Download Basics of bookkeeping

BASICS OF BOOKKEEPING
The topics to be covered key understandings of
bookkeeping knowledge.
BY
HON. DR. LUCAS WEBIRO
1
TOPICS TO BE COVERED
NATURE OF ACCOUNTING
SINGLE ENTRY BOOKKEEPING
DOUBLE ENTRY BOOKKEEPING
THE ACCOUNTING EQUATION
DEBITS AND CREDITS
THE ACCOUNTING CYCLE
PREPARATION OF THE BALANCE SHEET
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BASICS OF BOOKKEEPING
OBJECTIVE - to introduce students to the
mechanics of bookkeeping
• a solid foundation in bookkeeping is necessary to
be able to evaluate the effects of selecting
alternative accounting policies
• bookkeeping has specific procedures that must be
followed or the entries are incorrect
• bookkeeping is only one component of accounting
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NATURE OF ACCOUNTING
Accounting is the process of identifying, measuring,
recording, interpreting and communicating the results
of economic activities of a business
• identification and measurement require significant
professional judgement
• once it has been determined what should be
recorded, the bookkeeping or recording process is
straight forward
• communication of the results of the economic
activities is done through the FINANCIAL
STATEMENTS
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SINGLE ENTRY ACCOUNTING
• use of your cheque book is single entry accounting
• cheques issued are recorded as a reduction in
the bank account, but there is not a separate
record kept for each type of expense paid
• for instance, if groceries were purchased, there
is no entry to show an increase to the total cost of
groceries purchased during the year
• the cheque register is part of the accounting system
• it is referred to as an account
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Single entry accounting
• Single entry accounting has been used for
proprietorships where the owner prepares an income
statement primarily for tax purposes
• No balance sheet is prepared
• Revenues and expenses are recorded from invoices
• there is no way to determine if all have been
recorded
• no attempt to record the changes in the asset
and liability account balances
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DOUBLE ENTRY ACCOUNTING
• Double entry accounting creates an account for each
type of asset, liability, equity, revenue and expense
• Every entry into a double entry accounting system
must balance
• If cash is received, the source must be recorded
• If cash is paid out, the use must be recorded
• If a sale is made on account, the receivable must
be recorded
• If a purchase is made on account, the debt must
be recorded
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• double entry accounting permits preparation of both a
balance sheet and an income statement
• checks and balances are available to ensure all
transactions are recorded
• Example
• a bank reconciliation is prepared to ensure the
ending bank balance per the bank statement
agrees to the balance in the accounting records
• if it does not, any unrecorded amounts will be
identified and recorded
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THE ACCOUNTING EQUATION
• the accounting equation is the foundation of
double entry accounting
• ASSETS = LIABILITIES + EQUITIES
• assets acquired by the business must be paid for,
and the funds are either borrowed or invested by
the owners
• Net Assets = Assets - Liabilities
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MECHANICS OF BOOKKEEPING
•Double entry accounting requires that the accounting
records of the business balance, just as the accounting
equation balances
• to accomplish this, left and right side entries are
recorded
• DEBIT - an entry on the left side
- also used as a verb, to make an entry on the
left
• CREDIT - an entry on the right side
- also used as a verb, to make an entry on
the right
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ASSETS = LIABILITIES + EQUITIES
Assets appear on the left side of the accounting
equation (debit side of the equal sign)
• The normal balance for an asset account is a
debit balance
• Assets are increased by a debit
• Assets are decreased by a credit
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ASSETS = LIABILITIES + EQUITIES
Liabilities appear on the right side of the accounting
equation (credit side of the equal sign)
• The normal balance for a liability account is a
credit balance
• Liabilities are increased by a credit entry
• Liabilities are decreased with a debit entry
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ASSETS = LIABILITIES + EQUITIES
Equities are on the right side of the accounting
equation ( the credit side of the equal sign)
• Accounts that increase equity are increased with
credit entries and decreased with debit entries
• Accounts that decrease equity are increased with
debit entries and decreased with credit entries
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•The permanent equity accounts have a normal
credit balance
• Temporary accounts may have debit or credit
