Accounting Technicians Scheme (West Africa) : Basic Accounting Processes & Systems (BAPS)

NOTE: This is a work in progress.
All topics in the syllabus are covered but

editing for necessary corrections is in progress.
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ACCOUNTING TECHNICIANS
SCHEME
(WEST AFRICA)

BASIC ACCOUNTING PROCESSES & SYSTEMS
(BAPS)

NOTE: This is a work in progress. All topics in the syllabus are covered but
Thanks.

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CHAPTER ONE

THE ROLE OF ACCOUNTING

1.0 Learning Objectives
At the end of this chapter, candidates should be able to:
narrate the historical development of accounting
explain the purpose and scope of accounting
identify users of accounting information and the need for such
information
explain the qualities of accounting information
describe the range of services provided by accountants

1.1 Introduction
Accounting is concerned basically with accountability. The
underlying purpose of accounting is to provide financial information
about an economic entity. The information is provided, periodically,
to shareholders and others connected with the organization to
enable them decide the extent to which they want to continue to
associate with the organization. The need for accounting is more
pronounced in a business where a lot of finance, risk, and energy
have been involved. Financial information is needed to plan and
control the finance and operation of a business.

Every other person such as the owner, creditor, government,
employee and other parties need financial information of a business
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for one purpose or the other, details of which would be discussed
later in this chapter.

1.2 The Historical Development of Accounting
Rudimentary form of accounting started with bookkeeping by Lucia
Pacioli, an Italian monk. In his book titled Summa de Arithmetical,
Geometrica, proportioni et proportionalita, published in 1494 on
Arithmetic, Geometry and Proportion, he devoted a chapter to
expound the principles of the double entry system. It became
necessary for managers to report to the owners of their business
activities during the period under review. Such report would include
mainly the following:
How the financial resources of the business have been
invested during the period,
The profit earned or loss incurred during the period, and
The assets, liabilities and the owners equity at the end of the
period under review.
After this initial development, a lot of changes have been witnessed
in accounting. These changes were informed by sophistication and
complexity of businesses and industrial and political environments
which placed more responsibilities on management of business to
disclose more information to owners and other interested parties.

For instance a lot of Generally Accepted Accounting Principles
(GAAPs) have been developed to be followed in the preparation of
financial statements. Also, accounts have to be audited and
reported on as presenting a true and fair position. Accounting has
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also gone beyond mere reporting for managerial decisions, to
include tax management, government accounting and social
responsibility accounting.
The GAAPs are developed from time to time to keep pace with
changes in the economic and political environment. The GAAPs are
also codified into what is known as Accounting Standards.
Therefore, accounting is not a fixed set of rules but a constantly
evolving body of knowledge.

Most countries have their own Local Accounting Standards Board
but the body responsible for developing and issuing International
Accounting Standards is the International Accounting Standards
Board (IASB) based in the United Kingdom. In Nigeria, the Nigerian
Accounting Standards Board (NASB) is charged with the
responsibility of developing and issuing local accounting standards
for use by all preparers and users of financial statements in Nigeria.
Accounting has also changed from manual records alone; it now
also makes use of computer and video displays.

1.2.1 Regulatory Framework
Due to the increasing changes in the economic and political
environment, statutory and other regulations have been put in place
to ensure the reliability, relevance and comprehensiveness of
financial information, and to narrow areas of differences.

The main statutory document for the regulation of business in
Nigeria is the Companies and Allied Matters Act 1990 (as amended
in 2004). The company laws are enforceable in the court of law.
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Other legislations relate directly to specific industry such as:
Banks and Other Financial Institutions Act of 1991 (BOFIA
1991)
Insurance Act 2003
Other regulations consist of the following accounting standards:
Statements of Accounting Standards (SAS) issued by NASB
from time to time
International Accounting Standards (IAS) and International
Financial Reporting Standards (IFRS) issued by IASB from
time to time

1.3 The Purpose of Accounting
Accounting is the art of recording, classifying, summarizing and
analyzing financial transactions of a business.

Accounting transactions are classified into related groups or
categories. The transactions are then recorded in the books of
original entry. Thereafter, the transactions are analyzed and posted
to accounts in the ledger. Then, the accounts are summarized into
financial statements. Finally, the financial statements are
interpreted through the development of significant relationship and
by way of explanations.

The accounts of companies contained in their Annual Reports and
Accounts are examples of the product of accounting and they are
called financial statements.
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1.3.1 Financial Transactions
Financial transactions are those on which monetary values can be
placed and that can be measured objectively. They consist of cash
transactions, credit transactions or contra. A financial transaction
must be able to cause a change to assets or liabilities or capital; or
a combination of them. It is the exchange of goods and services for
cash or a promise to pay in future for goods or services.

1.3.2 Types of Business
A business is a commercial outfit which sells goods or provides
services. There are three main types of business enterprises; the
sole traders, the partnerships and the limited liability companies.

The commonest form of business entity is the sole trader who owns
and manages his business though he may have employees.

Partnerships are formed by two or more persons who contribute
finance and technical knowledge in order to share the risks and
rewards of the business together. Limited liability companies are
those that are incorporated under the company laws of a country.
The owners take advantage of the fact that their liability is limited to
the amount payable on their shares.

Details, characteristics, and operations of these various business
enterprises shall be dealt with progressively in this study pack.

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1.4 Bookkeeping and Accounting
Bookkeeping is the recording phase of accounting. It is the
classification and recording of business transactions in the books of
account. The recording of the transactions is a routine task,
therefore it tends to be repetitive. Accounting on the other hand
includes not only the keeping of accounting records, but also the
design of efficient accounting systems, the interpretation of
accounts and the development of forecast.
The processes involved in bookkeeping are as follows:
(a) The classification of business transactions using source
documents;
(b) Recording of classified transactions in appropriate subsidiary
books or books of prime entry;
(c) Posting of entries from subsidiary books to the ledger; and
(d) Extraction of the Trial Balance .

1.5 Scope of Accounting
The starting point in the study of accounting is financial accounting;
others are cost accounting, management accounting, auditing,
government accounting, and tax management.

1.5.1 Financial Accounting
Financial accounting involves an accounting process that starts
with bookkeeping and ends with the preparation and interpretation
of financial statements. The components of financial statements are
the statement of financial position, the Income statement or the
income statement.
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For limited liability companies other statements required by the
company laws or standards are; Chairmans Report, Directors
Report, Auditors Report, Group Financial Statements, Statement of
Accounting Policies, Notes on the Accounts, Value Added
Statement, Cash flow Statement and a Five year Financial
Summary.

The financial statements enable owners of the business to assess
how efficiently management has run the business. The information
needs of other parties who are interested in the business are
satisfied to a large extent by the financial statements.

For instance, the Statement of Accounting Standard (SAS 2) states
that all accounting information that will assist users to assess the
financial liquidity, profitability and viability of a reporting entity
should be disclosed and presented in a logical, clear and
understandable manner.

You shall come across the details of each of these issues as you
progress in the study of accounting.

1.5.2 Cost Accounting
Cost accounting is the procedure for accumulating data to provide
information for managerial action. Cost accumulation is the
collection of cost data in some organised ways by means of
accounting systems. The cost accumulated will be related to
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specific products and departments for planning, control and
decision making by management.

1.5.3 Management Accounting
Management accounting provides information to management of a
business to help them take better decision and to improve upon the
efficiency and effectiveness of existing operations (Drudry, 2004). It
is concerned with providing accounting information to management
for the purpose of planning, decision making and control.
Management accounting uses various quantitative analysis tools to
forecast the future. It is sometimes referred to as managerial
accounting.

1.5.4 Auditing
Only complete and reliable financial statements can be of any use
to the creditors, investors, government agents and other interested
parties. To guarantee these, the accounts must be audited by an
independent person called an Auditor. Auditing is the independent
examination of the books of accounts and records of the company.
The professional accountant will gather various forms of audit
evidence before he forms an opinion on the financial statements. At
the end of the audit exercise he will write a report on the true and
fair view of the financial statements and the scope of work he
carried out before arriving at his opinion.

1.5.5 Government Accounting
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Government accounting is the process of recognising and reflecting
in the appropriate books of accounts and records government
generated revenue and disbursed expenditure in such a way as to
extract with ease relevant financial information vital for appropriate
decision making from time to time, and in compliance with the laws
regulating government finances.

It is a class of Accounting in the Public Sector where government
has some executive responsibility. Public sector consists of the
ministries and parastatals.

Government accounting is concerned with planning, control and
appraisal of government activities and in effect, accountability.

1.5.6 Accounting for Taxation
The accounting profits generated in the financial statements
provide the basis for determining the taxable profits of a company.
The taxable profits are different from the accounting profits because
certain expenses and income are allowable for accounting purpose
but disallowable for tax purpose. A good understanding of the
knowledge of these taxable incomes and expenses and non-
taxable incomes and expenses would help a business in its tax
management.

1.6 The Need for Accounting Information
The need for accounting information can be summarized as follows:
It provides information useful for making economic decisions.
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It provides information to users for predicting, comparing and
evaluating the earnings power and financial strength of a
business.
It is used to judge the ability of management to utilize the
entitys resources effectively in achieving the goal of the
entity.
It provides information to creditors for predicting and
evaluating the cash flows of the entity.
It provides management with detailed accounting data for use
in planning and controlling the daily operations of the
business.
It provides information to government for determining the tax
payable on the profit and/or other incomes of an individual or
company and for formulating fiscal policies.
It forms the basis of reporting on the activities of an enterprise
as they affect the society.
It serves as the basic instruments by which investors decide
the securities in which to invest.
1.7 Qualities of a Good Accounting Information
Accounting information should possess the following qualities
before users can rely on it:
(a) Relevance: The accounting information must include enough
facts to satisfy the need of the user. For instance
management accounting information should be relevant to the
decision to be taken with it. Financial accounting information
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should disclose enough information to satisfy the various
users.
(b) Reliability: The source of information must be verifiable and
one source of evidence must corroborate the other.
(c) Comparability: There should be no change in the basis for
the preparation of the accounting information from period to
period so that it will be easy to compare the result of
operations over some accounting periods.
(d) Timeliness: Accounting information must be made available
early enough for its use. For instance management requires
certain information on daily basis or weekly basis for effective
running of the business; if it comes late it would be useless.
Annual reports and accounts must be published not long after
the year end.
(e) Objectivity: There must be no bias, window dressing or
subjective judgement in the presentation of accounting
information. Objectivity includes ability to trace transactions to
documentary evidence and complying with required
regulations in its presentation.
(f) Comprehensiveness: Accounting information must contain
just enough details for good understanding. The detail must
neither be too little nor too much.
1.8 Users of Accounting Information
Accounting information, as contained in financial statements, is of
interest to various groups of people. The following people are likely
to be interested in accounting information.
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(a) Owners of the business/investors: These are sole traders,
partners and shareholders. They need accounting information
to assess how efficiently the management is performing
they want to know how profitable the business is and how
much of this profit they can withdraw for their own use. It will
also allow shareholders to make appropriate investment
decision such as buying and selling of shares.
(b) Management: These are the people who manage the affairs
of the business for the owners. In a limited liability company,
they are the members of the board of directors and other
management staff. They need accounting information to
ascertain the efficiency of the policy they formulate and to
plan and control the resources of the business.
(c) Trade Creditors: These are the people who supply goods to
the business on credit. The trade creditors want to know the
ability of the business to pay for the goods supplied to the
business promptly. They will be interested in the liquidity of
the business.
(d) Customers: These are the people who purchase the goods
or services provided by the business. The customers want to
know whether the business will continue to be a reliable
source of supply though they will also be interested in the
quality of the products of the business.
(e) Tax authority: Profits determine the basis of computing tax.
The tax authority wants to determine the tax payable by the
company and its employees.
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(f) Employees of the entity: They need accounting information
to enable them decide how secure their job is and the ability
of the business to pay good salaries and provide good
welfare0facilities.
(g) Lenders: These include the banks and other loan creditors.
Financial statements enable them to decide whether more
credit facility can be granted and whether the company will be
able to pay interest and principal when they fall due. They are
interested in the liquidity, profitability and reliability of
underlying assets.
(h) Government: Government needs accounting information to
enable it formulate fiscal policies.
(i) Financial Analysts: They analyze financial statements for
their clients in order to help them take informed decisions.
Financial analysts include inventories brokers, credit agencies
and financial reporters.

1.9 The Work of an Accountant
A professional accountant performs various types of work for an
organization either as an employee of the organisation or as a
consultant to the organisation. For instance, members of the
Institute of Chartered Accountants of Nigeria (ICAN) are classified
into two broad categories; members in public practice and
membmrs not in public practice.

1.9.1 Members in Public Practice
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These are accountants working in accounting firms which offer a
variety of accounting services to their clients. Their principal
functions are:
(i) Auditing: They examine the books and records of the
company, obtain reliable, relevant and sufficient audit
evidence and then issue a report on the true and fair view of
the financial statements. The certificate issued by the auditor
enables users to rely on the financial statements.
(ii) Tax Services: They engage in tax planning for a company or
an individual with a view to minimizing the tax payable. Their
services are also engaged by government in the investigation
of the adequacy of tax paid by companies and individuals.
(iii) Management advisory services: Firms rely on the extensive
knowledge of accountants to provide a range of management
consulting services. They could render advice in the area of
mergers and acquisition, whether an organisation should
enter a new line of business or divest. They could also offer
advice on asset replacement policy, the best of computer
based accounting system to adopt, setting up and operating
the accounting system of a small firm etc.
(iv) Insolvency Services: They could act as receiver manager in
the process of winding up a company.
(v) Investigation Services: They investigate fraud or any other
matter for which investigation services are required.

1.9.2 Members not in Public Practice
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These are accountants in the employment of government ministries
and parastatals or private business concerns. Their main functions
include the following:
(i) They prepare the financial statements and the annual reports
of the organisation on behalf of management.
(ii) They provide relevant management accounting information to
management for decision making.
(iii) They set up and run an efficient system of accounting and
internal control.
(iv) They act as treasury managers.

1.10 Summary
In this chapter we have looked at the nature and scope of
accounting. We have also considered the importance of accounting
information to management, investors, creditors and the other
users.

We also discussed the development of accounting from the
rudimentary form to the modern form of accounting. We also
discussed the regulatory framework of accounting.

1.11 Revision Questions
Multiple choice and short-answer questions
(1) The last phase of book keeping is
(a) extraction of the Trial Balance
(b) preparation of final accounts
(c) issuing annual reports
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(d) preparation of source document

(2) Who reports on the true and fair view of the financial
statements?
(a) Government agencies
(b) Owners of the business
(c) The companys accountant
(d) The Auditor
(3) What is the usefulness of the Annual Reports and Accounts?
(a) To boost companys profit
(b) For periodic review of companys performance
(c) For daily operations of the business by management
(d) To be able to minimize tax payable by the company

(4) The following is not an example of business entity
(a) Sole trader
(b) Partnership
(c) Limited liability company
(d) Club or Association

(5) One of the following is NOT an importance of accounting and
book keeping.
(a) Book keeping provides permanent records for all
financial transactions
(b) The records are used by the Inland Revenue for tax
assessment.
(c) The records can be used to determine the promoters of
the organization
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(d) The assets and liabilities of a business are shown

(6) The two main financial statements drawn up by a sole trader
are ________ and __________
(7) Which form of accounting information is needed for the day to
day running of a business?
(8) State briefly the purpose of accounting.
(9) To what extent should accounting information be
comprehensive?
(10) The Body responsible for developing Accounting Standards is
the

1.11 Solution to Revision Questions
(1) A
(2) D
(3) B
(4) D
(5) C
(6) The statement of comprehensive income and statements of
financial position
(7) Management/managerial accounting information
(8) The purpose of accounting is to provide financial information
about an economic entity that can be used to plan and control
the operation and finance of the entity.
(9) Financial information should contain just enough information,
not too detailed or too little for the users.
(10) International Accounting Standard Board (IASB)
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References
O. Adetifa, J. O. Ajileye, R. Oluwasanmi (2001) Get Your Financial
Accounting Right, Book 1, Temlad Press International, Ibadan

A. R. Anao (1996) An Introduction to Financial Accounting, Longman,
Nigeria

M. M. Hassan (2001) Government Accounting, Malthouse Press Limited,
Lagos, Nigeria.

W. W. E. Glautier and B. Underdown (2002) Accounting Theory and
Practice, Pitman, London.

Igben, R. O (2004) Financial Accounting Made Simple, Volume 1, ROI
Publishers, Nigeria.

ICAN Study Pack (2006) Fundamentals of Financial Accounting for
Foundation, VI Publishing Limited, Nigeria

Companies and Allied Matters Act, 1990 (Amended 2004)

Charles, T. Horngren, S. M. Data and George Foster (2005) Cost
Accounting; A Managerial Emphasis,
CHAPTER TWO

2.1 Learning objectives
2.2 Forms of Business Organisations
2.2.1 Sole-proprietorship
2.2.2 Advantages and disadvantages
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2.3 Partnership
2.3.1 Contents of Partnership agreements
2.3.2 The main advantages of Partnership over sole proprietorship
2.4 Limited Liability Company
2.4.1 Formation Procedure
2.4.2 Statutory Books
2.4.3 Issued share capital
2.4.4 Reserves and Provisions
2.4.5 Public Enterprises
2.6 Summary and Conclusions
2.7 Multiple Choice Questions and Short Answer Questions
2.8 Solutions to Multiple-Choice Questions and Short Answer Solutions.

FORMS AND STRUCTURES OF BUSINESS ORGANISATIONS
2.1 LEARNING OBJECTIVES

After studying this Chapter, readers should be able to understand the
forms and structures of business organizations, their characteristics,
advantages and disadvantages.

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2.2 In an economy, in which free-enterprise is allowed and encouraged by
the government, business organizations take different forms in this
situation, we discuss four different forms of business organizations:
sole-proprietorship, partnership, limited liability company and public
enterprise.

2.2.1 Sole-proprietorship
It is a business owned by an individual. He bears the responsibility for
running the business, and he alone takes the profits or loss. The sole-
proprietorship is not regulated by special rules of law.

2.2.2 Advantages and disadvantages

Advantage

(a) The individual provides the capital and employs a handful of
people, if and when necessary.
(b) He takes decisions quickly without consulting anybody.
(a) He is highly committed because the profit is entirely his own in
case of success, and he depends on the business for his
livelihood.
(b) There is privacy
(c) It is not regulated by special rules of law.

Disadvantages

(a) The finance available for expansion is limited to that which the
sole trader can raise.
(b) The owner has unlimited liability because all his assets outside
his business might be seized if the business goes bankrupt.
(c) It lacks continuity because the death of the owner automatically
leads to the collapse of the business.

Sole-proprietorship is common in retailing farming, personnel service
such as hairdressing and fashion designing.

2.3 PARTNERSHIP FORMATION AND AGREEMENT

Partnership Formation
Partnership is the relationship which exists between two or more persons,
commonly referred to as partners, carrying on a business in common with a
view to making profit. The business may also result in a loss although the
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purpose is that of profit. Coming together is voluntary and exit of a partner
may also be voluntary.

The Partnership Act 1890 and the Limited Partnership Act 1907 contain the
Provisions which govern the relationship between persons carrying on a
business with the intention of making profit.

The maximum number of partners in a firm is twenty. There is no maximum
limit for professional firms such as accountants and solicitors who have
received the approval of the law for this purpose. A firm with more than
twenty members would normally be incorporated as a Limited Liability
Company.

Most partnerships are formed under a formal agreement. In the absence of
an agreement the Partnership Act 1890 provides, among other things, that:
(a) All profits and Losses are to be shared equally between the partners
(b) No interest is allowed on capital
(c) No remuneration will be paid to a partner.
(d) Any advance or Loan made by a partner in excess of his agreed share
of capital will attract interest at 5% per annum.

An agreement is most important, therefore, if it is intended that partners
should be rewarded according to their differing contributions made to the firm
in form of capital, expertise, experience or effort. Resulting from this, an
agreement would necessarily contain provisions regarding the following, to
ensure as far as possible, that there is an equitable distribution of profits or
losses.
(a) The amount of Capital to be provided and maintained by each partner.
(b) The rate of interest (if any) to be paid on capital.
(c) The extent to which drawings are allowed and the rate of interest (if
any) to be charged on drawings.
(d) The remuneration (if any) to be paid to partners for their services.
(e) The interest to be paid on any advance or Loan made to the firm by a
partner over and above his agreed capital.
(f) The proportions in which profits and losses are to be shared after taking
account or any adjustments as a result of the above.

Decisions regarding the distribution of profits can be quite interesting in
Practice due to the search for an equitable relationship between
partners. If all partners provide equally in all respects, an equal
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distribution of profits might adequately represent each interest. But
differing amounts of capital, all other contributions to the firm being
equal, would usually be compensated for by allowing interest on capital
at an agreed rate. In this way each partner would be given a return on
his capital before distribution of the remaining profit. Differences in
partners contributions in the form of expertise, experience or effort
could be taken into account by salaries and/or differential distribution of
profits.

The problems inherent in determining a just and equitable distribution
of profits are not usually a concern of examination students. A question
will normally indicate:
(a) Whether salaries are to be paid.
(b) Whether interest is to be allowed on capital
(c) Whether interest is to be charged on Drawings, and
(d) How the remaining profit should be distributed.

Students problems are usually technical, arithmetical and
presentational.

A partnership will often maintain a fixed amount of capital. Under these
circumstances, it is preferable that only an agreed capital ratio should
be credited to a separate capital account for each partner. All other
transactions involving partners such as share of profits, interest, salary,
Drawings, should involving partners such as share of profits, interest on
salary, Drawings, should be dealt with in their current accounts rather
than through the capital accounts. It is simple in this way to keep a
constant check on the current accounts and provided a partners
Current Account is not overdrawn, the agreed capital at least must
remain with the firm. Of course profits (or losses) are accruing over the
whole of the year, and not just when the final accounts are prepared.
It follows therefore that an overdrawn current account is not necessarily
an indication that a partner is not maintaining his agreed capital. It is
up to the partners to agree on the extent to which drawings are allowed
and whether the drawings may exceed the current account balance at
the beginning of the year.

Partnership Agreements
Since the essence of partnership is mutual agreement, it is desirable for
the partners to come to some understanding before entering into
partnership as to the conditions upon which the business is to be
carried on and their respective rights and powers.

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The Act provides certain rules to be observed in the absence of any
agreement. The circumstances must determine whether these rules are
applicable in the particular case and since many matters should be
decided which are not included in these rules, it is desirable that a
formal agreement be entered into with a view to preventing disputes in
the future. The advantages of written agreements need no emphasis
and it is preferable that it should be under seal, since the character of a
deed precludes contradiction by any party of the terms which have
been agreed.

Even though a formal agreement is made, this does not preclude
subsequent variation where changing circumstances demand it; such
variation can always be effected with the consent of all the partners,
which may be evidenced by an amended agreement.

2.3.1 Contents of Partnership Agreements

The provisions affecting partnership accounts are as follow:
(a) Capital Contribution
The agreement states whether each partner should contribute a
fixed or a flexible amount.

(b) Division of Profits and Losses
The basis as to how profits and losses shall be shared among the
partners.

(c) Fixed or Flexible Capital
Whether the Capital Accounts are to be Fixed Account, or if
drawings and profits are to be adjusted in the current accounts,
or in the capital accounts.

(d) Interest on Capital and/or Drawings
Whether interest on any of the two or both, is to be allowed or
charged before arriving at the profits divisible in the agreed
proportions, and if so, at what rate.
(e) Current Accounts
Whether current accounts (if any) are to bear interest, and if so,
at what rate.

(f) Partners Drawings
Whether partners drawings are to be limited in amount in order
to prevent a negative balance against the capital account, and/or
whether interests are to be charged on drawings and at what
rate.
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(g) Partners Remuneration
Whether partners are to be allowed remuneration for their
services before arriving at divisible profits, and if so, the amount
of the remuneration.

(h) Accounting Records
Proper accounts shall be prepared at least once a year and that
these shall be audited by a professional accountant and signed
by all the partners.

(i) Signed Accounts
The accounts, when prepared and duly signed, shall be binding
on the partners, but shall be capable of being reopened within a
specified period on an error being discovered.

(j) Valuation of Goodwill
The method by which the value of Goodwill shall be determined
in the event of admission, retirement or death of any of the
partners

(k) Compensation to the Estate of Deceased Partner
The method of determining the amount due to the estate of a
deceased partner and the manner in which the liability to his
payment within a specified period, by installments of certain
proportions etc. and the rate of interest to be allowed on
outstanding balances.

(l) Insurance Premiums
In the even of any partnership insurance policies, the method of
treating the premiums thereon and the division of the policy.

2.3.2 The main advantages of Partnership over sole-proprietorship are:
(a) More finance is available
(b) Higher performance may be achieved since two heads are better
than one.
(c) Decision-making is also swift since partners are friends and they
are not many.

The disadvantages are:
(a) The major disadvantage is that the liability of members of the
partnership is unlimited

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(b) The amount of capital the partners can raise is still too small to
enable them carry out large investments.

(c) The death and bankruptcy of a partner may lead to the
dissolution of the firm.

(d) Disagreement may occur between the partners. They may then
find out that they are not compatible which may lead to the
dissolution of the partnership.

2.4 Limited Liability Company

Nature, Formation And Statutory Books Of Limited Liability Companies

A limited liability company is a form of business organisaion that has a
personality distinct from those of its owners. The attraction of this form
of business enterprise is its access to capital larger than what its
promoters can provide. Because of its distinct legal personality, it can
sue and be sued in its name and enter into contracts for which it is
solely liable.

The following are different types of companies:
(a) Private Limited Liability Company;
(b) Public Limited Liability Company;
(c) Company Limited by Guarantee; and
(d) Unlimited Liability Company.

Normally companies derive their existence under the provisions of the
Companies and Allied Mattes Act, Cap. C 20 LFN 2004. The rules and
procedures guiding the incorporation or formation of limited liability or
unlimited liability companies are contained in Sections 18 49 of the
Companies and Allied Matters Act, Cap. C 20 LFN 2004.

2.4.1 Formation Procedure

(a) A limited liability company, private or public, may be brought into
existence when the documents enumerated below and
appropriate fees are paid to the Registrar, Corporate Affairs
Commission:

(i) A Memorandum of Association signed by at least two
subscribers, dated and witnessed. Each subscriber must
agree to subscribe for at least one share.

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(ii) A minimum of 25% of the authorized share capital must
be taken up at incorporation.

(i) Articles of Association will be similarly signed, dated and
witnessed.

(ii) A statement of nominal capital (unless the company is to
have no share capital). Stamp duty varying with the
amount of authorized share capital is payable. Rate is at
present N3 for every N200 worth of shares.

(iii) There is no upper limit to the amount of the authorized
share capital, although the minimum is currently N10,000
for a private company while that of a public limited liability
company is N500,000 (except in cases of special
companies such as, banks and insurance companies).

(iv) A statutory declaration by a solicitor engaged in the
formation of the company or by one of the persons named
as a director or secretary that the requirements of the
Companies and Allied Matters Act in respect of registration
have been complied with.

(v) A statement (in the prescribed form) of the particulars of
the first directors and secretary and the first address of
the companys registered office. The persons named as
directors and secretary must sign the form to record their
consent to act in the relevant capacity and when the
company is incorporated these persons are automatically
appointed.

(b) The Registrar Corporate Affairs Commission is satisfied that all
the documents are in order and that the objects specified in the
memorandum are lawful after which he issues a certificate of
incorporation.

(a) The purpose of the memorandum and articles of association is to
define the constitution of the company. The memorandum sets
out basic elements of the constitution while the articles are
mainly internal rules, but of interest to outsiders since they
define the powers of the directors to enter into contracts on
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behalf of the company. The memorandum prevails if there is
any inconsistency between it and the articles.

(b) A private company may do business and exercise its borrowing
powers from the date of its incorporation but a public company
(incorporated as such) may not do business or borrow until it has
obtained a trading certificate (not a statutory expression) from
the Registrar.

(c) The memorandum of every company limited by shares must
include:
(i) The companys name, which if the company limited by
shares or by guarantee, should end with the word limited.
A limited company may in some circumstances omit the
word limited from its name. An unlimited company does
not end its name with the word Limited.
(ii) The country (not the address) in which the companys
registered office is to be situated. This determines the
nationality and the place of domicile of the company
which cannot be changed.
(i) The objects of the company contained in an objects
clause which, because of the developments of company
law over time, specifying both alternative business
activities and express powers to engage in every kind of
business which the company might wish to undertake.
The objects stated in the opening paragraphs are treated
as main objects while the following ones are ancillary to
them, unless the contrary is stated.
(ii) The liability of members: If the company is one limited by
guarantee, this is followed by a second clause which
states the maximum amount which each member
undertakes to contribute in a winding-up to enable the
company pay its debts. The authorized share capital (of a
company limited by shares) must disclose the amount of
the share capital with which the company proposes to be
registered and specify shares of stated value into which
that amount is divided for example, the share capital of
the company is N100,000 divided into N200,000 shares of
50k each. The amount of the authorized share capital
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may be increased (or reduced) in the manner provided by
the articles, usually by passing an ordinary resolution.
The authorized share capital is the maximum amount in
shares which the company may issue.

(d) The articles of association deal mainly with the internal conduct
of the companys affairs, e.g. the issue and transfer of its shares,
alterations of its capital structure, conduct of and at general
meetings and members voting rights, powers of directors and
board meetings, dividends, accounts and the issue of notices.

(e) The articles of association usually delegate the power to allot and
issue shares to the directors as one of their management
functions. The formal procedure is that the subscriber applies for
shares (often in response to an invitation by the company) and
the directors accept his offer by deciding at a board meeting to
allot shares to him. His name is entered in the register of
members, a share certificate is issued and within one month of
allotment a return is submitted to the Registrar.

2.4.2 Statutory Books
(a) Once the company has been formed and it commences trading it
has a statutory obligation to prepare financial statements
showing a true and fair view of the companys operations and
statement of affairs and keep accounting records sufficient to
show and explain the companys transactions.

(b) Redeemable Preference Shares
Under section 122 and 158 of the Companies and Allied Matters
Act Cap C20 LFN 2004, a company so authorized by its articles
may issue redeemable preference shares, provided that:
(i) There are in issue other shares which are not redeemable.
(ii) The redeemable shares may not be redeemed unless they
are fully paid.
(i) The terms of redemption provide for the company to
make payment at the time shares are redeemed. The
redemption may be effected on such terms and in such
manner as may be provided by the articles as long as the
provisions of the Act are complied with.
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(ii) Redemption is made out of the:
- Distributable profits of the company, or proceeds of
a fresh issue of shares made for the purposes of
the redemption.
- Proceeds of a fresh issue of shares made for the
purposes of the redemption.
(v) Any premium payable on redemption is payable out of the
companys distributable profits, except: the premium
payable on the redemption of redeemable preference
shares which were issued before the appointed day may
be paid out of the share premium account or partly out of
the distributable profits (section 158(4) of the Companies
and Allied Matters Act, Cap. C20, LFN 2004).
(vi) Where the redemption is made out of the proceeds of a
fresh issue of shares made for the purpose of the
redemption and the shares to be redeemed were originally
issued at a premium, any premium payable on their
redemption shall be paid out of the share premium
account up to an amount equal to the lower of:
the aggregate of the premium received by the
company on the issue of the shares redeemed, or

the current amount of the companys share
premium account (including any sum transferred to
that account in respect of premium on the new
shares.

Where specific provision is made in the articles,
preference shares may be participating preference shares.
This type of shares entitles the holders to share in any
remaining profits after the preference shares and ordinary
shares have received specified dividends.

(c) Ordinary shares
The ordinary share capital of a company is often termed
the equity capital. Ordinary shares may be divided into
preferred and deferred ordinary shares, in which case the
balance of the profit is shared between the two types of
ordinary shares in some prescribed proportions.

2.4.3 Issued Share capital
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A company does not necessarily issue all its authorized share capital
immediately, or indeed ever. The amount of capital that it does issue,
whether for cash or otherwise, is known as its Issued Share capital.

Both the authorized share capital and the issued share capital must be
shown in a companys statement of financial position.

2.4.4 Reserves and Provisions
Reserves are grouped under a separate heading in the statement of
financial position with opening reserves shown first and ending with
the balance carried forward on the income statement, i.e. retained
profit.

It is important that reserves are distinguished from provisions. The
expressions Reserves and Provisions are defined in the Companies
and Allied Matters Act, Cap. C20 LFN 2004, as follows:

(a) Provision means any amount written off or retained by way of
providing for depreciation, renewals or diminution in value of
assets or retained by way of providing for any known liability of
which the amount cannot be determined with substantial
accuracy.

(b) Reserves include any amount written off or retained by way of
providing for depreciation, renewals or diminution in the value of
assets or retained by way of providing for any known liability, or
any sum set aside for the purpose of its being used to prevent
undue fluctuations in charges for taxation.

(c) Any excess of the amount retained by way of providing for any
known liability which in the opinion of the directors is reasonably
necessary for the purpose, shall be treated as a reserve and not
as a provision.

It should be noted, particularly, that the expression provision
should be used only to indicate known depreciation, renewals or
diminution in the value of assets and known liabilities, the
amount of which, however, cannot be estimated with substantial
accuracy. It follows that the provisions will generally be
deducted from the assets to which they relate.

2.4.5 Advantages and disadvantages of Limited Company

Advantages
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(a) The liabilities of the shareholders is limited to the amount they
have subscribed to the firms capital if the company goes
bankrupt.

(b) It can raise substantial amount of capital from the numerous
shareholders or from financial institutions.

(c) The chance of survival is high because the company is controlled
and managed by highly skilled professional management team
appointed by the Board of Directors who were elected by and
answerable to the shareholders.

(d) The limited company is separate legal entity distinct from its
members. It can sue and be sued in its name.

(e) Unless it is wound up, a limited company has perpetual
succession so that it is not affected by the death, bankruptcy,
mental disorder or retirement of its members.

(f) Floating charges can be created by a limited company.

(g) Shares in a public company can be transferred without the
consent of other members.

Disadvantages
(a) Formation of limited liability company requires costly legal
expenses
(b) Decision making may be delayed due to bureaucratic
bottlenecks.
(c) The members of the company have no power to manage its
affairs.
(d) Much legal and publicity formalities are observed e.g. filing of
annual returns, annual general meeting etc.

2.5 Public Enterprises
The public corporation is an enterprise owned by and controlled by the
government. The government provided the capital for the company. The
Commissioner (Minister) acting on behalf of the State or Federal government
appoints the members of the Board of Directors who in term formulate policies
within the enabling Act establishing the Corporation and the framework.
Examples of public corporation are Ghana Airways, the Nigerian Railway
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Corporation, the Nigerian Ports Authority, Nigerian National Petroleum
Corporation.

Advantages
(a) Some activities such as the generation of electricity, provision of port
facilities and rail transport services involve huge financial considerations
which the private entrepreneurs cannot provide. These facilities must
be provided to quicken the pace of economic development and
industrial growth.

(b) It enables some natural resources, especially minerals to be efficiently
exploited and effectively managed.

(c) Some essential goods or services if left in the hands of private business
may not be sufficiently provided or may be provided at exorbitant
prices. Thus, the common people will not be able to afford them as a
result of which their conditions of living will worsen.

(d) The public company can borrow money externally by issuing bonds or
debentures. This is not possible for the private company.

The major disadvantage of public enterprises is that members of the Board of
Directors are politically appointed to control and manage the corporation. At
times, they may not possess the relevant skills to manage such organization
efficiently. Some members of staff are appointed on political grounds and
quota basis, resulting in low quality of labour.

The performance of public enterprise is poor when compared with the private
sector. Most of the public enterprises are being run at loss as the motive for
establishing them is not for profit, thus receiving subventions from the
government.

Chapter 2 dealt with the forms and structures of business organizations
covering their characteristics, advantages and disadvantages.

At the end of the chapter, students would have sufficiently formiliarised
themselves with
- advantages and disadvantages of Sole Trader.
- Procedure for the formation and drafting of Partnership Deed.
- Procedure for formation of limited company, the required statutory
books and sources of capital
- advantages and disadvantages of Public Enterprises.

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2.7 Multiple Choice Questions and Short Answer questions.
1. The maximum number of partners in a professional firm such as solicitors,
accountants is
(a) Five
(b) Unlimited
(c) Between Ten and Twenty
(d) Between Twenty and Thirty
(e) Fifty

2. In the absence of a partnership deed
(a) Partners remuneration is 5% of profit
(b) No remuneration will be paid to a partner
(c) Remuneration will be paid equally to partners
(d) Remuneration will be paid net of tax
(e) Partners remuneration is 10% of profit.

3. The minimum authorized capital of a public limited liability company is
(a) N10,000
(b) N25,000
(c) N500,000
(d) N1,000,000
(e) N50,000

4. The body charged with the responsibility of incorporation limited liability
companies in Nigeria is

(a) The Central Bank of Nigeria
(b) The Federal Ministry of Finance
(c) The Ministry of Foreign Affairs
(d) Corporate Affairs Commission
(e) Security and Exchange Commission

5. The under listed are forms of Debenture EXCEPT
(a) Secured
(b) Bearer
(c) Preference
(d) Registered
(e) Naked

6. Identify two sources of capital available to public limited company.

7. A company that has no share capital is described as.

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8. Undistributed profits accumulated over the years by a limited liability
company are referred to as

9. The major advantage of limited liability company over partnership is.

10. The major disadvantage of public enterprise is

2.8 Solution to Multiple Choice Questions and Short Answer Questions

1. B
2. B
3. C
4. D
5. C
6. Issue of shares and debentures
7. Limited by guarantee
8. Reserves
9. The Liability of members of the company is limited by the Memorandum
of Association to the amount unpaid on their shares.
10. Political influence.

CHAPTER THREE

ACCOUNTING CONCEPTS AND CONVENTIONS

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At the end of this chapter candidates should be able to:
Identify and explain the relevance of accounting concepts.
Explain the relationship between a business entity and its
owner.
Explain the relationship between accounting equation and
statement of financial position .
Differentiate between assets, liabilities and owners equity.

3.1 Accounting Concepts and Conventions
Accounting concepts and conventions are the basic assumptions
that underlie the preparation of the periodic financial statements of
a business entity. They are rules regulating the manner in which
transactions are recorded. They are deemed to be in existence
though not actually stated or referred to. The concepts and
conventions give reasons why accounting data are prepared in a
typical manner.

We shall now discuss some of the fundamental concepts and their
importance in the preparation of financial statements. (SAS 1)

3.2 Entity Concept
In the strict legal sense, only limited liability companies are
regarded as a legal entity separate from its owners. It can acquire
assets and incur liabilities. It can enter into contract on its own and
can owe debt. It can sue and be sued.
In accounting, however, all forms of businesses are regarded as
being separate from their owners. The assets (such as cash)
contributed by the owner to the business is regarded as the liability
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of the business to the owner, which is called capital or owners
equity.

The essence of the entity concept is to distinguish the income and
costs relating to a business from the private income and costs of
the proprietor or his drawings from the business. For instance, if the
owner of a business draws cash from the business bank account to
repair delivery vans, it would be regarded as business expenses.
But if he pays his childs school fees with the cash, the amount will
be treated as drawings of the owner rather than expenses of the
business. The entity concept also gives rise to what is called the
Accounting Equation.

3.2.1 Accounting Equation
The cash or other assets invested in a business by the owner are a
form of liability of the business to the owner. Therefore, assets =
capital (liability to owner) at the commencement of the business.

As the operation progresses the owner may obtain goods on credit
from suppliers or borrow additional loan from the bank to finance
the business. The value of the goods supplied and the cash
received as loan would increase the assets of the business, while
liabilities to third parties (not owners) would increase. The
accounting equation becomes Assets = Capital + Liabilities.

Let us illustrate the two scenarios.
(a) Ade, a proprietor of Adisco Enterprises started business with
cash of N50,000
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The accounting equation is
Assets = Capital + Liabilities
N50,000 (cash) = N50,000 + 0

(b) Assuming that in addition to the cash invested, Ade
introduced N25,000, borrowed from a friend into the business.
The cash position is now N75,000, made up of owners
capital of N50,000 and liability N25,000
Assets = Capital + Liability
N75,000 (Cash) = N50,000 + N25,000

We shall now consider the effect of different transactions on
the Assets, Capital and liability of a business.

(c) Adisco Enterprises spent N20,000 to rent an office and
bought furniture for N10,000. He also purchased for cash
some textile materials for resale at the cost of N30,000.

The accounting equation will remain as in (b) above but the
composition of the assets has changed.
Furniture + Inventories of Goods + Rent + Cash = Capital +
Liability
N10,000 + N30,000 + N20,000 + N15,000 = N50,000 +
N25,000
i.e. N75000 = N50,000 + N25,000
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(d) If the goods have been purchased on credit the accounting
equation would be
Furniture + Inventories of Goods + Rent + Cash = Capital +
Loan + Supplier
N10,000 + N30,000 + N20,000 + N45,000 = N50,000 + N25,000 +
N30,000
N105,000 = N50,000 + N55,000
We shall now consider the effects of profits and drawings on
owners equity and the accounting equation.

Profits will increase the owners equity/capital while drawings
would reduce it.

(e) Assuming in our number illustration in (d) above, Adisco
Enterprises sold all the textile materials for N52,000 making a
profit of N22,000 (N52,000 N30,000). The cash from the
sale would increase cash balance by N52,000 while capital is
increased by N22,000 profit.

Furniture + Rent + Cash = Original Capital + Profit + Loan +
Supply
N10,000 + N20,000 + N97,000 = N50,000 + N22,000 +
N25,000 + N30,000
i.e. Assets = Capital + Liability
N127,000 = N72,000 + N55,000

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(f) In addition to the information in (e) above, Ade withdrew
N16,000 cash for private use. The accounting equation will
become
127,000 N16,000 = N72,000 N16,000 + N55,000
N111,000 = N56,000 + N55,000
You would notice that though capital is described as a sort of
liability, it is not described with the word liability. It is only the
amount owed to third parties by the business that is described
as liability. The reason is that in the event that the business
ceases to exist, the liabilities to third parties are settled first
from the business assets.

Other examples on accounting equation are
Transactions Effects on Assets and Liabilities
1. Buy goods on Credit for N1,200,000 Assets (Inventories) is increased by N1,200,000
Liabilities (Creditors) is increased by N1,200,000
2. Buy goods by Cash for N300,000 Asset (Inventories) is increased by N300,000
Asset (Cash) is also decreased by N300,000
3. Pay Creditors for N1,200,000 Asset (Cash) is decreased by N1,200,000
Liability (Creditors) is decreased by N1,200,000
4. Proprietor takes N400,000 for private use Asset (Cash) is decreased by N400,000
Capital decreases by N400,000
Let us now see how the above four transactions affect the accounting
equation.
Assets = Liabilities
1.
2.
Buy goods on Credit
Buy goods by Cash
N1,200,000
N300,000
Inventories
Inventories
N1,200,000
N300,000)
Creditors
Cash
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3.
4
Pay Creditors
Proprietors drawings
Grand total effect
(N1,200,000)
N400,000)
N400,000
Cash
Cash
=
(N1,200,000)
N400,000
N400,000
Creditors
Capital

All figures in brackets denote decrease while others denote
increase.

The two sides of the equation are equal, that is (N400,000) both
ways. This confirms that for any transaction, the effect is of equal
weight on the two sides of the accounting equation i.e. Asset =
Liability

3.3 Explanation of some of the terms used in the Accounting
Equation.
The accounting equation; assets = capital plus liability represents
the two sides of a statement of financial position; Assets on one
side and capital and liabilities on the other side. The capital and
liabilities are claims against the assets. The net worth of the
business is the capital. The net worth is the original capital plus the
profits earned (or less the losses incurred) during the period less
the proprietors drawings during the same period.

