Cac 100 Fundamental of Accounting 1 Acco

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KENYATTA UNIVERSITY

INSTITUTE OF OPEN LEARNING

CAC: 100
FUNDAMENTAL OF ACCOUNTING 1

C.K. NYAGA

ACCOUNTING DEPARTMENT

CAC 100 FUNDAMENTALS OF ACCOUNTING


CAC 100: FUNDAMENTALS OF ACCOUNTING 1
SUBJECT CONTENT
PAGE

1. INTRODUCTION TO ACCOUNTING 1

2. THE ACCOUNTING CYCLE 23

3. ACCOUNTING FOR CASH 68

4. SPECIAL JOURNALS AND CONTROL ACCOUNTS 86

5. FINAL ACCOUNTS: 102

6. ACCOUNTING FOR INCOMPLETE RECORDS 117

7. PARTNERSHIP ACCOUNTS 133

CAC 100 FUNDAMENTALS OF ACCOUNTING


INSTITUTE OF OPEN LEARNING
DEPARTMENT OF ACCOUNTING
CAC 100: FUNDAMENTALS OF ACCOUNTING 1

OBJECTIVES

1. To equip a student with the principles and concepts of preparing and keeping financial records.
2. To equip students with techniques to enable them prepare and interpret financial information.
3. The course seeks to build a solid foundation upon which student can rely upon as a building block for
further advanced courses in Accounting and Finance.

SUBJECT CONTENT
PAGE

1. INTRODUCTION TO ACCOUNTING 1
• Nature and scope of Accounting 1
• Users of accounting information 2
• The fundamental accounting principles, conventions and concepts 4
• The work of accountant 7
• The accounting equation and statement 9
• Questions, Problems and Exercises 17

2. THE ACCOUNTING CYCLE 23


• Steps in accounting cycle 23
• Recording changes in the financial position 24
• The trial balance 36
• Suspense account 40
• Preparation of financial statements 55
• Worksheet 59
• Problems 64

3. ACCOUNTING FOR CASH 68


• Cash control 68
• petty cash system 69
• Cash book 74
• Bank reconciliation statement 79
• Problems 83

4. SPECIAL JOURNALS AND CONTROL ACCOUNTS 86


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CAC 100 FUNDAMENTALS OF ACCOUNTING


• Sales Journal and ledger 86
• Purchases Journal and ledger 90
• Return inward journal 93
• Return outward journal 93
• Control accounts 95
• Problems 100

5. FINAL ACCOUNTS: 102


• Trading, profits and loss account 102
• Balance sheet 107
• Manufacturing accounts 110
• Problems 113

6. ACCOUNTING FOR INCOMPLETE RECORDS 117


• Background of incomplete records 117
• Reconstructing accounts 117
• Trading, profits and loss account 118
• Balance sheet 122
• Problems 143

7. PARTNERSHIP ACCOUNTS 133


• Features of partnership 133
• Accounts and Division of profit 137
• Problems 143

RECOMMENDED TEXTS
1. Frankwood “ Business Accounting 1”
2. Basis for Business Decisions; 10th Edition, Meigs & Meigs
3. N.D. Nzomo. Basic Accounting, concepts, principle and procedures incorporating Kenya, laws &
Standards, Nairobi University Press
4. Saleemi N.A “ Financial Accounting 1”
5. Hermanson, Edwards and Maher “ Accounting Principles, 5th Edition, Vin Hoffman Press, U.S.A
6. Relevant International Accounting Standards

CAC 100 FUNDAMENTALS OF ACCOUNTING


LESSON 1
INTRODUCTION TO ACCOUNTING

OBJECTIVES

This lesson introduces you to Accounting showing clearly the broad accounting systems
and the underlying accounting principles. At the end of the lesson you should be able to:-

(i) Define accounting


(ii) Understand the purpose of accounting
(iii) Know the users and purpose of accounting information
(iv) Know and understand the underlying accounting principles
(v) Understand the career prospects of accountants

LESSION 1

Nature and Scope of Accounting

Accounting has often been called the “language of business” people in the business world
i.e owners, managers, bankers, stockbrokers, attorneys, engineers, investors – use
accounting terms and concepts to describe the events that make up the day-to-day
existence of every business, large or small. Since a language is a man-made means of
communication , it is natural that languages should change to meet the changing needs of
society. Accounting too, is a man-made art, one in which changes and improvements are
continually being made in the process of communicating business information.

1.1. Definition:
Book Keeping
This is the analysis classification and recording of financial transactions in books of Account. Hence its
merely concerned in making records of business transactions.

Accounting
Accounting is the process or art of recording classifying and summarizing financial information and
interpreting the results thereof. This information is used in making economic decisions. The accounting
information is financial data about business transactions expressed in monetary terms.
Or Accounting has been refered to as the process of identifying, measuring and communicating economic
information to permit informed judgement and decisions by the users of information.

The distinction between Accounting and book-keeping. Book-keeping means the recording or of
transactions , the record making phase of accounting. To keep books is to record transactions, and a
bookkeeper is one who records transactions either manually with pen and ink or with a book keeping
machine. The work is often routine and primarily clerical in nature.

Accounting system can be classified broadly into


(i) Financial accounting
(ii) Cost accounting
(iii) Management accounting

CAC 100 FUNDAMENTALS OF ACCOUNTING


Financial Accounting
Financial Accounting can be defined as the analysis classification and recording of financial transactions
and the ascertainment of their effect on the performance and financial position of an organisation / business
/ firm / economic entry.
This gives general purpose financial information which describe financial resources, obligations and
activities of an economic entity.

Management Accounting
Management Accounting involves the development and interpretation of accounting information which is
intended to aid management is running the business. This gives specific financial information to meet the
demands of the management.

Cost Accounting
This is the establishment of budgets, standard costs and actual costs of operations, processes, activities or
products; and the analysis of variances, profitability or social use of funds.

Business Transactions
These are the economic activities of a business. Accountants classify these transactions
into two types:

External transactions: (often called exchange transactions) are those involving economic
events between two or more independent firms.
Internal transactions are those economic events that take place entirely within one firm.
- Transactions constitute inputs to accounting information system and it should be
noted that before the effect of Transaction can be recorded however, they must be
measured. To be useful, accounting data must be expressed in terms of a common
denominator.
So that the effect of transactions can be combined. Business transactions are therefore
expressed in terms of a common measuring unit-money.

1.2. Users of Acccounting Information


Accounting extends beyond the process of creating records and reports. The ultimate
objective of accounting is the use of this information, its analysis and interpretation.
Accountants are always concerned with the significance of the figures they have
produced. They look for meaningful relationships between events and financial results
they study the effect of various alternatives they search for significant trends that may
throw some light on what will happen in future.

Interpretation and analysis are not the sole province of the accountant. If managers,
investors and creditors are to make effective use of accounting information, they too must
have some understanding of how the figures will be put together and what they mean. An
important part of this understanding is to recognize clearly the limitations of accounting
reports.

Purpose Of Accounting
Accounting information is useful to the following groups of people.
(i) the shareholders who provide capital and carries the risk of the firm / business.
(ii) Creditors who provide loans to the business.
(iii) Government and government agencies provide security
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CAC 100 FUNDAMENTALS OF ACCOUNTING


(iv) Public at large – financial analyst / economist / labour union / potential investors.
(v) Management – who manage the business.

The above group of people use accounting information to make financial / economic
decisions about the firm which includes.
For the investors they are interested with the profitability of the firm to know that
they are earning the required return. The profitability firm can be improved by
using accounting as a tool of control where the unnecessary costs/expenses are
checked and potential income generating venture / projects are under taken. The
accounting information also helps the investors to decide where to invest their
scarce resources.
The creditors needs the accounting information so that they can be sure that they
will receive back their money.
For the government it has to regulate the activities of the business to be in line
with the over all objective of the government. The government also imposes
various type of tax. The accounting information (mostly financial accounting) is
used as a base for tax returns. Note more often than not this information is
reorganized or adjusted to confirm with income tax reporting requirements.
Managers of business enterprises use the management (managerial) accounting
information in setting the overall goals, evaluating the performance of
departments and individuals deciding whether to introduce a new line of products
etc – used a base for further or future planning. The financial information
provided by an accounting system is needed by managerial decision makers to
help them plan and control activities of the economic entity.
This means that the underlying purpose of Accounting is to provide financial information
about an economic entity (business enterprise

A system for creating accounting information


In order to provide up-to-date financial information about a business, it is necessary to
create a systematic record of the daily business activity in terms of money. For example,
goods and services are purchases and sold, credit is extended to customers, debts are
incurred, and cash is which can be expressed in monetary terms, and must be entered in
accounting records. The recording process may be performed in many ways: that is, by
writing with pen or pencil, by printing with mechanical or electronic equipment, or by
punching holes or making magnetic impressions on cards or tape.

It should be noted that not all business events can be measured and described in monetary
terms. As such we do not show in the accounting records the appointment of a new chief
executive or the signing of a sale contract, except as these happenings in turn affect
future business transactions. In addition to compiling a narrative record of events as they
occur, we classify various transactions and events into related groups or categories.
Classification enables us to reduce a mass of detail into compact and usable form. For
example, grouping all transactions in which cash is received or paid out is a logical step
in developing useful information about the cash position of a business enterprise.

To ensure the created accounting information is in a form which will be useful to the
users of the information, we summarize the classified information into financial reports,
called financial statements. These financial statements are concise, perhaps only three or
four pages for a large business. They summarize the business transactions of a specific
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CAC 100 FUNDAMENTALS OF ACCOUNTING


time period such as a month or a year. Financial statements show the financial position of
the business at the time of the report and the operating results by which it arrived at this
position.

These three steps we have described i.e recording, classifying, and summarizing- are the
means of creating accounting information. Thus one part of accounting is a system for
creating financial information.

Characteristics of Useful Information


i) Relevance - should satisfy the need of the user and /or purpose intended.
ii) Reliability – increased by being checked by an independent person like the
auditor
iii) Objectivity – free from personal bias -should be checked for subjectivity
iv) Ability to understand / Under stability – presentation should be understood by
the users or recipients.
v) Comparability – year to year of the same company and with other companies
i.e inter-period and intercompany comparison.
vi) Realism - Accounts should show a true and fair view information should
show economic realities.Its not necessary to give a precision which is not
practical.
vii) Consistency business should observe consistency in applying various methods
and polies but changes in policies can be disclosed and their effect.
viii) Timeless – up-to-date information is of more useful.
ix) Economy of Presentation / Detail – too much or too summarized A/c – not
good. Too detailed can obscure or hind some important factors – cause
difficulties in understanding. Amount of detail should be that which is
sufficient for the intended purpose.
x) Completeness – a summarised picture of the companies activities is needed.
xi) Accuracy – should be sufficiently accurate for the internal purpose.
Information prepared according to correct principles that can be relied upon
for the intended purpose. This may mean that a realistic speedily prepared
estimate may be more useful than a more precise answer produced some time
latter.

1.3. The Fundamental Accounting Concepts, Principles And Assumption (Gaap)

GAAP which means Generally accepted accounting principles constitute the ground roles
for financial reporting. Accounting principles may also be termed as standards
assumptions conventions or concepts. Accounting principles do not exist in nature but
are developed considering the most important objective of financial reporting. Hence
they vary from one country to another.
The broad concepts include:

1)The business or Accounting entity concept


If the transactions of a business are to be recorded, classified and summarized into
financial statements the accountants must be able to identify clearly the boundaries of the
unit being accounted for. Under the accounting entity concept the business is considered a
separate entity distinguishable from its owners and from all other entities. Each entity is
assumed to own its assets (resources) and incur its liabilities(obligations). The assets
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CAC 100 FUNDAMENTALS OF ACCOUNTING


liabilities and activities of the business are kept completely separate from those of the
owner of the business and from those of other businesses.

2)The going – concern assumption / continuity principle.

Financial statements are prepared on the assumption that the existing business will
continue to operate into the future. Its assumed that the business will not be sold in the
near future but will continue to use its resources in operating activities. For this reason
therefore the current market value of the assets are of little importance to decision
makers. In the event that management is planning the sale or liquidation of the business,
the going concern assumption and the cost principle are set aside and financial statements
are prepared on the basis of estimated sales or liquidation values. When this is the case
the statement should identity clearly the basis upon which the values are determined.

3)The Cost Principle or Asset Valuation Principle


Resources of a business are recorded initially at their cost under the cost principle. Cost
is determined by the exchange price agreed upon by the parties and is measured by the
amount of cash to be given in exchange for resources received. If the consideration given
is something other than cash, cost is measured by the fair (market) value of what is given
or the fair value of the asset or service received whichever is more clearly evident. It is
important therefore, to remember that the amount reported in financial statements do not
show the amount that would be received if the assets were sold but the costs of the assets
on the date that they were acquired.

4)Objective Principle
The objectivity principle holds that accounting data should be reported on a factual basis
ie free from personal bias. Cost of the resources acquired is determined objectively on the
basis of the exchange price negotiated by the independent parties to the exchange. The
recording of current market values require use of estimates, appraisals or opinions all of
which are much more subjective. Users of accounting information should be given the
most objective factual data available. In other words the transactions to be recorded
should be at a arms length.

(5.) The Stable Shilling or Dollar Assumption


Under this principle or assumption changes in the purchasing power of money are
ignored. As a result 1980 shilling is added to 1999 shilling as though all represent the
same purchasing power. Unfortunately this is not, realistic when the general purchasing
power of a shilling / dollar changes the value of money declines. Although this is
recognised by accountants its ignored. As a result gains are reported on sale of assets
where there has, infact ,been little or no gain in purchasing power.

(6) Time Period Principle / (periodicity Principle


The life of a business must be divided into a series of relatively short accounting period
of equal length. This assists the users of accounting information who need reasonably
current and comparable information-relating to prior accounting periods. The need for
periodic reporting is one of the most challenging problems of accountants . The life of a
business is usually divided into segments of a year or quarter which calls for various
estimates such as :- useful life of depreciable assets, methods of depreciation to be used

CAC 100 FUNDAMENTALS OF ACCOUNTING


etc. The tentative nature of periodic measurements should be understood by those who
rely on periodic accounting information.

(7) Revenue Recognition or The Realization Principle


Accountants should recognize revenue when it has been realized i.e.
-the earning process is essentially complete
-Objective evidence exists as to the amount of revenue earned.
Revenue should be recognized at the time goods are sold or services are rendered.
NB. Cash basis of accounting does not conform to GAAP.

(8) Matching Principle or Expenses reorganization


To measure the profitability of an economic activity we must consider not only the
revenue earned but also all the expenses incurred in the effort to produce this revenue.
The accountants thus try to match the revenue appearing in the income statement will all
the expenses incurred in generating that revenue. The matching principle governs the
timing of expense recognization in financial statements. This principle underlie such
practises as:-
-depreciating plant assets
-Computation of cost of goods sold each period
-Amortization of cost of unexpired insurance policy
-Recording revenue when earned but not received and expenses when incurred but not
paid.

(9) Materiality Principle


Materiality refers to the relative importance of an item or an event. An item is “material
“ if knowledge of the item might reasonably influence the decisions of users of the
financial statements. Accounts must ensure that all material items are properly reported
in the financial statements. This should be based on cost-effectiveness e.g. tools waste
paper basket etc-deferred benefits or future benefits but expensed in the period of
purchase.

(10) Consistency Principle


This principle implies that particular accounting method once adopted will not be
changed from period to period. This assists the users in interpreting changes is financial
position and changes in net income. In case of changes full disclosure principle should be
applied.

(11) Disclosure Principle


Adequate disclosure means that all material and relevant facts concerning financial
position and the results of operation are communicated to the users. This can
accomplished either in the financial statement or in the notes accompanying the
statements. This increases the usefulness of the statements and makes them less
subjective to misinterpretation.
Example of information disclosed include
- A summary of the accounting methods used
-Dollar / shilling effect in the changes of these accounting methods during the current
period.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


-Any loss contingencies that may have a material effect upon the financial position of the
organisation.
-Contractual provisions that may affect future cash flows eg terms and conditions of
borrowing agreements commitments to buy or sell material amounts of assets.

(12) Conservatism
May not qualify as an accounting principle but implies that Accountant must be
conservative in their estimates and opinions. They should base their estimates on sound
logic and select those accounting methods which either overstate nor under state the facts.
In case of alternatives should chose those that have the least favourable effect / situation.

13)Prudence
Holds that accountants have the duty of ensuring that people get the proper facts abort a
business. Assets should not be over valued and liabilities or obligations should not be
under valued. Prudence concept means that the figure taken should understate profits
rather than overstating the profits. In other words anticipate loss but not profit.

1.4. The Work of an Accountant


Accountants are employed in three main fields: In a public accounting, In private
accounting, or in government

Public Accounting
Public accountants are individuals who offer their professional services and those of their
employees to the public for a fee, in much the same manner as a lawyer or a consulting
engineer. This can be done in such as Auditing, Management Advisory services and tax
services.

Auditing
The principal service offered by a public accountant is auditing. Banks commonly
require an audit of the financial statements of a company applying for a suitable loan,
with the audit being performed by a CPA who is not an employee of the audited concern
but an independent professional person working for a fee. Companies whose securities
are offered for sale to the public generally must also have such an audit before the
securities may be sold. Thereafter, additional audits must be made periodically if the
securities are to continue being traded.

The purpose of an audit is to increase credibility to a company’s financial statements. In


making the audit, the auditor carefully examines the company’s statements and the
accounting records from which they were prepared. In the examination, the auditor seeks
to assure that the statements fairly reflect the company’s financial position and operating
results and were prepared in accordance with generally accepted accounting principles
from records kept in accordance with such principles. Banks, investors, and others rely
on the information in a company’s financial statements in making loans, in granting
credit, and buying and selling securities. They depend on the auditor to verify the
dependability of the information the statements contain.

Management Advisory Services


In addition to auditing , accountants commonly offer management advisory services. An
accountant gains from an audit an intimate knowledge of the audited company’s
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CAC 100 FUNDAMENTALS OF ACCOUNTING


accounting procedures and its financial position. Thus, the accountant is in an excellent
position to offer constructive suggestions for improving the procedures and strengthening
the position. Clients expect these suggestions as a useful audit by-product. They aslo
commonly engage CPAs to conduct additional investigations for the purpose of
determining ways in which their operations may be improved . Such investigations and
the suggestions growing from them are known as management advisory services.

Management advisory services include the design, installation, and improvement of a


client’s general accounting system and any related information system it may have for
determining and controlling costs. They also include the application of machine and
computer to these systems, plus advice in financial planning, budgeting , forecasting, and
inventory control.

Tax Services
In this day of increasing complexity in income and other tax laws and continued high tax
rates, few important business decisions are made without consideration being given to
their tax effect. A CPA, through training and experience, is well qualified to render
important service in this area. The service includes not only the preparation and filing of
tax returns but also advice as to how transactions may be completed so as to incur the
smallest tax.

Private Accounting
Accountants employed by a single enterprise are said to be in private accounting. A small
business may employ only one accountant or it may depend upon the services of a public
accountant and employ none. A large business, on the other hand, may have more than a
hundred employees in its accounting department. They commonly work under the
supervision of a chief accounting officer, commonly called the controller, who is often a
CPA. The title controller results from the fact that one of the chief uses of accounting
data is to control the operations of a business.

The one accountant of the small business and the accounting department of a large
business do a variety of work, including general accounting, cost accounting, budgeting,
and internal auditing.

General Accounting
General accounting has to do primarily with recording transactions, processing the
recorded data, and preparing financial and other reports for the use of management,
owners, creditors, and governmental agencies. The private accountant may design or help
the public accountant design the system used in recording the transactions. He or she will
also supervise the clerical or data processing staff in recording the transactions and
preparing the reports.

Cost Accounting
The phase of accounting that has to do with collecting, determining and controlling costs,
particularly costs of producing a given product or service, is called cost accounting.
Knowledge of costs and controlling costs is vital to good management. Therefore, a large
company may have a number of accountants engaged in this activity.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Budgeting
Planning business activities before they occur is called budgeting. The objective of
budgeting is to provide management with an intelligent plan for failure operations. Then,
after the budget has been put into effect, it provides summaries and reports that can be
used to compare actual accomplishments with the plan.

Internal Auditing
In addition to an annual audit by an independent firm of CPAs , many companies
maintain a staff of internal auditors, who constantly check the records prepared and
maintained in each department or company branch. It is their responsibility to make sure
that established accounting procedures and management directives are being followed
throughout the company.

Government Accounting
Furnishing governmental services is a vast and complicated operation in which
accounting is just as indispensable as in business. Elected and appointed officials must
rely on data accumulated by means of accounting if they are to complete effectively their
administrative duties. Accountants are responsible for the accumulation of these data.
Accountants also check and audit millions of income, payroll, and sales tax returns that
accompany tax payments upon which governmental units depend.

This means Accounting includes the design of accounting systems, preparation of


financial statements, audits, studies , development of forecasts, income tax work,
computer applications to accounting processes, and the analysis and interpretation of
accounting information as an aid to making business decisions.

A person might become a reasonably proficient book-keeper in a few weeks or months


but to become a professional accountant, however, requires several years of study and
experience.

1.5 Accounting Equation and Statements


Accounting statements are the end products of the accounting process, but a good place to
begin the study of accounting. They are also referred to as financial statements.

Financial statement
- Means of conveying to management and to interested outsiders a concise picture
of the profitability and financial position of a business. Financial statements are
set of accounting reports. The principal purpose of financial statement is to
communicate to users (person receiving these reports) the effect of operating
activities during a specific time and the financial position at the end of the period
for a specific business.
- A set of financial statements consist of four related accounting reports
summarizing
- financial resources
- obligations
- profitability
- cash transactions of a business

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CAC 100 FUNDAMENTALS OF ACCOUNTING


The type of financial statement most generally prepared are:-

- balance sheet
- income statement
- cash flow statements
- statement of owners equity

(i) Balance Sheet


- The balance sheet reports the financial position of a business at a specific point in
time.
- It is sometimes called statement of financial position. The financial position is
reflected by the amount of business assets (resources owned), the amount of
liabilities or debts owed and the amount of its owners equity (investment).
The title/header consist of
- The name of business
- The name of the statement “Balance Sheet”
- The date of the Balance sheet

The body of the Balance Sheet consist of:


- Assets, liabilities, and owners equity.

Example

West side cleaning shop


Balance Sheet
As at 31st December 2000

Assets Liabilities & Owners equity


Liabilities
Cash 19,500 Notes payable 18,000
Account Receivable 9,000 Accounts payable 12,000
Land 21,000 Total liabilities 30,000
Building 45,000
Office Equipment 3,000 Owners equity
Delivery equipments 7,500 Capital 75,000
105,000 105,000

Assets
Assets are economic resources (cash and non-cash resources owned by a business. They
may be tangible assets e.g land, building and equipment or intangible assets e.g legal right
such as accounts receivable, patent rights or rights to use leased assets). Assets have
economic value because they contain service benefits that can be used in future
operations or sold to another entity.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Liabilities
Liabilities are debts owed by a business to outside parties (called creditors). Liabilities
include such thins as amount owed to suppliers for goods or services purchases on credit (
accounts payable) , amount borrowed from Banks or other lenders (notes payable),
amount owed to employees for salaries and wages etc. Cancellation of liabilities requires
either an outlay of assets (generally cash), or the performance of future services.
Liabilities may also be thought of as creditors claim against the assets of the business.

Owners equity
Owners equity is the owners interest in the assets of the business. It may be thought of as
the owners claim against these assets. The equity of the owner is the residual claim
because the claim of the creditors usually comes first.

Increase in owners equity


The owners invests cash or other assets to get the business started. Whenever the owner
of the business transfers cash or other assets to the business, the owner’s equity increase.
Two ways :
1. owner’s investment
2. earnings from profitable operations of the business

Decrease in owner’s equity


- In single proprietorship, the owner has right to withdraw cash or other assets from
the business at any time. This can be through the Bank, or getting some
company’s equipment for personal use, or paying a personal debt using the
business cash. Two ways:-
(i) Withdrawal of cash or other assets by the owner.
(ii) Losses from unprofitable operations of the business.

Accounting Equation (Balance Sheet Equation)


A balance sheet is so called because its two sides must always balance. The sum of the
assets shown on the balance sheet must equal liabilities plus the equity of the owner or
owners of the business. This equality may be expressed in equation form for a single
proprietorship business as follows:

Assets = Liabilities + Owner’s equity

When balance sheet equality is expressed in equation form, the resulting equation is
called the balance sheet equation. Or the accounting equation, since all double entry
accounting is based on it.

In other words the two sides are the same view of the business property. The list of assets
show what resources the business own and the liabilities and owner’s equity shows
who/what supplied them (and how much each group supplied).

