................................... 61

Introduction .............................................................................................. 61


2.1 Accounting Standards ................................................................................ 63

2.1.1 FRS ................................................................................................ 63

2.1.2 Aim of accounting standards .......................................................... 64

2.1.3 HMRC advisory and forensic accountants ...................................... 65

2.2 FRS 102 ..................................................................................................... 68

2.2.1 The Qualitative Characteristics of Information ................................ 68

2.2.2 Accounting bases and concepts ..................................................... 74

Review..................................................................................................... 82

Learning check ........................................................................................ 83

Learning check – answers ....................................................................... 84

Appendix .......................................................................................................... 86

Before moving on .................................................................................... 88



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Chapter 3 Basic Bookkeeping Principles .......................................... 89

Introduction .............................................................................................. 89


Study advice ............................................................................................ 90

3.1 The Separate Entity Concept ..................................................................... 91

3.2 The Balance Sheet Equation ..................................................................... 92

3.3 The Dual Effect .......................................................................................... 97

3.3.1 The dual effect and the balance sheet equation ............................. 97

Review................................................................................................... 118

Learning check ...................................................................................... 119

Learning check – answers ..................................................................... 121

Before moving on .................................................................................. 125

Chapter 4 Double Entry Bookkeeping ............................................. 126

Introduction ............................................................................................ 126

Learning outcomes and study objectives .............................................. 127

Study advice .......................................................................................... 127

4.1 Types of Bookkeeping Systems ............................................................... 128

4.1.1 Single-entry system ...................................................................... 128

4.1.2 Double-entry system..................................................................... 132

4.2 Golden Rules of Double-entry Bookkeeping ............................................ 134

4.2.1 Golden rule number 1 ................................................................... 134



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4.2.4 ‘T' accounts .................................................................................. 139

4.3 Double-entry Bookkeeping – a Practical Example ................................... 145

Review................................................................................................... 164

Learning check ...................................................................................... 165

Learning check – answers ..................................................................... 168

Before moving on .................................................................................. 173

Chapter 5 Financial Accounts Preparation ..................................... 174

Introduction ............................................................................................ 174

Study advice .......................................................................................... 175

5.1 The Trial Balance ..................................................................................... 176

5.1.1 Balancing 'T' accounts .................................................................. 176

5.1.2 Preparation and presentation of a trial balance ............................ 193

5.2 Closing the 'T' Accounts ........................................................................... 200

5.2.1 Income and expenditure accounts ............................................. 201

5.2.2 Asset and liability accounts .......................................................... 207

5.2.3 Capital and drawings accounts ..................................................... 208

5.3 Financial Accounts Preparation ............................................................... 214

5.3.1 Trading account ............................................................................ 215

5.3.2 Profit and loss account ................................................................. 216



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5.3.3 The balance sheet ........................................................................ 222

Review................................................................................................... 227



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About this Manual

This introduction gives you some general information about the self-study manual

(SSM) on Bookkeeping – Introduction to Bookkeeping. It includes notes on the

content and some suggestions on how you can maximise your learning from the

material.

Assessment

All of the material in this manual is assessable. You can assume material outside

this manual, or only given as a margin note or in an appendix, is not assessable

unless we say otherwise.

You can find more details on the particular criteria you'll be assessed on in the

catalogue entry for the product.

You may have some prior knowledge and experience, which means that some topics

covered are already familiar to you.

If you think you can already meet the chapter's objectives you can assess yourself

by working through the learning check at the end of the chapter.

If you get any of the answers wrong, or are unsure about any points, we strongly

advise you to study the chapter. If you get all the answers correct and feel you can

meet the assessment criteria you may go straight to the assessment.

For some of the activities or learning checks you undertake you may want to record

your answers in a separate document.

Content of this manual

In this manual, you'll look at recording transactions in the books and records of a

business and preparing



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financial accounts from those books and records. You'll learn about the principles of

'double-entry' bookkeeping and go on to look at how accountants prepare and

present information in financial accounts.

This manual primarily uses the accounts of sole traders to explain bookkeeping and

accounting principles, but these principles also apply to the accounts of a partnership

or company. The way in which items are presented in the accounts may sometimes

be different with a partnership or a company and these differences in presentation

are covered in the manual Bookkeeping – Financial Accounting for Limited

Companies.

All extracts from accounting standards are:

© The Financial Reporting Council Limited and are adapted and reproduced with the

kind permission of the Financial Reporting Council. All rights reserved. For further

information please visit https://www.frc.org.uk/accountants/accounting-and-reporting-

policy or call +44 (0)20 7492 2300.

Chapter 1 – Financial Accounts Overview

Explains the form and content of financial accounts.

Chapter 2 – Accounting Standards

Outlines the purpose of accounting standards and their role in the preparation of

financial accounts.

Chapter 3 – Basic Bookkeeping Principles

Considers the three basic principles which are fundamental to understanding double-

entry bookkeeping.

Chapter 4 – Double-Entry Bookkeeping

Explains and demonstrates the application of the double-entry bookkeeping system

in detail.



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Chapter 5 – Financial Accounts Preparation

Shows how to prepare a trading and profit and loss account and balance sheet for a

sole trader.

Assessment preparation

This SSM includes some assessment-standard questions at the end for you to

practise on before the assessment. The questions give a suggested timing and you

might like to work them as far as possible under exam conditions. You can then

compare your answer to those given.

Time to complete

We estimate it should take you this long to finish the manual.

Reading main text 7hrs 35m

Completing activities and the learning check 9hrs 35m

Completing and reviewing assessment standard questions 1hr 30m

Total 18hrs 40m



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Other tax professional learning products (TPLPs)

Within this manual you will see references to some other TPLPs which you may find

useful.

We've listed these below, together with their product codes.

Module Manual Online product

code

Bookkeeping Financial Accounting for Limited Companies 0013875

Bookkeeping Accounting Standards and Year End

Adjustments

0013848

Bookkeeping Extended Trial Balance 0013858

Company Tax The Return – Manual 2 0013507

ITSA Business Income 0016342

Known issues

Whilst we aim to ensure that all our products are free from errors, mistakes

sometimes occur.

Before you start studying this manual, please look at the entry for the module in the

TPLP catalogue and click on the 'known issues' link. This will give you a list of any

known errors so you can make the necessary corrections yourself.

Please continue to feed back any other errors you spot to the Maintenance team

mailbox.

DL-TA, Maintenance Mailbox (HR)

Feedback

We value your feedback. The TPLP Maintenance team would like to hear from you if

you have any comments to make about this manual or can suggest how we could

improve it. Please send your feedback to the dedicated Maintenance team mailbox

address given above.



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Chapter 1 Financial Accounts Overview

Introduction

In this chapter, you'll look at the main business entities you'll come across as an

HMRC officer. You'll then look at the types of accounts which they may prepare and

who may be interested in the results they show. Finally, you'll look at the form and

content of a sole trader's financial accounts.

Learning outcomes and study objectives

Learning outcomes

You will

• understand the main types of business entities, the accounts they may

prepare and who may use them

• understand the form and content of sole trader accounts.

Study objectives

To achieve this, you need to be able to

• describe the main types of business entity

• explain the difference between management and financial accounts

• name four users of financial accounts

• describe the form and content of sole trader accounts



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Study advice

We think it will take you approximately this long to finish the chapter.

Reading main text 1hr 45m

Completing activities and the learning check 1hr 20m

Total 3hrs 5m

This is only a guide. The important thing is for you to make sure you understand all

the material in the chapter.



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1.1 Types of Business Entity

The basic bookkeeping principles are the same for all the main types of business

entities you'll come across as an HMRC officer.

These are

• sole traders

• partnerships

• limited companies

• limited liability partnerships (LLPs)

Before you go on to look at bookkeeping, let's look at the differences between the

main types of business entities.

1.1.1 Sole traders

Many people start their business life as a sole trader. The sole trader (proprietor) is

responsible for the day–to–day running of the business and its success or failure.

A sole trader business can vary in size – from one where the proprietor carries out all

the work themselves, to a large concern employing many people.

A sole trader can start up in business with a minimal amount of personal investment

(capital) from their own savings. Or, they may borrow start-up capital from a bank or

other lender.

Advantages

• Fewer legal requirements than limited companies or partnerships.

• Proprietor has complete control of business.

• Can offer a personal service to customers.

• Can make business decisions quickly – no-one to consult.



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Disadvantages

• Unlimited personal responsibility for business debts.

• Potentially difficult to obtain further investment capital.

• Inability to match pricing and marketing of larger competitors.

1.1.2 Partnerships

Reference - BIM 72001

Partnerships are governed by the Partnership Act of 1890 which states that

“a partnership is the relationship which subsists between persons carrying out a

business in common with a view to profit”.

This refers to two or more people in business together. The organisation is usually

more formal than a sole trader's. Partnerships can vary in size – from a husband and

wife trading as a corner shop, to a large firm of solicitors.

Partners may have a partnership deed – a legal agreement setting out the rights and

obligations of each partner. They will also have an agreement setting out how the

profits of the business will be allocated between the partners.

A partnership isn't a legal entity separate and distinct from its members, except in

Scotland.



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Advantages

• The risks of the business are shared with others.

• A partner may bring capital or new skills into the business allowing it to

expand or change.

• A partnership may increase efficiency, for example by sharing common

expenses and reducing duplication.

Disadvantages

• Joint and several liability. The partners' liability is unlimited. Each may have

to contribute own funds up to the full amount of any debts incurred by the

partnership. (Does not apply to individual partner's income tax liability).

• Profits are shared with the other partners in accordance with the profit sharing

agreement.

• No-one has complete control as each partner will usually have a say over the

way the business is run.

1.1.3 Limited company

In this manual, you'll look at companies with limited liability that are registered under

the Companies Act.

Private limited companies have 'limited' or 'ltd' after their name. Public limited

companies have 'plc' or 'public limited company' after their name. Unlike private

limited companies, plcs can offer their shares for sale to the general public.

Companies are owned by their shareholders – the people who have invested in the

company by subscribing for shares. The larger the company, the greater the number

of shareholders (or members) is likely to be. The operations of the company can't

be managed by large groups of people, so the shareholders appoint directors who

are responsible for the day–to–day running of the company.



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The directors are officers of the company.

In law, a company is regarded as a legal entity in its own right, separate and distinct

from its shareholders and directors.

Limited companies can vary in size, ranging from a small company with just one

director, to a large multinational enterprise.

In many small private companies, the directors are the majority shareholders and

have considerable power over the day–to–day operations of the company.

In larger companies with more shareholders, a board of directors takes decisions so

that each director will have less individual power.

Advantages

• Limited liability. Shareholders are only liable up to the amount they have to

pay for their shares in the company.

• Companies can raise investment capital through the issue of shares.

• Tax advantages not available to sole traders and partnerships.

Disadvantages

• Subject to more stringent control and legislation than sole traders or

partnerships.

• Companies over a certain size have to undergo a statutory audit.

• Directors may need to consult with other directors or shareholders.

1.1.4 Limited liability partnership

The Limited Liability Partnerships Act 2000 introduced limited liability partnerships

(LLP) from 6 April 2000. They combine the flexibility of partnerships with the benefit

of limited liability for their members. An LLP has features like a company, but its



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income and gains are usually taxed on its members as if they were partners in an

ordinary partnership.

An LLP must be registered at Companies House. It must publish its accounts and is

regarded in law as a separate person from its members.

Advantages

• The LLP isn't usually taxed. LLP members are normally taxed on their share

of the profits.

• Retains the day–to–day flexibility of a partnership.

Disadvantages

• An LLP has greater legal and financial responsibility than an ordinary

partnership.

• Not entitled to the tax advantages available to limited companies.

From 6 April 2014, new rules apply to members of LLPs who are engaged on terms

that are closer to employment than to self-employment, but who have previously

been treated as self-employed.

Members who meet a statutory test will be treated as employees ('salaried

members') for tax purposes. The salaried member will move from self-assessment to

PAYE and the LLP (the employer) and the salaried member will become liable to

Class 1 NICs.

Now have a go at the activity that follows.



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Activity one

Check your understanding of sole traders, partnerships and companies by

completing the following table. Some of the statements may apply to more than one

entity, so mark X in each box that applies (or record your answer in a separate

document).

All the entities are in England or Wales.

Options Sole trader

Partnership

(not LLP)

Limited company

It provides limited liability for owners.

Owners have joint and several liability for

debts of the business.

Owners make the day–to–day

operational decisions.

The business is owned by shareholders.

It's a distinct legal person separate from

its owners.



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Response

(Options first followed by answer)

• It provides limited liability for owners – Limited company.

• Owners have joint and several liability for debts of the business – Partnership

(not LLP)

• Owners make the day–to–day operational decisions* All – Sole trader,

Partnership (not LLP) and Limited company’

* Although the owners (shareholders) of limited companies don't usually make

the day–to–day operational decisions, we have ticked the limited company

box for the third statement because in many small private companies the

directors are the majority shareholders and have considerable power over the

day–to–day operations of the company.

• The business is owned by shareholders - Limited company.

• It's a distinct legal person separate from its owners - Limited company.

Next you'll look at the main differences between management and financial

accounts.



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1.2 Types of Accounts

In this subchapter you will consider the main differences between management and

financial accounts.

1.2.1 Management accounts

There is no legal requirement to produce management accounts, but businesses

often find that they're a useful tool to ensure they're running successfully.

Management accounting mainly involves preparing accounting information for the

proprietor or management of a business to help them control their business. They

may also include an element of forward planning. This helps them to make more

informed decisions for the future, for example, about future sales and profitability

forecasts.

Management accounts have no specific format because it depends on what areas

are critical to the success of the business. For example, manufacturing companies

are interested in the management of their stock levels; they need to ensure that the

business has sufficient stock on hand to meet all orders, whilst reducing the risk of

stock going out of date.

1.2.2 Financial accounts

Financial accounting involves

• the day-to-day recording of the economic transactions of a business – the

bookkeeping

• preparing financial accounts from the bookkeeping records.

When a business prepares financial accounts, they should ensure that all

transactions have been properly recorded, and the information in the accounts is

relevant to the various users of the accounts. Financial accounts should therefore

be prepared and presented in a consistent manner.



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Accountants are expected to follow legislation and other principles when preparing

financial accounts. We've given a brief overview of these principles in chapter 2 of

this manual.

Companies have to produce financial accounts to comply with the Companies Act. It

isn't a statutory obligation for other types of business to do this, but most do.

Financial accounts are prepared for an accounting period – usually 12 months. They

allow the users of the accounts to review the past performance and current financial

position of the business. You'll look at this in more detail in the next subchapter.

Differences between management accounts and financial accounts

Some of the main differences between financial and management accounts are

summarised in the below.

Financial accounts

• Prepared and presented in a consistent manner for an accounting period,

generally a 12-month period.

• Usually a summary of the entire business operations.

• Comply with basic accounting concepts and are governed by specific rules

and regulations.

• Prepared from the business's bookkeeping records.

• Primarily concerned with the history and current financial position of the

business.

Management accounts

• May be prepared more frequently (monthly or quarterly).

• May focus on specific operations within the business.



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• Comply with basic accounting concepts but are not governed

• by specific rules and regulations.

• May include information from other sources.

• May also include an element of forward planning.

Now try the activity that follows.

Activity 2

Jake is a self–employed electrician. He's been trading for

30 years. He obtains most of his work through recommendations from his customers

and by advertising in the local paper. His turnover is relatively low, but his expenses

are low; he's single and paid off his mortgage years ago. He intends retiring in 2

years’ time.

Based on this information, explain why you think Jake is unlikely to prepare

management accounts for the current year.



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Response

Based on this information there are various reasons why Jake is unlikely to prepare

management accounts for the current year. You may have thought of other reasons

as well as the ones we've shown below.

There is no legal requirement to produce management accounts, but businesses

often find that they're a useful tool to ensure they're running successfully. Jake's

business has been running satisfactorily for many years without them.

Management accounting mainly involves preparing accounting information for the

proprietor or management of a business. Management accounts enable proprietors

or managers to control their business. Jake's business is small enough not to need

this level of control. For example, he wouldn't have to draw up management

accounts to ensure his stock is adequately controlled.

Management accounts may also include an element of forward planning about future

sales and profitability forecasts. As Jake is going to retire soon this isn't likely to be

necessary.

Next you're going to look at the parties who would be interested in a trader's financial

accounts.



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1.3 Users of Financial Accounts

Financial accounts are not just prepared for HMRC. Other parties are also

interested in the business results shown in the financial accounts. Let's look at some

of them.

Business owner/proprietor

Most business owners know how well their business is doing. However, because of

all the costs involved in running a business it can be difficult to know exactly how

much the business is making. This is one of the reasons why financial accounts are

prepared. The business owner may also use them to make business decisions, such

as whether to expand the business.

Financial institutions

Businesses may ask the bank, or other lender, for a loan or overdraft facilities. The

lender's decision to make the loan will be based on a number of factors but one of

the most important will be the results shown by the financial accounts.

The lender will use the financial accounts to see if the business is profitable and

whether it can pay the interest and charges (service the loan) and repay the capital

borrowed.

Some businesses will prepare accounts in a certain way simply to keep the

financiers happy. You shouldn't overlook this factor when you examine accounts.

For some business owners, keeping the financiers happy is more important than

worrying about HMRC. If the lender doesn't continue to provide funding, the

business may close.

Suppliers

Most businesses obtain goods on credit. The business may have to demonstrate its

ability to pay the bills by producing the latest set of financial accounts. The supplier

will use the information in the same way as any other lender.



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Shareholders

Companies attract investment by encouraging people to subscribe for shares in the

company. The shareholders (investors) may hope to get a return on this investment

without having to sell the shares. They get this return in the form of a dividend paid

on their shares. The amount depends on how much profit the company has made

and how much it's prepared to pay out. It also depends on how much the company

needs to retain in the business to finance its future development.

Shareholders are interested in financial accounts because they can find out

• whether the value of their investment is increasing or

• the likely level of income from their shareholding.

Government departments

HMRC makes the most use of financial accounts, but other government departments

may also be interested. For example, DEFRA may look at a farmer's accounts when

considering subsidies and other payments.


Activity three

Dmitri is a self-employed joiner. He buys any wood he uses on credit from the local

timber yard. He wants a loan from his bank to buy new equipment.

Explain why his supplier and his bank want to see his latest set of financial accounts.



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Response

Dmitri's supplier and the bank want to see his latest financial accounts for similar

reasons.

The supplier wants to see Dmitri's latest financial accounts so they can see if he's

able to pay their bills.

Dmitri's bank want to see his financial accounts to help them to decide whether to

lend him the money he needs to buy the new equipment. They'll use the information

in the financial accounts to see if Dmitri's business is profitable and whether he can

service the loan and repay the capital he wants to borrow.

Next you'll find out about the general layout of financial accounts.



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1.4 Form and Content of Sole Trader Accounts

In this subchapter, you're going to look at the form and content of sole trader

accounts and their general layout. The financial accounts shown on the following

pages are typical for a sole trader although many of the entries in the accounts

would be very similar if the business was a small partnership or limited company.

However, accountants present financial information in different ways, particularly for

certain types and sizes of businesses. They may provide more pages and

information than shown in the example, or less if the business is a small concern.

At this stage of your learning, you need only a general idea of the layout and content

of financial accounts.

There are two primary financial statements which are fundamental to any set of

accounts, and they are the

• trading and profit and loss account, and

• balance sheet.

The Financial Reporting Standard Applicable in the UK and Republic of Ireland (FRS

102) uses terminology commonly used in International Accounting Standards, in

contrast to terminology used in the UK Companies Act.

For example, balance sheet and profit and loss account are Companies Act terms.

The equivalent terms used in FRS 102 are statement of financial position and

income statement.

FRS 102 allows businesses to retain the Companies Act terminology as long as it's

not misleading. You are therefore likely to see different terminology being used by

different businesses to refer to the same items in accounts.

In this manual, we have used the terminology that we expect most UK

businesses/companies will continue to use. For example, we will continue to refer to

the balance sheet and profit and loss account throughout.



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1.4.1 Trading and profit and loss account

The trading account and the profit and loss account are referred to separately and

together in this manual. You calculate the gross profit in the trading account. In the

profit and loss account, you take the gross profit and deduct overheads (or other

expenses) to arrive at the net profit.

The trading account and the profit and loss account can be considered together to

form one statement known as the trading and profit and loss account.

The trading and profit and loss account is a summary of the trading and business

activities for the whole of the accounting period. It shows whether the business is

making a profit or a loss and reflects the performance of the business for the whole

of the period concerned. It provides details of the income generated by the business

and the expenses incurred in earning this income.

A business's financial year can end on any date. It doesn't have to coincide with the

end of the calendar year or the tax year.

On the following page, you'll find the trading and profit and loss account for Harry's

newsagents business for the 12-month period 1 June 2018 to 31 May 2019. We'll

refer to Harry's trading and profit and loss account, and balance sheet, throughout

this subchapter.



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Here we have Harry’s Newsagents Profit and Loss Account document for the

year ended 31 May 2019. (This is set out in 5 columns).

Description 31 May 2019

31 May 2019

31 May 2018

31 May 2018

Turnover 116,558 114,897

Less cost of sales

Opening stock 11,476 9,625

Plus purchases 94,180 92,938

Less closing stock 105,656

102,563

(11,143) (11,476)

(94,513) (91,087)

Gross profit 22,045 23,810

Less overheads

Rent, rates and insurance 2,059 4,591

Light and heat 609 1,105

Telephone 1,167 1,014

Motor expenses 1,730 1,377

Accountancy fees 300 300

Interest paid 1,280 2,199

Wages 1,175 512

Bank charges 160 844

Depreciation 454 (8,934) 583 (12,525)

Net profit 13,111 11,285

You'll see that 2 years' accounts are shown here – the year ended 31 May 2018 and

the year ended 31 May 2019. This is usual and allows anyone viewing the accounts

to compare the results for the latest period with those of the previous period.

Next you'll look at the entries in the trading account in more detail before considering

what would be shown in the profit and loss account.



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1.4.2 The trading account

The trading account reflects the trading results of the business for the year – whether

the business is making a gross profit or loss on the goods or services it provides.

The trading account normally shows

• the turnover of the business

• the purchase of goods and materials used in the business

• the opening and closing stock.

You'll now look at each of these items in turn.

Turnover

Turnover is the term used to describe the income of the business. You'll also often

see this described as sales. Alternatively, some accountants may use the following

terms

• revenue

• fees

• income

• work done.

In Harry's newsagents business, the turnover will be the amount earned through the

sale of newspapers, magazines, confectionery and so on.

If a business is a service trade, for example, a plumber or an electrician, the figure of

turnover will be made up of the charges for the trader's own labour together with any

charge for materials supplied by the trader.

Have a go at the activity that follows.



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Activity four

a) During a year, Enzo, a plumber, charged his customers £800 a week for his time.

He worked for 48 weeks during the year.

Calculate Enzo's turnover from his labour.

b) Enzo incurred £10,000 on purchases in the year on items such as boilers,

radiators and bathroom suites and supplied these items to his customers. He

charged his customers £11,000 for these items.

Calculate Enzo's total turnover from his labour and the materials he supplied.



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Response

a) Enzo's income from his labour charges is

48 weeks x £800 = £38,400.

b) Enzo has also supplied materials to his customers for £11,000. He therefore has a

total turnover of £49,400.

In chapter 2 of this manual, you'll look at the income which should be included in

turnover and when it should be recognised in the financial accounts.

Purchases

In general terms, purchases is the term used to describe goods that the business

has acquired to sell to its customers. In Harry's case, the likely purchases would be

newspapers, magazines, confectionery and so on.

In a non–retail trade, it may also be the materials a business uses. For example, a

plumber may include piping, washers and so on, as purchases.

Stock

Stock represents purchases that have been made by the business, but which have

not yet been sold. Financial accounts for an ongoing business will normally show

two entries for stock

• opening stock, and

• closing stock.

Opening stock is the value of stock on hand at the start of the accounting period.

Closing stock is the value of stock at the end of the accounting period.

In an ongoing business, the figure of closing stock at the end of one year becomes

the figure of opening stock for the following year. In Harry's case, the closing stock

of £11,476 at 31 May 2018 is the opening stock figure in the accounts to 31 May

2019.



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Businesses need to keep accurate records of their stock, and the valuation of stock

should ideally be arrived at by a physical count of stock on hand. You'll look at stock

valuation and accounting for stock in the manual Bookkeeping – Accounting

Standards and Year End Adjustments.

Businesses use the figures for purchases and stock to calculate the actual cost of

sales. Let's look at this next.

Cost of sales

Cost of sales (COS) is also commonly referred to as cost of goods sold (COGS). In

general terms, cost of sales represents the goods that the business sold to generate

the figure of turnover.

Cost of sales is therefore usually shown in the trading account as follows.

Example

Look at Harry's trading account for the year ended 31 May 2018 and you'll see that

cost of sales of £94,513 is made up of



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Direct costs

The cost of goods sold is a direct cost in the trading account. You may also see

other direct costs included there. Generally, these relate specifically to the core

business activity of producing goods or providing a service.