3.3.1 Assets
Assets are the economic resources of a business that are expected
to bring immediate and future benefits to the business. They are
classified into non-current and current assets.

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2.3.2 Non-current Assets
These are the economic resources that aid in income generation for
more than one accounting period. They include land and buildings,
motor vehicles, equipment, machinery, furniture etc.

2.3.3 Current Assets
These are the economic resources of the business which are easily
converted to cash or can be consumed within an accounting period
or operation cycle, whichever is longer. Examples are cash in hand
and at bank, receivables and other receivables, prepaid expenses
and inventories of goods meant for resale.

2.3.4 Liabilities
Liabilities are claims against the assets of the business. Liabilities
give rise to creditors. Some of the liabilities may arise from the use
of the services or goods of another person on credit basis; some
other liabilities may arise from financing the organization i.e. loan
creditors. They are divided into current liabilities and long-term
liabilities.

2.3.5 Current Liabilities
These are the liabilities of the business that are meant to be paid
within twelve months. Examples of current liabilities are trade
creditors (supplier of goods on credit), and other payables such as
outstanding bills on electricity, salary and wages, taxation etc. and
bank overdraft.

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2.3.6 Non-current liabilities: These are liabilities that will take more
than one year before repayment is due. They are long-term loans.

We have discussed the entity concept much because it is
fundamental to the principle of double entry. We shall now consider
the other concepts and conventions.

3.4 Money Measurement Concept
Money serves as the common denominator for measuring the
various assets and liabilities of an organization, therefore
accounting transactions are expressed in monetary values. The
Naira and the Cedi represent unit of value which have the ability to
command goods and services in Nigeria and Ghana respectively.
Apart from the fact that money serves as a common unit,
accountants also believe that it is stable in value.

There are some limitations in the use of money as measure of
value in accounting.
(a) The value of money does not always remain stable
particularly in an inflationary economy.
(b) Apart from inflation, the time value of money today is greater
than the time value of money in any future time, due to the
cost of funds.
(c) There are some activities of an organization that are not
recorded because monetary value cannot be attached to
them. Examples are good management, employees morale,
strength of competition etc.

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Thus accounting does not provide all the information about a firm, it
provides only economic information that can be expressed in
monetary terms.

We may then understand why limited liability companies are
required to discuss a lot of non-accounting information in their
annual reports.

3.5 The going concern concept
Unless otherwise stated, it is always assumed that a business
entity will continue in operation for the foreseeable future. It is
assumed that the enterprise has neither the intention nor the
necessity of liquidation or curtailing significantly the scale of
operation.

The going concern concept will help investors, creditors,
employees, customers and other stakeholders to determine the
extent to which they want to continue to patronize the business.
The going concern concept may be more justified in a limited
liability company where the death or withdrawal of any member
(shareholder) may not affect its scale of operation.

Assets and liabilities of a going concern enterprise are valued on
historical cost basis (this is discussed further later). When the going
concern is in doubt the assets are valued on break-up value basis
i.e. forced sale values.

3.6 Periodicity concept
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Notwithstanding the going-concern assumption, the operations and
performance of a business entity should be subjected to periodic
review, for instance limited liability companies are required to
present their financial statements to members of the company
annually. Management accounting information is even prepared
more frequently.

The periodic review would help to assess management efficiency
and in the planning and control of future operations.

3.7 Prudence
The prudence concept requires that an accountant should not
recognize income until the income has been earned and that losses
should be fully written off when it is probable. The essence of the
principle is that profits are not overstated in any accounting period.

The prudence concept is most useful when matters of judgement or
estimates are involved. For instance, if the credit policy of a
business requires a customer to pay for the goods sold to him in 60
days and he has not paid after 120 days, it may be reasonable to
make provision for the entire amount as bad and doubtful debt.
Another example is when inventories becomes obsolete and its net
realizable value falls below cost, the difference between the cost
and the net realizable value will be written off to income statement.

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Failure to write foreseeable losses off or the recognition of
unrealized income will produce a misleading result which will
eventually lead to losses to creditors and shareholders.

3.8 Substance Over Form
Business transactions are usually governed by legal principles;
nevertheless they are accounted for and presented in accordance
with their financial substance and reality and not merely by their
legal form.

Examples are found in; sales and re-purchase agreements, lease
contracts and consignment of goods.

3.9 The Consistency concept
Consistency concept requires that when a method has been
adopted in treating an item in the financial statements, the method
should not be changed but used consistently from period to period.
For instance, there are many methods of depreciating a non-current
assets; straight line, reducing balance, sum of the digits. If straight
line is chosen to depreciate building in year one, the company
should continue to depreciate building on straight line basis from
year to year.

The essence of this principle is to make it easy for users of the
financial statements to compare the result of one period to another.
Constant change in method will distort profits and make
comparison difficult.
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Occasionally there may be justification to change from one method
to another. If the change is made, adequate disclosure must be
made about the nature of the change and the effect of the change
on profits.

3.10 Accrual concept
The accrual concept states that income should be recognized when
they are earned, not when they are received and expenses should
be recorded when they are incurred, not when they are paid. The
application of this concept gives rise to prepayments and accrued
expenses. An accrued expense occurs when an expense has been
incurred but it has not been paid off. Prepaid expenses occur when
payment has been made for services but benefits have not been
derived from them. They give rise to liabilities and assets
respectively. Prepaid expenses and outstanding receivables are
assets while income received in advance and outstanding
expenses are liabilities of the business.

All expenses due but not yet paid should be added to the expenses
paid in order to determine the total expenses for the period. All
expenses prepaid should not be included in the amount to be
deducted in the income statement. All income due and receivable
should form part of the income for the period. While all income
received in advance should be excluded.

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3.11 Matching Concept
This is related to the accrual concept in a way. The concept holds
that for any accounting period, the earned revenue should be
matched with the cost that earned them. If revenue is deferred from
one period to another, all elements of cost relating to them will be
carried forward.

The concept is important in measuring the cost of goods sold or
services rendered in a period. It is also useful in determining when
the cost of an item becomes expenses (that is expired cost). The
matching concept is applied to products where the costs can be
related directly to the products. It is applied in relation to time period
where while the cost incurred cannot be related to the product.

For instance, if a trader bought 50 pairs of shoes for N50,000 and
sold 35 pairs for N70,000 at the end of a period. The cost of goods
sold would be measured on the 35 pairs sold. That is 35/50 x
N50,000 = N35,000. N15,000 would be deferred to the next period.

Some cost that cannot be related to specific transactions are
depreciation, electricity bill, insurance cost etc. When the matching
concept is not properly applied profits are either overstated or
understated.

3.12 Materiality Concept
The principle of materiality holds that financial statements should
separately disclose items which are significant enough to affect
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evaluation or decisions. It refers to the relative importance of an
item; therefore some level of judgement may be required in
determining what is material to an organization; as what is material
to a sole trader may be immaterial to a mega firm.

In any event the amount (size) of an item would affect materiality.
For instance, stapler, perforator, waste basket are expected to be
used for more then one period, so that their costs should be
measured over the period of use. However, because of the
insignificant amount involved, the concept of materiality permits the
immediate write off of these costs as expenses.

The nature of an item and type of a business entity will also affect
materiality.

3.13 Historical Cost Concept
The basis for initial recognition of an assets acquisition, service
rendered or received and an expense incurred is cost. The concept
also holds that after acquisition cost values are retained throughout
the accounting process except to allocate a portion of the original
cost to expense as the assets expire (see matching concept). The
justification for the historical cost principle is its objectivity; that is,
the cost can be traced to source documents and that other
measures of value would be based on the subjective judgement of
management.

The main criticism against the historical cost concept is that with
the passage in time cost would no more represent the fair value of
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50
an asset. For instance the value of a building constructed ten years
ago might have appreciated considerably over the period. In
periods of inflation the use of historical cost instead of fair values
also normally leads to the recognition of holding gain because cost
would significantly understate the value of the resources being
consumed. Recognizing holding gain may lead to the distribution of
the profits that would have been retained in the business for further
expansion.

3.14 Objectivity Concept
Objectivity concept holds that accounting statement should not be
influenced by personal bias of management. The use of historical
cost for asset valuation is an attempt to be objective, because it can
be backed up by vouchers, invoices, cheques, bills etc.

A change in the value of an asset should be recognized when it can
be measured in objective terms.

Objectivity is useful in accounting in the following ways:
(a) Auditing is made possible
(b) Accounting data are standardized.
(c) Fraud and falsification of accounts are minimized.
(d) Data is available for independent party to cross-check.
In spite of the goals of objectivity concept some personal opinion
and judgement are brought into accounting information in few
instances. For instance, estimates are required to determine the
useful life of a non-current asset, the net realizable value of
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51
inventories or the amount to be provided for bad and doubtful
debts.

However, figures built into financial statements should rely as little
as possible on estimates or subjectivity.

3.15 Fairness
This is an extension of the objectivity principle. In view of the fact
that there are many users of accounting information, all having
differing needs, the fairness principle requires that accounting
reports should be prepared not to favour any group or segment of
society.

3.16 Realisation Concept
Under accrual concept, revenue should be recorded when it is
earned. The realisation concept is concerned with determining
when revenue is earned.

The realisation concept holds that revenue should be recognised at
the time goods are sold and services are rendered; that is the point
at which the customer has incurred liability.

Before revenue can be realised and recorded it must have met the
following two conditions
(a) The revenue is capable of objective measurement
(b) The value of asset received or receivable is reasonably
certain.

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52
The realisation concept may be difficult to apply in hire purchase
transactions, lease transactions, contract jobs, advertisement
agencies etc.

You will learn the rules that are applied in recognising revenue as
you progress in the accounting profession.

3.17 Summary
In this chapter we have discussed the fundamental accounting
concepts including entity, going-concern, historical cost, periodicity,
monetary measurement, realisation, matching, consistency,
prudence, materiality, accrual, substance over form and fairness
concepts.

We discussed the usefulness of these concepts in accounting
information and their limitations.

The chapter also treated the importance of accounting equation in
the preparation of the statement of financial position .

3.18 Revision Questions
(1) What effect would purchase of goods for credit have on the
assets, liability and capital of a business?
Assets Liability Capital
(a) Increase decrease no effect
(b) Increase no effect decrease
(c) Increase increase no effect
(d) Increase no effect no effect
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53
(e) No effect increase increase
(2) Which of the following are the effects of matching concept?
i. Determination of periodic profits
ii. Unexpired costs are deferred
iii. Cost of goods sold may be different from purchases
(a) I, II, and III
(b) I and III
(c) II and III
(d) I and II
(e) None of the above
(3) The accrual concept requires a business to treat as income
those which are due and receivable and to treat as expenses
those which are in arrears respectively.
(a) Yes Yes
(b) Yes No
(c) No Yes
(d) No No
(e) None of the above
(4) The implication of the entity concept to a sole trader is that
the
(a) business can sue and be sued separately
(b) liability of the owner is limited
(c) owner cannot own private assets
(d) private use of business assets reduces owners capital.
(e) Owner can issue shares to the public
(5) Which of the following transactions would reduce asset and
reduce liability?
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54
(a) Sale of goods on credit
(b) Cash paid to trade payables
(c) purchases of goods on credit
(d) cash purchases
(e) Cash receive from trade receivable
(6) The main advantage of the going-concern concept is ______
(7) State the effect of the historical cost concept on profit in a
period of rising prices.
(8) The relevant concept that justifies the charging to expense
the cost of small waste basket even though the basket has
useful life of several years is _____
(9) State which accounting concept justifies the depreciation of
non-current assets.
(10) Mensa and Co., a sole trader, discovered that the business
liability is in excess of the assets. He thus included his private
assets in the Statement of financial position . Which concept
is violated?

(1) C
(2) A
(3) A
(4) D
(5) B
(6) The main advantage of the going-concern concept is that it
enables stakeholders in a business organisation to assess
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55
the extent to which they want to continue to patronize the
business.
(7) Use of historical cost would understate cost of assets
consumed thereby causing the business to report holding
gain or to overstate profits.
(8) Materiality.
(9) Matching concept.
(10) Entity concept.

Thanks.

56
References

Nigeria



J. J. Lerner (1993) Schaums Outlines Bookkeeping and Accounting,
Mcgraw Hill, USA

J. K. Shim and J. G. Siegel (1999) SCHAUMS OUTLINE Financial
Accounting, Mcgraw Hill, USA

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57
CHAPTER FOUR

SOURCE DOCUMENTS AND BOOKS OF ORIGINAL ENTRY

Know the role of source documents
Know the nature and functions of books of original entry
Prepare day books and Journals
Transfer from the books, of original entry to the relevant
ledgers
Know the effect of trade discount and value added tax (VAT)
on sales and purchases.

4.1 Introduction
In the last chapter we said that the historical cost concept makes
financial transactions to be objective because they can be traced to
source documents. In this chapter we shall explain those source
documents, their importance and the books of original entry to
which they relate. The book of original entry is the accounting
record in which transactions are first recorded from source
documents.

4.2 The Need for Source Documents
Source documents constitute the source of all original information
on the financial transactions of a business.

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58
They perform the following functions:
They serve as evidence of financial transactions thereby
guiding against fraud.
They serve as evidence of financial transactions thereby
making audit possible.
They are usually signed by the parties to the transaction
therefore they are not usually denied.
They are usually signed by the parties to the transaction,
therefore it is almost impossible to alter or collude in order to
defraud.
In some cases, there could be more than one source
document for a transaction but they would compliment one
another.

4.3 Main Source Documents
The main source documents that are used for recording in the
books of original entry are:
Sales Invoices
Purchases Invoices
Credit notes
Debit notes
Payment vouchers
Bank Pay-in-slips
Cheque counterfoils
Receipts

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Others which may not contain full information to make recording
possible in the books of original entry are
Purchase order
Delivery note
Goods Received Note
Bin Card

4.3.1 Sales Invoices
A sales invoice serves as the source document to record in the
sales day book. This is a document sent by the seller to the buyer
(usually for credit sales) requesting the buyer to pay for the amount
stated on the invoice for goods or services rendered to him. Usually
bills are sent for service rendered while invoices are sent for goods
sold.

A Sales invoice would contain the following particulars
Name and address of the seller and purchaser
Date of the sales
Description and quantity of goods sold
Unit price and total amount of invoice
Amount charged for value added tax (VAT)
Conditions and terms of sales such as trade discount, cash
discount and the date payment fall due.
Signature of the parties

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Sales Invoices are pre-numbered and prepared in duplicate. The
original is sent to the buyer while the duplicate provides what is
recorded in the sales day book.
SPECIMEN SALES INVOICE

As you will learn later, the 10% discount is a trade discount. Trade
discount does not form part of the double entry. It is deducted from
the gross sales to arrive at the net amount of sales that would be
recorded in the ledger.

4.3.2 Purchases Invoice
A purchase invoice serves as the source document to record in the
purchases day book. As explained in the last paragraph the
purchases invoice is the original of the sales invoice sent by the
supplier to the customer. Therefore, the sales invoice and the
purchases invoice contains the same details. The only difference is
that purchases invoices are in the books of buyer and are received
Grace Enterprises
Iludun Street
Ado-Odo

Invoice No.: 7491
Date: 2 June 2006
Your Order No S/K/158

To: Ajala Ventures
11 Ajala Street
Idimu

The goods underlisted have been delivered in line with your request

N
500 pairs of shoes at N200 per pair 100,000
128 silk shirts at N250 each 32,000
132,000
less 10% discount 13,200
sales amount due 118,800

Please arrange for the payment immediately. A cheque drawn on the firms name is
acceptable.

----------------------------- -----------------------------
Accountant Sales Manager

Thanks.

61
from various customers and therefore will not be re-numbered
because goods are purchased from different sources.

4.3.3 Credit note
A credit note is a document relating to goods returned by the buyer
or refunds to him when the buyer has been overcharged.

Goods may be returned by a customer for any of the following
reasons:
Damage to the goods before delivery
Wrong specification from the one ordered by the customer.

The purpose of credit note is to inform the buyer that his
indebtedness has been reduced by the amount stated on the credit
note.

Credit note issued represents returns on sales while credit note
received represents returns on purchases. A credit note is made
out in red to distinguish it from an invoice.

4.3.4 Debit note
The buyer normally issues a debit note to a supplier to request for a
credit note. The buyer may not debit the account of the supplier
until his request is approved by him evidenced by the issue of the
credit note to the buyer.

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62
A debit note is also prepared whenever it becomes necessary, for
one reason or the other, to increase the amount due from a debtor.
An example is where the seller has under-charged a customer on
an invoice.

Generally, any expenses that should have been charged to the
customer but were erroneously omitted when the invoice was made
out would be charged subsequently by means of a debit note
prepared by the supplier.

4.3.5 Payment Vouchers
In an organization every payment must be supported by a payment
voucher. Examples are payment vouchers for salary and wages,
and petty cash vouchers etc.

Payment voucher is an authorising document for payment for a
particular expense or service. The voucher must be checked and
authorised by a responsible or authorising officer before cash can
be paid.

4.3.6 Bank Pay-in-slips
This serves as evidence of cheque and cash paid into the bank by
an organization. It is the major source documents for recording in
the bank column of cash book (debit side).

Pay-in-slip contains the following information:
Name of the business and the account number
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63
Name of the person paying in the cheques or cash
If it is cash, the total amount of each cash denomination is
stated
Column for signature of the person paying in
Column for signature of the bank official receiving the
cheques with the banks official stamp.

4.3.7 Cheque Counterfoils
Cheque counterfoils serve as evidence of payment to creditors
through the bank and withdrawals made for office or personal use.

In most organizations all cash received must be paid to the bank
and all cash payments must be made through the bank, (except
petty cash that is operated through the imprest system). Therefore
for many businesses, cheque counterfoils have become major
source documents for recording in the bank column of the cash
book (Credit side).

4.3.8 Receipts
Receipts are issued for cash received from a customer for goods
sold or service rendered to him. The original is issued to the buyer,
it represents the document for recording cash paid in his cash
book. The seller retains the duplicate, which is the document for
recording cash received in the cash book of the seller.

4.3.9 Purchase Order
A purchase order is issued by a customer requesting the seller to
supply certain quantities of goods of specified description. The
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64
purchase order will also state the agreed price and the delivery
point and date.

Invoices are compared with the purchase order when invoices are
received. The goods received note is issued after it has been
ascertained that the goods supplied meet the specification in the
purchase order. An example of a purchase order is the Local
Purchase Order (LPO).

4.3.10 Delivery Note
Delivery note accompanies the goods dispatched to the customer.
Delivery note protects the dispatch driver from harassment on how
he comes about the goods and serves as evidence of goods
received by the purchaser when it is signed by him.

4.3.11 Goods Received Note (GRN)
The good received note shows the evidence that the goods
dispatched to an organization are received in good condition and
meet the specification. The account department will require seeing
the relevant GRN before paying a suppliers invoice. The GRN is
also used to update the Bin Card.

4.3.12 Bin Card
Bin card records movement of inventories. When inventories is
added to the store or warehouse bin card is debited and when
inventories is issued to production, the bin card is credited.

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65
4.4 The Need for Books of Original Entry
These books are also referred to as books of prime entry or
subsidiary books or day books or journals. They are the books in
which transactions are first recorded. Transactions can be recorded
directly to the ledger but the books of original entry are in use
because they have the following advantages which the ledger does
not have.
(i) They record the total of transactions in one place rather than
the individual accounts.
(ii) They provide an explanation of the transactions recorded. For
instance the journal shows the complete story of a
transaction. You will not need to look at the debit and credit
for a transaction in different accounts/folio.
(iii) They provide records of transactions in chronological order.
(iv) They help to prevent error. The total in the book of original
entry can be reconciled with the total in the individual
accounts.

Main Books of Original Entry
(i) Sales day book
(ii) Purchases day book
(iii) Sales returns book/Returns inward book
(iv) Purchases returns book/Returns outward book
(v) Journal
(vi) Cash book (described in chapter 6)
(vii) Petty cash book (described in chapter 6)

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66
In a computerized accounting system the books may not be in
printed form but stored in a computer memory.

4.4.1 Sales Day Book
Sales day book is the book of original entry that records credit
sales. The source document is the duplicate of the invoice issued to
the customer. The volume of daily sales normally demands that it is
issued first to collate a periods sale before being transferred to
sales ledger accounts.

The sales day book shows the following information:
(i) A list of the sales invoices in the order in which they are
issued
(ii) The date of issue
(iii) The name of the customer
(iv) The number of the invoice
(v) The sales ledger number to which the individual accounts are
posted
(vi) The net amount of the invoice after deducting trade discount
and VAT

The sales day book does not show the description of the goods.
These are contained in the invoice.
Illustration 3.1
Baba Olu Enterprises made the following credit sales with invoice
numbers 072 079 respectively. Baba Olu trades in textile
materials
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67
N
2006, March 1: Addo Enterprises 1,500,000
,, 2: Moslad & Sons 800,000
,, 3: Kanfo Ltd. 2,500,000
,, 4: Aburi & Sons 900,000
,, 5: Akapo Enterprises 1,500,000
,, 6: Nwosu Ventures 400,000
,, 7: Bamiro Enterprises 600,000
,, 7: Adeolu Ventures 700,000

Record the above sales in the sales day book.

Solution to Illustration 3.1
Baba Olu Enterprises
Date Customer Invoice Sales Reference Total Amount
No Ledger
2006 N
March 1 Addo Enterprises 072 SL 18 1,500,000
,, 2 Moslad & Sons 073 SL 11 800,000
,, 3 Kanfo Ltd. 074 SL 15 2,500,000
,, 4 Aburi & Sons 075 SL 7 900,000
,, 5 Akapo Enterprises 076 SL 16 1,500,000
,, 6 Nwosu Ventures 077 SL 10 400,000
,, 7 Bamiro Enterprises 078 SL 8 600,000
,, 7 Adeolu Ventures 079 SL 5 700,000
March 7 Transfer to sales a/c 14 18,900,000

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68
The sales ledger reference means the ledger folio to which the
sales to each customer is posted. At the end of the period the total
of N8,900,000 is posted to the sales account. Each customers
transaction is also posted to the debit side of the subsidiary ledger.

A business entity may trade in more than one type of products. The
periodic sales may be analyzed according to each product in the
sales day book.

Illustration 3.2
In the first week of September 2006 Victor Enterprises issued the
following invoices to his customers. The invoice numbers are 1182
to 1187. He trades in wooden chairs and wall clocks.
Date Description of goods N
2/09/06 Jacobs & Sons
12 wooden chairs at N500 6,000
4 wall clocks at N650 2,600
8,600
3/09/06 Moruf Enterprises
4/09/06 Sago Ventures
52,500
Trade discount at 5% 2,625
49,875
4/09/06 Koku Emmanuel
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69
5/09/06 Solola and Co.
7/09/06 Annan Enterprises
102,000
Trade discount at 8% 8,160
93,840

Prepare the analytical sales day book of Victor Enterprises for the
week ending 7
th
September, 2006.
Date

Customer Invoice
Number
Sales
Ledger
Wooden
Chairs
Wall
Clock
A M O U N T
N N N
2/9/06
3/9/06
4/9/06
4/9/06
5/9/06
7/9/06
Jacobs & Sons
Moruf Enterprise
Sago Ventures
Koku Emmanuel
Solala & Co
Anna enterprises
1182
1183
1184
1185
1186
1187
SL 114
SL 83
SL 68
SL 101
SL 94
SL 71
8,600
12,500
49,875
1,300
6,500
93,840
172,615
6,000
12,500
19,000
-
-
46,000
83,500
2,600
-
30,875
1,300
6,500
47840
89,115

Notes
(i) The analysis would help managers to assess the rate at
which each class of inventories is sold for efficient
management of the business.
(ii) Where trade discounts were given, the effects were
distributed on a pro-rata basis between the two classes of
goods sold. For instance in the sales to Sago Venture the
amount on wooden chairs and wall clocks were calculated as
follows
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70
Wooden chairs N20,000 (20,000 x 5%)
Wall clocks N32,500 (32,500 x 5%)

4.4.2 Trade Discount
A. Trade discount is a discount given to a trader buying in large
quantity. The invoice price would be the same for all
customers but the net selling price may be different for
customers depending on the quantity purchased by them.
B. Trade discount is not recorded in the books of accounts. It is
only a means of calculating the net selling price of goods.
Only the net amount of goods sold is transferred to the books.

We shall discuss cash discount in the next chapter.

4.4.3 Purchases Day Book
The purchases day book is the book of original entry used to record
all credit purchases. The total therein is transferred to the debit of
the purchases ledger at regular intervals. Each suppliers account is
credited in the subsidiary ledger. The period may be daily, weekly
or monthly depending on the volume of purchases transactions.
The details on purchases day book are got from incoming invoices.
Each suppliers account is credited in the subsidiary ledger.
Illustration 3.3
Maomao Enterprises made the following purchases on credit
1/8/2006 Mrs B. Kent 150,000 with invoice N0.1062
I. Akolade Ltd. 108,000 with invoice No. 083
4/8/2006 Saidi Ojo 60,000 with invoice No. 003
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71
Wasiu Stars 82,800 with invoice No 288
Akala & Co 98,250 with invoice No. 1124
7/8/2006 Onuo Paul & Sons 120,000 with invoice No. 002
J. Mfon Ltd. 67,500 with invoice No. 116
Festac Enterprises 337,500 with invoice No. 644
Enter the transactions in the purchases day book of Maomao
Enterprises.
Maomao Enterprises
Purchases day book
Date PL ref. Supplier Amount

1/8/2006 PL 22 Mrs. B. Kent 150,000
PL 132 I. Akolade 108,000
4/8/2006 PL 08 Saidi Ojo 60,000
PL 042 Wasiu Stars 82,800
PL 015 Akala & Co 98,250
7/8/2006 PL 06 Onuo Pan & Co 120,000
PL 04 J. Mfon Ltd. 67,500
PL 105 Festac Enterprises 337,500
7/8/2006 Transfer to purchases ledger 1,024,050

Note
(i) PL reference is the reference to the Purchases Ledger
(ii) The invoice number column is excluded in the Purchases day
book because the numbers are erratic. Remember that the
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72
purchases day book records invoices coming from different
suppliers.

4.4.4 Analytic Purchases Day Book
Like the sales day book, the purchases day book can be analyzed,
but unlike the case of sales day book, it may contain columns for
goods meant for resale, goods not meant for resale and bills
received for services.

Illustration 3.5
Benard Carena, a sole trader, trades following transactions which
relate to the month of July, 2006.

2006
July1 Bought goods in credit from J. Leye Ltd. 1,500,000
,, 2 Bought goods on credit from Bala & Sons 850,000
,, 6 Bought stationery on credit from Suzie Ltd. 750,000
,, 9 Bought goods on credit from Sasa & Sons 640,000
,,12 Received invoices for carriage on goods from Samcol 940,000
,,14 Bought goods on credit from Bala & Sons 1,050,000
,,15 Received invoice for electricity from NEPA 750,000
,,18 Bought goods on credit from Mike Essien & Co 645,000
,,25 Bought stationery on credit from Suzie Ltd. 874,000
,,26 Received invoice from Babs motors for vehicle repair 682,000
,,28 Bought goods on credit from Bala & Sons 1,200,000
,,30 Bought goods on credit from Nana & Co 450,000
,,31 Received invoices for gas consumed from Owusu Ltd. 894,500

Prepare the Analytic purchases day book for the month of July
2006 in the books of Benard Carena.
NOTE: This is a work in progress. All topics in the syllabus are covered but editing for necessary corrections is in
progress.
Thanks.

73
Analytic Purchases Day Book
Date Names of PL Total Purchases Stationery Carriage Motor Electric
Supplier Folio

inwards

Expenses

& Gas
2006

July 1 J. Leye PL 40 1,500,000 1,500,000
,, 2 Bala & Sons PL 36 850,000 850,000
,, 2 Suzie Ltd. PL 48 750,000 750,000
,, 9 Sasa & Sons PL 16 640,000 640,000
,, 12 Samcol PL 12 940,000 940,000
,, 14 Bala & Sons PL 36 1,050,000 1,050,000
,, 15 NEPA PL 18 750,000 750,000
,, 18 Mike Essien & Co PL 06 645,000 645,000
,, 25 Suzie Ltd. PL 48 874,000 874,000
,, 26 Babs Motors PL 64 682,000 682,000
,, 28 Bala & Sons PL 36 1,200,000 1,200,000
,, 30 Nana & Co PL 72 450,000 450,000
,, 31 Owusu Ltd.

PL 04 894,500

________

_______

______

______

894,500
Total 11,225,500 6,335,000 1,624,000 940,000 682,000

1,644,500
Transfer GL 28

GL 30

GL 43

GL 68 GL 46
Thanks.

74

Notes
(i) The goods that are to be resold are called purchases
(ii) The analysis shows all invoices for transactions that will not
be paid for immediately.
(iii) The sum of the row totals should be equal to the sum of the
column totals. This is useful for control.
(iv) The total in each column will be debited to the purchases
account, stationery account, carriage inwards account, motor
expenses account and electricity and Gas account in the
general ledger.

4.5.5 Sales Returns Book
The sales returns book or returns inward book is the book of
original entry that records returns on goods sold to customers.

The sales returns book analyses what goods were returned.

Illustration 4.6
Refer back to Illustration 3.2

Victor Enterprises
Sept. 10, 2006 Jacobs and Sons returned 3 wooden chairs
Sept. 12 2006 Annan Enterprises returned 2 wall clocks
Sept. 14 2006 Moruf Enterprises returned 1 wooden chair

Prepare the Sales returns book for Victor Enterprises.

Thanks.

75

Victor Enterprises
Sales Returns Day Book
Date Particulars Sales ledger ref Amount
2006 N
Sept. 10 Jacobs & Sons
3 wooden chairs SL 114 1,500

Sept. 12 Annan Enterprises
2 wall clocks SL 71 1,196

Sept 14 Moruf Enterprises
1 wooden chair SL 83 500
Transfer to sales return GL12 3,196

4.5Ltd.
4
Benard Carena
Returns Outwards Book
Date Supplier Purchases ledger ref Amount
2006
Aug 3 J. Leye Ltd. PL40 200,000
Aug 5 Bala & Sons PL36 150,000
Aug 10 Mike Essien & Co PL06 40,000
Aug 10 Nana & Co PL72 45,000
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76
Transfer to returns outward account GL 180 435,000

The relevant purchases ledger reference would be transferred
from the purchases day book.

4.6 The Journal
The journal is used as the book to record transactions that do not
fit into other subsidiary books. The information recorded in the
journal about each transaction includes:
The date of the transaction
The debit and credit changes in specific ledger accounts
A brief explanation of the transaction, referred to as narration
or narrative.

The narration is required to indicate the purpose and authority of
the transaction. For efficient use of the journal, candidates must be
able to analyse the effect of a transaction on assets, liabilities, and
owners equity.

4.6.1 Uses of the Journal
The journal is used for the following:-
Opening and closing entries
Transfer from one account to the other
Purchases and sales of non-current assets on credit.
End of period adjustments
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77
Correction of errors.

4.6.2 The layout of the Journal
The Journal
Date Particulars Folio Dr Cr
The name of account to debit XX
The name of account to credit XX
The Narration

The name of the account to be debited is always shown first. The
name of the account to credit is inset to the right hand side. The
narration is not indented. A blank space should be left after each
entry to make each set of journal entries stand out clearly.
4.6.3 Opening Entries
When the journal is used for opening entries the aim is to
determine the value of the opening capital.

Illustration 4.8
N. Gyans business affairs on 1 January, 2006 stood as follows:

Cash in hand 66,000
Cash at bank 366,000
Inventories 375,000
Furniture and fittings 180,000
Creditors 150,000

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78
Record these transactions in a journal.

Thanks.

79
N. Gyan
Journal
Date Dr Cr
2006
1 Jan Cash in hand 66,000
Cash at bank 366,000
Inventories 375,000
Creditors 150,000
Capital (difference) 837,000
Being assets and liabilities of N. Gyan at 1 January, 2006.

4.6.4 Transfer from one account to the other through the journal
Only the journal can readily explain the transferring from one
account to the other, what happens will be narrated and any doubt
will be set aside.

Illustration 4.9
Record through the journal entry transfer of N600,000 from
Wasobia & Cos account in the bought ledger to their account in
the sales Ledger, to set off purchase against sales. The
transaction took place on 31 January 2007.

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80
Wasobia and Co
Journal
Dr Cr
31/01/07 Bought ledger control account 600,000
Sales ledger control account 600,000
Balance on bought ledger transferred
to sales ledger on contra basis.

4.6.5 Other uses of the Journal
The use of journal for other purposes is shown in the following
illustration:

Illustration 4.10
The following transactions took place in the books of Orire Ltd. in
June, 2006
(i) A machine is bought on credit from Jerry Enterprises for
N186,000 on June 1
(ii) A motor vehicle is sold to Jebeleje on credit for N360,000 on
June 8
(iii) Bobo. T a debtor owed N160,000. He offers a motor car in
full settlement of the debt on June 16 and the offer was
accepted.
(iv) Ilemobayo is a creditor. On June 25, his business is taken
over by Prospect Ventures to which the debt of N45,000 is
now to be paid.
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Show the journal entries to record the transactions.

Orire Ltd.
Journal
Date Dr. Cr.
2006 N N
June 1 Machinery 186,000
Jerry Enterprises 186,000
Recording machinery brought on credit.

June 8 Jebeleje 360,000
Motor vehicle 360,000
Recording motor vehicle sold on credit

June 16 Bobo T 160,000
Recording acceptance of motor car in
full settlement of debt.

June 25 Ilemobayo 45,000
Prospect Ventures 45,000
Debt owed to Ilemobayo to be paid
to Prospect Ventures.

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The use of journal for end of period adjustments and correction of
errors would be examined in detail later.

4.7 Summary
In this chapter we have discussed source documents, their uses
and their relationship to the books of original entry. We also
examined the importance of the books of original entry and
illustrated how they are to be transferred to the ledger accounts.
The Journal, as a means of recording unusual transactions, was
also examined.

4.8 Review Questions
Multiple choice questions and short-answer questions
(1) Which of the following statements about a journal are
correct?
I. The double entry for a transaction is completed in a
journal.
II. Journal is used to record withdrawal of cash to the
office.
III. A set-off between customers and suppliers is resolved
through journal
IV. Journal records adjusting events.

A. I, III and IV
B. I, II and III
C. II and IV
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83
D. III and IV
E. II, III and IV
(2) Which of the following journal entries may be accepted as
being correct according to their narration?
Dr Cr
N N
(A) Plant and machinery 250,000
Ernest Opare & Co 250,000
Purchases of goods on credit

(B) Baoku Ltd. 160,000
Cash account 160,000
Cash received from Baoku Ltd.

(C) Sangisha & Sons 840,000
Motor Vehicles 840,000
Sales of motor vehicle

(D) Capital account 1,500,000
Power generation 1,500,000
Introduction of generator into
a business.
(E) Cash Account 20,000
Motor Vehicles 20,000
Sales of motor vehicles
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84
(3) The invoiced price of a commodity is N50,000 with a trade
discount of 10%. C. Eghan issued the invoice to Wii Dromo.
How much is recorded in the books of original entry of Wii
Dromo and in what book is it recorded?
(A) N50,000 and purchases day book
(B) N45,000 and purchases day book
(C) N50,000 and sales day book
(D) N45,000 and sales day book
(E) N50,000 and sales journal
(4) Which of the following roles does a debit note serve?
(A) A document issued by the seller informing the buyer
that his account has been credited for overcharge on
the invoice.
(B) A document issued by the seller informing the buyer
that his invoice was undercharged.
(C) A document that generates a credit note from the seller
to the buyer
(D) A document by which goods are issued from store to
production.
(E) A document by which goods already issued are return
to store
(5) What is the relationship between a Purchase Order and
Goods Received Note (GRN)?
(A) The GRN confirms that goods are supplied according
to the specification in the purchase order.
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85
(B) The purchase order is issued after goods have been
received stating that the goods are in order.
(C) The amount on the purchase order is compared with
the amount on the GRN before payment is made to the
buyer.
(D) There is no relationship between GRN and Purchase
order.
(E) Goods Received Note is issued before arrival of the
goods
(6) What is the main source document for recording cash paid
into the bank?
(7) The total in a sales day book is transferred to ___________
account in the ____________ ledger.
(8) The duplicate copy of credit note will serve as the source
document to record in the _________________ book.
(9) State the importance of narration in a journal.
(10) What is the source document for cash sales?

4.9 Solution to Review Questions
(1) D
(2) C
(3) B
(4) B
(5) A
(6) Bank Pay-in-Slips.
(7) Sales ledger.
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86
(8) Returns inwards/Returns on sales.
(9) To indicate the purpose and authority of the transaction.
(10) Duplicate of the cash receipt issued by the seller.
Thanks.

87
References

Nigeria



Mcgraw Hill, USA

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88
CHAPTER FIVE

APPLICATION OF DOUBLE ENTRY BOOKKEEPING
AND THE TRIAL BALANCE

Understand the double entry principle
Use the principle of double entry to post transactions to the
relevant ledger accounts
Differentiate between various classes of accounts.
Balance the ledger accounts
Extract the Trial Balance

5.1 Introduction
From our discussion of the accounting equation in chapter two,
you will discover that every transaction has a dual effect. That is
when there is a transaction it is recorded twice in form of a
balancing equation. This principle of dual effect called the double
entry principle is applied in recording every transaction in the
ledger accounts.

5.2 Principle of Double Entry
Double entry principle states that for every debit entry, there must
be a corresponding credit entry and vice versa. If the principle is
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89
properly followed the total of the debit entries in the accounts must
be equal to the total of the credit entries.

Before we go into the application of the double entry principle let
us discuss the nature, types and functions of ledger accounts.
5.3 Ledger Accounts
A ledger is the book containing a group of accounts. It contains the
permanent records of the assets, liabilities, income, expenses and
capital of a business entity. The accounts in a ledger are those to
which entries are posted from the subsidiary books.

5.3.1 Importance of the ledger accounts
(i) They serve as the means of keeping permanent records of
assets, liabilities, income and expenses.
(ii) They provide relevant information that is required to prepare
the income statement and the statement of financial position
.
(iii) They give the origin of every transaction and the parties
involved.
(iv) They show the details of the movement in each account. For
instance a bank account will show what amount had been
deposited or how much had been withdrawn and for what
purpose.
(v) The Trial Balance is extracted from the ledger accounts at
the end of the accounting period.

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5.3.2 Types of Accounts:
Accounts can be grouped under three main headings
Real Accounts
Personal Accounts
Nominal Accounts

Real Accounts: These are accounts relating to tangible things
that can be seen, felt, touched and moved in most cases e.g.
cash, cars, goods etc. The rule of double entry to these types of
accounts is Debit, when there are additions, that is, when more of
these items are acquired. Credit, when these items are disposed
off, either by selling them off, when damaged beyond use or when
given out as gift.
Personal Accounts: These are accounts dealing with persons,
corporate bodies or even partnership. Before these accounts can
exist there must be credit transactions unlike the real accounts
where both cash and credit transactions are involved.

In personal accounts, the accounts are opened only if the persons
concerned purchase goods or services on credit or if they sell
goods or services on credit. There is no need of writing or
recording the names of persons who have purchased on cash
basis. This amounts to waste of resources since the company has
nothing to do with the persons again.

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91
The case will be different if payment is deferred till a future date, it
will be necessary to know those who owe and those who are owed
as the case may be.

Nominal Accounts: These are the accounts opened for gains or
losses. They are not real or personal but are for profits and losses
items. We only talk of benefit arising from these accounts as a
result of the services rendered. Examples are rent, salaries,
electricity, discounts, drawings etc.

5.3.3 Types of Ledgers
Ledgers can also be classified into the following four groups:-
(a) Sales Ledger or Trade Receivables Ledger
This contains all the personal accounts of customers
otherwise referred to as trade receivable.
(b) Purchases Ledger or Payables Ledger
This contains the personal accounts of suppliers of goods
and services, otherwise referred to as trade payables.

(c) Private Ledger
The Private ledger contains details of capital accounts,
drawings account, loan account, and investment account.
Usually only the senior managers have access to these
accounts in order to prevent office staff from seeing details
of the items contained therein.

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92

(d) General Ledger
The general ledger, also referred to as the nominal ledger,
contains the remaining accounts such as:-
Nominal accounts, relating to expenses, wages, rent,
sales, purchases, bad debts accounts; and
Real accounts; relating to assets such as land and
buildings, motor vehicles, inventories, plant and
machinery.

5.4 Application of the double entry principle
To record a transaction using the double entry principle the
following steps must be taken.
(i) Ensure that a transaction has actually taken place. That is at
least two parties are involved and the transaction can be
measured in monetary terms.
(ii) Identify the two main accounts involved. That is, under which
two main subject matters the transaction can be divided.

For example: Adeolu Enterprises purchased a motor car for
N750,000 cash.
The transaction can be measured monetarily and it
involves at least two parties
Two main subject matters can be identified
(a) Motor car was purchased
(b) Cash was paid
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93
(iii) Identify the one that receive value. In the above example
motor car has increased, therefore it has received value.
(iv) Identify the one that has given value cash has been
reduced, in this case it has given value
(v) Debit the account that has received value with N750,000 (i.e.
debit motor car) and credit the account that has given value
(i.e. credit cash)

5.4.1 Debit and Credit Entries
(a) An account consists of two sides; the debit side to the
left hand side and the credit side to the right hand side.
By the time it is ruled a T account is formed.
Debit side Title of the account Credit side
Date Particulars folio Amount Date Particulars folio Amount

(b) On both sides of the accounts we have column for
date, particulars (details of the transaction), the folio
and the amount.
(c) An amount recorded on the debit side is called debit
entry while an amount recorded on the credit side is
called the credit entry.
(d) The corresponding entry of the debit entry is found on
the credit side of another account and the
corresponding entry for the credit entry is found on the
debit side of another account.
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94
(e) The folio is the ledger page on which the
corresponding debit or credit entry could be found.

What is explained above can be summarized as follows
Asset Account

(Debit) N Credit N
Increase (Decrease)

Liability Account
(Debit) N (Credit) N
Decrease Increase

Capital Account
(Debit) (Credit)
Decrease Increase

Revenue Account
(Debit) (Credit)
Decrease (Increase)

Expenses Account
Debit Credit
(Increase) Decrease
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5.4.2 The general rules for recording in the ledger are as follows:
A. An account that receives is debited
(i) An increase in an asset or in an expense is debited.
That is there is addition to assets and expenses.
E.g. Office rent is paid. The rent is an expense and has
increased by the transaction; therefore the rent
account should be debited.
(ii) A decrease in revenue or a decrease in liability is
debited.
Examples
(a) Returns on sales is a decrease of sales revenue,
therefore the return on sales/returns inwards
account should be debited.
(b) When creditors are paid, the liability due to the
suppliers will reduce, therefore the creditors
account is debited with the amount paid.

B. An account that gives is credited:
(i) Any decrease in an asset or in an expense account is
credited. E.g. when a machine is sold, the amount in
the account will decrease, therefore machine account
is credited.
(ii) Any increase in liabilities or income is a credit. E.g.
when goods are sold the revenue of the company
increases, therefore sales account is credited.

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96
5.4.3 Cash Transactions
The simplest way to look at the application of the double entry is
through cash transactions.
a. When cash is received, debit cash and credit the
corresponding accounts
b. When cash is paid, credit cash account and debit the
corresponding account.

