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Accounting Principles > Chapter 2 - Accounting Principles and Techniques (continued) > Flashcards

Chapter 2 - Accounting Principles and Techniques (continued) Flashcards

1
Q

The dual aspect of financial transactions (duality)

The source of financial information

A

The source of financial information comes from business documents: invoices, orders, credit notes, cheques, etc.

The information they provide are recorded in Day Books: purchases, sales, purchase returns, sales returns and cash book.

The information is then recorded into accounts in the ledgers by using a Double Entry system.

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2
Q

Dual effect if there is a change in the elements of the accounting equation

A

Assets - Liabilities = Capital

Any changes in assets results in a similar change in capital or liabilities.

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3
Q

Rules of double entry

Accounts and Ledgers

A

Every item the firm owns, person and firm it deals with, will have an account, which is kept in a ledger.

Ledger is the main book of account, as all financial information will be collected there at the end of the recording process

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4
Q

Rules of double entry

T-accounts

A

Each account is divided in 2 sides: Debit (DR) and Credit (CR), in the form of a T shape.

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5
Q

Rules of double entry

Folio Number

A

Reference number allocated to each account, so that it can be easily located for cross-referencing, and to help locate errors.

Example: Salaries (NL70)

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6
Q

Rules of double entry

A

A financial transaction is an exchange of goods, services or cash, and most transactions will be between the firm and a third party.

Monetary value received by one party and value is given by another party. So every financial transaction is recorded twice. Once on the credit side and once on the debit side.

Receiving value is debited
Giving value is credited

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7
Q

Rules of double entry

Example

A

Firm is receiving money and giving goods:

Bank account is debited
Sales revenue is credited

Bank
(date) Sales Revenue 500DR

Sales
(date) Bank 500CR

Each transaction will need the date, and a reference as to where the other part of the double entry can be found.

£ is not used, as all figures represent money, which makes the sign unnecessary.

Even after various transactions have been added, both sides will need to match. Debit and credit totals must be the same.

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8
Q

Trial Balance

A

Usually done at the end of every month.

If both debits and credits agree, it means there are no arithmetical errors.

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9
Q

Ledger accounts sections

A
  1. Sales Ledger: customer accounts
  2. Purchase Ledger: supplier accounts
  3. Nominal Ledger: assets, liabilities, capital, income and expense accounts (also known as the general ledger)
  4. Cash book: cash and bank account
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10
Q

Books of prime entry

A

Sales Day Book
Purchase Day Book
Cash Book (including petty cash)
Journals

These feed into the other ledger

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11
Q

Cash Transactions

A

Is one where cash is received or paid the same day as the goods or services are supplied.

It can be actual cash, cheque, debit or credit card (personal or corporate), ‘fast’ bank transfer. After the transaction is complete there is no outstanding debt, so no ongoing debtor or creditor.

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12
Q

Credit Transaction

A

Where goods, services or finance are supplied on one date, and payment is being made at an agreed later date.

This creates an outstanding debt, and therefore a debtor or a creditor.

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13
Q

Capital and Revenue Expediture

A

Expenditure is an exchange of money to buy goods, services and assets.

There are 2 types of expenditure: capital expenditure and Revenue Expenditure

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14
Q

Capital Expenditure

A

Relates to non-current assets (premises, machinery, equipment, motor vehicles). They will be in the business for more than 1 accounting year.

Features are:

  • the cost of buying a non-current asset
  • cost of setting up a non-current asset
  • the benefit from the cost lasts more than 1 accounting year
  • it is treated as an increase in the non-current assets in the balance sheet
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15
Q

Revenue Expenditure

A

Refers to costs involved with day-to-day operating activities of the firm.

Purchases, salaries, insurance, rent.

Features are:

  • an expense, a cost to run the business
  • benefit from the expenditure will be less than 1 financial year, it has no lasting value
  • treated as an expense or overhead in the profit and loss account, and decreased the profit for the year.
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16
Q

Making double entries in ledger accounts

A
  1. Decide which 2 accounts are involved in the transaction
  2. Which accounting is giving and which is receiving
  3. The giving account is credited, the receiving is debited
  4. Always view the transactions from the firm’s point of view
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17
Q

Recording the Entry

A

It neds to have:
Date
Details: the name of the other transaction of the double entry
DR or CR as appropriate
Balance: update balance in the running account, ensure that DR or CR are added.