Effects of transactions on the Accounting Equation. A business transaction is an exchange


of goods or services, and business transactions effect the elements of an accounting
equation. However, regardless of what transactions a business completes, its accounting

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CAC 100 FUNDAMENTALS OF ACCOUNTING


equation must remain in balance. Also, its assets always equal the combined claims of its
creditors and its owner or owners.

This may be demonstrated with the transactions below:

Effect of business transactions upon the Balance Sheet

Assume that Robert started a business under the name Robert Real Estate Company and
deposited Kshs. 60,000 under the name of the business.

Initial Balance Sheet

Robert Real Estate Company


Balance Sheet
As at 1st Sept 2000

Assets Owner’s equity


Cash…………...60,000 Robert, capital ……….60,000

Purchase of an asset for cash

3rd Sep. purchase of land - Kshs 21,000


(i) Cash decreased by the amount paid out
(ii) A new asset land – acquired

Robert Real Estate Company


Balance Sheet
As at 3rd Sept 2000

Assets Owner’s Equity


Cash 39,000 Robert, Capital 60,000
Land 21,000
60,000 60,000

Purchase of an asset and incurring of liability


Sept 5, an opportunity arose to buy from xyz company a complete office building which
had to be removed to permit the construction of a freeway. A price of 36,000/= was
agreed upon which involved the cost of moving the building and installing it upon
Roberts Company Ltd. It could have costed 60,000/= to build. This was very fortunate
purchase.

The terms provided were:-


- Immediate payment of 15000/= and payment of the Balance of 21,000/= within 90
days.

Effect
Cash decreased by 15,000 but a new asset, building was recorded in the amount of
36,000. Total assets were increased by 21,000 and total liabilities and owners equity was

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CAC 100 FUNDAMENTALS OF ACCOUNTING


also increased by 21000/= as a result of recording 21000/= . Accounts payable as a
liability.
Robert Real Estate Company
Balance Sheet
As at 5th Sept 2000

Assets Liabilities and Owner’s equity


Cash 24000 Liabilities
Land 21000 Accounts payable 21000
Building 36000
Owner’s Equity
81000 Robert capital 60,000
81,000

Sale of an asset
Sept 10: Sold the unused part of the lot to Carter’s Drugstore for a price of 6000. Agreed
that the whole amount to be paid in three months. By this transaction an new asset, A/C
receivable was acquired but the Asset land was decreased by the same amount.- No
charge in total assets.

Robert Real Estate Co.


Balance Sheet
As at Sept 10 2000

Assets Liabilities and Owner’s equity


Liabilities
Cash 24000 Accounts payable 21000
Accounts Receivable 6000
Land 15,000 Owner’s Equity
Building 36,000 Roberts capital 60,000
81000 81000

Purchase of an asset on credit


14th Sept purchased office furniture and equipment on credit form general equipment inc.
for 5,400 – new asset and incurrence of liabilities.

Robert Real Estate Company


Balance Sheet
As at 14th Sept. 2000

Assets Liabilities & Owner’s Equity


Cash 24000 Liabilities
A/C Rec. 6000 A/C payable 26400
Office equipment 5400
Land 15000 Owner’s Equity
Building 36000 Capital, Robert 60,000
86,4000 864,000
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Collection of Accounts Receivable

Sept 20: Cash of Kshs. 1500 received from the drugstore. Increase cash and decrease
A/C receivable .

Robert Real Estate Company


Balance Sheet
As at 20th Sept. 2000

Assets Liabilities & Owner’s Equity


Cash 25500 Liabilities
A/C Rec. 4500 A/C payable 26400
Office Equip. 5400 Owner’s Equity
Land 15000 Capital, Roberts 60,000
Building 36000
86400 86400

Payments of a liability

On Sept 30 Robert paid 3,000 in cash to general equipment.


Robert Real Estate Company
Balance Sheet
As at 30th Sept. 2000

Assets Liabilities & Owner’s Equity


Cash 22,500 Liabilities
A/C Rec. 4,500 A/C payable 23400
Off. Equip. 5,400 Owner’s Equity
Land 15,000 Capital 60,000
Building 36,000
83,400 83400

Effect of business transactions upon the accounting equation


- A balance sheet is a detailed expression of the accounting equation.
- The Sept. transactions are summarized below and the effects
Date:
Sept 1 Started a business by depositing Ksh. 60,000 in a Company Bank Account
Sept 3 Purchased land for 21000/= cash.
Sept 5 Purchased a building at a price of 36,000/= paying 15,000/= cash and incurring a
liability of 21,000/=
Sept 10 Sold part of land for a price of 6000/=, collectible within three months.
Sept 14 Purchased office equipment on credit for 5,400/=
Sept 20 Received 1500/= as partial collection of the 6000/= account receivable
Sept 30 Paid 3000/= on the accounts payable

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CAC 100 FUNDAMENTALS OF ACCOUNTING


In the table below, each transaction is identified by date; its effect on the accounting
equation and also the new balance of each item are shown. Each of the times labeled
Balances contains the same items as the balance sheet previously illustrated for the
particular date. The final line in the table corresponds to the amounts in the balance sheet
at the end of September. Note that the equality of the two sides of the equation was
maintained throughout the recording of the transactions.

EFFECTS OF TRANSACTIONS ON THE ACCOUNTING EQUATION

ASSETS LIABILITIES CAPITAL


Date Cash +A/c +Lan +Buildi +Equipme =A/c payable +capital
Sept receivable d ng nt
1 60,000 +60,000
3 21000 +2100
0
Bal 39000 21000 60,000
Sept -15000 +36000 +21000
5
Bal 24000 21000 36000 21000 60000

Sept -
10 +6000 -6000
Bal 24000 6000 15000 36000 21000 60000

Sept - +5400 +5400


14
Bal 24000 6000 15000 36000 5400 26400 60000

Sept +1500 -1500


28
Bal 25500 +500 15000 36000 5400 26400 60000
Sept -3000
30
Bal 22500 500 15000 36000 5400 23400 60000

NB/ The Balance at every date is the same as the Balance Sheet prepared on the same
date in the previous section.

The Income Statement


It shows whether or not the business achieved or failed to achieve its primary objective i.e
earning a ‘profit’ or net income. A net income is earned when revenues exceed expenses,
but a net loss is incurred if the expenses exceed the revenues. An income statement is
prepared by listing the revenues earned during a period of time, listing the expenses
incurred in earning the revenues, and substracting the expenses from the revenues to
determine if a net income or a net loss was incurred.

This means that the income statement indicates/reports the results of earnings activities
for a specific time period, usually one year.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


The heading of an income statement consist of: name of business, name of statement i.e
income statement and the time period covered by the statement.

Below is specimen of an income statement showing the components.

Illustration 1-1
River load Ltd
Income statement
For the year ended December 31, 2000

Kshs Kshs
Revenues:
Commissions earned 55,150
Property management fees 1200
Total revenues 56350

Operating expenses:
Salaries expense 12800
Rent expense 6000
Utilities expense 915
Telephone 760
Advertising 4310
Total operating expenses 24785
Net income 31565

Now we shall describe or explain each of the major components.

Revenues

Revenues are increases in owners equity from the sale of goods or performance of
services. They are measured by the amount of cash or other assets received. Although
revenue often consist of cash, it may consist of any asset received such as customers
promise to pay in the future (an account receivable) or the receipt of property from a
customer. Regardless of type of asset, it represents revenue. It must reflect compensation
for the sale of goods or the performance of services. Other types of revenue are –
interest, dividends, received on shares owned and rent received.

Expenses

Expenses are decreases in owner’s equity resulting from the cost incurred in order to earn
revenue.
- Expenses are measured by the amount of assets consumed or the amount of
liabilities incurred.
- They may be immediate cash payment such as wages and salaries or promise to
pay cash in the future for services received such as advertising. In some cases
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CAC 100 FUNDAMENTALS OF ACCOUNTING


cash may be paid out before the expense is incurred as for example payment for
next years rent.

3. Statement of owner’s equity

- Statement explaining certain changes in the amount of owner’s equity


(investment) in the business. In corporation this statement is replaced by
statement of retained earnings.

4. Statement of Cash Flow


- Statement summarizing cash receipts and payments of the business over the same
period covered by the income statements.

NB/ In addition financial statements include notes to the accounts which contain
additional information useful to the interpretation of the statements.

KEY WORDS

- Booking Keeping
- Accounting
- Business transactions
- Financial statements
- GAAP
- Public accountant
- Private accountant
- Government accountant
- Balance sheet
- Assets
- Expenses
- Revenue
- Owner’s equity
- Income statement
- Net income

Questions, Exercises and Problems


Questions
1.Why is the knowledge of accounting useful to persons other than management of
business entities?
2.Briefly explain the purpose of accounting.
3. Clearly distinguish internal and external business transactions.
4. Accounting system can be classified broadly into two main categories. Explain them
showing clearly their scope of use.
5. Explain the system of creating accounting information stating clearly major sources of
such information.
6.Explain briefly clearly the concept of business entity giving appropriate examples.
7.Accounting information provides a basis for decision making by various users. State
three such decisions made by:
(i) Management
(ii) Creditors
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CAC 100 FUNDAMENTALS OF ACCOUNTING


(iii) Government
(iv) Public

7. Not all happenings of a business can be expressed in monetary terms although they
may significantly affect the business. Name two examples of such happenings which
may not be measured satisfactorily be recorded in books of account.
8. Clearly state the main functions of a public and private accountants.
9. Explain consistency as a characteristic of useful information and secondly as a
accounting principle.
10. Discuss the need of generally accepted accounting principles. What factors determine
the development of these principles.

EXERCISE

1.1 a Beta Company has total assets of $256,000 and the owner’s equity amounts to
$64,000. What is the amount of the liabilities?
b. The balance sheet of Border Inc. shows that the owner’s equity is $192,000: It
is equal to two-third the amount to total assets. What is the amount of the
liabilities?
c. The assets of Joytech Company amounted to $96,000 on December 31 of year 1,
but increased to $136,000 by December 31 of Year 2. During this same period,
liabilities increased by $20,000. The owner’s equity at December 31 of Year 1
amounted to $66,000. What was the amount of owner’s equity at December 31 of
Year 2? Explain the basis for your answer and support with the necessary
calculations.

1.2 The items included in the balance sheet of Daily Company at December 31 2001
are listed below in random order. You are to prepare a balance sheet (including a
complete heading). Arrange the assets in the sequence. You must compute the
amount for Shah Daily, capital.

$
Land 36,000
Accounts payable 44,800
Accounts receivable 18,900
Shah Daily, Capital ?
Office equipment 3,400
Building 80,000
Cash 42,100
Notes payable 75,000

1.3 Indicate the effect of each of the following transactions upon the total assets of a
business by use of the appropriate phrase: “increase total assets”, “decrease total
assets”, “no change in total assets”.
(a) Investment of cash in the business by the owner.
(b) Collected an account receivable
(c) Made payment of a liability.
(d) Purchase an computer desk on credit.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


(e) Borrowed money from a bank
(f) Sold equipment on credit for a price equal to its cost.
(g) Sold equipment for cash at a price equal to its cost.
(h) Sold equipment for cash at a price below its cost.
(i) Sold equipment for cash at a price above its cost.
(j) Purchased a motor van at a price of $7,000 terms $1,000 cash and the balance to
be paid in 30 equal monthly installments.

1.4 For each of the following, describe a transaction that will have the required affect of
elements of the accounts equation.
(a) Increase an asset and increase owner’s equity
(b) Increase an asset and increase a liability.
(c) Increase one asset and decrease another asset.
(d) Decrease an asset and decrease a liability.
(e) Increase one asset, decrease another asset, and increase a liability.

1.5 Certain transactions of Kresty Company are listed below. For each transactions you
are to determine the effect on total assets, total liabilities, and owner’s equity.
Prepare your answer in tabular form identifying each transactions by letter and
using the symbols (+) for increase (-) for decrease , and (NC) for no change. An
answer is provided for the first transaction to serve as an example. Note that some of
the transactions concern the personal affairs of the owner, Joan Cresty rather than
being strictly transactions of the business entity.
Total Liabilities Owner’s
Assets Equity
+ NC +
a. Owner invested cash in the business
b. Purchased office furniture on credit ………………
c. Purchased a motor vehicle truck for cash ……………….
d. Owner withdrew cash from the business ……………
e. Paid a liability of the business ………………………..
f. Returned for credit some defective office furniture
Which had been purchased on credit but not yet paid
For ……………………………………………………….
g. Obtained a short term loan from the bank for business use
h. Owner wrote gave a typewriter used in the business to
His son as a birthday present………………………….
Owner paid his daughter fees using business money……………………….

1.6 List the following four column headings on a sheet of paper as follows:

Transaction Total assets Liabilities Owner’s Equity

On the first column identify each of the following transactions by number. Then indicate
the effect of each transactions on the total assets liabilities and owner’s equity by placing
a plus sign (+) for an increase a minus sign (-) for a decrease or the letters (NC) for no
change in the appropriate column.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


(1) Purchased office supplies on credit
(2) Owner invested cash in the business
(3) Purchased office equipment for cash
(4) Collected an account receivable
(5) owner withdrew cash from the business
(6) Paid a supplier who had supplied goods on credit
(7) Returned for credit some of the office equipment previously purchased on credit
but not yet paid for.
(8) Sold land for a price in excess of cost.

As an example, transaction (1) would be shown as follows:

Transaction Total Liabilities Owner’s Equity


Assets
(1) + + NC

PROBLEMS
1.7 The items to be included in the balance sheet of Mwanzo Estate Ltd as at
September 30, 2000 are listed below in random order. Prepare a balance sheet include a
figure for the total liabilities and owners equity.
$ $
Accounts Payable 26,000 Delivery truck 76,920
Accounts receivable 19,840 George Klein, capital ?
Land 89,200 Office Equipment 26,240
Building 24,000 Cash 10,008
Notes payable 30,200

1.8 The transactions listed below occurred during the organization of sub expert service,
a refrigeration repair business. You are to show the effects of business transactions upon
the balance sheet by preparing a new and separate balance sheet for expert service at
each of the four dates listed below. Each balance sheet should reflect all transactions
completed to date.

(1) On June 1 Dan Robert deposited $68,000 cash in a bank account in the name of the
new business, expert Service.

(2) On June 5 land and a building were acquired at a cost of $9,400 for the land and
$13,600 for the building. Full payment was made on this date.

(3) On June 15,expert Service purchased tools and equipment to do repair work for a
down payment of 31,440 cash and final payment of $2,800 due in 30 days.

(4) On June 30, expert Service bought a motor van at a cost of $4,320. A cash 50%
down payment was made with payment of the balance to be made within 60 days.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Also on this date the account payable incurred by the purchase of tools and
equipment on June 5 paid in full.

1.9 Five transactions of Bruno Company are summarized below in equation form, with
each of the five transactions identified by a letter. For each of the transactions (a) through
(e) you are to write a separate sentence explaining the nature of the transaction.

Assets = Liabilities + Owner’s Equity


Cash + Accounts + Land + Building + Office
equipment = Accounts + J.Winn Capital
payable

Balances $ 3,100 $6,400 $21,000 $57,100 -0- $9,100 $78,500


(a) + 1,500 -500
Balances $ 4,600 4,900 21,000 57,100 -0- 9,100 78,500
(b) -1,000 +1,000
Balances $ 3,600 4,900 21,000 57,100 1,000 9,100 78,500
© + 4,000 +4,000
Balances $ 7,600 4,900 21,000 57,100 1,000 9,100 82,500
(d) +1,600 +1,600
Balances $ 7,600 4,900 21,000 57,100 2,600 10,700 82,500
(e) -400 +2,400 +2,000
Balances $ 7,200 4,900 21,000 57,000 5,000 12,700 82,500

1.10 After several years of experience with a practicing firm of certified public
accountants, Jostone resigned from his position on September 1, 2001, in order to begin
a public accounting practice of his own, named Jostone $ Sons. The following events
occurred during September, some of these relate to the business entity, Jostone & Co
CPA, and other are personal in nature and do not affect the business entity.

Sept 1:. Sold personal investments consisting of an apartment building and some IBM
stock for a total of $198,000 cash. Deposited $80,000 of this cash in a bank
account in the name of the practice Jostone & Co CPA.

Sept 2: Purchased land with a small office building suitable for his accounting practice.
Total cost was $290,000 of which $50,000 was paid from the business bank
account as a cash down payment. Jostone signed a note payable for the balance
calling for payment in three years or less. The property valuer had indicated
that the land had a current fair value 50% greater than the office
building.(divide the total cost between land and office building.)

Sept 3: Purchased office equipment for cash $5,200

Sept 5: Signed an agreement to employ a college graduate as staff assistant at a monthly


salary of $1,000. The staff assistant was to report for work on October 1.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Sept 6: Johnstone purchased a dirt track motorcycle which he planned to use on
weekend trips. He turned in an old motorcycle and paid a balance of $800 in
cash.

Sept 7: Returned a defective chair included in the September 3 purchase of office


equipment for full credit of $20. Received in exchange another model chair
priced at $ 185 and a cash refund of $25.

Step 8: On Sunday while visiting a friend who was going out of business and entering
military service, Johnstone had an opportunity to buy for $600 cash some office
supplies which had originally cost $1,000. Used a personal check to pay for the
supplies.

Sept 9: Johnstone brought to his office supplies purchased the previous day.

Required
a. Prepare a list of those transactions which are personal in nature, do not affect the
business entity and should not be included in the balance sheet of Johnstone & Sons
CPA
b. Prepare a balance sheet for the business entity Johnsstone & Sons CPA at September
9,2001.

1.11. Jane graduated from the University with a degree in a Business Administration.
She decided to put in practice the skills acquire during the four-year programme.
Jan 2. Jane Invested Kshs. 100,000 in a business, she planned to start under the name
Jane enterprises.
Jan 3. Purchased Equipment costing Kshs. 35,000/= from Furniture Ltd. paid Kshs
20,000/= cash and the balance to be paid within 30 days.
Jan 5. Performed services and was paid cash amounting to Kshs 5,000/=
Jan 15. Purchased a van for Kshs. 200,000 paid a deposit of Kshs 50,000/= and signed 1
year notes payable for the balance.
Jan 25. Performed services for credit customer for Kshs 7,000
Jan 30 Paid the Accounts payable to furniture Ltd. in full.
Jan 30 Paid rent Kshs 10,000/= for January

REQUIRED:
(i) Journalize the above transactions.
(ii) Explain three advantage of using a journal

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CAC 100 FUNDAMENTALS OF ACCOUNTING


LESION 2
THE ACCOUNTING CYCLE
Objectives:
This lesson introduces you to the Accounting cycle showing clearly the broad accounting
procedures followed every accounting period. At the end of the lesson you should be able
to:-
(i) Define accounting cycle
(ii) Understand the of the purpose various accounting record books
(iii) Know the uses and procedure for recording and summarizing financial
information i.e. journalizing, posting and extraction of a Trial balance.
(iv) Understand the need to prepare adjusting entries
(v) Understand and prepare the financial statements
(vi) Prepare a worksheet

OVERVIEW OF ACCOUNTING CYCLE

We shall now consider how financial information is accumulated. The accounting cycle
or process consists of procedures used to collect process, and report the effects of
economic events that affect an entity during an accounting period. As the exhibit below
shows, this process begins with collecting or capturing economic data and ends with
reporting these data in the financial statements. Each step is described and illustrated
below.

The accounting process consist of three major parts:-

i) The recording of transactions during an accounting period.


ii) The summarizing of information at the end of the period.
iii) The preparation of financial statements.

The accounting cycle is a complete sequence of accounting procedures which are


repeated in the same order during each accounting period.

Major steps in Accounting Cycle

(i) Transactions occur and information is collected through use of source


documents i.e collecting data about economic events
(ii) Transactions are analysed on the basis of the source documents and are
recorded in a journal, a process refered to as journalizing
(iii) Information is transferred (posted) from the Journal to Ledger accounts, a
process refered to as posting
(iv) A trial balance is prepared from the account balances in the ledger.
(v) Adjusting, correcting and updating recorded data.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


(vi) Preparation of adjusted Trial Balance and summarizing the data in the form of
financial statements.
(vii) Closing the accounting records (nominal accounts) to summarize the
operations of the accounting period.
(viii) Preparation of post-closing T.B
(ix) Recording and posting reversal adjusting entries to facilitate the recording
process in the subsequent accounting period. (optional or if applicable).

The concepts presented in the pen-and-paper approach on the following pages apply
equally well to most, if not all, computerised accounting processes. Any differences in
application are due tot he improved manner in which data can be processed on the
computer.
Note:
-Steps 1-4 occur during the accounting period. Steps 5-10 occur at the end of the
accounting period. Step II (optional) occurs at the beginning of the following accounting
period. At this time, adjusting entries also must be recorded and posted of a worksheet is
used.
-These steps are usually presented in a worksheet. (optionally)

Recording Changes in Financial Position

Accounting Cycle
During each fiscal period a sequence of accounting procedures called the accounting
cycle is completed. The occurrence of a business transaction is the initial step in the
accounting cycle, the end product is the firms year-end financial statements.

Steps in accounting cycle


FORM OF INFORMATION

Source Documents
- Include:-
- Invoices (purchase and sales)
- Paying in slips
- Remittance advice
- Cheque book summaries
- Correspondences etc

2. Books of original entry:


- Day books (sales, sales return, purchase, purchase returns)
- Cash book
- Petty cash book
- General Journal

3. Ledger Accounts: types


- Personal accounts
- Real accounts
- Impersonal accounts
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CAC 100 FUNDAMENTALS OF ACCOUNTING


- Nominal accounts
Types of Legers.
- Sales ledger
- Purchases ledger
- General ledger

4. Financial Statements
- Manufacturing A/C
- Trading profit and loss A/C
- Balance sheet
- Cash flow statement
- Statement of retained earnings (or owners equity)

We shall examine the procedure used by the accountant. Although journalizing is,
primarily, the first step of record keeping we shall start with the ledger and latter deal
with the journal, for a better understanding.

The Ledger
Each transaction recorded results in an increase or decrease in one or more assets,
liabilities, owners equity, revenue or expenses. An account is a device used to provide a
record of increases and decreases in each item that appear in a firms financial statements.

Thus as part of the accounting system, a firm will typically maintain an account for each
kind of asset, liabilities, owners equity, revenue and expense item e.g account to record
increases and decreases in cash, accounts receivable, accounts payable , capital etc.

Ledger is a collection of the entire set of accounts. It accumulates in one place all the
information about changes in a specific asset, liability or owner’s equity in a
computerized system the ledger may consist of tracks of a tape or a floppy disk.

Each account has three (3) basic parts:-

1. Title that is descriptive of the nature of the items being recorded in the account.
2. The debit.
3. The credit

This can be represented in two basic types of ledger accounts

(i) T-Account
(ii) Running balance

(i) T- Account
The T-Account has the basic three parts.

The account is normally called T-account because of its similarity to the letter “T”. Its
format is:-

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Accounts Title

Debit side Credit side


(Dr) (Cr)

Debits and Credit Entries

An account is debited when an amount is entered on the left side and credited when an
amount is entered on the right side.
- A debit is also called a Ctiange to the account.
- The difference between the credits and Debit is called the Balance or Account
Balance.
- If the credits exceed the debits the account has a credit balance and if the
debits exceeds the credit, the account has a debit balance.i.e

DR> CR DR Balance
CR> DR CR Balance

If we consider the example in lession i.e Roberts Example: Cash account can be shown as
follows:
Receipt - Left side
Payments – right

CASH

1/9 60,000 3/9 21,000


20/9 1,500 5/9 15,000
61,500 30/9 3,000
39,000

Since 61500 > 39000 the account has a debit balance of 22500/=.i.e (61,500-39000)
Where 61,500 is total debits and 39,000 is total credit.

Debit and Credit Rules

Each transaction affects at least two financial statement items, a system called Double
Entry Accounting.

When accounts are used in accounting process each transaction must be analyzed to
determine which accounts are affected and whether the affects are increases or decreases
so as to determine whether they are debited or credited.

Whether a debit or credit is a decrease or increase to the account balance depends on


whether the account is an asset, liability or owners equity. The following rules are used:-

Assets A/C Liabilities A/C


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CAC 100 FUNDAMENTALS OF ACCOUNTING


Debit to Credit to Debit to Credit to
Increase decrease decrease increase
+ _ - +

Owners equity A/c Expense A/C


Debit to Credit to Debit to Credit to
Decrease- increase + increase+ decrease-

In summary this means increases in asset are debited to asset accounts, consequently,
decreases are credited.

