GBS 520 :FINANCIAL AND MANAGEMENT ACCOUNTING BY BRYSON MUMBA MBA, MAcc, FCCA, FZICA, DiCG, BSc(Hons)

Unit 3 Accounting Process

Unit Structure Accounting Cycle Steps in Accounting Process

The accounting process Accounting “links” decision makers with economic activities and with the results of their decisions. Accounting Information System Economic activities Actions (decisions) Decision makers 3

Accounting Information System Management Accounting Reports Inputs Processing Outputs Source Documents Accounting Cycle Financial Statements: Statement of Financial Position(Balance Sheet) Statement of Comprehensive Income(Income Statement) Statement of Cash Flows Statement of Owners’ Equity

The “BOOKS” in accounting General Journal - Book used to record transactions before recording them in the accounts. - Listing of transactions by date. General Ledger - Binder of all the accounts. (T or ledger format) - Table of contents to the general ledger is called the “Chart of Accounts” Information ends up being recorded twice. It’s just organized differently. Process of copying transactions from journal to ledger is called POSTING JOURNAL LEDGER

“BOOK KEEPING” The process of making entries in the books of account, reconciling the accounts and preparing reports from the books of account is normally referred to as Book Keeping. JOURNAL LEDGER

Steps in The Accounting Cycle Prepare a trial balance. Post entries to the accounts in the Ledgers & general ledger. Journalize transactions in the general journal. Analyze source documents. Prepare financial statements. Prepare Management reports

Tools of The Recording Process Debits and Credits Journal Entries Ledger Accounts

Tools of The Recording Process Debits and Credits Journal Entries A journal entry is the record of a financial transaction recorded (entered) in a journal. A journal details all the financial transactions of a business and which accounts these transactions affect. Ledger Accounts An account is a place where all the information referring to a particular asset or liability or to capital is recorded Debits and credits are systems of notation used in bookkeeping to determine how to record any financial transaction

The Account and its Analysis An account is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item. The general ledger is a record containing all accounts used by the company. Here are more complete definitions of account balances and ledger accounts.

ACCOUNTING PROCESS Ledger Account Think of it as a storage container like a bucket. Kwachas, which are used to measure economic transactions, are “poured” into and out of the container.

Types of Ledger Accounts Asset Accounts Resources in a business – e.g. cash, debtors, motor vehicles Liability Accounts Amounts owed by the business for companies that have supplied assets to the business – e.g. loans, creditors Equity/Capital Accounts Amounts put into the business by owners e.g. share capital, retained earnings Expenses Accounts – e.g. salaries, telephones, Revenue or Sales accounts – e.g. cash sales, credit sales

Asset Accounts Asset Accounts Cash Accounts Receivable Land STOCKS Buildings Here is a listing of common assets accounts we are likely to find in all businesses. Prepaid accounts may be new to you. Think about your auto insurance. Many of us pay our auto insurance semi-annually or annually. The payment is made in advance and is referred to as a prepaid amount. Prepaid Accounts Equipment Supplies

Liability Accounts Liability Accounts Accounts Payable Other creditors This is a listing of common liability accounts we are likely to see in the general ledger. An unearned revenue is one in which the cash has been received but the product or service has not be delivered. If you subscribe to a magazine, you generally pay a one-year subscription in advance. For the publishing company, cash is received but nothing has been done to earn the revenue. As the magazine is delivered to you, the publishing company recognizes a portion of the money received as revenue. At the end of the year, all the revenue will be earned and the liability no longer exists. Loans Accrued Liabilities

Equity Accounts Equity/Capital Accounts Dividends Revenue accounts Share Capital/Common Stock Dividends Equity/Capital Accounts Revenue accounts Expenses Retained Earnings/Reserves

Expenses Accounts Expenses Accounts Payroll expenses Telephone costs Stationery Expenses Accounts Depreciation Bank charges

Revenue Accounts Revenue accounts Sales Interest received Dividends Sundry income

Ledger and Chart of Accounts The ledger is a collection of all accounts for an information system. A company’s size and diversity of operations affect the number of accounts needed. The chart of accounts is a list of all accounts and includes an identifying number for each account. A chart of accounts is a listing of all accounts in the ledger. Notice that all assets accounts begin with an account number of one, all liabilities with two, equities with three, revenues with four, and expenses with six.