Example

Roger is a building contractor. Several self-employed subcontractors work for him

and he also employs a secretary.

The wages paid to the subcontractors are direct costs and are included in the trading

account. The wages paid to the secretary are indirect costs. They're included in the

profit and loss account. The secretary isn't directly involved in the building work that's

the core business activity.

Gross profit

Gross profit is the amount of profit earned by the business from its main trading

activity. Basically, it's the difference between turnover and the cost of sales.

Harry's business made a gross profit of £22,045 for the year ended 31 May 2019.

This is the difference between the income earned from selling goods, and the

expenditure incurred on purchasing the goods that were sold.

This principle applies to most retail trades.



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Here we have an extract from Harry’s trade account

Harry's trading account for the year ended 31 May 2019

Description £ £

Turnover 116,558

Less cost of sales

Opening stock 11,476

Plus purchases 94,180

Sub-total 105,656

Less closing stock (11,143)

Sub-total (94,513)

Gross profit 22,045

The figure of gross profit is then carried forward to the profit and loss account.



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1.4.3 The profit and loss account

The trading account shows the result of the main trading activity for the year, in other

words the gross profit. In addition to the cost of sales, most businesses incur

additional day–to–day running costs (sometimes called overheads or indirect costs).

These costs don't normally form part of the cost of sales of the business so they

should be in the profit and loss account, rather than in the trading account.

Harry's newsagent's business incurred additional expenditure on everyday items

such as rent, lighting and heating costs, motor expenses and so on. These are

included in his profit and loss account.

The entries in Harry's profit and loss account are fairly small and easy to identify. In

larger company accounts with substantial overheads, the entries in the profit and

loss account are likely to be presented in a different way. You'll find out about the

format of company accounts in the manual Bookkeeping – Financial Accounting for

Limited Companies.

You deduct the expenditure in the profit and loss account from the gross profit to

arrive at the net profit for the period of trading.




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Activity five

Use the following information to calculate both the gross profit and the net profit.

Description Amount £

Purchases 38,000

Turnover 96,000

Opening stock 3,200

Motor expenses 3,500

Insurance 1,250

Closing stock 3,600

Accountancy fees 650

Bank interest paid 150

Rent 1,750



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Response

By following the general layout of financial accounts that you looked at earlier, the

gross profit and net profit can be calculated as follows.

Description £ £

Sales/Turnover 96,000

Less cost of sales

Opening stock 3,200

Plus purchases 38,000

Less closing stock (3,600)

(37,600)

Gross profit 58,400

Net profit is arrived at by deducting the day–to–day running expenses (overheads)

from the figure of gross profit.

Description £ £

Less overheads

Rent 1,750

Motor expenses 3,500

Insurance 1,250

Accountancy fees 650

Bank interest 150

(7,300)

Net profit 51,100



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1.4.4 The balance sheet

The balance sheet sets out the financial position of the business at the accounting

date and reflects the position at that moment in time only. In other words, it's a

'snapshot' of the financial position of the business at the balance sheet date. The

trading and profit and loss account on the other hand is a summary of the

performance of the business for the whole period, from the last accounting date to

this one.

In practice, many small businesses don't produce a balance sheet with their

accounts. This isn't necessarily a cause for concern. It usually just means that the

business is fairly small, and it's not cost–effective to produce a balance sheet.

In all the examples in this manual, you should assume that the business prepares a

balance sheet, as this is fundamental to understanding the bookkeeping.

Harry's balance sheet as at 31 May 2019 is shown on the following page.



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Harry’s Newsagents

Balance sheet as at 31 May 2019

Description 2019 2019 2018 2018

Fixed assets

Motor vehicles 928 1,237

Fixtures and fittings 820 965

Shop premises 50,000 50,000

Sub-total 51,748 52,202

Current assets

Stock 11,143 11,989

Cash on hand 501 265

Trade debtors 215 248

Sub-total 11,859 11,989

Current liabilities

Creditors (3,200) (4,741)

Trade creditors (3,233) (3,025)

Net current assets 5,426 4,223

Total assets less current

liabilities

57,174 56,425

Long term liabilities

Loan account (11,759) (16.336)

Net assets 45,415 40,089

Capital account

Opening capital 40,089 36,256

Profit for the year 13,111 11,285

Capital introduced 0 648

Less drawings (7,785) (8,100)

Closing capital 45,415 40,089



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If you look at Harry's balance sheet, you'll see that it's divided into three main parts.

• Assets

• Liabilities

• Capital account

Assets

Broadly speaking, assets are items that are owned by the business or owed to the

business. Assets of a business are usually broken down into two categories, fixed

assets and current assets.

Fixed assets

A fixed asset is an asset which is acquired for use in the business, without the asset

itself being sold in the day–to–day activities of the business. Fixed assets are owned

by a business over a period of time and are used to generate income of the

business.

Harry's fixed assets consist of a motor vehicle, fixtures and fittings and the shop

premises.

These items are used in the business, without actually being sold as part of the

trading activity of his newsagents business. Generally, fixed assets are shown at

cost less a provision for accumulated depreciation to allow for wear and tear,

passage of time or becoming out of date.

You'll look at depreciation and the valuation of fixed assets in the manual

Bookkeeping – Accounting Standards and Year End Adjustments.

Current assets

Generally, the value of current assets changes on a day–to–day basis. Current

assets can usually be turned into cash in a short period of time and include items

such as cash itself, stock, funds held in a bank account and debtors.



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A debtor is someone who owes money to the business. More specifically, a trade

debtor is a customer to whom the business has supplied goods or services, but who

has not yet paid the business what they owe. In Harry's case, the figure of trade

debtors will almost certainly represent small amounts still owed by customers for

newspaper accounts on the last day of the accounting period.

Liabilities

Broadly speaking, a liability is something the business owes. Harry's liabilities

include a loan and an amount owed to creditors. In general terms, a creditor is a

third party to whom the business owes money for goods or services provided to the

business on credit. A trade creditor is a supplier from whom the business has

purchased goods on credit terms for resale. Liabilities are also broken down into two

categories – current liabilities and long-term liabilities.

Current liabilities

A current liability is usually something a business owes that it will need to pay within

12 months of the accounting date. Typical current liabilities might include creditors,

short–term loans, VAT or PAYE owed to HMRC or even an overdrawn bank current

account.

Long-term liabilities

Long-term liabilities usually relate to liabilities that are repayable after more than 12

months, typically amounts owed on long-term loans and mortgages.

Capital account

A business is a separate entity from the proprietor. The capital account represents

what the proprietor has invested in the business and shows what the business owes

to the proprietor.

For accounting purposes, the proprietor and the business itself are treated

separately. When Harry started in business many years ago, he used £5,000 of his



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own personal cash to open his newsagents shop. Harry put his own capital into the

business. Until he withdraws any of that capital, it remains in the business and is

owed by the business to Harry.

Harry's capital account is shown below. Look at the other entries appearing in it.

Capital account 2019 2018






Profit for the year

This is the figure of net profit that's produced by the trading and profit and loss

account each year. Net profit is added to the capital account and therefore

increases the proprietor's investment in the business. If a business makes a loss

instead of a profit, the amount of the loss is deducted from the capital account and

decreases the proprietor's investment in the business.

Capital introduced

Capital introduced is the value invested in the business by the proprietor. A

proprietor usually introduces capital when they first start up in business, but they can

also introduce capital at any time.

Capital introduced can take various forms. You'll often see it described as 'paid out

of the proprietor's own pocket'. However, although it may be personal cash paid out

of their pocket (or a cheque from their private bank account), it may also be assets

that were previously owned privately, such as a car.



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Capital introduced of any kind can be recorded in the drawings account as a credit

entry. This is quite acceptable although it's more usual for these transactions to be

recorded as a credit entry in the capital account.

You can see that Harry introduced capital worth £648 in year ending 31 May 2018.

This was recorded in the capital account.

If capital introduced is included in the capital account, it's added to the capital

account because it increases the proprietor's investment in the business.

The final element in the capital account is the drawings figure. Let's look at this next.

Drawings

Drawings are assets or money taken out of the business by the proprietor for their

own benefit. They reduce the value of the capital account. Drawings can be

• cash taken from the business

• from the till

• from cash takings kept elsewhere

• drawn from the business bank account using an ATM.

• money transferred from the business bank account to the proprietor's

personal bank account, for example, by writing a cheque or by standing order

• personal bills or expenses paid for by the business

• a business asset taken out of the business for the proprietors own use.

Drawings is a term used for sole traders and partners – you won't see it used in

company accounts. Directors of companies obviously take funds for their own use

and similar principles apply but they're recorded in a director's current, or loan,

account, rather than a drawings account.

In larger limited companies, the directors may be paid a salary and other benefits like

other employees of the business. In that case there won't generally be a directors'



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loan account. You'll consider this in more detail in the manual Bookkeeping –

Financial Accounting for Limited Companies.

If capital introduced is included in the drawings account it decreases the value taken

out of the business by the proprietor. (As the balance on the drawings account is

taken to the capital account, any decrease in drawings will increase the amount the

business owes the proprietor.)

Opening capital and closing capital

You won't see the term 'capital' in company accounts.

Capital is invested in a company by the shareholders and it's generally referred to as

'share capital'. You can learn about share capital and shareholders' funds in the

manual Bookkeeping – Financial Accounting for Limited Companies.

The closing capital of one year becomes the opening capital of the following year.

Let's look at an example to see how this works. Look again at Harry's capital account

for the year ending 31 May 2018.

Capital account 2019 2018






Opening capital for the year was £36,256. Net profit of £11,285 and capital

introduced of £648 were added, drawings of £8,100 were deducted. The result was

closing capital of £40,089.

The closing capital of £40,089 for the year ending 31 May 2018 becomes the

opening capital for the following year.




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Activity six

Mark X in the relevant box to show where you would expect to find the following

items in the balance sheet for a haulage contractor (or record your answer in a

separate document).

Description Fixed assets

Current assets

Current liabilities

Long-term liabilities

Capital account

Cash

Overdrawn bank current

account

Loan repayable within 6

months

Premises

Drawings

Lorries

Mortgage on premises –

5 years remaining

Net profit

Capital introduced

Creditors

Debtors



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Response

(Description first followed by answer)

Cash - Current assets

Overdrawn bank current account - Current liabilities

Loan repayable within 6 months - Current liabilities

Premises - Fixed assets

Drawings - Capital account

Lorries - Fixed assets

Mortgage on premises with 5 years remaining - Long-term liabilities

Net profit - Capital account

Capital introduced - Capital account

Creditors - Current liabilities

Debtors - Current assets



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1.4.5 Different types of business expenditure

You've now looked at the general layout of financial accounts. You have also seen

what might appear in a trading and profit and loss account or balance sheet. So how

do you decide which expenditure should be included in the trading and profit and

loss account, and which expenditure should be reflected on the balance sheet?

Generally speaking, whenever a business incurs business expenditure, it's to

• acquire a fixed asset for the business (which would be recorded and reflected

in the balance sheet), or

• meet the normal running expenses of the business (which would be recorded

in the trading and profit and loss account).

When you're considering whether expenditure is for an asset or an expense,

you'll often need to consider the nature of the business.

Look at the following example to see what this means.

Example

Alison and Daniel attend an auction sale. Alison runs a teashop and wants to

buy a cooker to make food to sell in the shop. Daniel runs a second–hand shop

and wants to buy a cooker to sell in his shop. They each buy a cooker.

Alison uses her cooker to make food in her teashop. Once the food has been

sold, she still owns the cooker. This is therefore a fixed asset of her business

and will appear on her balance sheet.

Daniel buys his cooker to sell on at a profit.

Daniel's business involves buying and selling items such as cookers. The cooker

is therefore just part of Daniel's purchases. The cost of the cooker would be

reflected in his trading account as part of his purchases figure.

Try the next activity.



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Activity seven

Below is a list of expenditure for Artem's garage. In each case, state whether the

expenditure should be reflected in Artem's balance sheet as an asset, or in his

trading and profit and loss account (T&P&L a/c) as an expense.

Mark X in the relevant box (or record your answer in a separate document).

Description Expenses in T&P&L a/c

Assets in balance sheet

Rent and rates for a building used by the

business.

Expenses for maintaining the breakdown

lorry.

Two cars bought at a car auction for resale.

Petrol for resale.

Petrol used for the breakdown lorry.

New petrol pumps for the garage forecourt.

Accountancy fees.

Extension to the garage premises.

Repair a broken window in the garage shop.

New hydraulic ramp for carrying out repairs.



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Response

(Description first followed by answer then further information relevant to the option)

• Rent and rates for a building used by the business - Expenses in T&P&L a/c.

This is a day–to–day running expense (an overhead); it will appear in the

profit and loss account.

• Expenses for maintaining the breakdown lorry - Expenses in T&P&L a/c.

The lorry is a fixed asset, but the cost of maintaining it's a day–to–day

expense of the business shown in the profit and loss account.

• Two cars bought at a car auction for resale - Expenses in T&P&L a/c.

The cars are purchases of goods for resale, so they'll be included in

purchases in the trading account.

• Petrol for resale - Expenses in T&P&L a/c.

This is the purchase of goods which will appear in the trading account.

• Petrol used for the breakdown lorry - Expenses in T&P&L a/c.

This is a day–to–day expense of the business, shown in the profit and loss

account.

• New petrol pumps for the garage forecourt - Assets in balance sheet.

Artem doesn't sell petrol pumps, but he does use them to make profits.

They're fixed assets of the business and go into the balance sheet.

• Accountancy fees - Expenses in T&P&L a/c.

Accountancy fees are a day–to–day expense of the business; they'll appear in

the profit and loss account.

• Extension to the garage premises - Assets in balance sheet.



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The premises are a fixed asset of the business and any improvement or

extension is treated in the same way. This is also shown in the balance sheet.

• Repair a broken window in the garage shop - Expenses in T&P&L a/c.

The cost of maintaining or repairing an asset is part of the day-to-day running

expenses of the business. It will appear in the profit and loss account.

• New hydraulic ramp for carrying out repairs - Assets in balance sheet.

The ramp is used to make profits in a similar way to the petrol pumps. It's a

fixed asset of the business and goes in the balance sheet.

That's the end of the material in this chapter.

Now read the review and try the learning check that follows it.



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Review

Although businesses can vary enormously in size and nature, the basic bookkeeping

principles are exactly the same for sole traders, partnerships and limited companies.

It's only the format and presentation which may differ.

A sole trader carries on a business alone whereas a partnership is two or more

people in business together. Partners generally have unlimited liability for any debts

incurred by the business. The liability of shareholders in a limited company is limited

to the amount they have invested into the company.

Management accounts help the proprietor to control their business and can be

prepared at any time.

Financial accounts allow users of the accounts to review the past performance, and

current financial position, of the business. Financial accounts are not prepared just

for HMRC. Other parties have an interest in them including the business owner,

financial institutions, shareholders and other government departments.

The two main primary financial statements are the trading and profit and loss

account and the balance sheet.

The trading and profit and loss account is a summary of the trading and business

activity for the period and shows the performance of the business for the whole of

the period covered by the accounts.

The trading account normally shows

• the turnover of the business

• the purchase of goods and materials used in the business the opening and

closing stock.

The profit and loss account contains the day-to-day running costs (sometimes called

overheads or indirect costs).

The balance sheet is a 'snapshot' of the financial position of the business at the

accounting date.



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It's divided into

• assets (fixed and current)

• liabilities (current and long term)

• capital account (opening and closing capital, drawings, capital introduced and

net profit or loss).

Now test your knowledge of this chapter by doing the learning check that follows.



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Learning check

Please record your answers in a separate document.

1. Oleanna wants to open a vintage clothes shop. She can't decide whether to do

this on her own or go into business with her sister. Oleanna has received a legacy

which she could use to pay the deposit on the premises and buy the initial stock. Her

sister has no money but she's a fashion designer and an excellent dressmaker. She

could work behind the scenes making repairs and so on, whilst Oleanna serves in

the shop, buys stock and does the administration.

a) What are the advantages and disadvantages of Oleanna starting her business as

a sole trader?

b) What are the advantages and disadvantages of Oleanna starting her business in

partnership with her sister?

2. Management accounts are always prepared for an annual accounting period and

are governed by the same rules and regulations as financial accounts.

Explain why this statement is false.

3. Other than the proprietor, list four parties who might be interested in the financial

accounts of a business and say why they might be interested.

4. Delete one of the bracketed words as appropriate to complete the following

statements

The trading and profit and loss account shows whether the business is making a

profit or a loss and reflects the (position / performance) of the business for the

whole of the period concerned.

The balance sheet on the other hand is a 'snapshot' and shows the financial

(position / performance) of the business at the accounting date only.

5. State whether the following items should be reflected in the trading account, the

profit and loss account or the balance sheet of a butcher's shop. In the case of



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balance sheet items, state where in the balance sheet you would expect to find these

(for example, fixed assets, current liabilities etc).

• Business premises.

• Turnover.

• Purchases.

• Motor expenses.

• Trade creditors.

• Heating and lighting expenses.

• Accountancy fees.

• Van used for deliveries.

• Mortgage used to buy business premises – term remaining 10 years.

• Drawings



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Learning check – answers

1. Oleanna wants to open a vintage clothes shop. She can't decide whether to do

this on her own or go into business with her sister. Oleanna has received a legacy

which she could use to pay the deposit on the premises and buy the initial stock. Her

sister has no money but she's a fashion designer and an excellent dressmaker. She

could work behind the scenes making repairs and so on, whilst Oleanna serves in

the shop, buys stock and does the administration.

a) What are the advantages and disadvantages of Oleanna starting her business as

a sole trader?

If Oleanna sets up business as a sole trader she'll need to notify HMRC about her

new source of income but there are fewer legal obligations and requirements

involved in setting up as a sole trader than in setting up as a partnership or

company.

If Oleanna starts her business as a sole trader, she'll have complete control over the

business and will be able to make business decisions quickly without the need to

consult her sister. One common advantage of being a sole trader is being able to

provide a personal service to customers, but this doesn't really apply in this case.

These are the advantages. The disadvantages are that Oleanna would have

unlimited liability for the debts and actions of the business. She may have difficulties

in obtaining further capital to invest in the business and she may not be able to

match the pricing and marketing policies of any larger vintage clothes shops in the

area.

b) What are the advantages and disadvantages of Oleanna starting her business in

partnership with her sister?

If Oleanna forms a partnership with her sister, she'll bring additional useful skills into

the business. But the liability of partners is unlimited, and the two sisters will be

jointly and severally liable. Oleanna's sister has no money so Oleanna would

effectively be responsible for all debts the business incurs.



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She would have to share the profits with her sister in accordance with a profit sharing

agreement. Also, as a partner her sister would have a say in the operation and

direction of a partnership business and neither of them would have complete control

over the business.

This is in subchapter 1.1.

2. Management accounts are always prepared for an annual accounting period and

are governed by the same rules and regulations as financial accounts.

Explain why this statement is false.

Management accounts may be prepared more frequently, for example on a monthly

basis. Whilst management accounts comply with basic accounting concepts, they're

not governed by specific rules or regulations.


3. Other than the proprietor, list four parties who might be interested in the financial

accounts of a business and say why they might be interested.

Financial institutions – a lender can use the financial accounts to help to determine

whether the business is profitable and whether it can pay the interest and charges

(service the loan) and repay the capital.

Suppliers – they'll use the financial accounts in a similar way to other lenders.

Shareholders – they'll use financial accounts to monitor their investment in the

company's shares.

Government departments – obviously HMRC, but also others, for a variety of

reasons.


4. Delete one of the bracketed words as appropriate to complete the following

statements.



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The trading and profit and loss account shows whether the business is making a

profit or a loss and reflects the (performance) of the business for the whole of the

period concerned.

Position was deleted.

The balance sheet on the other hand is a 'snapshot' and shows the financial

(position) of the business at the accounting date only.

Performance was deleted.


5. State whether the following items should be reflected in the trading account, the

profit and loss account or the balance sheet of a butcher's shop. In the case of

balance sheet items, state where in the balance sheet you would expect to find these

(for example, fixed assets, current liabilities etc).

• Business premises.

• Turnover.

• Purchases.

• Motor expenses.

• Trade creditors.

• Heating and lighting expenses.

• Accountancy fees.

• Van used for deliveries.

• Mortgage used to buy business premises – term remaining 10 years.

• Drawings.

Turnover and purchases will both appear in the trading account.

Motoring expenses, heating and lighting expenses and accountancy fees should be

recorded in the profit and loss account.



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The rest of the items will appear in the balance sheet. The business premises and

the van will be recorded under fixed assets. Trade creditors will appear under

current liabilities and the mortgage will be a long-term liability. Drawings will be in

the capital account.




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Before moving on

If you have answered the learning check correctly, you will have successfully

completed the learning outcomes and study objectives for this chapter, which you

can see below.


Learning outcomes

You will

• understand the main types of business entities, the accounts they may

prepare and who may use them

• understand the form and content of sole trader accounts.

Study objectives

To achieve this you need to be able to

• describe the main types of business entity

• explain the difference between management and financial accounts

• name four users of financial accounts

• describe the form and content of sole trader accounts

If you had difficulty in achieving any of these objectives, have another look at the

relevant part(s) of the chapter and try the learning check again.

You should be confident that you have achieved them before moving on.

Finally, please note any points you might want to discuss with your line manager or

tutor.



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Chapter 2 Accounting Standards

Introduction

Accountancy isn't an exact science. You'll find that accountants will sometimes

disagree with each other, as well as with HMRC, about how information should be

recorded in financial accounts.

These potential differences can cause confusion for anyone who examines financial

accounts. To help overcome this, the accountancy profession developed

accounting standards so that accounts can be prepared in accordance with

generally accepted accounting practice (GAAP).

In certain circumstances, business entities may prepare their accounts in

accordance with international accounting standards (IAS)/International Financial

Reporting Standards (IFRS). HMRC accepts accounts which have been prepared in

accordance with IAS/IFRS for tax purposes, for accounting periods commencing on

or after 1 January 2005.

This module focuses on the application of UK accounting standards (UK GAAP).

In this chapter, you'll consider what accounting standards are and look at the

concepts and principles that accountants follow when preparing accounts.

You'll also see what is meant by materiality.



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This is what you will be able to achieve after you have successfully studied this

chapter.

Learning outcomes

You will

• understand why generally accepted accounting concepts and principles are

important to HMRC.

Study objectives


• describe the main aim of accounting standards

• explain the importance of accounting concepts. We think it will take you

approximately this long to finish the chapter.


Completing activities and the learning check 30m

Total 1hr 45m

This is only a guide. The important thing is for you to make sure you understand

all the material in the chapter.



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2.1 Accounting Standards

In this subchapter you'll look at accounting standards and how HMRC advisory and

forensic accountants can help you in your work.

2.1.1 FRS

Accounting standards describe how particular transactions should be reflected in the

financial accounts. For the UK and Republic of Ireland, Financial Reporting

Standards (FRSs) are mandatory for accounting periods starting on or after 1

January 2015.

• FRS 100 Application of Financial Reporting Requirements.

• FRS 101 Reduced Disclosure Framework (FRS 101).

• FRS 102 The FRS Applicable in the UK and Republic of Ireland (FRS 102).

• FRS 103 Insurance Contracts.

• FRS 104 Interim Financial Reporting.

• FRS105 The Financial Reporting Standard applicable to the Micro-entities

Regime (FRS 105).

Example

FRS102, chapter 13, Inventories (stocks) gives guidance on how stocks should be

provided for in the accounts, and chapter 17 gives guidance on accounting for

property, plant and equipment (tangible fixed assets) and depreciation.

FRS 102 does not apply to entities that are required or elect to apply EU-adopted

IFRSs, FRS 101’s IFRS reduced disclosure framework or FRS 105’s requirements

relating to the micro-entities regime. You can learn more about accounting

frameworks in Accountancy - Increasing Financial Awareness. For the purposes of

this module the focus is on FRS 102.



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2.1.2 Aim of accounting standards

The main aim of the accounting standards is to assure anyone looking at the

accounts that the information in them is presented consistently and that they reflect a

true and fair view of the financial activities for the period they cover.

Accountants are expected to follow accounting standards when preparing financial

accounts.

S25 ITTOIA 2005

Accounting standards are primarily for use when preparing company financial

accounts. However, accountants are also expected to use them when preparing

financial accounts for individuals and for partnerships.

This is because section 25 Income Tax Trading and Other Income Act (ITTOIA)

2005 says that, for tax purposes, the profits of an individual, or a partnership, must

be calculated in accordance with generally accepted accounting practice –

unless the taxes acts state otherwise.

So the process to be followed when calculating the profit for income tax purposes is

to

• prepare accounts in accordance with GAAP to arrive at the figure of net profit

and then

• adjust the figure of net profit because the taxes acts specifically allow or disallow

certain entries in the accounts.

HMRC can insist that profits are computed in accordance with GAAP for tax

purposes, if necessary by adjusting the profits shown by the accounts. But they can't

insist that the accounts themselves follow GAAP for sole traders and partnerships.