Revenue a/c
Debit to decrease- Credit to increase +

Example: Consider the following transaction which took place in the first week of
October:

1. 1st Oct the proprietor starts the firm with £ 1000


2. 2nd Oct a van was bought for £ 275 cash
3. 3rd Oct fixtures bought for £ 115 on credit from shop fitters.
4. 4th Oct paid the amount owing in cash to shop fitters Ltd

Summary of the transactions in Ledger Accounts


Cash A/C Capital A/C
1/10 1000 2/10 275 1/10 1000

Fixtures A/C Shop fitters A/C (Accts Payable)


3/10 115 4/10 115 3/10 115

Van A/C
1/10 275

(ii) Running Balance form of a Ledger A/C


It has:
- Date column – Date of transaction which is not necessary the date the entry is
made.
- Explanation column – description mostly of unusual items.
- Ref. (reference column- used to record the page no of the journal in which the
transaction is recorded.
- Debit and credit columns
- Balance column- The new balance is entered each time the account is debited
or credited.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


ACCOUNT TITLE: A/c No.

Date Explanation Ref Dr. Cr. Balance

Once the Accounts balances are computed, it may be tedious to keep track of whether the
balance is a debit or a credit. To overcome this, we consider the normal account
balances.

Normal A/C Balance


The normal account balance is the side on which increases to the account are recorded.
This can be summarized as follows:

Account Normal Balance (side increases recorded)


Assets Debit
Liability Credit
Owners equity:
Investment Credit
Withdrawals Debit
Revenues Credit
Expenses Debit

Account Balances which are not normal are usually specified as either DR or CR.

NB: A chart of accounts is a list of the account titles and numbers being used in a given
business.

Ledger Accounts Commonly Used Include:-

1.Balance Sheet Accounts


Assets Accounts
- Cash -Notes receivable -Accounts receivable
- Prepaid expenses -Land -Buildings
- Equipments -Inventories/stock - Stock

Liabilities Accounts
- Notes payable -Accounts payable -Unearned revenues
- Long term loans -Other short term liabilities
Owners equity Accounts: - records owners interest in the firm. Four main
Transactions affecting this account include:

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CAC 100 FUNDAMENTALS OF ACCOUNTING


(i) Investment of assets in the firm by the owner
(ii) Withdrawals of assets by the owner
(iii) Earning of revenue
(iv) Incurring of expenses to produce revenue

Owners equity= Investment – withdrawal + revenue earned- expenses incurred


2. Income Statement A/C
- Revenue a/c /- sales A/C
- Expense A/C
-Salaries and wages
-Rent
-Electricity
-Depreciation

Step 1 Collecting Data About Economic Events

The first step in the accounting cycle is to collect data about those economic events that
will enter a company’s accounting system. Data about economic events are collected
from source documents. A source document provides evidence that an economic event
has occurred. Some examples of source documents that provide verification about the
occurrence of economic events are listed below:

Economic Event Source Document


Cash sales Cash register tapes
Credit sales Sales invoices
Purchases of merchandise purchase orders, purchase
Supplies; other assets invoices, freight bills
Purchase of labour services (e.g. salaries; wages) Time tickets, clock cards
Depreciation of bug-lived assets Depreciation schedules
Interest on savings accounts; Monthly bank statements
Service charges on checking accounts

Step 2 JOURNALIZING

In the typical manual accounting system, a transactions is analyzed and recorded in a


book called a Journal, before the effect of the transaction are entered in the individual
accounts in the ledger. The journal is a chronological (day-to-day) record of each
business transaction. It is the initial recording of a transaction, hence referred to as Book
of Original Entry. One method of recording transactions makes use of a single journal
called a general journal.

Although transactions could be entered directly to the accounts in the ledger, there are
several advantages of first entering transactions in a journal especially in a manual
Accoounting system which include:-

33

CAC 100 FUNDAMENTALS OF ACCOUNTING


i) More information/description

A journal shows all information about a transaction in one place and also provides an
explanation of the transaction. In a Journal debits and credits of a transaction are
recorded/entered together but in a ledger the debits and credits are entered in various
accounts in various pages. Where ledger has several pages/accounts becomes so
difficult to locate the particulars of every transaction.

ii) “ Permanency” of records


The Journal provides a chronological record of all events in the life of the business. It
makes it easy to locate a transaction and its particulars however ancient it is.

iii) Prevention of errors

The use of Journal helps to prevent errors. If information was entered directly in the
ledger, it would be very easy to make errors such as omitting the debit or the credit or
entering the debts or the credit twice.

Categories of Journals:-
- General journal
- Special journals

General Journal is a “basic” Journal where all financial transactions are recorded.

Special Journals are used.


When large numbers of transactions of the same type occur, a firm establishes special
journals to reduce the clerical work in recording and posting the transactions. e.g of
special journals include:-
- Sales day book
- Purchases day book
- The cash book
- Recording transactions in a journal is called Journalizing.
At this particular point, you should remember that and this will be illustrated using a
general journal. The journal has the following:
- Date Column: - To record the date of the transaction
- Accounts and explanation column
- Reference column
- Debit and credit columns

General Journal Illustration

Consider the following:


1. A company made sales by cash of Shs. 15,000 on July 5 2000.
2. The company purchased office equipment worth 62,000 by paying cash 22,000
and issuing short term notes payable of Kshs 40,000.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


General Journal Page 10
Date Accounts and explanation Ref Debit Credit
2000 Cash A/C 15,000
July 5 Sales A/C 15,000
To record cash sales
10 Office equipment 62,000
Cash 22,000
Notes payable 40,000
Being purchases of equipment for
partly cash and partly by issue of short
term notes payable

An entry with one credit and one debit is called a Simple Journal Entry. While one with
more than one credit or debit is called Compound Journal Entry.

The Process of Journalising

1. The date that each transaction occurred is entered in the first two columns.
2. The title of the account to be debited is entered against the left margin of the
accounts and explanation column.
3. The amount to be debited to the account identified is entered in the debit amount
column on the same line as the account name.
4. The title of the account to be credited is entered on the line immediately below the
account to be debited. It is indented to set it apart from the account to be debited.
5. The amount to be credited to the account identified is entered in the credit amount
column on the same line as the account name.
6. An explanation of the transaction may be entered on the line immediately below
the credit entry.
7. The posting reference shows the account number to which the Journals are posted.
8. A blank line is left after each entry to ensure that each Journal entry stands out
clearly as a separate unit and improves the readability.

ILLUSTRATION 1

Refer to the Roberts illustration in Lesson 1 and prepare Journal Entries

NB: Robert is starting a business, hence the general ledger is page 1.

General Ledger Page 1


DATE ACCOUNTS & EXPLANATIONS DEBIT Credit
1990 Sept Cash 60,000
1 Roberts Capital 60,000
Invested cash in the business
Land 21,000
3 Cash 21,000
Purchased land for office
Site and paid cash
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Building 36,000
5 Cash 15,000
Accounts payable 21,000
Purchased building partially in cash and the
balance to be paid within 90 days
Accounts Receivable 6,000
10 Land 6,000
Sold the unused part of land at cost to drugs
store within 3 months
Office equipment 5400
14 Accounts payable 5400
Purchased office equipment on credit from
general equipments inc.
Cash 1500
20 Accounts receivable 1500
Collected part of A/C
Receivable from drugstore
Accounts payable 3000
30 Cash 3000
Made partial payment of the liability to
General Equipment inc.

Step 3: Posting
- The process of transferring the amounts entered in the Journal to the proper ledger
accounts is called posting. Each amount listed in the debit column of the Journal
is posted by entering it on the debit side of an account in the ledger and each
amount listed in the credit side of the ledger account. The objective is to classify
the effect of transactions on each individual asset, liability, owner’s equity,
revenue and expense account.
- Posting is done periodically e.g end of day/week.

Steps involved in posting process:-

1. Locate in the ledger the account to be debited.


2. Enter the date the transaction occurred as shown in the Journal.
3. Enter the debit amount in the debit column of the ledger account.
4. Enter the account that was credited in the explanation column.
5. Reference the entry by inserting the Journal page in the reference column.
6. Compute the balance
7. Repeat Step 1 through 6 for the credit part of the entry.

Illustration 11
G. Powel started a business with 2.5 million in the Bank on 1st July. The following
transactions were entered into (figures in )
July 2 Bought office furniture by cheque shs. 150,000
3 Bought machinery sh. 750,000 on credit from Planners Ltd
5 Bought a motor van paying by cheque Shs. 600,000

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CAC 100 FUNDAMENTALS OF ACCOUNTING


8 Sold some of the office furniture (defective) to J. Walker & Sons for
60,000 on credit
15 Paid part of the amount owing to planers Ltd Sh. 350,000 by cheque
23 Received the amount due from J. Walker sh. 60,000 in cash
31 Bought more machinery by cheque shs. 28,000
31 Paid salaries Kshs 12,000 office secretary
Required:
(a) Prepare Journal Entries to record the above transaction
(b) Post the Journal entries to appropriate accounts
© Prepare a Trial Balance
(Try and prepare Journal entries without first checking the solution).

Solution to Illustration 11

1. Journal Entries

Accounts & Explanations Ref DR CR.


1999 1 Bank A/C (Cash A/C) L02 2,500,000
July Capital A/C L30 2,500,000
To record the start of business on July 1 &
the owners (power) investment
2 Furniture A/C L12 150,000
Bank A/C L02 150,000
Purchase of office furniture by cheque
3 Machinery A/C L24 750,000
Account payable L20 750,000
Purchase of machinery on credit
5 Motor van A/C 46 600,000
Bank A/C L02 600,000
Purchase of Motor by Cheque
8 Accounts Receivable A/C L04 60,000
Furniture A/C L12 60,000
Sale of defective furnitures on credit
15 Accounts payable (Planners) L20 350,000
Bank A/C L02 350,000
Payment to a creditor
23 Cash (Bank A/C) C02 60,000
Accounts Receivable C04 60,000
Receipt of cash from a debtor
31 Machinery L14 280,000
Bank A/C L02 280,000
Purchase of machinery by cheque
31 Salaries expenses L32 12000
Bank L02 12000
To record payment of salaries to
the office secretary

To enable the referencing, you require the chart of accounts.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


CHART OF ACCOUNTS

Bank Account (cash) 02


Accounts Receivable 04
Furniture A/C 12
Machinery A/C 14
Motor Van A/C 16
Accounts payable 20
Capital 30
Salaries and wages 32

GENERAL LEDGER

TITLE: Bank/cash A/C A/C No: 02


DATE EXPLANATION RE DR CR BALANCE
F
1999 1 Capital Account J1 2,500,000 2,500,000
July
2 Furniture A/C J1 150,000 2,350,000
5 Motor van A/C J1 600,000 1,750,000
15 Accounts payable (planners) J1 350,000 1,400,000
23 Accounts Receivable J1 60,000 1,460,000
31 Machinery A/C J1 280,000 1,180,000
31 Salaries & Wages A/C J1 12,000 1,168,000

TITLE: Accounts Receivable A/C NO: 04


DATE EXPLANATION RE DR CR BALANCE
F
199- 8 Furniture A/C J1 60,000 60,000
July
23 Bank A/C JI 60,000 0

TITLE: Furniture A/C A/C NO: 12


DATE EXPLANATION RE DR CR BALANCE
F
199- 2 Bank A/C J1 150,000 150,000
July
8 A/C Receivable J1 60,000 90,000

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CAC 100 FUNDAMENTALS OF ACCOUNTING


TITLE: Machinery A/C A/C NO: 14
DATE EXPLANATION RE DR CR BALANCE
F
199- 3 Accounts payable J1 750,000 750,000
July
31 Bank J1 280,000 1030,000

TITLE: Motor Van A/C A/C NO: 16


DATE EXPLANATION RE DR CR BALANCE
F
199- 5 Bank A/C J1 600,000 600,000
July

TITLE: Accounts payable A/C NO: 20


DATE EXPLANATION RE DR CR BALANCE
F
199- 3 Machinery A/C J1 750,000 750,000
July
15 Bank J1 350,000 400,000

TITLE: Capital A/C A/C NO: 30


DATE EXPLANATION RE DR CR BALANCE
F
199- 1 Bank J1 2,500,000 2,500,000
July

TITLE: salaries and wages A/C A/C NO: 32


DATE EXPLANATION REF DR CR BALANCE
199- 1 Bank J1 12,000 12,000
July

To answer part (c) you need first to cover step 4 of the accounting cycle.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


STEP 4 The Trial Balance
Preparation Of A Trial Balance (Tb)

One aspect of a double-entry accounting system is that for every transaction there must be
equal amounts of debit and credits recorded in the accounts. The equality of debits and
credits posted to the ledger account is verified by preparing a list of all general ledger
account in order in which they appear in the ledger with their current balances. The
amount of accounts with debits balances are listed in one column and the amounts of
accounts with credit balance are listed in the second column. The sum of the two
columns should be equal. A Trial Balance may be prepared at any time to test the
equality of the debits and credits in the ledger.

The specimen below should be preliminary guide to the form and construction of a Trial
Balance.

SPECIMEN OF TRIAL BALANCE

TRIAL BALANCE
AS AT 31ST MARCH 19…..

Serial No. Name of Account Dr. Cr.


Shs shs
1 Capital A/c 18,000
2 Purchase A/c 2,500
3 Account payable 8,000
4 Office Expenses A/c 1,200
5 Insurance expenses A/c 2,400
6 Rent A/c 10,500
7 Salaries A/c 10,000
8 Sale A/c 55,000
9 Cash at Bank 33,000
10 Cash in hand 1,300
11 Debtors 27,500
12 Creditors 8,400
--------- ---------
89,400 89,400
======== =====

From the above specimen, one will recognise that a Trial Balance is in a tabular form
similar to the ruling of a Journal and, indeed, in practice a Journal is used for the
representation of a Trial Balance. One should note that the Date Column is dispensed
with as the statement is strictly prepared as a particular date; however the space is used
for recording the Ledger page or serial number of the account from where balance is
extracted and this is important for easy reference. The title of the account is written in the

40

CAC 100 FUNDAMENTALS OF ACCOUNTING


“Name of Account” column and the respective balances, i.e. Debit balances or Credit
balances are written in the appropriate columns.

CONSTRUCITON OF A TRIAL BALANCE:

The construction of the trial Balance is bound to present some difficulty and you are
advised to revise how accounts are balanced in the Ledger noting especially their normal
balances. For this section, it is sufficient to note that in the Ledger there are three types of
Accounts namely the Real, Nominal and Personal Accounts. These Accounts are
balanced at the end of the accounting period either by bringing down the balances or
transferring the balances to other accounts or in the case of personal accounts whose two
sides are equal by merely ruling off. The important points to bear in mind are that Real
Accounts extend to more than one period;

Nominal Accounts are generally restricted to one period and include operational expenses
or incidental gain. Personal Accounts can generally be of one period or extend to more
than one period. Thus, the balances of Real Accounts are brought down as they are to
appear in the next accounting period; the balances of Nominal Accounts are closed or
transferred to income Summary account. Personal Accounts if they are fully paid or are
equal on both sides are balanced and then the balance brought down.

A Trial Balance can be constructed in two ways (1) by means of totals (2) by means of
balances.

The first method is seldom used these days as it is laborious and clumsy. The modern
method of preparing the Trial Balance is to take out the balances of accounts ignoring
altogether those accounts in which the amounts on the one side corresponds with amounts
on the other side.

Constructing the Trial Balance by means of balances can be effected in two ways; either
by asking one to extract the balance from the Ledger and tabulate them accordingly or
tabulate the balances accordingly from a list of balances already extracted from the
Ledger. Thus, in the latter case, the items have to be sorted into debits and credits, the
totals of which must agree. The procedure is not so simple as it looks at first sight and
one should familiarise oneself with the rules as discussed the previous.

Refer to illustration 1 and prepare a trial balance. Extract the balances from the ledger
accounts. Compare your solution with the one below

41

CAC 100 FUNDAMENTALS OF ACCOUNTING


TRIAL BALANCE
AS AT 31ST MARCH 199…..

Serial No. Name of Account Dr. Cr.


Shs Shs
1 Bank/Cash A/c 1,168,000
2 Furniture 90,000
3 Machinery 1,030,000
4 Motor Van A/c 600,000
5 Account payable 400,000
6 Capital A/c 2,500,000
7 Salaries and Wages 12,000
------------- -------------
2,900,000 2,900,000
======== ========

USES OF TRIAL BALANCE

Trial balance provides proof that the ledger is in Balance. If it balances it gives the
assurance that
1. Equal debits and credits have been recorded for all transactions
2. The debit and credit balance of each account has been correctly computed
3. The addition of the account balances in the trial balances has been correctly
performed.

If the debit and the credit totals of the TB do not agree, it means one or more errors has
been made. Typical errors inculde:-

(i) the entering of credit as debit and viceversa


(ii) Arithmetic mistake in balancing accounts
(iii) Clerical error in copying account balances into the trial balance eg in
stead of writing 87,000 one writes 78,000
(iv) Errors of principle listing the debit balances in the credit side of the
Trial balance and vice versa.
(v) Errors of addition in the trial balance or subsidiary books.
(vi) Omission of a balance of any account in the trial balance.

LOCATING ERRORS

The lack of balance may be a result of combination of errors. There is no single


technique, which will give the best results every time, but the following procedure done
in sequence will often save considerable time and effort in locating errors.

1. Prove the addition of the trial balance columns by adding these columns in the
opposite direction from that previously followed.
2. If the error doesn’t lie in addition, determine the actual error (difference) by which the
schedule is out of the balance.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


- Rule of division by 9. If the difference is division by 9 it implies that it’s a
transposition error or slide error e.g. cash account has a balance sh. 4,3385 but copied
as sh. 4,835. The resulting error is 450/= all transposition errors are divisible by 9.
- Slide error or incorrect placement of a decimal e.g. Shs. 408.75 copied as 40875/= the
discrepancy will also be divisible by 9
- Check for an entry with half the error or (discrepancy) – where a debit was entered as
a credit.
- Check for the account with the exact discrepancy and determine the corresponding
entry (either debit or credit) was entered.
3. Compare the amounts in the trial balance with the balances in the ledger check that
the ledger balances are included in the correct column of the trial balance.
4. Recomputed the balance of each ledger account.
5. Trace all postings from the journal to the ledger accounts.

LIMITATION OF TRIAL BALANCE

A TB can still balance even when some Errors have been committed.
- If for example a purchase of furniture was erroneously recorded by debiting the land
account instead of furniture A/C. The T.B would still balance.
- Also a complete omission of a transaction. The error would not be disclosed by the
T.B.
However, trial balance acts as the stepping for financial statements e.g. balance sheet.

ERRORS THAT A TRIAL BALANCE DOES NOT REVEAL

1. Errors of Omission – a transaction is completely omitted from the books.


2. Errors of Commission – this type of error is where the correct amount is entered but in
the wrong persons account.
3. Errors of Principle – where an item is entered in the wrong class of account e.g. if an
asset such as motor van is debited to an expenses account such as motor expenses
account.
4. Compensating errors – where errors cancel out each other e.g. sales and purchases
being overstated by the some amount.
5. Error of original entry – where the original figure entered is incorrect, yet double
entry is still observed using this incorrect figure. E.g. sales of 98,000/= entered as
89,000/= in both sales A/c and personal account.
6. Complete Reversal of Entries – where the correct accounts are used but each item is
shown on the wrong side of the account e.g. sales account debited and personal
account credited instead of vice versa.

SUSPENSE ACCOUNTS
Accountants should try as much as possible to trace the errors and correct them. Where
this effort is futile the trial Balance totals are made to agree or balance by inserting the
amount of the difference between the credits and debits in a suspense account.

43

CAC 100 FUNDAMENTALS OF ACCOUNTING


Illustration

Trial balance as at 31 Dec 2000

Dr Cr
Total after all the Accounts have been listed 154,740 154,600
Suspense account. 140
154,740 154,740

SUSPENCE ACCOUNT
DR CR
31/12/2000 Difference per T.B 140

Where the financial statement have to be prepared before the error is located the
suspense Account Balance (if a credit balance) is added to the liabilities and Equity
side of the balance sheet. If the balance is a debit it would be added to the assets in the
balance sheets.

NB whenever the error is discovered it should be corrected by an appropriate journal


entry.

EFFECT OF ERRORS ON REPORTED PROFITS.

Errors discovered at a latter date affect the previous period statements when the
error was committed but undetected.

Illustration
Assume that the trading & Loss A/c for the year 2000 was as follows

$ $
Sales 100,000
Cost of sales
Opening stock 5,000
Add Purchases 61,000
Goods Available for sale 66,000
Less: Closing stock 7,500
Cost of goods sold 58,500
Gross profit 41,500
Add; Discount received 2,800
44,300
Expenses
Salaries and wages 14,000
Discount Allowed 1,600
Rent expense 2,500

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Telephone 500
Depreciation 2,400
Total expense 21,000
Net Profit 23,300

BALANCE SHEET
As at 31st Dec. 2000

Fixed Costs:
Fixtures 45,000
Less Accumulated Depreciation 12,000
Net fixed asset 33,000

Current Assets
Cash in hand 1,500
Cash at bank 60,000
Stock 7,500
Debtors 4,500
Total current assets 73,500

Current Liabilities
Rent payable 200
Creditors 3,500 3,700
Net current Assets 69,800
Suspense 5,000
Net assets 74,800

Financed by:
Capital:
Balance as 1/1/2000 60,000
Add Net profit 23,300
Less; Drawing 8,500
74,800

The following errors were discovered in 2002 but relate to the year 2001.
(1) Sales under cast by $500
(2) Salaries and wages over stated by $ 1,500
(3) Cash payment to a creditor entered in the cash book only $ 3,000.
(4) Complete commission of drawing by cheque $ 450.
(5) A purchase of $ 7,650 was entered in the book as $ 6,750 both credit and debit.
(6) Discount received over cast $1,000

45

CAC 100 FUNDAMENTALS OF ACCOUNTING


REQUIRED
(I) For each of the above errors show the effect in the net profit and prepare the
corrected profit and loss account.
(2) Show the suspense account after errors are corrected.

solution

Statement of corrected Net profit for the year ended 31 Dec.2000

Net profits for the accounts 23,300


Under cost of sales (1) 500
Add: over cast of salaries and wages (2) 1,500 2,000
25,300

Less Discount received overcast 1,000


Purchase under stated 900 1,900
Corrected Net Profit 24,400

NB Errors not affecting the net profit:


(3) Creditors were overstated in the balance sheet.
(4) Bank balance in the balance sheet is overstated and the drawing account is
understated.

The corrected suspense A/c appears below suspense A/c

31/12/2000 difference in T.B 5,000 31/12/2000 Salaries & wages 1,500


31/12/200 Sales 500 31/12/2000 Discount Received 1,000
31/12/2000 Creditors 3,000
5,500 5,500

NB Errors No. 4 and 5 are not corrected using a suspense account as they do not make
the Trial Balance to be out of balance

46

CAC 100 FUNDAMENTALS OF ACCOUNTING


ILLUSTRATION III
This illustration helps to understand the practice the accounting cycle procedures. Try it
before checking the solution

The following transactions were recorded in the book of ABC company limited in the
first month of operation.

JUNE
1 Mr. A deposited Shs. 600,000 cash in the Bank for the real estate business.
1 An agreement for the firm to manage on apartment complex for a monthly fee of
Shs. 400 to be paid on the fifth day of the following month.
1 Purchase land and office building for Shs.72,000 the terms of the agreement
provided for a cash payment of Shs. 120,000 the remainder to be financed with a
20 year mortgage bearing interest at 12% per year. The purchase price is
allocated Shs. 100,000 to land and Shs. 620,000 to building.
3 Cash payment of Shs. 96,000 was made for a 24 month fire and business liability
insurance policy.
5 .Purchased office supplies for the amount of 6,200 on credit.
5 Purchase office furniture and equipment for a total price of 96,000 paid 50,000 in
cash with the balance due in 60-days.
5 Hired two sales agents and an office secretary
6 Paid Sh 1,200 for radio commercial aired on June 3rd and 4th .
15 Sold a residence that had been listed with the firm. A commission of Shs. 42,000
was earned on the sale to be received when loans closes.
22 Paid salaries and wages for the two weeks, 18,000/= cash.
23 He performed an appraisal and was paid Ksh. 2,500 cash
23 The owner withdrawal Ksh 6,000 cash for personal use
27 Paid for the office supplies purchase on credit.
29 Received Ksh.2,800 for an appraisal to be performed in July.
30 Paid telephone bill Kshs 7,200 cash
30 The loan closed the commission was received.

CHART OF ACCOUNTS

Cash/bank 001 Office supplies exp. 076


Account Receivable 005 Depreciation Exp. 078
Land 010 Acc Dep. Bidg 056
Building 012 Furniture 058
Note Payable 032 Insurance Exp. 080
Prepaid insurance 008 Interest Exp. 082
Office Supplies 006 interest payable 036
Accounts payable 030 Unearned appraisal fees 054
Office equipment 014 Advertising Exp. 070
Commission Revenue 060 Salaries & wages 072
Appraisal fees 062 Drawing A/c 052
Telephone Exp. 074 Capital A/c 050

REQUIRED
a)
47

CAC 100 FUNDAMENTALS OF ACCOUNTING


(i) Journalize the June Transactions
(ii) Post to a running balance ledger accounts
(iii) Prepare a trial balance.