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18
Q

Double Entry for owner’s Capital

A

DR in Bank: as company is receiving the money

CR in Capital: as owner is giving a ‘loan’ to the firm

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19
Q

Double Entries for trading (selling)

A

DR in bank: as the firm is receiving cash or cheques

CR in Sales Revenue: as the firm is giving goods to customers (goods leaving the business)

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20
Q

Double Entry for expenses

A

DR in the account of the goods or services provided (advertising, packaging, etc)
CR in bank: as money is being giving away to the supplier

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21
Q

Double Entry for expenses - Asset

A

When it refers to an asset:

DR in equipment: as the company is receiving that
CR in bank or cash: as firm is paying for that asset.

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22
Q

Trial Balance

A

It list the closing balances , and when debits and credits are totalled, they must be the same.

It’s done for the following reasons:

  • check arithmetical accuracy of the double entries in the ledger
  • help finding errors, so that they can be corrected
  • summary of all the account balances in the ledger
  • basis for the preparation of Income Statement and Statement of Financial Position
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23
Q

Credit Transactions

A

The majority of large firms will operate on a credit basis.

Money will be owed by the firm to suppliers, and to the firm by customers. This makes it even more important that transactions are accurately recorded, so that there is a clear view of money owed and of who owes money.

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24
Q

Debtors and creditors

A

Purchasing on credit means that the goods are supplied on one date and paid for at a later date.

Seller: the transaction is a sale, which creates a debtor

Buyer: the transaction is a purchase, which creates a creditor.

When debtor pays, the bank account will increase.
Both bank and debtors are current assets.

Creditor is owed money by the firm, so classed as a liability.

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25
Q

Buying goods for resale on credit

A
  1. Record the exchange of goods
  2. Record the exchange of money at a later date

Example:
£200 invoice received for purchased goods

200DR in Purchases (NL) because goods are received
200CR in Creditor account (PL) is owed money by the firm

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26
Q

Other credit purchases

A

DR: account receiving the value (purchases, stationary, assets)
CR: the person or company giving the item

Debit entries will all be part of the Nominal Ledger, as they involve receiving of expenses or an asset.

The credit providers, give the items, so their accounts are credited, and they are part of the Purchase Ledger.

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27
Q

Credit Sales

A

DR: Customer
CR: Sales Revenue

Example:
Sale of £300 made

300DR in Customer account (as customer is receiving the goods)
300CR in Sales Revenue (as the firm has given goods to the customer)

The Customer Account will be part of the Sales Ledger.

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28
Q

Returns and credit notes

A

When goods are returned to the supplier (damaged or not as ordered) and supplier agrees to take them back.

If goods were obtained on credit, they will have been returned before any paid was made.

Both buyer and seller need to record the returns to reduce the outstanding balance.

29
Q

Credit Note

A

Seller will raise a credit note for returned goods, and it will include its details, and the layout will be similar to and invoice.

The invoice is the ‘bill’, whilst the credit note is an allowance that reduced the amount owed

30
Q

2 types of Returns

A

Purchase and Sales returns.

They rare recorded in their own separate accounts, not in the sales and purchase revenue accounts.

31
Q

Purchase Returns

A

when company returns goods that have been purchased on credit back to the supplier.

The supplier will rise the credit note for the value of the returned goods.

double entry would be:

Debit in the supplier account (PL)
Credit in the Purchase returns (NL)

Because the company is giving back the goods, purchase is credited.

the entry in the supplier account, the debit, is added to reduce the amount owed.

32
Q

Sales Returns

A

When customer returns goods that were sold on credit.

company will issue a credit note with the value of the returned goods and will send it to the customer.

Double entry:
Debit in Sales Returns (NL)
Credit in Customer Account (SL)

Customer is returning the goods back, so their account needs to be credited, as they will owe less money.

33
Q

Value Added Tax

A

VAT is payable by all companies that that have a certain level of sales revenue, and they must register for VAT.

Companies don’t need to register if their sales don’t have above that level.

This threshold is set by the Treasury and the government amends it from time to time. it is collected on behalf of the HMRC.

34
Q

Output Tax

A

VAT charged when company sell.

35
Q

Input Tax

A

VAT that is paid in goods that the company purchases.

36
Q

Output and Input tax

A

Output tax will be deducted from the input tax when firms makes its quarterly VAT returns.

Example:

Output tax charged to customers in sales £6,000
Input tax paid in purchases made to suppliers £2,500

£6,000 (output tax) - £2.500 (input tax) = £3,500 owed to the HMRC

20% is the VAT rate used for this course.

37
Q

Recording of VAT

A

It’s recorded in invoices and credit notes, at 20% of the net value of the goods.
VAT is tac and not part of the of the cost of the goods to the firm, that is why VAT needs to appear separately.