THE ACCOUNTING EQUATION By adding up what the accounting records say belongs to a business and deducting what they say the business owes, you can identify what the business is worth according to the accounting records. The whole of financial accounting is based upon this very simple idea. It is known as the accounting equation. It can be explained as follows;

THE ACCOUNTING EQUATION If the business is to be set up and start trading, it will need resources. Assuming it is the owner of the business who supplied all of the resources. This can be shown as : Resources in the business = Resources supplied by the owner

THE ACCOUNTING EQUATION CONTINUED Resources owned by the business are called ASSETS. Resources supplied by the owner is called CAPITAL This means if the owner has supplied all the resources ,the accounting equation can be shown as Assets = Capital

THE ACCOUNTING EQUATION CONTINUED Usually however ,people other than the owner have supplied some of the assets. The accounting equation changes to : Assets = Capital + Liabilities The two sides of the equation will have the same totals.

THE ACCOUNTING EQUATION Assets = Capital + Liabilities Alternatively Resources: what they are = Resources :who supplied them (Assets) = (Capital + Liabilities)

THE STATEMENT OF FINANCIAL POSITION OR BALANCE SHEET The accounting equation is expressed in a financial position statement or Balance sheet. Listing all the assets on one side and the capital and liabilities on the other side.

EXAMPLE 1 INTRODUCTION OF CAPITAL On 1 MAY 2014 Robert Banda started a business and deposited K60,000 into a bank account opened specially for the business. Show his statement of financial position as at this date: Effect of the transaction is to increase the asset called bank balance by K60,000 and the capital by K60,000.

EXAMPLE 1 INTRODUCTION OF CAPITAL Robert Banda ‘s Statement of financial position as at 1 May 2014 Assets: K Assets :Cast at bank 60,000 Capital 60,000 Note: The accounting equation balances 60,000 = 60,000

EXAMPLE 2 PURCHASE OF AN ASSET BY CHEQUE On 3 May 2014 Robert Banda buys a small shop for K 32,000 paying by cheque . Show his statement of financial position as at this date: The effect of this transaction on the statement of financial position is that the asset cash at the bank is decreased by K32,000 and is replaced by a new asset shop worth K32,000;

EXAMPLE 2 PURCHASE OF AN ASSET BY CHEQUE Robert BANDA Statement of financial position as at 3 May 2014 Assets: K Shop 32,000 Cash at bank 28,000 Total assets 60,000 Capital 60,000 Note: The accounting equation balances 60,000 = 60,000

EXAMPLE 3: PURCHASE OF AN ASSET AND INCURRING OF A LIABILITY On 6 May 2014 Robert Banda buys some goods for K7,000 from H.Mboozi and agrees to pay for them some time within the next two weeks. Show his statement of financial position as at 6th May 2014: The effect of this is that a new asset ,stocks or inventory is acquired and a liability for the goods is created because the goods are not yet paid for. A person to whom money is owed for the goods is known as a creditor and is described in the statement of financial position as part of Account Payable or Trade Creditors. The statement of financial position is as shown below;

SOLUTION EXAMPLE 3 Robert Banda Statement of financial position as at 6 May 2014 Assets: K Shop 32,000 Inventory /Stocks 7,000 Cash at bank 28,000 Total assets 67,000 Capital and liabilities: Capital 60,000 Liabilities: Accounts payable 7,000 Total Capital and Liabilities 67,000 Note: The accounting equation balances 67,000 = 67,000

EQUALITY OF THE ACCOUNTING EQUATION It can be seen that every transaction has affected two items. Sometimes it has changed two assets by reducing one and increasing the other. In other cases it has different effects. The accounting equation has held true throughout the examples ,and it always will.

THE DOUBLE ENTRY SYSTEM The double entry system of accounting is characterised by the following features: Each transaction requires two entries to be made Each transaction requires One debit entry One credit entry. For each transaction this means that a bookkeeping entry will have to be made to show an increase or decrease of one item and another entry to show the increase or decrease of the other item

THE DOUBLE ENTRY SYSTEM Instead of constantly drawing up statements of financial position after each transaction ,what we have instead is the double entry system. The basis of this system is that the transactions which occur are entered in a set of accounts within the accounting books. An account is a place where all the information referring to a particular asset or liability or to capital is recorded. Thus there will be an account where all information relating to specific transactions will be entered.