(b) Assume monthly financial statements were to be prepared.


(i) prepare adjusting journal entries
(ii) post the adjustment
(iii) prepare adjusted trial balance
(iv) prepare a balance sheet as at 31st June and an income statement.

48

CAC 100 FUNDAMENTALS OF ACCOUNTING


SOLUTION : ILLUSTRATION III

Journal Entries:

DATE ACCOUNT & EXPLAINATIO REF DR CR


JUNE 1 Cash A/c L/001 60,000
Capital A/c L/050 60,000
To record cash invested by the owner
1 Land A/c L/010 100,000
Building A/c L/012 620,000
Cash A/c L/001 120,000
Notes payable A/c L/032 600,000

Purchase of land and building party in cash


and party by a 20-year mortgage beginning
12% interest.
3 Prepaid insurance A/c L/008 9,600
Cash L/001 9,600
Payment of a 24-month insurance fire and
business liability insurance policy.
5 Office supplies A/c L/026 6,200
Accounts payments L/030 6,200
To record purchase of office supplies on credit

5 Office equipment L/014 96,000


Cash L/001 50,000
Accounts payable L/030 46,000
Purchase of furniture and equipment partly in
cash and balance to be paid in 60 –days.
6 Advertising Exp. A/c L/070 1,200
Cash A/c L/001 1,200
Payment for radio commercial aired on 3rd and
4th of June
15 Accounts receivable A/c L/005 42,000
Commission Revenue L/060 42,000
To read commission earned to be received
when the loan is closed.
22 Salaries and wages A/c L/072 18,000
Cash L/001 18,000
Payment of two weeks salaries and wages.
23 Cash L/001 2,500
Appraisal fee revenue A/c L/062 2,500
To record appraisal fee received.
23 Drawing A/c L/052 6,000
Cash L/001 6,000
Money withdrawn for personal use by the
owner.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


27 Accounts payable L/030 6,200
Cash L/001 6,200
Paid for the office supplies purchased on
credit.
29 Cash L/001 2,800
Un earned appraisal fees L/054 2,800
To record money received for an appraisal to
be performed in July.
30 Telephone expenses L/074 7,200
Cash L/001 7,200
Payment of telephone bill.
Cash L/001 42,000
30 A/c Receivable L/005 42,000
Receipt of commission earned on June 15

NOTE:

1. The transaction of June 1 of signing an agreement does not create a recordable asset
or revenue and therefore is not given accounting recognition.
2. The transaction of June 5 of hiring of employee is not given accounting recognition
since there are no effects at this time on the firm’s accounting equation.

TITLE: CASH A/C No.001


June Date Explanation Ref Dr Cr. Balance
1 Capital A/c J1 600,000 600,000
1 Land & building J1 120,000 480,000
3 Pre paid insurance J1 9,600 470,000
5 Office equipment J1 50,000 420,000
6 Advertising Exp. 1,200 419,200
22 Salaries and wages 18,000 401,200
23 Appraisal fee revenue 2,500 403,700
27 Drawing A/c 6,000 39,1500
29 Unearned appraisal
fees 2,800 391,500
30 Telephone Exp 7,200 387,100
30 A/c receivable 42,000 429,100

TITLE: LAND A/c No. 010

June Date Explanation Ref Dr Cr. Balance


1 Cash /note payable 100,000 100,000

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CAC 100 FUNDAMENTALS OF ACCOUNTING


TITLE: ACCOUNTS RECIEVABLE A/c No. 005

June Date Explanation Ref Dr Cr. Balance


15 Commission Rev. J1 42,000 42,000
30 Cash 42,000

TITLE: ACCOUNTS PAYABLE A/c No. 030

June Date Explanation Ref Dr Cr. Balance


5 Off. Supplies A/c 6,200 6,200
5 Off Equipment 46,000 52,200
27 Cash 44 6,200 46,000

TITLE: NOTES PAYABLE A/c A/c No. 032

June Date Explanation Ref Dr Cr. Balance


1 Land & building 44 600,000 600,000

TITLE: CAPITAL A/C A/c No. 050

June Date Explanation Ref Dr Cr. Balance


1 Cash A/c 44 600,000 600,000

TITLE: BUILDING A/c No.012

June Date Explanation Ref Dr Cr. Balance


1 Cash/Note payable 43 620,000 620,000

TITLE: PREPAID INSURANCE A/c No 008

June Date Explanation Ref Dr Cr. Balance


3 Cash 9,600 9,600

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CAC 100 FUNDAMENTALS OF ACCOUNTING


TITLE:OFFICE SUPPLIES A/C A/c No. 006

June Date Explanation Ref Dr Cr. Balance


5 A/c payable 43 6,200 6,200

TITLE: OFFICE EQUIPMENT A/c No. 014

June Date Explanation Ref Dr Cr. Balance


5 Cash A/c payable 43 96,000 96,000

ADVERTISING EXPENSE A/c No. 070

June Date Explanation Ref Dr Cr. Balance


6 Cash A/c 44 1,200 1,200

COMMISSION REVENUE A/c No 060

June Date Explanation Ref Dr Cr. Balance


15 A/C Receivable 44 42,000 42,000

SALES AND WAGES A/c No. 072

June Date Explanation Ref Dr Cr. Balance


22 Cash 44 18,000 18,000

APPRAISAL FEES A/c No. 062

June Date Explanation Ref Dr Cr. Balance


23 Cash 44 2,500 2,500

DRAWINGS A/C A/c No.052

June Date Explanation Ref Dr Cr. Balance


23 Cash 44 6,000 6,000

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CAC 100 FUNDAMENTALS OF ACCOUNTING


UNEARNED REVENUE A/c No.054

June Date Explanation Ref Dr Cr. Balance


29 Cash 44 2,800 2,800

TELEPHONE EXPENSE A/c No.074

June Date Explanation Ref Dr Cr. Balance


30 Cash 44 7,200 7,200

A COMPANY LIMITED
TRIAL BALANCE
AS AT JUNE 30TH 19 ---

ACCOUNT NAME DR CR

Kshs. Kshs.
Cash 429,100
Land 100,000
Accounts Payable 46,000
Notes Payable 600,000
Capital A/C 600,000
BuildingPre Paid Insurance 620,000
Office Supplies A/C 9,600
Office Equipment 6,200
Advertising Expenses 96,000
Commission Revenue 1,200
Salaries And Wages 42,000
Appraisal Fees 18,000
Drawing Account 6,000 2,500
Unearned Revenue
Telephone 7,200 2,800

1,293,300 1,293,300

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CAC 100 FUNDAMENTALS OF ACCOUNTING


STEP 5 Adjusting Accounts And Preparing Financial Statements

Many transactions recorded during a period affect the current periods financial statements
as well as those prepared in future periods for example; The cost of a 24 month insurance
policy purchased in the current period should be allocated as an expense to all accounting
periods receiving the protection.

There are also other events such as the increase in interest revenue earned on notes
receivable which are often recorded at the end of the current period. This as part of the
accounting cycle, the accounts an source documents are analysed and entries made to
adjust the accounts before the financial statements are prepared. These entries are called
adjusting entries.

The adjusting entries are recorded to the general journal and posted to the ledger. A trial
balance called an adjusted trial balance is then drawn from the general ledger to varify the
equality of debits and credits the financial statements are then prepared from the adjusted
trial balance. Therefore the other remaining steps in the accounting cycle are:

(a) recording adjusting entries.


(b) Preparation of an adjusted trial balance
(c) Preparation of financial statements.
(d) Recording closing entries

CLASSIFICATION OF ADJUSTING ENTRIES

Adjusting entries are classified into four general categories.


1. Entries to apportion recorded costs : A cost that will benefit more than one
accounting period. Initially recorded by debiting on asset account. Adjustments
are made to allocate a portion of the assets cost to expense e.g. building.
2. Entries to apportion unearned revenue : where advance collection is done for
services to be rendered in future accounting periods. In the period in which the
services are rendered an adjusting entry is made to record the portion of the
revenue earned during the period.
3. Entries to record unrecorded expenses :- Incurrence of an expense in current
accounting period yet no bill received hence payment will be done in a future
period.
4. Entries to record unrecorded revenue:- Revenue earned but not yet billed to
customers or recorded in accounting records.

In determining whether an adjusting entry is needed the accountant examines the


appropriate source document e.g. insurance policy or the billing from the insurance
company. The account balances listed in the trial balance are examined to compute
the amount of the adjustment needed.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


ILLUSTRATION III Continued.

Consider the A limited trial balance. Such a trial balance is called unadjusted trial
balance because it is prepared from the general ledger before the adjusting entries are
recorded.
Assume that monthly financial statements are to be prepared and therefore monthly
adjusting entries are required.

1. Prepaid Expenses

Prepaid insurance to entered June 3 covers a period of 24 months.


Monthly insurance expenses = 9600/24 = 400

Prepaid Insurance Insurance exp


Bal B/f 9,600 30/6 insurance Exp. 400 30/6 Prepaid 400

2. Office Supplies Inventory (entered June 5)

The cost of unused office supplies is report as an asset in the balance sheet. As the office
supplies are used their cost is transferred to an expense account. The recognition of the
expenses is normally deferred until the end of the accounting period, (in a manual
Accounting Systems).
Assume that the cost of supplies that A ltd had on hand at the end of June was Shs 5,400.
The cost of supplies used would be Shs. 800 i.e. (6,200-5,400)

30/6 office supplies Expense 800


office supplies A/C 800
To record supplies used for the month

Supplies Expense Supplies a/c


30/6 800 30/6 bal. 6,200 30/6 800

Journal Entry
June 30 Insurance Expenses 400
Prepaid Insurance 400
Being adjusting entry
For insurance expense

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CAC 100 FUNDAMENTALS OF ACCOUNTING


When this entry is posted to the appropriate ledger account, the accounts will be as shown
below.

3. Depreciation Of Equipment And Building

To provide proper matching of revenue with expenses the cost of each asset less its
estimated residual value is allocated as an expense in the accounting period in which the
asset is expected to be used to produce revenue.

The residual value of plant asset is its estimated value at the end of its useful life. The
amount of time that the asset is expected to be used is called its estimated useful life. The
position of the assets cost assigned to expense is referred to as depreciation. In making
the adjusting entries for depreciation a separate account call accumulated depreciation is
credited for the cost associated with the period. This is done instead of making a direct
credit to the asset account.
The balance in the accumulated depreciation is the portion of the cost that has been
assigned to expense since the time the asset purchased.
The accumulated depreciation account is an example of a central account.
A contra account is reported as an off set to or deduction from a related account.

In our illustration let assume that the building has a useful life of 25 years at which time is
expected to have a residual value of Kshs 20,000 and the office equipment has a eight-
year estimated useful life and a zero redual value at the end of eight years. There are
various methods that can be used to calculate depreciation. At this point we shall use
straight line method and the other methods will be covered in the next lesson. Straight
line methods allocate equal depreciation expensed period. The monthly depreciation
assuming straight line method:-

The monthly depreciation assuming straight line method:-

Depreciation per period = Cost – Residual value


Useful life
Hence:

Depreciation for Buildings = (620,000 – 20,000)/ (25 x 12) month. = 2,000

Depreciation Office equipment = (96,000 - 0)/ 8x12 = 1,000

Journal entry:

30/6 Depreciation expense 3,000


Accumulated dep. Building 2,000
Accumulated depreciation equipment 1,000
To record depreciation for the month of June

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CAC 100 FUNDAMENTALS OF ACCOUNTING


The depreciation expense is reported as an expense in the income statement. The building
and office equipment account will be shown in the balance sheet as follows.

FIXED ASSET

Building 620,000
Less Acc. Depreciation: Building 2,000 Shs. 618,000

Office equipment 96,000


Less Acc. Depreciation: Equipment 1,000 Shs. 95,000

Interest Expense

The mortgage has an interest rate of 12% hence monthly interest expense is computed as
follows:-

Interest expense = 12% x 600,000


12 months
= 6,000

Journal Entries

30/6 Interest expense 6000


Interest payable 6000
To record the interest expense for the month of June

Interest Exp. Interest payable


30/6 6,000 30/6 6,000

The difference between the original cost of the asset and its accumulated depreciation is
called the Book Value of the asset and represents the unexpired cost of the asset.

Unearned Revenue
A firm may receive payment in advance for services that are to be performed in the future
until the service is performed a liability equal to the amount of the advance payment is
reported in the balance sheet. Thus the firms obligation to perform future services is
reported.

Unearned Appraisal Fees


Assuming that the services were performed in July then the following entry will be
entered.
July 16 Unearned appraisal fees 2,500
Appraisal fees Revenue 2,500
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Between the totals of the two income statements columns and enter this as a balancing
amount in both the income statement and balance sheet columns. Add the four columns
together with the balancing amount include.

ADJUSTED TRIAL BALANCE

After adjusting entries, have been journalised and posted to the ledger accounts on
adjusted trial balance is prepared to test the equality of debits with the credits.

A LTD
Adjusted Trial Balance
As at 30/6/92

ACCOUNT NAME DEBITS CREDITS


(Shs.) (Shs)
Cash 429,100
Land 100,000
Accounts payable 46,000
Notes payable 600,000
Capital 600,000
Building 620,000
Prepaid insurance 9,200
Office supplies A/c 5,400
Office equipment 96,000
Advertising expense 1,2000
Commission Revenue 42,000
Salaries and wages 18,000
Appraisal fees 2,500
Drawing A/c 6,000
Unearned appraisal Revenue 2,800
Telephone expenses 7,200
Interest expenses 6,000
Insurance Expenses 400
Interest payable 6,000
Office supplies 800
Depreciation Exp. 3,000
Accumulated depciation:.building 2,000
Accumulated depciation: Office equipment 1,000
------------- -------------
TOTAL 1,302,300 1,302,300

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CAC 100 FUNDAMENTALS OF ACCOUNTING


PREPARATION OF FINANCIAL STATEMENT

After the adjusting process is complete the financial statements can be prepared directly
from the adjusted trial balance.
Income Statement
The major purpose/objective of the income statements is to get the net income of the
period. For this purpose all the revenues will be added together and all expenses will be
subtracted from the revenues to determine the net income.

Therefore: Net Income = Revenue – Expenses.

Illustration III continued:

Using the Adjusted Trial Balance we can prepare an income statement and a Balance
Sheet as shown below.

A Ltd
INCOME STATEMENT
For The Period Ended June 30 1992

Revenues

Commission Revenue 42,000


Appraisal fee 2,500
Total revenue 44,500

Expenses

Salaries and wages Exp. 18,000


Insurance Exp. 400
Office Supplies Exp. 800
Depreciation Exp. Building 2,000
Depreciation Exp. Office Equip. 1,000
Advertising Exp. 1,200
Telephone Exp. 7,200
Interest Exp. 6,000 36,600

Net Income 7,900

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CAC 100 FUNDAMENTALS OF ACCOUNTING


BALANCE SHEET

A balance sheet reports the financial position of a firm on a specific date as opposed to
income statement which reports the flow of revenue and expenses during a period.

A Ltd
BALANCE SHEET
AS AT 30/6/92

Fixed Assets Shs. Shs.


Land 100,000
Building 620,000
Less Acc. Depreciation-building 2,000 618,000
Office Equipment 96,000
Less Acc. Dep. Office equipment 1,000 95,000
813,000
Current Assets
Office supplies 5,400
A/c Receivable -
Prepaid insurance 9,200
Cash A/c 429,100
443,700
Current liabilities
Interest payable 6,000
A/c Payable 4,600
Unearned appraisal fees 2,800 388,900
Net Assets 1,201,900
Financed by:
Long term liabilities
Note payable 600,000
Capital 600,000
Add net Income 17,900
Less drawings 6,000 601,900
1,201,900

THE CLOSING ENTRIES

The income statement reports revenue earned and expenses incurred to earn those
revenues during a single accounting period. Data needed to prepare the income statement
are accumulated in the individual revenue and expense accounts. Once the income
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CAC 100 FUNDAMENTALS OF ACCOUNTING


statement has been prepared for the current period the revenue and expense account have
served their purpose and they are closed or cleared by transferring their balances to the
income summary account. The closing process results in each expense revenue account
beginning the next period with a zero balance.
Because revenue and expense accounts are closed each period they are called Temporary
or Nominal accounts.
Balance sheet accounts are not closed the ending balance of one period are carried
forward and becomes the beginning balance of next period. Thus balance sheet accounts
are called permanent or real accounts.

STEPS IN CLOSING THE BOOKS:

Closing entries are generally made in the following sequence:


(1) Each revenue account is reduced to zero by transferring its balance to the income
summary account.
(2) Each expense account is reduced to zero by transferring the balance to the income
summary account
(3) The balance in the income summary account is transferred to the owner’s capital
account.
(4) The balance in the owner’s drawing balance in the owner’s drawing account is
transferred to the owner’s capital account.

Illustration
Assume that x Ltd had the following balances in the revenue and expense accounts after
the preparation of year end financial statements.

Salaries and wages 270,900


Commission expenses 480,000
Utilities expenses 28,200
Advertising expenses 12,000
Office supplies expense 8,000
Insurance expense 4,000
Depreciation Exp. Building 20,000
Depreciation Exp. Office Equipment 10,000
Interest Expense 6,000
Commission Revenue 960,000
Appraisal fees Revenue 25,000
Service fees Revenue 40,000
Drawings 6,000

REQUIRED

1. Close these account to the income summary


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CAC 100 FUNDAMENTALS OF ACCOUNTING


2. Close Income summary and drawing A/c to capital account.

Solution

(i) Commission Revenue 960,000


Appraisal Revenue 25,000
Service fees Revenue 40,000
Income summary 1,025,000
To close Revenue A/c

(ii) Income Summary 839,100


Salaries and wages 270,900
Commission expenses 480,000
Utilities Expense 28,200
Advertising exp. 12,000
Office Supplies Exp. 8,000
Insurance Exp. 4,000
Depreciation Exp: Building 20,000
Depreciation Exp: Office Equip. 10,000
Interest exp. 6,000
To close the Expense A/c

(iii) Income Insummary 185,900


Owners capital 185,900
To close the Income summary

(iv) Owners capital 6,000


Drawings A/c 6,000
To close the drawing A/c

Income Summary A/c


Total exp. 839,100 Total Revenue 1,025,000
Owners Capital 185,900
1,025,000 1,025,000

Step 9: THE POST- CLOSING TRIAL BALANCE

After the closing entries have been posted, a trial balance may be prepared to varify the
equality of debit and credits in the ledger. The trial balance is known as a post closing
trial balance.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


PREPERATION OF A WORK SHEET

A work sheet is a device designed to bring together in one place the information needed
to prepare formal financial statements and to record the adjusting and closing entries. It
should be noted that worksheet are:
(a) not part of the permanent accounting records
(b) not prepared for use by the owners or management of the firm
(c) replaces neither the financial statements nor the necessity to Journalize and post
the adjusting and closing entries and
(d) are tools used to gather and organize the information needed to complete the
accounting cycle.

STEPS IN PREPARATION OF A WORK SHEET.


1. Enter the ledger account titles and balances in the account title and un
adjusted trial balance columns, respectively.
2. Enter the necessary adjusting entries in the adjustments columns – key
letters can be placed for reference.
3. Prepare an adjusted trial balance by considering the entry in the unadjusted
Trial Balance, making the necessary Adjustment and determining the
adjusted balance.
4. Extend every account balance listed in the adjusted trial balance column to
its proper financial statement column. I.e either income statement or
balance sheet.
5. Add the two income statement and the two balance sheet columns.
Compute the difference.

ILLUSTRATION III Continued:


Recall the following adjusting journal entries for A Ltd

a) Insurance Expense 400


Prepaid Insurance 400

b) Office supplies expenses 800


Office supplies A/c 800

c) Depreciation Expense 3,000


Accumulated Depreciation: Building 2,000
Accumulated Depreciation: Equipment 1,000

d) Interest expense 6,000


Interest payable 6,000

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CAC 100 FUNDAMENTALS OF ACCOUNTING


A LTD
WORK SHEET
For The month Ended 30/12/2002

UNADJUSTED ADJUSTMENT INCOME BALANCE SHEET


ACCOUNT TRIAL BALANCE ADJUSTMENT TRIAL BALANCE STATEMENTS
TITLE DR CR DR CR DR CR DR CR DR C
R
Cash 429,100 429,100 429,100
Land 100,000 100,000 100,000
Acc. Payable 46,000 46,000 46,000
Note payable 600,000 600,000 600,000
Capital 600,000 600,000 600,000
Buildings 620,000 620,000 620,000
Prepaid Insurance 9,600 (a) 400 9,200 9,200
Off. Supplies A/c 6,200 (b) 800 5,400 5,400
Office Equipment 96,00 96,000 96,000
Advertising Exp. 1,200 1,200 1,200
Commission Rev. 42,000 42,000 42,000
Salaries & wages 18,000 18,000 18,000
Appraisal fees 2,500 2,500 2,500
Drawings A/c 6,000 6,000 6,000
Unearned 2,800 2,800 2,800
appraisal
Revenue
Telephone Exp 7,200 7,200 7,200
Insurance exp. (a) 400 400 400
Office Supplies (b) 800 800 800
Exp.
Dep. Exp. (c) 2,000 2,000
Building 2000
Dep. Exp. Equip. (d) 1,000 1,000
1000
Accumulated © 2,000 2,000 2,000
Dep. building
Interest Exp. (d) 1,000 1,000 1,000
Interest payable (e) 6,000 6,000 6,000 6,000 6,000
SUB-TOTAL 36,600 44,500 1,265,700 1,257,800
NET INCOME 17,900 17,900
TOTAL 1,293,300 1,293,300 4,200 4,200 1,296,300 1,296,300 44,500 44,500 1,265,700 1,265,700

Self Testing Problem

To illustrate recording in a general journal, assume that the transactions listed below for the
garden shop took place in May 2001, during its first month of operations:

May 1 Certificate of incorporation was received authorizing the issuance of 100,000


Shares of $ 5 per common stock. Issued 16250 shares at $ 8 per share.
May 1 Borrowed $ 30,000 from Caty Bank by issuing a $ 30,000 note due in two years.
Interest at 10% is payable annually.
May 1 Purchased the assets of real-value landscapers for $ 75000 in cash. The assets
Consisted of inventory of $ 60,000, supplies of $ 4000, and fixtures and
Equipment of $ 11000.
May 2 Paid rent on a building for 12 months in advances $ 7200. Debited rent expense.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


May 3 Purchased display equipment for $ 10,000 from East African Company. Paid $
2000 cash, the balance in 60 days.
May 4 Purchased merchandise on account from quick wholesale. The cost of the merchandise
was $ 44100.
May 4 Paid $ 1800 cash for supplies, which were recorded as an asset.
May 5 Sold miscellaneous items totalling $ 25000 to Ace Nursery on account
May 9 Purchased merchandise costing $ 30,000 from plants Inc, on account. The transportation
cost on the merchandise totaled $ 250 and was paid in cash.
May 11Received $ 12000 of the amount due from Ace Nursery
May 12 Paid salaries totaling $ 3000
May 20 Cash sales of lawn supplies, $ 15000
May 20 Subleased the top floor of the building rented on May 2 for $ 300 per month. Credited
rent revenue.
May 22 Received $ 5000 from sale of gift certificates. Credited unearned revenue-gift
certificates
May 24 Purchased temporary investments for cash at a cost of $ 3600
May 25 Returned defective merchandize costing $ 1200 to plants, Inc
May 26 Sold miscellaneous lawn supplies totaling $ 24000 to rite-way construction. Rite-way
paid $ 6000 cash, and the balance was on account.
May 28 Paid the amount due to Quick wholesale, $ 441000
May 29 Purchased merchandise on account from Handy & Dandy supply at a cost of $ 6000
May 30 Cash sales of lawn supplies, $ 18000

The above transactions are recorded in general journal form. Notice the format of the
General journal and of the journal entries. The first column in the journal shows the date
of the transaction. Next, the accounts debited and credited and a brief explanation of the
transaction are shown Go through the steps once to remond your self of the journalizing
procedure. Finally, the last two columns are for the dollar amounts of the
debits and credits.