38
Q

Recording of VAT

Purchases

A

Total value of the invoice is posted on the debit side of the 2 accounts:
purchases will have the value of the goods
VAT with the tax element.

39
Q

Recording of VAT

Sales

A

total value of the invoice is posted on the credit side of the 2 accounts:
sales revenue with the value of the goods
VAT with the tax element

40
Q

Input Tax

A

VAT charged to firm when purchasing assets: plant, equipment, machinery, goods for resale.
But also expenses such as stationary, advertising, heating and lighting costs.

These are debited to the VAT account.

Example:
Purchased goods at £1,000, but £200 added

£1,000 Debit in purchases
£200 Debit in VAT
£1,200 Credit in the supplier account

Amount owed to supplier includes VAT, so it needs to be paid to them.

41
Q

Output tax

A

VAT added to sales value when invoicing customers.

Sales revenue is credited with the selling price, and VAT is credited in the VAT account.

Example:
Goods sold at £600, plus VAT at £120

£720 debit in the customer account
£600 credit in the sales account
£120 credit in the VAT account

42
Q

VAT account

A

It is opened in the nominal ledger.
The entries are added in chronological order.
The balance will change from debit to credit depending on the entries.

Debit balance is higher than credit, means input tax is higher than output tax —> HMRC how the firm, and will appear in the balance sheet as a current asset.

Credit balance is higher than debit, means output tax is higher than input tax —-> firm owes the HMRC, it will appear in the financial position balance sheet as a current liability, as it needs to be paid within 3 months.

43
Q

VAT on sales returns

A

Customer is invoiced for goods sold, and this is debited in the customer’s account. the credit note will be the opposite of the invoice.

Double entry example:

Debit Sales Returns £10
Debit VAT £2
Credit customer account £12

44
Q

VAT on Purchase Returns

A

When goods are purchased on credit , supplier’s account is credited, and the credit note is the opposite.

Double entry example:

Debit supplier account £24
Credit Purchase Returns £20
Credit VAT £4

45
Q

VAT Calculations

A

VAT is usually shown as a separate figure both on the invoice and the credit note.
Some invoices may show the total amount, which includes VAT.
so the value of the goods and the VAT needs to be calculated separately, so that the double entries are made correctly.

46
Q

Calculate VAT from price

A

Multiply cost by 20%

Goods £750 x 20 /100
VAT £150
Invoice total: £900

47
Q

Calculating VAT inclusive

A

1st method: divide the VAT inclusive total by 1.2 to obtain the exclusive value, the difference is the VAT

Invoice total £900 / 1.2
Goods £750
VAT £150

48
Q

Calculating VAT inclusive

Alternative method

A

VAT in fraction is 1/6; so you can divide by 6.

VAT inclusive price £120
120 / 6 = 20
VAT £20

49
Q

The Cash Book Accounts

Recording receipts and payments

Receipts

A

A paying-in slip counterfoil which records money paid into the bank, and itemises payments in cash and cheques.

There will also be income via BACS and direct transfer.
There will normally be a remittance advice from the payer to identify what the payment relates to.

50
Q

The Cash Book Accounts

Recording receipts and payments

Payments

A

A cheque counterfoil which records money paid out of the bank.

Payments are also done via BACS, direct transfer, direct debit and standing order.

Payments to suppliers should have accompanying paperwork to ensure payments are recorded correctly and relate to legitimate expenditure.

51
Q

The Cash Book Accounts

Recording receipts and payments

Receipts and payments of credit purchases and sales revenue

A

Example:

Cheque of £468 received from client:

Debit £468 in bank
Credit £467 in client account (client gave payment owed to firm)

52
Q

The Cash Book Accounts

Recording receipts and payments

Receipts and payments of credit purchases and sales revenue

A

Example:

Cheque of £960 sent to supplier:

Debit £960 in supplier account 9as they are receiving the owed payment
Credit £960 in bank account (as firm owed money)

53
Q

Rules for posting figures from the cash book

A

Receipt is a debit (credit somewhere else in the ledger account)

Payment is a credit (debit somewhere else in the ledger account)

54
Q

The Cash Book Accounts

VAT

A

When dealing with receipts and payments connected with credit transactions, no entries are made in VAT, because VAT was already accounted for when the purchase or sales invoice was entered in the accounts

55
Q

The Cash Book Accounts

VAT: Cash transactions

A

When dealing with cash transactions, it is necessary to account for VAT, because it won’t have been included in any previous accounts:

  • cash purchases
  • cash sales
  • cash expense
  • purchase of a non-current asset for cash
56
Q

The Cash Book Accounts

VAT: Cash transactions

Cash Purchase example

A

Cash purchase of goods for resale for £300 plus VAT of £60, paid by cheque:

Debit £300 purchases
Debit £60 input tax
Credit £360 Bank

57
Q

Trade and cash (settlement and prompt payment) discounts

A

Each firm will have a pricing policy which determines the list price for each item or for the services.

