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By the end of this session you should be able to:
identify the different types of business there are
describe the different types of accounting and the financial statements
understand the basic principles of accounting including the accounting equation
define common terms used in accounting including capital income, capital expense, revenue income and revenue expense
and answer questions relating to these areas.
Chapter 1
Double entry bookkeeping – an
introduction
Outcome
The underpinning detail for this Chapter in your Workbook can be found in Chapter 3 of your Study Text
Resources
This topic is covered on MyKaplan
OnDemand module: Double entry bookkeeping and ledger accounting – Double entry – an introduction
Bookkeeping Transactions
Overview
Types of
businesses
Double entry
bookkeeping
Types of
accounting
Capital and revenue
income and
expenditure
Basic
principles of
accounting
Accounting
for profit
Bookkeeping Transactions
Sole trader
The business is owned and operated by one individual.
The business is usually small.
The owner is personally liable for the business debts (one legal entity).
Partnership
Two or more people carry on a business together.
Partners are usually personally responsible for business debts (one legal entity).
Partners are usually jointly and severally liable for the business debt, unless an agreement has been drawn up that states otherwise.
The business can be very large.
Company
An incorporated business which has its own legal entity, distinct from the owners of the business.
The owners of the business are shareholders who are not usually liable for business debt.
Accounts preparation and presentation in accordance with international accounting standards.
Double entry bookkeeping – an introduction : Chapter 1
Statement of profit or loss
This summarises the effects of trading – the income and expenses, and shows the financial performance of the business for a given time period, usually the last twelve months.
Statement of financial position
This presents a snap shot of the financial position of the business at a specific moment in time, summarising the assets and liabilities of a business.
Depending on what purposes the statements are being produced for, the accounts can be referred to as being either management accounts or financial accounts.
Management accounts
These are usually prepared on a monthly basis to present timely financial and statistical information to business managers. This aids managers to run the business more effectively by making day-to-day and short-term decisions.
Financial accounts
These are prepared annually, mainly for the benefit of people outside the management of the business, such as the owners of the business (for example, shareholders who have appointed directors to run the business on their behalf), HM Revenue and Customs, banks, customers, suppliers and the government.
Financial statements
There are two key financial statements.
Types of accounting
Double entry bookkeeping – an introduction : Chapter 1
These items you will find on the statement of financial position:
Asset Something owned or controlled by the business, available for use by the business.
Examples: Buildings, Vehicles, Inventory, Receivables, Bank and Cash.
Assets can be categorised as being either ‘non- current’ or ‘current’.
Non-current asset An asset which is to be used for the long term and not resold as part of the trading activities.
Examples: Buildings, Vehicles, Plant and Machinery.
Current asset A short term asset of the business which is either cash or will soon be converted into cash.
Examples: Inventory, Receivables, Bank and Cash.
Receivable An example of a current asset – a receivable is someone who owes the business money. A receivable is created when the business sells to a customer on credit.
Liability An amount owed by the business. It is an obligation to pay money at a future date.
Examples: Loans, Mortgages, Payables and Bank Overdraft.
Liabilities can be categorised as being either ‘current’ or ‘non-current’.
Bookkeeping Transactions
These items you will find on the statement of financial position:
Non-current liability An amount owed by the business and due to be paid in the longer term (after 12 months).
Examples: Loan, Mortgages.
Current liability An amount owed and due to be paid by the business in the short term (less than 12 months).
Examples: Trade payables, Bank overdraft, VAT payable.
Payable An example of a current liability – a payable is someone the business owes money to. A payable is created when the business buys goods on credit from a supplier.
Capital The amount which the owner has invested in the business – this is owed back to the owner and is therefore considered to be a special liability of the business.
Drawings Amounts withdrawn from the business by the owner for the owner’s personal use. Drawings can either be cash or inventory.
Bookkeeping Transactions
Shown below is a sample format of the statement of financial position:
Statement of Financial Position as at 31 December 20X
Cost Depreciation Carrying amount £ £ £
Non-current assets:
e.g. land and buildings X X X
––––– –––––
Current assets:
Inventories X
Trade receivables X
Bank X
––––– X
Non-current liabilities: (X)
Current liabilities:
Trade payables X
VAT payable X
––––– (X) –––––
Total net assets X
–––––
Capital account
Capital X
Profit/(Loss) for the year X/(X)
Less: Drawings (X)
––––– X –––––
Double entry bookkeeping – an introduction : Chapter 1
Capital and revenue income and
expenditure
Capital income
Income received from the sale of non-current assets.
Example: The proceeds received from selling a motor vehicle.
Revenue income
Income received from the trading activities.
Example: The proceeds received from selling goods (inventory).
Capital expenditure
Expense of acquiring or improving non-current assets.
