Accounting Notes
Accounting Notes
THE LEDGER
o Prepare ledger accounts
o Post transactions to the ledger accounts
o Balance leger accounts as required and make transfers to final accounts
o Interpret ledger accounts and their balances
Q. Explain why there could be a Cr balance in a bank account, but not the cash account?
Can withdraw more money from the bank than put in as we can take an
overdraft. However, we cannot take more cash than it is physically present.
Q. State why it is useful for a business to maintain a sales journal?
To reduce the number of entries in the sales account
It allows work to be shared between several people
Provides a list of credit sales
Q. Account which is kept to check for fraud or error in the book-keeper’s work?
Sales ledger control account
Q. Why would a ledger be divided into different sections?
To allow division of work
Allow easier reference
Reduces the possibility of frauds
CURRENT ASSETS – items which can be turned into cash quickly, goods
for resale, items having a short life (less than 1 year)
(e.g. cash, bank, inventory, receivables(debtors))
NON-CURRENT ASSETS – items which cannot be turned into cash, not for
resale, long life items held for more than 1 year
(e.g. furniture, buildings, machinery)
OWNER’S EQUITY – the owner’s share of the assets of the business (capital)
o Explain and apply the accounting information
ASSETS = LIABILITIES + CAPITAL
o Outline the double-entry system of book-keeping
A system where all business transactions are entered twice i.e. Dr and Cr side.
o Process accounting data using the double entry system
Assets increased – Dr
Assets decreased – Cr
Liabilities increased – Cr
Liabilities decreased – Dr
Capital increased – Cr
Capital decreased – Dr
Expenses – Dr
Revenue – Cr
o Recognize the division of ledger into –
Ledger
RATIO ANALYSIS
Current Ratio
CURRENT ASSETS
CURRENT LIABILITIES
This ratio compares the ability to use current assets to pay the current liabilities.
An ideal ratio is 2:1. A ratio too high means that the business has more current assets than it
needs.
This ratio shows if there are enough cash assets to pay current liabilities. Stock is the least cash
– like current asset and so it is subtracted.
An ideal ratio is 1:1.
Return on equity
Profit after tax ,interest ∧ prefered dividends
X 100
Ordinary share capital +reserves
This ratio measures the return earned on the money provided by the Ordinary Shareholders.
The higher this answer the better. The ROE should be compared to previous years in order to
see if the trend is on the increase or decrease.
Dividend Yield
Dividend per share
X 100
Market price
Shareholders pay the market price for shares. This ratio shoes the return (dividend) each
shareholder receives as a percentage of the price paid for the share. The higher this figure the
better. Shareholders will usually calculate this ratio for several companies they are thinking of
buying shares in, to see which will pay the highest dividend compared to the market price for
the share.
Limitations of Ratios
1. Results do not explain the results, but mere show which areas of the business need
further investigation
2. Ratios do not take seasonal factors into account
3. For ratios to be accurate, the information must be timely to be of use – information may
not be available for a long time after the end of the financial year
4. To be useful, ratios must be accurate – some information may not be shown in the
accounts of the business.
ACCOUNTING PRINCIPLES AND POLICIES
Accounting Principles/concepts
Accruals (Matching) – sales revenue of this period must match against the expense of this
period.
Business Entity and Ownership – know that a distinction is made between the financial
transactions of a business and those of its owners.
Consistency – the same accounting treatment should be applied to similar items at all times.
Duality – every transaction has a 2-fold aspect – debit and credit.
Going concern – accounting assumes that a business will continue to operate indefinitely.
Money measurements – financial statements only include items which can be expressed in
monetary terms.
Prudence – profits and assets should not be overstated and liabilities should not be
understated.
Realization – revenue is recognized as being earned when legal liability to pay is incurred by the
customer (i.e. when ownership of goods passes to the customer)
Historic – costs are only valued at their own original cost.
Accounting Policies
Comparability – recognize that a financial report can only be compared with reports for other
periods of similarities and differences can be identified.
Relevance – financial information is relevant only if it affects the business decisions.
Reliability – financial information is reliable only if it can be depended upon to represent actual
events and is free from error and bias.
Understandability – a financial report must be capable of being understood by the users of that
report.
*Valuing the inventories on the basis of ‘lower of cost and net realizable value’ is an example of
the principle of prudence.
*Credit sales were recorded at the time of sales rather than when payment was received is an
example of realization.
*No entries were made for expenses paid by the owner for running his personal expense is
known as an example of business entity.
*An example of accruals (matching) is when an accrued expense is included in the income
statement.
Q. How does reducing the value of inventory be an accounting principle of prudence?
It avoids inventory, profits, and current assets to be overstated.
Q. How does reducing the value of inventory be an application of accruals (matching)?
The loss arising from the damage is recorded in the same year as the damage occurred.
