Accounting Environment and Bookkeeping

The Accounting Environment

Private and Public Sector Organizations

• Types of Sectors
  • Private
  • Public
• Types of Organizations
  • Private
    • Sole traders
    • Partnerships
    • Private Limited Company
  • Public
    • Public Limited Company
  • Society, club, or charity

Private Sector vs. Public Sector Organizations

Sole Traders and Partnerships

Sole Traders

• A person who owns and controls a business on their own.
• Advantages
  • Keep all the profit.
  • Make all decisions.
  • Flexible work hours.
• Disadvantages
  • Unlimited liability.
  • No one to share the workload.
  • Limited funds to invest.
  • Banks might not want to lend.

Partnerships

• A business owned by two or more people.
• Often formed when a sole trader wishes to expand their business.
• Deed of Partnership (Partnership Agreement)
  • A document that sets out the terms of how a partnership should operate.
  • Contains information about:
    • Money each partner invests.
    • The interest each partner is allowed on their capital.
    • The interest that is charged to each partner for taking drawings.
    • Salaries given to each partner.
• Advantages
  • Easy to be formed.
  • More skills are available.
  • Sharing of risk.
• Disadvantages
  • Profits are shared.
  • Disagreements occur.
  • Longer to make decisions.

Limited Partnerships

• Some partners will have limited liability.
• At least one partner must have unlimited liability.
• Partners with unlimited liability are the ones who manage the business.
• Partners with limited liability are often considered silent investors.

Limited Liability Partnership

• All partners have limited liability.
• Separate legal identity.
• All partners are involved in the management of the business.

Limited Companies

• Owned by shareholders.
• Separate legal identity from the owners.
• Advantages
  • Raise more capital.
  • Limited Liability.
• Disadvantages
  • Need more legal requirements.
  • Publish finances.
  • More expensive.

Private Limited Company vs. Public Limited Company

Stakeholders

• People who have an interest in the business.
• Stakeholders have different interests.

Internal Stakeholders

• Owners
  • Check profitability.
  • Assess the profitability of the business.
• Managers
  • Compare the performance with previous years.
  • Check efficiency of the business.
  • Evaluate Profitability.
  • Check progress and compare with previous years.
  • Plan for the future.
• Employees
  • Evaluate pay raise.

External Stakeholders

• Customers
  • Goods will continue to be supplied.
• Investors
  • Assess the likelihood of making money.
• Suppliers
  • Check whether the business can pay for its supplied goods.
  • Set the credit terms for goods and services.
• Competitors
  • Identify gaps in the market.
• Government and Tax Authorities
  • Calculate how much is owed.
  • Gather data for government statistics.
• Banks
  • Assess whether it's suitable for an overdraft/loan.

Accounting Concepts

• Business entity: Only record and report on business activities.
• Money measurement: Only contain information about the transactions involving money.
• Materiality: Small expenses.
• Consistency: Use a specific method every year.
• Accruals: Incomes and expenses must be matched to the year made.
• Prudence: Do not overstate its profit of net assets.

Manual vs. Computerized Accounting Systems

Manual Accounting System

• Physical Journals
• Physical Ledgers

Computerized Accounting Systems

• Accounting software
  • Receivables, Payables, Nominal Ledger A/Cs
  • Cashbooks
• Spreadsheets
  • Financial, cash flow statements
  • Forecasts
  • Budgets

Advantages of Using a Computerized System Over a Manual System

• Calculations are completed by the software.
• Financial information is always available.
  • Elimination of human errors
  • Financial Statements can be produced instantly
  • Information is up-to-date
  • Helps managers with decision-making
• Information is stored electronically.
• Information can be processed quickly.
  • Physical Storage is not needed
  • Reduces cost of wages for staff
  • Easier to share information

Security Issues in Computerized Systems

• Data could be lost.
• Confidential information might be shared.
• Data might be accessed by others.