Illustration 5.1
The following transactions took place in the books of Olu Aina
Enterprises
2006
(i) January 4, 2006 Cash sales of N900,000
(ii) January 10, 2006 Payment of office rent N250,000 in
cash
(iii) January 18, 2006 Purchased N200,000 goods for cash
(iv) January 25, 2006 Purchased stationery for N40,000
cash.

Prepare the necessary ledger Accounts for each of the
transactions.

i. Cash is received for goods sold
Debit cash with N900,000
Credit sales with N900.000

Cash Account
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97
2006 N
January 4 Sales a/c 900,000

Sales Account
N 2006 N
Jan. 4 Cash 900,000

Note the narration/particulars: in the cash account the
particulars is Sales Account because the corresponding
credit entry is found in the Sales Account. Following the
same logic the particulars in the Sales Account is stated as
Cash because the corresponding debit entry is in the Cash
Account.

ii Cash is paid for office rent
credit cash account and debit rent
Cash Account
2006 N
Jan 10 Office rent 250,000

Office Rent Account
2006 N
Jan 10 Cash account 250,000

iii Purchased goods for cash N200,000
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98
Cash is given, therefore credit cash account and debit
purchases account.
Cash Account
2006 N
Jan 18 Purchases 200,000

Purchases Account
2006 N
Jan 18 Cash 200,000

iv. Purchased stationery for cash cash is given, therefore credit
cash and debit stationery account
Cash Account
2006 N
Jan. 25 Stationery 40,000

Stationery Account
2006 N
Jan. 25 Cash 40,000

Note
You will notice that for each of the four transactions of Olu
Aina Enterprises cash account is affected. The four cash
Accounts can be combined as shown below
Olu Aina Enterprises
Cash Account
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99
2006 N 2006 N
Jan 4 Sales 900,000 Jan 10 Office rent 250,000
Jan 18 Purchases 200,000
Jan 25 Stationery 40,000

This is not different from how a firms purchases and sales of
different dates will be combined in one purchases account
and sales account respectively.

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5.4.4 Transactions made on credit
(i) When cash is not received immediately for goods sold then it
is sold on credit. Therefore the receivables/customers
account receives instead of cash, there the receivables
account is debited and sales account is still credited.
(ii) When cash is not paid immediately for goods, then it is
purchases on credit, therefore, the creditor gives. Creditors
account will be credited and purchases account debited.

Illustration 4.2
R. Okonkwo is a sole trader. The following transactions took place
in his books.
N
(i) bought goods on credit from Jaja Ltd. 85,000
(ii) Sold goods on credit to Sule I & Co 176,000
(iii) Purchased some office machines on credit from
Apala Engineering Ltd. 150,000

Show the double entries for each of the transactions.

(i)
R. Okonkwo
Purchases Account
N N
Jaja Ltd. 85,000

Creditors Account (Jaja Ltd.)
N N
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101
Purchases 85,000
(ii)
Receivables Account (Sule I & Co)
N N
Sales 176,000
Sales Account
N N
Sule I & Co 176,000
(iii)
Office Machine
N N
Apala Engineering Ltd. 150,000

Apala Engineering Account
N N
Office machine 150,000

Note the following
We just decided to post the transactions to the ledger accounts for
demonstration only. In real life situation, the amount recorded in
the sales ledger, purchases ledger and office machines would
have been accumulated in the relevant books of original entry,
only the totals would be transferred to the different Ledger
accounts.

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5.4.5 Balancing a ledger Account
At the end of every period, all ledger accounts must be balanced
off. Balancing means to find the difference between the debit side
and credit side of one account.
(i) Balance carried down (bal c/d): This is the figure that is used
to force the lesser side to agree with the higher side,
because the total of the two sides of an account must be
equal.
(ii) Balance brought down (bal b/d): This is the closing balance
(bal c/d) of the period that becomes the opening balance at
the beginning of the next period.

5.4.6 Interpretation of the balances
(i) In a trade receivables account, the debit side is expected to
be greater than the credit side, therefore the balance c/d
would be on the credit side of the trade receivable account
but when it is brought down (bal b/d) in the next period, it is
debit balance. Therefore a debit balance in trade receivables
account and other assets account represents an asset.
(ii) In a trade payables account, the credit side is usually greater
than the debit side. Balance c/d is on the debit side and
balance b/d on the credit side. This is a liability.
(iii) The cash account will always be a debit balance, except
where it is a bank account when it can be a credit balance
(bank overdraft). Detail of this shall be dealt with in Chapter
Five.
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103
(iv) The capital account will always be a credit balance.

5.4.7 Comprehensive Illustration
We shall now take a comprehensive question to demonstrate all
the principles we have explained in this chapter.

Illustration 5.3
Mensa Joe Enterprises started a retail business, selling cement on
retail basis. On 1
st
of March 2006, he introduced the following into
the business:
(i) Motor van valued at N480,000
(ii) Cash from his salary account N330,000
(iii) Money borrowed from a friend N66,000

The following transactions took place in March

N
March 3 Purchased cement on credit from Fola Ltd.
189,000
,, 3 Paid carriage on cement to warehouse 16,456
,, 6 Sold goods on credit to Aburi & Co 190,000
,, 8 Sold cement for cash 26,280
,, 11 Paid sundry expenses 16,278
,, 15 Purchased cement on credit from Fola Ltd. 60,000
,, 17 Bought some Dunlop tyres from Okechukwu
Enterprises on credit 10,852
,, 20 Paid cash to Fola Ltd. on account 167,500
,, 22 Aburi & Co paid cash on account 125,000
,, 25 Paid Salaries and wages 77,958
,, 25 Paid electricity bill 6,000
,, 27 Sold cement on credit to K. Opobo 68,000

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(i) Open the ledger accounts and post the above transactions
(ii) Balance the ledger accounts.

Mensah Joe Enterprises
Capital account
2006 N 2006 N
March 31 Bal c/d 810,000 March 1 Cash 330,000
March 1 Motor vehicle 480,000
810,000 810,000
April 1 Bal b/d 810,000
Loan account
2006 N 2006
March 31 Bal c/d 66,000 March 1 Cash Account 66,000
Cash account
2006 N 2006 N
March 1 Capital 330,000 March 3 Carriage inward 16,456
,, 1 Loan 66,000 11 Sundry expenses 16,278
,, 8 Sales 26,280 ,, 20 Fola Ltd. 167,500
,, 22 Aburi & Co 125,000 ,, 25 Electricity bill 6,000
31 Bal c/d 263,088
547,280 547,280
April Bal b/d 263,088
Motor vehicle Account
2006 N 2006 N
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105
March 1 Capital 480,000 March 31 Bal c/d 480,000
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106

Carriage Inwards
2006 N 2006 N
March 3 Cash 16,456 March 31 Bal c/d 16,456
Aburi & Co-Debtor
2006 N 2006 N
March 6 Sales 190,000 March 22 Cash 125,000
March 31 Bal c/d 65,000
190,000 190,000

Fola Ltd. Creditor
2006 N 2006 N
March 20 Cash 167,500 March 3 Purchases 189,000
March 31 Bal c/d 81,500 March 15 Purchases 60,000
249,000 249,000

Sundry Expenses Account
2006 N 2006 N
March 31 c/d 16,278

Motor Van expenses
2006 N 2006 N
March 17 Okechukwu 10,852 March 31 Bal c/d 10,852
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107
April 1 Bal c/d 10,852

Salaries & Wages account
2006 N 2006 N

Electricity Bill Account
2006 N 2006 N
April1 Bal b/d 6,000

Purchases Account
2006 N 2006 N
March 3 Fola Ltd.189,000
March 15 Fola Ltd. 60,000 March 31 Bal c/d 249,000

249,000 249,000
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Sales Account
2006 N 2006 N
March 31 Bal b/d 284,280 March 6 Aburi & Co 190,000
8 Cash
26,280
,, 27 K. Opobo 68,000
284,280 284,280

Okechukwu Enterprises Accounts payable
2006 N 2006 N
March 31 Bal c/d 10,852 March 17 M/V expenses 10,852
K. Opobo Account Debtor
2006 N 2006 N
March 27 Sales 68,000 March 31 Bal c/d 68,000

Notes
(i) The balance carried down on 31
st
March 2006, the end of
March became the balance brought down on 1
st
of April, the
beginning of the next period.
(ii) (a) All assets accounts, i.e. cash account, motor vehicle
account, and receivables account, have debit
balances.
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109
(b) All liabilities accounts, i.e. loan account and creditors
account have credit balances.
(c) Capital accounts have credit balances
(iii) In our illustrations in this chapter, the transactions are
posted directly to the ledger accounts. In real
practice the transactions would first pass through the
books of original entry.
5.5 Trial Balance
A Trial Balance is a list of balances extracted from the ledger
accounts at a given date, arranged according to whether they are
debit balances or credit balances. The total of the debit and credit
balances should agree if the double entry rules have been
properly followed. Though a Trial Balance can be drawn at any
time, it is usual practice to prepare it at the end of an accounting
period before preparing the entitys final accounts.

Illustration 4.4
We can now draw up the Trial Balance to our illustration 4.3
Mensah Joe Enterprises
Trial Balance at 31 March 2006
Dr Cr
Capital 810,000
Loan 66,000
Cash 263,088
Carriage inwards 16,456
Debtor Aburi & Co 65,000
Creditors 81,500
Sundry expenses 16.278
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110
Motor van expenses 10,852
Salaries and wages 77,958
Electricity bill 6,000
Purchases 249,000
Sales 284,280
Account payable 10,852
Debtor Opobo 68,000 _______
1,252,632 1,252,632
NOTE
(i) The two receivables (i.e. Aburi & Co and Opobo) accounts
could have been summed up in the General Ledger but they
are shown separately here for convenience.
(ii) The balances brought down represent the position of the
items in the Trial Balance . For instance, the balances
brought down for capital, loan, creditors, sales and accounts
payable are on the credit side, this is also their position in
the Trial Balance .
5.5.1 Uses of the Trial Balance
The main uses of the Trial Balance are:
(i) To check the arithmetical accuracy of entries in the ledger
(ii) To detect such errors of posting that can easily be identified
by the Trial Balance
(iii) To facilitate easy preparation of the final accounts.

4.5.2 Errors not affecting Trial Balance Agreement
The preparation of a Trial Balance does not prove that
transactions have been completely and correctly recorded in the
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111
proper accounts. There are errors that do not affect the agreement
of the Trial Balance and they include the following:
(i) Error of omission: This is a complete omission of a
transaction from the ledger. Both the debit entry and the
credit entry were not recorded.
(ii) Error of principle: This is the correct posting of a transaction
in the correct side of the ledger but in a wrong account. For
instance a repair of motor vehicle is posted to motor vehicle
account.
(iii) Error of commission: This is an error within the same class
of account but affecting different persons. It is the posting of
entry to the account of a person other than the one intended.
(iv) Compensating errors: This is where one or more errors are
cancelled out by one or more errors elsewhere. For instance,
sales account may be understated by N800 and wages and
salaries account also understated by N800.
(v) Complete reversal of entries: This involves error in which, for
a transaction, the account that ought to be debited is
credited and the one to be credited is debited. For instance,
cash paid to creditors is debited in cash account and
credited in creditor account.
Errors of original entry: double entry is correctly observed but the
original figure that is posted from the subsidiary books is incorrect
4.5.3 Errors that affect the Trial Balance
The total of the debit side and credit side of the Trial Balance may
not agree which means that one or more errors have been
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112
committed. Some of these errors are:
(i) Arithmetic errors in balancing ledger accounts
(ii) Using one figure for the debit entry and another figure for the
credit entry in respect of one transaction.
(iv) Errors of extracting the wrong figure from the ledger to the
Trial Balance
(v) Listing a debit balance to the credit side of the Trial Balance
(vi) Listing a credit balance to the debit side of the Trial Balance.
(vii) The posting of debit as credit or vice versa while the other
entry is correctly made.
(viii) Making an entry on only one side of the accounts, omitting
the second entry.

4.6 Correction of Errors
There are two approaches to the correction of errors. This is
dependent on the effect of the error on the Trial Balance . For errors
which do not affect the agreement of Trial Balance totals, there will
always be two affected accounts in between which the error will be
corrected, while errors which affect the agreement of the Trial
Balance will affect only one ledger account, thereby requiring one
other account, which is the Suspense Account for correction to be
effected.
4.6.1 Suspense Account
The suspense account is an account in which the net difference in
Trial Balance totals is recorded pending the location and
correction of the errors causing the difference.
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4.6.2 Location of Errors
Errors which affect the agreement of the Trial Balance totals are
more easily discovered than those which do not affect Trial
Balance totals. In most cases errors not affecting the Trial
Balance will come to light through complaints from affected third
parties such as customers or suppliers.
An error of or either type can be located by taking the following
steps:
(i) Re-cast the addition of the Trial Balance
(i) Check for any omission of the Trial Balance
(ii) Make sure that the ledger balances appear on the correct
side of the Trial Balance i.e. Income, Liabilities, capital and
sales for the credit side while Expenses, Assets, Drawings
and Purchases should be on the debit side.
(iii) Check for correct transfer of ledger balances to the Trial
Balance .
(iv) Take a general look at the entries in the ledger to see if a
figure close to the difference sought is in them.
(v) Check the double entries in the ledger.
(vi) Check the arithmetic in the ledger.

5.6.3 Steps involved in correcting Errors
In correcting errors which are not revealed by the Trial Balance
the following steps should be taken:
(i) Read the question well and try to understand the transaction
involved.
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114
(ii) When the transaction is understood, determine the accounts
involved and the entry which ought to be passed.
(iii) Compare the entries which ought to be passed with what
has been done, as reported in the question.
(iv) On the basis of the observed difference, effect the correction
of error.

Illustration 5.5
After extracting the Trial Balance of Giringori Enterprises on 31 March,
2006 a difference of N6,180 was discovered. A review of the ledger
revealed the following errors:
(a) A sum of N720 on a creditors account was omitted from the
balance of creditors.
(b) An item of furniture purchased for N5,760 had been debited to
repairs.
(c) The payments side of the cash account had been undercast by
N3,900
(d) The total of one page of the sales day book had been carried
forward as N12,924, whereas the correct amount was N15,084.
(e) A debit note of N1,260 received from a customer had been posted
to the wrong side of his account.
(f) Mr. Laku whose debts of N3,120 to the business had been written
off, paid during the year. His personal account was credited but no
corresponding entry was made.

You are required to:
(i) Prepare Journal entries to correct the errors.
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115
(ii) Write up the Suspense account.

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116
GIRINGORI ENTERPRISES
(i) Journal Entries on 31 March, 2006
DR
CR
N N
(a) Suspense Account D 720
To Creditors Account 720
(Being entry in respect of omitted
Creditors balance)

(b) Furniture Account Dr 5,760
To Repairs Account 5,760
(Being correction of the purchase of
Furniture earlier debited to repair Account)

(c) Suspense Account Dr 3,900
To Cash Account 3,900
(Being correction of the undercasting
of cash book payment)

(d) Suspense Account 2,160
Sales Account 2,160
(Being correction of wrong amount
c/f on one page of the sales daybook)

(e) Suspense Account 2,520
Receivables Account 2,520
(Being correction of posting a
debit note to the page of the Sales day book)

(f) Cash Account 3,120
To Suspense Account 3,120
(Being entry of recovered debt
omitted from cash account)

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117
(ii) Suspense Account
N N
Creditors 720 Trial Bal diff 6,180
Cash 3,900 Cash 3,120
Sales 2,160
Receivables 2,520 _____
9,300 9,300

5.7 Comparing manual and computer based accounting system
Computers are programmed to perform mechanical tasks with
great speed and accuracy. The computer can re-arrange
accounting data in a required format and can add and balance
accounting data programmed into it automatically. Therefore they
eliminate the need for copying and re-arranging what has already
been entered into the computer system. They also eliminate most
of the paper work required in a manual accounting system.

However, the procedure and principles involved in the operation of
manual and computer based accounting system are usually the
same.

The human aspects in the processing of transactions through the
computer are as follows:
(i) Determine which transactions to be recorded in the
accounting records.
(ii) Determine which accounts to debit or credit
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118

5.7.3 Recording in computer-based system
The manner in which accounting data is recorded in a manual
based accounting system is different from how it is recorded in the
computer based system.
(i) Accounting data are not handwritten but entered through the
keyboard, optical scanner and other input devices.
(ii) Accounting data are entered in a data base instead of the
books of original entry.
(iii) Therefore data posted to the ledger accounts in a computer-
based system come directly from the data base and not from
the books of original entry.
(iv) The information required for the preparation of the Trial
Balance is already contained in the data base; they are
automatically extracted by the computer.

5.8 Summary
In this chapter we have discussed the double entry system. We
also described the ledger accounts and the rules of debits and
credits in these accounts.

We prepared the Trial Balance and extracted the Trial Balance .
We discussed the uses of the Trial Balance and touched on
possible errors. We also discussed briefly the use of the computer
to record accounting transactions.

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119
Review Questions

(1) Which of the following will increase the value of the account?
I. Debit an asset account
II. Debit a liability account
III. Debit an expense account
IV. Debit an income account

(A) I and II
(B) I and III
(C) II and III
(D) II and IV

(2) When a photocopy machine is purchased on credit for
N500,000 state the account to be debited and credited
Debit Credit
(A) Office equipment Purchases
(B) Purchases Office equipment
(C) Seller Office equipment
(D) Office equipment Seller

(3) An entry on the right-hand side of a ledger account is
(A) Credit
(B) Debit
(C) Transaction(D) Balance c/d

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120
Use the following information to answer questions 4 and 5

The following two accounts show the application of the double entry for
a transaction on a particular date.
Motor Vehicle Olu Ventures
N N
Olu Ventures 75,000 Cash 15,000 Motor Car 75,000
Bal c/d 60,000 ____
75,000 75,000

(4) What does the entry on the debit side of Motor vehicle account
represent?
(A) Olu Ventures purchased N75,000 motor vehicle
(B) A motor vehicle of N75,000 is purchased from Olu Ventures
(C) Motor vehicle is sold to Olu Ventures for N75,000
(D) Olu Ventures sold a motor vehicle for N75,000

(5) What does the balance c/d in Olu Ventures account stand for?
(A) Trade Payables
(B) Trade Receivable
(C) Accounts payable for motor car
(D) Accounts receivable for motor car

(6) Information stored in a computer-based accounting system which
can be arranged into any desired format is called ___
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121
(7) The relationship between the ledger and the Trial Balance is that
a debit balance in the ledger will be on the _____ side of the Trial
Balance and a credit balance on the _______ side.
(8) How does the Trial Balance complement the usefulness of the
double entry principle?
(9) State any four types of errors that do not affect the Trial Balance
(10) While the Trial Balance proves the equality of the debit and credit
entries in the ledger it does not __________ such errors.
(11) It is common to divide the ledger for a large organisation into four
separate ledgers known as the general, __________,
___________ and ___________.

5.9 Solution to Review Questions
(1) B
(2) D
(3) A
(4) B
(5) C
(6) Database
(7) Debit, credit
(8) The Trial Balance tests whether the principle of double entry
is properly followed in recording in ledger accounts.
(9) - Error of principle
- Error of commission
- Error of complete omission
- Errors of compensation
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122
(10) Detect.
(11) Private, Sales ledger and Purchases ledger.

References
Accounting Right,
Book 1, Temlad Press International, Ibadan

Nigeria



Mcgraw Hill, USA

Njikolai & Bazley (2000) Instructors Manual, Intermediate Accounting
South-Western College Publishing, Ohio

Thanks.

123
CHAPTER SIX
CONTROL OR TOTAL ACCOUNTS
At the end of this chapter candidates should be able to
Explain control accounts and know their usefulness.
Know the main types of control accounts
Prepare control accounts from given information
Describe trade receivable statement or statements of
account
Prepare trade receivables statement or statement of
accounts.

6.1 Introduction
In a small organisation it may be possible for one person to
maintain all the ledger accounts. Where a business maintains a
large number of accounts it will become necessary to divide the
ledger into sections and to assign the recording of each section to
different persons. The main areas to which such ledgers can be
divided are in the subsidiary ledger, trade ledger, trade receivables
ledger, trade payables ledger and general ledger.
In very large organisations, the sub-division may further be divided
among employees.
Where this type of divisions takes place, it will be necessary to
institute controls on the accuracy of the postings made to each
ledger. This is achieved by maintaining total accounts for trade
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124
receivables and payables in the general ledger. These total
accounts are referred to as control accounts.
6.2 The Nature and Functions of Control Accounts
A control account is an account, the balance of which reflects the
aggregate balances of many related subsidiary accounts which
are part of the double entry system.

It is a memorandum record only, it does not form part of the double
entry system but it is kept using double entry principle. Control
accounts can be kept in respect of customers (sales ledger)
accounts, suppliers (bought ledger) accounts and expenses.
Control accounts are maintained to facilitate easy detection of
errors because they act as a check on the entries in the various
ledgers. Where the Trial Balance totals are not equal, balances in
each ledger can be added together and compared with the
balance in the respective control accounts. Ordinarily the two
should be equal, where there is a difference, such ledger that fails
to reconcile with the control account will be investigated rather
than all the ledger accounts.

Control accounts are also called self-balancing ledgers because
the total trade receivables and total trade payables in the general
ledger should be equal to the aggregate of the balances in the
respective individual accounts in the subsidiary ledger.

6.2.1Merits of Control Accounts
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125
The merits of using control accounts can be summarized as
follows:
They can be used to locate errors more easily
They make it difficult to commit fraud because they are
normally under the control of responsible officers and their
preparation is separate from the clerks who maintain the
individual ledger accounts.
They provide information about the total trade receivables
and total trade payables thereby making management of the
receivables and payables accounts easy.
They allow for account set-off
6.2.2 Sources of Information for Control Accounts
Information recorded in control accounts are obtained from:
Receivables and creditors accounts
Returns inwards and outwards accounts
Bills payable and receivable accounts
Dishonoured cheques
Cash paid to creditors and cash received from receivables
(obtained from the cash book).
Discount received and discount allowed accounts
Sales day book and purchases day book.

6.2.3 Receivables or Sales Ledger Control Account
Sales ledger control account is the account containing the
summary of all trade receivables or customers accounts. What is
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126
posted to the debit side of this account is the aggregate of all the
items recorded on the debit side of the receivables accounts. The
same thing applies to the credit side of the account.
Summary of Entries
(i) Debit (a) Credit Sales from sales day book
(b) Dishonoured cheques from customers
(c) Debit notes issued
Credits:(a) cash received from receivables as recorded in the
cash book.
(b) Discount allowed as recorded in the cashbook
(c) Returns inwards as recorded in the sales return
day book.
(d) Set off between sales ledger control and
purchases ledger control accounts
(e) Bad debts written off

6.2.4 Trade payables or Purchases Ledger Control Account
This is the account containing the summary of all the accounts of
the creditors or suppliers in the purchases ledger.

Summary of entries in the Purchases Ledger Control
Accounts
Debit entries
(a) Payment to customers obtained from the cash book
(b) Returns outwards
(c) Cheques paid to suppliers from the cash book
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127
(d) Discount received from the memorandum column on the
credit side of the
(e) cash book
(f) Credit notes
(g) Transfer between sales ledger control and purchases ledger
control accounts.

Credit entries
(a) Credit purchases obtained from the purchases day book
(b) Cash refund from suppliers
(c) Dishonored bills payable

NOTE
Cash sales should not be debited to the sales ledger control
account rather cash sales should be debited to the cash book.
Cash purchases should also not be credited to purchases ledger
control account.
Illustration 6.1
Extracts from the books of JK Ltd. shows the following balances
for the month of June 20X6
N
Sales ledger balances 1
st
June 20X6 4,702
Purchases ledger balances 1
st
June 20X6 2,757
Sales journal balances 30
th
June 20X6 37,437
Purchases journal balances 30
th
June 20X6 40,800
Returns Inwards 910
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128
Returns Outwards 749
Receipts from Customers Cash 38,529
Discount allowed 1,345
Payment to Customers 35,415
Discount received 746
Bad debt written off 115
Sales ledger set off 209
Purchases ledger set off 110
On 30
th
June 20X6, it was discovered that a supplier was paid
twice in error for N157. The amount was refunded on that date.
You are required to determine the sales and purchases ledger
balances at 1
st
July 20X6. (Adapted from ATS ICAN)
JK Ltd.
Sales Ledger Control Account
20X6 N 20X6 N
1
st
June Bal b/f 4,702 30
th
June Cash 38,529
30
th
June Sales 37,437 30
th
June Returns inwards 910
30
th
June discount allowed 1,345
30
th
June bad debts 115
30
th
June set-off 209
______ 30
th
June bal c/d 1,031
42,139 42,139
1
st
July bal b/d 1,031

Thanks.

129

Purchases Ledger Control Account
20X6 N 20X6 N

30
th
June returns outwards 749 1
st
June bal b/f 2,757
30
th
June Cash 35,415 30
th
June purchases 40,800
30
th
June discount received 746 30
th
June cash refund 157
30
th
June set-off 110
30
th
June bal c/d 6,694 _____
43,714 43,714
1
st
July bal c/d 6,694
Illustration 6.2
Aji Father Enterprises controls his Trade payables accounts by
drawing up monthly, a Trade Payables Ledger Control Account in
two parts A and B.
The following figures are available at January 31
st
2006 when
there is a difference on the Trial Balance of N2,000.
A B
N N
Jan 1 Balances on Trade Payables (credit side) 18,400 13,600
Jan 1 Balances on Trade Payables Ledger (debit side) 150 184
Jan 1 31 Purchases 114,512 17,372
Jan 1 31 Returns 11,000 1,652
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130
Jan 1 31 Sundry charges by suppliers 1,200 144
Jan 1 31 Cheques paid to suppliers 17,980 13,420
Jan 1 31 Discount received from suppliers 1,420 1,180
Jan 31 Balances carried down to debit side 150 132

The book-keeper in charge of the A Ledger makes his accounts total
N113,712 while the clerk in charge of the B Ledger makes his Ledger
balances total N16,812.

Draw up the two Control Accounts and draw any conclusion you can
from them.
AJI Father Enterprises
Ledger Control Account A
2006 N 2006 N
Jan Balance b/d 150 Jan 1 Balance b/d 18,400
1 31 Returns 11,000 1 31 Purchases 114,512
1 31 Bank 17,980 1 31 Sundry charges 1,200
1 31 Disc. Received 1,420 31 Balance c/d 150
31 Balance c/d 113,712 _______
134,262 134,262
Feb 1 Balance b/d 150 Feb 1 Balance b/d 113,712

Trade Payables Ledger Control Account B
2006 N 2006 N
Jan Balance b/d 184 Jan 1 Balance b/d 13,600
1 31 Bank 13,420 1 31 Purchases 17,372
1 31 Disc Received 1,180 1 31 Sundry charges 144
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131
1 31 Returns 1,652 31 Balance c/d 132
1 31 Balance c/d 14,812 _____
31,248 31,248
Feb 1 Balance b/d 132 Feb 1 Balance b/d 14,812

The Control Accounts reveal that there is a difference of N2,000
between the Control Account for the B Ledger (N16,812 N14,812)
which is the total discovered by the book keeper in charge of that
Ledger. The A Ledger seems to be correct. The obvious solution is to
check the Ledger entries in the B Ledger very carefully.

6.2.5 Trade Receivables Statements or Statements of Account
Trade receivables statements are documents sent periodically, usually
once a month, by a seller to his customers showing the position of their
accounts up to a certain date. Each statement gives the particulars of the
invoices, debit notes and credit notes that the seller has sent to the
customer during a month, payment made and how much the customer
owes the seller and when the amount will be due for payment. The
statement is often a copy of the customers account in the sellers books.

The statement may be kept for reference purpose or returned to the seller
with the customers cheque. In either case neither the customer nor the
seller records the statement in his books.
Illustration 6.3
The following transactions took place between Sisi Eko Enterprises of 2,
Balinga Street, Lagos and her customer Ambrose & Co of 10 Dennis
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132
Avenue, Ikeja in January 20X1.

2
nd
Jan 20X1 Invoiced goods worth N23,120 on invoice number 426
9
th
Jan 20X1 Invoiced goods worth N16,240 on invoice number 489
16
th
Jan. 20X1 Ambrose & Co paid a sum of N25,140 with cheques
22
nd
Jan. 20X1 Invoiced goods worth N52,910 on invoice number 563
25
th
Jan. 20X1 Credit note number 1326 for N6,000 was sent
Required:
Prepare a Trade Receivables Statement to show these transactions
(ATS ICAN)
SISI EKO Enterprises
2, Balinga Street, Lagos
Ambrose & Co January 20X1
10, Dennis Avenue, Ikeja
Date of Details Invoice/ Debits Credits Balances
Invoice Credit
January Note No N N N
2
nd
Goods 426 23,120 23,120
9
th
Goods 489 16,240 39,360
16
th
Payment Cheque 25,140 14,220
22
nd
Goods 563 52,910 67,130
25
th
Credit note 1326 6,000 61,130
Amount due on 31
st
January 61,130
Cash discount terms: 5% for payment within 15 days
6.3 Summary
In this chapter we have explained the importance of control
account in detection of error and in the management of the
subsidiary accounts. We also showed through illustration how
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133
errors in a Trial Balance that does not balance can be detected
easily through the control account. We also described the
receivables statement and how they are prepared.
Multiple- choice questions and short-answer questions.
(1) When there is a set off between trade receivables and trade
payables, and creditors the amount is
A. debited in sales ledger control account
B. debited in purchase ledger control account
C. refunded to the customer
D. Debited in the cash book
E. Credited in the cash book

(2) Which of the following will NOT be recorded in the sales
ledger control account?
I. Amount received from receivables
II. Bills payable discounted
III. Cash sales
IV Discount allowed

A. I and II
B. I and III
C. II and III
D. II and IV
E. II,III and IV
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134
(3) Control accounts are also called
I. Total accounts
II. Self balancing ledger
III. Three column cash book
IV General journal
A. I and II
B. II and III
C. I and III
D. III and IV
E. I,III, and IV
(4) What is the effect of purchases set-off on control account?
A. It will reduce amount receivable from trade receivables
B. It will increase the amount receivable from trade receivables
C. It will require issue of credit note to the trade payables.
D. It will require to supply goods amounting to the set-off
in full settlement.

(5) What is the source of information for dishonoured cheques
recorded in total account?
A. Bank statement credit side
B. Cash book credit side
C. Cash book debit side
D. Debit note
E. Credit note
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135
(6) The account in the general ledger that after posting shows
the total amount owed and agrees with the totals in the
subsidiary ledger is termed the _______ account.
(7) How often are postings made to the general ledger?
(8) A supplementary record used to provide detailed information
for control account in the general ledger is known as
_______ ledger.
(9) List the items that are normally posted to the credit side of
the purchases ledger control account.

(1) B
(2) C
(3) A
(4) A
(5) B
(6) Purchases Ledger Control account
(7) Every month end
(8) Subsidiary ledger
(9) (i) Credit purchases
(ii) Cash refund from suppliers
(iii) Dishonored bill payable

Thanks.

136
References

Nigeria



Mcgraw Hill, USA

Njikolai & Bazley (2000) Instructors Manual: Intermediate Accounting

Ola, C. S. (1986) Principles and Techniques of Accountancy, Macmillan
Nig. Publishers Ltd.. Nigeria

Thanks.

137
CHAPTER SEVEN

ACCOUNTING FOR CASH TRANSACTIONS

Know the need for control over cash
Know basic requirements for internal control over cash
Distinguish between trade discount and cash discount
Know the need for the use of petty cash book
Explain the importance of using the imprest system to
control cash.

7.1 Introduction
Cash is defined to include cheques, money order, coins and paper
money that a bank will accept for immediate deposit from a
customer.

Cash is the asset most susceptible to loss through theft and other
means; therefore there is a need for proper internal control over
cash to minimize the loss of cash.

7.2 The need for Control over Cash
A good internal control over cash will help management to achieve
the following objectives:
(i) There will be accurate accounting for cash transactions.
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138
(ii) Management will maintain sufficient amount of cash at all
times
(iii) Management will not keep excessive cash rather they will
invest idle cash in profitable ventures.
(iv) It will prevent losses of cash from fraud or theft.
(v) It will save employees from unnecessary suspicion and
harassment that result from losses of cash through fraud and
theft.

7.2.1 How to Handle Cash
In order to have good internal control over cash, the following
steps should be taken in handling cash:
(i) Cash must be deposited daily in the bank
(ii) All payments (except for petty cash transaction) should be
made by cheques.
(iii) The function of receiving cash should be separated from that
of maintaining records of cash. Each function should be
performed by different persons.
(iv) All cash receipts must be recorded in a cash register. At the
end of each day the amount in the register should be
compared with the physical cash.
(v) All payments must be checked and approved in writing by
responsible officers before payments are made.
(vi) The function of approving payment must be separated from
the function of signing cheques.
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139
(vii) Carbonized receipts must be issued for all cash sales and
cash received.
(viii) When payment is made for a transaction the invoice and
other supporting documents relating to that transaction
should be stamped paid with date so that payment will not
be made for a transaction twice.

7.3 Definition of Some Terms Relating to Control Over Cash
(i) Voucher System: A voucher system involves a written
authorization called a voucher that is prepared for every
cash payment transaction. It requires that every transaction
be verified, approved and recorded before payment is made.
(ii) Voucher: A voucher is a written authorization used in
approving a transaction for payment.
(iii) Voucher register: This is a special journal used to record
the payment of cash.
(iv) Cash over or short: This is the account in which errors in
making change to a cash customer would be recorded.

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140
7.4 Trade Discounts and Cash Discounts
In chapter two we describe the trade discount as a reduction in the
invoiced price for goods and that it is usually given for bulk
purchase. We also explain that only the net amount of purchases
or sales would be recorded in the books. This means that trade
discount is not part of the double entry.

6.5 Cash Discount
A cash discount is also called a settlement discount. It is given for
prompt payment. The cash discount on sales is referred to as
discount allowed and the cash discount on purchases is referred
to as discount received.

A cash discount is not recorded until the customer has fulfilled the
terms of payment specified in the invoice. When cash is paid
promptly the customer will deduct the discount from the amount
due.

Illustration 7.1
Appiah Enterprises sold goods to Sule Ventures for N250,000. A
trade discount of 10% was granted and cash discount of 5% if
payment is made within 60 days.

Required:
Calculate (i) The net sales value (ii) the cash discount and the
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141
amount received by Appiah Enterprises if it paid within 60 days.

Immediately the goods were sold a trade discount of 10% is
deducted i.e.
N
Invoiced price 250,000
Less: 10% trade discount 25,000
Net sales value 225,000

Assuming the customer paid within 60 days the amount due, the
settlement discount of 5% would be deducted from N225,000. i.e.
N
Net sales value 225,000
Less: Cash discount of 5% 11,250
Amount received by Appiah Enterprises 213,750

7.4.2 Accounting Treatment of Cash Discounts
(a) Cash discounts are recorded in a memorandum column in
the cash book. Discount allowed is recorded in a column on
the debit side of the cash book, the same side in which
receipts from cash sales are recorded. Discount received is
recorded on the credit side.
(b) The sales and purchases would be recorded in the books at
their invoice value less trade discount.
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142
(c) Discount allowed is debited in discount allowed account and
credited in the receivables account. When the income
statement is being prepared the amount will be transferred
from the discount allowed account to Income statement as
expenses.
(d) Discount received is debited to trade receivables account
and credited to discount received account. When the income
statement is being prepared, it is transferred from discount
received account to statements of comprehensive income as
addition to income.

We shall illustrate the treatment for cash discount later in this
chapter.

7.5 The Main Cash Book
We have seen in chapter four that cash book records only cash
receipts and payments. Another thing is to note that cash book is a
book of original entry as well as a ledger account for cash
transactions.

In this chapter we shall consider the double column and three
column cash book.

7.5.1 Double Column Cash Book
The double column cash book has two columns on both sides of
the accounts namely; cash and bank columns.

The cash column records the cash transactions that involve cash
in hand. The bank column records cash transactions that involve
cash in bank. Supporting documents for these bank transactions
are mainly cheques and pay-in-slips.

Contra entries
When related to the cash book, contra entry refers to either the
lodgement of cash into the bank account or the withdrawal of cash
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143
from the bank for office use.

Illustration 7.2
Mallam Ture has been in business for many years as a sole trader.
His cash at hand was N75,000 but there was no bank account.
The following transactions took place during the month of June
20X6.
N
June 1 Opened bank account and paid in cash 75,000
,, 4 Rented premises and paid for 2 months by cheque 3,000
,, 7 Bought furniture and fitting by cheque 9,000
,, 11 Purchased goods for sale by cheque 12,000
,, 14 Cash sales to date 22,500
,, 16 Received cheque from Kojo on account of May Sales 12,300
,, 19 Paid Cash into bank 19,000
,, 20 Purchased goods for resale from Shuaib and Sons 15,000
,, 25 Cash Sales 11,250
,, 26 Paid cash into bank 11,250
,, 28 Sold goods to Stephens & Co 2,700
,, 29 Withdrew Cash for office use 10,000
,, 29 Paid Shuaib and Sons on account by cheque 7,500
,, 30 Paid Salaries by cash 8,155
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144
,, 30 Paid electricity bill by cheque 1,350
,, 30 Paid sundry expenses by cash 600
Required: Prepare the two column cash book of Malam Ture
Enterprises

Solution to illustration 7.2
Mallam Ture
Date Particulars L/F Cash Bank Date Particulars L/F Cash Bank
20X6 N N 20X6 N N
June 1 Bal b/d 75,000 June 1 Bank C 75,000
,, 1 Cash C 75,000 ,, 4 Premises 3,000
,, 14 Sales 22,500 ,, 7 F & Fittings 9,000
,, 16 Kojo 12,300 ,, 11 Purchases 12,000
,, 19 Cash C 19,000 ,, 19 Bank C 19,000
,, 25 Cash Sales 11,250 ,, 26 Bank C 11,250
,, 26 Cash C 11,250 ,, 29 Shuaib & Sons 7,500
,, 29 Bank C 10,000 ,, 29 Cash C 10,000
,, 30 Salaries 8,155
,, 30 Electricity bill 1,350
,, 30 Sundry expenses600
______ ______ ,, 30 Bal c/d 4,745 74,700
118,750 117,550 118,750 117,550
July 1 Bal b/d 4,745 74,700

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145
NOTES
(i) When cash was paid into the bank we debited bank account
and credited cash account and we indicated by C in the
ledger folio column that it is a cash transaction.
(ii) When cash was withdrawn from the bank for office use, it
was also a contra entry. We debited cash account and
credited bank account.
(iii) The transactions of June 20 and June 28 did not pass
through the cash book because they were not cash
transactions.
(iv) The cash book will normally show a debit balance but the
bank column may show a credit balance when the business
enjoys overdraft facility from the bank, otherwise a person
cannot spend more than what he has.

7.5.2 Three Column Cash Book
The three column cash book has three main columns for discount,
cash and bank. The only additional column is the discount column.
Discount allowed is shown as a memorandum column on the debit
side of the cash book. Discount received is shown as a
memorandum column on the credit side of the cash book.

As explained earlier, memorandum records do not form part of the
double entry.
Illustration 7.3
Solo Enterprises started a business with N96,000 on July 20X6
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146
and paid the money into the bank on 4 July, 2006. His transactions
for the rest of the month were as follows:
20X6 N
4/7 Purchases by cheque 32,760
7/7 Credit purchases 30,240
,, Electricity paid by cheque 600
,, Rent paid by cheque 840
10/7 Sales - on credit 51,024
- cheque 60,000
- by cash 576
,, Drew cash for office use 2,400
11/7 Paid trade payables by cheques 18,120
,, Cash discount recorded from creditors 384
12/7 Cash Sales 20,538
,, Wages paid by cash 600
14/7 Cheques received from customers 47,040
,, Discount allowed to customers 960
17/7 Drew cash for Office use 300
18/7 Paid cash for repairs 144
Purchases credit 54,000
- cheques 6,000
- cash 23,000
22/7 Sales cash 45,000
- cheques 20,400
24/7 Paid trade payables by cheques 32,400
Discount received from trade payables 120
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Cash Sales immediately paid into bank 2,400
26/7 Paid rent by cheque 1,800
Paid Wages & Salaries by cheques 6,720
31/7 Cash paid into bank 12,000
Drew cheque for petty cash 240

Required:
(a) Enter the above transactions in the cash book of Solo
Enterprises
(b) Show the double entry for discount on sales and discount
on purchases
(c) Show also the receivables account and the creditors
account.

SOLUTION TO ILLUSTRATION 7.3
Discount Allowed Account
20X6 N 20X6 N
July 14 Receivables 960 July 31 Bal c/d 960
July 14 Bal b/d 960

Trade Receivable Account
20X6 N 20X6 N
July 10 Sales 51,024 July 14 Balance 47,040
July 14 Discount allowed960
______ July 31 Bal c/d 3,024
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51,024 51,024
Aug. 1 Bal b/d 3,024

Discount Received Account
20X6 N 20X6 N
July 31 Bal c/d 504 July 11 Creditors 384
___ July 24 Creditors 120
504 504
August 1 Bal b/d 504

Trade Payables Account
20X6 N 20X6 N
July 11 Discount received 384 July 7 Purchases 30,240
July 11 Bank 18,120 July 18 Purchases 54,000
July 26 Discount received 120
July 31 Bank 32,400
July 31 Bal c/d 33,216 _____
84,240 84,240
Aug 1 Bal b/d 33,216
Cash Book Analysis
The cash book may be analyzed to columns according to the
nature of transactions. For instance, the debit side of cash book
with analysis columns can be as follows

Cash Book (Receipts)
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Date Particulars L/F Total Receivables Cash sales Others
20X7 N N N N
Jan 1 Bal b/d 5,400
,, 5 Cash Sales 1,440 1,440
,, 9 Receivables Ajayi 6,840 6,840
,, 12 Receivables Sannie 12,960 12,960
,, 19 Loan Dangote 32,400 32,400
,, 22 Cash sales 2,700 2,700
,, 27 Sales of assets 3,600 3,600
,, 29 Receivables Kabir 2,520 2,520 _____ _____
67,860 22,320 4,140 36,000

Cash Book Payments
Date Particulars L/F Tot al Creditors Petty cash Salaries Others
20X7 N N N N
N
Jan 2 Credit Ade 2,160 2,160
,, 4 Credit Ola 5,580 5,580
,, 7 Salaries&wages 13,320 13,320
,, 12 Telephone 7,200 7,200
,, 17 Petty cash 1,800 1,800
,, 24 Furniture 27,000 27,000
,, 27 Office rent 5,040 5,040
,, 31 Bal c/d 5,760 _____ _____ ______ ____
67,860 7,740 1,800 13,320 39,240

Note
The total of receipts is N67,860 while the total of payments is
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N62,100. Therefore the balance carried down is N5,760 (i.e.
N67,860 N62,100).
7.6 The Petty Cash Book
The petty cash book is used for recording expenses of a smaller
size than those recorded in the main cash book.
The petty cash book is usually operated on the imprest system in
which cash float is maintained. The cash float is reimbursed by the
amount spent at the end of a specific period.
The only source of cash inflows to the petty cash is the imprest.
The expenses are spread on various items which are separately
analyzed. At the end of specific periods the columns are added
and posted to the debit side of the ledger accounts to which they
relate.
7.6.1 Control over Petty Cash Imprest
A petty cash voucher must be filled and approved before the
disbursement of any expenditure. The petty cash voucher shows
the date, the amount paid, the purpose of the expenditure, the
signature of the person who approved the payment and the
signa|ure of the person receiving the money.
A surprise count of the imprest should be done occasionally so
that the fund can always be kept intact.
7.6.2 Advantages of the Imprest System
(a) It trains young staff (the petty cashier) to be responsible
about money and accurate in accounting for it.
(b) It saves the time of the main cashier, who is a person with
great responsibilities.
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(c) The main cash book will not be overloaded with payment of
items with low amount.
(d) It makes expense analysis and monitoring easy.
(e) It reduces the number of accounts to be opened in the
ledger accounts thereby facilitating balancing of periodic
accounts with ease

Illustration 7.4
Rasak Ventures maintains an imprest of N10,000 per month. The
transactions for the month of February, 20X7 are as follows:
N
Feb. 1 Petty cash in hand 2,500
Received cash to make up the imprest
Feb. 3 Bought postage stamps 650
Transport fare 400
Feb 6 Telephone bills 1,500
Paid carriage 650
Taxi fares 850
Feb 7 Paid for repairs to computer keyboard 1,600
Paid carriage 2,500
Office entertainment (beverages) 1,000
Purchase of envelopes 550

Prepare the petty cashbook for the period.
Rasak Ventures
Petty Cash book

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Date Voch. Particulars Dr. Cr. Postage & Travelling Carriage
Office
No. Stationery
20X7 N N N N N N
Feb 1 Bal b/d 2,500
Cash 7,500
Feb 3 Stamps 650 650
Transport 400 400
Feb 6 Telephone 1,500 1,500
Carriage 650 650
Taxi fare 850 850
Feb 7 Repairs 1,600 1,600
Carriage 2,500 2,500
Beverages 1,000 1,000
Envelopes 550 550
Feb 7 Bal c/d _____ 300 ___
10,000 10,000 1,200 1,250 3,150 4,100
Feb 8 Bal b/d 300
Cash 9700

7.7 Summary
In this chapter we have explained the need for control over cash,
the internal control required for the security of cash transactions
and the operation of the petty cash system.

