Chapter 2

Basic accounting and financial statements

 Learning Outcomes

 Explain the difference between the terms ‘bookkeeping’ and

‘accounting’.
 Write up the analysis cash book for an enterprise.
 Carry out a bank reconciliation of the enterprise’s cash book
and bank statement.
 Draw up a balancing trial balance from a given list of balances.
 Draw up a statement of comprehensive income and a
statement of financial position from a trial balance.
 Explain the meaning of a cash flow statement.
 Define the function of a petty cash record in the enterprise.

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 ‘bookkeeping’ vs. ‘accounting’

Bookkeeping represents the writing up (recording) of financial

transactions and the collection of data to create basic financial
statements.

Accounting is the summarising, reporting, analysis and

interpretation of financial statements. You must be able to
understand the financial implications (results) of all decisions
and policies made by the business.

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 The business cycle

• A business transaction
occurs when income is
obtained from sales made or
services provided.

• The business cycle starts

with cash payments for
purchases of materials.

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 The process of recording transactions

Transaction: Transaction:
Additional
sales purchases

Receipts Payments Journal

cash book cash book entries
– debtors
– creditors

General ledger

Trial balance

Income
statement

Balance sheet

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 The entity concept
For the purposes of accounting, every business is considered to
be an entity separate from its proprietors.
There are two distinct groups of people or institutions that hold
an interest or equity:

 Internal group: These are the suppliers of capital and funds,

which gives them the right to make decisions affecting the
entity and its management. This group includes shareholders,
members, partners and sole proprietors.
 External group: This group mainly furnishes long-term loans
and does not usually have any influence on the business
activities of the company.

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 Primary accounting equation
 NB! The basic principle of accounting is that for every debit
entry there must be a credit entry of a corresponding (equal)
amount.
 The entity concept is the basis for the primary accounting
equation:

Total
Equity Liabilities
assets

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  A debtor is a person who owes you money for goods/services
sold to him or her. A debtor is debited with the amount sold.

 A creditor is a person to whom you owe money for goods

supplied to you. A creditor is credited with your purchases.

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 The cash book
We record cash transactions in one book, namely the cash book,
which has two sections:
1. Cash receipts: All money that is received and banked, such as
from cash sales, is recorded here.
Day Details Sales Debtors Sundries Bank
1 S Small 120 120

2. Cash payments: Cash payments consisting of purchases,

electronic funds transfers (EFTs), debit card transactions,
debit orders, bank charges and cheque payments are
recorded here.
Cheque Details Wages Purchases Transport Bank
0203 Big Five Traders 2100 2100

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 Analysis cash book
An analysis cash book is a cash book with various columns to
record the cash payments made or income received.

 All receipts, as indicated on the deposit slips from the bank,

are entered in the receipts cash book.
 Payments, as shown on the cheque counterfoils, are recorded
in the payments cash book.
 Only goods that are bought to resell should appear in the
purchases column.

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 Value-added tax (VAT)
 A value-added tax (VAT) is a type of consumption tax that is
placed on a product whenever value is added at a stage of
production and at final sale.
 Registering to pay for VAT - All enterprises with a turnover of a
certain amount a year must register for VAT.

 Refer to the SARS website for more guidance about when and
whether to register for VAT.
http://www.sars.gov.za/Pages/default.aspx

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 Bank reconciliation
Principles of the bank reconciliation:
1. The final balance of the cash book is the basic point of
departure in reconciling.
2. The overall principle is that any entry that appears on the
bank statement but is not in the cash book should be
corrected in the bank reconciliation.
3. Any bank statement item that causes an additional
expenditure to the business must be deducted from the final
balance of the cash book.

The opposite must be done if the cash book balance indicates an

overdrawn account!

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 How to do a bank reconciliation
Step 1
Check the bank statement. Compare each EFT (or cheque) paid
from your bank account against the entries in your cash book.
Step 2
Compare each deposit received with the deposits shown on the
bank statement and mark them if correct.
Step 3
Payments in the cash book not yet reflected on the bank
statement is recorded separately as outstanding payments.
Step 4
All other costs and sundry items on the bank statement not yet
ticked must be recorded in the cash book.

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 Trial balance
A trial balance reflects the balances of every kind of income,
expenditure, asset and liability. If you are certain that the cash
book balance is correct, record the amounts in a trial balance.

 NB! A trial balance is a test to ensure that a debit and a credit

entry were made for each transaction. If this is the case, then
the trial balance will balance.

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 Adjustments trial balance
An adjustments trial balance gives us the opportunity to make
adjustments where necessary. The following kinds of
adjustments can be made to a trial balance.

 Depreciation on assets
– Straight-line method
– Reducing balance method
 Writing off bad debtors
 Provision for compulsory expenditures that have not yet been
paid

After we have made all the adjustments to the trial balance, we

call the result an adjustments trial balance.
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 Statement of comprehensive income
 Once we have a trial balance that balances, we can proceed to
draw up a statement of comprehensive income, also known as
an income statement.
 This is a record of all the income and expenditure of the
business in the year or period under review.
– Receipts and payments for the purchase and sale of capital items are
not regarded as operating expenditure, but are shown on the
statement of financial position (balance sheet).
– Profit or loss from the sale of these assets is shown on the statement
of comprehensive income (income statement).

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 The statement of financial position
A statement of financial position shows all the items that
contribute to the economic benefit of the business, such as
assets, loans and cash. It is also known as the balance sheet.
 Current assets and current liabilities are those items that can
be converted to cash in a short period (less than one year).
 The two sections of the balance sheet must balance.

Total
Equity Liabilities
assets

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 Cash flow statement
 A cash flow statement provides information on the flow of
funds (cash), namely the inflows and outflows of cash.

 A cash flow statement consists of three major sections, which

show how cash has been produced and used over a particular
period of time. namely the inflows and outflows of cash.

– Operating activities
– Investment activities
– Financing activities

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 Cash flow statements can be used to

 Form an opinion of the risk of the business.

 Make projections about the amount of cash available in the
future to finance expansion.
 Determine which sources of cash were used for financing
operating and investment activities.
 Evaluate the ability of the enterprise to generate cash from its
operating activities to plough back into the business.

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 An example of a Cash flow statement

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 Petty cash

 Every business requires petty cash to cover day-to-day

expenses that do not justify cheques being written – for
example tea, coffee, postage and parking.
 Businesses generally keep a small amount of cash on hand to
meet such needs, preferably in a small lockable metal box
known as the petty cash box.

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