General Journal Entries

The Garden Shop


General Journal
PAGE: 1
Date Account Title and explanation Ref Debit Credit
May 1 Cash 130,000
Common Stock 81250
Share premium 48750
To record sale of common stock
May 1 Cash 30,000
Notes payable 30,000
To record issuance of notes payable
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CAC 100 FUNDAMENTALS OF ACCOUNTING


May 1 Inventory 60,000
Supplies 4,000
fixtures and Equipment 11,000
Cash 75,000
To record acquisition of assets of rent Value
landscapers

May 2 Rent expense


Cash 7200
To record advance payment of rent 7200

May 3 Fixtures and equipment 10,000


Cash 2000
Accounts payable 8000
To record purchase of equipment

May 4 Supplies 1800


Cash 1800
To record purchase of supplies

May 5 Accounts receivable 25000


Sales 25000
To record sales on credit

May 9 Purchases 30000


Transport expenses 250
Accounts payable 30000
Cash 250
To record purchases of merchandise
and related freight costs

May 11 Cash 12000


Accounts receivable 12000
To record collections from customers

Salaries expense 3000


May 12 Cash
To record salaries expense 3000

May 20 Cash 15000


Sales 15000
To record cash sales of merchandise

May 20 Cash 300


Rent revenue 300
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CAC 100 FUNDAMENTALS OF ACCOUNTING


To record receipt of rent in advance
May 22 Cash 5000
Unearned revenue- gift certificates 5000
To record receipt of cash for gift certificate

May 24 Investments 3600


Cash 3600
To record purchase of investments

May 25 Accounts payable 1200


Purchase returns 1200
To record return of detective merchandise

May 26 Cash 6000


Accounts receivable 18000
Sales 24000
To record cash sales & sales on credit

May 28 Accounts payable 44100


Cash 44100
To record payment of amount due

May 29 Purchases 6000


Accounts payable 6000
To record purchases on credit

May 30 Cash 18000


Sales 18000
To record cash sales

Key words:
Account
Journal
General
Trial Balance
Source Documents
Books of original entry
Debits and Credit rules
Normal Accounts Balance
Posting
Adjusting
Worksheet

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CAC 100 FUNDAMENTALS OF ACCOUNTING


PROBLEMS
Problem 2.1
Tradar Winds Airlines provides passenger and freight service among some Pacific Islands. The
accounts are adjusted and closed each month. At June 30 the trial balance shown below was
prepared from the ledger.

TRADAR WINDS AIRLINES


Trial Balance
June 30, 2000

£ £
Cash 38,000
Prepaid rent 9,600
Unexpired insurance 21,000
Prepaid maintenance service 22,500
Spare parts 57,000
Airplanes 664,000
Accumulated depreciation: airplanes 108,000
Notes payable 400,000
Unearned passenger revenue 60,000
Stephen Morry, Capital 231,050
Stephen Morry , drawing 12,000
Passenger revenue earned 110,950
Fuel expense 13,800
Salaries expense 66,700
Advertising expense 5,400
£910,000 £910,000

Additional information

(a) Monthly rent amounted to £ 3,200 reducing the Prepaid Rent account to £ 6,400.
(b) Insurance expense for June was £ 2,400. Reduce the Unexpired Insurance account.
© All necessary maintenance work was provided by Ryan Air Service at a fixed charge of £
7,500 a month. Service for three months had been paid for in advance on June 1. (Debit
Maintenance Expense).
(d) Spare parts used in connection with maintenance work amounted to £ 3,750 during the
month. (Debit Maintenance Expense. Use two lines on work sheet for this expense
account).
(e) Depreciation of the airplanes for the month of June was £ 7,200.
(f) The Chamber of Commerce had purchased 2,000 special tickets for £ 60,000. Note that
the special price per ticket was £30. Each ticket allowed the holder one flight. During
the month 400 of these special price tickets had been used by the holders. (Debit
Unearned Passenger Revenue).
(g) Salaries earned by employees but not paid amounted to £ 3,300 at June 30.
(h) Interest accrued on notes payable at June 30 amounted to £ 7,000.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Required:

(a) Prepare a work sheet for the month ended June 30, 2000
(b) Prepare an income statement, a statement of owner’s equity, and a balance sheet.
© Prepare adjusting and closing journal entries.

Problem 2.2
Ms Robinson , after completing her medical education established her own practice on May 1.
The following transactions occurred during the first month.

May 1 Ms Robinson opened a bank account in the name of the practice, Robs Health Care
(RHC) by making a deposit of £ 42,000.
May 1 Paid office rent for May, £ 1,000
May 2 Purchased office equipment for cash, £ 6,200
May 3 Purchased medical instruments from Niles Instruments, Inc. at cost of £ 19,000. A cash
down payment of £ 9,000 was made and a note payable was issued for the remaining £
10,000.
May 4 Agreement signed with Granny Hospital to be on call for emergency service at a
monthly fee of £ 1,400. The fee for May was collected in cash.
May 15 Excluding the receipt for May 4, fees earned during the first 15 days of the month
amounted to £ 3,600 , of which £ 2,400 was in cash and £ 1,200 was in accounts
receivable.
May 15 Paid Mary, the secretary her salary for the first half of May, £ 00.
May 16 Dr. Robinson withdrew £ 975 for personal use
May 19 Treated Joyce Truda for minor injuries received in an accident during employment at
Granny Hospital . No charge was made as these services were covered by the payment
on May 4.
May 27 Treated Joshua, who paid £ 50 cash for an office visit and who agreed to pay £ 75 on
June 1 for laboratory medical tests completed May 27.
May 31 Paid the secretary £ 800 salary for the second half of month.
May 31 Received a bill from MarkGray Medical Supplies in the amount of £ 840 representing
the amount of medical supplies used during May.
May 31 Paid utilities for the month, £ 300

Other information
Dr. Robinson estimated the useful life of medical instruments at 6 years and of office equipment
at 10 years. The follows is the Chart of Accounts used by Robs Health Care (RHC):

Cash 10 Robison, drawing 41


Accounts receivable 13 Income summary 43
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Medical instruments 20 Fees earned 45
Accumulated depreciation: Medical supplies expense 50
Medical instruments 21 Rent expense 51
Office equipment 22 Salaries expense 52
Accumulated depreciation: Utilities expense 53
Office equipment 23 Depreciation expense:
Notes payable 30 Medical instruments 54
Accounts payable 31 Depreciation expense:
Robison, capital 40 Office equipment 55

Required:
(i) Journalize the above transactions. (Number journal pages to permit cross-reference to
ledger).
(ii) Post to ledger accounts. (Use running balance form of ledger account. Number ledger
accounts to permit cross reference to journal).
(iii) Prepare a trial balance at May 31, 2000
(iv) Prepare adjusting entries to record depreciation for the month of May and post to ledger
accounts. (For medical instruments, cost £ 9,000 ÷ 6 years x 1/12. For office equipment,
cost £ 7,200 ÷ 10 x 1/12).
(v) Prepare an adjusted Trial Balance.
(vi) Prepare an income statement and a balance sheet in report form.
(vii) Prepare closing entries and post to ledger accounts.
(viii) Prepare an after-closing trial balance.

Problem 2.3
The following is an unadjusted trial Balance for Saidia Enterprises as at 31st. January for the first
month of operation.
DR CR
Cash 215,000
Prepaid Insurance 12,000
Short term Investment 6,000
Accounts Receivable 20,000
Furniture & Fittings 50,000
Equipment 75,000
Office Expenses 2,000
Supplies 19,000
Salaries and Wages Exp. 5,000
Advertising Expenses 3,500
Travel Expenses 4,000
Commission expenses 1,500
Revenue 125,500
Accounts payable 26,000
Long term loan 200,000
Capital, Zaidia ______ 62,000
413,500 413,500

Discussion with the Accountant reviewed the following:


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CAC 100 FUNDAMENTALS OF ACCOUNTING


(i) Insurance policy cover six months.
(ii) Rent is paid quarterly in advance.
(iii) The management decided to use the straight line method of depreciating their assets whose
useful life is 5 years and 3 years for furniture & fittings and equipment respectively. The assets
have no residual value.
(iv) Include in the revenue account is Kshs 5,000 for services to be rendered in February 2001.
REQUIRED:
Prepare the necessary adjustment as at 31st January and pass the Journal entries.
Prepare the adjusted Trial Balance.

Problem 2-4
On checking a profit and Loss Account for 2001 it was found that the following errors had occurred in
its preparation:
1. Telephone for £1,600 were outstanding and had not been paid. No entry had
been made.
2. Equipment were depreciated by £400; the amount should have bee £200
3. Expenses of £500 had been credited instead of being debited.
4. The Gross Profit had been entered as £35,000 it should have been £53,000. If
the net profit had been shown originally as £26,000 what should be the correct
figure? Would any of the changes have affected the Balance sheet?

Problem 2-5
Black and Co have produced a trial balance for the year ended 31 march 2000 which does not balance. A
suspense account was opened for the difference. An examination of the company’s books disclose the
following errors:
1. An invoice from Joy stationers amounting to £600 for goods purchased, has been omitted from the
purchase day book and posted direct to purchases account in the nominal ledger but not to Joy
stationers. Account in the purchase ledger.
2. The sales day book has been undercast by £240 and posted to the debtors control account
accordingly .
3. Discount allowed for the month of March amounting to £680 has not been posted to the nominal
ledger.
4. Goods received from Imani Ltd. On 31 March 2000 costing £20,450 have been included in stock but
the invoice has not yet been received.
5. A cheque for £ 1,920 received from Robert a debtor, has been posted direct to the sales account in
the nominal ledger.
6. Sales account in the nominal ledger has been credited with a credit note for £850 being trade-in
allowance given on a company van.
Required
(i) To give the journal entries, where necessary to correct these errors, or if no journal entry is
required, state how they will be corrected.
(ii) To prepare a statement showing the effect the corrections would have on the company’s
profit for the year, and
(iii) If the net profit before the corrections are made is £90,000, determine the corrected net
profit.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


LESSION 3

ACCOUNTING FOR CASH

Objectives:
At the end of this lesion you will be able to
Define cash
Understand the cash control system
Prepare a Petty cash book
Prepare a Cash book
Post the Petty cash entries to the ledger
Post the cash book entries to the general and subsidiary ledger
Prepare a Bank reconciliation statement

Definition
Cash is the term used in accounting to identify money and any other investment such as a check
or money order. Cash is a medium of exchange as well as a measure of value in our economy.
Cash is unproductive asset because it produces no revenue directly. Therefore any cash
accumulated in excess of what is needed for current use should be invested in some type of
revenue generating investment.

Cash must be adequately protected because


it is most easily misappropriated,
usually in short supply
desired by every one
can be idle.

CASH CONTROL

A good internal control system for handling cash and cash transactions is vital. Such a system
must contain procedures for protecting cash on hand as well as for handling both cash receipts
and cash disbursement elements of internal control system for cash.

1. The separation of the responsibility for handling and custodianship of cash from
responsibility for maintaining cash records/accounting records.
2. The deposit of each day’s cash receipt intact (on daily basis). This prevents the cash
custodians from borrowing the finds until the next deposit day.
3. Making all cash payment by Cheque. This allows the firm to use the bank record as a cross
check of its internal records. Except small payments.
4. Separate the function of approving expenditure from the function of signing cheques.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


5. Require that the validity and amount of every expenditure be verified before a Cheque is
issued in payment.
6. Preparation of a control listing of cash receipts at the time and place the money is received.

THE PETTY CASH SYSTEM

The Petty Cash Fund And The Imprest System


As stated earlier all disbursement should be made by cheque. However, to avoid the expense and
inconvenience of writing may small cheques for minor expenditures such as postage stamps a
pretty cash fund is established. A pretty cash fund is a specified amount of cash placed under the
control of a specified employee for use in making small payments.

Establishing The Fund

The petty cash fund is establish by writing a cheque to the petty cash fund cashier. A debit to a
petty cash account and credit to the cash A/c record the Cheque.
e.g. Assuming a fund of Shs. 1000 is established on Jan 2nd the journal entry is.

Jan 2 petty cash 1000


Cash 1000
To establish a petty cash fund.

Making Disbursements From The Fund

As cash payments are mode from the fund, the recipient should be required to sign a petty cash
receipt prepared by the petty cash fund cashier. The recipient should show the amount paid. The
purpose of the payment and the date paid.

The petty cash fund must be replenished periodically. Every paid receipt in the fund should be
sent to the accounting department to serve as a basis for the entry needed to record
replenishment. A Cheque should then be issued in an amount sufficient to restore the fund to its
original amount (Shs. 10,000).

Various expense accounts are debited as indicated by the petty cash receipts and cash is credited
for the amount needed to replenish the fund.

Example
Assume that the petty cash box contained the following receipts and cash at the end of the first
month of operation.
Receipt No. Purpose Amount(Kshs.)
1,3 Postage stamp 5,650.00
2,5 Office supplies 1,240.00
4 Office Coffee 1,520.00
Cash in Box 1,590.00
10,000.00
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CAC 100 FUNDAMENTALS OF ACCOUNTING


The fund should be replenished and the following Journal entry is recorded:-

Jan 31 Postage Expenses 5650


Office Supplies Expenses 1240
Miscellaneous Expenses 1520
Cash 8410
To replenish petty cash fund.

NB
Petty cash A/c is not affected by the replenished entry. The petty cash account is debited only
when the fund is initially established and no other entries are made to the petty cash amount
unless a decision is made to increase or decrease the size of the fund.

THE ANALYTICAL PETTY CASH BOOK

The analytical petty cash book is often prepared by the petty cash fund float cashier. Its format
is as follows.

Receipt Folio Date Details Folio Vouch Total Motor Travel Postage
er No Exp. Exp. Exp.

You are expected to understand:


- Explain the entry process for each column
- Balancing the petty cash book means adding up the columns
- Posting the totals at the end of the period.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


ILLUSTRATION

1. On 1st of March the finance manager established a petty cash fund/float of Kshs. 5,000 by
authorizing the writing of a Cheque in the name of the petty cashier.

2. Payments out of the petty cash during the month of march were as follows:-

(a) 2nd messager transport by public means 50/=


(b) 3rd bought postage stamps – 150/=
(c) 10th paid wages amounting to 1,200/=
(d) 15th incurred office expenses amounting to Ksh 550 relating to office tea.
(e) 16th messager transport 60/=
(f) 17th bought office stationery 265/=
(g) 17th bought cleaning materials 700/=
(h) 18th bought postage stamps 180/=
(i) 20th paid wages 1,000/=
(j) 22nd replenished petty cash fund
(k) 25th transport paid for the cashier 60/=
(l) 26th paid a creditor Mr. Jones 1,500/=
(m) 27th bought stationery for the office 371/=
(n) 28th transport for the message 50/=
(o) 30th paid wages 1,100
(p) 31st petty cash replenished

Required
(i) Enter the transactions in the petty cash book
(ii) Balance off the petty cash book
(iii) Post the entries to the ledger.

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PETTY CASH BOOK page: 1

Stationer

Cleaning

.Creditor
Voucher

material
Postage
Receipt

Details

Wages

Travel
Office
Total
Folio
Folio

Date

Exp

Exp
exp
No

s
5,000 CB Mar Replenish
. ment
1
2 Transport 1 50 50
3 Stamps 2 150 150
10 Wages 3 1,200
15 Office exp. 4 550 550
16 Transport 5 60 60
17 Stationery 6 265 265
17 Cleaning 7 700 700
material
18 Stamps 8 180 80
20 Wages 9 1000 1000
4155 CB 22 Replenish
ment
25 Transport 10 60 60
26 Creditor- 11 1500 1500
Jones
27 Stationery 12 371 371
28 Transport 13 50 50
30 Wages 14 1100 1100
3081 CB 31 Replenish
ment
Bal. c/d 5000
------ ------- ---- ---- ---- ---- ---- ---- ----
12236 Total 12236 150 716 700 550 2100 110 1500
Gl/ Gl/ Gl/ Gl/ Gl/ Gl/ Gl/
34 37 08 36 35 38 12
5000 Bal b/d

You post the entries in the General ledger book in the appropriate Accounts:

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General ledger Book

TITLE: Postage exp. A/c No 34

Explanation Ref Dr Cr. Balance


Date
March 30 PCB 1 150 150

TITLE: salaries and wages A/c No. 35

Date Explanation Ref Dr Cr. Balance


March 30 PCB 1 2100 2100

TITLE: Office Exp. A/c No. 36

Date Explanation Ref Dr Cr. Balance


March 30 PCB 1 550 550

TITLE: Stationery A/c No. 37

June Date Explanation Ref Dr Cr. Balance


March 30 PCB 1 716 716

TITLE: Travel A/c No. 38

Date Explanation Ref Dr Cr. Balance


March 30 PCB 1 110 110

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TITLE: cleaning exp. A/c No 008

Date Explanation Ref Dr Cr. Balance


March 30 PCB 1 700 700

PURHASES LDGER BOOK

TITLE: Mr. Jones A/c No.012

Date Explanation Ref Dr Cr. Balance


March 30 PCB 1 1500

THE CASH BOOK

The Two Column Cash Book.

The Cashbook is the cash A/c and the bank account brought together in one book. The account
column for bank and cash transaction are placed together so that the recording of all the money
received and paid out on a particular date can be found on the some page.

The bank column contains details of the payments made by cheque and money received and
paid into the bank account. The bank will have a copy of the account in its own books. The
bank will periodically send a copy of the accounts in its books to the firm usually known as the
bank statement.
When the firm receives the bank statement it will check against the bank column in its own
cashbook to ensure that there are no discrepancies.

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EXAMPLE OF TWO COMN CASH BOOK

date Details ref cash Bank date details re Cash Bank


f

Capital 100 Rent 10


Flake loan 500 B McKenzie 65
Sales 98 B Burton 22
N.miller Bank 50
Sales 62 Flake loan 100
Gmoores 65 53 Motor Exp. 12
Cash © Cash © 100
Sales 50 Wages 97
Bank 100 66 Bal. c/d 184 454
------ ------ ------ -------
363 731 363 731

Bal. b/d 184 454

CASH DISCOUNT AND THE THREE COLUMN CASH BOOK

When a firm receives and allows discount the cash book may be extended to include the discount
column.

It should be noted that the discount allowed and discount received columns are contained in the
general ledger along with all the other revenue and expense account.

Sample Three column cash book

Date Details fol Discount Cash Bank Date Details fol Discount Cash Bank
io allowed io Received

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ILLUSTRATION
Balance brought forward as at 1st Jan 2000
Cash balance 2,900
Bank Balance 157,800
Debtors A/c Balances
XYZ Co. 210,000
Bell Inc. Ltd. 27,500
Mwanzo Ltd 40,000
Creditors A/c Balances
ABC Co. Ltd. 50,000
Joyland 56,000
Payjack Ltd 112,000

2nd Jan. Mwanzo Ltd paid by cheque the total amount having deducted 2% discount.
8th Jan Joyland paid his account by cheque less a 5% cash discount.
11th Jan Withdraw Ksh.10,000 cash for business use
13th Jan XYZ Co. paid half of the amount owing less 2% cash discount bycheque.
25th Jan wages amounting to Ksh 5,200 was paid in cash.
28th Jan Bell Inc. Ltd paid in cash after deducting 2% discount
30th Jan Pay Jack Ltd was paid full amount by cheque
30th Jan XYZ Co. paid the remaining balance in full by cash which was banked the same day.
30th Jan Salaries amounting to Kshs. 20,000 were paid by cheque.
30th Jan Purchase office stationery by cash Kshs.6,925.
31st Jan Bank the cash received from Bell Inc.

REQUIRED
1. Prepare the cash book including the discount column.
2. Show the closing balances of
-sales ledger accounts
-purchases ledger account
-general ledger accounts

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Solution

CASH BOOK

Page 23
Date Folio DISC CASH BANK folio DISC CASH BANK
Allow Receive
ed d
Jan Kshs. Kshs. Kshs. Jan Kshs Kshs Kshs Kshs
1 Balances b/f 2,900 157,800 8 Joyland PL 78 2,800 53,200
2 Mwanzo Ltd SL 25 800 39,200 11 Cash C 10,000
11 Bank C 10,000 25 Wages GL/02 5,200
13 XYZ Co. SL 12 2,100 102,900 30 Pay jack PL 80 112,000
28 Bell Inc. Ltd SL 19 550 26,950 30 Bank C 105,000
30 XYZ Co. SL 12 105,000 30 Salaries GL/02 20,000
30 Cash C 105,000 30 Stationery GL/04 6,925
31 Cash 26,950 31 Bank C 26,950
31 Balances c/d 775 236,650
--------- ----------- ----------
3,450 144,850 431,850 Total 2,800 144,850 431,850
GL/32 GL/30
feb
1 Feb 1 Bal. B/d 775 236,650

SALES LEDGER

XY Z CO. A/c No. 12


Date & Details Folio DR Date & Details folio CR
Jan 1 Bal B/d 210,000 Jan 13 Disc CB23 2,100
Bank CB23 102,900
30 cash CB23 105,000

Bel Inc. Ltd. A/c no 19


Date & Details Folio DR Date & Details folio CR
Jan 1 Bal. b/d 27,500 Jan 28 Disc CB23 550
Bank CB23 26,950

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Mwanzo Ltd. A/c No.25
Date & Details folio DR Date & Details folio CR
Jan 1 bal. b/d 40,000 Jan 2 Disc CB23 800
Bank CB23 39,200

PURCHASES LEDGER

ABC CO.Ltd A/c No 70


Date & Details folio DR Date & Details folio CR
Jan 1 bal.
B/d 50,000

Joyland Ltd. A/c No.78


Date & Details folio DR Date & Details folio CR
Jan 8 Discount CB23 2,800 Jan 1 bal.
Bank CB23 53,200 B/d 56,000

Pack Jack A/c No. 80


Date & Details folio DR Date & Details folio CR
Jan 30 bank CB23 112,000 Jan 1 bal.
B/d 112,000

GENERAL LEDGER

Salaries and Wages A/c No.02


Date & Details folio DR Date & Details folio CR

Jan 25 Cash CB23 5,200


30 Bank CB23 20,000

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Stationery A/c No. 04
Date & Details folio DR Date & Details folio CR

Jan 30 CB23 6,925

Discount Received A/c No. 30


Date & Details folio DR Date & Details folio CR

Jan 31 Total for CB23 2,800


the month

Discount Allowed A/c No. 32


Date & Details folio DR Date& Details folio CR

Jan 31 total for the


Month CB23 3,450

BANK RECONCILIATION STATEMENT

The cash balance reported on the closing date of the bank statement rarely agrees with the
balance shown in the depositors general ledger cash account (or cash book).

As a result a bank reconciliation statement is prepared for each bank account. Its main purpose
is to reconcile the cash balance reported on the bank statement with the balance according to the
deposits records. The bank reconciliation therefore proves the accuracy of both records.

The bank statement may differ from the depositors record for several reasons which include.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


(a) Cash shown as deposit in the cash book has not yet been added to the bank a/c by the
bank. Such deposits are referred to as Deposit in transit.

(b) Amount deducted from cash on the depositors books have not yet been deducted from the
bank account balance by the bank. These are known as outstanding cheques.

(c) Amount added to the depositors bank A/c by the bank and not yet recorded on the
depositors books e.g. a note or other receivables collected by the bank on behalf of the
depositor and credited directly to the bank a/c.

(d) Amount deducted from the bank A/c by the bank but not yet recorded by the depositors
books e.g. service charges interest on overdraft Cheque printing charges etc.

FORMAT OF BANK RECONCILIATION STATEMENT

Balance as per cash book xx


Add Amount added to the bankA/c not yet recorded in cash
Books (eg direct deposit) xx

Less Amount deducted from the bank A/c by bank but not yet recorded
In the cash book eg charges xx
Adjusted cash book balance xx

Balance as per bank statement xx


Add amount added to cash book but not bank statement eg deposit in transit xx
xx

Less Amount deducted from the cash books but not yet deducted
From the bank e g (outstanding Cheques) xx
Adjusted Bank Balance xx

PROCEDURES FOR LOCATING RECONCILING ITEMS

1. The individual deposits listed on the bank statement are compared with those recorded on
the depositors cash book. Any discrepancies are identified. Any deposits unrecorded by the
bank is added to the bank statement balance on the reconciliation as deposits in transit.
2. The amount of individual cheques paid by the bank as listed on the bank statement are
compared with the amounts listed on the depositors records. Issued cheques that have not
yet been cleared by the bank are deducted from the bank balance as outstanding cheques.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


3. Any debit or credit memos included with the bank statement are separated so that they can
be deducted from or added to the cash book balance. Adjusting journal entries must be
prepared to record these items.
4. Errors discovered in step 1 through 3 are listed separately as reconciling items. The bank
is notified of errors in its records so that bank employees can make appropriate
adjustments to the bank account. Errors discovered in the depositors own record are
corrected by appropriate journal entries.

ILLUSTRATION BANK RECONCILIATION

Assume that Data Company received a bank statement showing a bank balance of $5,425.53 on
September 30th 1992. The cash book Balance on the books of Data Company on the same date
was $4,215.51.

The following differences between the bank statement and Data Company’s cash record were
identified.