Methods of Protecting Data

• Firewalls: A security system that monitors both incoming and outgoing computer network traffic.
  • Protected by hackers, viruses
• Antivirus: A simple program made to harm a computer system.
• Spyware software: Gathers data from the device and sends it to third parties without consent.

Prevention of Loss of Electronic Data

• Users should save regularly.
• Back up their data.
• Data should be password protected or encrypted.

Principles of Professional Ethics

• Sets how people working in accounting roles must behave.
  • Payroll
  • Reporting
  • Auditing
  • Bookkeeping
  • Accountants
  • Financial Statements
• If not followed
  • Unethical practices can damage an accountant's reputation.
  • Businesses will refuse to hire unethical accountants.

Principles of Professional Ethics

• Integrity: Accountants must be honest, straightforward, trustworthy.
• Objectivity: Must be fair and free of bias.
• Confidentiality: Not share information without permission.
• Professional competence and due care: Must be suitably qualified, follow laws and regulations, be kept up to date with changes.
• Professional behavior: Not harm the reputation of the Profession.
• Public Interest for accountants: Refers to the external stakeholders of a business.
  • Accountants need to create accurate and reliable financial statements.
  • Relevant and understandable information.

Introduction to Bookkeeping

Business Documents

• Used to keep records of all transactions
• Source documents
  • Purchase orders
  • Invoices
  • Debit/Credit Notes
  • Statements of accounts
  • Remittance advice
  • Cheques
  • Receipts
  • Paying-in slips
  • Bank Statements
  • Petty cash Vouchers

Trade Discount

• A reduction in the selling price of goods.
• Offered when:
  • If the customer buys in bulk
  • If the customer is loyal

Cash Discount

• Offered to credit customers for early repayment.

Business Documents for Credit Transactions

Purchase Order

• Completed by the customer of a business
• States the goods that the customer wants to buy

Invoice

• A record of a credit Sale/Purchase
• The supplier will keep a copy
• Information contained in an invoice:
  1. Date of transaction
  2. Details of suppliers -> Name and address
  3. Details of customers -> Name and address
  4. Details of the goods/services -> quantity and price
  5. Trade Discount
  6. Total amount owed
  7. Terms of eligibility of cash discount
  8. Date Payment is required by

Debit Note

• A Credit customer issues a debit note to a supplier to request a reduction in the balance of an invoice
• The customer could ask for a reduction if:
  • The goods are damaged or faulty
  • They were sent the wrong items
  • Goods are missing from their order
• Information contained on a Debit Note:
  1. Date of the request
  2. Details of the suppliers name and address
  3. Details of the customer name and address
  4. Reason for the request for a reduction
  5. Details of the goods being returned
  6. Details of the goods missing
  7. Total reduction that is being requested

Credit Note

• A supplier issues a credit note to a credit customer when the balance on an invoice is reduced
• The customer uses the credit note received to record the return.
• The supplier keeps a copy of the credit note issued to record the return. It will be matched and filed to the invoice
• The customer enters the value in the purchases returns day book
• The supplier enters the value in the sales returns day book
• Information contained in a credit note
  1. Date of reduction
  2. Details of the suppliers name and address
  3. Details of the customer name and address
  4. Reason for the reduction
  5. Details of the goods that are being returned
  6. Details of the goods that were missing
  7. Total reduction that is being given

Remittance Advice

• A document prepared by the customer which notifies the supplier that a payment has been made.
• A source document for payments of goods that were purchased on credit.
• The customer and supplier enter the value in the cashbook

Statement of Account

• Used to show all transactions between a credit customer and a supplier within a given time frame.
• Issued by the supplier each month
• The Statement of account is written from the point of view of the supplier
• What information is contained in a statement of account
  1. The date that the statement is issued
  2. The details of the suppliers -> name and address
  3. The details of the customer name and address
  4. Opening balance
  5. Date and amount of any purchases by the customers. Correspond to invoices
  6. The date and amount of any returns by the customer. Correspond to credit notes that were issued
  7. Payments made by the customer
  8. Cash Discounts Received by the customer
  9. Closing balance