In this manual, you'll see how to record transactions in an accounting system so that

financial accounts can be prepared. However, further adjustments may then be

needed for tax purposes. You can learn about these adjustments in the Company

Tax and Sole Traders and Partnerships manuals.



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2.1.3 HMRC advisory and forensic accountants

Although you'll find it useful to have a working knowledge of accounting standards,

you're not expected to be an expert

in financial reporting. HMRC employs advisory and forensic

accountants to give advice on the interpretation and application of GAAP.

Advisory and forensic accountants are professionally qualified accountants, most of

whom trained and spent years in the profession or industry prior to joining HMRC.

Advisory accountants are able to advise tax specialists, policy colleagues, solicitors

and courts on appropriate accountancy treatments in the accounts of our customers.

Forensic accountants support criminal caseworkers including tax specialists with

financial advice and assist the courts through objective reports and giving

independent expert opinion.

HMRC's advisory and forensic accountants provide technical advice and support,

either informally or by a written submission. They'll also attend meetings with

customers and their agents and help with records examinations and interpretation of

accounting records.

HMRC advisory and forensic accountants only get involved in accountancy matters,

not tax issues, technical or procedural matters. They may however, be required to

give expert evidence before the First–tier Tribunal, Upper Tribunal or the Courts.

You're strongly advised to ask them for advice when technical accounting issues are

concerned.

You can find the advisory and forensic accountants' site on the intranet by clicking on

Legal and Accountants from the A – Z index.

HMRC officers often have to look at historic information. Should you require

information about withdrawn standards that are relevant to your case, please consult

an advisory and forensic accountant.



OFFICIAL

Accounting standards become effective from a specific date. It would be

embarrassing to challenge accounts on the grounds that they didn't comply with an

accounting standard, only for the accountant to point out that the standard in

question was not effective for the period covered by the accounts.

You should always get advice from an HMRC advisory and forensic

accountant before making a formal challenge based on accounting standards.

Throughout the Bookkeeping manual, we include the specific relevant accounting

standards where appropriate and, within that standard, the general principles that

you should follow.

Before you can start recording transactions in the accounts you need to be aware of

FRS 102 The FRS Applicable in the UK and Republic of Ireland.

First try the activity that follows.

Activity One

Indicate whether the following statements are true or false.

1. HMRC can insist that the accounts themselves follow

GAAP for sole traders and partnerships.

2. HMRC advisory and forensic accountants can get involved in accountancy

matters, tax issues and technical or procedural matters.

3. You should always get advice from an HMRC accountant before making a formal

challenge based on accounting standards.



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Response

1. HMRC can insist that the accounts themselves follow

GAAP for sole traders and partnerships. - False

HMRC can insist that profits are computed in accordance with GAAP for tax

purposes, if necessary by adjusting the profits shown by the accounts. But they can't

insist that the accounts themselves follow GAAP for sole traders and partnerships.

2. HMRC advisory and forensic accountants can get involved in accountancy

matters, tax issues and technical or procedural matters. - False

HMRC advisory and forensic accountants only get involved in accountancy matters,

not tax issues, technical or procedural matters.

3. You should always get advice from an HMRC accountant before making a formal

challenge based on accounting standards. – True



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2.2 FRS 102

The objective of accounts is to provide information about the financial position,

performance and cash flows of an entity that is useful for economic decision making

by a broad range of users.

2.2.1 The Qualitative Characteristics of Information

In this section you'll look at the qualities that make accounting information useful to

users. FRS 102 refers to these as 'the qualitative characteristics of information'.

FRS 102 identifies 10 characteristics that are likely to make information useful. The

most critical characteristics are relevance and reliability. The other characteristics

are less critical but are still desirable because they enhance.

Reference - FRS 102, 2.5

Relevance

Information must be relevant to the decision making needs of users. This will

only be the case where the information may make a difference to users' decisions.


Reliability

Information is reliable when it is free from material error and bias and it

represents faithfully what it claims to represent.

Information does not have to be accurate in all respects to be reliable. For example,

you may not be able to say with certainty that an estimate of the value of an asset is

accurate. However, the estimate can still be reliable if you describe it as an estimate

and explain its limitations.




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Understandability

Information should be presented in a way that makes it understandable to users.

It is assumed that users of accounts have a reasonable knowledge of business and

are willing to study the information – it is not acceptable to omit information on the

grounds that it is difficult to understand.


Materiality

Materiality is closely linked to relevance. Information is material if its omission or

misstatement, individually or collectively, could influence the economic decisions of

users taken on the basis of the financial statements.

Materiality is the judgement made by preparers of accounts about whether to include

an item to give a true and fair view. They do this so that the information provided is

relevant and important, and not swamped by unnecessary detail.

An item would be material to the financial statements if it could influence the

economic decisions of the users.

It's a question of judgement whether something is material. It's doubtful that £2

would be important in any business, but what if the amount is £2,000? If the turnover

for a year is £48,000, this is turnover for 2 weeks. That's important and could be

said to be material.

If the annual turnover is £48,000,000 it may be less important and not material.

The concept of materiality is considered in more detail in chapter 1 of the Increasing

Financial Awareness manual. If you're carrying out a compliance check and have

any problems concerning materiality, contact your local HMRC advisory and forensic

accountant.




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Substance over form

Transactions should be accounted for in accordance with their substance and

not merely their legal form, which may not reflect the commercial effect. The

concept of substance over form enhances the reliability of information..

A company sells a property to a bank for £1,000,000 and at the same time enters

into an agreement to purchase it back from the bank a year later for £1,080,000.

The legal form of the transaction is that the company has sold the property to the

bank. However, the substance of the two transactions taken together is that the

company has taken out a bank loan of £1,000,000 secured on the property (this is

the commercial effect of the two transactions).

The company should not recognise income from the sale of the property. Instead, it

should recognise a bank loan of £1,000,000 as a liability and continue to recognise

the property as an asset.


Prudence

The uncertainties that surround many transactions and events are acknowledged by

the exercise of prudence. Prudence is the inclusion of a degree of caution when

making judgements necessary to arrive at estimates.

The exercise of prudence does not permit bias. If information is biased it will not

be reliable. In other words, prudence does not allow the deliberate understatement

of assets or income, or the overstatement of liabilities or expenses.


Completeness

Completeness is linked with reliability. To be reliable, information must be

complete (within the bounds of materiality and cost).



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Comparability

Comparability enables users to identify and understand similarities in, and

differences between, items. Information is more useful if it can be compared with

similar information about the company for another accounting period, or with

information about another company.

Comparability can be improved by the use of consistent accounting policies from one

accounting period to the next.


Timeliness

Timeliness means having information available in time for it to influence

decisions of users. Generally, the older

the information is, the less useful it will be. However, some information will continue

to be timely long after the end of an accounting period, because some users may

need it to identify trends.

A conflict between relevance and reliability may arise over the timeliness of

information. A delay in providing information can make it out of date, which affects

its relevance.

On the other hand, reporting information too early can affect its reliability if, for

example, there are significant unresolved uncertainties. Companies need to

consider the needs of users in achieving a balance between relevance and reliability.


Balance between benefit and cost

The benefit derived from information should exceed the cost of providing it.



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It's often difficult to assess costs and benefits because the company providing the

information generally incurs the costs, but other parties usually get the benefits.

An assessment of costs and benefits will not always justify the same reporting

requirements for all companies. For example, differences in the way in which

information is presented may be appropriate because of the different ways in which

companies raise funds (publicly or privately), or different sizes of company, or

differing users' needs.

It is not always possible for information to possess all of the characteristics in FRS

102 and companies may need to strike a balance between them. For example, a

temporary loss of comparability when applying a new accounting policy may be

worthwhile if it improves the relevance of the information presented in the accounts.

FRS 102 does not provide any guidance on the relative importance of each

characteristic. This is a matter of professional judgement.

Now try the following activity.

Activity two

Indicate whether the following statements are true or false.

a) 'Prudence' implies that management should have a bias towards understating

assets and income and overstating liabilities and expenses.

b) 'Prudence' implies that management should have a bias towards overstating

assets and income and understating liabilities and expenses.

c) Information is only 'reliable' when there is little or no uncertainty surrounding its

measurement.

d) Information is 'relevant' when it may make a difference to the decisions of users.

e) It is acceptable for some information to be omitted on the basis that it would be

too costly to gather.



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Response

a) False – Prudence requires the inclusion of a degree of caution but does not

permit bias.

b) False – Prudence requires the inclusion of a degree of caution but does not

permit bias.

c) False – Reliable information must be free from material error but does not have to

be accurate in all respects.

d)True – Information must be relevant to the decision making needs of users.

e)True – The benefit derived from information should exceed the cost of providing it.



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2.2.2 Accounting bases and concepts

FRS 102 recognises the importance of the accrual basis of accounting (or

matching basis) and the going concern concept. These are fundamental to

accounting. Let's look at these next.

The accruals basis

In accordance with FRS 102 the accrual (or matching) basis requires that income

and expenditure are recognised in the period in which they're earned and incurred

and not in the period when money is received and paid. This is important to ensure

that the financial accounts give a true and fair view.

The accrual basis is at the heart of the definitions of assets and liabilities. FRS 102

defines assets and liabilities as follows.

Assets

A resource controlled by the entity as a result of past events and from which future

economic benefits are expected to flow to the entity.

Reference - FRS102, Appendix I Glossary

Liabilities

A present obligation of the entity arising from past events, the settlement of which is

expected to result in an outflow from the entity of resources embodying economic

benefits.

So under the accrual basis you need to see if an asset or liability has arisen before

you can see whether to recognise income and expenditure in the profit and loss

account.

Let's see what this means.



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Assets and income

Example

Louise starts in business as a consultant on 1 January 2018. She makes up her first

accounts to 31 December 2018. During the year, she received payments of £35,000

from customers for the work that she did. In the middle of December 2018, she

completed a job worth £2,000, but agreed to allow the customer 30 days to pay the

amount owed to her.

Although Louise hasn't physically received the cash of £2,000 by the balance sheet

date, this £2,000 is an asset of the business. Louise has earned the right to receive

that income as a result of the work which she had performed by the balance sheet

date.

So the income is accrued (matched) to the period in which it's earned. Louise should

include the £2,000 as turnover in the trading account to 31 December 2018 along

with the £35,000 she had already received. Her total turnover for the year ending 31

December 2018 is £37,000.

She would show the £2,000 as a trade debtor in current assets in the balance sheet

to reflect the amount which the customer owes her.

Generally speaking, a trade debtor arises when the business has clearly made a

sale or supplied a service for which payment is due but hasn't yet been received.

Activity three

Jack is a butcher, who prepares his accounts to 31 May each year. During the year

ending 31 May 2018, Jack received

£45,000 in takings from his customers. All of Jack's customers have paid what they

owe by the end of the year, except for Clive.



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Jack sells meat to Clive each day of the week except Sunday and Clive pays Jack

every Saturday for that week's meat. During the week ending Saturday 2 June 2018,

Jack sold goods to Clive as follows.

Date £

Monday 28 May 40

Tuesday 29 May 45

Wednesday 30 May 30

Thursday 31 May 50

Friday 1 June 55

Saturday 2 June 60

Total sales for the week 280

Using this information, state the entries that you would expect to see in Jack's

financial accounts for the year ended 31 May 2018.



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Response

The financial accounts for the year ended 31 May 2018 should show the following.

At 31 May 2018, Jack should show £165

The sum of, (£40 plus £45 plus £30 plus 50), as a trade debtor in current assets in

the balance sheet. Although he hasn't yet received the cash by 31 May 2018, he has

earned the right to receive this income as the sale was made in the period.

The £165 will also be recognised in turnover, along with the £45,000 which he had

already received for sales made in the period.

The sales that Jack made to Clive from Friday 1 June will be included in his following

year's accounts.

Expenditure and liabilities

Example

Ian started in business as a plumber on 1 January 2018 and prepares his first

accounts to 30 September 2018. His local plumbing merchant allows Ian to settle

what he owes them within 30 days. During the period, Ian paid for purchases costing

£18,000. On 20 September, he bought a bathroom suite and radiators costing £650

from the plumbing merchant, which he fitted the following week.

Although Ian hasn't physically paid the cash of £650 by the balance sheet date, this

£650 is a liability of the business. This is because Ian has incurred an obligation to

pay the supplier as a result of the purchase.



OFFICIAL

The £650 would be included as purchases in the trading account to 30 September

2018 along with the £18,000 which Ian had already paid for other purchases by the

balance sheet date.

The liability of £650 would be shown as a trade creditor in current liabilities in the

balance sheet to reflect the amount which Ian owes to his supplier.

Generally speaking, a trade creditor arises when the business has made a purchase

or received a service for which payment is due but hasn't yet been made.

Activity three

Let's look again at the previous activity with Jack and Clive, but this time from

Clive's point of view.

Clive is a market trader who also prepares his accounts to 31 May each year. During

the year, Clive paid for purchases costing £14,000.

Clive buys meat from Jack each day of the week except Sunday. He pays Jack on a

Saturday for that week's meat. During the week ending Saturday 2 June,

Clive bought the following goods from Jack.

Date £

Monday 28 May 40

Tuesday 29 May 45

Wednesday 30 May 30

Thursday 31 May 50

Friday 1 June 55

Saturday 2 June 60

Total sales for the week 280

Using this information, state the entries that you would expect to see in Clive's

financial accounts for the year ended 31 May 2018.



OFFICIAL

Response

Clive's financial accounts for the year ended 31 May 2018 should show the following.

As at 31 May 2018, Clive should show £165

The sum of, (£40 plus £45 plus £30 plus 50), as a trade creditor in current liabilities

in the balance sheet. Although he hasn't paid the cash by 31 May 2018, Clive has

incurred an obligation to pay this money to Jack because he made the purchases in

the period.

The £165 will also be in purchases, along with the £14,000 which he had already

paid for purchases in the period.

Purchases made by Clive from Friday 1 June will be included in his following year's

accounts.

Cash basis

The cash basis scheme was launched in April 2013. It can be used from 2013/14 by

most sole traders and partnerships with an annual income of less than £150,000.

Under the cash basis scheme, income is recognised in the period it's received and

expenditure when it's paid.

So a business will show the income it receives in the year less any money spent on

allowable business expenses in its self assessment return.

Next, you'll consider the concept under FRS 102 that's likely to have a significant

impact on all businesses – the going concern concept.



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Going concern concept

An entity is a going concern unless management either intends to liquidate the entity

or to cease trading or has no realistic alternative but to do so.

This means that, unless there is evidence to the contrary, you should assume that

the business will continue to operate for the foreseeable future with no intention to

stop trading or significantly reduce operations.

A balance sheet splits assets between fixed and current. This indicates that the

business will continue to trade in the future, otherwise there wouldn't be any need to

distinguish between the two types of assets. The same is true of current and long-

term liabilities.

If a business intends to stop trading or significantly reduce its operations, this can

affect how the assets of the business are valued. You don't need to know any more

than this for the purposes of this module.

Reference - FRS 102, Appendix I glossary

Activity four

Which of the following do you think are material to the financial accounts?

a) The business records show that Walter withdrew £25 a week in cash to pay for

incidental business expenditure. There is no documentation to support this. The

total expenses of the business for the year are £650,000.

b) Melvin is a self-employed plumber. He says that three deposits totalling £204 in

his business bank account had come from the sale of scrap material accumulated

during the year. He hadn't recorded this in the business records and consequently it

wasn't treated as business income. Total turnover for the year was £125,000.



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Response

These are questions of judgement, so there are no right or wrong answers. In view

of the amounts involved, an accountant would probably take the view that neither of

these was material.

But an HMRC officer carrying out a compliance check may be concerned that Walter

has no documentation to support his claim that it was business expenditure.

This is the end of the material in this chapter.

Now read the review and try the learning check that follows.



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Review

Accounting standards form the basis on which financial accounts are prepared.

Accountants are expected to follow accounting standards when preparing financial

accounts to ensure consistency of preparation and to give a true and fair view.

These standards include Financial Reporting Standard 102 The FRS Applicable

in the UK and Republic of Ireland.

Now you'll look at the qualitative characteristics of information which are considered

to make sure the accounts give a true and fair view of a business's state of affairs.

These are

• relevance

• reliability

• understandability

• materiality

• substance over from

• prudence

• completeness

• comparability

• timeliness

• balance between benefit and cost.

Most important is the 'accruals basis' also known as the matching basis. This

ensures that financial accounts reflect income earned and expenses incurred in the

accounting period, rather than in the period in which any cash is received or paid.

You also saw that the accruals basis results in the creation of debtors and creditors.

A trade debtor is created when a business makes a sale or supplies a service for

which payment is due but hasn't yet been received from the customer.



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A trade creditor is created when a business has made a purchase from a supplier for

which payment is due but hasn't yet been made to the supplier.

Now test your understanding of this chapter by doing the learning check that follows.

Learning check

1. -What is the main aim of accounting standards?

2. Briefly explain what is meant by the accruals basis and why it's important.

3. Grass Roots Ltd is a company specialising in lawn care and landscape gardening.

It has a contract with the local authority to take care of lawns in parks and public

areas.

The company prepares its annual accounts to 30 September each year. During

September 2018, it carried out work worth £10,000 for the local authority and issued

the sales invoice on 30 September 2018. Grass Roots Ltd allows 30 days to settle

the amount owed. The local authority eventually paid the amount owed on 14

November 2018.

a) Should Grass Roots Ltd include the amount of £10,000 in its figure of turnover for

the year ended 30 September 2018 or the year ended 30 September 2019? Briefly

give the reasons for your answer.

b) Where would you find an entry in the company balance sheet for this transaction,

and for which year?

5. What does it mean if a business is a going concern?

6. Complete the following statement by deleting one of the bracketed words.

It's a question of (judgement/fact) whether something is material.



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1. What is the main aim of accounting standards?

The main aim of the accounting standards is to assure anyone looking at the

accounts that the information in them is presented consistently and that they reflect a

true and fair view of the financial activities for the period they cover. Accountants

are expected to follow accounting standards when preparing financial accounts.


2. Briefly explain what is meant by the accruals basis and why it's important.

The accruals basis means that income and expenditure are recorded in the period in

which they're earned and incurred and not in the period when money is received and

paid.

This is a fundamental accounting basis and is important to ensure that the financial

accounts give a true and fair view.


3. Grass Roots Ltd is a company specialising in lawn care and landscape gardening.

It has a contract with the local authority to take care of lawns in parks and public

areas.

The company prepares its annual accounts to 30 September each year. During

September 2018, it carried out work worth £10,000 for the local authority and issued

the sales invoice on 30 September 2018. Grass Roots Ltd allows 30 days to settle

the amount owed. The local authority eventually paid the amount owed on 14

November 2018.

a) Should Grass Roots Ltd include the amount of £10,000 in its figure of turnover for

the year ended 30 September 2018 or the year ended 30 September 2019? Briefly

give the reasons for your answer.



OFFICIAL

Under the accruals concept, income should be recognised when it's earned; it

doesn't matter when payment is actually received. The £10,000 should therefore be

included in the figure of turnover for the year ended 30 September 2018.

b) Where would you find an entry in the company balance sheet for this transaction,

and for which year?

You would expect to find an entry for trade debtors of £10,000, under the heading

of current assets. This would appear on the balance sheet at 30 September 2018.

Grass Roots Ltd is a company but the same answers would apply if it was a sole

trader business or a partnership.


4. What does it mean if a business is a going concern?

This means that unless there is evidence to the contrary, you should assume that the

business will continue to operate for the foreseeable future with no intention to stop

trading or significantly reduce operations.


5. Complete the following statement by deleting out one of the bracketed words.

It's a question of (judgement) whether something is material.

Fact was deleted.




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Appendix

Table of equivalence for company law terminology

The following table compares both UK and Irish company law terminology with

broadly equivalent terminology used in FRS 102.

Company law terminology FRS 102 terminology

Accounting reference date Reporting date

Accounts Financial statements

Associated undertaking Associate

Balance sheet Statement of financial position

Capital and reserves Equity

Cash at bank and in hand Cash (note 53)

Debtors Trade receivables

Diminution in value [of assets) Impairment

Entity [financial statements) Individual [financial statements)

Financial year Reporting period

Financial year end date Reporting date

Group [accounts/ financial statements] Consolidated [financial statements]

Holding undertaking Parent

lAS / IFRS EU-adopted IFRS

Individual (accounts) Individual [financial statements)

Interest payable and similar expenses Finance costs

Interest receivable and similar income Finance income/Investment income

Minority interests Non-controlling interest

Net realisable value [of any current asset) Estimated selling price less costs to complete and sell

Parent undertaking Parent

Profit and loss account Income statement (under the two-statement approach) Part of the statement of comprehensive income (under the single-statement approach) Related undertakings (note 54) Subsidiaries, associates and joint ventures

Stocks Inventories

Subsidiary undertaking Subsidiary

Tangible assets Includes: Property, plant equipment; Investment property

Trade creditors Trade payables



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(53) FRS 102 requires the cash flow statement to reconcile the movement in 'cash

and cash equivalents'. Disclosure is required of reconciliation between amounts

presented In the statement of financial position (i.e. cash) and 'cash and cash

equivalents'.

(54) This would also include entries in which a company has at least a 20 per cent

holding, but when are not a subsidiary, joint venture or an associate. A shareholding

of 20 per cent is pressed to give significant influence to the holder, such that the

investment would be classified as an associate, therefore in practice there are

unlikely to be many related1.11dertaldngs that are not subsidiaries, joint ventures or

associates.



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Before moving on



can below.

Learning outcomes

You will

• understand why generally accepted accounting concepts and principles are

important to HMRC.

Study objectives


• describe the main aim of accounting standards

• explain the importance of accounting concepts. We think it will take you

approximately this long to finish the chapter.


relevant part(s) of the chapter and try the learning check again. You should be

confident that you have achieved them before moving on.

Finally, please note any points you might want to discuss with your line manager or

tutor.



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Chapter 3 Basic Bookkeeping Principles

Introduction

In chapters 1 and 2, you looked at how financial accounts are set out and who uses

them. You've also considered accounting standards and how they provide principles

to ensure that the financial accounts reflect a true and fair view of the financial

activities of a business.

The term bookkeeping is often used to cover all aspects of recording the financial

transactions of a business. The information recorded is then used to prepare

financial accounts.

The accounts in turn are used to complete tax returns submitted by individuals,

partnerships and companies. The accounts themselves may also be submitted to

HMRC. For example, all companies must submit their financial accounts with their

self-assessment return.

Many businesses use computerised bookkeeping and accounting packages.

However, these packages work on exactly the same bookkeeping principles covered

in this manual.

In this chapter, you'll consider three basic principles that are fundamental to

understanding bookkeeping

• the separate entity concept

• balance sheet equation and

• dual effect



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chapter.

Learning outcomes

You will

• be able to apply double-entry bookkeeping principles.

Study objectives


• describe the separate entity concept

• explain the balance sheet equation and how business transactions affect it

• demonstrate the dual effect of business transactions.

Study advice



Completing activities and the learning check 1hr 10m

Total 3hrs 30m





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3.1 The Separate Entity Concept

Financial accounting is based on the principle that a business is a separate entity to

its proprietor, with its own assets and liabilities. This is also known as the business

entity concept. It ensures that the activities of the business are kept separate and

distinct from the personal activities of the proprietor.

Example

In chapter 1, you looked at the financial accounts for Harry's newsagents business.

Harry's balance sheet only included business assets and liabilities.

If Harry owned, say, a personal motorbike this wouldn't be shown on his balance

sheet because it's a personal asset. If Harry had a personal loan to buy his

motorbike, this would be a personal liability and that wouldn't feature on the business

balance sheet either.

A business should be regarded as a separate entity, with its own assets and

liabilities. If a business owner invests their personal money into the business, the

cash introduced is an asset of the business, but the liability to repay that money is a

business liability. This type of liability is recorded in the capital account in order to

distinguish it from the other external liabilities of the business.

Have a go at the activity that follows.

Activity one

Natalie uses £500 from her private bank account to open a business bank account.

Complete the blanks in the paragraph below. (add a word at each instance of (input

here)).

The cash of £500 is now a business (input here). The business owes Natalie £500.

This is a business (input here) but it's shown in the (input here) rather than in (input

here) or (input here).



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Response

The input words are inside brackets.

The cash of £500 is now a business (asset). The business owes Natalie £500. This

is a business (liability) but it's shown in the (capital account) rather than in

(current) or (long-term liabilities).

Next, you'll look at the balance sheet equation.

3.2 The Balance Sheet Equation

A balance sheet is called this because it always 'balances'.

Assets less liabilities must always equal capital. This is known as the balance sheet

equation. Some accountants may also refer to it as the accounting equation.

In Harry's case, the balance sheet for the year ended 31 May 2018 can be

summarised as follows.

Description £ £

Fixed assets 51,748

Current assets 11,859

Total assets 63,607

Current liabilities 6,433

Long term liabilities 11,759

Total liabilities 18,192



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Look again at Harry's balance sheet in subchapter 1.4 and you'll see that this golden

rule has been followed.

Description £

Assets 63,607

less liabilities (18,192)

equals capital of 45,415

Note that you always use the figure of closing capital in the balance sheet equation.