(i) A deposit in the amount of $546.87 was deposited on 30th September and was not
shown in the bank statement.
(ii) Cheques issued and recorded in the cash book but not paid by the bank were:

Cheque No. Amount


1027 94.67
1029 174.83
1031 102.62
1032 39.58
1034 216.47
628.17

(3) Two debit memos were included with the bank statement
(i) One memo was for dishonored Cheque from Mary James,$ 89.78.
(ii) The second amounting to $ 8.50 represented bank service charges for the
month of September.

(4) A credit memo included in the bank statement showed that the bank had collected a note
receivable of $ 1,225. The bank charged a collection fees of $25. This had not been
entered in the cash book.
(5) It was discovered that Cheque No. 1024 amounting to $ 36.72 in payment of purchase of
office supplies had been incorrectly entered in the cash disbursement Journal as $ 63.72
there by producing an understatement of the cash book by $ 27.

REQUIRED

(i) Prepare a bank reconciliation statement for data company As at 30th September 1992.
(ii) Prepare the necessary adjusting entries.
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BANK RECONCILIATION STATEMENT
AS at 30 SEPT 1992

$
Balance per cash book 4,215.51
Add – Direct deposit notes Receivable 1,225.00
-Error correction = Cheque No.1024 27.00
5,467.51

Less
-Bank Charges: collection fees 25.00
-Dishonored cheque Mary Jones 89.78
-Bank service Charge 8.50 123.28
Adjusted Cash Book Balance 5,344.23

Balance per Bank Statement 5,425.53


Add. Deposit on transit 546.87
5,972.40

Less Outstanding cheques


Cheque No. Amount
1027 94.67
1029 174.83
1031 102.62
1032 39.58
1034 216.47 628.17
Adjusted Bank Balance 5,344.23

ADJUSTING JOURNAL ENTRIES

(i) Cash 1225


Notes Receivable 1225

(ii) Cash 27
Office Supplies 27

(iii) Bank Charges 33.50


Cash 33.50
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CAC 100 FUNDAMENTALS OF ACCOUNTING


(iv) A/c Receivable 89.78
Cash 89.78
To reverse the Entry to show dishonored Cheque.

Key words:
Cash
Petty cash book
Petty cash fung imprest system
Discount received
Discount allowed
Deposit in transit
Direct deposit
Outstanding cheques

PROBLEMS
3.1 Information necessary for the preparation of a bank reconciliation and other related
data for Batian Peak company is listed below as at March 31st , 1980.

(1) The balance per cash book records of Batian Peak company at March 31.1980 is
Shs. 16,604.05
(2) The bank statement shows a balance of Shs. 21,886.50 as of March 1980.
(3) Accompanying the bank statement was a Cheque of D. Tergut for Shs 1795.90
which was marked refer to drawer by the bank.
(4) Cheques unpresented as of March 31 were as follows Cheque No. 84 for Shs.
1,841.05 Cheque No.88 for Shs.1,323.00 and Cheque No. 89 for Shs.1,626
(5) Also accompanying the bank statement was a debit memorandum for Shs.44.80
for rental charges for a safe deposit box; the bank had erroneously charged this
item to the account of Batian Peak Company.
(6) On March 29,1980 the bank collected a 90 days 10% note receivable for Batian
peak Company the bank charged a collection fee of Shs. 8.40. The bank
received Shs. 2,963. The bank charged a collection fee of Shs. 8.40
(7) A deposit Shs. 2,008.40 was in transit oit has been mailed to the bank on march
31, 1980.
(8) In recording a Cheque for Shs. 1,600 from Ross Construction Co. the accountant
of Batian Peak erroneously listed the collection in the cash receipts journal as
Shs.160/= . The Cheque was correctly recorded by the bank.
(9) The bank service charge for march amounted to Shs.53.10 debit memo in this
amount was return with the bank statement.

REQUIRED
(i) prepare a bank reconciliation at March 31,1980.
(ii) Prepare the necessary journal entries to update the records of Batian Peak Company.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


3.2 Jackson Harrison started business on 1st November 1998 as a stationery retailer. He has been
so busy promoting his business during the first month that he has only kept brief list of
transactions. He was surprised when his first month’s Bank Statement arrived and the balance
did not seem to bear any resemblance to his calculations.

Jackson started his business with $45,000 in the bank.

The list that jack kept were as follows:-

Cheque payments Receipts (bank)


Cheque No. Amount Amount Paid in date
Nov Nov

01 Rent 0001 $1,600 03 Sales $500 10 Nov


03 Purchases 0002 $3,490 09 Sales $460 10 Nov
09 Fixtures 0003 $760 19 Sales $300 20 Nov
14 Stationery 0004 $365 20 Sales $2,010 20 Nov
17 Till 0005 $1,900 21 Sales $1,090 25 Nov
25 Fixtures 0006 $800 24 Sales $470 25 Nov
26 Purchases 0007 $55 30 Sales $3,450 30 Nov
30 Sundries 0008 $200 30 Sales $ 900 30 Nov

In addition Jackson scribbled on a piece of paper that on 10th November he withdrew $2,400 in
cash on 27th November. Although the information that jack has kept is a little brief you can
assume that it is accurate as far as the entries that he has made.

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The Bank Statement is as follows:-

FIRST BANK of KENYA


Account No. 133-001-200 -456 Page 1

Jackson Harrison 30th November 1998


GPO 32 Central Nairobi
Debit Credit Balance
01 Nov Opening balance 45,000
04 Nov Cheque 0001 1,600 43,400
07 Nov Cheque 0002 3,490 39,910
10 Nov Receipt 960 40,870
10 Nov withdrawal 2,400 38,470
12 Nov DD Rates 256 38,220
20 Nov Receipt 2,310 40,530
22 Nov SO rent 500 40,030
23 Nov Cheque 0004 365 39,665
25 Nov Credit transfer A Smith 550 40,215
25 Nov Receipt 1,560 41,775
27 Nov Withdrawal 500 41,275

YOU ARE REQUIRED TO


(a) complete the cash book (Bank columns only) for the month of November 1998. (9marks)
(b) Prepare a Bank Reconciliation statement as at 30th November 1998 starting with the Cash
Book Figure. (11marks)
(c ) State the importance of producing a Bank Reconciliation Statement on a regular basis.

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Lesion 4:

SPECIAL JOURNALS AND CONTROL ACCOUNTS

OBJECTIVES:
At the end of the lesion you will be able to understand, prepare and post the following:
• Purchases Journal
• Sales Journal
• Return inward journal
• Return outward journal
• Control accounts

Introduction

- Books of original entry are books where Transactions are recorded first.
- Each book contains transaction which are related.

SALES JOURNAL AND THE SALES LEDGER

Records credit sales for each period sales Journal shows:


- Date
- Name of customer /debtor
- Invoice number
- Folio column
- Final amount of invoice

Name of customer
When sales are made in cash there is no need of keeping details of the customer. When sales
are on credit maintain customers name & address for future communication.

Invoice
- Document sent by the selling firm to the buying firm. To the seller its called a sales
invoice and the buyer is called a purchase invoice.
Invoice contains:-
- Date
- Address of the buyer
- Number
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CAC 100 FUNDAMENTALS OF ACCOUNTING


- Quatity & description of items
- Amount in per unit & total
- Terms of payment

SALES JOURNAL SAMPLE:

DATE DESCRIPTION INVOICE NO. FOLIO AMOUNT

POSTING CREDIT SALES TO SALES LEDGER

The sales ledger contains all the credit customers. Each credit sale is posted to the debit side
of each customer’s account in the sales ledger. The total is posted to the sales account in the
general ledger as a credit.

TRADE DISCOUNT
Discount given to customers who buy in bulk. The invoice amount is shown adjusted for the
discount.

Example
(1) without trade Discount

If customer A bought the following items on credit:-


25 dozens of exercise Books @ 60
20 dozens of pens @ 360
330 pockets of ink rubber @ 1500

Required: Prepare an invoice

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Invoice will look like:

Your Purchase Order: 12/A/879 Joyland Ltd


P O Box
INVOICE No. 1785 NAIROBI
6 th March

To: A Ltd.
P.O Box
Nairobi

Qty Description Per Unit Total

20 dozens Exercise Books 60 1,500


20 packets pens 360 7,200
30 packets Ink rubber 1500 45,000

Total 53,700

Terms 2% cash discount if paid


within one month.

(2) If customer B. Bought the following which allow for 20% trade Discount:-

200 Dozens of exercise books @ 60


350 Pockets of pens @ 360
250 Pockets of Ink rubber @ 1500
500 Cartons of Ink @ 2500

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Your Purchase Order: 12/A/879 Joyland Ltd
P O Box
INVOICE No. 1785 NAIROBI
6 th March

To: A Ltd.
P.O Box
Nairobi

Qty Description Per Unit Total

200 Dozens Exercise Books 60 12,000


350 Packets Pens 360 126,000
250 packets Ink rubber 1500 375,000
500 cartons Ink 2500 1,250,000
Total 1,763,000
Less 20% trade discount 352,600
1,410,400

This is the amount which is entered in the


sales ledger.
Student Assignment:

Find out how a firm can ensure that its customer pay in time & measures which can be
implemented for the credit control.

Hint
- Credit limit for every customer.
- Refusing to offer further credit to defaulters
- Legal Action
- Keep the customer informed of possible action in case of failure to pay.

NB: No entry is made for trade Discount.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


PURCHASES JOURNAL & LEDGER

As noted earlier, the same invoice which becomes a sales invoice to the accounts books of the
seller, it becomes a purchases invoice to the accounts books of the buyer.

Same format as sales Journal & Similar posting only that the purchases ledger book keeps
record of the creditors whose normal balances are credits.

Posting
(1) Credit purchases are posted to individual suppliers accounts in the purchase ledger - credit
(2) The total is posted to purchases Account in the general ledger - Debit
Illustration

XYZ Co. Ltd. had the following purchases on credit for month of May.

May 1 From a motors 3 motor van at 600,000/= less 10% trade discount.
5 From sunshine Ltd. 2 driers at 15,000/= each 3 dish washers @ 13,000
16 From joy Ltd. 10 Dish washers @ 14,000/= less 25% trade discount
20 From sunshine Ltd. 20 driers @ 15,000/= less 15% trade discount
25 From ABC Ltd. 3 washing machine @ 20,000
30 from stationers Ltd. 15 video cassette @ 500/=

Required

(i) Prepare the purchases Journal for the month


(ii) Post the items to the suppliers account.
(iii) Transfer the total to the purchases account

Purchases ledger Account No:


A motors 12
Sunshine Ltd. 14
Joy Ltd. 16
ABC Ltd. 18
Stationers Ltd. 20

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General Ledger A/c No.
Purchases A/c 30

solution

PURCHASES JOURNAL :

PAGE: 1
DATE DESCRIPTION INVOICE NO. FOLIO AMOUNT
May 1 A Motor PL/12 1,620,000
5 sunshine Ltd PL/14 69,000
16 Joy ltd PL/16 105,000
20 sunshine Ltd PL/14 255,000
25 Abc ltd PL/18 60,000
30 Stationers ltd PL/20 7,500
TOTAL 2,116,500
GL/30

PURCHASES LEDGER

A Motor A/c No. 12


Date & Details Folio DR Date & Details folio CR
May 1 purchases PL1 1,620,000

sunshine Ltd A/c no 14


Date & Details Folio DR Date & Details folio CR
May 5 purchases PL1 69,000
20 purchases PL1 255,000

Stationers ltd. A/c No.20


Date & Details folio DR Date & Details folio CR
May 30 purchases PL1 7,500

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CAC 100 FUNDAMENTALS OF ACCOUNTING


ABC CO.Ltd A/c No 18
Date & Details folio DR Date & Details folio CR
May 25 purchases PL1 60,000

Joy ltd A/c No.16


Date & Details folio DR Date & Details Folio CR
May 16 purchases PL1 105,000

GENERAL LEDGER

PURCHASES A/C A/c No. 30


Date & Details folio DR Date& Details folio CR
May 31 Credit purchases
for the month PL1 2,116,500

COLUMNAR DAY BOOK

Where an organization records all items obtained on credit in one book. Then an analysis
book is used.

Date Name of firm Pl Folio Total Purchases Stationery Motor


Exp

PL
PL

GL GL

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RETURN INWARDS JOURNALS

Customers may return good for various reasons which include:-


- Goods being of wrong type
- Wrong colour
- Defective or faulty
- Customer bought more than needed.

NB Prices may be reduced instead of returning.

CREDIT NOTE
-Sent to the customer showing the amount of allowance given to reduce the price of the goods
or for the return of the goods.
-Reduces the amount the customers owes.

POSTING
- Individual Entries are credited to the accounts of the customers in the sales ledger.
- total of the returns inwards Journal is posted to the debit of the returns inwards account in
the general ledger

RETURNS OUTWARDS JOURNAL


These are returns to the supplier the goods already delivered. Returns outwards deals with the
purchases ledger – Debited to show the reduction of the amount to paid to the suppliers or
creditors.
In the General ledger, the returns outwards A/c is credit .

POSTING
Individual entries are debited to the accounts of the creditors in the purchases ledger.
The total is posted to returns outwards A/c in G/L as credit.

OTHER DOCUMENTS USED

Already dealt with


- Invoice
- Credit note
- Debit note

Statements:
- Sent periodically to the debtors showing
- Amount owing beginning of period
- Amount of invoices sent over the period
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CAC 100 FUNDAMENTALS OF ACCOUNTING


- Credit notes sent over the period
- Cash & cheque received
- Amount due end of period.
The statement shows copy of a customer, personal account taken from the suppliers books.

Delivery note:

Find out the differences between Delivery and invoice.

SUMMARY

BOOKS OF ORIGINAL ENTRY and SOURCE OF INFORMATION


-Sales Journal - Credit Sales
-Purchase Journal - For credit purchases
-Returns inwards Journal - For returns inwards
-Returns outwards Journal - For returns outwards
-Cash Book - for receipts and payments of cash and cheques
General journal for other items.

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CONTROL ACCOUNTS

The control accounts are maintained where many ledgers are kept hence difficult to check
accuracy by a Trial Balance. What is required is a Trial Balance for each ledger. This is
accomplished y means of control accounts. A control account is an account which checks the
arithmetic accuracy of a ledger.

PRINCIPLES OF CONTROL A/c

Based on :-

Total Opening Balance xx


Add: Total Increases to the A/c xx
xx
Less: total decreases to the a/c xx
Total Closing Balance xx

A control account is also referred to as total accounts as totals are used.

Examples of Control Accounts.


• Sales ledger control account or total debtors.
• Purchases ledger control account or total creditors accounts.

In large organizations the control accounts are often part of the double entry system with the
individual personal accounts for debtors and creditors being treated for memorandum purpose
only.

In small firms, the control account is aften seen as a form of Trial Balance for each ledger.

INFORMATION FOR CONTROL ACCOUNTS

Sales Ledger Control Source

(1) Opening debtors -List of debtors’ balances drawn up at the


end of previous period
(2) Credit Sales -Total from sales Journal

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CAC 100 FUNDAMENTALS OF ACCOUNTING


(3) Returns inwards -Total of returns inward journal.

(4) Cheques received - Cash book, Bank column on receipt side.


-List extracted or total of a special column
which has been included in the cash book.

(5) Cash Received - Cash book cash column on received side.


-List extracted or total of a special column
which was included in the cash book.

(6) Closing debtors - list of debtors balances drawn up at the


end of the period.

Sales Control A/c

Opening Bal. XX Bank receipts XX


Credit Sales XX Cash XX
Dishonored Charges XX Returns inwards XX
Bad debts written off XX
Balance c/d XX
------ -----
XX XX
====== =====

Purchase Ledger Control Source

(1) Opening Creditors -List of creditor Balances drawn up at end of


previous period.
(2) Credit Purchases - Total from purchases journal
(3) Returns outwards -Total of returns outwards Journal.
(4) Cheques paid -cash book ; cash column on payments side.
(5) Closing creditors - List of creditors’ balance drawn up at end of
the period.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Purchase Control Ledger

Bank payment XX Opening Bal. XX


Cash payment XX Credit Purchase XX
Returns outwards XX
Closing Balance XX
------ -----
XX XX
===== =====

NB: If an error is located the double underlining is left out ie account not ruled off, until
when the error is discovered and corrected.

ADVANTAGES OF CONTROL ACCOUNT

(1) Locating Errors


(2) Prevent or minimum fraud
(3) Balances can be used for management report without individual listing of Balances.

NB: In very large there may be more then one sales or/and purchases ledger. Accounts can be
dividend in various ways:-
(i) Alphabetically - e.g. A-G, H-M and N-Z
(ii) Geographically - split - Eastern, Central, Upper, Lower etc.

For each ledger there is a separate control Account. Then an analytical sales Books can be used
.
e.g.

Date Details Total Area A Area B Area C

________
Total XXX XXX XXX

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OTHER TRANSFERS

Where a firm is both a supplier and a customer then inter-indebtedness is set off.

e.g. Where a firm has sold to sunshine limited goods – Kshs.9,000 and sunshine has supplied
goods Kshs. 13,000

SALES LEDGER

Sunshine Limited

Credit Sales 9,000 Set off purchase Ledger 9,000

PURCHASE LEDGER

Sunshine Limited
_______________________________________________________________________

Set off sales Ledger 9,000 Purchase 13,000


Balance c/d 4,000
13,000 13,000

N.B The transfer of Kshs. 9,000 will appear on the credit side of the sales ledger control
account and on the debit side of the purchases ledger control account and on the debit side of
the purchases ledger control account.

CONTROL ACCOUNTS AS PART OF THE DOUBLE ENTRY

In large organization control accounts are an integral part of the double entry system the
balance of the control account being taken for the purpose of extracting a trial balance.

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In this case the personal accounts are used as subsidiary records.

ILLUSTRATION
Prepare a sales ledger control account from the following information for may 1999 carrying
down the balance as at 31/5/99

1 May 99 Sales Ledger Balances 20,800


31,May 99 Sales Journal 150,000
Bad debts written off 1,500
Cheques received from debtors 120,000
Discount allowed 1,350
Charges dishonoured 2,400
Returns inwards 3,150
Set off against balance in
Purchases ledger 500

SALES LEDGER CONTROL ACCOUNT

1999 Bad debts 1,500


1/5 Bal b/d 20,800 Cheque received 120,000
31/5 Sales 150,000 Discounted allowed 1,350
Cheque Dishonoured 2,400 Returns inwards 3,150
Set off 500
31/5 Bal. c/d 46,700
173,200 173,200

1/6 Bal b/d 46,700

PROBLEM

1. You are required to prepare a sales ledger control account from the following for the Month
of June 2001

£-
June 1 Sales Ledger Balances 54,930
Totals for June
Sales Journal 149,910
Returns Inwards Journal 21,130
Cheques and Cash received from customers 66,490
Discounts allowed 11,455
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Bad debts written off 900
Balances in the Sales Ledger set off against credit balances
In the purchases ledger 3250
June 30 Sales Ledger Balances 101615

2. You are required to prepare a purchases ledger control account from the following for the
month of December. The balance of the account is to be taken as the amount of creditors as
on 31 December 2001
£
Dec 1 Purchases Ledger Balances 43,670
Totals for June:
Purchases Journal 42,257
Returns Outwards Journal 4,098
Cheques paid to suppliers 48,760
Discounts received from suppliers 1,880
Cash paid twice in error to a supplier, now refunded 2,000
Balances in the Purchases Ledger set off against
Balances in the Sales Ledger 770
Dec 30 Purchases ?

3. The trial balance of Queen and Square Ltd revealed a difference in the books. In order that
the error(s) could be located it was decided to prepare purchases and sales ledger control
accounts.

From the following prepare the control and show where an error may have been made:

19-6 #
Jan 1 Purchases Ledger Balances 11,874
Sales Ledger Balances 19,744
Totals for the year 19-6:
Purchases Journal 154,562
Sales Journal 199,662
Returns Outwards Journal 2,648
Returns Inwards Journal 4,556
Cheques paid to suppliers 146,100
Petty cash paid to suppliers 78
Cheques and Cash received from customers 185,960
Discounts allowed 5,830
Discounts received 2,134
Bad Debts written off 396
Customer’s cheques dishonoured 30
Balances on the Sales Ledger set off against balances
In the Purchases Ledger 1,036
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Dec 31 The list of balances from the purchases ledger shows
a total of 14,530
and that from the sales ledger a total of 21,658

4. The following information relating to the year 2001 has been extracted from the books of
Joytech . All purchases and sales have been entered in personal accounts in the Purchases
Ledger and Sales Ledger respectively.
£
Sales Ledger debtor balances 1 January 2001 64,490
Purchases Ledger creditor balances 1 January 2000 32,200
Receipts from customers (including # 760 in respect of a debt
Written off as bad in 2000) 84,640
Payments to suppliers 48,490
Sales 158,120
Purchases 141,740
Returns inwards 2,860
Returns outwards 3,420
Bad debts written off in 2001 1,040
Increase in provision for doubtful debts at 31 December 2001 1,240
Received from suppliers in respect of overpayment 480
Credit balance on sales ledger 31 December 2001 820
Required:
The sales ledger control account and the purchases ledger control account for 2001 showing the
balance of debtors and creditors respectively as at 31 Dec. 2001.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


LESSION 5

FINAL ACCOUNTS
OBJECTIVES:
At the end of the lesion you should be able to prepare and differentiate the various final account
statements.

INTRODUCTION
Final accounts includes: -

(i) Trading profit & loss A/C


(ii) Balance sheet

Trading, profit & loss A/C


- Prepared by a trader who buys goods for sale.
Format
Two parts:
- Trading Account gives Gross profits
- Profit & loss A/C gives net profit

HorizontaL format

Debits and credits on left and right hand respectively.

Trading Profit & Loss A/C


For the year ended 31 Dec. year

Cost of goods sold xx Sales xx


Gross profit c/d xx
xx xx

Expenses xx Gross profit b/d xx


Net profit xx Net loss xx
xx xx

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Vertical format

Trading Profit & Loss A/C


For the year ended 31 Dec. year

Sales xx
Cost of sales xx
Gross profit xx
Expenses xx
Net profit (loss) xx

Required for preparation of Trading, profit and loss account


(i) Trial Balance (already covered)
(ii) Establishment of cost of goods sold

The Establishment of cost of goods sold

Beginning inventory xx
Add: purchases xx
Goods available for sale xx
Less: ending inventory xx
Cost of goods sold xx

Illustration
Fresher enterprises
Trial balance
As at 31/12/yr 2
DR CR

Sales 1950,000
Purchases 610,000
Rent 24,000
Office expense 15,000
Fixtures and fitting 600,000
Equipment 350,000
Debtors 580,000
Creditors 480,000
Cash at Bank 789,000
Cash in hand 25,000
Drawings 70,000
Stock 1/1/yr 2 550,000
Depreciation exp. 95,000
Acc. Depreciation 190,000
Capital 1,088,000
3,708,000 3,708,000
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Additional information

1. Stock as at 31/12/yr2 amounted 150,000/=

Required:

Prepare a trading, profit and loss A/C using.


- Vertical format and
- Horizontal format

Solution:
Vertical format
Fresher enterprises
Trading , profit and loss A/C
For the year ended 31/12/yrs

Sales 1,950,000

Cost of Goods Sold


Stock 1/1/yrs 2 550,000
Purchases 610,000
Available for sales 1160,000
Less: stock 31/12/yr 2 150,000 1,010,000
Gross profit 940,000

Expenses
Rent 24,000
Office exp. 15,000
Depreciation exp. 95,000 134,000
Net profit 806,000

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Horizontal format

Fresher enterprises
Trading , Profit and loss Account
For the year ended 31/12/yr2

Stock 1/1/yr2 550,000 Sales 1,950,000


Purchases 610,000
Available for sale 1,160,000
Less: stock 31/2/yr 2 150,000
COGS 1,010,000
Gross profits c/d 940,000 -----------
1,950,000 1,950,000

Expenses Gross profit b/d 940,000


Rent 24,000
Office exp. 15,000
Depreciation 95,000
Net profit 806,000
---------- -----------
940,000 940,000
======= =======

Expense A/C after closing

Rent A/C
31/12 yr 2 Bal. 24,000 31/12/yr 2 P & L A/C 24,000

Office expense
31/12 yr 2 Bal. b/f 15,000 31/12/yr 2 P & L A/C 15,000

Depreciation expense
31/12 yr 2 Bal. b/f 95,000 31/12 yr 2 Profit & A/C 95,000

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Capital Account

31/12/yr 2 Drawing 70,000 1/1/yr 2 Bal B/d 1,088,000


31/12/yr2 Bal c/d 1,824,000 31/12/yr 12 Net profit 806,000
1,894,000 1,894,000

31/12/yr2 Bal b/d 1,824,000

Drawing A/C

31/12 yr 2 Bal. b/f 70,000 31/12 yr 2 capital A/C 70,000

Post Closing Trail Balance

Fixtures and fittings 600,000


Equipment 350,000
Debtors 580,000
Creditors 480,000
Cash at Bank 789,000
Cash in hand 25,000
Stock 1/1/yr 3 150,000
Acc. Depreciation 190,000
Capital 1824,000
------------ -----------
2,494,000 2,494,000

Preparation of a Balance Sheet using:


- Vertical format
- Horizontal format

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Horizontal

Fresher enterprises
Balance sheet
As at 31/12/yr2

---------------------------------------------------------------------------------------------------
Fixed Assets Capital
Fixture & fittings 600,000
Less. Acc Dep. 120,000 480,000 Balance 1/1/yr 2 1,088,000
Add. Net Profit
Equipment 350,000 For the year 806,000
Less Acc Dep. 70,000 280,000 1,894,000
760,000 Less: Drawing 70,000
1,824,000

CURRENT ASSETS
CURRENT LIABILITIES
Stock 150,000
Debtors 580,000 Creditors 480,000
Bank 789,000
Cash 25,000 1544,000

2,304,000 2,304,000

Vertical

Fresher Enterprises
Balance sheet
As at 31/12/yr2

Fixed Assets

Fixture& Fittings 600,000


Less: Accumulated Depreciation 120,000 480,000

Equipment 350,000
Less Accumulated Depreciation 70,000 280,000
760,000

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CURRENT ASSETS

Stock 150,000
Debtors 580,000
Bank 789,000
Cash 25,000
1,544,000

CURRENT LIABILITIES

Creditors 480,000 1,064,000


1,824,000

Financed by:
Capital: Bal 1/1/yr2 1,088,000
Add. Net profit for the year 806,000
1,894,000
Less Drawings 70,000
1,824,000

Other Consideration

(i) Returns inwards and returns outwards.