The chapter also discussed the nature of cash discounts and the
accounting entries for cash discounts. We also explained how to
prepare double column cash book and three column cash book.

Multiple-choice and short answer questions
(1) Which of the following represents discount on goods sold?
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(A) Amount on the discount column in the credit side of the
cash book.
(B) Amount on the discount column in the debit side of the
cash book.
(C) Credit balance in a discount account
(D) Discount found in the payables account
(E) Discount found in the creditors account
Use the following information to answer questions 2 and 3
Petty cash book (Extracts)
Debit Credit
N Date Particulars Total (N)
2006
400 April 1 Balance b/d
8,600 Cash
April 30 Sundries Payment 7,200
April 30 Bal c/d 1,800
(2) What is the cash float every month?
(A) N8,600
(B) N7,200
(C) N9,000
(D) N7,600
(E) N400

(3) On 1 May; the petty cashier will be reimbursed with
(A) N1,800
(B) N7,200
(C) N400
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(D) N8,200
(E) N8,600
(4) The following are the aims of good internal control over cash
except to
(A) Prevent theft of cash
(B) Maintain the same level of cash always
(C) Maintain proper banking system for cash transactions
(D) Keep optimal level of cash
(E) Ensuring that receipts are issued for cash/cheques
received

(5) Which of the following is both a book of original entry and a
ledger?
(A) Journal
(B) Cash discount
(C) Trade discount
(D) Cash book
(E) Sales Day Book
(6) State how a voucher system helps to establish a proper
check over cash.
(7) Some steps are involved in the disbursement of cash; the
first step is to raise a voucher. List the other two steps.
(8) What specific measure should a business entity take to
ensure that it does not pay for the same transaction twice?
(9) An overdraft would be represented by a _______ balance in
a business entitys cash book
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(10) State the two types of transactions that give rise to contra
entry in the double column cash book.
(1) B
(2) C
(3) B
(4) B
(5) D
(6) A voucher system requires that every transaction for which
cash would be paid should be verified, approved and
recorded before the cash is paid.
(7) i. Authorisation of payment
ii. Issue of cheque or payment of cash
(8) All invoices relating to the transaction should be stamped
paid with the date of payment.
(9) Credit balance.
(10) (i) Paid cash into bank
(ii) Drew cash for office use.

References

Nigeria

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Mcgraw Hill, USA


Nig. Publishers Ltd.. Nigeria.

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CHAPTER EIGHT

BANKING SYSTEMS AND SERVICES

Know the types of accounts a business can open with the
bank
Understand inter bank transfers
Understand the role and operations of the electronic fund
transfer (EFT).
Recognize the causes of discrepancy between bank
statement and cash book balances.
Determine the cash available to a business for inclusion in
the end of period statement of financial position .
Prepare a bank reconciliation statement.

8.1 Introduction
In the last chapter we said that one of the ways to guide against
loss of cash through theft and fraud is to open and maintain a
bank account. Apart from guiding against theft a business entity or
customer can also enjoy some credit facilities and professional
advice from its/his bank. There are two main types of account a
customer may keep with the bank. These are current accounts and
savings accounts.

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8.2 Current Account
A current account is operated by the use of cheques. Money can
be withdrawn from the account anytime without giving prior notice
to the banker. For this reason it is called Demand Deposit. The
customer usually does not enjoy any interest on current account
balances. In a few cases, little interest may be given by the bank.
A current account customer may be granted an overdraft.

A Cheque book is issued to the account holder when a current
account is opened. Each cheque is assigned with identification
number that is serially numbered. The holder of the account can
issue cheques for payment to any person he has done business
with. However, the cheques must be duly signed by the drawer
and the signature which must be regular or identical to the
signature on the mandate card.

Money is deposited into the bank account through pay-in-slip. The
number assigned to the cheques and pay-in-slip is printed in
magnetic ink to make processing of transactions possible by the
computer.
At intervals, usually every month, the banker will send bank
statement to its customers, detailing all cash lodgement, payment
cheques, dishonoured cheques, bank charges, direct payments,
dividend warrants received on behalf of the customer etc.
8.2.1 Opening a Bank Current Account
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Every business entity is required to open a current account to
transact its business. The bank requires the customer to provide
the following items /information for opening a current account.
(a) A written application to open an account, stating the type
and purpose of the account.
(b) Two or more reference letters from people who maintain
current accounts with any branch of the bank or other banks.
(c) Completed mandate cards.
(d) Two or more passport photographs.
(e) Copy of the Article and Memorandum of Association if it is a
corporate organization or deed of partnership for partnership
firms and constitution in respect of un-incorporated body.
(f) An extract of the minutes of the meeting in which the
decision to open the account was taken.
(g) An initial deposit as may be stipulated by the bank from time
to time.
(h) In some countries evidence of payment of tax by the sole
trader, partner or the limited liability company.
(i) The specimen signature by the authorized person must be
signed on the mandate card. The signature on cheques is
compared with the specimen signature each time the
customer wants to make withdrawal.

8.2.2 Cheques
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A cheque is a written order upon a particular banker to pay a
certain sum of money to a specified person or organization. There
are three parties to a cheque namely
i. The drawer- who issues the cheque
ii. The drawee- The bank on which the cheque is written and
iii. The payee- the person to whom the cheque is payable.

One of the means by which a bank customer can know the
balance in his/her account is to record on the cheques
counterfoils the amount of money drawn and the amount of money
deposited. Another means of knowing the balance is through the
amount recorded in the bank columns of the cash book.

8.2.3 Pay-In-Slip
A bank customer fills out pay-in-slip for each deposit usually in
duplicate or triplicate. Some pay-in-slips are carbonised.

Items to be found on a pay in-slip or cash lodgement teller are:-
i. Date
ii. Bank and branch
iii. Account number
iv. Account name
v. Note and coin denomination
vi. Amount in words
vii. Amount in figures
viii. Total amount
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ix. Payers name and signature
x. Payers telephone number

Details of cheques are analyzed on the reverse side of the pay-in-
slip, if the latter is not the carbonised type.

The bank teller will sign the duplicate copy of the pay-in-slip. This
will serve as documentary evidence of the amount deposited. The
pay-in-slip can be compared with the amount debited in the cash
book.

8.2.4 Dishonoured Cheques
A business may deposit a cheque received from a customer into
its bank account but the bank may refuse to honour the cheque for
various reasons. A cheque that is so treated is referred to as a
dishonoured cheque.

A cheque may be dishonoured for any of the following reasons:-
i. The cheque is not dated
ii. The amount in words does not correspond to the figure
written on the cheque
iii. The balance in the drawers account is not sufficient to
accommodate the amount to be drawn with the cheque.
iv. The cheque has been mutilated
v. The cheque has become stale
vi. Signature on the cheque is irregular
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vii. The cheque is post-dated
viii. The cheque is not signed.
ix. Suspicion that the cheque has been stolen from the drawer
and there is a need to seek further confirmation from the
drawer.

8.2.5 Stop Payment Order
When a cheque is lost or stolen, the owner of the cheque should
issue a stop payment order on the bank. He should identify the
missing cheque by its serial number and amount if the cheque had
been issued and signed. The stop order is issued to prevent
payment to a wrong person.

8.3 Interest Bearing Accounts
Some business organisations transact a large volume of business
through their current accounts every month, and they may not be
able to earn any interest on their current account balances.
Therefore some businesses usually open some other accounts on
which they can earn interests; these could be referred to as
interest-bearing accounts. These consist of savings account and
fixed deposit account. They will transfer surplus cash from the
current account to these accounts to earn interests

8.3.1 Savings Account
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This type of account is meant for the small savers to keep their
surplus funds. This account is usually opened by individuals such
as clubs, associations, salary earners, petty traders etc. A
prospective customer who is a salary earner should bring a letter
of introduction from his/her employer, upon which he/she will be
given the banks application forms to complete and supply the
following information:
(i) His full names and address (Not P. O. Box)
(ii) Business or Occupation
(iii) Specimen signature or thumb print
(iv) Three (3) recent passport photographs, and
(v) Customers identity card or international passport or drivers
license.
(vi) The initial deposit. This varies from bank to bank. The bank
then issues the paying-in-booklet to the customer to enter
the initial deposit and every subsequent deposits.

Some other distinguishing features of savings account are:
(i) No cheques are required for withdrawal
(ii) Customers may not be granted overdraft facilities on this
type of account
(iii) Interest is payable on the sum standing to the customers
credit
(iv) The balance standing to a customers credit on savings
account is repayable on demand. Although, there is a
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dormant rule, which requires at least 7 days notice before
withdrawal is made.
(v) Customer must be present physically when withdrawal is
made.
(vi) In some years back, passbooks were issued to the customer
to show both the credit and debit entries of the account. But
nowadays, paying-in-slips and withdrawal booklets are
issued to customers to make payments to and withdrawals
from their accounts.
(vii) No reference is required for this type of account except
where cheques will be paid into the account in the future, but
a letter of introduction is required where the account will be
used to receive the customers salary.

8.3.2 Fixed Deposit Account
In this situation, an account is kept with the bank in form of
investment for a specific period of time usually 30 days, 60 days,
90 days or 180 days. A fixed rate of interest is paid by the bank on
such bank deposits. The banker needs to be adequately informed
before cash can be withdrawn from this account.
The features of this type of account are as follows:
(i) The balance standing to a customers credit on deposit
account is repayable or rolled-over upon a written application
after a stated or agreed period.
(ii) The customer is not issued with cheque book but with a
receipt or certificate indicating the terms and conditions of
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the deposit e.g. amount fixed, interest rate, date of maturity
etc.
(iii) Both the bank and the customer agree on the terms and
conditions of the relationship, such as interest rate, amount
and duration of the account.
(iv) No bank statement is issued to the customer.
(v) No reference is taken since the account requires cash
transaction. But where lodgement of cheque is anticipated in
the future, bank must ensure that references are taken and
all the necessary account opening procedures are followed.
(vi) No commission is charged by the bank.

8.4 Inter-Bank Transfers
Through the use of computer and the internet, a lot of electronic
equipment is now available which enables banks to transfer funds
from the account of one customer to another without the need for
exchange of paper document. This electronic equipment is turning
the monetary system to a cashless society.

At present in Nigeria, some of the available Electronic banking
products are Auto-Teller Machine (ATM), Electronic Fund Transfer
(EFT) and Electronic devices such as the Magnetic Ink Character
Recognition (MICR).

Apart from the foregoing, there are some other forms of electronic
banking which are yet to be available in Nigeria. These include:
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Electronic Fund Transfer At Point of Sales (EFTPOS), Debit Cards
and Smart Cards.

We shall now discuss the mode of operation of some of these
products.
8.3.2 Mode of Operation of Electronic Banking Products
i) Auto-Teller Machines (ATM)
ATM is a cash dispenser which is designed to enable
customers enjoy banking services without coming in contact
with the Bank Teller (Cashier). The machine, therefore,
performs the function traditionally reserved for cashiers. It is
electronically operated and as such response to request by
customers is done instantly.
(a) ATM is user-friendly and it guides users through the
instructions that have been pre-programmed into it for
easy operation.
(b) Access to the ATM is through the use of Personal
Identification Number (PIN) and a plastic card that
contains magnetic strips with which the customer is
identified. Banks usually handover the PIN personally
to the customer who is usually instructed not to
disclose the number to a third party.
(c) It is essential for users to ensure the safety of the ATM
card as well as to ensure that its surface is not
mutilated. Otherwise, the machine may reject it, even
where the PIN has been correctly entered.
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(d) The first step to take while using the ATM is to insert
the Card and thereafter the PIN. Then the customer
can select the service required e.g. withdrawal, in
which case the Withdrawal Key is depressed, and
then presses the number keys for the amount of
money required as well as the denominations wanted.
It is not enough to punch the amount required, it is also
necessary to press ENTER for the ATM to work.

Other functions that the machine is capable of performing are:
Printing of statements
Provision of account balances
Transfer of funds
Payment of bills
Cash Advances and
Display of Promotional messages

The objective of introducing the ATM in Nigeria is to decongest the
counter; hence these ATM can only perform withdrawal functions.

ii) Electronic Fund Transfer (EFT)
EFT system allows customers account to be credited
electronically instantly anywhere in the country especially in
banks where there is on-line service. It provides a more
suitable and cost-effective way of transferring funds when
compared with the traditional modes such as
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Mail/Telegraphic transfers. It is more secure and time saving
when money is transferred through EFT. Such money is
transferred electronically by the bank through their branches
or accredited agents.

iii) Electronic Fund Transfer At Point of Sale (EFTPOS)
This is a system which enables a customers account to be
debited instantly with the cost of purchase in an outlet. The
system requires the customer to be an ATM Card holder.

iv) Electronic Card Products (DEBIT CARD)
At present, most banks in Nigeria issue electronic debit
cards. Debit Cards are like the EFTPOS, that are supposed
to be passed to a customers account immediately.

There are two popular debit cards; the Pass Card and the
Smart Card.
(a) Pass Card
This product is processed in an IBM machine by
debiting a customers bank account.

(b) Smart Card
This is a debit card whose micro-chips contain
additional information on bio-data and financial position
of the holder.

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8.5 Credit Cards
A credit card is a convenient method of payment which embodies
two essential aspects of basic banking functions; the transmission
of payment and the granting of credits.

A credit card is similar to a cheque which is drawn upon the funds
of the credit card company rather than upon the personal account
of the customer. The credit card company would pay cash
promptly to the creditor to redeem the credit card.

At the end of the month, the credit card company bills the credit
card holder for all the drafts it has redeemed during the month.
Making sales through credit cards, suppliers receive cash more
quickly from credit sales and avoid problems of bad debts.

There are bank credit cards and non-bank credit cards.
(a) Bank Credit Cards: - Some widely used credit card is the
master card. A business may deposit bank credit card draft
directly in its bank account together with cash and cheques
received from a customer. The bank accepts the credit cards
for immediate deposit. Therefore sales to bank customers
using credit cards are treated immediately as cash sales.
The banker deducts some service charges from the
customers balances for handling the credit cards.

(b) Non bank credit cards: - Non bank credit cards drafts are
not deposited directly into the bank. Therefore non bank
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credit cards drafts received from customers are not treated
as cash sales but amount receivable from them.

The credit cards are sent to the credit cards company at periodic
intervals. The credit cards company will now send cheques to the
holder of the credit card draft. The amount received by this holder
would not be the face value of the sales made or services
rendered. The credit card company would have discounted the
amount say by 5% to pay him for handling the credit cards.

Illustration 8.1
Ossei Ltd. based in Ghana, sold some goods for N65,400 to a
customer who uses Bafo Ltd.. credit card. After seven days Ossei
Ltd. sent the credit card drafts to Bafo Ltd.. which redeems the
draft after deducting 7.5% discount.

Show the entries in the book of Ossei Ltd.

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(1) When the sales is made DR CR
N N
Receivables 65,400
Sales 65,400
To record sales to a customer using Bafo
Ltd.. credit cards

(2) When Bafo Ltd.. redeems the draft
DR CR
N N
Cash 60,495
Discount expenses on credit cards 4,905
Receivables Account 65,400
To record the collection of Amount due
from Bafo Ltd. less 7% discount.

Note: The credit card expenses will be treated as part of the
operating expenses in the income statement.

8.6 Bank Statement
The bank usually sends a bank statement to its customer at the
end of every month. The statement contains details of the receipts
and payments by and on behalf of the customer for that period.
Receipts will include cash paid into the customers account and
those paid by third parties direct into the bank. Until the customer
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172
receives the bank statement or a credit advice transaction alert in
respect of the direct credit to his bank account, the business may
not be aware of it or the amount involved.

Payment or withdrawal will also include details of cheques issued
by the customer, bank charges and payments made on behalf of
the customer to third parties by the bank ( if the customer so
directs the bank, this is called a standing order).

The balance at the end of the period represents the balance as
per bank statement. This balance can be a credit balance
(favourable) or a debit balance (overdraft). Remember though that
in the cash book of the customer, a favourable balance is a debit
balance and a credit balance is an overdraft.

8.6.1 Example of a Bank Statement
Illustration 8.2 below is used as an example of a bank statement.

Illustration 8.2
Mr. K. A. Afolabi maintains a current account No. 000023456 with
XYZ Bank Ltd.. The balance on the account as at 31/12/2001 was
N15,500 credit.

Mr. Afolabis transaction with the bank in the month of January
2002 were as follows
(i) N10,000 cash deposited on 2/1/2002.
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(ii) A cheques of N2500 issued to Mr. Afolabi by one of his
receivables was lodged into his bank account on 6/1/2002.
(iii) He drew a cash cheque number 000062 for N4000 on
7/1/2002. The cheque was presented to the bank and
payment received on that date.
(iv) He issued a cheque No.000063 for N5000 to one of his
creditors, Mr. S. O. Babalola on 10/1/2002. Mr. Babalola
presented the cheque to XYZ Bank Ltd.. on 13/1/2002 and
received payment.
(v) Received cheques totaling N22,000 from various customers
and lodged them into the account on 14/1/2002. All cheques
matured for credit to the account on 19/1/2002.
(vi) There was a standing agreement between the bank and Mr.
Afolabi that his monthly life assurance premium of N2,150
should be paid direct to the insurance company by the bank.
The bank remitted this on 25/1/2002
(vii) A customer living upcountry deposited a cash sum of N9,500
into Mr. Afolabis account No 000023456 with the local
branch of XYZ Bank Ltd.. on 27/1/2002. The bank credited
Mr. Afolabis Account the same day.
(viii) On 31/1/2002 XYZ Bank Ltd.. debited Mr. Afolabis account
with a service charge of N420.50.

You are required to prepare a statement as it would have been
prepared by XYZ Bank Ltd.. reflecting the above transactions

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XYZ Bank Limited
202 Marina, Lagos
Statement In respect of:
Account No: 000023456
Customer: Mr. K. A. Afolabi
Period covered: 01/01/2002 31/01/2002
Date issued: 05/02/2002

Date Transaction Debit N Credit N Balance N
01/01/2002 Balance b/f 15,500
02/01/2002 Cash deposit 10,000 25,500
06/01/2002 Cheque deposit 2,500 28,000
07/01/2002 Cheque No 000062 -cash 4,000 24,000
13/01/2002 Cheques No 000063- 5,000 19,000
19/01/2002 Cheque deposit 22,000 41,000
25/01/2002 Standing Order 2,150 38,850
27/01/2002 Cash deposit 9,500 48,350
31/01/2002 service charge 420.50 47,929.50

Opening Balance 15,500.00
Total Debit 11,570.50
Total credits 44,000.00
Closing balance 47,929.50

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8.7 Bank Reconciliation Statement
The bank and its customer (e.g. a business entity) maintain
independent records in respect of the transactions taking place
between them. Therefore it is necessary to reconcile the bank
statement balance with the bank balance in the cash book to be
assured that the two are in agreement on the amount of money
deposited and cheques drawn.

Usually the bank column balance and bank statement balance are
not always in agreement and they need to be reconciled.
The disagreement between the two may be traced to the following
factors:-
(a) Unpresented cheques:- These are the cheques drawn on
the bank and given to the payees but they have not been
presented for payment to the bank. The cash book of the
business has been credited (that is it has been treated as
payment through the bank by the business) this transaction
would appear on the credit side of the cash book but missing
from the debit side of the bank statement.
(b) Uncredited cheques:- these are cheques deposited in the
business bank account and not yet recorded in the bank
statement until three or four days thereafter, whereas it
would have been recorded on the debit side of the cash
book .
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The transaction will appear on the debit side of the cash
book but missing from the credit side of the bank statement.

(c) Bank charges:- These are charges made by the bank to
cover the expenses in handling bank account. The major
charges are based on the volume (i.e. turnover) of the
transactions on the account. It is sometimes called
commission on turnover (COT). Other charges are charges
for cheque book, interest charges on bank overdraft facilities
from the bank, administration expenses etc.
These charges would have been recorded in the bank
statement but will be missing on the credit side of the cash
book.

(d) Direct Debits: These are direct payments of expenses on
behalf of the business. These have the same effect as the
bank charges.
(e) Direct Credits: These are amounts received on behalf of
the business directly by the bank. The bank statement would
have been credited but the entry will be missing from the
debit side of the cash book.
(f) Error of the customer or of the bank

8.7.1 Steps Involved In the Recognition of Discrepancies
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(a) Tick items on the debit side of the cash book against items
on the credit side of the bank statement. Outstanding items
on the debit side of the cash book but missing on the credit
side of the bank statement are uncredited cheques. List
them.
(b) Tick items on the credit side of cash book against items on
the debit side of the bank statement. Items outstanding on
the credit side of the cash book but missing on the debit side
of the bank statement are unpresented cheques. List them.
(c) The remaining items on the debit side of the bank statement
are bank charges and standing order. List them.
(d) The remaining items on the credit side of the bank statement
are amounts paid into the bank directly for the benefit of the
business entity by its customers (i.e. direct credits).
(e) After all these have been adjusted, it should be possible to
reconcile the cash book balance with the balance on the
bank statement. If it is not, then there are some errors which
further investigation would reveal and be traced to their
sources.

8.7.2 Preparation of the Bank Reconciliation Statement
Two main steps are involved in the preparation of a bank
reconciliation statement.
(1) Determine the adjusted cashbook balance. This adjustment
will not be affected by items (a) and (b) above. The
adjustment will be affected mainly by items (c) and (d).
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(2) Reconciling the adjusted cash book balance with the bank
statement balance.

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180
Step 1 - Determining the adjusted Cash Balance
Format
Cash Book (with Adjustment)
N N
Balance b/d x Standing order x
Direct debit x
Dishonoured cheques x
Add:- Direct Credit x Bank charges x
Understatement x Overstatement of cash x
_ Adjusted cash balance x
xx xx

The adjusted cash book balance is the amount that will be shown
in the statement of financial position

Step 2 - Reconciling the adjusted cashbook with the bank
statement
N
Adjusted Balance as per cash book xx
Add: Unpresented cheques xx
Error of overstatement by bank xx
xx
Less: Uncredited cheques xx
Error reducing the business balance
committed by bank xx
xx
Balance as per bank statement xx
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Using an Alternative Method
N
Balance as per bank statement xx
Add: Uncredited cheques xx
Bank error reducing cash balance xx xx
xx
Less:
Unpresented cheques xx
Bank error overstating cash balance xx (xx)
Adjusted Balance as per cash book xx

Illustration 8.3
The following bank account and bank statement relate to the firm
of Mohammed and Sons for the period of 1
st
to 12
th
September,
2007
Bank Account
2007 N 2007 N
Sept 1 Bal b/f 6000 Sept 2 Cheque Owen 400
3 Cash 500 2 Cheque Peter 150
5 Cheque Kuku 85 6 Cheque Ringo 105
7 Cheque Labe 220 8 Cheque Smith 365
9 Cheque Michael 155 10 Cheque Thomas 1,120
11 Cheque Ndidi 360 12 Balance c/d 5,180
7,320 7,320
Balance b/d 5,180
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183
Bank statement as at 12
th
September, 2007
2007 Debit Credit Balance
N N N
Sept 1Balance 6,000
2 Cheque no. 98876 400 5,600
3 Cash 500 6,100
4 Charges 20 6,080
5 Cheque deposits 85 6,165
6 Cheque no.98877 150 6,015
7 Cheque deposit 220 6,233
8 Cheque deposit (by Umoru) 600 6,835
9 Cheque dishonoured 85 6,750
10 Standing order 560 6,190
(Insurance Premium)
11 Cheque 98878 105 6,085

You are required to
(a) Effect the necessary adjustment to the bank account and
find the adjusted balance.
(b) Prepare a Bank Reconciliation Statement

(A) Adjusted Bank Account
Date N N
Sept 2007 Balance b/d 5,180 Bank charges 20
Direct credit (Umoru) 600 Standing Order 560
Dishonoured cheques 85
_____ Bal c/d 5,115
5,780 5,780
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Balance b/d 5,115

(B) Bank Reconciliation Statement at 12 September, 2007
N
Adjusted balance as per cash book 5,115
Add:- unpresented cheques:-
Smith 365
Thomas 1,120 1,485
6,600
less:- Uncredited cheques:
Micheal 155
Ndidi 360 515
Balance as per Bank statement 6,085

Illustration 8.4
The following is the summary of the cash book of Akintola
Enterprises for the month ended 31/12/20X5

Cash Book
N N
Balance b/d 2,110 sundry payment 23,280
Sundry receipt 22,610 bal. c/d 1,440
24,720 24,720
Balance b/d 1,440

On investigation the following errors were discovered.
i. Bank charges of N53 showed on the bank statement had not
been entered in the cash book.
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185
ii. A cheque drawn for N27 had been returned by the bank
marked Returned to Drawer but this had not been recorded
in the cash book.
iii. The opening balance in the cash book was wrongly brought
down as N2,110 instead of N2,205.
iv. The last page of the pay-in-slip book showed a deposit of
N2,178 which had not yet been credited to the account by
the bank.
v. The bank had debited a cheque for N108 in error to the
entitys account.
vi. The bank statement showed an overdrawn balance of N50
vii. A payment of N70 cheque was treated as a receipt in the
cash book.
viii. Three cheques issued to suppliers for N321, N555 and N45
had not been presented for payment.

You are required to
(a) Write up the cash book.
(b) Prepare a bank reconciliation statement.

Akintola Enterprises
(a) Adjusted Cash Book
N N
Balance b/d 1,440 Bank Charges 53
Difference in opening bal. 95 Error in cheques drawn
140
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186
Dishonoured cheque 27
_____ Balance c/d 1,315
1,535 1,535
Balance b/d 1,315

(b) Bank Reconciliation Statement at 31 December 1996
N N
Adjusted balance as per cash book 1,315
Add: unpresented cheques 321
555
45 921
2,236
Less: Uncredited cheque 2,178
Debit in error by the bank 108 2,286
Balance as per Bank Statement (Overdraft) 50

Note: Payment of N70 cheque recorded in error as receipt
gave a correction of N140 in the cash book because the
error will be cancelled first before the N70 is reinstated on
the credit side.

Illustration 8.5
The following information was extracted from the records of a petty
trader as at 30
th
of June 20X9.

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187
Balance as per Bank Statement was N1,000 credit. Cash Book
balance showed N37,000 credit in the Bank Account column.
The following had been reflected in the Bank Statement but not in
the Cash book.Bank charges N5,000
Bank loan interest N1,000
Interest from investments N2,000
Dividends from shares N12,000

In addition a cheque for N20,000 issued to Kete was dishonoured
because of insufficient fund. Another cheque for N30,000 issued to
Jimoh remained unpresented. A cheque for N20,000 from
Kudiratu was yet to be credited
You are required to produce an adjusted Cash Book and then a
Bank Reconciliation as at 30
th
June 20X9.
Solution to Illustration 8.5Adjusted Cash Book Account
N N
Interest on Investments 2,000 Balance b/f 37,000
Dividends 12,000 Bank charges 5,000
Kete (dishonoured Cheque) 20,000 Interest on loan 1,000
Balance c/f 9,000 ______
43,000 43,000
Bank Reconciliation Statement as at 30
th
June 20X9
N
Adjusted Cash Book Balance (9,000)
Add: unpresented cheques 30,000
21,000
Less: Uncredited cheque 20,000
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188
Balance per Bank statement 1,000

(1) Which of the following reconciliation items will affect the cash
book balance?
I. Bank error overstating the bank balance
II. Cash book error, overstating the bank balance
III. Income received through the bank
IV. Imprest cheques
(A) I and II
(B) II and III
(C) II and IV
(D) I and III
(E) III and IV

(2) The effect of items that are recorded on the debit side of a
bank statement but are not found on the credit side of the
cash book is that
(A) Bank balance is overstated
(B) Bank balance is understated
(C) It resulted in an overdraft
(D) Has no effect on bank balance
(E) Cash book balance is overstated
(3) What is the effect of non-bank credit card draft on the
account of a business when it is deposited by the customer?
(A) Receivables account is increased
(B) Cash account is increased
(C) Payables account is reduced
(D) Sales is reduced
(E) None of the above
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189
(4) The cash book of a trader shows an overdrawn account.
Which of the following will reduce the balance when the
necessary recordings are completed?
(A) Bank charges
(B) Unpresented cheques
(C) Uncredited cheques
(D) Dividend received by bank on behalf of customer.
(E) Bank debit note
(5) Name the two main steps involved in preparing the bank
reconciliation statement.
(6) When a customers cheque that is lodged is dishonoured by
the bank, what is the effect on cash balance?
(7) Name the account that a business normally maintains with a
bank when it has fund for investment for a relatively long
period.

Use the following information to answer questions 8 & 9
Given: N
i. Balance as per cash book 23,760 DR
ii. Dividend received by bank onbehalf of customers 1,170
iii. Bank charges 360
iv. Unpresented cheques 21,600
v. Uncredited cheques 33,300
vi. Lodgements credited by the bank 750,000

(8) How much is the bank balance to be included in the
statement of financial position ?
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190
(9) Determine the balance as per bank statement.
(10) State two main functions of the Credit Card.

(1) B
(2) A
(3) A
(4) D
(5) i. Determining the correct cash book balance
ii. Reconciling the adjusted balance with the bank
statement balance
(6) It will reduce the cash balance
(7) Fixed deposit account
(8) N24,570 (i.e. N23,760 + N1,170 N360)
(9) N12,870 (i.e. N24,570 + N21,600 N33,300)

Tutorial
The N750,000 lodgements credited by the bank would affect
neither the calculation of the correct account balance nor the
bank reconciliation statement.
(10) i. Prompt payment of cash to creditors
ii. Granting of credit to customers
References

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191
Nigeria



Mcgraw Hill, USA


Nig. Publishers Ltd.. Nigeria.

Paul A. Ogwuma (1998) The Role of Technology in Banking
Development, The Nigerian Banker, A Journal of the Chartered
Institute of Bankers. (Jan. to June 1998)
Alaba Ogunsemore (1992) The Emergence and Impact of Electronic
Banking". The Nigerian Banker, A Journal of the Chartered
Institute of Bankers.

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192

CHAPTER NINE

PAYROLL ACCOUNTING


After you have studied this chapter, you should be able to:
Define and explain payroll
Explain the difference between gross salary, net salary and
take-home pay
Explain and calculate the difference between employees and
employers social security contributions
Calculate the net salary or pay of an employee where his or her
gross pay, statutory and other deductions and personal income
tax schedule are given
State the control procedures required in the management of
payroll
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193
Demonstrate your ability to record payroll activities in the
accounting record of a business organisation

9.2 Introduction
In this chapter you will learn how to calculate the salary or pay of
employees and also the various deductions that are made from
the gross pay before calculating the income tax. You will also learn
how to use the progressive personal income tax schedule to
calculate the income tax of any employee. You will learn why
statutory deductions like social security contributions are made
and how they are calculated. Finally you will learn what types of
reliefs are available to employees and how they are adjusted
before the employees net pay is calculated.

9.3 Payroll
Payroll may be defined as a record showing the names of
employees, rates of pay, hours worked, bonuses, allowances,
gross earning (salaries), statutory deductions and other
contributions withheld during a given pay period. In simple terms,
payroll may be understood as a document showing for each
worker his gross earning, any deductions (statutory and otherwise)
made from his gross earning and the net amount payable to him in
a particular pay period.

The objectives of payroll accounting are to process such
information as; Hours Worked, Pay Rate, Gross Earning,
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194
Deduction and Net Pay (salary). Business organisations record
information relating to employees pay due to the following:

1) Payroll usually constitutes the most significant or material
obligation or expense in most business establishments.

2) Business organisations are required by law to send returns
on their payroll including the amount of income tax
deducted at source to the tax authorities.

3) It is used for cost control purposes, usually in the form of
variance analysis.
4) It is also the basis upon which most tax clearance
certificates are prepared.

Employees are usually paid either a wage or a salary. Wages refer
to the type of employee remuneration package that is time based.
In this situation the rate of pay is given as a fixed amount per
hours for number of hours actually worked or reported for duty.
Salary though time based is quoted on an annual basis.

In both Ghana and Nigeria all employees are taxed under the
PAYE (Pay As You Earn) system. This is a form of withholding tax
system where the employer is legally required to deduct at source
the income tax and social security contributions from the wages or
salaries of employees and pay the same to the tax authorities.
This therefore means that the employee will not have to wait till the
end of the year for him to personally pay his tax liabilities to the
state. The PAYE is a monthly phenomenon which is seen as an
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195
estimate and as such may result in overpayment or underpayment
of an employees income tax liability.

9.4 Gross pay or earning is the total amount of wages or salaries
that employees earn in a particular period before statutory and
other deductions are made. In Ghana gross pay is the
consolidated income of an individual earned from employment.
The consolidated salary of an employee may consist of the
following components:
Basic Salary
Leave allowance
Responsibility allowance
Transport allowance
Overtime allowance
Risk allowance
The two main remuneration methods often used are: Time based
system and Piecework system. Others include: Straight salary,
bonuses, commission and allowances.

9.5. Methods of calculating Gross pay
Methods of remuneration refer to the basis used in calculating
wages of workers. In the preparation of payroll, the organisation
must initially determine the employees Gross Salary or wages
using the most appropriate remuneration plan adopted by the firm.
9.5.1 Time Based System
In this system of remuneration, employees are paid according to
number of hours actually worked multiplied by a fixed amount or
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196
rate. This simply means that the longer the period for where an
employee works, the larger his or her gross pay will be. This
method of remuneration is usually employed in the manufacturing
industries. The payment to the employees is based on this
formula:

Earnings = Clock hours x Rate per hour

Advantages
It is simple to understand and administer
Wage negotiations (changes) can easily be effected
It has stood the test of time
It provides incentive for longer period of work
It facilitates cost control
Disadvantages
There is no incentive to improve productivity and efficiency
It is not a sound accounting practice to pay all employees in
the grade the same rate irrespective of performance.
Cost of supervision under this method is very high
It is not a very good basis for cost control.
It does not encourage innovations.

9.5.2 Performance related Systems
Under this system, the remuneration in terms of wages or salaries
that is paid to each employee is dependent on his or her level of
output, performance or services rendered. Here workers are
normally given a fixed sum per unit of output so that the higher
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197
ones output is the larger his gross pay or salary. Direct labour,
cooks, painters, contractors etc. are often paid by this method. The
payment to the employee is based on the formula below:

Earnings = Number of units produced x rate per unit

Advantages
It attracts higher grade worker (scholars and macho men).
It provides direct incentive for innovations, efficiency and high
productivity without any difficulty of individual piecework rates.
It is simple to understand and administer.
It facilitates cost control.
It has stood the test of time.

Disadvantages
Output may exceed target if proper supervision is not carried
out.
It results in competition for higher grade workers thereby
increase the cost per output.
Shoddy work or inferior goods will be made, if proper
supervision is
not put in place.
It does not take into account individual disabilities.

9.5.3 Straight Salary
Under this method of remuneration, employees are paid a fixed
amount annually with a constant increase per annum. This is
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198
usually referred to as the notch system and is usually stated as
follows:
Gross Pay = 10,000,000 x 2,000,000 18,000,000.
The above statement means that this employee will receive
10,000,000 for the first year of his engagement. Thereafter his
gross pay will increase by 2,000,000 every subsequent year
following the date of his employment. This increment will not
continue when it gets to 18,000,000 until he or she is promoted to
the next grade.
It must however be noted that the gross pay under this method
does not depend on the number of hours worked or output
produced.

9.5.4 Bonus Schemes
These are schemes which are used to reward exceptional
employees by paying bonuses on top of these normal earnings
mentioned above. Such incentives vary from one company to the
other. The main purpose of providing these incentives is to
encourage workers to produce their best for the company.

9.5.6 Types of Bonus Schemes

9.5.6.1 Halsey Premium Plan.
This plan was introduced by F. A. Halsey in 1891. The plan
simply combines the time and piece rate systems. The main
features of this plan are as follows:
a. Workers are paid at a rate per hour for the actual time
taken to perform a task.
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199
b. A standard time is set for each piece of work, job or
operation.
c. If a worker takes standard time or more than the standard
time to complete his work, he is paid wages for the actual
time taken by him at the time rate.
d. If a worker takes less than the standard time, he is paid a
bonus equal to 50 % of the time saved at the time rate
fixed.
Under this system, total earnings of a worker are equal to wages
for the actual time taken by him plus a bonus. The formula for
calculating bonus and total earnings under this incentive plan is:
Bonus = 50% of [Time saved x Time rate]
Total earnings = Time rate x Time taken + 50% of [Time
saved x Time rate]

Illustration 9.1
Standard time (or Allowed time) = 250 hours.
Wages rate per hour = 15
Actual time taken = 220 hours

Thus time saved = 250hrs 220hrs = 30hrs.
Bonus = 50% [30hrs x 15] = 225
Total earnings = 15 x 220hrs + 50% [30hrs x 15] = 3,525

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Advantages of Halsey Plan.
1. It is easy to understand.
2. It guarantees a minimum time wages to all the workers. This means
that slow or lazy and relatively inefficient workers have nothing to fear
from the plan.
3. The benefits resulting from saving in time is equally divided between
workers and the employer.
4. Bonus is separately calculated for each job. As a result any time
saved by a worker on a particular job is not adjusted against excess
time taken by him on another job.

Disadvantages of Halsey Plan
1. Workers do not like the employer to share the benefits of time saved
by them.
2. It does not provide the employer with full protection against high rate
setting.
3. Extra efficiency of a worker is not fully recognised and rewarded.

9.5.6.2 Rowan Plan.
This plan is similar to the Halsey incentive plan mentioned above. The
difference lies in the calculation of bonus. The main features of Rowan
Plan are as follows:
a. Wages are paid on time basis for the actual time worked by the
worker
b. A standard time is determined for each piece of work or job.
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201
c. If a worker completes his work in standard time or in more than the
standard time, he is paid wages for the time actually taken by him.
d. If a worker completes his work in less than the standard time, he is
entitled to a bonus.
e. The Bonus is calculated as the proportion of wages of actual time
taken which the time saved bears to the standard time.

The formula for calculating bonus and total earnings under this incentive
plan is:

Bonus = Time saved x Time taken x Time rate
Time allowed

Total earnings = (Time taken x Time rate) + Bonus

Illustration 9.2
Standard time (or Allowed time) = 250 hours.
Wages rate per hour = 15
Actual time taken = 220 hours

Bonus = 30 hrs x 220 hrs x 15 = 396
250 hrs

Earnings = (220 hrs x 15) + 396 = 3,696

Advantages of Rowan Plan
1. Just like Halsey plan, it provides guaranteed minimum wages to
workers.
2. It protects the employers against loose rate setting.
3. It pays a higher bonus than that under the Halsey plan up to 50%
of the standard time saved.
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202
4. The worker is not induced to rush through the work if time saved is
more than 50% of the standard time, the bonus increases at a
decreasing rate.
5. It provides good incentives for comparatively slow workers and
beginners.

Disadvantage of Rowan Plan
1. The calculation of bonus is complicated and may not be easily
understood by workers who may suspect the employers motives.
2. In case of extra efficient workers, bonus is less than under Halsey
Plan. This is true when the time saved is more than the time taken.

8.5.4.3 Comparison of Halsey Plan and Rowan Plan

1. Bonus. When time saved increases, bonus under Halsey Plan
also keeps on increasing. But under the Rowan Plan, when time
saved increases, bonus increases only when time saved is up to
50% of the standard time allowed, thereafter the amount of bonus
begins declining. Bonus under the two plans is the same when
time saved is exactly 50%. Before 50% of standard time saved,
bonus under Rowan Plan is higher than that of Halsey Plan and
after 50% of the time saved, bonus under Rowan plan is lower
than that of Halsey Plan. For example under Rowan plan, a
person who has saved 60% of time allowed earns the same
amount of bonus if he saves 40% of the time allowed.
2. Earnings per hour. Under both plans earnings per hour of
workers keep on increasing. But the rates of earnings under the
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203
two plans differ. When time saved is less than 50% of time allowed
, the rate of increase in per hour earnings is higher in Rowan Plan
whereas when time saved is more than 50% of time allowed , the
rate increase in per hour earnings is higher in Halsey Plan. At 50%
time saved, earnings per hour under both schemes are the same.

3. Effect on labour cost. Labour cost per unit decreases as
production increases up to the standard time allowed; thereafter, it
continues to decrease but not at a faster rate. Rowan plan cost per
unit is higher than under Halsey Plan until time saved is 50% of
time allowed .Thereafter it is lower and soon becomes significantly
lower. At 50% time saved, labour cost per unit is the same under
both plans.

9.6 Allowable deductions and reliefs
These are statutory and other deductions that are expected to be
deducted from the gross salary of an employee at the end of a
given period. In Ghana these deductions include the following:

a. Income Tax
b. 5% employees Social Security Contributions
c. employees provident fund
d. Any percentage contribution towards a Special retirement
fund by an employee
e. Medical Insurance
f. Union/Senior Staff Dues or Welfare Fund Contributions
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g. Repayment of Employees Advances or Loan from
Employers
h. Hire Purchase Deductions
i. Others

The first two deductions (income tax and social security
contribution) are compulsory in Ghana. However, the other
deductions will depend on the regulations of the company in
question and the employees own preferences.

9.7 Net Pay
This is the excess of the gross pay or salary over statutory deductions
and income tax. It is often called disposable income or take home pay.
It is the pay the worker actually takes home for a given period.

At the beginning of each Government fiscal year (1
st
January in the case
of Ghana), the Minister of Finance presents the Budget to Parliament. In
Nigeria, the President presents the Appropriation bill to the National
assembly a few months before the commencement of a fiscal year (1
st

January). After due process the bill is passed into law and becomes the
Appropriation Act.