You arrive at the figure of closing capital by adding net profit and any capital

introduced to the opening capital and deducting any drawings. If the business

makes a loss instead of a profit, you deduct the amount of the net loss in the capital

account.

Activity one

Test your understanding of the balance sheet equation by identifying the missing

figures in each of the following balance sheet summaries.

Balance Sheet 1 summary

Description £

Fixed assets 60,000




Opening capital 45,000

Net profit 20,000

Drawings 15,000

Closing capital



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Balance Sheet 2 summary

Description £

Fixed assets 50,000



Long term liabilities 25,000


Net loss 12,000

Capital introduced 3,500

Drawings

Closing capital



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Response

Balance sheet 1 summary

You were provided with the figures of opening capital, net profit and drawings. You

could therefore work out the figure of closing capital of £50,000 by adding net profit

and deducting drawings.

Description £


Plus net profit 20,000

Less drawings of 15,000

Equals closing capital 50,000

You then needed to identify the amount of the long-term liabilities. The balance

sheet equation states that assets less liabilities must equal capital.

Remember it's the figure of closing capital which is used in this equation. The assets,

liabilities and capital can be summarised as follows.

Description £

Total assets of 70,000

Less current liabilities 5,000

Less long term liabilities 15,000

Equals capital of 50,000

In this example, assets less current liabilities equals £65,000. The amount of the

long-term liabilities must therefore be £15,000 if the balance sheet is to balance.



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Balance sheet 2 summary

You were given the amounts of all of the assets and liabilities. You could therefore

work out the figure of closing capital of £30,000 by using the balance sheet equation.

Total assets £65,000 less total liabilities £35,000 equals closing capital of £30,000.

Description £

Total assets 65,000

Less total liabilities 35,000

Equals closing capital 30,000

You then needed to identify the figure of drawings for the year.

Description £


Deduct net loss 12,000

Add capital introduced 3,500

Deduct drawings 14,000

Closing capital 30,000

Note

You can also work out the missing figures in activity two using 'T' accounts.

You'll learn about 'T' accounts in chapter 4. You may want to come back to this

activity after you've studied chapter 4.

You'll now consider the dual effect of any business transactions before you move on

to double-entry bookkeeping in chapter 4.



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3.3 The Dual Effect

Double–entry bookkeeping is called this because every transaction that's recorded in

a business has a dual effect.

So how does the dual effect work in practice?

Every time there's a business transaction, business assets, liabilities, or capital are

affected by the transaction.

The balance sheet equation will always hold true – the revised total business assets

less total business liabilities after the transaction has taken place must still always

equal capital.

3.3.1 The dual effect and the balance sheet equation

Balance sheet equation not affected

Let's begin by looking at the dual effect and the balance sheet equation at the very

start of a new business. You'll then look at subsequent transactions for the same

business.

Example

Following his redundancy, Lance starts in business as a mobile caterer on 1 April.

He uses £5,000 of his redundancy money to open a business bank account on that

date.

This is a business transaction so you must consider the dual effect and the balance

sheet equation. The business has a new current asset (the money in the business

bank account) and this is reflected by the money that Lance has invested into the

business (capital).



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The dual effect of this is to increase

• current assets (bank), and

• increase capital.

The balance sheet equation at this stage is therefore

Assets Less liabilities equals Capital

Description Amount Amount Amount

Bank £5,000 £0 £5,000

Example

On 2 April, Lance bought a second–hand van to use in the business. The van cost

£2,700 and Lance paid for it with a cheque from the business bank account. A

further business transaction has taken place so you must again consider the dual

effect and the balance sheet equation.

The business now has a new fixed asset (the van costing £2,700) but the value of its

current assets (the bank account) has reduced by the same amount.

The dual effect of this is to

• increase fixed assets (van), and

• decrease current assets (bank).

The revised balance sheet equation is shown below, with the revised figures in bold.



Bank £2,300

Van £2,700 £0 £5,000




OFFICIAL

Activity three

On 3 April, Lance buys catering equipment. This cost £500 which he paid by cheque

from the business bank account. He also withdrew £25 in cash from the business

bank account to pay for possible business expenses.

a) What is the dual effect of each of these transactions?

b) What is the revised balance sheet equation after both of these transactions have

been taken into account?



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Response

a) In the first transaction, the business acquires new fixed assets costing £500, but

its current asset (the bank account) has decreased by the same amount. The dual

effect of this is to

• increase fixed assets (equipment), and


In the second transaction, the business has a new current asset (cash on hand) but

another current asset (the bank account) has decreased by the same amount. The

dual effect of this is to

• increase current assets (cash)


b) The revised balance sheet equation after these transactions is shown below with

the revised figures in bold.



Cash £25

Equipment £500

Bank £1,775

Van £2,700 £0 £5,000

The overall balance sheet equation is not affected by these transactions. The

business still has total assets worth £5,000; it's just the nature of the assets that has

changed.

Business makes a profit

In the transactions you've considered so far, the dual effect hasn't altered the

liabilities or the capital position of the business. You'll now consider a business

transaction that makes a profit.



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Example

Lance gets his first customer when he is asked to cater for a function at the cycling

club in Readstone on 5 April. On the day of the function, he buys food and drink

costing £300 using his debit card from the business bank account. He uses all of this

food and drink at the event. At the end of the function, he's paid £700 by cheque,

which he pays into the business bank account on the same day.

The £700 is income of the business. It will be included in turnover in the trading

account. The cost of the food and drink will be recorded as purchases in the trading

account. The business earned £700 and incurred expenses of £300. The net profit

from the function is therefore £400. As you have seen already, net profit is added to


Let's now consider the dual effects of this profit making transaction.

When Lance purchased the food and drink for the function, the first dual effect was

to

• increase purchases by £300

• decrease current assets (bank) by £300.

Later that day he received payment for the function and paid this into the business

bank account. The dual effect of this was to

• increase income by £700

• increase current assets (bank) by £700.

The business has increased its total assets by £400 but the liabilities have remained

the same. The balance sheet equation states that assets less liabilities must equal

capital. So the profit of £400 must be added to the existing capital of £5,000,

increasing the capital to £5,400.



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The revised balance sheet equation is shown below, with the revised figures in bold.


Description Amount Amount Description Amount

Cash £25 Opening balance £5,000

Equipment £500 Profit £400

Bank £2,175

Van £2,700

Total £5,400 £0 Closing £5,400

The profit from the function belongs to Lance but it stays in the business capital

account until Lance takes it in the form of drawings from the business.

Activity four

Readstone Rugby Club asks Lance to cater for their annual award ceremony on 9

April. Lance agrees to provide a buffet for £1,000. The rugby club ask if they could

settle the bill a fortnight later and Lance agrees.

On the day of the buffet, Lance buys food costing £550. He pays for this by cheque

from the business bank account. At the end of the buffet, he presents the rugby club

with a sale invoice for £1,000.

a) State the dual effect of each of these transactions.

b) Show the revised balance sheet equation after these transactions have been

taken into account.



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Response

a) When Lance purchased the food for the buffet, the first dual effect was to


• decrease current assets (bank) by £550.

Lance has supplied food for the buffet, but he hasn't yet been paid, although he's

issued a sale invoice. Income should be recognised when it's earned, rather than

when payment is actually received. A customer to whom a business has supplied

goods or services on credit is a trade debtor. A trade debtor is a current asset

because it represents money that it owes to the business.

The dual effect of this transaction is to

• increase income by £1,000

• increase current assets (trade debtors) by £1,000.

The £1,000 is income of the business which will be included in turnover in the trading

account. The £550 incurred on buying food will be claimed as purchases in the

trading account. The money owed by the rugby club will appear as a trade debtor on

Lance's balance sheet.

The business earned £1,000 and incurred expenses of £550. So the net profit from

the event is £450. This is added to the capital account. Total assets have increased

by £450, which is matched by the increase in the capital account.



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b) The revised balance sheet equation after these transactions is as follows, with



Description Amount Amount Description Amount

Cash £25 Opening balance £5,400


Bank £1,625

Van £2,700

Debtors £1,000

Total £5,850 Closing £5,850

So far in this subchapter, you have considered the dual effect and balance sheet

equation for the following transactions.

• Opening capital at the start of a new business.

• Acquisition of fixed assets paid for by cheque.

• Withdrawal of cash from the business bank account.

• A cash sale to a customer which results in a profit.

• A credit sale to a customer which results in a profit.

You'll now consider the dual effect when a business makes purchases on credit, and

the effect on the balance sheet equation.

Business makes purchases and earns income on credit

Example

Lance is asked to provide a buffet for a wedding reception on 15 April. He agrees to

do this for £1,500.



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On the morning of 15 April, Lance makes the necessary purchases costing £600 at

Cash and Carry Ltd. He opens a credit account with the supplier. This credit

arrangement allows him to pay for the goods 14 days later. He uses all the food to

prepare the buffet.

Expenditure should be recognised when it's incurred, rather than when payment is

actually made. A supplier who has provided goods or services on credit is a trade

creditor. A trade creditor is a current liability because it represents money that the

business owes. The business owes £600 to the cash and carry, and this will appear

as a liability (trade creditor) on the balance sheet.

Let's now consider the dual effect of this transaction and the effect on the balance

sheet equation. When Lance purchased the food on credit, the dual effect was to

increase purchases by £600 increase current liabilities (trade creditors) by £600.

Lance provides the buffet as agreed and pays the customer's cheque for £1,500 into

the business bank account on the same day.

When Lance earned the income for providing the buffet, the dual effect was to

• increase income by £1,500

• increase current assets (bank) by £1,500.

Assets increased by £1,500.

The £1,500 is income of the business and will be included in his trading account as

turnover. The £600 incurred on food will be recorded as purchases in his trading

account. It doesn't matter that he hasn't actually paid for the goods at this point.

The business has earned £1,500 and incurred expenses of

£600 in doing so. The net profit from this event is £900, which is added to the capital

account.

The balance sheet equation states that assets less liabilities must equal capital. The

net increase of £900 is matched by the increase in capital when the profit from this

transaction is added to the capital account.



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The revised balance sheet equation after these transactions is shown below, with



Description £ Description £ Description £

Cash £25 Creditors £600 Opening balance £5,850


Bank £3,125

Van £2,700

Debtors £1,000

Total £7,350 Total £600 Closing £6,750

Activity five

Lance agreed to provide the catering for a disco at Readstone RFC on 19 April for

£750. He also agreed to allow the club 14 days to pay the amount owed to him.

He purchased food for the event on the day for £300, using his credit account with

his cash and carry supplier. He used all the purchases to cater for the event.

After the disco, he gave the football club a sales invoice confirming that payment will

be due from the club in 14 days’ time.


b) Show the revised balance sheet equation after these transactions have been

taken into account.



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Response

a) The business has made a sale on credit and has also purchased goods for resale

on credit. No money has actually changed hands yet, but a business transaction has

taken place.

Income should be recognised when it's earned, and expenditure should be

recognised when it's incurred.

The dual effect of the food bought from the cash and carry on credit is to


• increase current liabilities (trade creditors) by £300.

The dual effect of the income earned from the disco event is to


• increase current assets (trade debtors) by £750.

The £750 earned will be included in turnover in the trading account. The money

owed to the business by the football club will appear as a trade debtor in the balance

sheet.

The £300 incurred on purchases will be included in purchases in the trading account.

The money owed to the cash and carry will appear as a trade creditor in the balance

sheet, and will be added to the amount already owed to Cash and Carry Ltd.

The business earned £750 and incurred expenses of £300 in resulting in a net profit

of £450 from the event, which is added to the capital account.

The balance sheet equation states that assets less liabilities must equal capital. The

net increase in assets of £450 is matched by the increase in capital.



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b)The revised balance sheet equation after these transactions is shown below, with






Bank £3,125

Van £2,700

Debtors £1,750









• Goods purchased by a business on credit.

You'll now consider the dual effect when a business receives and makes payment for

goods previously sold or purchased on credit. You'll also consider how this affects

the balance sheet equation.



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Business receives and makes payment for credit goods

Example

It's now 23 April and the rugby club gives Lance a cheque for £1,000 for the buffet he

provided on 9 April. Lance pays the cheque into the business bank account on the

same day.

The dual effect of this is to

• increase current assets (bank) by £1,000

• decrease current assets (trade debtors) by £1,000.

The income from this transaction was correctly recorded as turnover at the time the

income was earned. So the payment of £1,000 by the rugby club doesn't affect the

turnover figure.

The revised balance sheet equation after this transaction is shown below, with the

revised figures in bold.




Equipment £500

Bank £4,125

Van £2,700

Debtors £750


The bank balance has increased by £1,000 because of the cheque paid in. Debtors

have reduced by the same amount because the rugby club is no longer a debtor of

the business.



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The capital account isn't affected by this transaction as it didn't result in a profit or a

loss or involve any capital being introduced or withdrawn by the proprietor. The

business has simply reduced one current asset (trade debtors) and increased

another (the bank account). So it has the same total assets that it had before, it's

just the nature of the assets that has changed. The overall balance sheet equation

isn't affected.

Activity six

It's now 27 April and Lance decides to pay the cash and carry for the purchases

costing £600 that he bought on credit on 15 April.

a) State the dual effect of this transaction.

b) Show the revised balance sheet equation after this transaction has been taken

into account.



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Response

a) The business has paid £600 that it owes to the cash and carry. The bank account

has therefore decreased by

£600 and the amount owed to the cash and carry has decreased by the same

amount.

The dual effect is to decrease current assets (bank) by £600 decrease current

liabilities (trade creditors) by £600.

The purchase from the cash and carry was already correctly recorded as a purchase

of the business at the time the expenditure was incurred.

So the actual payment of £600 to the trade creditor doesn't affect the figure of

purchases again.

b) The revised balance sheet equation after this transaction is shown below, with





Equipment £500

Bank £3,525

Van £2,700

Debtors £750

Total £7,500 Creditors £300 Closing £7,200

The bank balance has decreased because £600 has been paid out. Creditors have

reduced by the same amount because the business no longer owes £600 to the

cash and carry.

The capital account isn't affected by this transaction as it didn't result in a profit or a

loss. Nor did it involve any capital being introduced or withdrawn by the proprietor.



OFFICIAL

The business has simply reduced a current asset (the bank account) and reduced a

liability (trade creditors) by the same amount.








• Goods purchased by a business on credit.

• Payment received for goods previously sold on credit.

• Payment made for goods previously purchased on credit.

You'll now look at the final business transactions made by Lance during the month of

April.

Example

It's now 28 April and Lance decides to take out an advertisement in his local

newspaper costing £250. He pays for this by cheque from the business bank

account.

Advertising is a day-to-day running expense of the business, and Lance claims this

as an expense in his profit and loss account.

The dual effect of this transaction is to

• decrease current assets (bank)

• increase advertising expenditure.

Expenses reduce the profit of a business, so because profit is added to the capital

account, the capital account will be reduced by this amount.



OFFICIAL

The revised balance sheet equation after this transaction is shown below, with the

revised figures in bold.



Cash £25 Creditors £300 Opening

balance

£7,200

Equipment £500 Expenses (£250)

Bank £3,275

Van £2,700

Debtors £750

Total £7,250 Totals £300 Closing £6,950

Activity seven

It's now 30 April and Lance makes the following transactions for the month.

• Pays motor expenses of £80 by cheque.

• Pays business insurance of £120 by cheque.

• Takes personal drawings of £1,000 for himself by cheque.


b) Show the revised balance sheet equation after all of these transactions have been

taken into account.



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Response

a) Motor expenses of £80 and business insurance of £120 are day-to-day running

expenses (overheads) of the business. Lance claims these in his profit and loss

account. The dual effect is very similar to the dual effect for advertisement expenses.

It will

• decrease current assets (bank) by £80

• increase motor expenses by £80,

and

• decrease current assets (bank) by £120

• increase insurance expenses by £120.

These expenses both reduce the profit of the business, and as profit is added to the

capital account, capital will be reduced by this amount.

Drawings are value taken out of the business by the proprietor for their own benefit.

Drawings are not part of the day-to-day running expenses of the business and

they don't go in the profit and loss account. The dual effect of Lance's drawings is to

• decrease current assets (bank) by £1,000

• increase drawings by £1,000.

Drawings are deducted in the capital account and therefore reduce the balance on




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b) The revised balance sheet equation after these transactions is shown below, with




Cash £25 Creditors £300 Opening

balance

£6,950

Equipment £500

Bank £2,075

Van £2,700 Drawings (£1,000)

Debtors £750 Expenses (£200)

Total £6,050 Totals £300 Closing £5,750

Benefits of considering dual effect

In this subchapter, you have looked at the bookkeeping transactions that occurred in

Lance's first month of trading. In each of the examples that you looked at, you

considered the dual effect and the impact on the balance sheet equation after every

single transaction. It was immediately apparent whether each transaction had an

effect on the capital account.



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Instead of considering the effect on the capital account after every transaction, you

can summarise the effect for the whole of April as follows.

Description £

Opening capital 0

Add Capital introduced 5,000

Add Net profit 1,750

Deduct Drawings (1,000)


At the start of the period, the value of the capital account was nil. The £5,000 that

Lance introduced into the business 'out of his own pocket' is capital introduced, and

as you've seen already, capital introduced is added to the capital account.

The net profit of £1,750 is the income earned from each of the events less the

expenses (purchases, advertising, motor expenses and insurance) incurred in

earning this income. You add net profit to the capital account. The profit from the

functions belongs to Lance but it stays in the business capital account until Lance

takes it in the form of drawings from the business.

If a business makes a loss, the amount of the loss is deducted from the capital

account.

Drawings represent capital withdrawn for the benefit of the proprietor. Drawings are

deducted from the capital account as they reduce the value of the capital account.

The main benefits of considering the dual effect of every business transaction when

preparing financial accounts are as follows.

• The dual effect ensures that each 'leg' of a business transaction is fully

recorded. For example, if a business makes a sale, the dual effect ensures

that the sale is recorded together with how the sale was actually made (for

example, whether this was a cash, cheque or credit sale, and so on).



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• Every business transaction will affect the assets, liabilities or capital of a

business. The effect on these is immediately apparent if the dual effect is

observed.

• It ensures that balance sheet equation is always maintained.

• A complete record of all dual effect transactions will allow a business to

prepare a fully balanced set of financial accounts.

In chapter 4 you'll look at how the dual effect and impact on the balance sheet

equation and capital account are maintained in a much more manageable and

efficient way.

This is the end of the material in this chapter. Now read the review and try the

learning check that follows..



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Review

Anyone who has to look critically at returns or financial accounts needs a good

understanding of basic bookkeeping principles. There are three basic bookkeeping

principles to follow.

• Separate entity concept.

• Balance sheet equation.

• Dual effect.

A business is a separate entity to the proprietor of the business. This is the separate

entity concept. It ensures that the activities of the business are kept separate and

distinct from the personal activities of the proprietor.

A balance sheet is called this because it always balances.

The balance sheet equation states that total assets less total liabilities must equal

capital.

Every business transaction has a dual effect on the assets, liabilities and capital of a

business.




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Learning check

1. Explain in simple terms what is meant by the separate entity concept.

2. What is the balance sheet equation?

3. The following figures are extracted from a trader's balance sheet. Calculate the

missing figure of current liabilities.

Description £

Fixed assets 75,500


Current liabilities

Long-term liabilities 50,000

Capital 28,500

4. The following is an extract from a trader's capital account.

Calculate the missing figure of capital introduced.

Description £


Net profit 15,500

Current introduced

Drawings 17,000


5. In each of the following three scenarios, state the dual effect of the transaction

and the effect on the balance sheet equation.

a) A business purchases a second-hand van for business use, with a cheque for

£2,000 drawn on the business current bank account.



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b) A business takes out a 12-month loan of £5,000 to build a small extension to the

business premises.

c) A business spends £50 in cash on purchases and sells all of the goods on the

same day for £125 in cash.



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1. Explain in simple terms what is meant by the separate entity concept.

It means that a business is a separate entity to its proprietor, with its own assets and

liabilities. It ensures that the activities of the business are kept separate and distinct

from the personal activities of the proprietor.


2. What is the balance sheet equation?

Assets less liabilities must always equal (closing) capital. This is in subchapter 3.2.

3. The following figures are extracted from a trader's balance sheet.

Calculate the missing figure of current liabilities.

Description £

Fixed assets 75,500



Long-term liabilities 50,000

Capital 28,500



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You can work this out as set out below (or by using a 'T' account as you'll see in

chapter 4).

Description £ £

Fixed assets 75,500

plus Current assets 12,250 87,750

less Capital (28,500)

Total 59,250

less Long-term liabilities 50,000

Current liabilities (total) 9,250


4. The following is an extract from a trader's capital account.

Calculate the missing figure of capital introduced.

Description £


Net profit 15,500

Current introduced 4,500

Drawings 17,000


You can calculate this by working out the apparent position before taking into

account the missing figure.

In this example opening capital plus net profit less drawings and closing capital

appears to be £11,000 compared to the actual figure of £15,500. So the missing

figure of capital introduced must account for the difference of £4,500.

You can also calculate this using a T account. For information, we show you how to

do this below.



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Dr £ Cr £


Drawings 17,000 Net profit 15,500

Closing capital 15,500 Capital introduced 4,500

Totals 32,500 32,500

5. In each of the following three scenarios, state the dual effect of the transaction

and the effect on the balance sheet equation.

a) A business purchases a second-hand van for business use, with a cheque for

£2,000 drawn on the business current bank account. This will

• increase fixed assets (vehicles) by £2,000

• decrease current assets (bank) by £2,000.

The overall balance sheet equation is unaffected as the financial position of the

business is the same. It still has the same total assets that it had before, although

made up of different amounts. The increase in one asset has been matched by a

decrease in another asset.

b) A business takes out a 12-month loan of £5,000 to build a small extension to the

business premises.

When the loan is initially advanced, the dual effect is to

• increase current assets (bank) by £5,000

• increase current liabilities (loan creditor) by £5,000.

The capital is not affected, and the financial position of the business is the same as

before. An increase in an asset is matched by an increase in a liability of the same

amount.

When the work is eventually carried out and paid for, the dual effect is to



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• increase fixed assets (premises) by £5,000


Again the overall balance sheet equation is unaffected as the financial position of the

business is the same. An increase in one asset is matched by a decrease in another

asset.

When the loan is repaid, the dual effect is to

• decrease current liabilities (loan creditor) by £5,000


Again the overall balance sheet equation is unaffected as the financial position of the

business is the same.

A decrease in an asset is matched by a decrease in a liability of the same amount.

c) A business spends £50 in cash on purchases and sells all of the goods on the

same day for £125 in cash.

At the time of purchase, the dual effect is to


• decrease current assets (cash) by £50.

When the goods are sold, the dual effect is to


• increase current assets (cash) by £125.

The balance sheet equation is affected by this transaction. Assets have increased by

£75 (£125 income less £50 purchases). The profit from this transaction is added to

the capital account. An increase in assets of £75 is matched with an increase in

capital of £75.

This is in subchapter 3.3



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Before moving on



can see below.

Learning outcomes

You will


Study objectives


• describe the separate entity concept

• explain the balance sheet equation and how business transactions affect it

• demonstrate the dual effect of business transactions.




Finally note any points you might want to discuss with your line manager or tutor.



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Chapter 4 Double Entry Bookkeeping

Introduction

In this chapter, you'll consider two systems of recording business transactions.

• The single-entry system.

• The double-entry system.

You'll then go on to consider the double-entry bookkeeping system in more detail,

and the fundamental principles which must be followed.

The same principles apply whether you're looking at a sole trader, partnership or

company, although some of the terms used may be different. Also, different

businesses may keep different records because of the way in which they're

structured, but the principles that you'll study apply equally to all businesses.

Finally, you'll see how various transactions are recorded in a double-entry

bookkeeping system.



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chapter.

Learning outcomes

You will


Study objectives


• state the differences between single and double- entry bookkeeping systems

• explain the three golden rules of double-entry bookkeeping

• record transactions in a double-entry bookkeeping system.

Study advice



Completing activities and the learning check 2hrs 25m

Total 4hrs 5m

This is only a guide.

The important thing is for you to make sure you understand all the material in the

chapter.



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4.1 Types of Bookkeeping Systems

Bookkeeping is a broad term that covers all aspects of recording the financial

transactions of a business. A key to efficient management of a business is to have a

bookkeeping system that suits that particular business. Let's look at the first of the

two systems used.

4.1.1 Single-entry system

'Single–entry' bookkeeping is where the bookkeeper makes only one entry to record

a business transaction.

Businesses may keep records of incomings and outgoings and amounts owed to and

by them in

• sales and purchases day books

• petty cash and cash books.

These are called books of single entry, or books of original or prime entry.

Sales daybook

This is normally a listing of all the sales invoices for credit sales issued by the

business. The business also keeps a record of the individual trade debtors.

Purchases daybook

This is normally a listing of all the purchase invoices for credit purchases by the

business. The business may also keep a record of the individual trade creditors.

In the purchases daybook, 'purchases' are usually goods for resale, but they may

include all types of business expenses, if they're made on credit.