- Returns inwards deducted from sales
- Returns outwards deducted from purchases
(ii) Carriage inwards and outwards
Carriage or transport cost of goods:
- Into a firm is called carriage inward
- Out of a firm is called carriage outward

• Carriage inward is added to purchases carriage outward – an expense in


profit and loss A/C.

Treatment of carriage-in, carriage-out, returns outwards and returns inwards.

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1) Merchandising firm

Trading A/C (Vertical format:)

Sales xx
Less: returns inward xx xx

COGS
Opening balance xx
Purchases xx
Less returns outwards xx
Add carriage xx xx
Goods available for sale xx
Less closing stock xx xx
Gross profit xx
Add: discount received xx

NB/ Discount allowed are part of the expenses.

HORIZONTAL

Opening stock xx Sales xx


Purchases xx Less returns inwards xx xx
Less returns outward xx
Add carriage-in xx xx
Available for sale xx
Less closing stock xx
Cost of goods sold xx
Gross profit cld xx
xx xx

Manufacturing Accounts

In a manufacturing firm Inventory includes: Raw materials , Work –in-progress (W-I-P) and
finished products.

Product costs are those costs necessary for the manufacture of a product. These are considered
when preparing a manufacturing statement or account. These costs are transferred to cost of
goods sold when a sale is recorded. This statement gives the cost of goods manufactured used in
the Trading Account.

Schedule of cost of goods manufactured.


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Direct Materials

Inventory (opening) xx
Purchases xx
Less: returns outward xx
Add: carriage-in xx xx
Cost of Raw Material available for use xx
Inventory ending xx
Direct material used xx
Direct labour xx
Factory overhead (indirect manufacturing Costs) xx
Manufacturing costs incurred during the period xx
Add: Work-in-process inventory (opening) xx
Manufacturing costs to account for xx
Less: W-I-P (closing) xx
Cost of good manufactured xx

Trading Profit & Loss A/C

Sales xx
Less: cost of goods sold
Finished goods: Opening balance xx
Cost of goods manufactured xx
Cost of goods available for sale xx
Finished goods: ending balance xx
Cost of goods sold xx
Gross margin xx
Less: S. admin (operating exp) xx
Operating income xx

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ILLUSTRATION

Year 4 Data
1 Jan Yr 4 Stock of Raw materials 1,600
31/Jan Dec yr 4 Stock of Raw Material 2,100
1 Jan yr 4 W-I-P 700
31- Dec- yr 4 W-I-P 840
Wages: Direct 7,920
Indirect 5,100
Purchases of Raw Materials 17,400
Fuel and Power 1,980
Direct expenses 280
Lubricants 600
Carriage inwards on raw materials 400
Rent for factory 1,440
Depreciation of factory plant & machinery 840
Internal transport expenses 360
Insurance of factory buildings & plant 300
General factory expenses 660

Prepare
Manufacturing A/C

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Solution:
Manufacturing A/C
For the year ended 31st Dec. year 4

Raw material used:


1 Jan Yr 4 Stock of Raw materials 1,600
Add:Purchases of Raw Materials 17,400
Carriage inwards on raw materials 400 17,000
Available for use 18,600
Less:31/Jan Dec yr 4 Stock of Raw Material 2,100
Raw material used 16,500
Labour cost:
Wages: Direct 7,920
Direct expenses 280
Prime costs 24,700

Factory Overhead
Wages: Indirect 5,100
Fuel and Power 1,980
Lubricants 600
Rent for factory 1,440
Depreciation of factory
plant & machinery 840
Internal transport expenses 360
Insurance of factory buildings & plant 300
General factory expenses 660 11,280
Current Manufacturing costs 35,980
Add: 1 Jan yr 4 W-I-P 700
Less: 31- Dec- yr 4 W-I-P 840
Cost of goods manufactured 35,840

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Key Words

Carriage inwards: Cost of transport of goods into a business


Carriage outwards: Cost of transport of goods out to the customers of a business
Final accounts: Term that includes the trading and profit and loss accounts and balance sheet

Main points to remember

1. Carriage inwards is shown as an expense item in the trading account.


2. Carriage outwards is shown as an expense in the profit and loss account.
3. In the second and later years of a business, both opening and closing stocks are brought
into the trading account.
4. It is normal practice to show cost of goods and sold as a separate figure in the trading
account.
5. Expense items concerned with getting the goods into a saleable condition are charged in
the trading account.
6. Returns inwards should be deducted from sales in the trading account.
7. Returns outwards should be deducted from purchases in the trading account.
8. For goods imported from abroad, the costs of import duty , insurance and freight are
treated as part of the cost of goods sold.

PROBLEMS
1. From the details draw up the trading account of Trolly for year 1 for his business.
£
Carriage inwards 6,750
Returns outwards 3,950
Returns inwards 1,890
Sales 79,740
Purchases 63,530
Stocks of goods: 31 December year 1 27,480

2.The following details for the year ended 31 Dec 2001 are available, for ABC Ltd.
£
Stocks: 31 Dec 2001 18,504
Returns inwards 1,372
Returns outwards 2,896
Purchases 53,397
Carriage inwards 1,122
Sales 54,600

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Required:
Prepare a Trading Account

3. From the following trial balance of Gramiro Co. draw up a trading and profit and loss account
for the year ended 31 March 2001 and a balance sheet as at that date.

Dr Cr
£ £

Stock 1 April 2000 2,3680


Carriage outwards 2,200
Carriage inwards 3,100
Returns inwards 1,205
Returns outwards 1320
Purchases 99,870
Sales 181,210
Salaries and wages 3,8620
Rent 3040
Insurance 880
Motor expenses 5640
Office expenses 1210
Lighting and heating expenses 1160
General expenses 3145
Building 75000
Motor vehicles 21800
Fixtures and fittings 4350
Debtors 8890
Creditors 3740
Cash at bank 1480
Drawings 1000
Capital 110,000
296,270 33,289
Stock at 31 2001 was £20,940

4. The following is the trial balance of Toy Enterprise as at 31 Dec 2001.

Dr Cr

Stock 1 Jan 2001 15160


Sales 101,560
Purchases 65,185
Carriage inwards 410
Carriage outwards 1,570
Returns outwards 630
Salaries and wages 10,240
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Rent and rates 3,015
Advertising expenses 524
Commissions payable 226
Insurance expense 415
Office expenses 800
Buildings 30,000
Debtors 14,320
Prepaid insurance 400
Creditors 8,150
Fixtures and fitting 22,000
Cash at bank 3,970
Cash in hand 105
Drawings 7,000
Capital 70,000
Depreciation expense 5,000
Accumulated depreciation 18,000
--------- --------
180,340 180,340

Required

Draw up a set of final accounts for the year ended 31st Dec 2001.

5. The Accountant of Joytech extracted the following trial balance as at 30 June

Dr Cr
£ £
Capital 42,000
Drawings 5,000
Cash at bank 13,015
Cash in hand 1,290
Debtors 14,300
Creditors 10,370
Stock 1 July 2001 20,910
Motor van 14,100
Office equipment 16,250
Sales 132,520
Purchases 82,100
Returns inwards 500
Carriage inwards 210
Returns outwards 1300
Carriage outwards 300
Motor expenses 1,530

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Rent 1,970
Telephone charges 305
Wages and salaries 15,810
Insurance 600
Depreciation expense 1,300
Accumulated depreciation 3,300

189,490 189,490

Stock at 30 June 2001 was £ 27,475.

Required:

Prepare Trading Profit and Loss Account for the year ended 30th June 2001 and a Balance sheet
as at that date.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


LESSION 6:

INCOMPLETE RECORDS
OBJECTIVES:

This lesson introduces you to preparation of financial statements using incomplete records. At
the end of the lesson you should:
Understand and appreciate why business keep in complete records
Be able to prepare financial statement from incomplete records including determination
of ending Balance of creditors, debtors and stock

Background of Incomplete records


Many small business organizations do not reap a full set of adequate accounting records because
they have neither the time nor the necessary experience to do so. Sole traders, in particular keep
only partial or incomplete records and rely on the services of an accountant to write up their
accounts at the end of the financial year. This is required for the purposes of calculating the
taxation due to the Kenya Revenue Authority and also to have some idea of how the business has
performed.

Some financial data are available, of course, because all businesses need to have essential
information such as:-
how much they owe suppliers.
How much customers owe them.
How much cash is available.
How much VAT is payable to customs i.e. Excise, etc.

Because of these reasons the accountant is able to use the financial information which may be
available, like invoices, credit notes, back statements, receipts for cash, etc., to prepare a set of
accounts (that is the trading and profit and loss account and balance sheet).

From incomplete financial data, therefore, it is still possible to reconstruct accounts by relating
and piecing them together in order to prepare the final accounts.

Procedure for Reconstructing Accounts


The procedure for reconstructing accounts using incomplete records using incomplete records is
varied. Many accountants like to use a worksheet which shows a logical sequence of working
extending to a trial balance. Any adjustments such as accrued and prepayments may also be
included, and the final accounts can then be prepared. The following method is a basically
simple procedure which pieces the accounts together without necessarily resorting to a
worksheet:-

Establish the owner’s capital (networth) at the beginning of the financial year by listing
his assets against the liabilities.
121

CAC 100 FUNDAMENTALS OF ACCOUNTING


Prepare the bank/cash summary in the form of a simplified cashbook which will identify
receipts and payments of money into and out of the business. The accountant would do this from
records such as bank statements, till rolls, etc.
Establish the sales and purchases for the year from the reconstruction of debtors’ and
creditors’ accounts. Financial data available to the accountant could come from invoices, credit
notes, cheques stubs, statements, cash receipts, etc.
Prepare the trading and profit and loss accounts including items for adjustments, and the
balance sheet for the year under review.

The role of the accountant in this capacity is to prepare the final accounts of the business as
accurately as possible from the given financial data available. He does not audit the accounts.

Statement of Affairs
The statement of affairs is equivalent to the balance sheet where double entry records are kept. It
has assets and liabilities of a business in arriving at the net worth, which is equivalent to the
owner’s capital.

Where no other records are maintained, we can calculate the profit by comparing the net worth
of a business at the start of a period with that at the end. The profit will be the increase in the net
worth, plus any drawings by the owner less any capital introduced by him.

The Trading And Profit And Loss Account


In order to prepare the trading and profit and loss account, it is necessary to work from detailed
cash and bank transactions. You should be prepared to reconstruct these from the information
given. You may have to insert opening or closing cash and/or bank balances as balancing
figures. Alternatively, you may be given opening and closing balances but required to insert
owner’s drawings or expenses as a balancing figure.

Even if not required by the question, you are recommended as a first step in incomplete record
questions to start a workings page with the reconstructed cash and bank transactions. Once this
is done, you can then start to calculate the other items as follows:-
(i) Sales will be receipts from debtors and cash sales, plus closing debtors, less
opening debtors. Also add back any discounts allowed.
(ii) Purchases will be payments to creditors and cash purchases, plus closing
creditors, less opening creditors. Also add back any discounts received.

You may prefer to ascertain the figure by constructing a debtors and/or creditors control account.
This would equally be acceptable.

In some questions you may not be given enough information to calculate sales and purchases by
the above method. Instead, you may be told the margin (gross profit as a % of sales) or mark-up
on purchase price. In this case calculate the figures which you are able to and insert the missing
value as a balancing figure.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Example 6.1
E.T. Nyambane is a sole trader in business as an electrician. He uses his garage at a small
workshop but most of his business is on contract with clients which takes him to various parts of
the locality where he works.

On 1 January, his statement of affair at the beginning of the financial year was as shown in the
table below.
E.T. Nyambane statement of affairs, 1 January

£ £

Tools & Equivalent 250


Motor Vehicle 950
Debtors 2150
Bank Balance 1970
Stock 3180 8500
Creditors 2800
Capital – 1 January 5700

From bank statements, till roles, cheque book records and other sources, it is possible to draw up
a bank summary to establish where money has come from and where it has gone, as well as
calculating the bank/cash balance at the end of the financial year. E.T. Nyambane’s records
provided the bank summary shown below on 31 December.

E.T. Nyambane: Bank Summary


Receipts £ Payments £
Bank Balance (1 Jan) 1,970 Payments to Suppliers 30125
Receipts from customers 39,750 Personal Drawings 3880
Cash sales 2,185 Wages (Assistants) 4375
General Expenses 560
Motoring Expenses 835
Insurance 160
Telephone & Rates 395
Light & Heat 170
Advertising 350
Bank Balance (31 Dec.) 3055
43905 43905

The figures from the bank summary are used to help reconstruct the final reports. At the end of
the financial year, E.T. Nyambane had £3055 in the bank, an increase of £1085 from the
beginning of the year. As receipts from debtors and payments to suppliers do not necessarily
correspond with the sales and purchases totals, it is therefore necessary to construct the debtors’
and creditors’ accounts in order to arrive at the sales and purchase details .

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Sales for the year
Sales Ledger Control Account

DR £ CR £
January 1 Balance b/f 2,150 Bank/Cash 39,750
Dec. 31 Sales 41,125 Discount allowed 650
Returns inward 200
Balance Dec. 31 2,675
43,275 43,275

To reconstruct debtors in order to find the sale, the opening debtors balance (2150) is subtracted
from the total of the CR column (£43,275) = £41,125.

Purchase for the year


Purchases Ledger Control Account

DR £ £CR
Bank/Cash 30125 January 1 Balance 2800
Discount received 875 Dec. 31 purchases 3272
Returns outward 1350
December 31 Balance 3170 ________
35520 35520
======= =======

To reconstruct creditors in order to find the purchase, the opening creditors balance of CR is
substracted from the total of the DR column (£35520) = £32720.
E.T. Nyambane had for the year ended 31 December:
Discount allowed £650
Discount received £875
Returns Inward £200
Returns outward £1350
Closing debtors £2675
Closing creditors £3170
The only other information required before preparing the final accounts is to check on any
adjustments such as accruals, prepayments and depreciation. The stock position at the end of the
financial year must also be calculated by the owner.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


The table below shows information that was available relating to E.T. Nyambane on 31
December:-

£
Stock 3246
Electricity owing 35
Depreciation:
Tools & equivalent 200
Motor Vehicle 100
Creditors’ Balances 3,170
Debtors’ Balances 2,675

The table below gives the trading and profit and loss accounts and the balance sheet of E.T.
Nyambane.

Trading and Profit and Loss Account for the year ended 31 December.
£ £
Sales (Credit) 41,125
Cash Sales 2,185
Returns Inward (200) 43110
Cost of Sales
Stock (1 Jan.) 3,180
+Purchases 3,272
-Returns outwards (1,350)
Available for sale 34,550
-Stock (31 December) 3246 31,304
Gross Profit 11,806
Expenses:
Wages (Assistant) 4375
General Expenses 560
Motor Expenses 835
Telephone & Rates 395
Light & Heat (+35acrrued) 205
Advertising 350
Discount allowed 650
Depreciation (tools, motor) 120
Insurance 160 7,650
4,156
+Discount received 875
Net Profit 5,031
=====

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E.T. Nyambane
Balance Sheet
as at 31 December
£ £
Fixed Assets

Tools & Equipment 250


-Depreciation 20 230
Motor Vehicle 950
-Depreciation 100 850
Net fixed assets 1,080

Current Assets
Stock 3246
Debtors 2675
Bank 3055 8976

Current Liabilities
Creditors 3170
Accrued Expenses 25 3,205
Working Capital 5,771
6,851
======
Financed by
Capital (E.T. Nyambane)
(January 1) 5,700
+Net Profit 5,031
10,731
-Drawings 3,880 6,851

====== ======
Example 2

You have just completed a business studies course and have been asked by an old school fried, J.
Starky to have a look at his books. J. Starky has been running a retailing business for the past
year and needs to know what his state of affairs is for taxation purposes.

J. Starky’s summary cash book for the year ended 31 March 19-5 is as shown below:

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J. Starky’s Summary Cash Book
£ £
1/4/19-4 Balance b/f 10000 Payment of Suppliers 157340
Cash Sales 50000 Cash Balances 7880
Rent 22500
Cash received from debtors 219500 Rates 900
Salaries 13080
Wages 30500
General Expenses 22000
Drawings 15000
31/3 Balance C/F 10300
279500 279500
========== ===========
His assets and liabilities were as shown below:-

Assets and Liabilities:


£ £
1 April 19-4 31 March 19-5
Creditors for goods 28400 30010
Rent Owing 1000 500
Stock 54000 53000
Debtors 46600 55700
Prepaid rates 170 295
Fixtures & Fittings 10000 7500

In preparing the accounts you decide:-


to depreciate the vehicle by 33 1/3%
to depreciate the fixtures and fittings by 10%
to make provision for bad debts of 5%
to assume (based on J. Starky’s estimate) that J. Starky has taken £1000
worth of goods from the business for his own use.
Solution
Calculation of sales and purchases: as per the requirements of the mataling (accounts concept we
should include the cost of purchases made in the year and the value of sales generated in the final
accounts which is not the same as payments made & bank receipts.

Sales Ledger Control Account


¼ balance B/F 46600 Cash from debtors 219500
Credit sales 228600 31/3 balance C/d 55700
275200 275200
========== ======
*Balancing Figure

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Purchases Ledger Control Account

Payments to Suppliers 157340 ¼ balance b/f 28400


31/3 balance c/d 30010 Credit Purchases 158950
187350 187350
====== ======

Now we prepare J. Starky’s Trading and Profit and loss account and the balance sheet.

J. Starky
Trading and Profit and Loss Account for the year ending 31 December, 19 – 5
£ £ £
Sales 278600
Less cost of sales:
Opening stock 54000
Purchases 166830
Less goods for own use (1000) 165830
219830
Closing stock 53000 166830
Gross Profit 111770
Rent (22500-1000+500)* 22000
Rates (900+170+295)* 775
Salaries 13080
Wages 30500
General Expenses 22000
Depreciation in vehicle 2500
Depreciation fixtures & fittings 1000
Provision for bad debts (5%) 2785 94640
Net Profit 17130
======

*Both rates and rent figures have to be adjusted in respect of opening and closing accounts and
prepayments.

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J. Starky
Balance Sheet
as at 31 March, 19-5
£ £ £
Cost Depreciation Net
Fixed Assets
Fixtures & Fittings 10,000 1,000 9,000
Vehicle 7,500 2,500 5,000
17,500 3,500 14,000
===== ===== =====
Current Assets
Stock 53,000
Debtors (55000 – 2785) 52,915
Prepayments 295
Bank 10,300 116510
Current Liabilities
Creditors 30,010
Accrued Rent 500 30510
Working Capital 86,000
100,000
======
Financed By:
Capital 98,870
Add Profit 17,130
Less Drawings (16,000)
100,000
==========
Example 3:
Nebuchadnazer, a manufacturer of wire baskets, keeps a few accounting records and is able to
provide only the following information for the financial year ended 30 September 1995.
1 October 1984 30 Sept. 1985
£ £
Cash 600 350
Bank Overdraft 1000 1860
Creditors 2300 2600
Debtors 1500 3300
Rent Prepaid 200 400
Plant and Equipment:
At cost less depreciation to date 5000 ?
Stocks at cost: raw materials 2000 2710
Finished goods 4000 3260
J. Green 310
In addition the following information is available.
J. Green, a regular customer, has paid £310 in advance for an order of 4 baskets due to be
delivered in November, 1985.
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It is Nebuchadnezer’s policy to depreciate the plant & equipment in his possession at the end of
the financial year at the rate of 10% of the book value. During the year ended 30 September
1985, he purchased a new item of plant at cost of £1500. In addition a business associate has
told Nebukadnezer that a wire cutting machine similar to the one used in his business, which had
a book value of £500 has recently been sold for £1400.
Included in the stock of finished goods on 30 September 1985 were some specially designed
baskets which had cost £590 to produce and which will be dispatched to a customer during
October invoiced at £950. In addition, finished goods costing £400 which were delivered to
customer on a sale or return basis have been excluded from the closing stock figure.
Included in the stock of raw materials on 30 September 1985 were some metal strips which cost
£550 but which are unsuitable for use in production due to a modification in design. The metal
strips have a scrap value of £120.
During the year, Nebuchadnezer had withdrawn £5000 in cash from the business receipts. In
April 1985, he accepted for his own use a supply of wire valued at £300 from a supplier in full
settlement of a debt of £400.

Required:
A detailed calculation of the profit of Nebuchadnezer for the year ended 30 September 1985.
A statement of affairs of Nebuchadnezer as at 30 September, 1985

Solution
a. Calculation of Capital Balances:
1 October 1984 30 Sept. 1985
£ £ £ £
Cash 600 350
Debtors 1500 3300
Rent Prepaid 200 400
Plant & Equipment(Note 1) 5000 5850
Stock of raw materials(Note 2) 2000 2280
Stock of finished goods(Note 3) 4000 3360
13300 15840
Less J. Green 310
Bank Overdraft 1000 1860
Creditors 2300 3300 2600 4770
Net Worth (hence Capital) 10000 11070
Notes:
1. Plant as at 1 October 1984 5000
Add Purchases 1500
6500
Less depreciation at 10% of £6500 650
5850
=======
Note that realisable value is irrelevant for fixed assets.

2. £2710 less £430 reduction in value to realisable value.


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3. £3260 plus £400 goods omitted.

Nebukadnezer’s profit is then £


Increase in net worth (£11070 - £10,000) 1070
Add amounts in withdrawn: Cash 5000
Goods in settlement of debt 300
6570
====

b. Nebukadnezer: statement of affairs as at 30 September 1985


£ £ £
Fixed Assets 5850
Current Assets
Stock 5940
Debtors: Prepayments 3700
Cash 350
9990
Less Current Liabilities
J. Green 310
Creditors 2600
Bank Overdraft 1860 4770
Working Capital 5220
Net Worth 11070

PROBLEMS

1 S. Olsen, a wholesaler did not keep proper books of account. The following
information on his business was available on 31 March 1984:
£
Longterm loan 10,000
Motor Vehicles 16,500
Trade debtors 23,650
Balance at bank 10,500
Fixtures & Fittings 12,000
Premises 50,000
Stock 12,500
Trade Creditors 14,500
Cash in Hand 3,400
Accrued general expenses 450
The balance at bank above included private investment income of his wife. This income arose
from interim dividend of 5% and a final dividend of 11% on 10,000 ordinary shares of 50 per
each.

The following information for the year ended 31 March 1985 was extracted from the cash book:
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Cash Bank Cash Bank
£ £ £ £
Opening Balances 3,400 10,500 Cash Purchases 26,500
Drawings 7,700
Receipts from 138,500 Payments to Creditors 74,800
trade Debtors Salaries & Wages 1,500 4,500
Heating and Lighting 1,500
Motor vehicle
Expenses 180 4,020
General Expenses 270 2,230
Receipts from trade
Debtors banked 138,500

Additional Information:
Discounts received during the year amounted to £1,100.
Olsen calculates his selling price by adding 25 per cent profit on cost. All the goods sold in the
year were sold at this mark-up except for £6,400 of the opening stock, which was marked up by
12 ½ per cent only.
All receipts from trade debtors were entered in the cash account, but the total amount received
has not been recorded properly. The figure for banking has been ascertained from bank
statements.
Depreciation to be provided:
-Motor vehicles 20 per cent of book value
-Fixtures and fittings 10 per cent of book value
-£1,000 salaries and wages were owing at 31 March 1985.
-Interest at 11 per cent per annum on the long-term loan is to be provided for.
-Other balances at 31 March 1985 were:
Closing stock £15,700
Trade Creditors £19,300
Trade Debtors £11,000

REQUIRED
a. A trading and profit and loss account for the year ended 31 March 1985.
b. A balance sheet as at 31 March 1985.
c. A concise statement giving three distinct advantages
that a computerised accounting system could bring to Olsen’s firm.