The budget statements contain the rates of income tax and any
deductible reliefs for the following year. Due to the annual changes in
rates and reliefs, the rates of income tax used in the computations in this
book are for illustration purposes only. The calculation of income tax and
net pay is as follows:
Income tax:
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Basic Salary xxxxx
Add Other Cash allowances xxxxx
Total Consolidated Salary xxxxx
Less Statutory deductions and reliefs xxxxx
Taxable Pay or Salary xxxxx
Income Tax = (Taxable pay x rate of
tax)
xxxxx

Net Pay:
Total Consolidated Salary xxxxx
Less Statutory deductions xxxxx
Taxable pay or salary xxxxx
Income Tax xxxxx
Net Pay or Salary xxxxx

Illustration 9.3
Mr Victor Kakapo has been in the employment of Pacheco Limited since
1
st
January 2005 on a salary scale of 50,000,000 per annum. For the
year 2005 his entitlements were as follows:

Inconvenience allowance 5,000,000
Leave allowance 3,000,000
Risk allowance 4,000,000
He is married with two children attending secondary schools in Ghana.
He contributes to the social security scheme. He qualifies for the
following reliefs:

Marriage 300,000
Child education 480,000
Aged dependent for two 400,000
You are required to calculate Mr Victor Kakapos Income tax and Net
pay in 2005 using the income tax rates below.
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Income Tax rate

First 1,800,000 0%
Next 1,800,000 5%
Next 4,800,000 10%
Next 27,600,000 15%
Next 33,000,000 20%
Exceeding 69,000,000 28%

Computation of Mr. Victor Kakapos Taxable Pay

Basic Salary (2005) 50,000,000
Inconvenience allowance 5,000,000
Leave allowance 3,000,000
Risk allowance 4,000,000
Consolidated Salary 62,000,000
Less Statutory deductions & reliefs:
5% Social secutity 2,500,000
Marriage 300,000
Child education 480,000
Aged dependent 400,000 3,680,000
Taxable Pay 58,320,000

Computation of Mr. Victor Kakapos Income Tax
Income Tax rate Tax amount

First 1,800,000 0% -
Next 1,800,000 5% 90,000
Next 4,800,000 10% 480,000
Next 27,600,000 15% 4,140,000
Next 22,320,000 20% 4,464,000
Total 58,320,000 9,174,000

Therefore Victor Kakapos Net Pay for 2005 is:

Basic Salary 50,000,000
Add Cash allowances 12,000,000
Total Consolidated Salary 62,000,000
Less:
5% Social security 2,500,000
Less Income tax 9,174,000 11,674,000
Net Pay or Salary 50,326,000

9.8 Accounting Entries
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For the purpose of Accounting, the entries in the pay slips are passed in
the general journal to record the payments made at the end of the given
pay period.

1. When Liabilities/Expenses are due
Debit Wages/Salaries Account with the Gross Salary.
Credit Provident Fund Account.
Credit Income Tax Account.
Credit Medical Insurance Account
Credit Union Dues Account
Credit any Other Deduction Account
Credit Payroll Payable Account with Net Salary or Wages.
Credit 12.5% Employers Social Security Fund Account
Debit Employers Social Security expenses Account (i.e.
contribution)

2. When Expenses or Liabilities are Paid

Debit provident fund account and credit Cash/Bank account
with the amount paid
Debit Income tax account and credit cash/bank with the sum
paid.
Debit any other deduction account and credit cash/bank
account with the amount paid.
Debit payroll payable account and credit cash/bank account
with the amount paid.
Debit 12.5% Employers Social Security Fund Account and
credit cash or bank account with the amount paid.

9.9 Multiple Choice Questions

1. Which document contains details of gross earnings made and
the amount of net earnings payable to a specific employee in
a particular pay period.
a. Payroll
b. Wages sheet
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c. Pay slip
d. Payment voucher
e. Salary control register
2. Which of the following payroll deductions is influenced by
statutory legislation?
a. Union dues
b. Income tax
c. Provident fund contribution
d. Salary advance
e. Loan refund

3. Which of the following is not a function of a payroll voucher?
a. It gives evidence that an employee has collected his salary
b. It shows the date of payment of wages and salaries
c. It is used to collect salary on behalf of an employee
d. It shows the total deductions from the gross salary.
e. It shows net salary payable

Use the information below to answer Questions 4 and 5.

Victor Akakpo works with a company which operates Rowan Bonus
scheme to reward its workers. His rate per hour is fixed at 250 with a
standard time of 12 hours to perform a job.

4. What is the bonus paid to Victor Akakpo when he takes 9
hours to complete a job?
a. 360
b. 2,160
c. 450
d. 563
e. 540
5. What is Victor Akakpos gross pay?
a. 2,060
b. 2,813
c. 2,160
d. 2,700
e. 41,260

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Use the information below to answer Questions 6 to 8

The pay slip of Musah Busanga for the month of August 2007 revealed
the following:
Basic Salary 100,000
Income Tax 15% of basic salary
Social Security Contribution:
Employer: 12% of basic salary
Employee: 5% of basic salary
Professional allowance: 25,000 per month

6. What was the amount of total deductions from Musah
Busangas basic pay?
a. 5,000
b. 23,750
c. 14,250
d. 20,000
e. 23,000

7. The total amount of social security contributions to the credit
of Musah Busanga for August 2007 was
a. 19,250
b. 20,000
c. 5,000
d. 17,500
e. 12,500
8. What was the net salary paid to Musah Busanga for August
2005?
a. 102,000
b. 62,500
c. 82,000
d. 89,500
e. 477,000

9. By how much of the salary will Musah Busanga take home for
the month of August 2007?
a. 87,500
b. 77,000
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c. 82,000
d. 89,500
e. 4102,000

10. When future expenses are paid for in the current year,
a. A liability is increased
b. An asset is created
c. Profit is reduced
d. Capital employed is reduced
e. Loss is increased

8.10 Examination type questions

Question 1

The table below shows the data relating to three employees of
Victorosky Ltd.. for the month ending 31
st
July 2007.

Name Regular
hours
worked
Hours
worked as
overtime
Rate
per
hour()
Busanga 250 50 45,000
Akakpo 200 45 38,000
Abinga 175 80 30,000

The overtime rate per hour is 2.5 times the regular rate. Income tax
liability is computed as follows:

Income Tax rate Tax amount

First 1,800,000 0% -
Next 1,800,000 5% 90,000
Next 4,800,000 10% 480,000
Next 27,600,000 15% 4,140,000
Next 22,320,000 20% 4,464,000
Total 58,320,000 9,174,000

It is the policy of Victorosky Ltd.. to grant the following to all staff:
1. Risk allowance of 15% of basic salary
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2. Leave allowance equal to 45% of the basic salary of each staff
3. Social security contribution and
4. Senior staff association dues of 500,000 per month in respect of
each staff.

You are required to prepare:
a. Payroll wok sheet, showing the basic pay, deductions and net
salary of each staff
b. Journal entries to record the above information

Question 2

Victor, Simon and Alata are in the employment of Sikaman Enterprise.
Their conditions of service for the year 2007 are as follows:

Name Basic
salary ()
Rent
allowance()
Bonus() Meal
Allowance()
27,500,000 2,000,000 40% of basic 500,000
Simon 26,200,000 1,800,000 35% of basic 450,000
Alata 24,800,000 1,500,000 30% of basic 400,000

Statutory deductions are:
a. Social security contribution of 5%
b. Income tax liability of 15%

The company also operates a special retirement fund to which all
employees are expected to contribute 8%. It is the policy of the
employer to top up each employees contribution by 10%.

During the year 2007 the following loans were granted to each staff:
Name Car loan() Distress
Loan()
Year loan
was taken
Victor 50,000,000 10,000,000 2005
Simon 40,000,000 8,000,000 2006
Alata 20,000,000 8,000,000 2006

All loans taken in the Enterprise with the exception of distress loans
attract a concessionary interest at a rate of 5% simple interest on the
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reduced balance at the beginning of the period. It is expected that the
principal amount will be repaid or amortised on an equal basis over a
period of five years.

You are required to prepare the salary schedule of Victor, Simon and
Alata for the year 2007.

Question 3

Explain briefly what is meant by:
a. Time rate method of remuneration
b. Piece rate method of remuneration
c. State any three (3) advantages and two (2) disadvantages of
each of the methods of remunerations mentioned above.
Question 4

State briefly the main features of:
a. Halsey Premium incentive plan of remuneration
b. Rowan incentive plan of remuneration
c. Compare the main features of the incentive plans discussed
above.
Question 5

The table below shows the data relating to three employees of Watonga
Ltd.. for the month ending 31
st
December 2006.

Name Standard
hours
expected
Actual
hours
worked
Rate
per
hour()
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Amartey 255 215 40,000
Osibio 200 222 35,000
Morton 180 160 30,000

Included in the conditions of service of Watonga Ltd.. for the above
members of staff are the following:
(ii) Rent allowance of 18% of basic salary
(iii) Risk allowance equal to 20% of the basic salary
(iv) Social security contributions and
(v) Personal income tax liability at the rate 17.5%.

You are required to prepare Payroll wok sheet, showing the basic pay,
deductions and net salary of each staff under the following:
(a) Halsey Premium incentive plan of remuneration
(b) Rowan incentive plan of remuneration

9.11 Solution to Multiple Choice Questions
1. c.
2. b.
3. c.
4. d.
5. b.
6. b.
7. d.
8. b.
9. a.
10. b.
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9.12 Solution to Examination type questions
Question 1
Victorosky Ltd..
Payroll Work sheet for the month of July 2007.
Busanga Akakpo Abinga Total
'000 '000 '000 '000
Basic Salary 11,250 7,600 5,250 24,100
Overtime 5,625 4,275 6,000 15,900
Leave allowance 5,063 3,420 2,363 10,846
Risk allowance 1,688 1,140 788 3,616
Consolidated Salary 23,626 16,435 14,401 54,462
Less Statutory deductions: -
5% Social security 563 380 263 1,206
Taxable Pay 23,063 16,055 14,138 53,256
Less Income tax 2,769 1,718 1,431 5,918
20,294 14,337 12,707 47,338
Less other deductions:
Senior stass associqation dues 500 500 500 1,500
Net Salary 19,794 13,837 12,207 45,838

Computation of Busangas Income Tax
Income Tax rate Amount
'000 '000
First 1,800 0% -
Next 1,800 5% 90
Next 4,800 10% 480
Next 14,663 15% 2,199
Total 23,063 2,769

Computation of Akakpos Income Tax

First 1,800 0% -
Next 1,800 5% 90
Next 4,800 10% 480
Next 7,655 15% 1,148
Total 16,055 1,718

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Computation of Abingas Income Tax
'000 '000
First 1,800 0% -
Next 1,800 5% 90
Next 4,800 10% 480
Next 5,738 15% 861
Total 14,138 1,431

The Journal Proper Dr. Cr.
'000 '000
Consolidated salary 54,462
12.5% Employer's SSNIT 6,808
IRS - PAYE 5,918
SSNIT - 5% Social security 1,206
SSNIT - 12.5% Social security 6,808
Senior staff association dues 1,500
Busanga 19,794
Akakpo 13,837
Abinga 12,207
Being the recording of salaries and
other deductions due
IRS - PAYE 5,918
SSNIT - 5% Social security 1,206
SSNIT - 12.5% Social security 6,808
Senior staff association dues 1,500
Busanga 19,794
Akakpo 13,837
Abinga 12,207
Bank 61,270
Being the payment of deductions and
net salary
122,540 122,540

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Question 2
Sikaman Enterprise
Payroll Work sheet for the Year ended 31
st
July 2007.
Victor Simon Alata Total
'000 '000 '000 '000
Basic Salary 27,500 26,200 24,800 78,500
Rent allowance 2,000 1,800 1,500 5,300
Meals allowance 500 450 400 1,350
Bonus 11,000 9,170 7,440 27,610
5% Social security 1,375 1,310 1,240 3,925
Taxable Pay 39,625 36,310 32,900 108,835
Less Income tax 5,944 5,447 4,935 16,326
33,681 30,863 27,965 92,509
Less other deductions: -
Special retirement fund 2,200 2,096 1,984 6,280
Loan repayment 10,000 8,000 4,000 22,000
Interest on loan 1,500 1,600 800 3,900
13,700 11,696 6,784 32,180
Net Salary 19,981 19,167 21,181 60,329

Computation of Loan Repayment Schedule - Victor
Beginning Interest Principal Closing
Year Balance Payment(5%) Repayment Balance

2005 50,000,000 2,500,000 10,000,000 40,000,000
2006 40,000,000 2,000,000 10,000,000 30,000,000
2007 30,000,000 1,500,000 10,000,000 20,000,000
2008 20,000,000 1,000,000 10,000,000 10,000,000
2009 10,000,000 500,000 10,000,000 -

Computation of Loan Repayment Schedule - Simon

2006 40,000,000 2,000,000 8,000,000 32,000,000
2007 32,000,000 1,600,000 8,000,000 24,000,000
2008 24,000,000 1,200,000 8,000,000 16,000,000
2009 16,000,000 800,000 8,000,000 8,000,000
2010 8,000,000 400,000 8,000,000 -

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Computation of Loan Repayment Schedule - Alata


2006 20,000,000 1,000,000 4,000,000 16,000,000
2007 16,000,000 800,000 4,000,000 12,000,000
2008 12,000,000 600,000 4,000,000 8,000,000
2009 8,000,000 400,000 4,000,000 4,000,000
2010 4,000,000 200,000 4,000,000 -

Question 5
Watonga limited
a) Halsey incentive plan
Payroll Work sheet for the month ended 31
st
December 2007.
Amartey Morton Osibio Total
'000 '000 '000 '000
Basic Salary 8,600 7,770 4,800 21,170
Rent allowance 1,548 1,399 864 3,811
Risk allowance 1,720 1,554 960 4,234
Bonus ( see workings) 800 - 300 1,100
5% Social security 430 389 240 1,059
Taxable Pay 12,238 10,334 6,684 29,256
Less Income tax (17.5%) 2,142 1,808 1,170 5,120
Net Salary 10,096 8,526 5,514 24,136

b) Rowan incentive plan
Payroll Work sheet for the month ended 31
st
December 2007.
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Amartey Morton Osibio Total
'000 '000 '000 '000
Basic Salary 8,600 7,770 4,800 21,170
Rent allowance 1,548 1,399 864 3,811
Risk allowance 1,720 1,554 960 4,234
Bonus ( see workings) 1,349 - 533 1,882
5% Social security 430 389 240 1,059
Taxable Pay 12,787 10,334 6,917 30,038
Less Income tax (17.5%) 2,238 1,808 1,210 5,256
Net Salary 10,549 8,526 5,707 24,782

Workings on bonus

Halsey incentive plan =

Bonus = 50% of [Time saved x Time rate]
Thus time saved =
Name Standard
hours
expected
(A)
Actual
hours
worked (B)
Time
saved
(A-B)
Amartey 255 215 40 hrs
Osibio 200 222 Nil
Morton 180 160 20 hrs
Bonus for Amartey = 50% [40hrs x 40,000] = 800,000
Bonus for Osibio = 50% [0hrs x 35,000] = Nil
Bonus for Morton = 50% [20hrs x 30,000] = 300,000
Rowan incentive plan =
Bonus = Time saved x Time taken x Time rate
Time allowed
Bonus for Amartey = 40hrs x 215 hrs x 40,000 = 1,349,020
255 hrs

Bonus for Osibio = 0hrs x 222 hrs x 35,000 = Nil
200 hrs

Bonus for Morton = 20hrs x 160 hrs x 30,000 = 533,333
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180 hrs
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References

Wood and Sangster, Business accounting; Financial Times -Prentice
Hall
Vickery B.G., Principles and Practice of Book-keeping and Accounts;
Cassell
Larson, Wild and Chiappetta, Fundamental Accounting Principles; Irwin
McGraw-Hall
Buyers and Hollmes, Princples of Cost Accounting; Domnington Press
Lucey T. Costing; ELST
Arora M.N., A Textbook of Cost Accountancy; Vicas Publishing House
PVT Ltd..
Drury, C. Costing: An Introduction; Int. Thompson

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CHAPTER TEN

ACCOUNTING FOR NON-CURRENT ASSETS
Mention the types and characteristics of non-current assets
Differentiate between capital and revenue expenditure
Define depreciation and explain why accountants provide
for depreciation in final accounts
Calculate depreciation using the straight line and the reducing
balance methods
Calculate any profit or loss made on the sale of non-current
assets
Explain the significance of maintaining non-current non-current
assets register

10.1 Introduction
In this chapter we are going to learn how non-current assets are
recorded and valued in the books of accounts of a business
organisation. We are also going to learn why depreciation should
be provided for and also calculate depreciation using the two most
popular methods. Finally we shall learn how to compute any profit
or loss that may arise from the sale of non-current assets.
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The Ghana National Accounting Standards (GNAS 9) defines Property,
Plant and Equipment as tangible assets that:
(a) are held by an enterprise for use in the production or supply
of goods or services for rental to others or for administrative
purposes and
(b) are expected to be used during more than one accounting
period.

The statement of Accounting Standard (SAS) No. 3 issued by the
Nigerian Accounting Standard Board (NADB) defines Property, Plant
and Equipment as tangible assets that:
(c) have been acquired or constructed and held for use in the
production or supply of goods and services and may include
those held for maintenance or repair of such assets and;
(d) are not intended for sale in the ordinary course of business.
From the above definition you must understand that an asset is
classified as a non-current asset by its function rather than by its type.
Generally speaking a non-current asset is held for use in the production
and supply of goods and services. The asset should have been bought
for use on a continuing basis rather than for sale in the ordinary course
of business. Any asset, which does not satisfy these general criteria,
would be classified as a non-current asset. Therefore it is not possible to
state whether an asset is current or non-current until we know its
function. The classification of an asset as fixed or current has to be
done with care; this is because an asset may indeed change with
changing circumstances. For instance, a company that manufactures
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223
and sells cars would normally expect to see such cars classified as
current assets. If, however, the company were to use one of their
manufactured cars within their own business, then the classification
would change from current to non-current
Examples of non-current assets include land, building structures (offices,
factories, warehouses), and equipment (machinery, furniture, tools).
10.3 The determination of the cost of non-current assets.
Almost every business enterprise of any size or activity uses assets of a
durable nature in its operations. Such assets are not acquired for resale
but rather they are used in the business to increase the earning capacity
or productivity in the organization.

An item of expenditure, which qualifies for recognition as a non-current
asset, should be initially recorded at its historical cost. Historical cost is
measured by the cash or cash equivalent price of obtaining the asset
and bringing it to the location and condition necessary for its intended
use. The purchase price, freight costs, and installation costs of a
productive asset are considered part of the assets cost. You must
remember that any trade discount and rebates are deducted in arriving
at the historical cost of the non-current asset.

The concept of including all of the incidental expenses necessary to put
the asset in use is illustrated by the following examples:

Illustration 10.1
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Slopworks (Ghana) Ltd.. orders a machine from a Nigerian tool
manufacturer at an invoice price of 100,000,000. Payment will be made
in 48 monthly installment of 2,500,000 which include 20,000,000
interest charges. Value Added Tax of 12, 500,000 must be paid, as
well as freight charges of 10,250,000. Installation and other start-up
costs amount to 4,000,000. The cost of this machine to be debited to
the machinery Account is 126,750,000, computed as follows:
Invoice Price * 100,000,000

VAT 12,500,000
Transportation charges 10,250,000
Cost of Installation 4,000,000
Total 126,750,000

The 20,000,000 interest charges on the installment purchase will be
recognised as interest expense over the next 48 months and written-
off in the statements of comprehensive income.

10.3.1 Land:
When land is purchased, certain incidental costs are generally incurred,
in addition to the purchase price. These incidental costs may include
commissions to real estate brokers, legal fees for examining and
insuring the title and fees for surveying, draining, clearing and grading
the property. All these expenditures are part of the cost of the land since
they are intended to get the assets ready for use. Any proceeds
obtained in the process of getting the land ready for its intended use,
such as the sale of cleared timber, are treated as reduction in the price
of the land.
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Special case is made for the treatment of local improvements, such as
pavements, streetlights, sewers, drainage system and land-scaping.
These are usually charged to the land account because they are
relatively permanent in nature. However expenditures on land such as
private driveways, fences, and car parks are recorded separately as
land improvements. These expenditures should be recorded as land
improvements and depreciated over their estimated useful lives because
they have limited useful lives.

10.3.2 Cost of building
The cost of building should include all expenditures related directly to
their acquisition or construction. These costs include materials, labour,
overheads costs incurred during construction, professional fees and
building permit. An organisation may engage the services of contractors
to have its building constructed. All costs incurred by the contractors
from excavation to completion, are considered part of the building costs.

There are occasions where land purchased as a building site has on it
an old building which is not suitable for the buyers use. In this case, the
only useful asset being acquired, is the land. Where this happens to be
the case any cost incurred in demolishing the old building should be
debited to the land account together with the purchase price of the land.
This is because the cost of demolition less its salvage value is a cost of
getting the land ready for its intended use.
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10.3.3 Cost of equipment
The term equipment in accounting includes delivery equipment, office
equipment, machinery, furniture and fittings, factory equipment and
similar assets. The costs of these assets include the purchase price,
freight and handling charges incurred, insurance on the equipment while
in transit and costs of conducting trial runs. Costs therefore include all
expenditures incurred in acquiring the equipment and preparing it for
use.

10.4 Capital expenditure versus Revenue Expenditure
Capital expenditure may be defined as the cost of acquiring a non-
current asset for use in an organization. The earning potential or
capacity of such assets will certainly last for more than one accounting
period. In addition capital expenditure includes such costs that are
incurred in adding value to existing non-current assets in order to
improve their earning capacity.

Examples of capital expenditure are:
a) Purchase price of non-current assets such as motor vehicles,
buildings, furniture and fittings, plant and machinery
b) Extension or any improvement of a permanent nature made to any
structure
c) Legal fees of acquiring land or buildings
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d) The cost incurred in bringing any non-current asset to its present
location
e) Any other cost that must be incurred in getting the non-current assets
ready for its intended use.

Revenue expenditure on the other hand is the incurring of any cost in
which its earning potential is exhausted within one accounting period.
Such expenditures are not made to increase or improve the value of
non-current assets but rather are made for the maintenance and day-to-
day running of the business.

Examples of revenue expenditure are:
1) The cost incurred in acquiring trading inventoriess for sale
2) Cost of repairing any non-current assets
3) Discount allowed on credit sales
4) Expenses in connection with rent, insurance, telephone and
electricity.

9.4.1 Differences between capital and revenue expenditure
Differences due to time:
Where the benefit that is derived from an item of expenditure is used up
or exhausted within one accounting period then such expenditure is
revenue expenditure. However if the benefit derived from an item of
expenditure extends to more than one period of account it should be
referred to as capital expenditure.

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Differences due to type of account:
An increase in capital expenditure is recorded or debited to a non-
current asset account, which eventually finds its resting place in the
statement of financial position. All revenue expenditures are charged to
the Statements of comprehensive income.

You should be careful not to incorrectly classify capital and revenue
expenditure. As you can see from the above, the classification of capital
and revenue expenditure has a direct impact on the resulting profit figure
in the Trading and Statements of Comprehensive Income and also the
assets values in the Statement of Financial Position. This is true
because if you wrongly classify revenue expenditure as a capital
expenditure, the total expenses figure in the income statement will be
understated. This will result in overstating the net profit of the business.
Should the owner appropriate the profit for his personal use, it might
lead to the collapse of the business since the owner is spending his
capital instead of the profits or gains from the business.

10.5 Depreciation
Capital expenditure like building, plant, fixtures and fittings do normally
last for more than one year. It is obviously possible that these assets
may deteriorate with the passage of time due to its usage. There is
therefore the need to recognise the loss in the value of a non-current in
the books of accounts of businesses. If this is not done the value of non-
current assets in the statement of financial position will be overstated.
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The process of recognising the loss in the value of non-current assets
as a result of using such assets is called depreciation. The Ghana
National Accounting Standards (GNAS 10) defines depreciation as: the
allocation of the depreciable amount of an asset over its estimated
useful life. The Nigerian SAS No. 9 states that depreciation represents
an estimate of the portion of the historical cost or revalued amount of a
non-current asset chargeable to operations during an accounting
period. The standard also recognises the fact that depreciation for the
accounting period is charged to income either directly or indirectly. This
definition implies that depreciation is effectively an accrual technique,
which matches the cost of a non-current asset with the benefits, which
are derivable from the asset.

Non-current Assets produce revenue through use rather than through
resale. They can be viewed as quantities of economic service potential
to be consumed over time in the earning of revenues. Depreciation
recognition transfers a portion of acquisition cost and capitalised post-
acquisition cost of non-current to an expense account called
depreciation expense. The corresponding credit is the provision for
depreciation, a contra non-current assets account that reduces gross
assets to net book value. This expense is recorded as an adjusting entry
at the end of each accounting period. Depreciation expense could be
classified as a selling or administrative expense, depending on the
assets function. Manufacturing firms include depreciation of plant and
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machinery or factory building in the cost of goods produced. When the
goods are sold, depreciation becomes part of cost of goods sold.
Certain types of non-current assets have unlimited useful economic
lives, and so do not require depreciation. This is usually true of land
unless the land is an agricultural land or land acquired for extractive
purposes. By contrast, buildings will normally have limited useful
economic life, and therefore, will normally be subjected to depreciation.
You must note that the Provision for Depreciation account does not
represent cash set aside for replacement of non-current; nor does
depreciation recognition imply the creation of reserves for asset
replacement.
10.5.1 Causes of depreciation
There are several factors that contribute to depreciation of non-current
assets. These factors or causes can be classified as follows:
1) Physical deterioration
This is where the fall in value of a non-current asset is due to
wear and tear as a result of its constant use. Natural
occurrences such as erosion, rust and decay will certainly
reduce the value of any non-current asset.

2) Economic factors
This is where an asset is put out of use even though it is in good
working condition. This occurs where an asset becomes out of
date as a result of new inventions or technological
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advancement. For example bakers use clay-molded oven in
baking bread. The invention of gas-molded oven will certainly
render the former out of date. This factor of depreciation is
known as obsolescence.

Another situation closely linked with economic factors is where a
non-current asset is rendered useless as a result of the growth
and changes in the size of business. A fisherman who uses
canoe may have to acquire a large fishing boat when the
demand for fish increases beyond the capacity that the canoe
can cope with. In this situation you can clearly deduce that it
would be more efficient and economical to operate a large
fishing boat than the canoe, and as a result the canoe will be
put out of use, though it is in good working condition. This factor
of depreciation is known as inadequacy.

3) Depletion
Natural resources such as mines, quarries, oil, coal and gas
deposits become worthless when the deposits or resources are
depleted. These assets are called wasting assets. The process
of providing for the consumption of such assets is called
depletion.
4) Time factor
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There are certain assets that have specific period of legitimate
life span. Assets such as patent, copyrights, finance leases have
a legal life fixed in terms of years. As and when the years
elapse, the value of these assts reduces. The cost of these
assets must be spread over their legal lives. The term used in
recognising the fall in value of these assets is termed
amortisation.

10.6 Methods of calculating depreciation
Depreciation is an attempt to allocate the cost of a non-current asset to
each accounting period that the asset is used to generate income or
earnings. Depreciation may be calculated simply by deducting the
amount receivable when the asset is either sold or put out of use by the
business from the cost of the non-current asset. The amount that will be
received when the asset is sold or put out of use is technically termed
the salvage value or the residual value of an asset. The cost less the
salvage value is called depreciable value or amount. It is this
depreciable value that the accountant seeks to spread over the useful
life of a non-current asset.

There are several methods of calculating depreciation. These include:
1) Straight Line Method
2) Reducing Balance Method
3) Sum-of- the-Years-Digits Method
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4) Units-of-Output Method
5) Revaluation Method
6) Machine Hour Method
7) Depletion of Unit Method

The purpose of this manual is to explain into details only two of the
methods mentioned above. The straight Line or fixed instalment method
and the reducing balance or diminishing balance method will be
discussed; the remaining methods will be treated in the next stage of the
course.

In order to calculate the depreciation charge for a period, we need to
know four factors:
The cost of (or revalued amount) of the non-current asset.
The estimated residual value of the non-current asset.
The estimated useful economic life of the non-current asset.
The method of depreciation that is appropriate for the
business.

All the factors mentioned above involve a certain amount of subjectivity.
As a result of the subjective nature of the depreciation computation,
GNAS 10 requires that the estimates that are used in the depreciation
calculation should be kept under constant review and, where
appropriate, revised. Where the estimate is revised during the period of
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depreciation then the existing net book value should be written down
over the remaining estimated useful economic life of the asset in
question. The depreciation method should be reviewed periodically.
When a change in depreciation method materially changes the annual
depreciation charge, then the effect of the change should be accounted
for as a change in accounting policy which will necessitate the
restatement of the beginning balance of the income surplus account. It
must be noted that the revision of the useful life of a non-current asset
does not constitute a change in accounting policy but rather a change in
accounting estimate. This type of change will not have retroactive effect
on the income statement.

10.6.1 Straight Line Method
The straight line method is the most widely used method of computing
depreciation charge for financial statement purposes. Under this
method, an equal amount of depreciation is recorded for each
accounting period over the useful life of the non-current asset. The
depreciation amount is computed by dividing the original cost of the non-
current asset less estimated salvage value by the useful life of the asset.
A mathematical formula can be deduced as follows:
Annual Depreciation = Original cost of Asset Salvage Value
Useful Life of Asset
Illustration 10.2
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On January 1, 2000 Hyde Limited purchased a motor vehicle for
250,000,000. The motor vehicle has an estimated useful life of five
years with a salvage value of 5,000,000.
You are required to calculate the depreciation charge and accumulated
depreciation for each of the years and show the net book value as at the
end of 2004 accounting period using the straight-line method.
Annual Depreciation = 250,000,000 5,000,000
5
= 49,000,000

Beginning Depreciation Accumulated Closing
Year Book value for the year Depreciation Book value

2000 250,000,000 49,000,000 49,000,000 201,000,000
2001 201,000,000 49,000,000 98,000,000 152,000,000
2002 152,000,000 49,000,000 147,000,000 103,000,000
2003 103,000,000 49,000,000 196,000,000 54,000,000
2004 54,000,000 49,000,000 245,000,000 5,000,000

10.6.2 Reducing Balance Method
Under this method of depreciation, the book value of a non-current asset
at the beginning of the year is multiplied by a fixed percentage to
determine the depreciation for the accounting year. This procedure is
repeated in subsequent accounting periods so as to reduce the
depreciable value of the non-current asset to zero (i.e. reduce its cost to
its residual value).
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Illustration 10.3
On January 1, 2000 John Kay Limited purchased plant for
250,000,000. It is the policy of John Kay to depreciate Plant at 20%.
You are required to calculate the net book value as at the end of 2004
accounting period using the reducing balance method.
Beginning Depreciation Depreciation Accumulated Closing
Year Book value Rate for the year Depreciation Book value

2000 250,000,000 20% 50,000,000 50,000,000 200,000,000
2001 200,000,000 20% 40,000,000 90,000,000 160,000,000
2002 160,000,000 20% 32,000,000 122,000,000 128,000,000
2003 128,000,000 20% 25,600,000 147,600,000 102,400,000
2004 102,400,000 20% 20,480,000 168,080,000 81,920,000

When a non-current asset is purchased during the year, depreciation is
calculated to the nearest month. In some organisations a full years
depreciation charge is provided on non-current assets acquired during
the year irrespective of the period in which they were purchased. Where
this is the case any asset sold in the year will also not attract
depreciation in the year of sale irrespective of the time of sale within the
accounting period.
9.7 Double entry records for depreciation
After calculating the depreciation charge for the accounting year you
must record the amount in the books of account. It is important for you to
remember that the process of providing for depreciation is recording for
the use of non-current assets during the accounting period. This
therefore means that depreciation is revenue expenditure and as such
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must be recorded in the same manner that accountants record normal
business expenses.
There are two main ways of recording depreciation in the books of
account of a business organisation. The old method and the modern
method of recording depreciation. In the case of the former, depreciation
charges are recorded in the non-current asset account. It is important to
note that this method is no longer used in practice. The double entry of
depreciation is as follows under the old method:
Dr. Depreciation Expense Account
Cr. The non-current asset Account in question
Dr. Income statement
Cr. Depreciation Expense Account
Illustration 10.5
On January 1,2000 Brown Kay Limited purchased Equipment for
450,000. It is the policy of John Kay to depreciate Plant at 20%. You
are required to show the Equipment account in the books of Brown Kay
Limited as at the end of 2004 accounting period using the reducing
balance method.
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Equipment account

01/01/2000 Bank 450,000 31/12/2000 Depreciation expense 90,000
31/12/2000 Balance c/f 360,000
450,000 450,000
01/01/2001 Balance b/d 360,000 31/12/2001 Depreciation expense 72,000
31/12/2001 Balance c/f 288,000
360,000 360,000
31/12/2002 Balance c/f 230,400
288,000 288,000
31/12/2003 Balance c/f 184,320
230,400 230,400
31/12/2004 Balance c/f 147,456
184,320 184,320
Balance b/d 147,456

Depreciation Expense Account

12/31/2000 Equipment account 90,000 12/31/2000 Profit and loss 90,000

The modern practice of recording depreciation treats depreciation as a
contra to the non-current asset account. The non-current asset account
is maintained at its original cost. A ledger account called Accumulated
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Provision for Depreciation account is opened and all depreciation
calculations are credited to that account, the corresponding entry being
passed into the Depreciation charge Account as a debit. The double
entry is as follows:
Dr. Depreciation charge Account
Cr. Accumulated Provision for Depreciation Account
Illustration 10.5
On January 1, 2000 Amoroso Limited purchased Equipment for
800,000. It is the policy of the Company to depreciate all equipment at
20% per annum. You are required to show the Equipment account in the
books of Amoroso Limited as at the end of 2004 accounting period using
the reducing balance method.

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Equipment account
1/1/2000 Bank 800,000

Accumulated Provision for Depreciation Account

12/31/2000 Balance c/f 160,000 12/31/2000 Deprecitioin expense 160,000
12/31/2001 Balance c/f 288,000 1/1/2001 Balance b/d 160,000
12/31/2001 Deprecitioin expense 128,000
288,000 288,000
390,400 390,400
472,320 472,320
537,856 537,856
1/1/2005 Balance b/d 537,856

Depreciation Expense Account


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The balance on the equipment account will be shown on the statement
of financial position at the end of the accounting year less the balance
on the Accumulated Provision for Depreciation Account as follows:

10.8 Disposition of non-current assets
An organisation can dispose off its non-current assets by either
selling it for cash, exchanging it for a similar asset or a different
one, or merely by discarding the asset. In all these three situations
you must remember to take out the disposed asset from the main
non-current asset account. This is done by opening an account for
the purpose of the disposal. Into this account is entered the cost of
the non-current asset and its associated accumulated depreciation
provision. A profit or loss may arise from the disposal of the non-
current asset depending on the outcome of the non-current asset
disposal account.
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On the disposal of non-current asset the following entries must be
passed:
1) Transfer the cost of the non-current asset sold to a named non-
current asset disposal account as follows:
Dr. Non-current asset disposal Account
Cr. Non-current asset Account
2) Transfer the accumulated depreciation on the asset sold to the
non-current asset disposal account as follows:
Dr. Accumulated provision for depreciation Account
Cr. Non-current asset disposal Account
3) The amount realized from the sale of the non-current asset
must be recorded as follows:
Dr. Cash, Bank or Sundry receivables Account
Where the balance on the non-current asset disposal account is credit, it
means that the amount received from the sale is more than the net book
value of the non-current asset, hence a profit is the resulting figure.
Dr. Non-current asset disposal Account
Cr. Income statement
Where the balance on the non-current asset disposal account is debit it
means that the amount received from the sale is less than the net book
value of the non-current asset sold, hence a loss must be recorded.
Dr. Income statement
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The entries above can be illustrated by assuming that the equipment
purchased by Amoroso in Illustration 9.5 was sold for cash amounting to
295,000 at 2
nd
January 2005. The cost of the equipment as at 2
nd

January 2005 was 800,000, its associated accumulated depreciation
amounted to 537,856 leaving a net book value of 262,144 (800,000-
537,856). Since the equipment was sold for 295,000 it means that a
profit amounting to 32,856 will be calculated as follows:

If one again assumes that the equipment purchased by Amoroso in
Illustration 10.5 was sold for cash amounting to 200,000 on 2
nd
January
2005. The balance on the equipment account as at 2
nd
January 2005 will
show cost of 800,000, with its associated accumulated depreciation
recording 537,856 leaving a net book value of 262,144 (800,000-
537,856). Since the equipment was sold for 200,000 it means that a
loss amounting to 62,144 will be calculated as follows:
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Calculation of loss on sale of equipment
cost of equipment 800,000
Less Accumulated depreciation 537,856
Net book value 262,144
Proceeds from sale of equipment 200,000
Less Net book value 262,144
Loss on disposalof equipment (62,144)

The transaction involving the sale of assets at a profit per Illustration 9.5
will be recorded as:

10.9 Summary
In this chapter the distinction between capital expenditure and revenue
expenditure has been clearly explained. The item of cost or expenditure
to be capitalised should include all the activities that are intended to put
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the asset in a condition ready for use. We have also defined
depreciation to mean the process of accruing the cost of a non-current
asset over its useful life and that where an asset is fully depreciated and
it is still in use one must not continue depreciating the asset. We again
learnt that where an asset is disposed off during the year the net book
value at the time of sale should be deducted from the sale proceeds and
either a profit or loss on disposal posted to the income statement.
10.10 MULTIPLE CHOICE QUESTIONS
Use the data below to answer Questions 1 and 2.

Acquisition cost of machine 200,000

Installation cost 50,000
Estimated annual maintenance cost 20,000
Estimated useful life 5 years
Estimated residual value 10,000

1. What is the depreciable value of the machine?
a. 200,000
b. 250,000
c. 270,000
d. 240,000
e. 48,000

2. Using straight line method, what would be the annual
depreciation charge for the second year of usage?
a. 48,000
b. 40,000
c. 52,000
d. 48,250
e. 40,250
3. Dominic bought a non-current asset on credit from Mepai
Company Limited. In which subsidiary book will Mepai
Company Limited record this transaction?
a. Purchases journal
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b. Sales journal
c. Cash book
d. Journal proper
e. Non-current asset register
4. The fall in value of non-current intangible assets as a result of
passage of time is referred to as?
a. Depletion
b. Deterioration
c. Wasting
d. Amortization
e. Obsolescence
5. Depreciation of an asset with fixed period of legal life is often
referred to as?
a. Obsolescence
b. Amortization
c. Diminishing balance method
d. Depletion
e. Deterioration

6. An increase in the value of a non-current asset over and
above its original cost is termed?
a. Depreciation
b. Appreciation
c. Inflation
d. Residual value
e. Deflation
7. The basic formula for the straight-line method of depreciation
is given as?
i. Annual depreciation = a b
c
ii. where
a. a = cost of the asset, b = expected asset life in years, c =
residual value
b. a = cost of the asset, b = residual value, c = expected
asset life in years
c. a = residual value, b = cost of asset, c = expected asset
life in years
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d. a = expected asset life in years, b = residual value, c =
cost of the asset
8. Which of the following assets will not be shown on the
statement of financial position of a business unit?
a. Intangible asset such as management services
b. Intangible asset such as goodwill
c. Tangible asset such as machinery
d. Tangible asset such as buildings
e. Intangible asset such as research and development
9. Which of the following is an example of revenue expenditure?
a. Expenditure on non-current assets bought by the firm
b. Expenditure on the repairs of buildings
c. Formation expenses before a company commenced
business
d. Tax paid to the Internal Revenue Service
e. Repairs to vehicle with hooked engine
10. Every asset should have at least
a. Tangible and intangible qualities
b. Monetary cost and future benefit
c. An adequate monetary value
d. An inadequate monetary value
e. Durable qualities
Use the information below to answer Questions 11 and 12.
A motor van was purchased by a bookshop on 1
st
July 2003 for
10,000,000 and sold on 30
th
June 2005 for 8,200,000. The firms
accounting year ends on December 31
st
. Motor vans are depreciated at
10% per annum on cost.

11. What is the profit or loss on disposal of the motor van?
a. 200,000 (loss)
b. 1,200,000 (profit)
c. 200,000 (profit)
d. 1,200,000 (loss)
e. 100,000 (loss)

12. What is the accumulated depreciation on the motor van
as at 30
th
June, 2004?
a. 1,000,000
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b. 500,000
c. 3,000,000
d. 1,500,000
e. 2,000,000
13. A company has business premises worth 80,000,000. An
additional amount of 20,000 was used to provide metal gate
for the building. The cost of the gate should be treated as
a. Revenue expenditure
b. Capital expenditure
c. Revenue receipt
d. Capital receipt
e. Income statement item

The following information relates to Questions 14 and 15

Motor vehicles at cost (1/1/2005) 50,000,000
Accumulated depreciation (1/1/2005) 18,000,000
Depreciation is at the rate of 20% per annum using
reducing balance method
Cost of additional motor vehicle bought on 1/7/2005 was

14. What would be the depreciation charge for 2005?
a. 6,800,000
b. 10,000,000
c. 7,200,000
d. 6,400,000
e. 29,400,000 non-current
15. What would be the written down value of the motor vehicles
as at 31
st
December, 2005?
a. 28,800,000
b. 32,000,000
c. 29,200,000
d. 43,200,000
16. The value of a non-current asset is recorded in a
a. Nominal account
b. Real account
c. Personal account
d. Control account
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17. Which of the following best describes the provision made for
the loss in value of non-current assets that is of a wasting
nature?
a. Depletion
b. Depreciation
c. Amortization
d. Capitalization
e. Payables account
18. An expense is said to be capital in nature if it
a. Reduces the capital of the business
b. Adds to or improves the value of a non-current asset
c. Necessitates the introduction of additional capital by the owner
d. Adds to or increases the operating expenses of the business
e. Increases the capital of the business.