THE ACCOUNTS FOR DOUBLE ENTRY Each account should be shown on a separate page in the accounting books. The double entry system divides each page into two halves. The left hand side of each page is called the debit side. While the right hand side is called the credit side The title of each account is written across the top of the account at the centre. The layout of a page of an accounts book can be shown as follows:

General Ledger Account T-Account Format For the sake of simplicity, we often use this format in teaching accounting even though it is no longer used in practice as it is now done on Computer using accounting packages such as Pastel, ACCPAC. Account Name Debit Credit

The T-Account Account Name Increases to the T-account are recorded on one side of the T-account, and decreases are recorded on the other side. Account Name Debit Credit

The T-Account Account Name The side which increases and the side which decreases is determined by the type of account. Debit Credit Account Name

What Are Debits and Credits? Debit refers to the LEFT and Credit to the RIGHT side of the T-Account. Debit and Credit are neutral terms and do not connote value judgments. Neither is “good” or “bad”! debits and credits are used to increase or decrease account balances. Determining whether to use a debit or credit to record an increase or decrease depends on the type of account in question. The Balance Sheet equation is the basis for the determination.

RULES FOR DOUBLE ENTRY BOOKKEEPING The rules for double entry bookkeeping are outlined in the following table:

COMPREHENSIVE EXAMPLE Write the following transactions in the books of L.Moyo, 2. Extract Trial Balance, 3 . Prepare SOCI and SOFP 2014   July 1 Started business with K5,500 in bank July 2 Bought stock for resale on credit for K 540 from M. Mundiay July 5 Sold goods on credit for K450 to N.Banda July 6 Paid rent on office premises by cheque for K450 July 10 Withdrew K800 from bank for use in cash till July 14 Sold goods for K180 cash July 22 Paid insurance in cash K45 July 23 Goods returned to us by N.Banda for K180 July 27 Bought delivery van on credit from Toyota (Z) Ltd for K2,500 July 31 Paid sundry expenses K67 cash

SOLUTION COMPREHESIVE EXAMPLE Capital Account 2014   K July 1 Bank 5,500 Bank Account 2014   K Jul 1 Capital 5,500 Jul 6 Rent 450 Jul 10 Cash 800

SOLUTION COMPREHESIVE EXAMPLE Purchases Account 2014   K Jul 2 M. Mundiay 540 Sales Account   K 2014 Jul 5 N.Banda 450 Jul 14 Cash 180 N . Banda Account 2014   K Jul 5 Sales 450 Jul 23 Returns inwards 180

SOLUTION COMPREHESIVE EXAMPLE M. Mundiay Account 2014   K July 2 Purchases 540 Rent Account 2014   K Jul 6 Bank 450 Cash Account 2014   K Jul 10 Bank 800 Jul 22 Insurance 45 Jul 14 Sales 180 Jul 31 Sundry expenses 67

SOLUTION COMPREHESIVE EXAMPLE Returns inwards Account 2014   K Jul 23 N .Banda 180 Insurance Account 2014   K Jul 22 Cash 45

SOLUTION COMPREHESIVE EXAMPLE Toyota (z) Ltd Account 2014   K Jul 27 Van 2,500 Van Account 2014   K Jul 27 Toyota(Z) Ltd 2,500 Sundry expenses Account 2014   K Jul 31 Cash 67

BALANCING-OFF ACCOUNTS Add up both sides to find out their totals. Note: do not write anything in the account at this stage. Deduct the smaller total from the larger total to find the balance. Now enter the balance on the side with the smallest total. This now means the totals will be equal. Enter totals level with each other. Now enter the balance on the line below the totals on the opposite side to the balance shown above the totals.

BALANCING-OFF ACCOUNTS

BALANCING-OFF ACCOUNTS If the account only has a single entry, it is unnecessary to enter the totals on both sides of the account. Just enter the same amount on the opposite side of where the single entry is to balance the account.

THE TRIAL BALANCE The Trial balance is a list of balances from the ledger i.e. the accounts. Only accounts with balances are shown in the trial balance and accounts without balances are ignored. The basic rule of double entry book-keeping is that for every debit entry there must be a credit entry. So, if you have followed this rule, the total debit entries made in your accounts should equal the total credit entries made.

THE TRIAL BALANCE The trial balance serves a dual purpose as follows: To check the numerical accuracy of the double-entry system; As a precursor to preparing the periodic reports of the statement of comprehensive income (profit and loss account)and statement of financial position (balance sheet).

RULES FOR A TRIAL BALANCE The name of the organisation is always shown on top of the Trial balance. The words as at follow before the name trial balance are put and the date when the trial balance is prepared. It should have a debit column and a credit column. The report should show the reporting currency and the level of precision just below the Debit and credit column. A details column is also shown to capture the transaction details.