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Cash book

A cash book is generally a record of all receipts and payments including both cash

and bank receipts and payments. Small businesses may use the purchases and

sales day books and the cash book to control which invoices have been paid.

Petty cash book

Businesses usually need small amounts of cash to spend on stationery, postage and

so on. Businesses often record this expenditure in a petty cash book under separate

headings for the different types of expenditure.

Example

Joe runs a market stall selling fruit. In his first week of trading, he records his

financial transactions in a notebook. Joe uses a notebook but when it's a

commercially produced product, it's usually called a cash book. Joe's income was all

received in cash and he also paid all of his expenses in cash.



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Joe’s cash Book - Week-ending 5 April 2008 (Accessible version)

Date Description Amount £

Tues 1/4 Fruit 50

Sales 75

Wed 2/4 Fruit 60

Paper bags 5

Sales 90

Thurs 3/4 Fruit 80

Sales 120

Fri 4/4 Sandy (petrol) 5

Fruit 80

Sales 120

Sat 5/4 Stall rental 50

Fruit 100

Weekly phone

Calls 5

Sales 150

Despite being called a cash book, the book is used to record all transactions,

whether in cash, through the bank account or on credit.

All cash books will be organised in much the same way, with the left-hand side being

used to record money coming in and the right-hand side used for money going out.

Cash receipts Cash payments



12

December

Sales 1,000 13

December

Purchases 500

The main advantage of a single entry system is that each entry is only made once.

This reduces the amount of time the business needs to spend on bookkeeping.

The main disadvantage of a single-entry system is that there is no way of checking

that the dual effect has been complied with. With a double-entry system, as you saw



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in chapter 3, you can check that the dual effect has taken place and the transactions

balance.

As you saw in chapter 1, calculating a figure of profit or loss can be a straightforward

matter. The profit or loss is the result of deducting expenditure from income.

Therefore, as long as you can identify the income and expenditure, the profit or loss

can be calculated.

Have a go at the following activity.

Activity one

Have another look at Joe's notebook.

a) Calculate his profit for this particular week. Assume that all stock has been sold.

b) How do you think Joe could organise the information in his notebook better?

Response

a. By deducting all of the expenditure from the income, you'll arrive at the figure of

profit

b) Joe should use his notebook as a cash book. To do this, he would be better

showing the entries for sales either on a different side of the page from the entries

for expenditure (as shown on the table below) or on another page.



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He can then add up each side to get the total for the week.

Sales Expenditure

Date Amount £ Date/description Amount £

April 1 75 April 1 Fruit 50


April 3 120 April 2 Paper bags 5



Total 555 April 4 Petrol 5

April 5 Stall rent 50

April 5 Fruit 100

April 5 Telephone 5

Total 435

Calculating his profit is now easier. All that's required is to subtract total expenditure

from total sales and you arrive at the figure of profit.

£555 minus £435 = £120.

Next you'll look at the double-entry system.

4.1.2 Double-entry system

Double-entry bookkeeping generally involves two entries in the accounts for each

transaction.

As you saw in chapter 3, in a double-entry bookkeeping system every transaction

has a dual effect. When Lance purchased his new van for £2,700, he acquired a

new fixed asset valued at £2,700. Another asset, his bank account balance, reduced

by the same amount. If this was Lance's only transaction during the year, he may be



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able to remember the details of the transaction when he completes his tax return.

However, what about Harry who trades as Harry's Newsagents?

In the year ended 31 May 2019, he had sales totalling £116,558. As a newsagent,

Harry's sales figure could be made up of thousands of transactions. He would also

have a similar number relating to expenses. Clearly, he needs an organised

bookkeeping system.

In the previous example, it's comparatively quick and easy for Joe to keep his

notebook.

However, there are two immediate disadvantages with Joe's method of record

keeping.

• There are no entries for cash on hand; only cash received or paid out.

• Joe can't be sure that he's recorded all of the money received or paid out. If

Joe had a record of cash on hand, he'd be able to reconcile this to physical

cash on hand, to ensure that he'd recorded all of the income and expenditure.

To help overcome these disadvantages, accountants use the double-entry system.

In chapter 3 you saw what is meant by the dual effect and the impact on the balance

sheet equation. If a business makes very few transactions in a period, the balance

sheet equation could, in theory, be carried out for each transaction. However, this

would be far too laborious in Harry's case – he'll have made thousands of

transactions in the year.

He requires a more practical way of recording transactions so that the dual effect is

maintained (without having to draw up the balance sheet equation after each and

every transaction) and the trading and profit and loss account and balance sheet can

be prepared. This is where double-entry bookkeeping comes in.

You'll consider the golden rules of double-entry bookkeeping next.



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4.2 Golden Rules of Double-entry Bookkeeping

There are three golden rules of double entry bookkeeping.

1. Transactions are recorded in 'T' accounts* using recognised classifications. The

left-hand side is called debit and the right-hand side is called credit.

* T accounts so called because of the way they appear on the page with a line under

the heading and another down the middle of the page dividing debits from credits.

2. For every debit entry there is an equal and opposite credit entry. This ensures the

dual effect is maintained and the balance sheet equation balances.

3. The words increase, and decrease are replaced with debit and credit, depending

on the classification of the transaction.

Next, you'll consider each rule in more detail.

4.2.1 Golden rule number 1

Transactions are recorded in 'T' accounts.

Transactions are recorded in various ledger accounts.

These ledger accounts are often referred to as 'T' accounts, because they look like

large capital 'T's when they're drawn up.

We'll use the term 'T' accounts throughout this manual. However, when you're

dealing with accountants you should use the term ledger accounts.

The left-hand side of the 'T' account is called the debit (Dr) side, and the right-hand

side is called the credit (Cr) side.

It's important that you remember which side is the debit and which the credit. One

way of remembering could be to think of driving a car. You drive (Dr) on the left and

crash (Cr) on the right!



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Most businesses deal in cash and require a cash account. In a double-entry

bookkeeping system the 'T' account would look something like this.

Cash

Debit (Dr) Credit (Cr)

Date Cash received Date Cash paid out

You'll look at how these 'T' accounts are prepared in more detail shortly.


For every debit entry there is an equal and opposite credit entry.

Every time you make an entry on the debit side of an account, there will be an equal

and opposite entry on the credit side of another account. This satisfies the dual

effect and maintains the balance sheet equation.


The words 'increase' and 'decrease' are replaced with debit and credit depending on the classification of the transaction.

All entries in the double-entry bookkeeping system are based on the following

grouping of the types of transaction.

Debit (Dr) Credit (Cr)

Increase expenses Increase liabilities

Increase assets Increase income

Increase drawings Increase capital

You can see that expenditure, assets and drawings are all debit entries and

liabilities, income and capital are all credit entries, within the relevant account.



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You may find it helpful to think of the phrase 'Dead Clic' which uses the first letter of

each type of transaction and entry to create the acronym (as set out below).

For example, a positive bank account is an asset, so a debit entry in the Bank 'T'

account increases assets. Sales are income, so a credit entry in the Sales 'T'

account increases income.

Example

In chapter 3.4 when Lance started in business, he paid £5,000 of his own money into

the business. The dual effect of this transaction was to increase both an asset (bank

account) and capital.

The entry of £5,000 will go on the debit side in the bank account. This is because the

deposit increases the value of an asset – that is, the bank account. The debit entry

fits the grouping of transaction types noted above.

Activity two

Following on from the previous example, what is the equal and opposite entry to

this transaction? Justify your answer by referring to the golden rules of

bookkeeping.



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Response

You've made an entry on the debit side in the bank account.

By following golden rule number 2, you know the equal and opposite entry to this

transaction must be an entry of equal amount, £5,000, on the opposite (credit) side

of another account.

The money that a proprietor introduces into the business is called capital. Therefore,

in this situation, the credit entry will go in the capital account to increase the level of

capital invested in the business. This fits the grouping of transaction types in

accordance with golden rule number 3.

Example

So far, you have only considered the bookkeeping entries for increases in expenses,

assets, drawings, liabilities, income and capital. You'll now consider the

bookkeeping entries for decreases in these transaction types.

Debit entries are the opposite of credit entries. Therefore, if a debit entry increases

an asset, then a credit entry must decrease an asset.

Similarly, if a credit entry increases liabilities, then a debit entry must decrease

liabilities.

So you only need to remember the bookkeeping entries for increases in transaction

types, as you'll be able to work out the entries for the decrease in transaction types

using logic. This is illustrated below.



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Description Debit Credit

Expenses Increase Decrease

Assets Increase Decrease

Drawings Increase Decrease

Liabilities Decrease Increase

Income Decrease Increase

Capital Decrease Increase

Look at the table on the previous page. You can see that sometimes an entry on the

debit side of an account increases the value of something, such as an expense, and

sometimes it will decrease the value of something, such as a liability.

The use of the words 'increase' and 'decrease' is, therefore, not consistent. You

couldn't, for example, say that for every increase there is an equal and opposite

decrease. It's possible for an increase in assets, perhaps the purchase of a new

van, to have an equal and opposite entry of an increase in a liability, such as a loan

taken out to fund the purchase. This would be confusing.

For this reason, an entry on the left is called a debit whether it increases or

decreases a particular transaction group. Similarly, an entry on the right is always

called a credit. Therefore, you can say that 'for every debit there is an equal and

opposite credit'.



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4.2.4 ‘T' accounts

You have already seen the basic format of a 'T' account earlier in this chapter. It is a

method of keeping a clear division between debit and credit entries in a particular

account.

'T' accounts are prepared for each type of transaction.

For example, there may be a 'T' account for motor vehicles and another one for

motor expenses.

You'll use 'T' accounts as the main form of recording transactions to understand the

basis of the double entry system. Although it's rare for a business to keep its records

using 'T' accounts, you'll find that when problems arise the accountant will invariably

use 'T' accounts to discover the solution. If you're involved in compliance checks,

you'll find yourself doing the same.

Entries in 'T' accounts generally include three specific pieces of information. These

are

• the date of the transaction

• where you can find the corresponding entry and

• the amount of the transaction.

Example

Lucy, a professional photographer, decides it's time to buy a new camera. She can't

decide which camera to get, but knows she'll need to take out a loan to cover the

cost. The cameras she's considering cost up to £2,000, so she decides to take out a

loan for that amount so that she'll have the money available when she finds the right

one. The loan is agreed, repayable over 3 years, and the money is paid into her

business bank account on 1 August.

So what has happened?



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Lucy has taken out a loan (a liability) and increased the value of her bank account

balance (an asset).

The dual effect of this transaction is to increase current assets (bank) and increase

long–term liabilities (loan).

The balance sheet equation would look like this.

Assets less Liabilities equals Capital

Bank - £2,000 Loan - £2,000 = £0

If she records these transactions in 'T' accounts, they will look like this.

Bank

Dr Cr

1 August Loan £2,000

Loan

Dr Cr

1 August Bank £2,000

Do these entries fit in with our bookkeeping rules?

The answer is yes.

1. They're recorded in 'T' accounts, in which the left side records debit entries and

the right side records credit entries.

2. For every debit (bank account) there is an equal and opposite credit (loan

account).

3. The debit entry increases an asset (bank balance), and the credit entry increases

a liability (loan outstanding). This satisfies the grouping of transaction types.



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Interpreting 'T' accounts

In the example on the previous page, the bank account shows you what money Lucy

has deposited into the account. You can see that on 1 August she deposited £2,000.

The description 'Loan' shows where the opposite entry for this transaction can be

found. Remember, the dual effect of bookkeeping means that for every debit entry

you make on the left, there will be an equal and opposite credit entry on the right.

By following the description 'Loan' to the loan account, you can find the opposite

entry. As the entry in the bank account was a debit entry of £2,000, you would

expect the entry in the loan account to be a credit entry of £2,000.

This is confirmed by the loan account, and you can check that the details agree. The

date and amount are the same, and the description of 'Bank' confirms where we can

find the corresponding entry.

Remember the rule that every debit entry has an equal and opposite credit entry.

This ensures that your balance sheet equation remains in balance, but it can also

help your learning. So long as you can decide which side of the relevant 'T' account

one entry goes, you know that the other entry must go on the opposite side of the

other account involved. Then all you need to decide is which account it is.

Now have a go at the two activities that follow.



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Activity three

Two weeks after paying the loan into her bank account, Lucy buys the new camera

to use in her business.

Lucy pays £1,900 for it on 15 August by cheque from the business bank account.

Record the entries in the appropriate 'T' accounts to reflect the purchase of the new

camera.

Bank

Dr Cr

1 August Loan £2,000

Camera

Dr Cr



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Response

Your 'T' accounts should look like this.

Bank

Dr Cr

1 August Loan £2,000 15 August Camera £1,900

Camera

Dr Cr

15 August Bank £1,900

The payment for the camera has come from the bank account. Golden rule number 3

tells you that to decrease an asset, such as a bank account balance, you need to

make a credit entry in that account. If you increase an asset, such as buying a new

camera, you must make a debit entry in that account. Golden rule number 2 has

also been complied with because for every debit entry there is an equal and opposite

credit entry.

As there wasn't a 'Camera' account at that time, you just need to prepare a new 'T'

account and name it appropriately. Make sure the name you give to the account is

reflected in the description entered in the account containing the opposite entry.

Activity four

On 20 August, Lucy receives an inheritance from her great aunt and decides to

introduce this into the business. So she deposits £5,000 into the business bank

account.

Record the entries in the appropriate 'T' accounts to reflect the introduction of the

money into the business.



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Response

Your 'T' accounts should look like this.

Bank

Dr Cr

1 August Loan £2,000 15 August Camera £1,900

20 Aug Capital £5,000

Capital

Dr Cr

20 Aug Bank £5,000

Lucy has deposited the inheritance in the business bank account. Golden rule

number 3 tells you that to increase an asset, such as a bank account balance, you

need to make a debit entry in that account. Lucy has invested £5,000 of her own

money into the business and has increased capital. Golden rule number 3 tells you

that to increase capital, you need to make a credit entry in that account. Golden rule

number 2 has also been complied with because for every debit entry there is an

equal and opposite credit entry.

As there wasn't a 'Capital' account at that time, you just need to prepare a new 'T'

account and name it appropriately. Make sure the name you give to the account is

reflected in the description entered in the account containing the opposite entry.



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4.3 Double-entry Bookkeeping – a Practical Example

In chapter 3 you considered the dual effect and balance sheet equation for Lance, a

mobile caterer. In this subchapter you'll see how to draw up his 'T' accounts.

The transactions are summarised below.

Date Transaction

1 April Invested £5,000 of his own money into a business bank account.

2 April Bought a van for £2,700 by cheque.

3 April Bought cooking equipment for £500 by cheque.

Withdrew £25 cash from the business bank account.

5 April Purchases of food and drink for £300 by debit card using the business bank

account.

Sales of £700 by cheque.

9 April Purchases of £550 by cheque.

Sales of £1,000 on credit to Readstone RFC.

15 April Purchases of £600 on credit from Cash and Carry Ltd.

Sales of £1,500 by cheque.

19 April Purchases of £300 on credit from Cash and Carry Ltd.

Sales of £750 on credit to Readstone RFC.

23 April Received cheque for £1,000 from Readstone RFC.

27 April Paid cheque for £600 to Cash and Carry Ltd.

28 April Placed an advert for £250 by cheque in the Readstone Gazette.

30 April Paid motor expenses of £80 by cheque.

Paid insurance of £120 by cheque.

Took out private drawings of £1,000 by cheque.

You saw the dual effect of these transactions and proved that the balance sheet

equation was satisfied in each case. You also found that it was a fairly laborious task

to carry out the balance sheet equation every time.



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One of the advantages of preparing 'T' accounts over the balance sheet equation, is

that it saves time. Once a 'T' account has been opened, you can start to build up

entries in it.

Using the transactions for Lance, summarised above, let's now consider how these

would be reflected in 'T' accounts.

Example

The first transaction carried out by Lance as a businessman was to invest £5,000 of

his own money into a business bank account.

You have seen that the dual effect of this transaction was as follows.

• Increase to current assets (bank), and

• Increase to capital.

The balance sheet equation at this stage was, therefore

Assets less Liabilities = Capital

Bank - £5,000 0 = £5,000

This transaction can be reflected by making bookkeeping entries in 'T' accounts, in

accordance with our golden rules of bookkeeping. You know that this transaction will

have both a debit and credit entry. By following the transaction grouping, you can

see that the capital introduced will be a credit entry. The opposite entry must be an

equal debit. In this case, Lance's business now has an asset, £5,000 in a bank

account.



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Therefore, the required bookkeeping entries are

Bank

Dr Cr

1 April Capital £5,000

Capital

Dr Cr

1 April Bank £5,000

Example

When Lance bought his new van on 2 April, the dual effect and balance sheet

equation looked like this.

Increase fixed assets - the van.

Decrease current assets – money in the bank.

The revised balance sheet equation was

Assets less Liabilities = Capital

Bank - £2,300 0

Van - £2,700 0

Total = £5,000 0 = £5,000

Again, let's consider how this transaction would be reflected in 'T' accounts.

The 'T' accounts concerned are 'Bank' and 'Van'. Both accounts are assets, so the

account that increases must have a debit entry and the account that decreases must

have a credit entry.



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The van account is clearly increasing and, as there is less money in the bank

account than there was before this transaction, that account must be decreasing.

Therefore the 'T' accounts would look like this.

Van

Dr Cr


Bank

Dr Cr

1 April Capital £5,000 2 April Van £2,700

As you can see, the bank 'T' account is starting to build up a picture of all

transactions that have gone through this account.

Activity five

Now complete 'T' accounts to record Lance's transactions on

3 April when he bought cooking equipment for £500 by cheque and withdrew £25

cash from the business bank account.

Remember that where an account has already been opened, such as bank, you

should continue to use it, so that you begin to build up a picture of all transactions

through that account.

Once you have completed this activity, check your answer with the response. You

should keep your workings, as you may need to refer to them again or expand on

them as the activities and examples progress.



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Response

The dual effect for the first transaction on 3 April was to

• increase fixed assets (equipment), and


The transaction would be reflected in the 'T' accounts as follows.

Cooking equipment

Dr Cr

3 April Bank £500

Bank

Dr Cr


3 April Cooking

equipment

£500

The dual effect for the second transaction on 3 April was to

• increase current assets (cash), and




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This transaction would be reflected in the 'T' accounts as follows.

Cash

Dr Cr

3 April Bank £25

Bank

Dr Cr


3 April Cooking

equipment

£500

3 April Cash £25

Both of these transactions represent movements in assets. Cash held in the bank is

a current asset. The cooking equipment is a fixed asset, and cash on hand is

another current asset.

The balance sheet equation is maintained by an increase in one asset being

balanced by a decrease in another.

Look at the transactions for Lance on 5 April. He purchased food and drink for £300

by debit card using the business bank account. Sales of £700 were paid for by

cheque.



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Example

The dual effect for the first transaction on 5 April was to

• increase purchases, and


This transaction is a purchase of goods for resale, so you'll need a purchases

account. Purchases are an expense, and golden rule number 3 tells you that to

increase an expense, you need to make a debit entry in the expense (purchases)

account.

This means that you already know that the opposite entry should be a credit entry.

The account affected is the bank account and, again, golden rule number 3 confirms

that to decrease an asset (bank), you should make a credit entry in that account.

This is the first purchase, so you need to draw up a new 'T' account, but you'll make

the entry for the bank account in the existing bank 'T' account.

Purchases

Dr Cr

5 April Bank £300

Bank

Dr Cr


3 April Cooking

equipment

£500

3 April Cash £25

5 April Purchases £300



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You don't need to check the dual effect and balance sheet equation for all

transactions. Once you're satisfied that you understand how the transactions

translate into 'T' account entries, all you need to show are the 'T' accounts.

Activity six

Now complete the bookkeeping entries to record the sales of £700 on 5 April, paid

for by cheque, and the purchase of £550 by cheque on 9 April, by either updating the

accounts you have already started to prepare or creating a new account if required.

Response

The bookkeeping entries required are

Sales

Dr Cr

5 April Bank £700

Bank

Dr Cr


5 April Sales £700 3 April Cooking

equipment

£500

3 April Cash £25





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Purchases

Dr Cr

5 April Bank £300

9 April Bank £550

The dual effect of the sale is to increase current assets (bank) and increase income.

You know from golden rule number 3 that an increase in assets is a debit entry, and

therefore the debit entry will be made in the bank 'T' account to reflect the increase in

the asset. From golden rule number 2, you also know that for every debit there must

be an equal and opposite credit. Therefore, the credit entry will be made in the sales

'T' account to reflect the increase in income.

The purchase is recorded in exactly the same way as before.

Example

The purchases on 9 April that you have just recorded resulted in sales of £1,000. On

this occasion, Lance didn't receive the money from Readstone RFC straightaway.

Instead, he agreed to allow them terms of up to 2 weeks to settle their bill.

The dual effect of this transaction is to increase income and increase current assets

(trade debtors).

A sale has been made, and golden rule number 3 confirms that income is a credit

entry in the income or sales account. The next step is to decide where to make the

debit entry.

No money has been received by Lance, so the debit entry isn't in either the bank or

the cash account.

However, the income that Lance has not yet received is an asset. Readstone RFC

owes Lance £1,000. They are a trade debtor, so to record the debit side of the

transaction a new account must be opened.



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Sales

Dr Cr

5 April Bank £700

9 April Readstone

RFC

£1,000

Readstone RFC (debtor)

Dr Cr

9 April Sales £1,000

You can see that by following the basic golden rules, the correct bookkeeping entries

can be made. Some bookkeepers may just open one account for all trade debtors,

rather than have a separate account for each individual debtor. Both methods are

acceptable. The important point is to ensure that the transactions are recorded on

the correct side of the accounts in question.

Activity seven

In the previous transaction, Lance made a purchase by cheque and a sale on credit.

On 15 April, the reverse happened; he made purchases of £600 on credit from Cash

and Carry Ltd and sales of £1,500 by cheque.

Complete the 'T' accounts required to record the transactions on 15 April.



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Response

The 'T' accounts should look like this.

Purchases

Dr Cr

5 April Bank £300

9 April Bank £550

15 April Cash &

Carry

Limited

£600

Cash & Carry Limited (creditor)

Dr Cr


Sales

Dr Cr

5 April Bank £700

9 April Readstone

RFC

£1,000




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Bank

Dr Cr



equipment

£500

15 April Sales £1,500 3 April Cash £25



The first bookkeeping entries required are for the purchases made on credit from

Cash & Carry Ltd. The dual effect of this transaction is to increase purchases and

increase current liabilities (trade creditors). The purchase can be debited in the

purchases account in the same way as the earlier purchases.

Unlike the earlier purchases, Lance hasn't paid for these yet, so the opposite credit

entry can't go into the cash or bank account.

Cash & Carry Ltd are a trade creditor of Lance's. He now owes money to this

supplier, and so his records need to reflect this outstanding liability. This is done by

opening an account in the supplier's name and making the opposite credit entry in

there.

As you saw with trade debtors, the bookkeeper may just open one account for all

trade creditors, rather than have a separate account for each individual creditor. The

important point is to ensure that the transactions are recorded on the correct side of

the accounts in question.

The second bookkeeping entries required are for the sales received by cheque. The

dual effect of this transaction is to increase income and increase current assets

(bank). The sale is credited to the sales 'T' account in the same way as earlier sales.

The opposite debit entry will be recorded in the bank 'T' account to reflect the

increase in current assets.



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Activity eight

Now update your 'T' account workings, or prepare new accounts as necessary, to

reflect the transactions that occurred on 19 April, which were purchases of £300 on

credit from Cash and Carry Ltd and sales of £750 on credit to Readstone RFC.

Response

Purchases

Dr Cr

5 April Bank £300

9 April Bank £550

15 April Cash &

Carry

Limited

£600

19 April Cash &

Carry

Limited

£300


Dr Cr




Dr Cr

9 April Sales £1,000

19 April Sales £750



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Sales

Dr Cr

5 April Bank £700

9 April Readstone

RFC

£1,000


19 April Redstone

RFC

£750

So far, you have looked at how to record investment of capital, expenditure on

assets, transfers of money between the bank account and cash account, and

purchases paid for at the time as well as on credit. You have also looked at the

bookkeeping entries required for sales by cheque and on credit. You'll now look at

what happens when a debtor makes a payment.

Example

On 23 April, Lance received a £1,000 cheque from Readstone RFC for the sale

originally made on 9 April.

When the original sale was recorded, a credit entry was made in the sales account,

with a corresponding debit entry in an account in the name of Readstone RFC.

So no new entry needs to be made in the sales account, but this time Lance has

received a cheque and this needs to be recorded in the bank account.



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The entries required in the 'T' accounts are as follows.

Bank

Dr Cr



equipment

£500


23 April Redstone

RFC

£1,000 5 April Purchases £300



Dr Cr

9 April Sales £1,000 23 April Bank £1,000

19 April Sales £750

The receipt of the cheque has been entered in the bank account as a debit entry

(increase an asset). The opposite entry is a credit entry (reduce an asset) in the

account for Readstone RFC.