9.11 EXAMINATION TYPE QUESTIONS
I. Kumbaya Ltd. made the following non-current asset purchases in
2001 accounting period:
Type of Asset Cost () Date
Motor vehicle 70,000,000 1
st
January
Furniture and fittings 120,000,000 1
st
March
Furniture and fittings 40,000,000 1
st
July
Motor vehicle 208,000,000 1
st
October

The companys policy is to depreciate motor vehicle and furniture and
fittings at the rates of 25% and 20%, using the fixed instalment and
reducing balance methods respectively.
Required:
1) The Office equipment account
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250
2) The Plant and machinery account
3) The respective Provision for depreciation accounts
4) A statement of financial position (extract) for the years 2001 and 2002

2. Attakora is a trader dealing in the sale of second hand clothes and
prepares account to 31
st
December of each year. The following
transactions in assets have taken place:
2005 1
st
January Purchased Office Equipment for 150.000,000
2005 1
st
July Purchased Plant and Machinery costing 500.000,000
2006 1
st
October Bought Plant for 300.000,000
2006 1
st
December Purchased Office Equipment for 200.000,000

Attakora maintains its non-current assets at cost and depreciates its
asset at a constant rate of 20% using the straight line method of
providing for depreciation. Assets purchased attract full depreciation
charge in the year such an asset is put to use, whilst any asset disposed
off attracts no depreciation charge.
You are required to prepare the following:
I. The Office equipment account
II. The Plant and Machinery account
III. The respective Provision for depreciation accounts
IV. A statement of financial position (extract for the years 2005
and 2006

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3. A company depreciates its fleets of motor vehicles at the rate of
25%, using the reducing balance method. From the information
given below, you are required to draw up the following:
a) The Motor vehicles
b) The Provision for depreciation accounts
c) The Motor vehicle disposal account
d) A statement of financial position(extract for the years 2005 and 2006

2004 1
st
January Purchased 6 cars for 50.000,000 each
2004 1
st
September Purchased 2 trucks costing 500.000,000
2005 1
st
November Sold 2 of the cars bought on 1
st
January 2004
for 90,000,000
2005 1
st
December Purchased one truck for 200.000,000

4. Watonga commenced business on 1
st
March 2000 selling mobile
phones and prepares account to 31
st
December of each year. The
following transactions in assets have taken place:
Date Asset Details Cost Scrap value Dep.
rate
1
st
Jan.2004 Land &
Buildings
Purchase 980,000,000 80,000,000 4 %
1
st
Jan. 2004 Plant &
Machinery
Purchase 550,000,000 20,000,000 10%
30
th
June 2006 Building Sale 480,000,000
1
st
Aug. 2006 Plant &
Machinery
Purchase 475,000,000 65,000,000 10%
1
st
Oct. 2006 Building Purchase 550,000,000 Nil 4 %
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Included in the land and buildings account is 100,000,000 representing
the cost of land with a scrap value of 40,000,000. The scrap values of
the various assets above were determined by a firm of professional
valuers. The depreciation method used is the straight line method and it
is the policy of the company to provide depreciation on the basis of one
month ownership one month depreciation charge. The building with a
scrap value of 20,000,000 was sold for 400,000,000 on 30
th
June
2006.
Required:
V. The respective non-current assets accounts
VI. The disposal of asset account
VII. The respective Provision for depreciation accounts

1. d. 10. b.
2. a. 11. c.
3. d. 12. a.
4. d. 13. b.
5. b. 14. a.
6. b. 15. c.
7. b. 16. b.
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8. a. 17. a.
9. b. 18. b.

1.
Motor vehicles Account
'000 '000
1/1/2001 Bank 70,000 . . .
1/10/2001 Bank 208,000 12/31/2001 Balance c/f 278,000
278,000 278,000
1/1/2002 Balance b/d 278,000
Furniture & Fittings Account
'000 '000
1/3/2001 Bank 120,000 . . .
1/5/2001 Bank 40,000 12/31/2001 Balance c/f 160,000
160,000 160,000
1/1/2002 Balance b/d 160,000

Provision for Depreciation Account-Motor vehicles
'000 '000
31/12/2001 Balance c/f 30,500 31/12/2001 Depreciation expense 30,500
30,500 30,500
31/12/2002 Depreciation expense 69,500
100,000 100,000
1/1/2003 Balance b/d 100,000

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Provision for Depreciation Account-Furniture & fittings
'000 '000
24,000 24,000
51,200 51,200
1/1/2003 Balance b/d 51,200

Balance sheet (extract) as at 31 december 2001 and 2002
'000 '000
2001 Motor vehicles at cost 278,000
Less Provision for Depreciation 30,500
247,500
Furniture & Fittings at cost 160,000
136,000
383,500
2002 Motor vehicles at cost 278,000
178,000
Furniture & Fittings at cost 160,000
108,800
286,800

2.
Office Equipment Account
'000 '000
1/1/2005 Bank 150,000 12/31/2005 Balance c/f 150,000
150,000 150,000
1/1/2006 Balance b/d 150,000 12/31/2006 Balance c/f 450,000
1/10/2006 Bank 300,000
450,000 450,000
1/1/2007 Balance b/d 450,000
Plant & Machinery Account
'000 '000
1/7/2005 Bank 500,000 12/31/2005 Balance c/f 500,000
500,000 500,000
1/12/2006 Bank 200,000
700,000 700,000
1/1/2007 Balance b/d 700,000

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Provision for Depreciation Account-Office equipment
'000 '000
30,000 30,000
120,000 120,000
1/1/2007 Balance b/d 120,000

Provision for Depreciation Account-Plant & machinery
'000 '000
100,000 100,000
240,000 240,000
1/1/2007 Balance b/d 240,000

'000 '000
2005 Office Equipment 150,000
120,000
Plant & Machinery at cost 500,000
400,000
520,000
2006 Office Equipment 450,000
360,000
Plant & Machinery at cost 700,000
460,000
820,000

3.
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Motor vehicles Account
'000 '000
1/1/2004 Bank 300,000 31/12/2004 Balance c/f 800,000
1/9/2004 Bank 500,000
800,000 800,000
1/1/2005 Balance b/d 800,000 1/11/2005 Disposal a/c 90,000
1/12/2005 Bank 200,000 31/12/2005 Balance c/f 910,000
1,000,000 1,000,000
1/1/2006 Balance b/d 910,000

Provision for Depreciation Account-Motor vehicles
'000 '000
116,667 116,667
1/11/2005 Disposal a/c 45,833 1/1/2005 Balance b/d 116,667
316,667 316,667
1/1/2006 Balance b/d 270,834

Disposal Account - Motor vehicles
'000 '000
1/11/2005 Motor vehicles 100,000 1/11/2005 Bank 90,000
1/11/2005 Profit & loss 35,833 1/11/2005 Prov. For dep. 45,833
135,833 135,833

'000 '000
2004 Motor vehicles cost 800,000
683,333
2005 Motor vehicles cost 910,000
710,000

4. Watanga
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Land & Buildingd Account
'000 '000
1/1/2004 Bank 980,000 31/12/2004 Balance c/f 980,000
980,000 980,000
980,000 980,000
1/1/2006 Balance b/d 980,000 1/7/2006 Disposal a/c 480,000
1/10/2006 Bank 550,000 31/12/2006 Balance c/f 1,050,000
1,530,000 1,530,000
1/1/2007 Balance b/d 1,050,000

Plant & Machinery Account
'000 '000
1/1/2004 Bank 550,000 31/12/2004 Balance c/f 550,000
550,000 550,000
550,000 550,000
1/1/2006 Balance b/d 550,000 31/12/2006 Balance c/f 1,025,000
1/8/2006 Bank 475,000
1,025,000 1,025,000
1/1/2007 Balance b/d 1,025,000

Provision for Depreciation Account- Buildings
'000 '000
33,600 33,600
67,200 67,200
1/11/2005 Disposal a/c 46,000 1/1/2006 Balance b/d 67,200
106,300 106,300
1/1/2007 Balance b/d 60,300

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Provision for Depreciation Account- Plant & machinery
'000 '000
53,000 53,000
106,000 106,000
176,083 176,083
1/1/2007 Balance b/d 176,083

Disposal Account - Buildings
'000 '000
30/6/2006 Motor vehicles 480,000 30/6/2006 Bank 400,000
30/6/2006 Prov. For dep. 46,000
30/6/2006 Profit & loss 34,000
480,000 480,000

References
1. Wood and Sangster, Business accounting; Prentice Hall
2. Edmonds, McNair, Milam and Olds, Fundamental Financial
Accounting Concepts; McGraw-Hall
3. Vickery B.G., Principles and Practice of Book-keeping and
Accounts; Cassell
4. Millichamp, Foundation Accounting; ELBS
5. Gavor, S.D.K.N., Basic and Intermediate Accounting; Academy
of Business and Finance
6. Dyckman, Dukes, Davis, Intermediate Accounting; Irwin
McGraw-Hall
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7. Ghana National Accounting Standards 9 (Property, Plant and
Equipment)
8. Ghana National Accounting Standards 10 (Accounting for
Depreciation)
9. Nigeria Accounting Standard Board (1984), statement of
Accounting Standard No. 3 Accounting for Property, Plant
and Equipment
10. Nigeria Accounting Standard Board (1989), statement of
Accounting Standard No. 9 Accounting for Depreciation

CHAPTER ELEVEN

END OF PERIOD ADJUSTMENTS
Differentiate between capital expenditure and revenue expenditure
Explain the effect on profit if a revenue expenditure has been
wrongly classified as a capital expenditure, and vice versa
Explain prepayments and accruals
Pass adjusting entries in respect of prepayment and accruals
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Explain and pass entries in respect of bad debts and provision for
doubtful debts
Record increases and decreases in the provision for doubtful
debts
Calculate and make entries with respect to provisions for discount
on receivables and creditors
Prepare Income statement and statement of financial position
(extracts) showing the treatment of bad debts provision for
doubtful debts, depreciation and provision for discount on trade
receivables and payables and provision for doubtful debts,
depreciation and provision for discount on trade receivables and
payables
11.2 Introduction
Many changes in a companys economic resources and obligations
occur continuously. For example, interest accrues daily on debts, as
does rent expense on an office building. Other resources and obligations
such as employee salaries originate as service is rendered, with
payment to follow at specified dates. The end of the accounting period
generally does not coincide with the receipts or payment of cash
associated with all the types of resource changes. Adjusting entries are
therefore, used to record such resource changes to ensure the accuracy
of the financial statements. This chapter will consider some of the
adjustments most commonly used in the preparation of the final
accounts. As well as discussing why such adjustments are required,
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their treatment in both the Income statement and statement of financial
position will be reviewed in detail.
Accountants rely on two principles in the adjusting process revenue
recognition and matching principles. The revenue recognition concept
requires that revenue be reported when earned, not before and not after.
Revenue is earned for most firms when services and products are
delivered to customers. If a firm sells goods in 2003 to a customer, the
revenue was earned in 2003 and as such should be reported in the 2003
Income statement, even if the customer paid for the goods in a period
other than 2003.
The matching principle aims to report expenses in the same accounting
period as the revenues that are earned as a result of incurring these
expenses. The matching of expenses with revenue is a major part of the
adjusting process. As an example if a business earns monthly revenue
while operating out of rented store space, the matching concept
stipulates that rent must be reported on the income statement for
December, even if rent is paid in a month either before or after
December. This ensures that the rent expense for December is matched
with December revenue.
At the end of an accounting period it is likely that an organization will find
that some expenses have been paid which relate to the next accounting
period, whilst other amounts, which relate to the current period remain
outstanding. In order that the account shows a true and fair view of the
firms financial performance, adjustments for such items are necessary.
Adjustments are classified into three categories:
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(1) Deferrals and prepayments
(2) Accruals
(3) Other adjustments

11.3 deferred Revenue and Prepayments
Deferrals or prepayments refer to transactions where cash is paid or
received before a related expense or revenue is recognized. These
transactions are recorded when cash is paid for expenses that apply to
more than one accounting period or when cash is received for revenue
that relates to more than one accounting period. The portion of the
expense or revenue that applies to the future periods is deferred as a
prepaid expense (asset) or unearned revenue (liability). If we do not
make adjustments for prepayments and unearned revenues, profit for
the current period will be understated or overstated respectively. Items,
which normally need to be prepaid, include rates, insurance and road
licensing fee.

The accounting entry requires the prepayment to reduce the relevant
expense in the Income statement thereby increasing profit. The same
applies to the unearned revenue, where the adjusting entry reduces the
relevant revenue in the Income statement thereby increasing profit.
Since conceptually the prepayment represents an amount owing to the
firm from a third party and unearned revenue represents amounts owed
by the business to third party, it is included under current assets and
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263
current liabilities respectively in the statement of financial position. The
accounting entries are as follows:
Debit: Prepayments (Statement of financial position)
Credit: Expenses (Income statement)
Debit: Revenue (Income statement)
Credit: Unearned revenue (Statement of financial position)

Illustration 11.1
As an illustration let us assume that Santo Ltd.. paid 240,000 for two
years insurance protection beginning on December 1, 2000.
The cash payment of 240,000 will be debited to the insurance account.
With the passage of time, the benefit of the insurance protection
gradually expires and a portion of the unexpired insurance is transferred
to the next accounting period as a prepaid expense. For instance, one
months insurance coverage expires by December 31, 2000. This
expense is 10,000, or 1/24 x 240,000 and will be as follows:
Insurance Account

1/12/2000 Cash 240,000 31/12/2000 Profit and loss 10,000
Prepaid c/f 230,000
240,000 240,000
1/1/2001 Prepaid b/f 230,000 31/12/2001 Profit and loss 120,000
(12/24 x 240,000)
31/12/2001 Prepaid c/f 110,000
230,000 230,000
1/1/2002 Prepaid b/f 110,000

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264

The balance carried forward of 230,000, and 110,000 represents
insurance prepaid to be shown under current assets in the statement of
financial position for the years 2000 and 2001 respectively.

The adjusting entrie will be journalized as follows:
2000
Debit: Insurance Prepaid 230,000
Credit: Insurance expense 230,000
2001
Debit: Insurance Prepaid 110,000
Credit: Insurance expense 110,000
Let us now illustrate the treatment of deferred revenue as follows:

Illustration 11.2
Assume that Santo Ltd.. rented a small office in its building to a
customer on January 1, 2001. The rental agreement required the
payment of 180,000 cash in advance for 18 months rent.

This transaction is recorded as a debit to cash and a credit to rent
received account. On December 31, 2001, the unadjusted Trial Balance
will report 180,000 as rent received, which is overstated by 60,000
(6/18 x 180,000) relating to 2002. The rent received account will be as
follows:
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265

The balance carried forward of 60,000 in 2001 represents unearned
revenue which will be recorded under current liabilities in the statement
of financial position for the financial statement for the year 2001. The
adjusting entry will be journalised as follows:

Debit: Rent receivable A/c 460,000
Credit: Deferred Rent Revenue 460,000

11.4 Accrued Expenses
Accrued expenses and accrued revenues reflect transactions where
cash is paid or received after a related expense or revenue is
recognized. It represents an item, the use of which the firm has already
benefited from during the current accounting period, but which will not
be paid for until the next accounting period. If we do not make an
adjustment the profit for the current period will be overstated. Examples
of items that need to be accrued for include electricity, since it is not
likely that these bills will exactly coincide with the firms accounting year-
end. The accounting entry for accrued expense is:

Debit: Expense (Income statement)
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266
Credit: Accrued expense (Statement of financial
position)

In this case the relevant expense in the Income statement is increased
by the accrued amount. Whilst in the statement of financial position
accruals appear under current liabilities, reflecting an amount owing by
the business.

Illustration 11.3
As an example let us assume that Santo Ltd.s Trial Balance recorded
electricity expenses of 600,000 which cover the period up to 31
st

October 2000. A careful examination of the previous electricity bills of
Santo Ltd.. shows that the companys consumption of energy is even
throughout the period.

The example above tells us that the electricity charge in the Trial
Balance does not cover the entire year. This means that an accrual is
required for the period of November to 31 December 2000. Since
electricity is used evenly throughout the year we can estimate the
outstanding amount based on the bills received to date. The 600,000
recorded in the Trial Balance represents 10 months of electricity
charge, therefore the accrual is estimated as follows:

Accrual =600,000 x 2/10 =120,000

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The electricity expense recorded as follows:

The balance carried forward of 120,000 in 2000 represents accrued
expense and will be recorded under current liabilities in the statement of
financial position . The adjusting entry will be as follows:

Debit: Electricity expense A/c 120,000
Credit: Accrued Expense A/c
120,000

10.5 Accrued Revenue
Accrued revenue refers to transactions where cash is received after
related revenue is recognized. It represents an item, the use of which
the firm has already dispensed with during the current accounting
period, but which will not be received until the next accounting period. If
we do not make an adjustment the profit for the current period will be
understated. Examples of items that need to be accrued for include
interest earned on treasury bills of which payment has not been
received, since it is not likely that the maturity of these bills will exactly
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268
coincide with the firms accounting year-end. The accounting entry for
accrued revenue is:

Debit: Accrued income (Statement of financial position)
Credit: Interest Receivable (Income statement)

In this case the relevant income in the Income statement is increased by
the accrued amount. Whilst in the statement of financial position the
accrued income will appear under current assets, reflecting an amount
owned by the business.

Illustration 11.4
As an illustration assume that the Trial Balance of Sky Ltd.. shows
interest receivable of 855,000. Excluded from the Trial Balance is a
182 days Bank of Ghana Bond purchased on 1
st
August 2001 at an
interest rate of 15% per annum at a cost of 12,000,000. Sky Ltd..
prepares account to 31
st
December each year.

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269
From the illustration above, Sky Ltd. will receive a total of 900,000
(15% x 12,000,000 x 6/12) representing interest that will be earned
on the bond for the period 1
st
August 2001 to 31 January 2002.
Since five months interest amounting to 750,000 (5/6 x 900,000)
relates to 2001 financial year it must be accrued in the Income
statement for 2001 though the amount will be received after 2001.
The interest receivable account will be recorded as follows:

The adjusting entry will be as follows:
Debit: Interest accrued A/c 750,000
Credit: Interest receivable A/c 750,000
11.6 Other adjustments
10.6.1 Depreciation Expense
Non-current assets are the statement of financial position classification
used to account for many productive assets with useful lives exceeding
one year. The capital expenditures for these assets are matched against
the revenues that the assets help to generate in an accounting period.
Depreciation is the process in which we spread the cost of a non-current
asset over the accounting periods that benefited from its use.
Irrespective of the method of depreciation used, the accounting
treatment is always the same:
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Debit: Depreciation expenses (Income statement)
Credit: Provision for Depreciation (Statement of financial
position )

The effect of the entry is to show depreciation as a business expense in
the income statement, thereby reflecting the proportion of cost or
valuation attributable to the current period. It should be cautioned that
depreciation is a non-cash item. This means it is a book adjustment,
which does not involve the physical movement of cash.

Illustration 11.5
The example below illustrates depreciation recorded for Santo Ltd.. at
the end of 2002 under the straight-line method.

Assets Cost Residual Estimated Proportionate use by function
Value Useful live Selling Administrative
Function Function
Building 1,600,000 100,000 15 yrs 46% 54%
Equipment 910,000 10,000 10 yrs 40% 60%

Computation:
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271
Total
Selling Administration
Building [(1,600,000-100,000)15yrs] 100,000 46,000 54,000
Equipment[(910,000-10,000)10yrs] 90,000 36,000 54,000
Totals 190,000 82,000 108,000

The adjusting entry for these two assets is:
Dr Cr

Depreciation Selling expense 82,000
Administration expense 108,000
Provision for Depreciation: Building 100,000
Equipment 90,000

The adjusting entry reduces the net book value of the building and
equipment accounts. The provision for depreciation is a contra account
that has a balance opposite that of the assets account to which it
relates. Thus, the provision for depreciation is subtracted from the gross
building and equipment accounts, leaving the net undepreciated account
balances of 1,500,000 (1,600,000-100,000) and 820,000
(910,000-90,000) for building and equipment respectively in the
statement of financial position .
11.6.2 Bad Debts
Where a business sells its goods on purely cash basis, it he does not
have to worry about customers not paying for such goods. This is
however not always the case. Goods and services are usually sold or
rendered on credit, giving rise to trade receivables. The business is
therefore taking the risk of some customers defaulting in the payment of
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272
their receivables. Trade receivables that are not collected are called bad
debts, which is a risk of doing business on credit terms.

Where a customers debt is found to have gone bad, steps must be
taken to remove such debts from the list of customers owing the
business. This is done by completely writing off the debt from the
receivables account. Writing off of a particular debt from the list of
receivables accounts means that the value of the assets of the business
has reduced or diminished. This in effect means that the business has
incurred losses that must be accounted for by increasing the expense
account of bad debt, which will eventually reduce profit and also reduce
assets of receivables, which will also result in the reduction of the net
assets of the business.

Where an account containing a debt is declared bad you must pass a
journal entry as follows:
Debit: Bad debts expense account (Income statement)
Credit: Trade receivables account (Statement of
financial position)

It is important for companies to review its receivables periodically and
identify those debts from which full payment is unlikely. These bad debts
may then be written-off in the statement of financial position . This
practice prevents overstatement of both profit and assets and is required
if bad debts are probable and can be estimated. At the end of the
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accounting period the total debt written off is transferred from the bad
debt account to the Income

statement as follows:
Debit: Income statement
Credit: Bad debt account

Illustration 11.6
Jack Terror has been in business for several years dealing in the sale of
second hand cloths. During the three years ended 31
st
October 2005 he
presented the following information relating to receivables:
Receivables
(including bad debts)

Bad
Debts
31
st
October 2003 4,500,000 1,200,000
31
st
October 2004 8,750,000 3,850,000
31
st
October 2005 12,200,000 6,300,000

You are required to show the above information for the year ended 31
st

October, 2003, 2004, 2005 in the following accounts:
(a) Trade receivables
(b) Bad debt
(c) Income Statement (extracts)
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Trade Debtors Account

31/10/2005 Sales 12,200,000 31/10/2005 Bad debt 6,300,000
31/10/2005 Balance c/f 5,900,000
12,200,000 12,200,000
1/11/2006 Balance b/f 5,900,000

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11.6.3 Provision for doubtful debts
This refers to the possibility of a debt going bad in the future but for
which the amount cannot be calculated with substantial accuracy. In the
case of doubtful debts, the amount or estimate still remains in the list of
receivables and is not cancelled from the receivables account as in the
case of debts that have actually gone bad. Doubtful debt does not relate
to any specific debtor, but the business recognizes the fact that not all
the existing debts will be collected and as such, it is prudent that such
uncertainty is reflected in the Income statement and the statement of
financial position . The accounting treatment necessary to make a
provision for doubtful debts is:

1. When a provision is made for the first time:
Debit: Income Statement
Credit: Provision for doubtful debts Account
With the initial provision.

In this way the current years profit is reduced, whilst in the statement of
financial position the provision is clearly shown and deducted from trade
receivables.
2. In subsequent accounting periods new estimate must be made in
respect of debt that may be considered doubtful. The new
provision should be compared with the existing one and where the
current provision is greater than the previous one, the difference
representing an increase in provision for doubtful debts should be
accounted for as:
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276
Debit: Income statement
Credit: Provision for doubtful debts
With the increase in provision (i.e. the difference)
If the current provision is less than the previous one, the difference
representing a decrease in provision for doubtful debts should be
accounted for as:
Debit: Provision for doubtful debts account
Credit: Income statement
With the decrease in provision (i.e. the difference)
Illustration 11.7
Viscosity Ltd. has been in business since 2003 dealing in the sale of
mobile phones. During the three-years period ended 31
st
December
2005 the company presented the following information relating to
receivables:
Trade Receivables(excluding
bad debts)

Bad Debts
31
st
December 2003 7,000,000 1,000,000
31
st
December 2004 18,250,000 2,500,000
31
st
December 2005 10,000,000 4,300,000

Viscosity Ltd. makes provision for doubtful debts at the rate of 6% on
receivables. There was no balance on the provision for doubtful debt at
the beginning of 2003 financial year.
You are required to show the above information for the year ended 31
st

October, 2003,2004,2005 in the following accounts:
(d) Bad debt
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(e) Provision for doubtful debt
(f) Income Statement extracts
(g) Statement of financial position (extracts)
Bad debts Account

31/12/2003 Trade debtors 1,000,000 31/12/2003 Profit and loss 1,000,000

Provision for doubtful debt

31/12/2003 Balance c/f 420,000 31/10/2003 Profit and loss 420,000
31/12/2004 Balance c/f 1,095,000 01/01/2004 Balance b/f 420,000
31/10/2004 Profit and loss 675,000
1,095,000 1,095,000
31/12/2005 Profit and loss 495,000 01/01/2005 Balance b/f 1,095,000
31/12/2005 Balance c/f 600,000 31/10/2005
1,095,000 1,095,000
01/01/2006 Balance b/f 600,000

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11.6.4 Bad debts recovered
It normally occurs that a debt, which has previously been written off in
past accounting periods, may be repaid or recovered. When this is the
case it is usually advisable that such recovered debt be reinstated. The
debt is reinstated in the sales ledger account to ensure that a detailed
and concise history and behaviour of the debtor or customer is available
to serve as a guide for future granting of credit in respect of the same
customer. It will therefore assist the company in its credit rating of all
customers that buy goods from them on credit.

The accounting entries when a debt is recovered are:
Debit: Trade Receivables account
Credit: Bad debts recovered account
With the amount of debt reinstated

Debit: Cash or bank account
Credit: Trade Receivables account
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With the amount recovered from receivables in settlement of all or
part of the debt.

At the end of the accounting period the balance in the bad debt
recovered account will either be transferred directly to the Income
statement or to the main bad debt account. Either mode of transfer
will produce the same result since the dab debt account will
eventually be transferred to the Income statement with the net
value.

11.6.5 Provision for discount on trade receivables
In certain businesses provision is made for cash discount that is
expected to be offered to customers on the trade receivables balance at
the statement of financial position date. Proponents of this concept
argue that since companies allow discounts from credit sale for prompt
payment recording net realisable value of receivables as the balance on
receivables account less provision for doubtful debt will not give the best
estimate of the amount expected to be collected from trade receivables.
They argue that to estimate the realisable value of receivables,
consideration should be given to the impact or effect of cash discount,
hence the determination of provision for discount on receivables.
The manner in which provision for discount on receivables is calculated
is almost the same as that obtained when calculating provision for
doubtful debts. You must however remember to apply whatever rate or
percentage on the net amount of trade receivables less provision for
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280
doubtful debts. This is so because discounts are allowed on debts
expected to be paid and not bad debts.

Illustration 11.7
Mahatma Ltd. has been in business since 2003 dealing in the sale of
Italian executive shoes. During the three years ended 31
st
December
2005 the company presented the following information relating to
receivables:
Trade
Receivables
Provision for
doubtful debts
Provision for cash
discount allowed
%
31
st
December 2003 17,000,000 1,000,000 4
31
st
December 2004 28,550,000 4,500,000 4
31
st
December 2005 22,000,000 2,800,000 4

You are required to show the above information for the years ended 31
st

October, 2003, 2004, and 2005 in the following accounts:
Provision for discount on receivables
Income Statement extracts
Statement of financial position extracts

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11.7 Summary
In this chapter we have considered some of the adjustments that are
often made to improve the quality of the year-end accounts used to
prepare the financial statements. We should also understand that these
adjustments are needed in order to record the actual expenses incurred
and the actual revenue earned for the accounting year. It must be
remembered that each of the adjustments considered will impact upon
the Income statement and the statement of financial position.

We have also learned that depreciation is a business expense that must
be charged in the Income statement of any period that a non-current
asset has been in use. In addition we learned that any business debt
that an organization is unable to collect is called a bad debt and that
there is the need to also record provision for bad debts so that the
receivables figures in the statement of financial position will reflect the
amount that the business is likely to collect from receivables.

Finally we have also learnt how to record bad debts, provisions for
doubtful debts, provision for cash discount in the ledger, Income
statement and the statement of financial position . It is hoped that,
students will have a better understanding of the purpose and accounting
treatment for depreciation, bad debts provision and accruals and
prepayments.

1. Which of the following would result from an increase in the
provision for doubtful debts?
a. A decrease in gross profit
b. An increase in gross profit
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c. A decrease in net profit
d. An increase in net profit
e. An increase in asset
Use the following details to answer Question 2.
Trade receivables control account balance 500,000.00
Provision for doubtful debts 50,000.00
Provision for discount allowed on receivables 5%
2. The receivables figure to be shown under current assets in the
statement of financial position is
a. 425,000.00
b. 427,500.00
c. 447,500.00
d. 450,000.00
e. 475,000.00
3. During 2000, Victor paid rent amounting to 500,000. He owed
50,000 at the beginning of the year and by 31
st
December 2000,
he had paid rent in advance of 100,000. His rent charge for
12000 was?

a. 350,000
b. 650,000
c. 500,000
d. 550,000
e 450,000

Use the information below to answer questions 4 and 5.

At the end of the first year of trading, a traders receivables
amounted to 5,000. This excludes 180 debts found to be
irrecoverable. At the same date, it was estimated that 70 of the
5,000 would turn out to be bad debts.

4. Determine the net realisable value of receivables at the end of
the first year of trading?
a. 4,820
b. 4,930
c. 4,750
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d. 5,000
e. 45,030
5. The amount of bad debts actually recognised during the first
year was -I- to which has been added the -II- expected but of
which the owner is not yet certain.
a. I 70 II 180
b. I 250 II 4,820
c. I 180 II 70
d. I 4,750 II 250
e. 1 44,000 II 70

6. When a debt thought to be bad and written off is subsequently
recovered, which additional entry is needed to complete the two
entries given below?
I. Debit Personal Account/Credit Bad Debts Recovered
Account
II. Debit Cash/Bank Account/Credit Personal Account
a. Debit Income statement/Credit bad debts recovered
account
b. Debit Income statement/Credit Cash/Bank account
c. Debit bad debts recovered account/Credit P/L account
d. Debit bad debts recovered account/Credit personal
account
e. Debit cash/credit income statement
7. From the following information, calculate the cash paid by trade
receivables during the year.

Receivables at the beginning of the year 350,000
Receivables at close of the year 500,000
Credit sales for the year 510,000

a. 360,000
b. 340,000
c. 660,000
d. 520,000
e. 380,000

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8. The fact that provisions are made against doubtful debts
upholds the concept of
a. Consistency
b. Prudence
c. Materiality
d. Business entity
e. Realisation

9. Which accounting concept does not agree with making
provision for discount receivable?
a. Prudence
b. Business entity
c. Accruals
d. Consistency
e. Materiality
10. A customer owing 200,000 was allowed to pay 180,000 in
full settlement of his indebtedness. This results in a
a. Decrease in liability, increase in asset and increase in
capital
b. Decrease in asset, decrease in capital and decrease in
liability
c. Decrease in asset, increase in asset and decrease in
capital
d. Decrease in capital, decrease in asset and increase in
liability
e. Increase in capital, decrease in asset and decrease in
liability

11. Annual rent payable is 500,000. Rent prepaid at 1
st
January,
2006 was 80,000 and rent accrued at 31
st
December 2006 was
60,000. How much was paid in respect of rent in 2006?
a. 520,000
b. 500,000
c. 480,000
d. 360,000
e. 420,000

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1. On 1
ST
January, 2001 the following balances among others stood in
the books of Menntua Enterprise.
Electricity and Water 15,000,000
Cr.
Insurance 50,000,000
Dr.
During the year ended 31
st
December 2001, the following information
relating to the above accounts have been provided:
1. Motor insurance of 870,000,000 was paid on 1
st
June 2001 for a
one year period.
2. Marine insurance of 190,000,000 covering the year ended 31
st

March 2002 was paid on 1
st
April 2001. The Enterprise had not
insured one of its buildings in respect of fire after the insurance
premium expired on 31
st
December 2000. The Building was
insured for 60,000,000 last year and the insurance company
does not intend reviewing the premium.
3. Electricity bill amounting to 750,000,000 was paid on 1
st
March
2001 and also electricity bill amounting to 250,000,000 in respect
of November and December 2001 had not been paid by the end of
the accounting period. Payment of 15,000,000 was made in
respect of an old building that is being used as warehouse by the
enterprise. This payment was made at a time when there was no
meter in the building. The electricity bill for the building was
arrived, at by charging the enterprise 13,500,000 for total
consumption in 2001.
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You are required to post and balance the above transactions in the
appropriate ledgers.

2. The following balances were extracted from the ledgers of
Vicotrosky Ltd..
01/04/2004 31/03/2005

Rent receivable Prepayments 108,000 215,000
Rates and insurance- Prepayment 450,000 385,000
Accruals 103,000 185,000
Trade receivables 798,000 985,000
Stationery: inventories in hand 235,000 275,000
Owing to suppliers 109,000 97,500

During the year ended 31
st
March 2005, the following transactions took
place:

Rent received by cheque 418,000
Rates paid to AMA by cash 950,000
Payment to suppliers for stationery 205,000
Bad debts written off on a customer who has been
declared bankrupt
50,000
Insurance paid by cheque 550,000
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Cheque received from customers 8,525,000

You are required to post and balance the above transaction in the
appropriate ledgers.
3. The Trial Balance of Santo Ltd. for 2000 reported an amount of
750,000 by way of trade receivables. At the time of preparing the
Trial Balance, the accounts clerk discovered that a customer owing
150,000 would not be able to settle such debts. It is the policy of
Santo Ltd. to make a provision for doubtful debts of 5% of all
outstanding trade receivables at the end of each accounting period.

During the accounting year of 2001 the company made a total credit
sale of 980,000 out of which an amount of 550,000 was collected
from trade receivables. A court in Accra declared a customer who
owes the company an amount of 85,000 bankrupt in August 2001.
The company recorded three cheques amounting to 175,000 that
were dishonoured.

The company recorded 1,500,000 and 850,000 in connection
with cash sales and credit sales respectively in the year 2002. The
company received 1,250,000 from trade receivables and also
showed 670,000 as the outstanding balance on the sales ledger
account. A cheque was received from the customer whose debt
was written off in 2000 in full settlement of his debt.

You are required to post and balance the following accounts:
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a. Trade receivables
b. Bad debts
c. Provision for doubtful debts
4. The net profit of Kumasa Ltd. for 2003, 2004, 2005 and 2006 were
450,000,000, 598,000,000, 515,000,000 and 798,000,000
respectively. It has now been found out that the wrong method of
depreciation has been used over the years for motor vehicles and
Plant and Machinery.
Details on the assets are as follows:
Date Cost Scrap
value
000 000
Plant and Machinery 1/01/2003 980,000 40,000
Motor vehicles 1/1/2003 670,000 20,000

The straight line method of depreciation was used with an estimated
useful life of ten (10) years and four (4) years for Plant and Machinery
and Motor vehicles respectively. The directors of the company have now
decided to adopt the diminishing balance method of providing for
depreciation as follows:
Plant and Machinery 15%
Motor vehicles 20%
You are required to re-compute the net profit of Kumasa Ltd. for the
years ended 31
st
December 2003, 2004, 2005.

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1. c.
2. b.
3. a.
4. b.
5. c.
6. c.
7. a.
8. b.
9. a.
10. c.
11. d.

11.11 Solution to Examination type Questions
Menntua Enterprise

Solution to question 1

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Victorosky Ltd..

Rates and Insurance Account

1/4/2004 Bal b/f 450,000 1/4/2004 Bal b/f 103,000
31/3/2005 Cash 950,000 31/3/2005 Profit and loss 1,647,000
31/3/2005 Bank 550,000
31/3/2005 Owing c/f 185,000 31/3/2005 Prepaid c/f 385,000
2,135,000 2,135,000
1/4/2005 Prepaid b/f -marine 385,000 1/4/2005 Owing b/f (fire) 185,000

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Santo Ltd..

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Kumasa Ltd..
Straight line method- Motor vehicles

Beginning Depreciation Depreciation Accumulated
Year Depreciable Rate for the year Depreciation
amount

2003 940,000,000 10% 94,000,000 94,000,000
2004 940,000,000 10% 94,000,000 188,000,000
2005 940,000,000 10% 94,000,000 282,000,000
2006 940,000,000 10% 94,000,000 376,000,000

Straight line method- Plant & equipment

Year Depreciable Depreciation Depreciation Accumulated
amount Rate for the year Depreciation

2003 650,000,000 25% 162,500,000 162,500,000
2004 650,000,000 25% 162,500,000 325,000,000
2005 650,000,000 25% 162,500,000 487,500,000
2006 650,000,000 25% 162,500,000 650,000,000

Reducing balance method- Motor vehicles

Year Depreciable Rate for the year Depreciation Depreciable
amount amount

2003 940,000,000 20% 188,000,000 188,000,000 752,000,000
2004 752,000,000 20% 150,400,000 338,400,000 601,600,000
2005 601,600,000 20% 120,320,000 458,720,000 481,280,000
2006 481,280,000 20% 96,256,000 554,976,000 385,024,000

Reducing balance method- Plant & equipment

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Year Depreciable Rate for the year Depreciation Depreciable
amount amount

2003 650,000,000 15% 97,500,000 97,500,000 552,500,000
2004 552,500,000 15% 82,875,000 180,375,000 469,625,000
2005 469,625,000 15% 70,443,750 250,818,750 399,181,250
2006 399,181,250 15% 59,877,188 310,695,938 339,304,063

Computation of Adjusted Net profit for the
years ended 2003, 2004, 2005, and 2006.

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References
Wood and Sangster, Business accounting; Prentice Hall
Cassell
Garbutt Douglas, Carter;s Advance Accounts; Pitman Publishing limited.
Millichamp, Foundation Accounting; ELBS
McGraw-Hall
Gavor, S.D.K.N., Basic and Intermediate Accounting; Academy of
Business and Finance
Dyckman, Dukes, Davis, Intermediate Accounting; Irwin McGraw-Hall
Chasteen, Flaherty and Oconnor, Intermediate Accounting; Irwin
McGraw-Hall
Ghana National Accounting Standards 9 (Property, Plant and
Equipment)
Ghana National Accounting Standards 10 (Accounting for
Depreciation)

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CHAPTER TWELVE

PREPARATION OF SIMPLE FINAL ACCOUNTS
Define, explain and record returns inwards, returns outwards,
carriage inwards and carriage outwards
identify items that will appear in the Comprehensive Income
Statement, Income statement and statement of financial position of a
sole trader
explain why carriage inwards is recorded in the Income Statement
and also why carriage outwards is recorded in the Income statement
prepare the inventories account and show how the opening and
closing inventoriess are treated in the Comprehensive Income
Statement
prepare anIncome statement and statement of financial position
to pass the necessary adjustment in respect of accruals,
prepayments and provisions that affect the Income statement
explain and calculate cost of goods sold taking into consideration the
appropriate adjustments such as returns inwards and outwards,
carriage inwards and outwards, and inventories
prepare Manufacturing Account

11.2 Introduction
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In this chapter you are going to learn how to prepare a simple
Comprehensive Income Statement and a statement of Financial
position for a sole trader who deals in the buying and selling of
goods. You will also learn how to prepare final accounts of a sole
trader who is involved in the Manufacturing process. New
terminologies such as returns inwards, returns outwards, carriage
inwards and carriage outwards will also be introduced. The chapter
will also consider the treatment and recording of trading
inventories that were purchased in the accounting period but the
trader was not able sell all.

12.3 The Trial Balance
The first step in the preparation of the final accounts is the compilation of
a Trial Balance, with a view to:
(a) Proving the arithmetical accuracy of the postings, and
(b) Providing in one statement a concise summary of the items,
which are to be included in the Comprehensive Income
Statement, Income statement and the Statement of financial
position .

Debit balances recorded in the Trial Balance normally represent either
assets, or losses and expenses. The assets are entered in the
Statement of financial position , while losses and expenses are debited
to the Comprehensive Income Statement or to the Income statement.

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Likewise, the credit balances represent liabilities, provisions, reserves,
or revenues and gains. The liabilities are entered in the statement of
financial position as deductions from assets of the firm, while income
and gains are credited either to the Comprehensive Income Statement
or to the Income statement.

Students must remember to carefully distinguish between balances,
which appear in the Comprehensive Income Statement, Income
statements, and those that appear in the Statement of financial position .
The trading and Income statement essentially closes off all the nominal
account balances during a particular accounting period. Any account,
which remains in the Trial Balance after the trading and Income
statement have been prepared, represents either assets or liabilities that
must be recorded in the Statement of financial position . The balance on
the Income statement will finally be transferred to the capital account in
the statement of financial position .

11.4 The Statement of comprehensive Income
The main objective of this Statement is the determination or calculation
of the gross profit for the period. It is also in this account that the cost of
obtaining the goods, usually referred to as cost of goods sold or simply
as cost of sales is calculated.

Another important function of this Statement of is that it enables the
owner of a business to compare the gross and net profit of a current
period with the results attained in previous periods. It is pertinent that,
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the component items in the Income Statement do not vary in any
material effect from previous and subsequent accounts, as this will make
it impossible for any analyst to make meaningful approximate
comparison. This therefore means that the Income Statement should be
standardized so that the same items should appear in similar form in the
successive final accounts so that an effective comparison may be made
of one trading period with another.

The actual items in the Income Statements of different classes of
enterprises or businesses will necessarily vary depending on the nature
of the nominal accounts in the respective business; for example,
customs duty, licenses, and freight and insurance on inward shipments
of raw materials will be essential items in the Statement of a cigarette
manufacturer, but these particular items would not appear in the
Comprehensive Income Statement of a retail tobacconist.

The following is the usual method of preparing the statement of
Comprehensive Income.

On the debit side are recorded:
(1) Inventories at commencement of the period, which is
usually, called opening inventories.
(2) Purchases during the period (less returns outwards).
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(3) All purchasing and expenses, such as wages, carriage
inwards, and other items which are incurred in putting the
product in a saleable condition or location.

The account is credited with-
1. Sales during the period (less returns inwards).
2. Inventories at end of period (it is the usual practice of deducting
the closing inventories figure from the sum total of opening
inventories and net purchases on the debit side of the
Comprehensive Income Statement so as to show on the face of
the account the cost of goods sold).

Where the balance remaining on the Statement is credit then the
business has recorded a gain, which is referred to as gross profit and
will be transferred to the Income statement as a credit entry by debiting
the Comprehensive Income Statement.

Before we attempt to prepare the Statement of comprehensive
Incomes of a business in detail we need to understand the
following accounting terminologies:

12.4.1 The movement of inventories
Organisations usually maintain four different accounts for the
inventories function. The accounts involved are:
Sales account
Returns inwards account
Purchases account and
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Returns outwards account

The sales and the returns inwards accounts are accounts in
which are recorded the respective goods sold and goods
returned by customers. The purchases account and the returns
outwards account contain transactions involving goods bought
for resale and goods returned to suppliers respectively.

The usual practice is to maintain the sales account separately
and not to deduct directly any goods that have been returned by
customers during the accounting period. The returns inwards
account serves as a contra to the sales account by recording all
sales that have been returned by customers. Being a contra
account to the sales account means that it has a debit balance
which when transferred to the sales account at the end of the
accounting period will show the net sales or turnover of the
organisation.

The accounting entries will be recorded as follows:
Dr. Bank or Receivables Account
CR. Sales Account
With goods sold for cash or on credit
Dr. Returns inwards Account
Cr. Bank or Receivables Account
With goods sold but returned by customers

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303
Dr. Sales Account
Cr. Returns inwards Account
With the balance on the return inwards account

Similarly the purchases account is maintained separately by
recording all goods bought for the sole purpose of resale relating
to the accounting period. The returns outwards account serves as
a contra to the purchases account. In to this account is recorded
all purchases that were returned to suppliers. Being a contra
account to the purchases account means that it has a credit
balance which when transferred to the purchases account at the
end of the accounting period will show the net purchases of the
organisation.

The accounting entries will be recorded as follows:
Dr. Purchases Account
CR. Bank or Payables Account
With goods bought for cash or on credit

Dr. Bank or Payables Account
CR. Returns outwards Account
With goods bought but returned to suppliers

Dr. Returns outwards Account
Cr. Purchases Account
With the balance on the return outwards account
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12.4.2 Carriage inwards and outwards
Carriage is an accounting terminology that refers to the cost of
transport that a trading concern incurs in moving goods meant for
resale into or out of a firm. Where the carriage is charged for
delivering goods purchased, it is called carriage inwards. Carriage
of goods upon sale out of a firm is called carriage outwards.

Carriage inwards is a cost that is incurred in order to bring the
goods into a condition that is necessary for its sale and as such
should be charged to the Income Statement. This is done by
adding the carriage inwards to the purchases figure in the Income
Statement. This ensures that the true cost of buying goods for
resale is taken into account in calculating the gross profit of a
business.

Carriage outwards, however, is not considered as a relevant cost
the purpose of which is to put the asset into a saleable condition. It
is therefore worthy to note that carriage outwards is an Income
statement item and for that reason is not included in the
calculation of gross profit. This is because carriage outwards is
seen as expenses on sales and as a result is debited in the Income
statement.