DEPRECIATION
Asset A/C Provision for Depreciation A/C Disposal A/C
Asset Dr I/S Dr Disposal Dr
Bank/Cash Cr Provision for Dep Cr Asset Cr
CONTROL ACCOUNTS
Understand the purposes of purchases ledger and sales ledger control account
Q. Why do we need to prepare a purchases ledger control account?
To assist in the location of errors
To provide instant total of trade payables
To prove the arithmetical accuracy of the purchase ledger
To enable a statement of financial position to be prepared quickly
To help reduce fraud
To provide a summary of transactions relating to trade payables
Q. Advantages of preparing the control account.
Assist in the location of errors
Provide instant totals of trade receivables (debtors)
Proves the arithmetical accuracy of the sales/purchase ledgers
Enable a balance sheet to be prepared quickly
Provides a summary of the transactions relating to trade receivables (debtors) and trade
payables (creditors)
Provides an internal check on sales/purchases ledger – may reduce fraud
Q. Why is information in the sales ledger not used to prepare sales ledger control A/C?
Any error in the sales ledger would not be revealed
Any fraud would not be revealed
*prepare purchases and sales ledger control accounts to include credit purchases and sales,
receipts and payments, cash discounts, returns, bad debts, dishonored cheques, interest on
overdue accounts, contra-entries, refunds, opening balances + closing.
*If balances on both the Cr and Dr side are mentioned, then write them down accordingly. But
if they aren’t then account receivable (asset) will be on debit side and account payable
(liabilities) on Cr side.
Account receivable increase = Dr
Account receivable decrease = Cr
Amount in T.B
Recognize that they are statements of balances of assets and liabilities on a specified
date.
Recognize and define non-current assets (fixed assets), intangible assets, current assets,
current liabilities, non-current liabilities, working capital, capital employed and capital
owned.
Intangible Assets – cannot be touched (e.g. goodwill, intelligence)
Capital Employed – the total amount of capital used for the acquisition of profits.
Working Capital – the capital which is used in the day-to-day trading operations of the
business.
Working Capital = Current Assets – Current Liabilities
Total Assets must equal to Total Capital and Liabilities
Subscriptions Account
Dr Subscriptions Cr
Balance b/d xxx Balance b/d xxx
Income of the year
xxx Cash xxx
(Difference)
Balance c/d xxx Balance c/d xxx
xxx xxx
Balance b/d xxx Balance b/d xxx
A club and society can own assets and have liabilities.
However, unlike business owners, members do not invest in their own funds and so
cannot withdraw cash or goods for their own use.
Net Assets = Total Assets – Total Liabilities = Accumulated Funds
LIMITED COMPANIES
Q. Why do companies make transfer to general reserves?
To indicate that that part of the profit is for long-term use and is not available for
distribution.
Dividends – Interim – paid during the year owing to good performance
– Final – proposed (declared)
Q. Ways the issue of debentures may affect ordinary shareholders?
Reduction in profit available for ordinary shareholders
They take prior claim on the assets of the company in the event of a winding up.
Interest on debentures is mentioned in both the profit and loss account and profit and
loss appropriation account
STATEMENT OF OWNER’S EQUITY
SHARE GENERAL RETAINED
DETAILS TOTAL
CAPITAL RESERVE EARNINGS
Balance c/d (at start date) xxx xxx xxx xxx
Share Issue xxx - - xxx
Profit for the year - - xxx xxx
Dividends paid (for the
- - (xxx) (xxx)
previous year)
Dividends paid (for the
- - (xxx) (xxx)
current year)
General Reserve - xxx (xxx) -
Balance b/d (at end date) xxx xxx xxx xxx
ORDINARY PREFERENCE DEBENTURES
Variable rate (%) of dividend Fixed rate (%) of dividend Fixed rate of interest
Members/owners of the Not members of the
Creditors of the company
company company
Not dependent on the
Dividend is a share of the Are paid, even if no profit is
profit. Are paid, even if no
profit earned
profit is earned
Repaid before the
Repaid last in the event of a Repaid after debenture-
shareholders in the event of
winding up holders. Repaid 2nd last.
a winding up. Repaid 1st.
Do not carry voting rights
Carry voting rights Do not carry voting rights
and are long-term loans
Don’t reduce taxable income, so are recorded in profit and Reduce taxable income, so
loss appropriation account is recorded in P&L account
Proposed Dividends = Current Liability = is paid the next year
MANUFACTURING ACCOUNT
PARTNERSHIP ACCOUNTS
Trading & Profit and Loss A/C/Income Statement
Profit & Loss appropriation A/C
Balance Sheet
Dr Capital A/C Cr
Balance c/d xxx Cash xxx
xxx xxx
Dr Current A/C Cr
Balance b/d xxx Balance b/d xxx
Drawings xxx Interest on Capital xxx
Interest on Drawings xxx Interest on Loans xxx
Share of Loss xxx Salary xxx
Balance c/d xxx Share of Profit xxx
Balance c/d xxx
xxx xxx
Balance b/d xxx Balance b/d xxx