Take a look at the account for Readstone RFC. You can see that Lance's debtor (an

asset) has been reduced, but another asset, the bank, has increased by the same

amount. This maintains the dual effect and balance sheet equation.

Activity nine

On 27 April, Lance paid £600 that he owed to Cash & Carry Ltd with a cheque. This

is a similar situation to the one with Readstone RFC. This time however, Lance has

made a payment to a creditor rather than received a payment from a debtor.

Update the necessary accounts to reflect this transaction.



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Response

The only accounts affected are the bank account, to record the payment and the

Cash & Carry Ltd creditor account, to reflect receipt of the payment. These are

shown below.

Bank

Dr Cr



equipment

£500


23 April Redstone

RFC



27 April Cash &

Carry Ltd

£600


Dr Cr

27 April Bank £600 15 April Purchases £600


The dual effect of this transaction is to decrease current liabilities (Cash and Carry

Ltd (creditor)) and decrease current assets (bank). You know from golden rule

number 3 that debit entries decrease liabilities. So the debit entry must be made in

the Cash & Carry Ltd trade creditor account. The opposite credit entry must be

shown in the bank 'T' account to reflect the decrease in the bank account.

Remember, the descriptions used should reflect the name of the account in which

the opposite entry will be located. They shouldn't be a description of what has



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happened. The credit entry in the bank account is described as Cash & Carry Ltd

(creditor) not purchases.

Activity ten

Now complete the bookkeeping entries for the remaining transactions.

On 28 April - placed an advert for £250 by cheque in the Readstone Gazette.

30 April - paid motor expenses of £80 by cheque, paid insurance of £120 by cheque

and took out private drawings of £1,000 by cheque.



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Response

Advertising

Dr Cr

28 April Bank £250

Bank

Dr Cr



equipment

£500


23 April Redstone

RFC



27 April Cash &

Carry Ltd

£600

28 April Advertising £250

30 April Motor

expenses

£80

30 April Insurance £120

30 April Drawings £1,000

Motor expenses

Dr Cr

30 April Bank £80

Insurance



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Dr Cr

30 April Bank £120

Drawings

Dr Cr


The first three transactions all have the dual effect of increasing expenses and

decreasing current assets (bank). You know from golden rule number 3 that debit

entries increase expenses. Therefore, the debit entry must be made in the relevant

expenses 'T' account. The corresponding credit entry will be made in the bank 'T'

account to reflect the decrease in the asset.

The dual effect for the final transaction is to increase drawings and decrease current

assets (bank). You know from the above example that decreases in cash are credit

entries. The corresponding debit entry must go to the drawings account. Golden rule

number 3 says that debit entries increase drawings. So you can be satisfied that

these entries have been accounted for correctly.

This is the end of the material in this chapter. The next stage will be to balance off

the accounts and prepare a trial balance. You'll look at this in the next chapter.

Now read the review and try the learning check that follows.



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Review

A 'single-entry' bookkeeping system is where you only make one entry to record a

business transaction. A typical example of this is a cash book.

A 'double-entry' bookkeeping system is where there are always two entries for each

transaction. Transactions are recorded in a systematic way using 'T' accounts. This

makes it easier to follow each business transaction and keep a closer control of

cash.

It's important that transactions are recorded in a systematic and efficient way. As the

number of bookkeeping transactions increases, it becomes even more important that

you are methodical, consistent and logical in your approach. Make sure each

transaction is fully dealt with before moving onto the next.

There are three golden rules of double-entry bookkeeping.

1. Transactions are recorded in 'T' accounts using recognised classifications. The

left-hand side is called debit and the right-hand side is called credit.

2. For every debit entry there is an equal and opposite credit entry. This ensures the

dual effect is maintained and the balance sheet equation balances.

3. The words 'increase' and 'decrease' are replaced with debit and credit, depending

on the classification of the transaction.

Debit entries increase expenses, assets and drawings (Dead).

Credit entries increase liabilities, income and capital (Clic).

If debit entries increase expenses, assets and drawings, then credit entries must

decrease expenses, assets and drawings.

Similarly, if credit entries increase liabilities, income and capital, then debit entries

must decrease liabilities, income and capital.




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Learning check

1. Correct the following statement.

Delete one of the bracketed words as appropriate to complete the following

statements.

All cashbooks are organised in a similar way, with the left-hand side being used to

record money (coming in / going out), and the right-hand side used to record

money (coming in / going out).

2. Complete the following phrase by adding a word at (enter here).

For every (enter here) there has to be an equal and opposite (enter here).

3. Complete the table below with the words increase or decrease in the spaces

provided in the Debit and Credit columns.


Expenses

Assets

Drawings

Liabilities

Income

Capital

4. On 26 July 2018, Joe purchased a new notebook in which to record his

transactions. He paid £3 in cash for this. Joe has decided to open a 'T' account

under the title 'stationery'.

Would the entry in the stationery 'T' account for the cost of this new notebook be a

Dr or Cr entry?



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5. Joe prepared the following 'T' accounts and has asked you to confirm that there

are no mistakes.

What is your response?

If any of the entries are incorrect, draw up the corrected 'T' accounts.

Cash

Dr £ Cr £

11 April Purchases 70 11 April Sales 90

Sales

Dr £ Cr £

11 April Cash 90

Purchases

Dr £ Cr £

11 April Cash 70



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6. Record the following transactions for Jamie in the relevant 'T' accounts.

Date Transaction

1 Jan Introduced £5,000 capital into the business bank account.

3 Jan Purchased plant and machinery using the business debit card costing

£3,000.

5 Jan Made purchases of goods for resale of £500 paid for using the business

debit card.

9 Jan Cash sales of £600.

10 Jan Sales of £300 on credit to Byron Ltd.

15 Jan Made purchases of goods for resale of £350 on credit from Cash Traders

Ltd.

20 Jan Took out private drawings by cheque of £200.

25 Jan Paid £200 by cheque to Cash Traders Ltd.

30 Jan Paid insurance of £110 using the business debit card.

31 Jan Received a cheque of £200 from Byron Ltd.



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1. Correct the following statement.

All cashbooks are organised in a similar way, with the left-hand side being used to

record money (coming in), and the right-hand side used for money (going out).


2. Complete this phrase - For every (enter here) there has to be an equal and

opposite (enter here).

Answer - For every Debit there has to be an equal and opposite Credit.

Or for every Credit there has to be an equal and opposite Debit.


3. Complete the table below with the words increase or decrease as appropriate.


Expenses Increase Decrease

Assets Increase Decrease

Drawings Increase Decrease

Liabilities Decrease Increase

Income Decrease Increase

Capital Decrease Increase


4. On 26 July 2018, Joe purchased a new notebook in which to record his

transactions. He paid £3 in cash for this. Joe has decided to open a 'T' account

under the title 'stationery'. Would the entry in the stationery 'T' account for the cost of

this new notebook be a Dr or Cr entry?



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It will be a debit entry. By purchasing the notebook, Joe has incurred expenditure.

Expenditure creates a debit entry in the appropriate expense account in the trader's

books (the credit entry will be in the cash 'T' account).


5. Joe prepared the following 'T' accounts and has asked you to confirm that there

are no mistakes. What is your response?

If any of the entries are incorrect, draw up the corrected 'T' accounts.

Joe has become slightly confused when recording purchases and sales.

Joe had to spend cash to buy fruit on the morning of

11 April. So the entry in the cash 'T' account for those purchases should be a credit

entry. The corresponding entry in the purchases 'T' account should be a debit entry.

Joe receives cash for goods sold and the entry in the cash

'T' account should be a debit entry. The corresponding entry in the sales 'T' account

should be a credit entry.

The correct entries should look as follows.

Cash

Dr £ Cr £

11 April Sales 90 11 April Purchases 70

Sales

Dr £ Cr £

11 April Cash 90



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Purchases

Dr £ Cr £

11 April Cash 70

Joe made two debit entries, £70 and £90, and two credit entries in equal amounts.

So the accounts would balance but the records are wrong as the entries are on the

wrong side.

This is in subchapters 4.2 and 4.3.

6. Record the transactions for Jamie in the relevant 'T' accounts.

Capital

Dr £ Cr £

1 Jan Bank 5,000

Bank

Dr £ Cr £

1 Jan Capital 5,000 3 Jan Plat &

Machinery

3,000

31 Jan Byron

Limited

200 5 Jan Purchases 500

20 Jan Drawings 200

25 Jan Cash

Traders

Limited

200

30 Jan Insurance 110



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Plant and machinery

Dr £ Cr £

3 Jan Bank 3,000

Purchases

Dr £ Cr £

5 Jan Bank 500

15 Jan Cash

Traders

Limited

350

Cash

Dr £ Cr £

9 Jan Sales 600

Sales

Dr £ Cr £

9 Jan Cash 600

10 Jan Byron

Limited

300

Byron Limited (debtors)

Dr £ Cr £

10 Jan Sales 300 31 Jan Bank 200



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Cash Traders Limited (creditors)

Dr £ Cr £

25 Jan Bank 200 15 Jan Purchases 350

Drawings

Dr £ Cr £

20 Jan Bank 200

Insurance

Dr £ Cr £

30 Jan Bank 110




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Before moving on



can see below.

Learning outcomes

You will


Study objectives


• state the differences between single and double- entry bookkeeping systems

• explain the three golden rules of double-entry bookkeeping

• record transactions in a double-entry bookkeeping system.



confident that you have achieved them before moving on. There is also a space for

you to note any points you might want to discuss with your line manager or tutor.



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Chapter 5 Financial Accounts Preparation

Introduction

In this chapter, you'll see how to balance off accounts at the end of a period of

trading. You'll consider the purpose of a trial balance and the stages involved in

closing the various accounts.

You'll then see how these processes help you to prepare the financial accounts. The

same principles apply whether you're looking at a sole trader, partnership or

company.

The purpose of the trading and profit and loss account is to establish whether a

business has made a profit or loss over a given period. You'll look at how to prepare

a trading and profit and loss account.

Finally, you'll consider the importance of the balance sheet, how it's prepared and

how certain transactions affect it.



chapter.

Learning outcomes

You will

• be able to prepare the initial financial accounts of a sole trader.

Study objectives


• demonstrate how to draw up a trial balance

• demonstrate how to close off the various accounts at a period end



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• prepare a trading and profit and loss account and balance sheet.

Study advice


Reading main text - 2hrs 25m, completing activities and the learning check - 2hrs

25m, Total - 4hrs 50m





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5.1 The Trial Balance

You can spend a lot of time preparing financial accounts and you can lose even

more time if they don't balance (in other words the balance sheet equation doesn't

balance: assets less liabilities do not equal capital). One of the main reasons for this

could be an error in recording transactions in 'T' accounts.

To avoid this, accountants prepare a trial balance before preparing the financial

accounts. The first stage in preparing a trial balance is to calculate the balance on

each 'T' account and you'll look at this next.

5.1.1 Balancing 'T' accounts

Balancing means adding up both sides of a 'T' account and checking that they agree.

Accounts are balanced for a number of reasons, including

• to establish the amount outstanding or accumulated at any particular time.

For example, the total on a sales account indicates the amount of sales a

business made in a financial period

• as a start to preparing a trading and profit and loss account, and a balance

sheet.

Example

Lucy's Bank 'T' account at the end of August showed the following transactions.

Bank

Dr £ Cr £

1 August Loan 2,000 15 August Camera 1,900

20 August Capital 5,000 20 August Purchases 550

20 August Sales 3,500 21 August Electricity 20

25 August Sales 750 28 August Telephone 25



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To balance off this account, Lucy will need to follow these steps.

1. Total up the entries on each side of the 'T' account to establish which side has the

highest amount. Take the largest figure and enter this as the total on both the debit

and credit sides.

2. Now deduct the smallest total from the largest. The difference is the balance.

Enter this on the side of the

'T' account which had the smallest total so that both sides of the account now

balance.

3. This entry is described as 'Balance c/d' or 'Balance c/f', which means balance

carried down or carried forward.

4. If the balance c/d is an entry on the credit side of the 'T' account, the opposite

entry will be a 'balance b/d' (brought down) or 'balance b/f' (brought forward) on the

debit side of the 'T' account. This is entered below the total figure showing the total

of the debit entries. Similarly, if the balance c/d is an entry on the debit side of the 'T'

account, the opposite entry will be a 'balance b/d' or 'balance b/f' on the credit side of

the account. This is entered below the total figure showing the total of the credit

entries. This maintains golden rule number 2 – for every debit there is an equal and

opposite credit.

Balance brought down dates

The convention used in this SSM is that 'T' accounts for assets and liabilities, which

will be reflected in the balance sheet, show the start of the following accounting

period as the balance brought down date.

So for accounts for the year ending 31 December 2019, the balance brought down

date for 'T' accounts for assets and liabilities would be 1 January 2020.

For income and expenditure (such as sales and purchases), which will go in the

trading and profit and loss account, the balance brought down date is the end of the

current accounting period.



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date for 'T' accounts for income and expenditure would be 31 December 2018.

The balance brought down date for the drawings account is the end of the current

accounting period.


date for the drawings account would be 31 December 2018.

The balance brought down date for the capital account may be either the end of the

current accounting period or the start of the next. You may start off as the end of the

current accounting period before you include the entries for drawings, net profit and

capital introduced. Once you've included these, the balance brought down date will

change to the date of the start of the next accounting period (like any other liability).

Balancing 'T' accounts is easier to demonstrate by example.

If Lucy's Bank 'T' account was balanced on 31 August it would look like this.

Bank

Dr £ Cr £

1 August Loan 2,000 15 August Camera 1,900

20 August Capital 5,000 20 August Purchases 550

20 August Sales 3,500 21 August Electricity 20

25 August Sales 750 28 August Telephone 25

31 Aug Bal c/d

(2 & 3)

8,755

(1) 11,250 (1) 11,250

1 Sept Bal b/d (4) 8,755



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The additional entries have been made in bold. The figures in brackets indicate

which of the steps from the earlier page has been used.

The balance on an account is described as a credit balance or a debit balance

depending on which side of the account the balance is shown at the start of the

following period. For example, Lucy's bank 'T' account has a debit balance brought

down of £8,755 on 1 September because the opening balance on the account in the

following period will be on the debit side.

Another way of thinking about whether the balance should be described as a debit or

credit balance is to consider which side of the account is the highest. If debits

exceed credits, the balance on the account is a debit balance and if credits exceed

debits, the balance on the account is a credit balance.

It may help you if you remember 'Dead Clic' again (take the first letter of the key

words in the next two sentences)

• a debit balance for expenses, assets or drawings

• a credit balance for liabilities, income or capital.

All individual accounts are balanced in the same way. All accounts must be balanced

correctly if accurate trading and profit and loss accounts and balance sheets are to

be prepared.

Because all accounts are balanced in much the same way, the process can become

monotonous. So you must be consistent and methodical in your approach to the

task.



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Example

In chapter 4 you prepared individual accounts for Lance for his capital, bank, van,

cooking equipment, cash, purchases, sales, Readstone RFC, Cash & Carry Ltd,

advertising, motor expenses, insurance and drawings.

At the end of April Lance decides to review his business performance for the first

month of trading. To do this he needs to start by balancing off all the accounts he

has opened so far.

The first two accounts that he opened were the capital and bank accounts so start

with these.

Bank

Dr £ Cr £

30 Apr Bal c/d

(2 & 3)

5,000 1 Apr Bank 5,000

(1) 5,000 (1) 5,000

30 Apr Bal b/d (4) 5,000

Add up both sides of the account and insert a balancing figure on the smallest side

to make sure they add up to the same amount.

This figure is then brought down to the opposite side of the account.



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Let's see how Lance's bank account, which has more entries, would be balanced.

Bank

Dr £ Cr £

1 Apr Capital 5,000 2 Apr Van 2,700

5 Apr Sales 700 3 Apr Cooking

Equipment

500

15 Apr Sales 1,500 3 Apr Cash 25

23 Apr Readstone

RFC

1,000 5 Apr Purchases 300

9 Apr Purchases 550

27 Apr Cash & Carry

Ltd

600

28 Apr Advertising 250

30 Apr Motor

Expenses

80

30 Apr Insurance 120

30 Apr Drawings 1,000

30 Apr Bal c/d

(2 & 3)

2,075

(1) 8,200 (1) 8,200

1 May Bal b/d (4) 2,075

To balance the bank account both the debit and credit side entries need to be

totalled. The debit entries total £8,200 and the credit entries £6,125. As debits



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exceed credits this immediately says that the balance on this account will be a debit

balance. In other words, an entry needs to be made on the credit side to balance the

account and this balance will be brought down to the debit side.

Remember it's the side to which the balance is brought down that dictates whether

it's known as a debit or credit balance.

Both sides need to add up to £8,200. To achieve this, make a credit entry of £2,075,

which is then carried down. As you have seen this is brought down as a debit

balance.

It's worth checking whether the balances brought down are as you would expect.

The capital account has a credit balance and so will be shown as a liability in the

financial accounts, meaning the business owes Lance £5,000. This is how much

Lance has put into the business and so he is due this amount back at some point. In

the circumstances, you would expect the capital account to have a credit balance.

Similarly more money has been paid into the business bank account than has been

withdrawn, so you would expect the bank account balance to be an asset of the

business. This is confirmed by the debit balance on the bank 'T' account.

Now try the next activity.



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Activity one

Now balance the van, cooking equipment and cash accounts for Lance. In each case

consider whether it's a debit or credit balance brought down and whether this is what

you would expect.

Van

Dr £ Cr £

2 Apr Bank 2,700

Cooking equipment

Dr £ Cr £

3 Apr Bank 500

Bank

Dr £ Cr £

3 Apr Bank 25



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Response

Here are the balanced accounts.

Van

Dr £ Cr £

2 Apr Bank 2,700 30 Apr Bal c/d

(2 & 3)

2,700

(1) 2,700 (1) 2,700

1 May Bal b/d (4) 2,700

Cooking equipment

Dr £ Cr £

3 Apr Bank 500 30 Apr Bal c/d

(2 & 3)

500

(1) 500 (1) 500

1 May Bal b/d (4) 500

Bank

Dr £ Cr £


(2 & 3)

25

(1) 25 (1) 25

1 May Bal b/d (4) 25

All of the accounts have debit balances, and all are assets so this is what you would

expect.



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Example

The next account to be balanced is purchases. Purchases are an expense of the

business and so you would expect the balance to be a debit balance.

The balanced account is as follows.

Purchases

Dr £ Cr £

5 Apr Bank 300

9 Apr Bank 550

15 Apr Cash &

Carry

Limited

600

19 Apr Cash &

Carry

Limited

300 30 Apr Bal c/d

(2 & 3)

1,750

(1) 1,750 (1) 1,750

30 Apr Bal b/d (4) 1,750

The account has a debit balance as expected. As purchases will go into the trading

account, the balance brought down date is 30 April (the end of the accounting

period).

Try the activity that follows.



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Activity two

You have seen what the purchases account looks like once it has been balanced.

Sales are, essentially, the opposite of purchases and so you would expect this to be

reflected in the accounts. Balance the sales account for April.

Sales

Dr £ Cr £

5 Apr Bank 700

9 Apr Read RFC 1,000

15 Apr Bank 1,500

19 Apr Read RFC 750



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Response

Sales

Dr £ Cr £

5 Apr Bank 700

9 Apr Read RFC 1,000

15 Apr Bank 1,500

30 Apr Bal c/d 3,950 19 Apr Read RFC 750

3,950 3,950

30 Apr Bal b/d 3,950

The balance on the sales account is a credit balance. This is opposite to the

purchases account and is exactly what you would expect.

Example

The accounts for Readstone RFC and Cash & Carry Ltd does need to be balanced

and this is done in the same way as all the other accounts.

Readstone RFC

Dr £ Cr £

9 Apr Sales 1,000 23 Apr Bank 1,000

19 Apr Sales 750 30 Apr Bal c/d 750

1,750 1,7507

1 May Bal b/d 750



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Cash and Carry Limited

Dr £ Cr £

27 Apr Bank 600 15 Apr Purchases 600

30 Apr Bal c/d 300 19 Apr Purchases 300

900 900

1 May Bal b/d 300

The debit balance on the Readstone RFC accounts shows that they are a debtor of

Lance's business and owe them £750.

The credit balance on the account confirms that

Cash & Carry Ltd will be a creditor of Lance's business. He still owes them £300 for

purchases made during April for which payment has not yet been made.

Now balance the 'T' accounts in the next activity.



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Activity three

There are now only four accounts that need to be balanced.

These are the accounts for advertising, motor expenses, insurance and drawings.

Balance each account off as at 30 April.

Advertising

Dr £ Cr £

28 Apr Bank 250

Motor expenses

Dr £ Cr £

30 Apr Bank 80

Insurance

Dr £ Cr £

30 Apr Bank 120



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Drawings

Dr £ Cr £

30 Apr Bank 1,000



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Response

Advertising

Dr £ Cr £


(2 & 3)

250

(1) 250 (1) 250

30 Apr Bal b/d (4) 250

Motor expenses

Dr £ Cr £


(2 & 3)

80

(1) 80 (1) 80

30 Apr Bal b/d (4) 80

Insurance

Dr £ Cr £


(2 & 3)

120

(1) 120 (1) 120

30 Apr Bal b/d (4) 120



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Drawings

Dr £ Cr £

30 Apr Bank 1,000 30 Apr Bal c/d

(2 & 3)

1,000

(1) 1,000 (1) 1,000

30 Apr Bal b/d (4) 1,000



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5.1.2 Preparation and presentation of a trial balance

The purpose of the trial balance is to check the arithmetical accuracy of the double

entry bookkeeping system. This is a key advantage of a double entry system

compared to a single entry system.

The trial balance is extracted by following three basic steps.

1. Balance all 'T' accounts to a particular date. Usually this is at the end of a

financial period, but it can be more regularly, for example on a monthly basis.

2. Extract the balances from the 'T' accounts and list all the debit balances in one

column of the trial balance and the credit balances in another.

3. Add up both columns. The totals should agree, and the accountant will then go on

to prepare the financial accounts.

If the totals don't agree then there's a problem. The accountant will need to carry out

remedial work in order to achieve a balance.

Remember that a debit balance is one that's brought down to the debit (left) side

and a credit balance is one that's brought down to the credit (right) side of the

'T' account. So when you prepare a trial balance the entries

in the debit column will be from 'T' accounts with a debit balance brought down and

entries in the credit column will be from 'T' accounts with a credit balance brought

down.



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Example

Here is an example of what a typical trial balance could look like.

Trial balance 2018

Description Dr Cr

Capital £30,000

Cash £250

Bank overdraft £2,250

Purchases £185,000

Sales £320,000

Debtors £39,000

Creditors £6,500

Loan £10,000

Motor vehicles £76,000

Wages £18,600

Rent and rates £10,000

Stationery £575

Motor expenses £5,750

Insurance £1,000

Drawings £32,575

Totals £368,750 £368,750

Some accountants may use a four-column approach to distinguish between the

trading and profit and loss account and balance sheet entries as shown on the next

page.



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Trial balance as at 31 December

Description Trading and profit and loss account

Balance sheet

Dr Cr Dr Cr Capital £30,000 Cash £250

Bank overdraft £2,250

Purchases £185,000 Sales £320,000

Debtors £39,000

Creditors £6,500 Loan £10,000

Motor vehicles £76,000

Wages £18,600

Rent and rates £10,000

Stationery £575 Motor expenses £5,750

Insurance £1,000

Drawings £32,575

Totals £220,925 £320,000 £147,825 £48,750

In this example, the sum of the debit entries (£220,925 and £147,825) still equals the

sum of the credit entries (£320,000 and £48,750).

You can often anticipate whether an account is likely have a debit or credit balance.

For example, cash on hand can never be a negative figure. Either you have some

cash on hand or you have nothing. So if there is cash on hand, it will always be a

debit balance on the cash on hand account.

One account that you can't anticipate as a debit or credit balance is the bank

account. If there are funds in the account, it is an asset and it will have a debit

balance. If the account is overdrawn, it will be a liability and therefore have a credit

balance.

Now you have balanced all of the 'T' accounts for Lance you can prepare a trial

balance for him as at 30 April.



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Activity four

The trial balance for Lance as at 30 April has been started below.

Use the balances from the 'T' accounts you have already prepared to complete the

trial balance.

Trial balance as at 30 April

Description Dr Cr

Capital £5,000

Bank

Van

Cooking equipment £500

Cash £25

Purchases

Sales

Cash & Carry Ltd

Readstone RFC

Advertising £250

Motor expenses

Insurance

Drawings

Totals £9,250



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Response

Here is the completed trial balance.

Description Dr Cr

Capital £5,000

Bank £2,075

Van £2,700


Cash £25

Purchases £1,750

Sales £3,950

Cash & Carry Ltd £300

Readstone RFC £750

Advertising £250

Motor expenses £80

Insurance £120

Drawings £1,000

Totals £9,250 £9,250

If your trial balance didn't balance go back and note alongside each figure in the

activity whether it's a debit or credit balance brought down. Then check that you

have included it on the correct side of your trial balance.