Examples: Buying a piece of machinery, removing single glazed windows and replacing with double glazed windows.
Revenue expenditure
Day to day running expenses of the business, including the repair and maintenance of non-current assets.
Examples: Gas, electricity, rent, repairs and maintenance.
Double entry bookkeeping – an introduction : Chapter 1
Example 1
For each transaction write down the dual effect:
1 John started the business by putting £5,000 into his business bank account.
The business has £5,000 more cash – asset (cash) increases
The business owes £5,000 back to the owner – liability (capital) increases
2 John pays himself £200.
The business has £200 less cash – asset (cash) decreases
The business has repaid some of John’s investment – drawings increase
3 John’s business buys a van for £1,000 cash.
The business has a van for £1,000 – asset (nca-vehicles) increases
The business has £1,000 less cash – asset (cash) decreases
4 John’s business buys a computer for £500 and promises to pay later (buys on credit).
The business has a computer for £500 – asset (nca-computer) increases
The business owes the supplier £500 – liability (payables) increases
Bookkeeping Transactions
The accounting equation
At its simplest, the accounting equation simply says that:
Assets = Liabilities
The owner’s capital is treated as a special form of liability as the money is owed back to the owner. If we include this the accounting equation is now:
Assets = Liabilities + Capital
This can be re-stated as:
Assets – Liabilities = Capital
Any profit the business makes will increase what is owed back to the owner and any drawings taken will reduce it. Therefore, we can re-write the equation as:
Assets – Liabilities = Capital + Profit* – Drawings
- NB: A loss would be subtracted from the capital
The statement of financial position is a more detailed display of the accounting equation.
Bookkeeping Transactions
Example 2 – continued
Answer 2
Dual effect
Increase inventory £2,500 (asset)
Decrease cash £2,500 (asset)
TLC’s position is:
Assets Capital £ £ Inventory 2,500 Capital introduced 10, Cash 7, 3 Buy inventory on credit In reality a business will not always pay for its purchases with cash but is more likely to buy things on credit. TLC buys inventory of 200 red roses on credit. Each red rose costs £10. What is the effect? Answer 3 Dual effect Increase Inventory £2,000 (asset) Increase Payables £2,000 (liability) TLC’s position is: Net assets Capital £ £ Inventory 4,500 Capital introduced 10, Cash 7, Payables (2,000) ––––– Net assets 10, Note: ‘Assets’ column is now referred to ‘Net assets’ due to the liability being deducted from assets.
Double entry bookkeeping – an introduction : Chapter 1
Example 2 – continued
4 Buy a delivery van
The delivery van is bought for ongoing use within the business rather than for resale. Such assets are known as non-current assets.
TLC buys a delivery van for £1,000 cash. What is the effect?
Answer 4
Dual effect
Increase non-current asset £1,000 (asset) Decrease cash £1,000 (asset)
TLC’s position is:
Net assets Capital £ £
NCA 1,000 Capital introduced 10,
Inventory 4,
Cash 6, Payables (2,000)
–––––
Net assets 10,
5 Sell inventory for profit
TLC sells 200 red roses for £15 cash each. What is the effect?
Answer 5
Dual effect
Increase cash £3,000 (asset) Decrease inventory £2,000 (asset) Increase profit £1,
TLC’s position is:
Net assets Capital £ £
NCA 1,000 Capital introduced 10,
Inventory 2,500 Profit 1, Cash 9,
Payables (2,000)
–––––
Net assets 11,
Double entry bookkeeping – an introduction : Chapter 1
Example 2 – continued
8 Take out a loan
In order to fund your future expansion plans for TLC, you persuade your Aunt to lend TLC £2,000.
TLC is loaned £2,000 cash by your Aunt. She expects to be repaid in two years’ time. What is the effect?
Answer 8
Dual effect
Increase cash £2,000 (asset)
Increase loan £2,000 (liability)
TLC’s position is:
Net assets Capital £ £
NCA 1,000 Capital introduced 10,
Inventory 500 Profit 3, Receivables 5,
Cash 11,
Payables (2,000)
Loan (2,000)
––––– Net assets 13,
Bookkeeping Transactions
So far when we have bought or sold inventory or paid expenses we have seen the effect on a single profit account.
However, in practice this is not ideal as the owners of the business will want to keep track of all of the separate elements that make up their profit and not have to calculate the profit after every single transaction.
To keep detailed accounting records we now need to record all sales, purchases and expenses separately, as opposed to working out the impacts on inventory and profit after every transaction.
From now on there will be no inventory account and no profit account as we have seen in the examples in this chapter. The inventory value will be calculated periodically by carrying out an inventory count or ‘stock take’ and will be entered into the accounts of the business as a year-end journal adjustment. The profit, or loss, for the period will be calculated by preparing the statement of profit or loss.
Accounting for profit