Question 2

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R. Gregg is a small wholesaler whose accounting year ends on 31 March each year. Because of
staff shortages he was unable to complete his stocktaking on 31 March 1986 and this was not
done until 6 April.
On that date the stock was valued at £102,450.
You offer to assist Gregg to calculate his stock as at 31 March and the following facts are found:
a. A sale or return invoice from a supplier value £5,700 had been included in the stock
sheets. No entry had been made in the accounting records for the delivery and none
of the goods had been sold.
b. Sales invoices during the period 31 March to 6 April amounted to £58,900: of this
total, £3,840 covered goods despatched before 31 March. Gregg adds 25 per cent
mark-up to cost.
c. Suppliers’ invoices received during the same period totalled £35,800: of this total,
£1,580 covered goods received after 6 April.
d. Stock sheet totals were incorrectly carried forward: on 31 December £102,403 was
carried forward as £104,203 and on 28 February £83,200 was carried forward as
£82,300.
e. Returns to suppliers between 31 March and 6 April amounted to £1,820 and returns
from customers at selling price were £4,740. Of the returns from customers, £1,380
had been marked up by 15%. None of these returns had been entered on the stock
sheets.

Required
Prepare a statement showing the value of stocks at 31 March 1986.

Question 3
Len Jackson, a retailer who does not keep full accounting records, provided the following
summarised bank account for the year ended 31 March 1984:

1984 £ 1983 £
31 March Cash Receipts 86,020 1 April Balance b/d 1,400
Sale of fixed assets 1,500 1984
Sale of private 31 March Payments to trade
Motor Car 5,000 Creditors 76,000
Purchase of fixed assets 6,000
Rates 2,000
General expenses 4,500
______ Balance c/d 2,620
92,520 92,520

The following information is also available:


31, March 1983 31 March 1984
£ £
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Premises 10,000 10,000
Stock 8,300 3,100
Trader Creditors 1,610 3,600
Fixed assets 3,000 7,000
General Expenses Owing 130 350
Warehouse rent accrued - ?

Before banking the receipts from cash sales Jackson withdrew £50 cash per week as drawings
and paid wages of £120 per week. Although owning his own freehold shop, owing to lack of
storage space Jackson rented a warehouse for £2,500 for the year. Unfortunately the warehouse
rented proved dto be unsuitable and as a result Jackson had to discard some stock that was
damaged by damp. The value of the stock discarded was not recorded and is not covered by
insurance. However, Jackson has agreed with the owner of the warehouse that half of the stock
loss can be deducted from the warehouse rent. A standard gross profit of 20 per cent on the
cost of goods sold is earned.

REQUIRED
a. A trading and profit and loss account for the year ended 31 March 1984.
(11 marks)
b. The balance sheet as at 31 March 1984.
(6 Marks)

QUESTION 4
Ivan Cavell a sole proprietor did not keep proper books of account. Currently he was in the
process of seeking a loan in order to finance further business development. Cavell produced the
following financial information that could be used in the support of his loan application.

Net Profit /(loss) for


The year ended 31 May
£
1987 30,000
1988 (10,000)
1989 40,000
1990 61,000
1991 78,000

The above figures have been compiled on the basis of an increase/decrease in net assets.
Summarised Revenue Statement
For the year ended 31 may 1992
£ £
Sales 338,000
Less cost of Goods sold 194,000
Gross Profit 144,000
Variable Expenses 35,000
Fixed Expenses 20,000 55,000
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Net Profit 89,000

Extract from Summarised Balance Sheet


As at 31 May 1992
£ £
Fixed assets at net book value 290,000
Current assets
Stock 40,000
Trade Debtors 38,500
Balance at bank 42,800
Cash 11,700
133,000
Less Current Liabilities
Trade Creditors 59,000 74,000
Net assets 364,000

ADDITIONAL INFORMATION
1. All Cavell’s sales are on credit. The sales for the year ended 31 May 1992 have been
estimated from the weekly amounts received from trade debtors as follows:
Weekly sales receipts from trade debtors £6,500 x 52
Trade debtors as at 1 June 1991 were £43,000
2. In order to present his business as being in a good financial position he valued his stock
on 31 May 1992 at the selling price of £40,000 instead of the cost price of £30,000.
3. On 31 March 1991 a fire in a warehouse destroyed stock which cost £25,000. After
protacted negotiations with his insurance company it was agreed that £14,000 would
be paid in compensation. No account had been taken of this item in the above
financial information and to date no cash had been received.
4. During 1988 Cavell and his family went on a world cruise which cost £30,000. He
decided to charge this against the business in 1988 because the family had not been on a
holiday for years and he felt like a good rest.
5. Cavell owed £7,000 for variable expenses as at 31st May 1992 but this amount had not
been included in the draft revenue statement on balance sheet.
6. His fixed assets at 31 May 1992 included redundant fixtures and fittings at a net book
value of £15,000. It was estimated that they could only be sold for £1,800 as scrap.

REQUIRED
a. (i) Revised net Profits/losses for the years ended 31 May 1987-1991 inclusive.
(ii) A revised revenue statement for the year ended 31 May 1992 and a
revised balance sheet as at that date. (11marks)
(iii) An explanation of which accounting concepts are relevant as a basis
for making adjustments in each of the items (1) to (6) above.
c. An explanation of the net assets method of calculating profits/losses when a
business keeps incomplete records. Critically evaluate this method.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


LESSION 6

PARTNERSHIP ACCOUNTS

OBJECTIVES

This lesson introduces you to partnership accounts showing clearly the broad accounting
methods used and how partners share the profits/losses. At the end of the lesson you should be
able to:-
(vii) Understand the types of partners and the advantages of such a entity
(viii) Know and understand the underlying accounting practices of the partnership accounts
(ix) Understand the process of profit appropriation

DEFINITION
A partnership is defined as “the relationship which subsists between two or more persons
carrying on a business in common by all or anyone of them acting for all with a view of profit.”

In the provisions and in businesses which stress the factor of personal service the partnership
form oF organization is widely used. The laws of state may even deny the incorporation
privilege to persons engaged in such professions as medicine ,law and public accounting
,because the personal responsibility of the professional practitioner to his or her client might be
lost behind the impersonal legal entity of the incorporation. however in recent years ,a number of
states have passed legislation extending the privilege of incorporation to the member of these
professions.

In the field of manufacturing ,wholesaling and retail trade ,partnerships are also popular because
they afford a means of combining the capital and abilities of two or more persons. Perhaps the
most common factor which impets an individual to seek a partner is the lack of sufficient capital
to begin or expand a business. A partnership is often referred to as a firm.”

SIGNIFICANT FEATURES OF A PARTNERSHIP


1.Ease of formation
A partnership can be formed without any legal formalities. When two persons agree to become
partners, a partnership is a automatically created. The voluntary aspect o a partnership agreement
means that no one can be forced into a partner ship or forced to confine as a partner.
2.Limited life
A partnership may be ended at any time by the death or withdrawal of any member of the firms
bankruptcy or incapacity of a partner ,the expiration of the period specified in the partnership
contract or the completion of the project for which the partnership was formed. the admission of
a new partner or the retirement of an existing member means an to the old partnership ,although
the business may be continued by the formation of a new partnership.
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CAC 100 FUNDAMENTALS OF ACCOUNTING


3.Mutual agency
Each partner acts as an agent of the partnership ,with authority to enter into contracts for the
purchase and sale of goods and services .The partnership is bound by the acts o any partner as
long as these acts are within the scope of normal operations .the factor of mutual agency suggests
the need for exercising great caution inn the selection of a partner .To be in partnership with an
irresponsible person or one lacking integrity is an intolerable situation.

4.Unlimited liability
Each partner is personally responsible for all the debts of the firm. The lacking of any ceiling
on the liability of a partner may deter a wealthy person from entering a partnership .a new
member joining an existing partnership may or may not assume liability for depts. Incurred by
the firm prior to his or her admission. A partner withdrawing from membership must give
adequate public notice of withdrawal; otherwise the former partner may be held liable for
partnership depts. Incurred subsequent to his or her withdrawal. the retiring partner remain liable
for partnership depts. Existing at the time of withdrawal unless the creditors agree to release his
obligation.

5.Co-ownership of partnership property and profits


When a partner invests a building ,inventory or other property in a partnership ,he o she does
not retain any personal right to the assets contributed .the property becomes jointly owned by
partners .Each member of a partnership also has an ownership right in the profits.

Advantages of partnership
1. There is an opportunity to bring together sufficient capital to carry on the business.
2. There is a opportunity to combine special skills as ,for example ,the specialized talents of
an engineer and an accountant may also induce individuals to join forces in a partnership.
3. The formation of a partnership is much easier and less expensive than the organization of
a corporation.
4. Operating as a partnership may produce income tax advantages .The partnership itself is
not a legal entity and does not have to pay income ,taxes on their respective shares of the
firms income.
5. Members of partnership enjoy more freedom and flexibility of action than do the owners
of corporation and partners may withdraw of funds and make business decisions of all
types without the necessity of formal meetings or legalization procedures.

Limitations
Limited life
Unlimited liability
Mutual agency
If a business is to require a large amount of capital ,the partnership is a less effective
device for raising funds than is a corporation.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


The partnership contract
Although a partnership can generally be formed without any written agreement, it is highly
desirable that a written contract of partnership be prepared by an attorney, setting forth the
understanding between partners on such matters as the following :
1. The name ,location and nature of business
2. Names of the partners, and the duties and rights of each
3. Amount to be invested by each partner
4. Procedure for valuing any non cash assets invested or withdrawn by partners
5. Procedure for sharing profits and losses
6. Withdrawals to be allowed each partner
7. Provision for insurance on the lives of partners with the partnership or the surveying
partners named as beneficiaries .
8. The accounting period to e used
9. Provision of periodic audit by certified public accounts
10. Provision of arbitration of disputes
Provision for dissolution .This part of the agreement may specify a method for computing the
equity of a retiring or deceased partner and a method of settlement which will not disrupt the
business.

Rights and duties of partners


Unless otherwise provided in the partnership dead, the provisions of the partnership act will
apply and may be broadly summarized as under:
Rights of partners:
1. Every partner has the right to take part in the conduct and right of the business
2. Every partner has a right to be consulted as heard in all matters affecting the business of
the partnership
3. Free access to all records ,books of accounts and also examine and copy them
4. Share in the profits equally
5. A partner who has contributed more than the agreed share of capital is entitled to interest
at 6% per annum, but no interest can be claimed on capital
6. A partner is entitled to be indemnified by the firm for all acts done by him in the course
of the partnership business
7. Every partner is as a rule ,a joint owner of the property. He is entitled to have the
property used exclusively for the purposes of the partnership.
8. Every partner is entitled to prevent the introduction of a new partner into the business
without his consent.
9. Every partner has a right to retire according to the dead or with the consent of other
partners.
10. Right to continue in the partnership
11. A retiring partner or heirs of the deceased partner are entitled to share in the profits
earned with the of the proportions of assets belonging to such partner or interest at 6%
per annum at the option of the outgoing partner until the accounts are finally settled.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Duties of partners
1. Every partner is bound to diligently carry on the business of the firm to the greatest
common advantage
2. Every partner must be just and faithful to the other partners.
3. A Partner is bound to keep and ender time, proper and correct accounts of the partnership
and must permit other partners to inspect and copy such accounts.
4. Every partner is bound to indemnity the firm for any loss caused by his willful neglect or
fraud is the conduct of the business.
5. A partner must not carry on competing business nor use the property of the firm for
private purposes.
6. Every partner is bound to share the losses equally with others.
7. A partner is bound to act within the scope of his authority.
8. No partner can assign or transfer his partnership interests to any other person so as to
make him a partner in the business.

POWERS OF PARTNERS:
1. Buy and sell goods on behalf of the firm
2. Receive payments on behalf of the firm and give valid receipts
3. Draw cheques and draw, accept and endorse bills of exchange and promissory note on
behalf of the firm .
4. Borrow money on behalf of the firm with or without Pledging the stock in trade.
5. Engage servants on behalf of the firm.
6. In the absence of any express or implied agreements between the partners relating to their
interests in the partnership properly, the following rules hold
- All partners are entitled to share equally in the profits of the business and must
contribute equally towards losses.
- A partner is not entitled, before the ascertainment of profits, to interest on capital
subscribed.
- No partner can claim remuneration, as a matter of right, for acting in the partnership
business.
- A partner is entitled to interest at 6% on amounts lent to the firm.

Liability of partners
Every general partner in a firm is liable jointly with the other partners for all debts and
obligation of the firm incurred while he is a partner is and after his death his estate is also
severally liable in and due course of administration for such debts and obligations, so far as they
remain unsatisfied, but subject to the prior payment of his separate debts.

Variation of the terms of partnership.


The mutual rights and duties of partners, whether ascertained by agreement or defined by
partnership and way be varied by the consent of all partners.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Explosion of Partner
No majority of the partners can expel any partner unless a power to do so has been
conferred by express agreement between the partners.

PARTNERSHIP ACCOUNTS AND DIVISION OF PROFITS


Partnerships accounts are based on the usual principle of “double entry” and do not
present much difficulty except where there is admission, retirement or death of a partner or
dissolution of a partnership. profit and loss accounts are prepared in the usual way and the
balance sheets are also prepared in the usual manner. The only point worth remembering is
regarding the distribution of profits after charging interest on capital, drawings, and salaries (if
any) to the pal account. In other words, before ascertaining the profits which are divisible in the
agreed proportions, adjustments are required to be made in respond of interest on capital, interact
on drawings and partners salaries ( if any).

Interest on capital
Where capital is contributed in certain proportions is sharing of profits or losses is not in
proportion to capital, interest on capital is generally calculated at an agreed rate per cent, and its
considered as a charge on the Pal Account before the ascertainment of net profits.

Where their capital is not equal but the profits are shared equally, the partner with larger
amounts of capital would otherwise be at a disadvantage.

Again, where their capitals are equal but the profits are shared in unequal proportions the
partner taking the largest share of profits would otherwise get an undue benefit over the others
and the adjustment in regard to interest on capital will tend to lessen the inequality.

Interest on Drawings
Where interest is allowed on capital, its desirable that interest should also be charged on
drawings by mutual agreement in order that accounts of the partners may be equitably
adjusted otherwise. The question of interest on drawings or capital is purely a matter of
agreement between the partners and the partnership accounts will have to be prepared with
due regard to the terms and conditions of such agreement, if there exists any.

Partners salaries:
A frequently happens that one of the partners may be devoting his entire time to the business
whereas the others may not, and under such circumstances, it is usual to allow the former an
agreed salary before ascertainment of net profits. The practice of allowing salary usually obtains
in a firm where there are junior partners with hardly any capital contribution and who take a very
small share of the profits and yet who devote the whole of their time and energy to the business.

Fixed and Fluctuating Capital Accounts


During a year, a partner withdraws money for his private use; at the end of the year he is
credited with interest on his capital, salary due to him, share of his profit and debited with
interest on his drawings (all depending on partnerships deed). If entries for all these are passed
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through the capital accounts the end capital will be different each year and therefore indicate
each year.

In some firms, these entries are passed through a separate current account or drawings
account. The capital account shows a constant figure. If this is the arrangement capital is fixed.
Balances of both capital and current accounts are shown in the balance sheet each year. If the
current account of a partner shows a debit balance it will appear on the asset side of the balance
sheet and , if it shows a credit balance, it will appear on the liability side.

In the following illustrations , it is proposed to show the effect of charging interest on


capital on final figures of profit entitlement and accounting procedures in the fixed and
fluctuating methods.

Illustration

Ahmed Bigala and Githu are partners, with capitals of Sh. 40,000 , Sh 25,000 and Sh. 5000
respectively and shared profits and losses equally. The net profit for the year 1999, before
charging interest on capital amounted to sh. 27,000. Show the amount of each partners gain
from the firm
If not interest is calculated on the capital
Where 5% interest on capital is brought into account before adjustment of profit.

(a) If no interest is calculated:

Ahmed = 1/3 of Sh. 27,000 = Sh. 9000


Bigala = 1/3 of Sh. 27,000 = Sh. 9000
Githu = 1/3 of Sh. 27,000 = Sh. 9000

= Sh. 27,000
(b) Where interest on capital is calculated prior to division of profits.

Profit and Loss Account


Dr for the year ended 31st December 1999 Cr
Sh Shs
Interest on capital Balance b/f 27,000
Ahmed’s 2000
Bigala’s 750
Githu’s 250 3,000
Net profit to capital
Accounts
Ahmed: 1/3 8000
Bigala: 1/3 8000
Githu: 1/3 8000 24,000

27,000 27,000
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Profits earned by each partner in the second case:-

Interest Profit Total

Ahmed 2000 8000 10,000


Bigala 750 8000 8750
Githu 250 8000 8250

3000 24000 27000

(Note: students should not the difference in amounts)

Illustration 2

Ahmed, Bigala and Githu are partners with capital of Sh. 20,000 each and share profits in
proportion of ½, 3/8th and 1/8th . The net profit for the year 1997, before calculating interest on
capital amounted to Sh. 27,000. Show the amount of each partners gain from the firm.

Of interest on capital is ignored


Of 5% interest on capital is calculated before adjustments of profits.

Answer

Where interest on capital is ignored

Ahmed - ½ of shs. 27,000 = sh. 13,500


Bigala – 3/8 of sh. 27,000 = sh. 10,125
Githu - 1/8 of shs. 27,000 = sh. 3,375
= sh. 27,000

Where interest on capital is calculated:-

Dr Profit and Loss Account for the year ended 31st December, 1967
Interest on 5% on Sh. Balance b/f Sh.
Ahmed’s capital 1000 27,000
Bigala’s capital 1000
Githu’s capital 1000 3000
Net profit to
Ahmed’s capital A/c 12000
Bigala’s Capital A/C 9000
Githu’s Capital A/C 3000 24,000
27,000 27,000
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CAC 100 FUNDAMENTALS OF ACCOUNTING


The profits earned by each partner will be as follows:

Interest Profit Total


Shs. Shs. Shs.

Ahmed 1000 12000 13000


Bigala 1000 9000 10000
Githu 1000 3000 4000

27000

(Note: Students should note the difference in amounts in the two cases).

Illustration 3

Ogola and Osewe are partners sharing profits in proportions of 7/10th, and 3/10th with capitals
of shs. 15,000 and sh. 10,000 respectively. 5% interest was agreed to be calculated on the capital
of each partner and Osewe to be allowed on annual salary of sh. 2400 which has not been
withdrawn during the year 1999. Ogola withdrew shs. 1200 and Osewe shs. 2000 in anticipation
of profits. The profits for the year prior to calculation of interest on capital, but after charging
Osewe’s salary amounted to Sh. 8000. A provision of 71/2% of this amount is to be made in
respect of commission to the manager. Show the partner’s accounts.

Where the capitals are fluctuating.


Where the capitals have been agreed to be fixed and
The account showing the allocation of profits.

Where capitals over fluctuating

Dr Ogolas Capital Account, 1999 Cr

Date Amount Date Particulars Amount


(shs) (shs)
Dec 31 Drawings 1200 Jan 1 Bal b/f 15000
‘’ Balance c/d 18855 Dec 31 Interest 750
Dec 31 Profit and
loss
appropriate
A/C 4305
20055 20055
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Dr Ogola’s Drawings Account, 1999 Cr

Date Particulars Amount Date Particulars Amount (sh)


(shs)
Dec 31 Bank 1200 Dec 31 Capital A/c 1200

Osewe’s Capital Account , 1999

Date Particulars Amount Date Particulars Amount (sh)


(shs)
Dec 31 Drawings 2000 Jan 1 Balance b/f 1000
A/C Salary 2400
Balance c/d 12745 Interest 500
Profit and
loss
Appreciation 1845
A/C 14745
14745 Jan 2000 Balance b/d 12745

Dr Osewe’s Drawings Account Cr


Date Particulars Amount Date Particulars Amount
1999 Shs 1999 Shs
Dec 31 Bank 2000 Dec 31 Capital A/C
Transfer 2000
2000 2000

Where the capitals are fixed

Dr Ogola’s capital Account Cr

Date Particulars Amount Date Particulars Amount


1999 Shs 1999 Shs
Dec 31 Bal c/d 15000 Jan 1 Balance b/f 15000
15000
15000
15000 Jan, 2000 Balance b/d 15000
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CAC 100 FUNDAMENTALS OF ACCOUNTING


Dr Ogola’s Current Account Cr

Date Particulars Amount Date Particulars Amount


1999 Shs 1999 Shs
Dec 31 Bank 1200 Dec 31 Interest on 750
capital
Balance c/d 3855 Profit a loss
Appropriatio 4305
n A/c 5055
5055

Jan1,2000 Balance b/d 3855

Dr Osewe’s Current Account Cr


Date Particulars Amount Date Particulars Amount
1999 Shs 1999 Shs
Dec 31 Bank 2000 Dec 31 Salary 2400
Balance c/d Interest on
“ 2745 capital 500
4745 Jan 1, 2000 Pal Appr. 1845
A/C
4745

Balance b/d 2745

Osewe’s Capital Account

Date 1999 Particulars Amount Date Particulars Amount


Shs 1999 shs
Dec 31 Balance c/d 10,000 Dec 31 Balance b/f 10000
10,000 10,000
Jan 1, 2000 Bal b/d 10,000

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CAC 100 FUNDAMENTALS OF ACCOUNTING


Dr Profit and Loss Appropriation Account Cr

7 ½ Commission manager 600 Profit and loss account 8000


Interest:
Ogola’s capital 750
Osewe’s capital 500 1250
Net profit transferred
To partner’s capital A/C
Ogola 7/10 4305
Osewe 3/10 1845 6150
8000 8000

PROBLEMS

1.To what extent can a partner bind the firm and his other partners by his acts?
2.State the principal clauses which should be incorporated in a partnership deed.
3. What are the rights and duties of partners?
4. Discuss fully the question of interest on the capital and drawings of partners.
5.What do you mean by the term fixed and fluctuating capitals of partners?
6.On 1st January 1995, Mutinda and Gathie entered into a partnership contributing sh. 20000 and
sh. 15000 respectively. They share capitals in the ratio of 3:2 Gathie is allowed a salary of sh.
4000 per annum.

Interest on capitals is to be allowed at 5% per annum. Interest and drawings is to be charged at


5% per annum. During the year Mutinda withdrew sh. 3000 and Gathie sh. 6000 interest being
sh. 70 and sh. 50 respectively. Profit in 1998 before the above mentioned adjustments amounted
to sh. 10580. Show how the profit is to be distributed. Also show the capital accounts of
Mutinda and Gathie.

If they are fluctuating


If they are fixed.

6.On 31st December 2000, the capital accounts (bearing interest at 5%) of Kiplangat, Motenje
and Khayota in proportion of 4/9, 1/3 and 2/9 stood at sh. 18,000, sh. 14,000 and sh. 12000
respectively. The profit for the year amounted to sh. 7600 before allowing interest on their
capital and after appropriating the remaining profit, the capital accounts of all of all the partners
were to be adjusted in proportion of their shares in profits and losses, the capital of the entire
firm being fixed at sh. 54,000. On this date, the cash balance stood at sh. 7000. Prepare the
capital accounts, profit and loss account and the cash account showing the adjustments necessary
in the case.

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CAC 100 FUNDAMENTALS OF ACCOUNTING


7. A and B have been carrying on business since 1 January 1984 and the results of their
business have been as follows after allowing interest on capitals.

loss sh. 8,000


profit sh. 36,000
profit sh. 41,000
profit sh. 53,600
Capitals of partners have remained unchanged at sh. 150000 and sh. 1000,000 respectively for A
and B, who shares profits and losses in the same proportion. On 1st

January 1984 C, the manager, gave a loan of sh. 25,000 at 8% interest. The interest has been
regularly paid but the loan has not been paid yet, C was paid a salary of Sh. 10000 per annum.
It was decided at the end of 1987 that C should be treated as a partner with effect from 1st
January 1984, giving him 1/5th share of profits. His loan was to be treated as capital bearing
interest at the rate of 5%. C’s salary was to be Sh. 4000 p.a with effect from 1st January 1984.
What entries would be necessary to adjust the matters? (treat the capitals as fixed).

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