Receipt

• A record of a cash payment
• A supplier issues a receipt to the customer when they pay using cash

Cheque Counterfoil

• Cheques are attached to counterfoils in the chequebook
  1. The name of the Person who is being Paid
  2. The amount to be paid
  3. The Gate that the cheque is written in

Cheque

• A form of payment. It is written by the customer and given to the supplier as payment. The supplier takes the cheque to the bank and deposits it
• The customer keeps the cheque counterfoil
• A cheque should contain:
  1. The details of the customers bank account
  2. Name of suppliers
  3. Amount to be paid
  4. Date on which the cheque is written
  5. Customer's signature

Bank Statements

• Issued by the bank. It shows the money going in and out of the business's bank account
• A bank Statement is used as a business document to identify and reconcile
  • Payments by credit transfer
  • Payments by telephone transfer
  • Payments by direct Debit
  • Payments by standing order
  • Bank charges and interest

Direct Debit

• Used by a business to make recurring bank transfer payments. The direct debit is set up by the person or business receiving the payments
• The payments can change:
  1. Dates of Payments
  2. Amounts of payments

Standing Order

• Used by a business to make recurring bank transfer payments to a person or another business
• It is set up by the business making the Payments
• Payments are fixed
• The dates are determined in advance
• Same day each month + same amount

The Day Books

• Sales day book: Credit Sales amounts should be after trade discount
• Purchases day book: Credit Purchases
• Sales Returns day book: Returns from credit customers
• Purchases Returns day book: Returns to credit suppliers
• Cashbook: Record all cash transactions
• Petty cash book: involving small amounts of cash
• Journal: capital, drawings, purchase/sell of non-current assets

Advantages of Using Books of Original Entry

• Check for errors
• Preparation of control accounts
• Check accuracy of the ledgers accounts

The Accounting Equation

$Assets = Liabilities + Equity$

• Assets: Premises, inventory, motor vehicles, money in the bank
• Liabilities: Amounts that are owed to the business
• Equity: Resources provided by the owners

$Liabilities = Assets - Equity$
$Equity = Assets - Liabilities$

The Double Entry System

• Used by bookkeepers
• Straightforward to prepare financial statements
• Improve accuracy of financial statements
• Give an accurate calculation of profit/loss

The Ledgers

• A collection of all the accounts of a business
• Three separate ledgers
  • Nominal
  • Receivables
  • Payables
• Trade Receivables Ledger Control account: All credit customers
• Trade payables ledger control account: Credit Suppliers
• Nominal Ledgers control a: All accounts except for credit customers/supplies
• Accounts in the nominal ledger:
  • Sales account
  • Returns outwards account
  • Discount allowed
  • Purchases account
  • Carriage Inwards account
  • Discount receive
  • Returns Inwards account
  • Carriage Outwards account

Cash and Credit Sales

Cash Sales

• When a customer pays upfront for goods or services
• The business issues the customer with a receipt
• A copy of the sales receipt is used as the source document
• How to record cash sales in the ledgers account
  1. Debit the cash or bank account in the nominal ledger
  2. Credit the sales account in the nominal ledger

Credit Sales

• When a customer pays later for goods or services
• The business will issue the customer with an invoice
• A copy of the Sales invoice is used as a source document
• Book of original entry is the sales day book
• How to record credit sales in the ledgers accounts
  1. Debit the trade receivables account
  • Business is owed money from credit customers
  1. Credit the sales account in the nominal ledgers

Payments from Credit Customers

• A credit could pay by
  1. Debit the cash or bank account in the nominal ledgers
  2. Credit trade receivables account in the receivables ledger
     • Cash Payment
     • Cheque
     • Bank Transfer
     • Telephone transfer

Discount Allowed

• For early repayment of an invoice
• Credit trade receivables account in the receivables ledgers
• Debit discount allowed account in the nominal ledgers

Sales Returns

• When a customer returns some goods
• Reasons for return might be:
  • Goods were damage
  • Goods were not what the customer wanted
  1. Credit the trade receivables account in the receivables ledgers
  2. Debit sale returns account in the nominal ledgers