A discount is a reduction in the normal list selling price.

Discounts are offered to encourage from the firm, instead of other rival firms, one of the ways is to offer trade discounts.

58
Q

Trade Discount

A

This is a discount given when the goods are invoiced, and it will take the form of a percentage off the list or catalogue price of the goods or service.

Discount will vary for each customer, as it represents the buyer’s profit.

59
Q

Reasons to give trade discount

A
  • bulk buying - it’s cheaper for the supplier to process a larger order, so the discount encourages customers to place larger orders
  • regular placing of orders - to encourage customer loyalty
  • encourage customers to buy new products
  • encourage customers to buy old stock
  • one-off promotions to increase sales, specially during off-peak seasons
60
Q

Trade Discount calculation

A

It is calculated as a percentage of the gross goods sold, and is shown as a deduction in the invoice.

It is however the net value of the goods which is entered into the accounts, as it is the actual price of goods that were sold.

The gross value of the goods and the trade discount never appear in the ledger accounts.

61
Q

Trade Discounts - returns - credit note

A

When goods are returned, the calculations in the credit note are the same.

Gross value of goods, less trade discount, which will provide net value.
Net value will then be the one entered in the accounts, together with the VAT and the credit note total.

62
Q

Cash Discount or prompt payment discount

A

One of the major issues with selling on credit is the delay on the payment, specially if the customer exceeds the agreed credit terms.

In order to encourage to pay on time, or even before the due date, a supplier can offer a discount for prompt payment.

This is an allowance off the monthly amount owed, if payment is made within a specified period. It is not necessarily a cash payment, it will be agreed between customer and supplier.

63
Q

Discount Received

A

Allowance given to the firm by a supplier, which in accounts is treated as a gain, because the firm will be paying less for the goods.

Double entry as follows:
Purchase of £468.60, firm was given a £8 discount, therefore:
Debit £460.60 in supplier account (PL)
Debit £8 in supplier account (PL)
Credit £460.60 in bank (CB)
Credit £8 in discounts received (NL)
64
Q

Discount Allowed

A

Allowance given by the firm to a customer.

It is treated as a loss, an expense, as the firm will be receiving less than owed.

Double entry as follows:
Goods sold on credit for £351.45, received from customer £345.45, as £6 discount was given:
Debit £345.45 in Bank (CB)
Debit £6 discount allowed (NL)
Credit £351.45 in customer account (SL)
65
Q

Cash Discount and VAT

A

When a discount is offered to a customer, it will affect the VAT to be paid. VAT will be calculated on the net value of the goods that are sold.
If a discount is given, it will decreased the net value of the goods and consequently the amount of VAT to be paid.

66
Q

Correction of Book-keeping errors

A
  1. Control accounts: they are the gate-keepers of the ledger divisions: sales ledger.
    Some book-keeping errors will not be readily detected by the trial balance, the control accounts will detect unresolved errors.
  2. Trial Balance: checks the overall arithmetic accuracy of the double entry transactions. Some book-keeping errors will not be detected by the trial balance though.
67
Q

What is a control account

A

Is one that controls the arithmetic accuracy of the balances of all customer accounts in the sales ledger, and all the supplier accounts in the purchase ledger.

The balance in the Sales Ledger control account (NL) should be the same as the total of all individual balances in the Sales Ledger.

The purchase ledger account (NL) should be the same as the total of the individual balances in the purchase ledger,

68
Q

Advantages of maintaining control accounts

A
  • checks arithmetic accuracy of the book-keeping (though it won’t detect if one entry was entered in the wrong account)
  • if done regularly, errors will be spotted early, which will make it easier and quicker to correct them
  • it will also help when preparing the trial balance, as totals can be accurately added in, rather than smaller amount (total of customers, for instance)
  • if the trial balance doesn’t agree, the receivables and payables totals can be excluded from the error search, as they have already been verified.
  • senior member of staff usually controls them on a daily basis, which prevents fraud
  • ## they indicated how much is owed to suppliers and how much is owed to the firm by customers
69
Q

Other reasons for maintaining control accounts

A

Control accounts are more commonly used by large companies, because the transaction value is very high.
A smaller company may just store all transactions in the nominal ledger

Accounting Principles (12 decks)

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