RULES FOR A TRIAL BALANCE The balances from the purchases account , assets account, expenses account ,drawings and returns inwards will be entered in the debit column of the trial balance. The balances from capital account , liabilities account, income accounts and returns outwards will be entered in the credit column of the trial balance. The total of the debit column and the credit column will be equal to each other if double entry is observed

EXAMPLE Balance off the accounts for L Moyo and then extract a trial balance as at 30 September 2014.

EXERCISE You are required to enter up the necessary accounts based on the following information for J Simon. All accounts should be balanced off and a trial balance should be extracted as at 31 October 2014.

EXERCISE – J Simon 2014 October 1   October 1 Started business with K5,000,000 deposited in bank October 4 Purchased delivery van for K1,800,000 paying by cheque October 5 Bought office equipment on credit from Eves Ltd for K800,000 October 8 Paid for advertising K54,000 cheque October 11 Withdrew K300,000 cash from bank October 14 Bought stock on credit from: S Gabriel K56,000 and S Phipps K76,000 October 16 Returned stock to Gabriel worth K10,000 October 19 Sold goods on credit to: S Suckling K113,000 and C Dimmock K89,000 October 21 Paid for stationery K23,000 cash October 22 Withdrew K275,000 from bank for personal use October 25 Paid rent K270,000 paying by cheque October 26 Goods retuned by Suckling worth K27,000 October 29 Sales made on credit to J Rudling for K96,000 October 30 Commission received by firm: K29,000 cash

Period End Adjustments Introduction The accounting process consists of a series of activities/tasks the performance of which ensures that transactions are recorded in the accounts using the double entry bookkeeping system. These transactions consist of cash and credit transactions as well as correction of errors and periodic adjustments.

Period End Adjustments Why adjust some accounts The accounts written up reflect transactions previously authorized by project/organizational/company managers. In view of certain circumstances, there may be need to adjust certain accounts in order to ensure that the accounts are correct, i.e. true and fair. When that is done, then the financial statements prepared using data from the accounts will give true and fair information to the users of the financial statements.

PERIOD END ADJUSTMENTS Typical adjustments and explanations: Closing Stocks/Inventory Accrued expenses Prepaid expenses Provisions for doubtful debts Correction of errors Depreciation expenses Unearned incomes

Period End Adjustments Typical adjustments Why adjustment is needed Closing Stock To remove the unsold stock from the cost of goods sold in the Trading Account. Prepaid expenses It is quite common to pay certain expenses in advance, e.g. insurance, rent, electricity, water, fuel. If financial reports are for shorter periods than the period paid for, the prepaid expenses have to be adjusted so as to correctly reflect expenses and hence the profit/surplus and the financial position. Accrued expenses Some expenses may accrue during an accounting period. Such expenses are actually incurred but are not yet recorded in the accounts. Adjustment is required to comply with the accruals concept Examples of accrued expenses are interest on loan, wages that have been incurred but not yet paid, etc.

Period End Adjustments Typical adjustments Why adjustment is needed Depreciation When fixed assets are used in project/business operations there is an expense represented by a part of the original cost of the fixed asset. This cost is a loss in the value of the fixed asset and is called Depreciation. It is wear and tear of the fixed asset as a result of using it in project operations. Depreciation is an expense like any other expense as it represents the cost of the fixed asset that has been used in generating the income/revenue Correction of errors Various errors may be made in the accounts during the financial year or period. Such errors may be unintentional or they may be due to fraud. When they are discovered, they should be corrected by debiting/crediting one account and crediting/debiting another account.

Period End Adjustments Typical adjustments Why adjustment is needed Provisions for doubtful debts It is prudent to provide for potential losses arising from debtors who may not pay. It is certain that some debtors will never pay for their accounts. Therefore a provision recognizes this loss before it actually happens. Unearned incomes Just as expenses can be incurred but be unrecorded in the accounts it is possible to receive cash in advance before revenue is earned.

PERIOD END ADJUSTMENTS Closing Stocks/Inventory Debit closing stock account Credit Trading account Accrued expenses Debit expense account Credit accruals account

PERIOD END ADJUSTMENTS Prepaid expenses Debit prepayments account Credit expenses Provisions for doubtful debts Debit Profit and loss account Credit Provision for doubtful debts account Correction of errors After review of the ledger, observed posting errors are corrected for in the respective accounts

PERIOD END ADJUSTMENTS Depreciation expenses Debit depreciation expense account Credit Provision for depreciation account Unearned (income received in advance)incomes Debit income account Credit Unearned income account

NEXT STEPS Once adjustments have been effected in the accounts ledgers, the next step in the accounting process is to extract the final trial balance and prepare the financial statements and other management reports. Preparation of financial statements are covered in Unit 4.

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