12.4.3 Goods taken by the Proprietor
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It is common in a one man business to find the proprietor making
use of the products that he is selling for his own benefit. The use of
products or goods by a proprietor is usually termed inventories
drawings. The accounting effect of inventories drawings is that it
reduces the amount of cost of goods available for sale since the
total goods bought for resale have been reduced by the inventories
drawings and as such the inventories drawings account must be
debited and the purchases account credited.

Illustration 12.1
From the following Trial Balance of Jack Terror after his first years
trading, you are required to prepare Income Statement for the year
ended 30
th
June 2007.

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The Income Statement will be compiled as follows:
Trading Account for the year ended 30th June 2007
'000 '000
Purchases 20,000 Sales 28,000
Add carriage inwards 650 Less returns inwards 450
20,650 27,550
Less returns outwards 745
Cost of sales 19,905
Gross Profit c/f 7,645
27,550 27,550
Gross Profit c/f 7,645

12.4.4 The accounting treatment of inventories
From the above Income Statement one can deduce that the
business is a new one and also was able to sell the goods that
were purchased during the year. This means that the business had
no opening and closing inventories during the accounting period
ended 30
th
June 2007. The usual practice is for business
organisations to hold certain minimum level of inventories to meet
future demand.

If this practice is accepted to be normal, then it should be expected
that in most situations a business would certainly have in closing
inventories that might have been bought in the current accounting
period but have not been sold. Goods that were bought for the
purpose of resale in an accounting period but have not been sold
in that particular period and carried forward to the next accounting
year constitute what is referred to in accounting terminology as
closing inventories.

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It must be noted that the closing inventories of an accounting
period is brought forward as the opening inventories of the next
accounting period. This is handled in the Income Statement by
adding the opening inventories to the purchases figure which gives
rise to cost of goods available for sale and deducting the closing
inventories figure resulting in cost of goods sold.

Illustration 12.2
The following is the Trial Balance of Victorosky Trading Enterprise who
has been in business for several years. You are required to draw up the
Income Statement for the year ended 31
st
December 2006.

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12.5 The Income statement
The main function of the statement of Comprehensive Income is to
ascertain the net Income statement resulting from the trading operations
of the accounting period.

It is debited with the gross loss and with the General, Selling,
Distribution and Administration expenses for the period, and is credited
with the gross profit (if any) and any miscellaneous gains made, such
as interest and discounts received.

There is no established arrangement or order in which items should be
set out in a Income statement, but a sequence frequently adopted in
practice and which is recommended for examination purposes is as
follows:

Debits-
1. Gross loss from the Comprehensive Income Statement (if any).
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2. Establishment charges, e.g., rent, rates, electricity. etc.
3. Administration expenses, e.g., clerical wages, salaries, director
fees, etc.
4. Selling and Distribution expenses, e.g., advertising, travelling
expenses; salaries and commission, carriage outwards,
packing materials, etc.
5. Other expenses, e.g., loss by fire, loss by defalcations.
6. Finance Charges, e.g., loan interest and bank charges.
7. Personal Income tax
Credits-
1. Gross Profit (if any)
2. Investment income, e.g., interest earned on treasury bills and
dividend receivable
3. Miscellaneous Income, e.g., rents received, discounts received.

In examination settings students may be required to prepare the Income
statement and Statement of financial position, from a Trial Balance ,
which already contains the gross profit figure. The inventories that
appears in the Trial Balance in this situation are the closing inventories,
which must be recorded in the statement of financial position as a
current asset and should not be treated as an adjustment Income
Statement. The opening inventories will not be recorded because it has
already been accounted for in the inventories prior to the extraction of
the Trial Balance .

The balance on the Income statement represents net profit or loss of the
business or the firm. Where the resulting balance in the statement is a
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credit, a transfer will be made by debiting the Income statement and
crediting the capital account of the proprietor. The effect of this entry is
to close off the Income statement to the capital account.

12.5.1 Adjustments in the Final Accounts
The ultimate objective of preparing the Income statements and the
Statement of financial position, is to enable the management of an
organisation determine:

(a) The result of its operations during a given period; and
(b) Its financial position at the end of that period.

It must also be cautioned that, in order to obtain these results
accurately, it is necessary to make adjustments for:

(1) Expenses incurred but not paid and as a result have not been
recorded in the books of account.
(2) Expenses paid in advance, a proportion of which relate to
subsequent accounting period.
(3) Income earned in respect of the current accounting period but
has not yet been received.
(4) Income received during the current accounting period but will
affect the next accounting period.
(5) Provisions for possible losses, e.g., bad debts, and discounts
on receivables.
(6) Necessary adjustments for depreciation in the values of the
assets at the end of the trading period.

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12.6 The statement of financial position
This is a statement that shows the financial position of a business as at
the end of an accounting period. It is therefore a presentation of a
concise summary of the assets and liabilities of an enterprise in a well-
arranged form, so that the financial position of the firm or company on
the date of the statement may be clearly ascertained.

The arrangement of the statement of financial position is nothing but the
expression of the accounting equation and as such must always agree
or balance. This means the total book values of assets must be equal to
the sum of the values of Capital and Liabilities. The assets of a business
are usually arranged in order of their permanence, and for this reason
they may conveniently be classified into four groups, as follows:
Non-current assets
Current assets
Liabilities
Capital
12.6.1 Non-current assets
These are assets that by their nature or the type of business in which
they are employed, are held with the aim of earning revenue and not for
the purpose of sale in the normal course of business. Non-current
assets are generally valued at cost, less provisions for accumulated
depreciation that is sufficient to reduce the carrying or book value of the
asset to its salvage or scrap value by the end of its useful working life.
Examples of non-current assets are land, buildings, motor vehicles and
office equipment.
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The amount at which non-current assets are shown in the Statement
does not reflect the amount that will be realised if sold or the cost that
will be incurred when they are replaced, but rather is a historical record
of their cost less amounts provided in respect of accumulated
depreciation. Depreciation represents that part of the cost of a non-
current asset to its owner, which is not recoverable when the asset is
finally scrapped or sold. Provision against this loss of capital must be
made before calculating the amount of profit or loss made by a business
organisation.

12.6. Current assets
These are assets that are acquired and held for resale, and not as
agents of production, but for the purpose of eventual conversion into
cash. They are therefore not permanent in nature, but are continually
changing in the ordinary course of business. Examples of current assets
are cash, receivables, closing inventories and bills receivable. The
professionally accepted basis of valuing inventories is cost price or net
realizable value, whichever is the lower. The fundamental reason for
this basis of valuation is that anticipated losses should always be
provided for as far as possible, while anticipated profits should be
ignored until actually realised.

Although examples current and non-current assets have been
mentioned above, it must be remembered that the dividing line between
current and non- current assets is a thin one. This is due to the fact that
what is considered as a non-current asset in one business may be a
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current asset in another, and any classification must depend upon the
nature of the particular business carried on by the firm. For example a
business that manufactures and sells furniture will certainly record a
motor vehicle purchased as a non-current asset and furniture as a
current asset but if he uses any of the furniture in the office such
furniture will be classified as a non-current asset.

11.6.3 Liabilities
These are the obligations of a business enterprise to outsiders. The best
method of arranging the liabilities in the case of a sole trader is in order
of permanence. The usual groupings are as follows:
Non-current liabilities.
Current Liabilities

12.6.4 Capital account
This represents the contribution of the proprietor of a business to the
assets that the firm has acquired. It is made up of the following:
(1) The initial amount that the owner used in starting the business
(2) Any additional amount that he invested in the business during
any accounting period
(3) The net profit from the Income statement, which has the effect
of increasing the capital of the owner at the end of the
accounting period
(4) The net loss from the Income statement that has the effect of
reducing the capital account balance at the end of the period,
and
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(5) Drawings, which eventually results in the reduction of the
capital balance.

12.7 Manufacturing Account
Though the Income statement is the acceptable means of determining
the performance of a trading enterprise, it is not a sufficiently
explanatory means of ascertaining the profit of a manufacturing concern.

Manufacturing firms usually prepare an additional account called
Manufacturing Account, which shows the cost of goods produced or
manufactured. The cost of goods manufactured, normally called the
production costs is transferred from the Manufacturing Account into the
Income Statement by crediting the Manufacturing Account and debiting
the Income Statement. The production cost effectively replaces
purchases found in the Income Statement of a retail enterprise. It must
however be noted that where a manufacturing firm produces more than
one product, a separate Manufacturing Account should be prepared for
each product.

The sequence and grouping of items in a Manufacturing Account
depends on the costing system of the firm and is usually designed to
yield the maximum amount of information on the composition of the total
cost of production. The classification, sequencing and grouping of the
Manufacturing Account is as follows:
Prime cost
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Factory overhead
Production cost
Work-in-progress
12.71 Prime cost:
(1) Cost of raw materials consumed. These consist of the cost of
direct materials that the firm purchased and used in the
manufacturing process. It is calculated as follows:

Opening inventories of raw materials 500,000
Add Purchases of raw materials 2,500,000
3,000,000
Less returns outwards of raw materials 200,000
Cost of raw materials available 2,800,000
Less closing inventories of raw materials 600,000
Cost of raw materials consumed 2,200,000

(2) Direct labour costs. These consist of the cost of labour such as
wages of operatives and workers (both casual and regular) whose
efforts are traceable directly to the manufactured product.

(3) Direct Expenses. These consist of all direct costs other that direct
materials and direct labour. Examples include royalties and cost of
hiring machine.
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The summation of the items above show the sub-total for prime cost.
12.7.2 Factory Overheads:
This sub-heading is shown immediately below the prime cost figure and
consists of all indirect costs in respect of materials, labour and
expenses. They may include rent, rates, electricity, depreciation of plant
and equipment, insurance, the wages of foremen in the factory and
research and development cost.
Certain expenses may be common to the manufacturing process as well
as to the general administration of the business. Such expenses should
be apportioned between the factory and Administration, Selling and
Distribution. The method or basis commonly used in apportioning these
common expenses is usually given in an examination question.

12.7.3 Production Cost:
This is the summation of the prime costs and factory overhead figures.
This represents the total cost that a manufacturing firm incurs in the
production process and is transferred to the Comprehensive Income
Statement for that accounting period.

Illustration 12.3
Kefir Enterprise is a manufacturing firm and has presented the following
balances for the year ended 30
th
June 2006.
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You are required to prepare the Manufacturing Account for the year
ended 30
th
June 2006.

The Manufacturing Account will be prepared as follows:
Kefir Enterprises

12.7.4 Work-in-progress
The time that manufacturing companies uses to complete a unit or batch
of production is not the same; it varies from company to company. It is
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therefore possible that by the time that the accounting period of a
manufacturing firm ends there might be some product s that are not fully
complete. Those products that have not been completed at the date of
the statement of financial position date are called inventories of work-in-
progress.

The cost of production must be adjusted for work-in-progress at the end
and the beginning of the accounting period. This is due to the fact that
the amount to be transferred to the Comprehensive Income Statement
must contain the cost of only products that are fully complete. Any item
or product that has not been completely through the manufacturing
process cannot be sold; hence they must not appear in the statement.

Illustration 12.4
Koki Enterprise is a manufacturing firm and has presented the following
balances for the year ended 30
th
June 2007.

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Required: Prepare the Manufacturing Account for the year ended 30
th

June 2007

The completed cost of production taking into consideration work-in-
progress would be prepared as follows:

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12.75 Transfer Pricing
The usual practice in the preparation of Manufacturing Account is to
transfer the production cost to the Income Statement at historical cost.
This means that the Manufacturing Account will not record any profit and
for that matter one will not know whether the manufacturing process is
profitable.

A technique is therefore devised with the purpose of ascertaining profit
on the Manufacturing Account. This is done by transferring from the
Manufacturing Account the market value of the goods produced for the
period. The reason for the use of the market value as the transfer figure
to the Income Statement is to ascertain the cost of the manufactured
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item had the firm decided to acquire those products in the open market
instead of producing them.

In this situation the Manufacturing Account will show a balance, which
will reveal either a profit or loss on production. This will therefore inform
management whether the production department is a profitable one. If
the answer to this question is negative management may have to decide
whether to close the production department or institute cost-cutting
measures that will result in lower cost of production by means of strict
supervision and economies to cheapen production.

Illustration 12.5
Given the same question in illustration 11.5 above, let us assume that
the production Department transfers the finished product from the
factory to the marketing department at cost plus 25%.

The Manufacturing Account will be prepared in the horizontal
format as follows:
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12.8 Summary
We have learned that the purpose of the Income statement of a sole
proprietor is to determine his performance for the accounting period. The
performance is determined by calculating the net profit or net loss as the
case may be. Important terms such as carriage inward, carriage
outward, returns inward and returns outward have also been explained.
The statement of financial position was also mentioned and explained
as a statement that shows the financial position of an enterprise as at a
particular time or date.

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We also saw that an enterprise that manufactures products for sale will
need an additional account called Manufacturing Account to record the
total cost incurred in producing the products.


1. Which of the following are factory overheads?
I. Factory rent
II. Carriage on purchases
III. Factory workers basic wages
IV. Basic raw materials
V. Plant repairs

a. I, III and V
b. III, IV and V
c. I and V only
d. IV and V
e. I, II and V

2. What is the effect of a decrease in Provision for Bad Debts on
the final account?
a. Decrease in assets, increase in expenses
b. Increase in expenses, increase in liabilities
c. Increase in capital, increase in expenses
d. Increase in assets, increase in revenue
e. Decrease in assets, decrease in revenue

Use the data below to answer Questions 3 and 4

Caterpillar Ltd.. has the following information at 31/12/2006

Cost of raw materials 4,500,000
Manufacturing overheads 2,300,000
Productive wages 2,600,000
Work in progress 1/12/2006 800,000
Work in progress 31/12/2006 300,000
Payment of royalties 800,000
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Manufactured goods transferred to Sales Dept at cost plus 25%
Closing inventories of finished goods 450,000

3. Prime cost is
a. 7,900,000
b. 7,600,000
c. 6,650,000
d. 9,750,000
e. 2,675,000

4. The manufacturing profit is
a. 1,862,500
b. 2,000,000
c. 2,050,000
d. 2,675,500
e. 2,562,500

5. A statement of financial position is usually prepared with
a. Assets and liabilities at the end of the period
b. Assets and liabilities at the beginning of the period
c. Liabilities and sales at the end of the period
d. Assets and equities at the beginning of the period
e. Inventories and payables at the end of the period

Use the information below to answer Questions 6 to 9

Returns inwards 40,000
Sales 820,000
Opening inventories 200,000
Purchases 740,000
Gross profit 200,000

6. The closing inventories figure is
a. 360,000
b. 160,000
c. 580,000
d. 320,000
e. 400,000
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7. The cost of goods sold is
a. 660,000
b. 640,000
c. 620,000
d. 580,000
e. 740,000

8. The mark-up of the business is
a. 24.39%
b. 25.64%
c. 34.48%
d. 32.26%

9. Rent prepaid is
a. An expense for the year
b. A current liability
c. A current asset
d. A revenue receipt
e. Non-current liability

10. In preparing a Statement Income, interest on overdue
receivables balance is treated as
a. A prepaid revenue
b. A current asset
c. An expense
d. An income
e. A current liability
11. Unearned commission received is
a. A current liability
b. An expense for the year
c. A current asset
d. A revenue for the year
e. A non-current liability

12. Which of the following is not a factory overhead?
a. Rent of factory building
b. Cost of direct raw materials
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c. Depreciation of plant and machinery
d. Factory supervisors salary
e. Factory managers salary

13. After preparing the final accounts of 2005, it was discovered that the
opening inventories was undervalued by 80,000. What was the
effect of this error on the years income statement?
a. Net profit understated by 80,000
b. Net profit overstated by 80,000
c. Gross profit overstated by 160,000
d. No effect on the income statement
e. Gross Profit understated by 160,000

14. A statement that shows the financial position of a business
organization at a point in time is referred to as a
a. Income statement
b. Balance Sheet
c. Statement of financial position
d. Flow statement
e. Cash statement

Use the following information to answer Questions 15 to 18

Inventories of raw materials 1
st
January 2004 24,500
31
st
December 2004 38,000
Purchases of raw materials 92,600
Carriage of raw materials 2,400
Royalties 22,000
Direct labour cost 29,000
Total overhead cost 47,000
Work-in-progress 1
st
January 2004 7,000
31
st
December 2004 4,200

15. What is the amount of prime cost?
a. 132,500
b. 130,100
c. 110,500
d. 170,500
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e. 114,000

16. Which of the following amounts is true for the cost of raw
materials consumed?
a. 79,100
b. 157,500
c. 70,500
d. 81,500
e. 95,000

17. How much of the manufactured products are yet to be
completed?
a. 4,200
b. 7,000
c. 38,000
d. 24,500
e. 22,000

18. What is the manufacturing cost of goods completed?
a. 179,500
b. 182,300
c. 164,200
d. 176,700
e. 185,100

12.10 EXAMINATION TYPE QUESTION

Question 1

The following Trial Balance was extracted from the books of Big F a
sole proprietor, whose business is known as Abigyagoro Enterprise as
at 31
st
December, 2006.

DR CR
000 000
Capital 112,000
Motor Van 40,000
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Inventories 32,800
Balance at bank 24,800
Purchases 320,000
Sales 446,000
Trade receivables 58,000
Trade creditors 33,120
Rent and rates 11,216
Salaries 70,080
General expenses 8,944
Motor expenses 5,120
Discount received 7,920
Insurance 3,920
Bad debts 6,080
Drawings 10,000 ______
599,040 599,040

The following matters are to be taken into account:

a) Inventories in trade as at 31
st
December 2006 was 40,320,000

b) Salaries and wages outstanding as at 31/12/06 amounted to
24,000,000.

c) Insurance paid in advance was 1,400,000

One fourth of the general expenses was for private purposes.
Required:

Prepare an Income statement of Comprehensive Incomes for the year
ended 31
st
December, 2006 and a Statement of financial position as at
that date.

Thanks.

329
Question 2
The following Trial Balance was extracted from the books of Victorosky
a trader, whose business was established to deal in the sale of second
hand clothes.

Thanks.

330
Trial Balance as at 30
th
June 2007.
DR CR
000 000
Capital 553,500
Purchases 1,255,500
Sales 1,644,300
Repairs to building 22,896
Motor Car 25,650
Car expense 8,586
Freehold land and buildings 270,000
Wages and salaries 232,362
Discounted received 21,978
Rate and insurance 6,696
Bad debts 9,693
Provision for doubtful debts 3,780
Drawings 64,800
Trade payables 108,945
Inventories 170,100
2,332,503 2,332,503

After adjusting for the following matters you are required to prepare
Income statement for the year ended 30th June 2007 and a statement of
financial position as at that date:

1. Inventories in trade at 30/06/2007, 237,600,000

2. Wages and salaries outstanding at 30/06/2007, 9,720,000

3. Rates and insurance paid in advance at 30/06/2007, 1,620,000

4. The provision for doubtful debts is to be increased to 4,860,000
Thanks.

331

5. During the accounting year ended 30/06/2007, Victorosky
withdrew goods valued at 16,200,000 for his own consumption.
He ordered the accounts clerk not to record the transaction in the
books.

Question 3
Alaskan Enterprise is a dealer in special traditional medicine for female
piles. He some times imports similar medicines from China whenever
there is shortage in the local market. The Trial Balance of the enterprise
as at 31
st
December 2005 is detailed below:

Thanks.

332

The following additional information is relevant:
1. The inventories at 31
st
December 2005 were recorded at
950,000.
2. The Enterprise depreciates its assets on cost as follows:

Assets: %
Buildings 4
Motor Vehicles 20
Office Equipment 15
Furniture & fittings 10

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333
3. Administrative expenses include rent of 250,000. This represents
rent for the period of 1
st
July 2005 to 31
st
May 2006.
4. The Enterprise is to make a provision of 345,000 in respect of
Personal income tax for 2005 accounting year.
5. Provision for bad debt is 500,000.

Required: Prepare statement of comprehensive income and
statement of financial position for 2005.
6. Amount owing in respect of electricity and vehicle running
expenses are 55,000 and 75,000 respectively.

Question 4

XYC Ltd.. is a Manufacturing Company. The following is an extract from
the companys books for the year ended 31
st
December 2006.

Stock of raw materials as at 1
st
January 30,000
Return outwards (raw materials) 2,000
Manufacturing wages 40,000
Office salaries 28,000
Royalties 10,000
Opening stock of finished goods 13,000
Carriage outwards 2,400
Printing and stationery 5,600
Travelling expenses 16,800
Factory expenses 10,000
Sales 480,000

You are also supplied with the following additional information:
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334
a. Depreciation of 10% is to be charged on Plant and machinery
worth 20,000
b. The following are inventories on hand at 31/12/2006:
Inventories of Raw materials 16,000
Inventories of finished goods 15,000
c. Half of the rent and rates is chargeable to the Manufacturing
Account

You are required to prepare the Manufacturing and Income statement
for the year ended 31
st
December 2006.
Question 5

Azotize is a well known manufacturer of toys for babies under the age of
one year. At 1
st
January 2005, he had the following in inventories:
Raw materials 1,200
Finished goods 600
Work-in-progress 1,500
During the year the following were recorded:


Manufacturing wages 4,000
Carriage of raw materials 260
Carriage of sales 340
Sales 25,000
Insurance 800
Rent 2,000
Printing and Stationery 90

Thanks.

335
You are required to prepare the Manufacturing and Income statement
st
December 2005, after due consideration is given
to the following:.
b. Plant and Machinery stood at 8,000 on 1st January 2005 and on 31st
December 2005, it was revalued to 7,500
c. Discount allowed 261
Sales returns 276
Return outwards (raw materials) 392
Bad debts written off 151
d. Inventories at 31st December, 2005 were: Raw materials 800;
Work-in-progress 600; Completed bags 470

Thanks.

336
Question 6

The following balances were extracted from the books of victorosky
Manufacturing Enterprise on 31
st
December 2007.
DR. CR.

Manufacturing Wages 21,000
Office Rent & Rates 810
inventories of raw materials 11,200
Sales 105,000
Purchases of finished goods 12,000
Capital 80,000
Debtors 3,550
Discount allowed 485
Creditors 2,980
Selling expenses 8,640
Plant and equipment 10,000
inventories of finished goods 9,500
Factory rent 900
Purchase - Raw materials 48,000
Plant repairs 6,575
Motor vehicles 8,000
Drawings 6,520
Office salaries 4,800
187,980 187,980

Additional information:
1. The manufactured goods were transferred to the warehouse at a
margin of 20%.
2. The Enterprise depreciates its assets on cost as follows:

Assets: %
Plant and Equipment 15
Motor Vehicles 20

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337
3. The following inventories were on hand as at end of the financial
year:

Raw materials 25,800
Finished goods 15,500

You are required to prepare the Manufacturing, and Income statement
st
December 2007, and a statement of financial
position as at that date.

1. c. 10. d.
2. d. 11. a.
3. a. 12. b.
4. d. 13. b.
5. a. 14. c.
6. a. 15. a.
7. d. 16. d.
8. c. 17. a.
9. c. 18. b.

Thanks.

338


Question 1

Abigyagoro Enterprise
Income statement for the year ended 31
st
December, 2006
000 000 000
Sales 446,000
Less cost of sales:
Opening Stocks 32,800
Add Purchases 320,000
352,800
Less closing stocks 40,320 312,480
Add Discount received 7,920
141,440
Less expenses:
Salaries 70,080
Add owings 24,000 94,080
Less drawings 2,236 6,708
Motor expenses 5,120
Bad debts 6,080
Insurance 3,920
Less prepaid 1,400 2,520
133,804
7,636

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339
Balance sheet as at 31st December 2006.
000 000 000
Fixed Assets:
Motor Van 40,000
Current assets:
Stocks 40,320
Trade debtors 58,000
Insurance prepaid 1,400
124,520
Less Current liabilities:
Trade creditors 33,120
accrued salaries 24,000 57,120
67,400
107,400
Represented by:
Capital 112,000
Add net profit 7,636
119,636
Drawings 10,000
Add private expenses 2,236 12,236
107,400

Question 2
Victorosky
Statement of Financial Position for the year ended 30th June 2007
Thanks.

340
000 000 000
Sales 1,644,300
Less cost of sales:
Add Purchases 1,255,500
Less inventories drawings 16,200 1,239,300
1,409,400
Less closing inventories 237,600 1,171,800
Add Discount received 21,978
494,478
Less expenses:
Salaries 232,362
Add owings 9,720 242,082
Less prepaid 1,620 5,076
Car expenses 8,586
Bad debts 9,693
Provision for bad debts 1,080
Repairs to building 22,896 360,882
Net profit 133,596

Thanks.

341
Statement of Financial Position as at 31st December 2007.
Non-current Assets: 000 000 000
Land & buildings 270,000
Motor car 25,650
Furniture & fittings 39,420
335,070
Current assets:
Inventories 237,600
Less provision 4,860 135,891
Prepaid expenses 1,620
389,691
Accrued expenses 9,720 118,665
271,026
606,096
Represented by:
Capital 553,500
Add net profit 133,596
- 687,096
Drawings 64,800
Add inventories taken 16,200 81,000
606,096

Question 3
Alaskan Enterprise
Statement of Comprehensive Incomes
for the year ended 30th June 2005
Thanks.

342
000 000 000
Sales 40,250
Less returns inward 930
39,320
Less cost of sales:
Add Purchases 7,970
Less returns outwards 485 7,485
Carriage inwards 300
8,925
Less Closing inventories 950 7,975
Gross profit 31,345
Add Investment income 550
31,895
Less expenses:
Electricity 325
Add owings 55 380
Administrative expenses 980
Less rent prepaid 114 866
Vehicle running expenses 320
Add owings 75 395
Discount allowed 285
Provision for bad debts 50
Salaries 3,650
Provision for depreciation:
Motor vehicles 760
Buildings 480
Office equipment 683
Furniture & fittings 500 2,423
12,834
Net profit before tax 19,061
Less Provision for tax 345
Net profit after tax 18,716

Thanks.

343

Statemen of Comprehensive Incomes as at 31st December 2005.
000 000 000
Non-Current Assets: Cost Dep Net
Land & buildings 14,000 5,980 8,020
Office equipment 4,550 2,933 1,617
Motor car 3,800 3,030 770
Furniture & fittings 5,000 500 4,500
27,350 12,443 14,907
Investment 8,500
23,407
Current assets:
Stocks 950
Less provision 500 4,350
Prepaid expenses 114
Bank and cash 4,380
9,794
Accrued expenses 130
Provision for tax 345 2,855
Net current assets 6,939
30,346
Represented by:
Capital 13,455
Add net profit after tax 18,716
- 32,171
Less drawings 1,825
30,346

Question 4
XYC Ltd.. Manufacturing Company

Manufacturing and Income statement
st
December 2006

Thanks.

344

Thanks.

345

Question 5
Azotize

Manufacturing and Income statement
st
December 2006

Thanks.

346

Question 6
Victorosky Manufacturing Enterprise

Manufacturing, Trading and Income statement
st
December 2007

Thanks.

347

Victorosky Manufacturing Enterprise

Statement of financial position as at 31
st
December 2007

Thanks.

348
000 000 000
Non-current Cost Dep Net
Plant & equipment 10,000 1,500 8,500
Motor vehicle 8,000 1,600 6,400
18,000 3,100 14,900
Current assets:
Inventories 61,300
Bank and cash 485 65,335
Net current assets 62,355
77,255
Represented by:
Capital 80,000
Add net profit after tax 3,775
- 83,775
Less drawings 6,520
77,255

References
Edmonds, McNair, Milam and Olds, Fundamental Financial Accounting
Concepts; McGraw-Hall
Cassell
McGraw-Hall
Smith, Keith and Stephenes, Accounting Principles; McGraw-Hall

CHAPTER THIRTEEN

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349
SINGLE ENTRY AND INCOMPLETE RECORDS
After you have studied this chapter you should be able to:
Use accounting equation to calculate profit where only opening
and closing net assets figures are available
Convert single entry and incomplete records into double entry
records
Prepare detailed trading and statement of comprehensive Income
from records that were not kept on double entry system
Derive proprietors cash drawings or additional capital as a missing
figure where all other information relating to cash payments and
receipts are known
Determine the figures for purchases and sales from the purchases
ledger control and the sales ledger control accounts
Derive expenses incurred and revenue earned from incomplete
records

13.2 Introduction
The term single entry is applied to any system, which does not provide
for the two fold aspect of transactions; while the alternative term
incomplete records is often applied to books of account kept on such a
single entry or incomplete double entry system. Pure single entry
recognises only the personal aspect of transactions, and, consequently,
the only essential books are personal ledgers for recording transactions
with receivables and creditors. In practice, however, a cashbook is
invariably kept, but, with this exception, the impersonal aspect of
transactions is usually left entirely unrecorded.

Thanks.

350
In this chapter you will learn the procedure involved in preparing the
statement of Comprehensive Income and statement of financial position
for an enterprise that has only opening and closing net assets and
perhaps capital as the only known figures. You will also understand and
learn how to ascertain the proprietors drawings and any additional
capital contribution during an accounting period from the scanty
information provided by a cash book summary.

Questions on incomplete records and single entry are popular for
examiners because they enable them to test techniques, which are also
relevant for other topics such as ledger control accounts. It also provides
the basic information necessary to prepare final accounts but without the
examiner presenting it in the form of a Trial Balance .

13.3 The Ascertainment of Profit from Incomplete Records
Generally speaking, profits (or losses) are ascertained, under the single
entry system, by a comparison of the values of the net assets at two
specified dates, after taking into account additions to, or withdrawals
from, capital during the period. The difference between these two values
represents the profit or loss, according to whether there is an increase or
decrease in the figures.

Remember the accounting equation, which states that:
Business Assets = Owners Capital + Business Liabilities

The equation above can be restated as:
Owners Capital = Business assets Business Liabilities

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351
If during an accounting period, the business realised an excess of
income over expenditure, the additional cash or assets generated
belong to the owner(s), thus increasing the capital. The accounting
equation will now become:

Opening capital + profit = opening net assets + increase in net assets.

The introduction or withdrawal of resources by the owner will also
increase or decrease the owners capital respectively. As a result profit
can be calculated using the format below:

Closing capital XXX
Less opening capital
XXX
Increase in net assets XXX
Owners Drawings XXX
Additional Capital (XXX)
Net profit for the year
XXX

Thanks.

352
Illustration to Illustration 13.1:
Calculate the net profit for the year ended 31 December 2001 from the
following information:
31/12/2000

31/12/2001

Property 200,000 200,000
Equipment 60,000 90,000
Trade Receivables 40,000 80,000
Cash 10,000 15,000
Overdraft 60,000 90,000
Trade Payables 50,000 30,000
Drawings during the year were 45,000 and additional capital introduced
during the year was 50,000.
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353
Solution:
31/12/2000 31/12/2001

Total Assets 310,000 385,000
Total Liabilities (110,000) (120,000)
Net Assets 200,000 265,000

Closing capital 265,000
Less opening capital
200,000
Increase in net assets 65,000
Owners Drawings 45,000
Additional Capital (50,000)
Net profit for the year
60,000

13.4 Preparation of detailed final accounts from Incomplete
Records
It is understandably certain that calculating the profit of an enterprise
using the method as presented above is not satisfactory. It is important
for you to note that the accountant does not only prepare the final
accounts of an enterprise but also communicates accounting and
financial information to stakeholders. It is therefore much more
informative when statement of comprehensive Income is drawn. It is
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354
important for the accountant to convert these scanty and incomplete
records into the acceptable double entry form.

For one to be able to prepare the Income statement and a statement of
financial position from single entry and incomplete records, the
procedures detailed below are recommended:

13.4.1 Preparation of statement of affairs
One must first construct a statement of financial position at the
beginning of the accounting year. This means that the assets and
liabilities of the business must be ascertained and calculated. The
statement prepared to show the financial position of the business at the
beginning of the year is technically called statement of affairs.

In most practical situations the owner of the business will provide lists of
values of non-current assets that he uses in the business together with
the dates of acquisition. It should therefore be easy for one to calculate
the accumulated provision for depreciation of the non-current assets
from the date of their purchase to the date of reporting. Values of such
items as inventories in trade, receivables and liabilities may have to be
estimated with the help of the owner.

From the above information a journal should be opened and accounting
entries with the aim of achieving the dual purpose of recording
accounting transactions should be effected. This means that appropriate
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355
debit entries must be posted into assets account and credit entries
entered into capital or liabilities accounts.

The difference between the assets and liabilities, which usually ends up
with the assets exceeding the liabilities may be assumed to be the initial
amount that the owner used in starting the business and therefore will
be recorded as the capital of the business. It is possible that the owner
may be able to mention the initial amount he used in commencing the
business. Where this is the case then, any difference between such
capital and the net assets estimated may be recorded as the balance on
the Income statement retained in the business.

13.4.2 Preparation of Cash and Bank Summary
Ascertain the cash position of the business. This is usually done by
carefully examining any available bank statement, any pay-in-slip and
the cheque counterfoil. The bank statement together with the cheque
counterfoil could reveal information concerning purchases, payment of
rent, bank charges, wages, insurance, interest earned, the acquisition of
non-current assets, and any personal withdrawals. Information extracted
from the pay-in-slip will help determine the amount of money paid in by
customers to whom goods were sold on credit and also direct sales by
cheque instead of cash. The above information may be used to prepare
a cash summary or a receipts and payments account for the business.
13.4.3 Analysis of unbanked cash sales
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356
One must at this stage determine the amount of cash sales which have
not been banked by the owner, but which might have been used by the
owner to pay for business expenses, cash purchases, and personal
drawings. It is possible that the owner might have made use of some of
the physical inventories in trade for his or her personal use. In such a
situation conducting an informal interview with the owner would confirm
the existence of such occurrences and so will help the bookkeeper make
an appropriate estimate for inventories drawings. Physical inventories
taking by head counting of items in inventories at the close of business
will give us the actual closing inventories figure and therefore may not
need to be estimated.
13.4.4 Posting from the Cash and Bank Summary
After the analysis above have been made, one can now carry out the
following postings into the ledger. Note that in step one opening entries
were made through the ledger, and therefore some of these entries will
be made into existing ledger accounts irrespective of how inaccurate
they may be.

From the analysis of the debit side of the cash and bank summary and
information obtained from the pay-in-slips:
a) All cash sales or takings should be credited to the trade
receivables account in the sales ledger;
b) Any proceeds from the sale of non-current assets should be
credited to the respective asset account;
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357
c) Any interest or income from investment must also be credited to
the appropriate revenue account;
d) Any other item should be posted to the credit of the relevant
account;

From the analysis of the credit side of the cash and bank summary and
information obtained from the cheque counterfoils:
a) All payments for goods purchased should be debited to the trade
payables account in the purchases ledger account;
b) Payment of expenses should be debited to the relevant nominal
account;
c) All purchases in connection with non-current assets should be
debited to the appropriate asset accounts;
d) Any charges should be posted to debit of the bank charges
account;
e) Any other item should be posted to the debit of the relevant
account;

Where any difference exists on the cashbook summary entries should
be posted to make it balance. If the difference is on the credit side
then the cashbook should be credited and the proprietors drawings
account debited. If the difference is on the debit side then one can
safely presume that the owner of the business has introduced
additional capital. This difference should be debited to the cash and
credited to the capital account of the business.

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358
13.4.5 Preparation of Trade receivables and payables Schedule
At this stage one will have to determine year-end adjustment and
balances.
A schedule will have to be compiled detailing all customers who are
owing the business, as a result of goods sold to them on credit. The total
of the schedule of receivables therefore represent debts owed to the
business and as such must be carried forward to the credit of the total
sales ledger control account. There is likely to be a missing figure in the
debit side of the total receivables account, which represent total sales on
credit for the period and should be transferred to the credit of the Income
Statement as sales or turnover.

Another schedule that must be prepared is a list of amount owing by the
business to its suppliers for goods purchased on credit. The total of this
schedule represent total liabilities by way of trade payables outstanding
at the end of the period and should therefore be carried forward to the
debit of the purchases ledger control account. The total of purchases for
the period will be derived from the credit side of the purchases ledger
control account as a balancing figure and should be transferred to the
debit side of the Income Statement.

Similarly accruals and prepayments will be carried forward as closing
balances in the appropriate expense accounts. The actual expense
amount which has been incurred for the accounting period being
accounted for as a balancing figure.

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359
13.4.6 Extraction of Trial Balance
This is the final stage since all the transactions would have been
recorded and the double entry will now have been completed and for
that matter the business will be able to extract a Trial Balance which will
form the basis for the preparation of the statement of comprehensive
Income and statement of financial position.

Illustration 13.2
Boakye, a sole proprietor, trading as KKB Enterprise requested Oko &
Associates, a firm of Chartered Accountants, where you are employed
as a trainee Accountant, to prepare the accounts of his business for the
year ended December 31
st
, 2006.
Your audit Manager assigned this work to you. Your interview with
Boakye revealed the following:
(i) He did not maintain double entry book-keeping system.
(ii) All sales were on credit basis. During the year Boakye received
9,025,000 and 475,000 in cheques and cash respectively from
his customers.
(iii) Suppliers of goods during the year paid 6,840,000 by cheque.
(iv) Boakye rented 2 premises at Dansoman and High Street for
residential and business purposes respectively. In July 2005, he
paid 480,000 as one-year rent in advance for his residence. In
July 2006, he again paid a cheque of 600,000 to cover one year
advance for his residence. The rent for the premises at High Street
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360
was 60,000 per month in 2006. Boakye always paid all his rent
by cheque.
(v) General business expenses paid by cheque amounted to
106,200
(vi) He took cash of 38,000 every month for his private use.
Boakye provided you with the following additional information.
31/12/06 31/12/06

Trade Receivables 1,254,000 1,045,000
Trade Payables 617,500 380,000
Rent Owing 60,000 120,000
Bank balance 3,000,000 1,073,500
Cash in Hand 60,000 76,000
Inventories 1,700,500 1,510,500
Fixture & fittings - 920,000

(vii) Depreciation is provided annually at the rate of 20% on Fixture
and Fittings.
(viii) Boakye agreed to pay 100,000 as accountancy fees.
(ix) Differences in cash and bank balances at the end of 2006
represents additional drawings and Capital respectively.
Required:
(a) Computation of the profit of Boakye using the net worth method
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361
(b) Cash and Bank Summary for 2006
(c) Statement of comprehensive Incomes for the year ended 31
st

December 2006.
(d) Statement of financial position as at 31
st
December 2006.

Thanks.

362
You may like to try the question before reading this discussion.
The examiner has been fairly lenient with this question. Let us view the
techniques to be used in answering it:

(a) Calculate opening net assets to arrive at opening capital
We need the opening capital to enable us calculate the closing balance
in the nt in the statement of financial position . All that is required is to
pick up all opening balances not forgetting the opening cash balance.
The information is presented clearly, and the examiner has even
included the bank and cash opening balances in the tabulation of assets
and liabilities.

Increase in net worth .. 5,973,000 - 4,125,000 =
1,848,000

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363
Computation of profit by the net worth method
Increase in net worth 1,848,000

Add Drawings(456,000+600,000+35,000) 1,091,000
2,939,000
Less Additional Capital 1,227,700
Net Profit 1,711,300

(b) Construct a cash and bank summary
Even if some of the information in the question is given in the form of a
cash or bank summary, it is usually necessary to build up one or both of
these summaries to calculate a missing figure such as payment for
purchases and owners drawings

CASH BOOK SUMMARY
Cash Bank Cash Bank

Bal b/d 76,000 1,073,500 Suppliers - 6,840,000
Received from customers 475,000 9,025,000 Drawings 456,000 -
Capital(missing figure) - 1,227,700 Rent - 600,000
Gen. Bus. Exp. 106,200
Rent (w3) - 780,000
Drawings (missing figure) 35,000 -
Bal. C/d 60,000 3,000,000
551,000 11,326,200 551,000 11,326,200
Bal b/d 60,000 3,000,000

(c) Income statement for the year ended 31
ST
December 2006

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364

Sales / turnover 9,709,000
Cost of sales (6,887,500)
Gross profit 2,821,500
Less Expenses:
Depreciation 184,000
Rent 720,000
General Business expenses 106,200
Consultancy fees 100,000
1,110,200
Net Profit 1,711,300

(d) Statement of financial position as at 31 December 2006

workings
(1) Construct sale and purchases ledger control accounts
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365
In a double entry- system, control accounts are used to confirm the
arithmetical accuracy of the sales and purchases ledger system. This
technique will be used to calculate sales and purchases as a missing
figure.

Bank 6,840,000 Bal. B/d 380,000
Purchases (missing figure) 7,077,500
Bal. C/d 617,500
7,457,500 7,457,500
Bal, b/d 617,500

(2) Workings for accruals and prepayments
In addition to these four techniques it will be necessary to construct
figures for the Income statement by adjusting cash paid for expenses for
opening and closing accruals and prepayment.

Computation of Depreciation
Fixture and fittings at cost(1/1/06) 920,000
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366
Less Depreciation (20% @ 920,000) 184,000
Net book value (31/12/06) 736,000

Illustration 13.3
Damask is a retailer who deals in spare parts at Kokompe. He pays into
his bank account the amount of his cash takings, after retaining 10,000
per week for personal use and after payment of wages and expenses,
which for the accounting period of 31
st
December 2006, were as follows:
Staff wages 1,200,000

Goods 220,000
Cleaning 75,000
Carriage 35,000
Others 20,000

The transactions in his Bank Account during the period were:
Balance as at 1st January 2006 2,000,000

Lodgements:
from takings (cash) 30,100,000
Bulk sales account (cheques) 4,800,000
Interest on treasury bills 30,000
36,930,000

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367
Withdrawals:
Goods 30,830,000
Rent 400,000
Rates in connection with store 345,000
Rates in connection with own house 55,000
Air conditioner expenses for store 200,000
Air conditioner expenses for house 20,000
Telephone and electricity 150,000
other expenses for store 70,000
Fire insurance 60,000
Life assurance policy 30,000
Repairs 150,000
Fixtures and fittings 600,000
Consultancy fees 70,000
Income tax 900,000
Owner's current account 180,000
Balance as at 31st December 2006 2,900,000
36,960,000

The following information were also provided:

You are required to prepare statement of comprehensive Income for the
year ended 31
st
December 2006 and a Statement of financial position as
at that date.


Calculate opening net assets to arrive at opening capital
You have to calculate the capital of the business by using the
information on assets and liabilities at the opening and closing dates.
This is done by preparing a statement of affairs of the business by
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368
picking up all opening balances and calculating the net asset of the
business as at 31
st
December 2000. The information is presented
clearly, and the examiner has even provided information on the bank
and cash balances in the presentation of assets and liabilities. The
statement of affairs of Damask as at 31
st
December 2006 is as follows:

Construct sale and purchases ledger control accounts
In a double entry- system, control accounts are used to confirm the
arithmetical accuracy of the sales and purchases ledger system. This
technique will be used to calculate sales and purchases by way of
missing figure. This calculation will explore the horizontal format of
determining the sales and purchases figures as missing figures instead
of the usual T account that you are familiar with.

The sales figure will be determined as follows:
Thanks.

369

The amount for Purchases is determined as follows:

Prepare the final accounts
Statement of comprehensive income for the year ended 31/12/2006

Thanks.

370

Statement of financial position as at 31/12/2006
Thanks.

371

Workings for accruals and prepayments
In addition to the above techniques it will be necessary to construct
figures for the Income statement by adjusting cash paid for expenses for
opening and closing accruals and prepayment.

Thanks.