The trial balance is the starting point in the production of financial accounts for a

business. However, you also need to consider how to close off the various 'T'

accounts at the end of a period. You'll look at this in the next subchapter. But before

then let's look at what may happen when the person who's prepared the 'T' accounts

and/or the trial balance finds out that although the totals of the debit and credit

columns may agree, data has been omitted from the 'T' accounts or entered

incorrectly.

The accountant may correct these when they draw up an extended trial balance.

You'll look at this in the manual Bookkeeping – Extended Trial Balance.

Alternatively they could redo the relevant 'T' accounts and amend the trial balance to

include the revised balances. Let's look at an example of this.



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Example

Rashmi's bookkeeper has prepared the trial balance at the end of the accounting

period, but she then realises that bank charges of £45 have not been recorded in the

business records or the relevant 'T' accounts.

The bookkeeper draws up a 'T' account for bank charges and amends the Bank 'T'

account. She then includes the revised balances for these 'T' accounts in the trial

balance. In this case, the totals of the debit and credit columns will remain the same

because whilst the balance for one debit entry (bank) has decreased, another (bank

charges) has increased by the same amount.

Original trial balance

Description Dr Cr Capital £499

Bank £1,237

Van £3,700

Cash £25

Purchases £1,699

Sales £22,650


Drawings £15,000

Totals £23,149 £23,149

Bank charges

Dr £ Cr £

Bank 45 Bal c/d 45

45 45

Bal b/d 45



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Revised Bank

Dr £ Cr £

Bal b/d 1,700

Expenditure 23,113

Income 22,650 Bank

charges

45

Bal c/d 1,192

24,350 24,350

Bal b/d 1,192

Revised trial balance

Description Dr Cr Capital £499

Bank £1,192

Bank changes £45

Van £3,700

Cash £25

Purchases £1,699

Sales £22,650


Drawings £15,000

Totals £23,149 £23,149



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5.2 Closing the 'T' Accounts

Once the trial balance has been drawn up and you're satisfied that it balances, the

next stage would be to deal with any year-end adjustments such as accruals and

prepayments or depreciation. These adjustments are considered in the manual

Bookkeeping – Accounting Standards and Year End Adjustments.

Once these adjustments are made, the next step is to close off the 'T' accounts so

that the financial accounts can be prepared.

• Any accounts which show income and expenditure are cleared by

transferring the balance on the account to the trading and profit and loss

account. Finally, the balance on the drawings account and the trading

and profit and loss account are cleared by transferring the balances to the

capital account.

The capital account is then balanced off in exactly the same way as you saw in

subchapter 5.1 and the remaining balance is transferred to the balance sheet.

It's brought down to the start of the following accounting period in the same way as

any other liabilities. You'll now consider each of these steps in more detail.



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5.2.1 Income and expenditure accounts

Let's see how Lance would close off his income and expenditure 'T' accounts.

Lance's sales account would be closed as follows.

Sales

Dr £ Cr £

5 Apr Bank 700

9 Apr Readstone

RFC

1,000

15 Apr Bank 1,500

30 Apr Bal c/d 3,950 19 Apr Readstone

RFC

750

3,950 3,950

30 Apr To Trading

A/c

3,950 30 Apr Bal b/d 3,950

3,950 3,950

The balance on the sales account will be cleared and transferred to the trading

account, the accounting entries being debit sales account £3,950, credit trading

account £3,950.

The trading profit and loss account continues to follow the double-entry bookkeeping

principles. The trading profit and loss account is another 'T' account and could be

presented as such.

We've included some examples of this in the following pages but you're unlikely to

see it in practice and you should normally prepare the trading account, profit and

loss account and balance sheet from the trial balance that you'll see described

shortly.



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Trading and profit and loss account

Month ended 30 April

Dr £ Cr £

Sales 3,950

Lance's purchases account would be closed in a similar manner.

Purchases

Dr £ Cr £

5 Apr Bank 300

9 Apr Bank 550

15 Apr Cash &

Carry Ltd

600

19 Apr Cash &

Carry Ltd

300 30 Apr Bal c/d 1,750

1,750 1,750

30 Apr Bal b/d 1,750 30 Apr To Trading

A/c

1,750

1,750 1,750



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The balance on the purchases account will be cleared and transferred to the trading

account, the accounting entries being

• debit trading account £1,750

• credit purchases account £1,750

The revised trading and profit and loss account 'T' account would now look as

follows.



Dr £ Cr £

Purchases 1,750 Sales 3,950

Activity five

Lance still has three income and expenditure accounts that need to be closed off.

These are the accounts for advertising, motor expenses and insurance.

Close off each account as at 30 April and transfer the balance to the trading and

profit and loss 'T' account.

Advertising

Dr £ Cr £

28 Apr Bank 250 30 Apr Bal c/d 250

250 250

30 Apr Bal b/d 250



OFFICIAL

Motor expenses

Dr £ Cr £


80 80

30 Apr Bal b/d 80

Insurance

Dr £ Cr £


120 120

30 Apr Bal b/d 120



OFFICIAL



Dr £ Cr £


Response

The closed accounts are shown below.

Advertising

Dr £ Cr £


250 250

30 Apr Bal b/d 250 30 Apr To P & L 250

250 250

Motor expenses

Dr £ Cr £


80 80


80 80



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Insurance

Dr £ Cr £


120 120


120 120

The completed trading and profit and loss 'T' account is as follows.



Dr £ Cr £


Advertising 250

Motor expenses 80

Insurance 120



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5.2.2 Asset and liability accounts

Assets and liabilities are shown on the balance sheet. Remember that the balance

sheet is a snapshot of the business assets, liabilities and capital at a particular

moment in time.

In Activity one, you balanced off Lance's cash account (asset) at 30 April. This

looked as follows.

Cash

Dr £ Cr £


25 25

1 May Bal b/d 25

The cash on hand (asset) of £25 as at 30 April will still exist on 1 May. It doesn't

disappear; it will be the opening balance for the next accounting period starting on 1

May.

The same can be said of Lance's liabilities. As at midnight on 30 April, Lance owes

£300 to the Cash and Carry Ltd.

He will still owe the Cash and Carry Ltd £300 as at 1 minute past midnight on 1 May.

This will be the opening balance for the next accounting period commencing on 1

May.



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5.2.3 Capital and drawings accounts

In subchapter 5.1, the capital and drawings accounts were balanced off. These

looked as follows.

Capital

Dr £ Cr £

30 Apr Bal c/d 5,000 1 Apr Bank 5,000

5,000 5,000

30 April Bal b/d 5,000

Drawings

Dr £ Cr £

30 Apr Bank 1,000 30 Apr Bal c/d 1,000

1,000 1,000


In chapter 1 you learned that the capital account as shown on the balance sheet is

made up of the following components.

At the moment, Lance's capital 'T' account shows opening capital of nil (as it was the

first year of trading) and capital introduced of £5,000. However, it doesn't yet show

the drawings or the overall profit or loss for the period.



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Drawings

The balance on the drawings account needs to be cleared and transferred to the

capital account.

The accounting entries required to close the drawings account are debit capital

account £1,000, credit drawings - £1,000.

The capital and drawings 'T' accounts will now look as follows.

Capital

Dr £ Cr £


5,000 5,000

30 Apr Drawings 1,000 30 April Bal b/d 5,000

Drawings

Dr £ Cr £


1,000 1,000

30 Apr Bal b/d 1,000 30 Apr To Capital 1,000

1,000 1,000



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In activity five, you transferred all of the balances on the income and expenditure 'T'

accounts to the trading and profit and loss 'T' Account.

This looked as follows.



Dr £ Cr £


Advertising 250

Motor expenses 80

Insurance 120

The balance on the trading and profit and loss account needs to be closed off and

transferred to the capital account.

The accounting entries required to close off the trading and profit and loss account

are as follows.

If an overall profit for the period has been made

• debit trading and profit and loss account

• credit capital

or

if an overall loss for the period has been made

• debit capital

• credit trading and profit and loss account.



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The capital and trading and profit and loss 'T' accounts will now look as follows.



Dr £ Cr £


Advertising 250

Motor expenses 80

Insurance 120

Net profit – to

Capital A/c

1,750

3,950 3,950

Capital

Dr £ Cr £


5,000 5,000


30 Apr T P & L 1,750

As Lance has made a net profit for the year, you can see that the accounting entries

required to close off the trading and profit and loss account are

• debit trading and profit and loss account

• credit capital.



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Capital

Now that you have closed off both the drawings account and the trading and profit

and loss account, all that remains is to balance off the capital account.

The capital account is balanced off in exactly the same way as you have learned in

subchapter 5.1.

Remember that capital is shown on the balance sheet, which is a snapshot of the

business assets, liabilities and capital at a particular moment in time.

In the same way as for asset and liability accounts, the closing capital account

balance as at 30 April will still exist on 1 May. It doesn't disappear and it will be the

opening balance for the next accounting period starting on 1 May.

Activity six

Now balance off the capital account.

Capital

Dr £ Cr £


5,000 5,000


30 Apr T P & L 1,750



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Response

The capital account will now look as follows.

Capital

Dr £ Cr £


5,000 5,000


30 Apr Bal c/d 5,750 30 Apr T P & L 1,750

6,750 6,750

1 May Bal b/d 5,750



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5.3 Financial Accounts Preparation

You can now prepare the financial accounts using the information from the trial

balance and the 'T' accounts.

The financial accounts show how profitable the business has been, what the

business owns and how it's financed.

As you saw in chapter 1, financial accounts include the trading and profit and loss

account and the balance sheet.

Here is Lance's trial balance again from activity four. However, this time each entry is

noted to show where each balance features in the financial accounts.

Description Dr Cr

Capital (balance sheet) £5,000

Bank (balance sheet) £2,075

Van (balance sheet) £2,700

Cooking equipment (balance sheet) £500

Cash (balance sheet) £25

Purchases (trading account) £1,750

Sales (trading account) £3,950

Cash & Carry Ltd (balance sheet) £300

Readstone RFC (balance sheet) £750

Advertising (profit & loss account) £250

Motor expenses (profit & loss account) £80

Insurance (profit & loss account) £120

Drawings (balance sheet) £1,000

Totals £9,250 £9,250

The first stage is to prepare the trading account.



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5.3.1 Trading account

The trading account is the top part of the account, down to gross profit.

Lance's trading account should look like this.

Trading account Month ended 30 April

Description Dr Cr

Sales £3,950

Less cost of sales

Opening stock 0

Add purchases £1,750

Sub-total £1,750

Less closing stock (0)

Total (£1,750)

Gross profit £2,200

The only significant differences between Lance's trading account and those you're

most likely to see in practice is that no stock has been included. As this is Lance's

first period of trading he didn't have any opening stock. As all of his purchases were

used in the period, he had no closing stock either. So there's no opening or closing

stock to be included in the trading account. Stock is considered in more detail in the

manual Bookkeeping – Accounting Standards and Year End Adjustments.

You can see that the trading account is essentially in two columns, just like the trial

balance. The trial balance is prepared to help the preparation of the trading and

profit and loss account. The figures are therefore extracted from the trial balance and

entered on the same side of the trading account as they appear in the trial balance.

The credit entry for sales is extracted from the trial balance and included as a credit

entry in the trading account. Similarly, purchases is a debit entry in the trial balance

and appears as a debit entry in the trading account.



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5.3.2 Profit and loss account

The profit and loss account shows the remaining business expenses, often called

overheads or indirect costs, to be deducted from the gross profit computed in the

trading account.

Activity seven

Use Lance's trial balance (above) to complete the trading and profit and loss

account.

Description Dr Cr

Sales £3,950

Less cost of sales

Opening stock 0


Sub-total £1,750


Total (£1,750)




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Response

Lance's completed trading and profit and loss account should look like this.

Trading and profit and loss account Month ended 30 April

Description Dr Cr

Sales £3,950

Less cost of sales

Opening stock 0


Sub-total £1,750


Total (£1,750)


Advertising £250

Motor expenses £80

Insurance £120 (£450)

Net profit £1,750

As you saw earlier, the trading and profit and loss account continues to follow the

double entry bookkeeping principles. You could present it as another 'T' account.

However, in practice, the trading profit and loss account is more likely to be

presented in the above format.

All of the debit entries for expenditure in the trial balance are debit entries in the

profit and loss account.

Because Lance's first month of trading didn't involve a large number of transactions,

his profit and loss account is small and straightforward. However, you apply exactly

the same process to preparing the profit and loss account regardless of the amounts

involved, or the number of accounts listed in the trial balance.



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Grouping expenditure

As the number of entries increases, businesses will often group their expenses

under broad headings when preparing final accounts. This will certainly be the case

with company accounts. Company accounts are considered in more detail in the

manual Bookkeeping – Financial Accounting for Limited Companies.

The headings you're most likely to see are things such as

• property expenses

• administrative expenses

• selling and distribution expenses

• financial expenses.

A typical profit and loss account will contain most of these elements but may simply

list them without categorising them under the above expense headings.

Some businesses may class a certain type of expense differently to other

businesses. For example, insurance could be a property, an administrative or a

motor expense. It depends on the nature of the insurance and the nature of the

business.

Grouping expenditure in this way makes the accounts easier to follow. There are no

hard and fast rules, but the following example provides an indication of a common

layout you may expect to see.



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Example

The following is a list of income and expenditure to go into the trading and profit and

loss account for Malcolm's Motorbike Shop.

Year ending 31 March 2019

Description £

Purchases £71,000

Salaries £18,000

Sales £134,000

Rent £10,000

Rates £7,500

Insurance £3,500

Bank overdraft interest £1,000

Heat and light £2,000

Telephone £1,500

Advertising £1,000

Bank charges £500

Marketing £1,500

Stationery and postage £1,000

The trading and profit and loss account, based on the information provided, is shown

on the next page.

Note that Malcolm's stock on hand as at 1 April 2018 was £2,300 and at 31 March

2019 it's £2,600.



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Trading and profit and loss account Year ended 31 March 2019

Description £

Turnover £134,000

Less cost of sales

Opening stock £2,300

Purchases £71,000

Closing stock £2,600

Sub-total (£70,700)


Rent £10,000

Rates £7,500

Insurance £3,500


Salaries £18,000

Telephone £1,500


Advertising £1,000

Marketing £1,500

Bank charges £500



Net profit £15,800



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The net profit figure is easy to identify but the nature of all of the expenses may not

be. This can be made easier by formatting the profit and loss account to include sub-

headings for particular groups of expenditure as follows.

Trading and profit and loss account Year ended 31 March 2019

Description £

Turnover £134,000

Less cost of sales


Purchases £71,000




Less overheads

Property expenses

Rent £10,000

Rates £7,500

Insurance £3,500


Administrative expenses

Salaries £18,000

Telephone £1,500


Selling and distribution costs

Advertising £1,000

Marketing £1,500

Financial expenses

Bank charges £500


(£47,500)

Net profit £15,800



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There would be nothing wrong with just listing the various expenses after the entry

for gross profit but, as you can see, separating them can make reviewing the

accounts easier. This is clearly even more important as the number of entries

increases.

5.3.3 The balance sheet

As you saw in the previous subchapter, income and expenditure balances from the

trial balance are taken to the trading and profit and loss account and used to

compute the profit or loss for the period.

The remaining trial balance entries relate to assets, liabilities, capital and drawings –

these items are all taken to the balance sheet.

The balance sheet in any business should, at a given date, reflect

• the value of resources owned by the business – assets, and

• the value of amounts owed by the business – liabilities and capital.

The balance sheet is a 'snapshot' of the business' financial position at the date it's

drawn up.



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The format of the balance sheet

In chapter 1, you were introduced to the format and content of a balance sheet.

We've reproduced an outline of a typical balance sheet below.

Balance sheet as at 31 December 2018

Description £

Fixed assets

Fixtures and fittings £1,000

Current assets

Closing stock £150

Cash £100

Bank £250

Sub-total £500

Less current liabilities

Trade creditors (£400)

Net current assets £100

Total assets less current liabilities £1,100


Bank loan (£400)

Net assets £700

Capital account

Balance b/f £600

Add net profit for the year £300

Add capital introduced £100

£1,000

Less drawings (£300)

Closing capital £700

In chapter 3 you learned that the balance sheet equation is

Assets less liabilities equals capital

This is demonstrated above.



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The capital account on the balance sheet

The majority of the balance sheet is essentially a summary of outstanding account

balances at the balance sheet date. So in the example above the figure of £1,000 for

fixtures and fittings represents the balance brought down on the fixtures and fittings

'T' account at 31 December 2018.

The capital account, however, is shown differently. The details included for the

capital account represent a summary of the movements on the account for the

period. It's the capital 'T' account in a linear format.

In the above example the capital account would look like this if it was presented in a

normal 'T' account format.

Capital account

Dr £ Cr £

31 Dec

2018

Bal b/d 600

31 Dec

2018

Drawings 300 31 Dec

2018

Net profit 300

31 Dec

2018

Capital

introduced

100

31 Dec

2018

Bal c/d 700

1,000 1,000

1 Jan 2019 Bal b/d 700

The capital account follows the double entry bookkeeping principles you have

already learned. The entry for drawings is the equal and opposite entry to balance

the credit entry in the drawings account.

Drawings are not a business expense but a withdrawal of capital. So the net figure

of drawings is included in the capital account and is deducted from any balance

brought forward.



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In subchapter 5.2 you saw how the trading and profit and loss account would look if it

was drawn up as a 'T' account. The net profit was entered on the debit side to

balance the account. The equal and opposite entry for net profit is the credit entry in

the capital account. This entry, therefore, clears the trading and profit and loss

account. There is no balance to carry down on this account and the next period

starts afresh.

The closing balance on the capital account of £700 will be carried forward to the

following accounting period.

In subchapter 5.2 you closed the capital account for Lance by transferring both the

balance on the drawings 'T' account and the trading and profit and loss 'T' account to

the capital 'T' account. Lance's completed capital 'T' account has been reproduced

below.

Capital

Dr £ Cr £


5,000 5,000

30 Apr Drawings 1,000 30 Apr Bal b/d 5,000

30 Apr Bal c/d 5,750 30 Apr T P & L 1,750

6,750 6,750

1 May Bal b/d 5,750

You have almost completed the financial accounts for Lance's first month of trading.

All that now remains is the balance sheet.

Activity eight

Use the trial balance you have already prepared for Lance and the closing capital 'T'

account above to draw up the balance sheet as at 30 April.



OFFICIAL

Response

Here is the completed balance sheet.

Balance sheet as at 30 April

Description Dr Cr

Fixed assets

Van £2,700


Sub-total £3,200

Current assets

Bank £2,075

Cash £25

Debtor (Redstone RFC) £750

Sub total £2,850


Creditors (Cash and Carry Ltd) (£300)

Net current assets £2,550

Net assets £5,750

Capital account

Opening balance 0

Add net profit for the year £1,750

Add capital introduced £5,000

£6,750

Less drawings (£1,000)

Closing capital £5,750

Although the closing capital account shows a balance of £5,750, the movement in

the year is actually shown in the balance sheet as above.

It doesn't matter if your balance sheet doesn't look exactly the same as the one

above. As your experience grows, you'll see that the information will be presented in

a number of different ways.

It's important, however, that the balance sheet balances and that entries have been

classified correctly. For example, there shouldn't be any entries on the balance



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sheet that ought to go in the trading and profit and loss account and fixed and

current assets should be included under the correct headings.

This is the end of the material in this chapter. Now read the review and try the

learning check that follows.

Review

A trial balance consists of balances from 'T' accounts and is the first step towards

preparing financial accounts. Its purpose is to confirm the arithmetical accuracy of

the double entry bookkeeping system.

The first stage in preparing a trial balance is to establish the balance on each 'T'

account. All debit balances are included in the debit column of the trial balance and

all credit balances are included in the credit column.

Both columns are totalled. If they balance then this suggests that the dual effect has

been complied with and 'for every debit entry there is an equal and opposite credit

entry'. If the trial balance doesn't balance, it may not have been prepared

accurately.

The next step in preparing financial accounts is to close off the 'T' accounts.

• Any accounts which show income and expenditure are cleared by

transferring the balance on the account to the trading and profit and loss

account. There is no balance to bring down to the following year. So the

date of the balance brought down figure is the accounting date.

• The balance on any assets and liabilities accounts is transferred to the

balance sheet and brought down to the start of the following accounting

period. So the date of the balance brought down figure is the start date of the

next accounting period.

• Finally, the balance on the drawings account and the trading and profit and

loss account are cleared by transferring the balances to the capital account.



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The capital account is then balanced off. Any balance remaining is

transferred to the balance sheet. So the date of the balance brought down

figure is the start date of the next accounting period.

The purpose of the trading and profit and loss account is to establish the profit or

loss made for a particular period.

The balance sheet shows at a given date, what the business owns, what it's owed

and what it owes.


Learning check

1. Give two reasons for balancing the 'T' accounts in a trader's books.

2. The balance brought down in Karen's cash account was a debit balance of £195.

What does this mean?

3. a) Balance the following 'T' account at 30 September.

Drawings

Dr £ Cr £

1 Sept Cash 100 3 Sept Petrol 25




29 Sept Bank 500

b) What do you think 'the balance' means in broad terms?

4. State the purpose of a trial balance.



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5. Ken has decided to prepare financial accounts for the 6-month period to 30

September. The 'T' accounts showing the balances brought down at 29 September

are shown below together with a list of transactions to 30 September.

You should enter these transactions into the relevant 'T' account (printed below),

balance each 'T' account and then prepare a trial balance.

29 September

Purchased goods on credit from Ajay for £50.

Withdrew £420 cash from business deposit account and paid Ajay £420.

Total sales for the day were £75, which included cash sales and a credit sale of £10

to Julian.

30 September


Total sales for the day were £80, which included cash sales and credit sales to

Julian of £10, and to the publican of the King's Horse, of £15.

Purchased a new tyre for the business van from own money. Cost £50.

There was no opening or closing stock.

Cash

Dr £ Cr £

29 Sep Bal b/d 42

Capital

Dr £ Cr £

29 Sep Bal b/d 425



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Bank

Dr £ Cr £

29 Sep Bal b/d 1,430

Motor van

Dr £ Cr £

29 Sep Bal b/d 350

Ajay

Dr £ Cr £


Julian

Dr £ Cr £

29 Sep Bal b/d 5

King’s Horse

Dr £ Cr £

29 Sep Bal b/d 30

Purchases

Dr £ Cr £

29 Sep Bal b/d 10,870

Sales

Dr £ Cr £

29 Sep Bal b/d 16,305



OFFICIAL

Stall rent

Dr £ Cr £


Motor expenses

Dr £ Cr £

29 Sep Bal b/d 330

Telephone

Dr £ Cr £

29 Sep Bal b/d 130

Paper

Dr £ Cr £

29 Sep Bal b/d 133

Drawings

Dr £ Cr £


For the remaining questions in the learning check, you'll need several pieces

of paper.

6. Close off the income and expenditure 'T' account balances for Ken from question

5 by transferring the balances to the trading and profit and loss 'T' account.

7. Close off the trading and profit and loss 'T' account and drawings account for Ken

from question 6 by transferring the balances to the capital account you prepared in

question 5.

8. Use the trial balance you completed for Ken in question 5 above to prepare the

trading and profit and loss account for the 6 months to 30 September.



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9. Use the trial balance you completed for Ken in question 5 above, and the closed

capital account from question 7 above, to prepare the balance sheet as at 30

September.



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1. Give two reasons for balancing the 'T' accounts in a trader's books.

You could have said two of the following. Accounts are balanced

• to check accuracy

• to establish the amount outstanding or accumulated at any particular time.

For example the total on a sales account indicates the amount of sales a

business made in a financial period

• as a start to preparing a trading and profit and loss account, and a balance

sheet.


2. The balance brought down in Karen's cash account was a debit balance of £195.

What does this mean?

This means that in balancing the 'T' account the amounts included on the debit side

exceeded those on the credit side. This is what you would expect in a cash account.

The balance should represent the amount of business cash on hand.




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3. a) Balance the following 'T' account at 30 September.

Drawings

Dr £ Cr £





29 Sept Bank 500 30 Sept Bal c/d 790

900 900

30 Sept Bal b/d 790

b) What do you think 'the balance' means in broad terms?

In broad terms, the balance of £790 shows that the trader has taken a net amount of

£790 out of the business by way of drawings in the month of September.

You can see from the 'T' account that the trader took £900 out in cash and from the

bank and they put in £110 by buying petrol for the business out of their 'own pocket'.

This is a form of capital introduced. It's shown here as a credit entry in the drawings

account. This is quite acceptable although it's more usual for these transactions to

be recorded as a credit entry in the capital account.

Don't worry if you found it difficult to describe the meaning of the balance. You'll look

at interpreting accounts in more detail later. Just start thinking in this manner. It

doesn't matter if you didn't get the same answer as us at this stage.


4. State the purpose of a trial balance.

The purpose of a trial balance is to check the arithmetical accuracy of the double

entry bookkeeping system.



OFFICIAL


5. Ken has decided to prepare financial accounts for the

6-month period to 30 September. The 'T' accounts showing the balances brought

down at 29 September are shown below together with a list of transactions to 30

September.