Capital and Revenue Expenditure

Capital Expenditure

• Money spend on non-current assets
  • Purchase of non-current assets
  • Delivery of non-current assets
  • Installation of non-current assets
  • Legal costs that come with the non-current asset purchases
  • Training costs
  • Decoration of non-current asset

Revenue Expenditure

• Spend on day-to-day running costs
  • Purchase of goods for resale
  • General expenses
  • Insurance
  • Wages
    *Included in SOFP under current assets
  • Repair of non-current assets
    *Included in the income statement

Incorrectly Treating Capital Expenditure as Revenue Expenditure

• Will affect the financial statements
  • Appear as an expense on the income statement
  • Expenses will be overstated
  • Profit for the year will be understated
  • Not appear as a non-current asset on the statement of financial Position
  • Non-current assets will be understated
  • Capital will be understated

Incorrectly Treating Revenue Expenditure as Capital Expenditure

• Will affect the financial statements
  • Not appear on the income statement
  • Expenses will be understated
  • Profit for the year will be overstated

Depreciation

• Applied to non-current assets to represent the reduction in their value
• It is an expense that does not involve spending money
• Use the accounting concept of consistency, accruals, prudence
• Causes of depreciation:
  • Wear and tear
  • Obsolescence
  • Passage of time

Methods of Depreciation

Straight Line Method

$Depreciation = (original value - expected value) / Scrap value$

Reducing Balance Method

$cost X rate$

Provision for Depreciation

• Used to record the depreciation for a specific asset
• How to record depreciation in the ledger accounts:
  1. Debit income statement
  2. Credit provision for depreciation account
• Closing balance will be accumulated depreciation
  • Opening balance (b/d) will be on the credit side
• How to record depreciation in the financial statements:
  • Income statement only shows the depreciation charge
  • Listed under expenses
  • Statement of financial position shows three values
    1. Cost
    2. Accumulated depreciation
    3. Carrying value

Disposal Account

• Show the calculation of the Profit/loss on a sale of a non-current asset
• How to record in the ledgers accounts ?
  1. Credit the non-current asset account by the original value
  2. Debit the disposal account
  3. Debit provision for depreciation
  4. Credit the disposal account
  5. Debit bank, cash or other receivables
  6. Credit disposal

Irrecoverable Debts

• Occur when a business is unable to receive payment from a credit customer bankruptcy
• It is an expense
• How to write off irrecoverable debts in the ledgers control accounts
  1. Debit trade receivables
  2. Debit irrecoverable debts account in the nominal ledgers

How to recover on irrecoverable debt written off

• If a customer pays their debt off after it's being written off
  • Reasons: contact customer, unexpected payment
• How to record the recovery of debts written off in the ledgers accounts ?
  1. Debt is added back to the trade receivables
  2. Debit trade receivables account
  3. Credit debts recovered

Trial Balance

• Uses of the trial balance
  • Check arithmetical errors
  • Helps with the preparation of financial statements
• Disadvantages
  • Not all errors are identified

Control Accounts

• Summary of all balances and transactions
• Purpose:
  • Summary of transactions
  • Total figure for trade receivables/payables
• Advantages:
  • Locate errors
  • Reduce and Prevent fraud
  • Help with arithmetical accuracy
• Errors not identified:
  • Omission -> transaction not entered
  • Commission -> incorrect account but correct type of account t - Journal

Common Errors

• Omission: Transactions not entered
  • How to fix: enter transactions correctly
• Commission: Incorrect account but correct type
  • How to fix: undo entry in incorrect account
• Original entry: Entered into both accounts with incorrect amount
  • How to fix: find difference and enter in both a/c's
• Complete Reversal: Wrong side of both accounts
  • How to fix: double the value and make entry on the correct site
• Principle: Incorrect account and type
  • How to fix: undo entry in incorrect account

Errors Identified by the Trial Balance

• Addition errors
• Posting errors
• Unequal posting errors
• Partial omission errors