372

Drawings

Bank 180,000 Bal. c/d 775,000
Cash 520,000
Rates 55,000
Air condition exp 20,000
775,000 775,000
Bal. b/d 775,000

13.5 Summary
In this chapter we have explained the difference between a double entry
accounting system and single entry system. We have also learned how
to use the closing and opening capital figures to calculate the net profit
of a trader that is not keeping his books of accounts on the double entry
system.

We have learnt how to convert from a single entry system to a double
entry one and also the means by which statement of comprehensive
income and statement of financial position are prepared from records
that are kept on single entry basis. We mentioned that figures such as
sales and purchases could be calculated as missing figures from the
Thanks.

373
sales ledger control account and purchases ledger control account
respectively.
It is imperative for students to note that as with all accounting topics,
frequent practice of incomplete record questions is essential to develop
speed and confidence.
1. In which ledgers can data relating to discount be found?

a) Nominal ledger
b) Cash book
c) Sales ledger
d) Private ledger
e) Purchases ledge

Use the data below to answer Questions 1 to 4.

31/12/05 31/12/06

Non-current assets (cost) 320,000 286,000
Current assets 750,000 920,000
Current liabilities 150,000 130,000
Provision for depreciation 70,000 74,000

During 2006, a non-current asset costing 54,000 with a book value
of 20,000 was sold for 15,000

2. What was the capital of the business as at 31
st
December 2005?
a. 920,000
b. 865,000
c. 860,000
d. 850,000
e. 1,002,000

3. What was the capital of the business as at 31
st
December 2006?
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374
a. 1,002,000
b. 865,000
c. 860,000
d. 1,076,000
e. 850,000
4. What was the value of the net profit or loss for the year
ended 31
st
December, 2006?
a. 152,000 loss
b. 152,000 profit
c. 140,000 profit
d. 240,000 loss
e.

5. What was the depreciation charge for 2006?
a. 4,000
b. 38,000
c. 14,000
d. 16,000
e. 74,000

6. A statement of affairs is similar to a/an
a. Trading Account
b. Income and Expenditure account
d. Trial Balance
e. Statement of Income

7. A Statement of Affairs may include only
a. Accrued expenses, assets, liabilities and outstanding
revenues
b. Expenses, assets, accrued revenues and liabilities
c. Assets, liabilities and expenses
d. Expenses, profits, assets and liabilities
e. Assets, liabilities and income

8. Koki started business on 1
st
January 2006 with 200,000. At the
end of the year, his total assets valued 500,000. He did not owe
anybody. Throughout the year, Koki took 70,000 out of the
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375
business to maintain his family. In June 2006, he won lotto of
150,000 and added the prize to the business capital. Calculate
Kokis profit for 2006.

a. 370,000
b. 300,000
c. 400,000
d. 220,000
e. N290,000

9. If cost price is 240,000 and selling price is 300,000, then
a. Mark-up is 20%
b. Margin is 33%
c. Margin is 20%
d. Mark-up is 33%
e. Margin is 25%

10. What is the cost of goods sold, given the sales figure as
800,000 with a mark-up of 25%?
a. 126,000
b. 504,000
c. 640,000
d. 160,000
e. 600,000


1. Victorosky who does not keep proper books of account has
presented the following information for the year ended 31
st

December 2004:
2004 () 2003 ()
Inventories 200,000 185,000
Cash at Bank 98,500 56,000
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376
Trade receivables 100,000 90,000
Office Equipment 450,000 400,000
Cash in hand 25,000 29,000
Trade payables 250,000 158,500
Motor vehicles 740,000 955,000
You are required to calculate the profit or loss of Victorosky for the year
ended 31
st
December 2004, after taking into consideration the following:
a) Victorosky makes monthly withdrawal of cash and goods valued at
50 and 15 respectively.
b) Customer with an outstanding bill to the tune of 5,400 was
declared bankrupt by a court in Accra.
c) Rent prepaid and electricity owing amounted to 16,000 and
8,500 respectively.

2. Babaginda is a trader who does not keep proper books of account.
He has however provided you with the following information:
a. He paid 10,000,000 in a bank account as his initial capital
b. He banked all sales after withdrawing cash for the following:

Personal use 350,000 per week
Staff salaries and wages 500,000 monthly
General expenses 11,140,000 monthly
Lodgments made into the Bank amounted to 450,000,000
Thanks.

377
Withdrawals from the Bank were:
Rent 13,000,000
Insurance 10,000,000
Transport expenses 6,750,000
Payment to suppliers 245,000,000
Purchase of motor car 63,500,000
Purchase of computers 18,000,000
Telephone expenses 8,698,000
The following balances were also available as at 30
th
September 2007:
Trade payables 134,000,000
Inventories 42,000,000
Bad debts 4,420,000
Trade receivables 25,000,000
Rent prepaid 2,800,000
Payables for insurance 2,150,000
Depreciation is to be provided on the cost of all non-current assets at the
rate of 20%.
You are required to prepare the statement of comprehensive income for
the year ended 30
th
September 2007 and a statement of financial
position as at that date.
3. Richardosky has kept the following summary of accounts:
Statement of financial position as at 1
st
January 2005
Thanks.

378

Sundry payables 105,000 Office equipment 250,000
Rent and Rates 6,000 Fixture and Fittings 50,000
Inventories 120,000
Loan 250,000 Sundry receivables 235,000
Surplus 404,000 Bank 110,000
765,000 - 765,000

Thanks.

379
Analysis of Trade Payables

Balance 1/1/05 105,000
Purchases 548,000
Cash paid 415,000
Discounts 7,000
Returns 4,000
Balance 31/12/05 227,000
653,000 653,000

Analysis of Receivables

Balance 1/1/05 235,000
Sales 980,000
Cash received 820,000
Discounts 42,500
Bad debts 35,000
Returns 29,500
Balance 31/12/05 288,000
1,215,000 1,215,000

Analysis of Balances as at 31/12/2005
Receivables 235,000
Rent prepaid 8,000
Rates owing 4,000
General expenses owing 28,000
Office equipments 366,000
Fixture & fittings 45,000

Thanks.

380
Analysis of Cash book
Dr. Cr.

Balance as at 1/1/05 110,000
Cash sales 95,000
Office equipment 150,000
Wages and salaries 150,000
Rent and Rates 42,500
Cash Purchaases 48,000
Balance as at 31/12/05 95,000
1,025,000 977,500
47,500

You are required to prepare Richardoskys Statement of financial
position as at 31
st
December 2005, together with statements of
comprehensive incomes for the year ended 31
st
December 2005.
1. a.
2. d.
3. a.
4. b.
5. b.
6. c.
7. a.
8. d.
9. c.
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381
10. c.
Question 1
Victorosky

Statement of affairs
31/12/03 31/12/04
Assets:
Office equipment 400,000 450,000
Motor vehicles 755,000 740,000
Trade Debtors 490,000 376,000
Stocks 185,000 200,000
Prepayments - 16,000
Cash at bank 56,000 98,500
Cash in hand 29,000 25,000
1,915,000 1,905,500
Liabilities:
Trade Creditors 158,500 160,000
Accruals - 18,500
158,500 178,500
Capital 1,756,500 1,727,000

The calculation of profit or loss could be based on the formula below:

Opening Capital + Net Profit (or Net loss) + Additional Capital
Drawings = Closing Capital

1,756,500 + Net Profit + 75,000 276,000 = 1,727,000

Solving for Net Profit

Net Profit = 1,727,000 - 1,756,500 75,000 + 276,000

Net Profit = 171,500

Thanks.

382
Question 2
Babaginda
Statement of comprehensive income for the year ended 30
September, 2007

Statement of financial position as 30
th
September 2007
Thanks.

383

workings
Cash book summary

Capital 10,000,000 Rent 13,000,000
Lodgements 450,000,000 Insurance 10,000,000
Cash sales 8,102,000 Transport 6,750,000
Payment to suppliers 245,000,000
Purchase of motor car 63,500,000
Purchase of computers 18,000,000
Telephone expenses 8,698,000
Cash payments:
Drawings 18,200,000
Staff salaries & wages 6,000,000
General expenses 11,140,000
Balance c/d 67,814,000
468,102,000 468,102,000
Balance b/d 67,814,000

Thanks.

384
Sales Ledger Control Account

Credit sales (missing figure) 479,420,000 Bank 450,000,000
Bad debts 4,420,000
Bal. c/d 25,000,000
479,420,000 479,420,000
Bal, b/d 25,000,000
Total sales = 479,420,000 + 8,102,000 = 487,522,000.


Bank 245,000,000 Purchases (missing figure) 379,000,000
Bal. c/d 134,000,000
379,000,000 379,000,000
Bal, b/d 134,000,000

Question 3
Richardosky
Statement of comprehensive income for the year ended 31
st

December 2005
Thanks.

385

Richardosky
Statement of financial position as 31
st
December 2005
Thanks.

386

References
Cassell

CHAPTER FOURTEEN

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387
ACCOUNTING FOR NOT-FOR PROFIT ORGANISATIONS
State the difference between a Receipts and Payments Account
and an Income and Expenditure Account
Explain the difference between the final accounts of not-for profit
organizations and those of sole traders and partnerships
Prepare Receipts and Payments Account
Prepare Income and Expenditure Account
Prepare subscription account making the necessary adjustment
entries with respect to amounts in arrears and payments in
advance.
Prepare the accumulated fund of a not-for profit organisation

14.2 Introduction
There are many types of not-for profit organisations. They include
government owned hospitals and voluntary health and welfare
organizations. In Ghana and Nigeria most citizens depend heavily on
such entities for religious, educational, social and recreational needs.
Examples of other not-for profit organisations include the following:
Private and community foundations
Professional associations
Research and scientific organisations
Social and country clubs
Trade associations
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388
Labour organizations
Political parties.

It is not only profit making organisations that need accounts.
Organisations set up for purposes other than profit, also need to tell their
stakeholders how they have dealt with the funds they have contributed.
The legal status of such entities is usually spelt out in club rules or
regulations. Students must however remember that external financial
information provided by such organisations must be in conformity to
generally accepted accounting principles.

The accounts of clubs, societies and charitable organisations may
consist of the following:
Receipts and Payment Account
Income and Expenditure Account and
Statement of Financial Position

14.3 Receipts and Payments Account
This is a statement of cash actually received and paid during a given
period. Receipts being debited and payments credited. It is, in effect, a
summary of the cashbook, and therefore shows the opening and closing
balances of cash in hand, and receipts and payments of any kind and on
any account made during the period.

Thanks.

389
Illustration 14.1
An example of a receipts and payments account is shown below:
Receipts 000 Payments 000
Bank balance 1/6/2001 118,000 Printing & stationary 228,000
Sponsored walk 23,000 Management expenses 109,000
Subscription 580,000 Caterer for president ball 113,250
Sundry income 57,000 Electricity and water 78,500
Sale of clubs manual 230,000 Bar creditors 278,500
Sale of equipment 254,000 Bank balance 31/5/2002 454,750
1,262,000 1,262,000

14.4 Income and Expenditure Account
Income and Expenditure Account of the club is the equivalent of the
Income statement of a trading concern. It contains only revenue items,
being debited with all expenditure, and credited with all incomes of a
period, whether or not it has actually been paid or received within that
period. The final balance of an Income and Expenditure Account
represents the excess of income over expenditure or the excess of
expenditure over income, as the case may be, for the period. This
balance is similar to the net profit or loss of a trading concern.

Readers must note that an Income and Expenditure Account differs from
the Receipts and Payments Account. The latter records only cash
movements, the former takes into consideration non-cash adjustments
for amounts owing and owed at the period end and for depreciation. It
also recognises the accounting distinction between revenue and capital
expenditure. The important point that students must note is that the
Income and Expenditure Account is prepared on an accrual basis.

Thanks.

390
14.5 Membership subscription:
A club or society receives payments from members for benefits, which
members have enjoyed. Annual membership subscriptions of clubs and
societies are usually payable one year in advance. Such payments in
advance by members is shown as liability in the statement of financial
position . This is because the years membership has still to run as at
the date of statement of financial position. A large number of club
subscriptions in arrears may never be received and the statement could
be distorted, since such amounts are usually shown as assets.

Illustration 14. 2
The Mambo Youth Club presented the following Receipts and Payments
Account for the period of 1
st
January 2001 to 31
st
December 2001.

Extracts from the membership subscription book revealed that
subscriptions owing by members amounted to 80,000 on 31
st

December 2000 and 120,000 on 31
st
December 2001. The accounts
clerk recorded subscription of 21,500 and 109,000 in respect of
subscriptions that have been paid by members in advance for 2001 and
2002 respectively.
Thanks.

391

The subscription account will be prepared as follows:
Subscription Account for the year ended 31st Dec. 2001
,000 '000
Balance b/f 80,000 Bal b/f 21,500
Income & Expenditure a/c 532,500 Receipts & Payment a/c 580,000
Balance c/f 109,000 Balance c/f 120,000
721,500 721,500
Balance b/f 120,000 Balance b/f 109,000

By carrying forward subscription in advance, the accountant is applying
the matching concept. This is because the payment of 109,000 in 2001
represents income meant for 2002 accounting year. This must therefore
be removed from the current years Income and Expenditure account,
hence the debit carry forward.
From the above solution subscription in arrears have been treated as an
asset. This will hold true as a result of the accrual concept since the
subscription in arrears are income that have been earned for the
accounting year of 2001 but for which cash has not been received.
In practice however, subscriptions in arrears are often excluded from the
statement of financial position on grounds of the prudence concepts.
This is due to the fact that subscriptions that are owed by members for a
long time end up not being paid eventually. In examination environment,
however, readers are reminded to follow the policy of the club or society
as provided by the examiner.
14.6 Bar Income Statement
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392
It is not uncommon for clubs to engage in other income generating
activities to raise additional revenue for the effective running of the club.
These other activities are done with the sole aim of making profit. For
instance the aim of a local trade union is not to make profit but the union
may operate a bar along side its activities with the object of making
profit. The profit will not be distributed among the members but rather
used for the purpose of the union.

If a club has a bar, a separate Income Statement will be prepared for its
trading activities. The net profit from the bar activities is then included
as income in the Income and Expenditure Account. Any loss on the bar
activities will be shown in the expenditure side of the Income and
Expenditure Account.

14.7 Life Membership
Subscriptions are often received from life members. Life members pay a
once and for all subscription which entitles them to membership facilities
for the rest of their lives. The once and-for-all payments from life
members are not income relating to the year in which they are received
by the club, because the payment is for the life of the members, which
can of course last a very long time to come. In practice, if life members
subscriptions are small, they are credited to income as received but if
they are significant in amount, then they should be credited in equal
proportion over the estimated active club membership of such members.
Thanks.

393

14.8 Accumulated fund
This represents the opening capital of a not-for profit making
organisation. It has the same meaning ascribed to the capital accounts
of a sole trader and partnership and is calculated as the difference
between total assets and liabilities. It is usually common to see most
not-for profit organisations keeping accounts on single entry basis. For
this reason the procedure for preparing the accumulated fund of a not-
for profit organisation is the same as that of statement of affairs as
obtained under incomplete records and single entry.
Illustrative 14.2
The following is the Receipts and Payments Account for the Victorosky
Fun Club for the year ended 31
st
October 2005.
RECEIPTS 000 PAYMENTS 000
Subscription 1,643,560 Printing & stationery 59,160
Sponsored walk 478,802 Bar stewards salary 69,600
Presidents Ball
collections
408,000 Caterer for Presidents ball 250,000
Sundry income 75,000 Light, cleaning etc. 32,640
Bar takings 510,000 Petty cash 65,000
Sale of equipment 7,923 Bar creditors 280,500
Raffle 183,030 Investment in ABC limited 450,000
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394
Donation 50,000
Sundry Presidents ball exp. 5,275
Prizes for raffle 21,600
Building project (materials) 839,000
Rent 360,000
Secretarys salary 120,000
Sundry bar expenses 3,360
Bank charges 36,000
Hiring of hall for Pres. Ball 20,000
Building project (wages) 525,000
Insurance 18,000
New equipment 67,800

The following additional information has been given:
1. Current Assets and Liabilities were:
2004 2005
000 000
Bar inventories 27,000 36,000
Bar payables 18,000 33,000
Subscriptions in arrears 240,000 360,000
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395
Subscriptions in advance 150,000 210,000
Light and cleaning owing 4,200 6,800
Insurance prepaid 4,200 5,200
Petty cash float 3,000 1,000
Cash in hand 15,565 14,340
Bank balance 246,500 281,105

2. The petty cash float is used exclusively for telephone and postages.
3. The club started constructing its club House during the year. The project
will take four years to complete. Amount owed for building materials
supplied at 31
st
October 2005 was 511,500,000. Wages owed for
October 2005 was 175,000,000. Inventories of materials at the end was
220,500,000
4. Tickets for the Presidents Ball were sold at 300,000 each. The Club
engaged the services of a caterer who agreed to charge on the number of
plates served under the following conditions:
Below 1,500 plates, amount to be charged per plate was 250,000.
From 1,501 to 2,000 plates, amount to be charged per plate was
220,000.
Above 2,000 plates, amount to be charged per plate was 200,000.
Of the 2,400 tickets sold, 90% attended the function and were served
5. Depreciation of equipment is to be calculated at 10% per annum on
written down value. The Clubs equipment which was disposed of during
the year had a net book value of 9,905,000 on 1
st
November 2004.
Thanks.

396
6. Subscriptions in arrears for more than one year are to be written off.
7. An amount of 1,000,000,000 is to be transferred from accumulated
fund to building fund.
8. Investment in ABC limited is expected to be held for at least five years.
9. Included in subscription is an amount of 192,000,000 in respect of
2004.
10. Rent paid represents one and half years to 30
th
April, 2007.

REQUIRED:
(a) Accounts showing the profit or loss on Bar operation and Presidents Ball
(b) The accumulated fund as at 1
st
November 2004.
(c) The Income and Expenditure Account of Victorosky Fun Club for the
year ended 31
st
October 2005 and Statement of financial position as at
that date.

Solution to illustration question
(a)
Victorosky Fun Club
(i)President ball Income statement for the year ended 31
st

December 2005
'000 '000
Sale of tickets (2,400@300,000) 720,000
Less: Cost of meals served 432,000
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397
[2,400x90%@200,000]
288,000
Less Expenses:
Hiring of Hall 20,000
Sundry Expenses 5,275 25,275
Profit to I & E a/c 262,725

(ii) Bar Comprehensive Income Statement for the Year Ended
31st October, 2005
'000 '000
Takings 510,000
Less cost of sales:
Add Purchases(w1) 295,500
322,500
Less Closing Inventories 36,000 286,500
223,500
Less Expenses:
Stewards salary 69,600
Sundry expenses 3,360 72,960
Profit to I & E a/c 150,540

(b) ACCUMULATED FUND AS AT 1ST NOVEMBER, 2004
Assets '000 '000
Equipment 9,905
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398
Cash in hand 15,565
Bank 246,500
Inventories 27,000
Subscriptions 240,000
Prepaid insurance 4,200
Petty cash 3,000
Less Liabilities 546,170
Bar creditors 18,000
Light & Cleaning owing 4,200
Subscriptions 150,000 172,200
ACCUMULATED FUND 373,970

Thanks.

399
Victorosky Fun Club
Income and Expenditure Account
st
October 2005.
INCOME: '000 '000
Subscription W2 1,751,560
Sponsored walk 478,802
Sundry income 75,000
Raffle (183,030-21,600) 161,430
Profit on Bar Trading 150,540
Profit on President Ball 262,725
2,880,057
Expenditure:
Bank charges 36,000
Insurance (4,200+18,000-5,200) 17,000
Printing & stationary 59,160
Light & cleaning (6,800+32,640-4,200) 35,240
Telephone & Postages W3 67,000
Depreciation (10% @67,800) 6,780
Donation 50,000
Secretary's Salary 120,000
Rent [12/18@360,000] 240,000
Bad debt W1 48,000
Loss on sale of equipment (7,923-9,905) 1,982 681,162

Thanks.

400

VICTOROSKY FUN CLUB
STATEMENT OF FINANCIAL POSITION AS AT 31
ST
OCTOBER,2005
ASSETS EMPLOYED '000 '000 '000
NON-CURRENT ASSETS:
Equipment at cost 67,800
Less depreciation 6,780 61,020
Building project (w 5) 1,830,000
1,891,020
Investment in ABC Shares 450,000
2,341,020
Current Assets:
Stock (220,500+36,000) 256,500
Debtors- President's ball (w4) 312,000
Subscription in arrears 360,000
Insurance prepaid 5,200
Rent prepaid 120,000
Bank balance 281,105
Cash (14340+1,000) 15,340
1,350,145
Current Liabilities:
Creditors: Building project
Bar
511,500
33,000

Caterer (432,000-250,000) 182,000
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401
Subscription in advance 210,000
Light & cleaning owing 6,800
Wages outstanding 175,000
1,118,300
Net current Assets 231,845
Net Assets 2,572,865

Financed by:
Accumulated Fund (6) 373,970
Excess of income over
expenditure
1,198,895
1,572,865
Building Fund 1,000,000
2,572,865

WORKINGS
1 Bar Purchases: '000
Payables 2005 33,000
Receipts & Payment a/c 280,500
313,500
Less creditors 2004 18,000
295,500

2 Subscription Account
Thanks.

402
000 '000
Balance b/f 240,000 Balance b/f 150,000
Income &
Expenditure a/c
1,751,5
60
Receipts &
Payments a/c
1,643,5
60
- Bad debt (240-
192)
48,000
Balance c/f 210,000 Balance c/f 360,000
2,201,5
60
2,201,5
60

3 Telephone & Postages '000
Petty cash 2004 3,000
Receipts & Payments 65,000
68,000
Petty cash 2005 1,000
Income & Expenditure a/c 67,000

4 Receivables on President's Ball: '000
Tickets sold 720,000
Less Amount Paid 408,000
Amount to be collected 312,000

Thanks.

403

5 Work in progress- Club
House
'000 '000
Payment for materials 839,000
Add Amount owed (2005) 511,500
1,350,500
Less Closing inventories 220,500
Materials used on project 1,130,000
Wages paid 52525,000
Add Amount owed (2005) 175,000
700,000
Cost to date 1,830,000

6 Accumulated Fund '000
Balance as at 1/11/2004 373,970
Transfer from I & E a/c 2,198,895
2,572,865
Amount transferred to building fund
1,000,000
1,572,865

14.9 Summary

We have learned the difference between a Receipts and Payment
account and an Income and Expenditure Account and have also
explained that the Receipts and Payments Account does not show the
true financial position of the organisation.
Thanks.

404

The Income Statement of a not-for profit organisation is called Income
and Expenditure Account from which any surplus (profit) or deficit (loss)
is calculated and also the accumulated fund is similar to the capital
account of a trader.

We also learned that where the club or society engaged in any activity
with the aim of earning income for the attainment of the objectives of the
organization, a separate Income Statement should be prepared and the
resulting profit or loss transferred to the income and Expenditure
Account.

We also mentioned the treatment of subscription owing should be seen
as part of the earnings of the organization for the period unless its
accounting policy dictates otherwise. Similarly life membership and
entrance fees should be accounted for bearing in mind the accounting
policy of the organization.


Use the data below to answer Questions 1 to 4

Receipts and Payments Account for the year ended 31
st

December, 2006.

Balance b/f 8,000 General expenses 7,800
Subscriptions 50,000 Equipment 9,000
Bar sales 36,000 Club house furniture 27,000
Bar purchases 30,000
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405
Bar keepers wages 4,000

The treasurer also stated that on 1
st
January 2006, the club had 24,000
worth of equipment and owed 500 for electricity. Bar inventories on 1
st

January and 31
st
December valued 10,000 and 13,000 respectively.
Non-current assets are depreciated at 10% per annum.

1. Bar operations surplus for the year was
a. 36,000
b. 6,000
c. 2,000
d. 9,000
e. 5,000

2. The accumulated fund at the beginning of the year was?
a. 42,500
b. 41,500
c. 42,000
d. 32,000
e. 335,000

3. The net value of the clubs non-current assets as at 31
st

December, 2006 was?
a. 60,000
b. 36,000
c. 54,000
d. 33,000
e. 24,000

4. The cash balance at the end of the year was?
a. 16,200
b. 18,200
c. 16,000
d. 16,700
e. 17,200

5. In the final accounts of not for profit rganization, capital
expenditures are recorded in
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a. Income and Expenditure account
b. Subscription account
d. Income statement
e. Receipts and payments account

6. Revenue receipts of a not-for profit making organization are
recorded in the
a. Statement of financial position
b. Income and Expenditure Account
c. Statement of Affairs
d. Bar Purchases Account
e. Profit and loss Account

7. Which of the following statements is NOT true about the accounts of
clubs and societies?
a. A deficit on income and expenditure account reduces
accumulated fund.
b. Income and expenditure account does not contain capital
receipts and expenditure.
c. The excess of total assets over total liabilities represents
accumulated fund
d. The closing balance of receipt and payments account is
transferred to income and expenditure account.
e. An increase on Income and Expenditure Account
increases accumulated fund

8. With regard to a not-for-profit organisation, a debit balance on
the subscription account is reported on
a. Income and Expenditure account
b. Statement of financial position
c. Accumulated fund
d. Receipts and payments account
e. Profit and Loss Account
Details of subscriptions account of Big Men Keep Fit Club are as
follows:

Subscription owing 1/1/07 30,000
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Subscription received 2007 320,000
Subscription received in 2007 included 40,000 in respect of
2008 financial year.

9. What is the subscription to be transferred to Income and
Expenditure account for 2007?
a. 390,000
b. 330,000
c. 310,000
d. 250,000
e. 290,000
10. A club received the following life membership fees in each of
its first two years:
Year 1 300,000
Year 2 160,000

The clubs policy is to take credit for life membership fees in equal
amounts over 10 years. Determine the amount to be transferred to
income and expenditure account in year 2.
a. 16,000
b. 43,000
c. 46,000
d. 32,000
e. 41,400

11. Which of the following are current liabilities?
I. Bills receivable
II. Bills payable
III. Unearned revenue
IV. Accrued expense
a. I, II and III
b. II, III and IV
c. I, III and IV
d. I, II and IV
e. I, II and IV


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1. The information below relates to the Madonna Youth Club for the
accounting period of 2007:
000
Cash in hand 1/7/06 1,800
Subscription received:
2006 2,000
2007 18,000
Receipts for renting of park 1,000
Receipts refreshing guest 6,000
Sundry receipts 12,500
Payments:
Repairs 1,200
Salaries and wages 10,000
Printing and stationary 3,000
Caretakers wages 6,800
Refreshment materials 8,500
Electricity expenses 4,000
Vehicle running expenses 5,000
Payables for repairs 800
Payables for vehicle running expenses
400
Payables for refreshment materials
2,200
Subscription owing for 2007 3,000

a) Receipts and Payments Accounts
b) Income and Expenditure Account for the year ended 30
th
June 2007.
3) The Financial Treasurer of Ayoyo Fun Club has presented the following
summary of Receipts and Payments Account for the year ended 31
st

December 2004:
Receipts and Payments Account for the year ended 31
st
December
2004
000 000
Balance b/f 4,900 Rent and rates 804
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Membership
subscription

5,760
Social activities
expenses

3,000
Membership
admission
840 Bar purchases 3,580
Bar receipts 7,500 Bar wages 1,104
Other receipts 3,800 General wages 2,560
Equipment 5,720
Electricity
expenses
208
Postage and
telephone

352
Bank charges 116
Insurance 604
Balance c/f 4,752
22,800 22,800

The following additional information is available:
31/12/03 31/12/04
Premises 60,000 60,000
Furniture and fittings 4,400 2,840
Bar inventories 1,040 1,420
Subscription in arrears 80 120
General wages owing 180
Subscriptions in advance 400
Insurance prepaid 136 180
Depreciation of 20% is to be written off equipment.
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c) Bar Income Statements
d) Income and Expenditure Account for the year ended 30
th
June 2004.
e) Statement of financial position as at 31
st
December 2004

3) The Azury Peoples Democratic Party prepared accounts for the year
to 31
st
December 2005.
a) They started the year with an amount of 11,416,000 in the
Koromiko Commercial Bank. The Bank statement as at 31
st

December 2005 shows an overdraft of 1,845,000.
b) The members contributed a total of 102,505,000 for the 2005
accounting year as their annual dues. Out of the total contribution
9,750,000 represents arrears of members in previous year and
12,150,000 in respect of dues for next year.
c) The party received the equivalent of 82,600,000 as donation from
the members in the London branch of the party. This amount was
raised from a fund raising rally organised by the chairman in London
after incurring 33,819,500 as rally expenses.
d) The investment in Ghana Government Treasury bill stood at
712,000,000 at the beginning of the year. The party however
discounted half of the bills and used all the proceeds as follows:
Campaign van 43,250,000
Electricity expenses 4,400,000
Congress expenses 218,750,000
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Insurance on Motor vehicles 8,200,000
Renting of constituency offices 22,582,000
Stationary 15,817,500

e) Total interest on the bill for the year amounted to 389,500 was
received during the year. Half of this amount was spent on buying
fuel for campaign activities.
f) The campaign Van is to be depreciated at the rate of 20%, using the
straight line method
g) The following additional information is available:
31/12/04 31/12/05
000 000
Head office Buildings 75,000 65,000
Furniture and fittings 950,000 888,500
Computer equipments 10,200 4,800
Vehicle running expenses owing 750 320
Stationery prepaid 230 1,050
Rent owing 950 1,125

You are required to prepare Receipts and Payments Account and
an Income and Expenditure account for the year ended 31
st

December, 2005, and a statement of financial position as at that
date.

4. The following is Receipts and Payment Account of the Hinton
Social Club for the year ended 31
st
December 2004.
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Receipts 000 Payments 000
Payment for
restaurant and

Annual
subscriptions:
Bar supplies 10,000
For the year 2003 240 Wages 3,400
For the year 2004 3,670 Electricity 460
For the year 2005 30 Secretarial
expenses
370
Restaurant and bar
sales
12,000 General
expenses
2,015
Interest on Bank of
Ghana bond
105 Payment on
account of new

Life membership
subscriptions
300 Furniture 300

You are given the following information:
a) Inventories of restaurant and bar supplies: 000
At 31
st
December 2003 820
At 31
st
December 2004 2,000
b) Payables for restaurant and bar supplies:
At 31
st
December 2003 900
At 31
st
December 2004 1,080
c) The assets of the Club at 31
st
December 2003
were:

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Furniture valued at 2,000
3
1
/
2
% Bank of Ghana Bond 3,100
Leasehold Premises valued at 2,500
(The lease has ten years to run from 2003)
d) During the year new furniture was acquired at a
cost of
500
e) The secretary extracted the following information:

31/12/03 31/12/04
Subscriptions received in
advance
40,000 Nil
Secretarial expenses owing 10,000 Nil
Electricity bills outstanding 60,000 Nil
Bank balance 700,000 500,000

f) The secretary to the Club is entitled to free meals valued at 50,000
per year.
g) The rules of the Club were amended in 2004 to make provision for
life membership at a subscription of 30,000 per life member. It was
also provided that 10% of each life members subscription should be
transferred annually to the Income and Expenditure account in the
year in which such payments are made.
h) It is the policy of the Club not to recognize any subscription in
arrears in the Income and Expenditure account until it is actually
received.

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You are required to prepare all the necessary accounts required to
show the financial position and performance of the Hinton Social
Club that will be acceptable to its members for the accounting
period of 2004.

1. C
2. B
3 C
4. A
5. C
6. B
7. D
8. B
9. D
10. C
11. D

14.3 Solution to Review questions
Q1.
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Subscription Account
000 000
Balance b/f 2,000 Receipts & payments:
Income & expenditure 27,000 1999 2,000
2000 24,000
Balance c/f 3,000
29,000 29,000
Balance b/f 3,000

Q2
Ayoyo Fun Club
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Income and Expenditure Account for the year ended 31st December 2004
000 000
Rent and rates 804 Membership subscription 6,200
Social activities expenses 3,000 Membership admission 840
Depreciation - furniture & fittings 1,560 Bar profit 3,196
Depreciation - Equipment 1,144 Other receipts 3,800
General wages 2,380
Postage and telephone 352
Electricity expenses 208
Bank charges 116
Insurance 560
Excess of income over expenditure 3,912
14,036 14,036

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417

Subscription Account
000 000
Balance b/f 80 Balance b/f 400
Income & expenditure 6,200 Receipts & payments: 5,760
Balance c/f 120
6,280 6,280
Balance b/f 120

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CHAPTER FIFTEEN
USE OF COMPUTER APPLICATION PACKAGES IN ACCOUNTING
15.2 Introduction
15.3 Sales Ledger Sub-system
15.4 Purchases Ledger
15.5 Inventory Sub-system
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15.6 Payroll System
15.7 Non-Current Assets Sub-system
15.8 Trade Receivables Control
15.9 Bank Reconciliation
15.10 Advantages and Disadvantages of Application Packages
15.11.1 Factors to consider when deciding on which package to use or
buy.
15.11.2 Sources of Application Packages
15.14 Solution to Multiple Choice Questions and Short Answer
Questions
15.1 LEARNING OBJECTIVES
In this chapter, readers will be able to understand:
the main information that will be required in developing software
packages for common accounting, such as:
- Sales and Purchases Ledgers
- Inventory
- Payroll
- Non-Current Assets
- Bank Reconciliation
- Control Accounts
15.2 INTRODUCTION
Accounting packages are probably the most widely used sort of off-the-shelf
package in business. A package may consist of a suite of program modules,
and the computer user can use a single module for a specific application or
sub-system or a number of modules in a more integrated system.
There might be separate modules for the general ledger, and subsidiary
ledgers such as:
(a) Payroll
(b) Inventory
(c) Non-current assets
(d) Treasury
(e) Financial reporting and analysis.
Each module may be integrated with the others, so that data entered in one
module will be accessible across all modules as required.
15.3 SALES LEDGER SUB SYSTEM
The main features of a sales ledger are:
(a) Files used.
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The main file in a sales ledger subsystem is the sales ledger. The fields
in each record will include:
(i) Customer account number
(ii) Customer name
(iii) Address
(iv) Credit limit
(v) Sales analysis
(vi) Account type
(vii) Transaction date
(viii) Transaction description
(ix) Transaction code
(x) Debits
(xi) Credits
(xii) Balance

(b) Output
(i) Day book listing
(ii) Invoices
(iii) End of month statements for customers
(iv) Age analysis of trade receivables
(v) Sales analysis reports
(vi) Trade receivables reminder letters
(vii) Customer lists
(viii) Responses to enquiries
(ix) Output on to disk file for other modules

(c) File updating (amendments):
Amendments to customer details e.g. change of address,
change of credit limit.
Insertion of new customers
Deletion of old non-active customers

(d) Transaction data relating to
Sales transaction (for invoicing)
Customer payments
Credit notes
Adjustments
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15.4 PURCHASES LEDGER
The simplest purchases system is one where the computer is used to
maintain the purchases ledger and produce a purchase analysis. The
main features would be:
(a) Inputs, which include data about
purchases invoices
credit notes
cash payments
adjustments

(b) Outputs, which include:
lists of transactions posted produced every time
the system is run;
an analysis of expenditure for nominal ledger
purposes. This may be produced every time the
system is run or at the end of each month;
lists of trade payables balances together with a
reconciliation between the total balance brought
forward, the transactions for the month and total
balance carried forward;
copies of payables accounts.
(c) Files used The fields in each record will include:
(i) account number
(ii) name
(iii) address
(iv) credit details
(v) bank details
(vi) cash discount details
(vii) details of transactions
(viii) balance outstanding.
15.5 INVENTORY SUB-SYSTEM
Inventory sub-system generates transactions in respect of purchase,
holding and issuing of inventories.
The main features of a stock control system are:
(a) Inputs, which would include data about:
(i) goods received note
(ii) issues to production
(iii) production to finished good store
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422
(iv) dispatch notes
(v) adjustments.
(b) Outputs, which would include:
(i) details of stock movements
(ii) stock balances produced as required
(iii) stock valuation lists
(iv) list of slow moving goods.
(c) Files used
The main file is the stock ledger. There would be a record on
file for each stock item, and record fields might include:
(i) stock number
(ii) description
(iii) standard cost
(iv) quantity in stock
15.6 PAYROLL SYSTEM
A simple payroll system would be mainly concerned with the
production of a weekly wages payroll. Salary systems are similar to
those encountered for wages, the principal difference being that it is
usual for the monthly salary to be calculated from details held on the
master file and, therefore with the exception of overtime, bonuses, etc
there is no need for any transaction input. The main features of a
simple wages system are:
(a) Inputs, which include:
(iii) Clock cards or time sheets. Details of overtime worked
will normally be shown on these documents.
(iv) Amount of bonus or appropriate details if the bonus is
calculated by the computer.

(b) Outputs, which include:
(i) Payslips
(ii) Payroll
(iii) Payroll analysis, including analysis of deductions and
details for costing purposes
(iv) Cash analysis, cheques, credit transfer forms, as
appropriate
(v) In some cases, a magnetic tape, cassette or floppy disk
with payment details for dispatch to the bank.
(c) Files used.
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423
The master file will hold two types of data in respect of each
employee:
(iii) Standing data, for example, personal details, rates of
pay, details of deductions
(iv) Transaction data, for example, gross pay to date, tax to
date, pension contributions, etc.
15.7 NON-CURRENT ASSETS SUB-SYSTEM
The main features are:
(a) Inputs, which include data about
(i) Capitalization policy
(ii) Depreciation policy
(iii) Purchase invoices
(iv) Cash payments
(v) Adjustments
(b) Output:
(vii) Non-current assets register which includes the cost of
assets, accumulated depreciation, current year
depreciation, asset type, depreciation rate and net book
value of asset.
(viii) Non-current asset ledger records cost of acquisition,
additional cost of improvement, disposal value of asset
and calculated depreciation based on asset classification.
(c) Files used The fields in each record will include:
(i) Asset class
(ii) Asset name/description
(iii) Asset identification code
(iv) Cost
(v) Date of acquisition
(vi) Estimated useful life
(vii) Depreciation rate
(viii) Disposal value and date
(ix) Current depreciation
(x) Accumulated depreciation
(xi) Book value of asset
15.8 TRADE-RECEIVABLES CONTROL
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424
The trade receivables system deals with transactions that involve sales
invoices raised, credit notes and debit notes issued to customers and
credit notes issued to trade payable control accounts for offset against
trade payables and trade receivables payments.
The main features are:
(f) File used
The main file used is sales ledger subsystem.
(g) Inputs, which include data about:
- total credit sales for the period
- total cash received from trade receivables during the
period.
- total credit notes issued during the period
- Adjustments.
(c) Outputs, which include:
- End of the period balance
- Comparative analysis of opening and closing balances
- Set-offs against purchases control ledgers
- List of credit notes not yet used by the customers.
15.9 BANK RECONCILIATION
The main features would be
(a) Inputs
- pay-in slips
- cheque stub/counterfoil
- bank debit notes
- bank credit notes
(b) Outputs
- Bank Balance as at the date of reconciliation
- List of stale cheques
- List of uncredited lodgements
- List of unpresented cheques
- List of unmatched items in the bank statement but not in
the cash book.
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15.10 ADVANTAGES AND DISADVANTAGES OF APPLICATION PACKAGES

Advantages
(a) They make implementation of an application to be quicker and
cheaper.
(b) They provide standard approach to common applications
(c) They are efficient in terms of speed, accurancy and storae
requirements
(d) They save programming efforts
(e) There is substantial reduction in systems efforts.
Disadvantages
(a) Some packages are not brought up-to-date.
(b) The packages may not be 100% suitable for a particular use, as
they may not be fully tailored towards the use
(c) One may not get experts who will come to ones immediate help
in case of challenges.
(d) Inefficiency may be experienced due to inclusion of features
that are not particularly relevant in the packages.
(e) The vendor company that wrote the package may cease to
exist. Users will then face the challenge of getting support for
and maintaining the software.
15.11.1 Factors to consider when deciding on which package to use or buy:
(a) Cost - This includes the cost of software, setting-up and
operating the system.
(b) Flexibility How easy is it to make future amendments.
(c) Types of processing What is the input and output medium
associated with the package.
(d) Timing of processing
(e) Hardware required
(f) Degree of reliability
(g) Integration with other systems
(h) Users processing requirements.

15.11.2 Sources of application packages
The main sources of application packages are:
(d) Computer Bureax
(e) Computer manufacturers
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(f) Specialist software Houses
This chapter treats the features, advantages and disadvantage of
software packages for common accounting use as it relates to general
and subsidiary ledgers, inventory, payroll, non-current assets, control
account and bank reconciliation.
1. The data storage hierarchy is as follows:
(a) Database, Files, Records, Fields, Bytes, Bits
(b) Bits, Bytes, Field, Records, Files, Database
(c) Bytes, Records, Bits, Files, Bits, Database
(d) Bits, Field, Bytes, Files, Records, Database
(e) Files, Records, Bits, Bytes, Field, Database
2. The following are optical Disks EXCEPT
(a) CD-ROMs
(b) WORMS
(c) DVD Digital video Disk
(d) MD Magnetoptical Disk
(e) Floppy disk
3. The process of locating and eliminating errors from a program is
known as.
(a) Tracing
(b) Debugging
(c) Dump
(d) Sorting
(e) File copying

4. The following are application packages EXCEPT.
(a) Rewrittables
(b) Peachtree
(c) Bank master
(d) Oracle
(e) Page maker

5. One of the following is a disadvantage of Application Packages.
(a) They make implementation of an application to be
quicker and cheaper.
(b) They provide standard approach to common applications.
(c) They save programming efforts
(d) There is substantial reduction in systems efforts
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427
(e) There may be inclusion of features that are not
particularly relevant in the packages.

6. What is Internet?

7. Many companies are designing application packages for routine
application. Name Five of such packages, giving examples.

8. List Two outputs of inventory sub-system of computer
Application Package.

9. List Two types of data being used in a payroll sub-system.

10. List Two transaction data items in sales ledger sub system.

11. A computer that connects incompatible networks is called

15.14 SOLUTION TO MULTIPLE CHOICE QUESTIONS
AND SHORT ANSWER QUESTIONS

1. B
2. E
3. B
4. A
5. E

6. The Internet is a network of networks, linking computers to
computers sharing information. It is a transport vehicle for the
information stored in files or documents on another computer.
It is the inter-connection of several computers located in
different locations around the world.

7. Any five of the following:

(a) Word-processing e.g. Word perfect, word star, multimate
and Microsoft word 2000.

(b) Spreadsheet e.g. Microsoft Excel, Lotus 1-2-3, supercalc

(c) Desktop Publishing e.g. Page Maker and Corel Draw

(d) Database management system e.g. Foxpro, Dbase and
oracle.
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(e) Utilities e.g. Pc tools, Norton and Antivirus

(f) Banking Application e.g. Globus, Finacle, Flexcube and
Bank master.

(g) Accounting packages e. g. Dac-Easy, Peach Tree and
Sage.

(8) - details of stock movements
- inventory balances produced as required
- list of inventories below minimum order quantity
- inventory valuation list.

(9) - standing data e.g. personal details, rates of pay details of
deductions

- transaction data e.g. gross pay to date, tax to date,
pension contributions.
(10) - Insertion of new customers
- Delection of old non-active customers
- amendments to customers details e.g. change of
address, change of credit limit

(11) - Gateway

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NOTE: This is a work in progress.

All topics in the syllabus are covered but

Invoice Price * 100,000,000

1/1/2000 Bank 800,000

Acquisition cost of machine 200,000

Purchases of raw materials 10,000

Increase in net worth 1,848,000

Staff wages 1,200,000

Balance as at 1st January 2006 2,000,000

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