You should enter these transactions into the relevant 'T' account, balance each 'T'

account and then prepare a trial balance.

29 September


Withdrew £420 cash from business deposit account and paid Ajay £420.

Total sales for the day were £75, which included cash sales and a credit sale of £10

to Julian.

30 September


Total sales for the day were £80, which included cash sales and credit sales to

Julian of £10, and to the publican of the King's Horse, of £15.

Purchased a new tyre for the business van from own money. Cost £50.

There was no opening or closing stock.

Your answer should have been as follows.



OFFICIAL

Cash

Dr £ Cr £

29 Sep Bal b/d 42 29 Sep Ajay 420

29 Sep Bank 420 30 Sep Bal c/d 162

29 Sep Sales 65

30 Sep Sales 55

582 582

Oct 1 Bal b/d 162

Capital

Dr £ Cr £

30 Sep Bal c/d 475 29 Sep Bal b/d 425

30 Sep Mot Exp 50

475 475

30 Sep Bal b/d 475

Bank

Dr £ Cr £

29 Sep Bal b/d 1,430 29 Sep Cash 420

30 Sep Bal c/d 1,010

1,430 1,430

1 Oct Bal b/d 1,010

Motor van

Dr £ Cr £

29 Sep Bal b/d 350 30 Sep Bal c/d 350

350 350

1 Oct Bal b/d 350



OFFICIAL

Ajay

Dr £ Cr £

29 Sep Cash 420 29 Sep Bal b/d 1,260

29 Sep Purchases 50

30 Sep Purchases 60

30 Sep Bal c/d 950

1,370 1,370

1 Oct Bal b/d 950

Julian

Dr £ Cr £

29 Sep Bal b/d 5

29 Sep Sales 10

30 Sep Sales 10 30 Sep Bal c/d 25

25 25

1 Oct Bal b/d 25

King’s Horse

Dr £ Cr £

29 Sep Bal b/d 30

30 Sep Sales 15 30 Sep Bal c/d 45

45 45

1 Oct Bal b/d 45

Purchases

Dr £ Cr £

29 Sep Bal b/d 10,870

29 Sep Ajay 50

30 Sep Ajay 60 30 Sep Bal c/d 10,980

10,980 10,980

30 Sep Bal b/d 10,980



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Sales

Dr £ Cr £

29 Sep Bal b/d 16,305

29 Sep Cash 65

29 Sep Julian 10

30 Sep Cash 55

30 Sep Julian 10

30 Sep Bal c/d 16,460 30 Sep King's

Horse

15

16,460 16,460

30 Sep Bal b/d 16,460

Stall rent

Dr £ Cr £

29 Sep Bal b/d 1,300 30 Sep Bal c/d 1,300

1,300 1,300


Motor expenses

Dr £ Cr £

29 Sep Bal b/d 330

30 Sep Capital

(Tyre)

50 30 Sep Bal c/d 380

380 380

30 Sep Bal b/d 380

Telephone

Dr £ Cr £


130 130

30 Sep Bal b/d 130



OFFICIAL

Paper

Dr £ Cr £


133 133

30 Sep Bal b/d 133

Drawings

Dr £ Cr £



3,370 3,370


Ken's purchase of the tyre with his own money is a form of capital introduced. It's

more usual for these transactions to be recorded through the capital account and

here it's shown as a credit entry in the capital account.

However, you could have correctly included it as a credit entry in the drawings

account instead.



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Trial balance as at 30 September

Description Dr Cr

Capital £475

Cash £162

Bank £1,010

Ajay £950

Julian £25

King’s Horse £45

Motor van £350

Purchases £10,980

Sales £16,460

Drawings £3,370

Paper £133

Motor expenses £380

Rent £1,300

Telephone £130

Totals £17,885 £17,885


If you have made mistakes in preparing or balancing your 'T' accounts, then you may

need to refer back to chapter 4.



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6. Close off the income and expenditure 'T' account balances for Ken from question

5 by transferring the balances to the trading and profit and loss 'T' account.



Dr £ Cr £

30 Sep Purch 10,980 30 Sep Sales 16,460

30 Sep Paper 133

30 Sep Motor 380

30 Sep Rent 1,300

30 Sep Tel 130

Purchases

Dr £ Cr £

29 Sep Bal b/d 10,870

29 Sep Ajay 50

30 Sep Ajay 60 30 Sep Bal c/d 10,980

10,980 10,980

30 Sep Bal b/d 10,980 30 Sep To trade 10,980

10,980 10,980

Sales

Dr £ Cr £

29 Sep Bal b/d 16,305

29 Sep Cash 65

29 Sep Julian 10

30 Sep Cash 55

30 Sep Julian 10

30 Sep Bal c/d 16,460 30 Sep King's

Horse

15

16,460 16,460

30 Sep To trade 16,460 30 Sep Bal b/d 16,460

16,460 16,460



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Stall rent

Dr £ Cr £

29 Sep Bal b/d 1,300 30 Sep Bal c/d 1,300

1,300 1,300

30 Sep Bal b/d 1,300 30 Sep To P & L 1,300

1,300 1,300

Motor expenses

Dr £ Cr £

29 Sep Bal b/d 330

30 Sep Capital

(Tyre)

50 30 Sep Bal c/d 380

380 380

30 Sep Bal b/d 380 30 Sep To P & L 380

380 380

Telephone

Dr £ Cr £


130 130

30 Sep Bal b/d 130 30 Sep To P & L 130

130 130

Paper

Dr £ Cr £


133 133

30 Sep Bal b/d 133




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7. Close off the trading and profit and loss 'T' account and drawings account for Ken

from question 6 by transferring the balances to the capital account you prepared in

question 5.


Capital

Dr £ Cr £

29 Sep Bal b/d 425

30 Sep Bal c/d 475 30 Sep Mot exp 50

475 475

30 Sep Drawings 3,370 30 Sep Bal b/d 475

30 Sep Bal c/d 642 30 Sep T P & L 3,537

4,012 4,012

1 Oct Bal b/d 642

Drawings

Dr £ Cr £



3,370 3,370

30 Sep Bal b/d 3,370 30 Sep To capital 3,370

3,370 3,370



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Dr £ Cr £

30 Sep Purch 10,980 30 Sep Sales 16,460

30 Sep Paper 133

30 Sep Motor 380

30 Sep Rent 1,300

30 Sep Tel 130

30 Sep To capital 3,537

16,460 16,460




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8. Use the trial balance you completed for Ken in question 5 above to prepare the

trading and profit and loss account for the 6 months to 30 September.

The trading and profit and loss account will look like this.

Trading and profit and loss account 6 months ended 30 September

Description Dr Cr

Sales £16,460

Less cost of sales

Opening stock 0


£10,980


(£10,980)


Rent £1,300

Telephones £130

Paper £133

Motor expenses £380 (£1,943)

Net profit £3,537




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9. Use the trial balance you completed for Ken in question 5 above and the closed

capital account from question 7 above to prepare the balance sheet as at 30

September.

The balance sheet will look like this

Balance sheet as at 30 September

Description Dr Cr

Fixed assets

Motor van £350

£350

Current assets

Bank £1,010

Cash £162

Debtor (Julian) £25

Debtor (King’s Horse) £45

Sub total £1,242


Creditors (Ajay) (£950)

Net current assets £292

Net assets £642

Capital account

Opening balance 425

Add net profit for the year £3,537

Add capital introduced £50

Sub total £4,012

Less drawings (£3,370)

Closing capital £642

This is in subchapter 5.



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Consolidation Exercise – Question

James

The following consolidation exercise will test whether you have understood how to

• record business transactions using 'T' accounts and the dual effect of each

transaction

• prepare a simple trial balance from 'T' accounts that you have prepared

• close off the various 'T' accounts at a period end

• use the trial balance and the closed 'T' accounts to prepare a trading and

profit and loss account and balance sheet.

James started in business on 1 April and decides to make up his first financial

accounts to 30 April. You're provided with a list of his initial business transactions.

We think it will take you about an hour to complete this exercise.

Instructions

Task 1

Prepare and then balance the 'T' accounts to 30 April for each transaction.

Task 2

Use your 'T' account balances to prepare a trial balance as at 30 April.

Task 3

Close off the income and expenditure 'T' accounts by transferring the balances to the

trading and profit and loss 'T' account.

Close off the trading and profit and loss 'T' account and drawings account by

transferring the balances to the capital account.



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Task 4

Prepare a trading and profit and loss account to 30 April.

Task 5

Prepare a balance sheet at 30 April.

You may find it helpful to check your answer at the end of each task, before moving

on to the next.

Data for tasks 1, 2, 3, 4 and 5

1 Apr - James used £5,000 of his own personal savings to open a business bank

account.

2 Apr - James made purchases of £2,000 and paid for these by cheque.

3 Apr - Bought a delivery van for £1,500 by cheque.

4 Apr - Made a sale for £500 in cash.

4 Apr - Made a sale of £2,000 on credit to Nicole.

8 Apr - Purchased a computer for £800 by cheque.

11 Apr - Purchased £4,000 worth of stock on credit from Brad.

13 Apr - Made a sale for £6,000 cash.

15 Apr - Paid £300 rent for the business premises in cash.

17 Apr - Paid £250 motor expenses in cash.

18 Apr - Made a sale for £1,000. The customer paid by cheque.

20 Apr - James took drawings of £1,000 in cash.

21 Apr - Nicole gave James a cheque for £700 towards what she owed him.



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25 Apr - James paid Brad £2,500 in cash for purchases previously bought on credit.

26 Apr - James paid business insurance of £450 in cash.

27 Apr - James made a further sale to Nicole for £500 on credit.

29 Apr - James obtained a loan of £6,000 and immediately bought fixtures and

fittings costing this amount. The loan will be repaid over the following 12 months.

There is no closing stock.



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Consolidation Exercise – Answer

Task 1

'T' Accounts

Bank

Dr £ Cr £

1 Apr Capital 5,000 2 Apr Purchases 2,000

18 Apr Sales 1,000 3 Apr Van 1,500

21 Apr Nicole 700 8 Apr Computer 800

30 Apr Bal c/d 2,400

6,700 6,700

1 May Bal b/d 2,400

Capital

Dr £ Cr £


5,000 5,000


Purchases

Dr £ Cr £

2 Apr Bank 2,000

11 Apr Brad 4,000 30 Apr Bal c/d 6,000

6,000 6,000




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Cash

Dr £ Cr £

4 Apr Sales 500 15 Apr Rent 300

13 Apr Sales 6,000 17 Apr Motor exp 250

20 Apr Drawings 1,000

25 Apr Brad 2,500

26 Apr Insurance 450


6,500 6,500

1 May Bal b/d 2,000

Van

Dr £ Cr £


1,500 1,500

1 May Bal b/d 1,500

Sales

Dr £ Cr £

£ £

4 Apr Cash 500

4 Apr Nicole 2,000

13 Apr Cash 6,000

18 Apr Bank 1,000

27 Apr Nicole 500

30 Apr Bal c/d 10,000

10,000 10,000



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Nicole (trade debtor)

Dr £ Cr £

4 Apr Sales 2,000 21 Apr Bank 700

27 Apr Sales 500 30 Apr Bal c/d 1,800

2,500 2,500

1 May Bal b/d 1,800

Computer

Dr £ Cr £


800 800

1 May Bal b/d 800

Brad (trade creditor)

Dr £ Cr £

25 Apr Cash 2,500 11 Apr Purchases 4,000


4,000 4,000

1 May Bal b/d 1,500

Rent

Dr £ Cr £

15 Apr Cash 300 30 Apr Bal c/d 300

300 300

30 Apr Bal b/d 300

Motor expenses

Dr £ Cr £


250 250

30 Apr Bal b/d 250



OFFICIAL

Drawings

Dr £ Cr £

20 Apr Cash 1,000 30 Apr Bal c/d 1,000

1,000 1,000


Insurance

Dr £ Cr £


450 450

30 Apr Bal b/d 450

Fixtures and fittings

Dr £ Cr £

29 Apr Loan 6,000 30 Apr Bal c/d 6,000

6,000 6,000

1 May Bal b/d 6,000

Loan

Dr £ Cr £

30 Apr Bal c/d 6,000 29 Apr Fixtures 6,000

6,000 6,000

1 May Bal b/d 6,000



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Task 2

James

Trial balance as at 30 April

Description Dr Cr

Capital £5,000

Bank £2,400

Purchases £6,000

Van £1,500

Sales £10,000

Cash £2,000

Nicole (trade debtor) £1,800

Brad (trade creditor) £1,500

Computer £800

Drawings £1,000

Loan £6,000

Fixture and fittings £6,000

Rent £300


Insurance £450

Totals £22,500 £22,500



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Task 3


Dr £ Cr £

30 Apr Purch 6,000 30 Apr Sales 10,000

30 Apr Rent 300

30 Apr Motor

expenses

250

30 Apr Insure 450

30 Apr Net profit

(to capital)

3,000

10,000 10,000

Capital

Dr £ Cr £


5,000 5,000

30 Apr Drawings 1,000 30 Apr Bal b/d 5,000

30 Apr Bal c/d 7,000 30 Apr T P & L 3,000

8,000 8,000

1 May Bal b/d 7,000

Drawings

Dr £ Cr £

20 Apr Cash 1,000 30 Apr Bal c/d 1,000

1,000 1,000

30 Apr Bal b/d 1,000 30 Apr Capital 1,000

1,000 1,000



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Purchases

Dr £ Cr £

2 Apr Bank 2,000

11 Apr Brad 4,000 30 Apr Bal c/d 6,000

6,000 6,000

30 Apr Bal b/d 6,000 30 Apr To trade 6,000

6,000 6,000

Sales

Dr £ Cr £

4 Apr Cash 500

4 Apr Nicole 2,000

13 Apr Cash 6,000

18 Apr Bank 1,000

27 Apr Nicole 500

30 Apr Bal c/d 10,000 10,000

10,000 10,000

30 Apr To trade 10,000 30 Apr Bal b/d 10,000

10,000 10,000

Rent

Dr £ Cr £


300 300


300 300



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Motor expenses

Dr £ Cr £


250 250


250 250

Insurance

Dr £ Cr £


450 450


450 450



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Task 4

James - Trading and profit and loss account for month to 30 April

Description Dr Cr

Sales £10,000

Less cost of sales

Opening stock 0

Purchases £6,000

Less closing stock 0

Sub-total (£6,000)


Less overheads

Rent £300


Insurance £450

Sub-total (£1,000)

Net profit £3,000



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Task 5

James – balance sheet as at 30 April


Fixed assets

Fixtures and fittings £6,000

Vans £1,500

Computer £800

Total £8,300

Current assets

Cash £2,000

Bank £2,400

Trade debtors £1,800

Total £6,200

Current liabilities

Trade creditors (£1,500)

Loan (£6,000)

Total (£7,500)

Net current liabilities (£1,300)

Net assets £7,000

Opening capital 0

Capital introduced £5,000

Add net profit £3,000

Deduct drawings (£1,000)




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Before moving on



can see below.

Learning outcomes

You will

• be able to prepare the initial financial accounts of a sole trader.

Study objectives


• demonstrate how to draw up a trial balance

• demonstrate how to close off the various accounts at a period end

• prepare a trading and profit and loss account and balance sheet.




Please note any points you might want to discuss with your line manager or tutor.



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Assessment Practice – Sample Questions

In this part of the Introduction to Bookkeeping manual, we've included a small

selection of multiple-choice questions (MCQ) and one example of a longer question

of the type you'll encounter in the assessment for this module.

Both the MCQ and long question are indicative of the standard which you're

expected to achieve for assessment purposes. The suggested marks are provided.

The questions and answers are arranged as follows.

• MCQ questions.

• MCQ answers.

• Long question.

• Long question – answer.

We think you should allow approximately 20 minutes to complete the MCQ

questions.

The value of the question is indicated after each question.

MCQ questions

For all of these questions Mark X in column 3 to indicate your choice (or record your

answer in a separate document).

1. Which of the following is most likely to be a sole trader?

A-D Option Input X

A Tim Taylor

B Taylor Tiles PLC

C Tim and Tony Tiles

D Taylor Tiles Ltd

1 mark



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2. The extracts from a trading and profit and loss account are as follows.


Turnover £270,445



Net profit £27,130

What is the figure for purchases for the period?

A - D Options Mark X

A £215,668

B £228,372

C £236,963

D £249,667

3 marks

3. Liam starts in business as a joiner on 1 June 2018.

He draws up his accounts to 31 May 2018. At the end of the accounting period he

owes his creditors £500. He has received payments totalling £56,450. One of his

customers still owes him £200, which they eventually pay in July.

What is Liam's total turnover for the year ending 31 May 2019? 2 marks

A - D Options Mark X

A £56,250

B £56,450

C £56,650

D £56,950



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4. The financial accounts of a business include the following.

Opening capital £13,675

Current liabilities £2,560

Current assets £19,225

Fixed assets £40,000

Net profit £17,430

Drawings £15,750

What is the value of the long term liabilities of the business?

A £33,570

B £41,310

C £46,475

D £54,670

3 marks

5. Victor bought 20 kitchen timers for £60 cash for sale in his shop.

The dual effect of this transaction could be described as

A-D Options Mark X

A Increase purchases £60 and increase cash £60

B Increase creditors £60 and increase stock £60

C Increase creditors £60 and decrease cash £60

D Increase purchases £60 and decrease cash £60

2 marks



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6. Hussein buys stock for £300 on credit.

The double entries that are most likely to reflect this transaction are

A-D Options Mark X

A debit purchases and credit cash

B debit trade creditors and credit purchases

C debit purchases and credit trade creditors

D debit purchases and credit trade debtors

2 marks

7. What is the balance on the bank T account at the end of the accounting period?

Bank

Dr Cr

Bal. b/d £100 Purchases £150

Sales £250 Purchases £125

Sales £300

Sales £300

A-D Options Mark X

A A credit balance of £675

B A credit balance of £275

C A debit balance of £675

D A debit balance of £950

2 marks

Total 15 marks



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MCQ answers

1. Which of the following is most likely to be a sole trader?

Answer - A. Tim Taylor


1 mark

2. The figure for purchases for the period?

Answer B - B. £228,372

This is calculated as follows.

Description Amount Amount Turnover £270,445

Less gross profit £48,425

CoGS * £222,020

Less Opening stock £29,315

Plus Closing stock £35,667

Purchases £228,372

(You calculate CoGS as opening stock plus purchases minus closing stock. It's the

reverse to calculate purchases.)


3 marks



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3. Liam starts in business as a joiner on 1 June 2018.

Liam starts in business as a joiner on 1 June 2018 etcetera.

What is Liam's total turnover for the year ending 31 May 2019?

Answer - C. £56,650

Total turnover (£56,450) is payments received (£56,450) plus income earned in a

period for which payment hasn't yet been received (£200).


3 marks

4. What is the value of the long term liabilities of the business?

Answer - B. £41,310

Description Amount

Opening capital £13,675

Plus profit £17,430

Less drawings £15,750


Fixed assets £40,000

Plus current assets £19,225

Less current liabilities (£2,560)

Less closing capital (£15,355)

Long term liabilities £41,310



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You can also use 'T' accounts to answer this question.

Dr £ £ Cr


Drawings 15,750 Net profit 17,430


31,105 31,105

This is the equivalent of assets less liabilities equals closing capital.

You can then use the closing capital figure in another 'T' account (effectively the

balance sheet in 'T' account form) to find the drawings figure.

Dr Assets Cr Liabilities

Fixed assets 40,000 Current liabilities 2,560

Current assets 19,225 Closing capital 15,355

Long term

liabilities

41,310

59,225 59,225


2 marks

5. Victor bought 20 kitchen timers for £60 cash for sale in his shop.

The dual effect of this transaction could be described as….

Answer - D. Increase purchases £60 and decrease cash £60


2 marks



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6. Hussein buys stock for £300 on credit.

The double entries that are most likely to reflect this transaction are….

Answer - C. Debit purchases and credit trade creditors


2 marks

7. What is the balance on the bank T account at the end of the accounting period?

Answer - C. A debit balance of £675.

Bank

Dr Cr

Bal. b/d £100 Purchases £150

Sales £250 Purchases £125

Sales £300

Sales £300 Bal. c/d £675

£950

£950

Bal. b/d £675


Total 15 marks



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Long question

Don Hamilton Autoparts

Time allowed 40 minutes 60 marks

You are required to

a) prepare T accounts to update the balances of those accounts affected by the

information provided. (16 marks)

b) prepare a trial balance using the T accounts prepared for a) above. (14 marks)

c) prepare the trading, profit and loss account and balance sheet for the period

ending 30 September. (30 marks)



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Information

You are the accounts assistant at Don Hamilton Autoparts. The main business

activity is the sale of motor parts. A computer malfunction on 29 September has

prevented the completion of the accounts for the year ending 30 September.

You extracted the following balances from the T accounts on 28 September.

Description Amount £

Property 127,500

Bank 18,260

Capital 205,455

Drawings 32,420

HMRC creditor 1,450

Loan from bank 27,240

Purchases 192,157

Sales 266,330

General expenses 33,890

Plant and machinery 76,248

Trade debtor (Vittex & Son) 20,000

The following transactions took place on 29 and 30 September.

1. On 29 September, the business purchased goods on credit from Alloy Holdings for

resale. The value of the transaction was £2,320.

2. On 29 September, wages of £642 were paid by cheque for casual labour. This

should be included in general expenses.

3. On 30 September Don Hamilton paid £2,000 off the bank loan. This was a cash

payment from the proceeds of a personal insurance policy that had matured on 15

September, which Don had received in cash.



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4. On 30 September a cheque for £10,000 was received from Vittex & Son as part

payment for supplies previously received from Hamilton Autoparts. Don banked the

cheque on the same day.

5. Don carried out a stock take on 30 September, which confirmed that the stock

value was £16,220. (This should be included as a current asset in the balance

sheet).



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Long question – answer

Don Hamilton Autoparts

a) T accounts 16 marks (total)

Purchases

Dr £ Cr £

28/09 Bal b/d 192,157

29/09 Alloy 2,320 30/09 Bal c/d 194,477

194,477 194,477

30/09 Bal b/d 194,477

Alloy (creditor)

Dr Cr

29/09 Purchases 2,320

30/09 Bal c/d 2,320

2,320 2,320

01/10 Bal b/d 2,320

Bank

Dr £ Cr £

28/09 Bal b/d 18,260 29/09 Wages 642

30/09 Vittex 10,000 30/9 Bal c/d 27,618

28,260 28,260

01/10 Bal b/d 27,618



OFFICIAL

Bank loan

Dr £ Cr £

30/09 Cash 2,000 28/09 Bal b/d 27,240

30/09 Bal c/d 25,240

27,240 27,240

01/10 Bal b/d 25,240

General expenses

Dr £ Cr £

28/09 Bal b/d 33,890

29/09 Bank 642 30/09 Bal c/d 34,532

34,532 34,532

30/09 Bal b/d 34,532

Capital

Dr £ Cr £

28/09 Bal b/d 205,455

30/09 Bal c/d 207,455 30/09

Cash

(introduced) 2,000

207,455 207,455

01/10 Bal b/d 207,455

3 marks for cash introduced (also give 3 marks if this is dealt with through the

drawings a/c or by another acceptable method)

Cash

Dr Cr

30/09

Capital

(introduced) 2,000 30/09 Bank loan 2,000

2,000 2,000



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Vittex (debtor)

Dr Cr

28/09 Bal b/d 20,000 30/09 Bank 10,000

30/9 Bal c/d 10,000

20,000 20,000

01/10 Bal b/d 10,000



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b) Trial balance 14 marks

(2 marks for each amendment)

Account Total £ Dr £ Cr £

Property 127,500 127,500

Bank 27,618 27,618

Capital 207,455 207,455

Drawings 32,420 32,420

HMRC creditor 1,450 1,450

Bank loan 25,240 25,240

Purchases 194,477 194,477

Sales 266,330 266,330

General expenses 34,532 34,532

Plant and

machinery 76,248 76,248

Vittex (debtor) 10,000 10,000

Alloy (creditor) 2,320 2,320

502,795 502,795



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c) Financial accounts 30 marks

12 marks (Deduct 3 marks for each bookkeeping error and 1 mark for each

arithmetic error)


Description £ £

Sales 266,330

Less cost of sales

Opening stock 0

Purchases 194,477

Less closing stock (16,220) 178,257

Gross profit 88,073

General expenses 34,532

Net profit 53,541



OFFICIAL

Balance sheet 30 September

Fixed assets £ £ £

Property 127,500

Plant and machinery 76,248

203,748

Current assets

Stock 16,220

Debtors 10,000

Bank 27,618

53,838

Current liabilities

Trade creditors 2,320

Other creditors 1,450

3,770

Net current assets 50,068

Total assets less current liabilities 253,816

Less long term liabilities

Bank loan 25,240

Net assets 228,576


Add capital introduced 2,000

Add net profit 53,541

Less drawings 32,420


Total 60 marks

bookkeeping: introduction to bookkeeping

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