balances:
• Revenues and gains increase equity and have
normal credit balances
• Expenses and losses reduce equity and have
normal debit balances
• Dividends distributed, if recorded in a separate
account, have a normal debit balance
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Equity in a business
If a company earns $10,000, this amount in not
payable to creditors. The value of the company will
increase and it is the shareholders that benefit
• Revenue and expense accounts are used to
measure the profit or loss in the year
• These accounts are really part of the equity of the
business, but are kept separate to facilitate the
preparation of the income statement
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COMPONENTS OF EQUITY OF A
CORPORATION
ASSETS = LIABILITIES + EQUITY
EQUITY = SHARE CAPITAL + RETAINED EARNINGS
RETAINED EARNINGS = OPENING RETAINED
EARNINGS + NET INCOME - DIVIDENDS
NET INCOME = REVENUES - EXPENSES
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Components of Equity of a
Proprietorship
For a proprietorship, contributions by the owner and
profits not withdrawn are combined in one account
• Owner’s name, capital
• Heather Johnston, capital
• EQUITY = OPENING CAPITAL + NET INCOME DRAWINGS
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•Dividends are a distribution of the after-tax profits of a
business to the shareholders (owners)
• the term dividend only applies to a corporation
• for a proprietorship and partnership, distributions
of profit to the owners are called drawings
• Dividends reduce the equity in the business
• Dividends are increased with a debit and have a
normal debit balance
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SHARE CAPITAL and RETAINED EARNINGS ( or
OWNER’S CAPITAL) are referred to as permanent
accounts because they carry forward on the Balance
Sheet from one year to the next
REVENUES, EXPENSES, GAINS and LOSSES are
referred to as temporary accounts because they
accumulate the transactions for the year only, and then
their balances are closed to Retained Earnings to
allow the next year’s transactions to be accumulated
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THE ACCOUNTING CYCLE
Steps carried out throughout the period:
• transaction analysis
• journal entry preparation
• posting journal entries to the general ledger
• End of period procedures:
• prepare trial balance
• prepare adjusting journal entries
• adjusted trial balance
• financial statement preparation
• closing journal entries
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Transaction analysis
• determine whether an event should be recorded in
the accounting records at this time
• if yes, determine which accounts are affected
• determine whether each account affected is
increased or decreased by this transaction
• requires significant professional judgement in the real
world
• in this course, most events are very straightforward
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General journal entries
• method of recording transactions in the accounting
records
• two columns needed for dollar amounts
• left column for debit entries
• right column for credit entries
• formal journal entry page on page 69 of text
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• simplification for the purposes of this course
• omit description and date (unless you are asked
to prepare entries for several dates at one time)
• Example
Heather contributes $10,000 cash to her business,
Heather’s Shoes, Ltd. and receives 1,000 shares
Debit
Cash
Share Capital
Credit
10,000
10,000
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General Ledger
• The general ledger is made up of a series of
accounts that resemble the cheque register
• Each account lists all increases and decreases to the
account, in chronological order, and the account
balance
• Actual format shown on page 65 of text
• T - account used in this course shown on page 59
• account balance determined only after all
entries to the account are posted
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Cash
10,000
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There should be a separate account in the general
ledger for each type of asset, liability, equity, revenue,
gain, expense and loss
• Example
• Assets:
• Cash
• Accounts receivable
• Inventory
• Prepaid expenses
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• Land
• Building
• Equipment
• Furniture
• Goodwill
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• Liabilities
• Demand loan payable
• Accounts payable
• Salaries payable
• Interest payable
• Income tax payable
• Unearned revenue / Deposits from customers
• Current portion of long term debt
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• Loans payable
• Bonds payable
• Deferred Tax Credits / Future Tax Payable
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• Revenues
• Sales revenue
• Service revenue
• Interest revenue
• Gains (Losses)
• Gain (Loss) on sale of fixed assets
• Gain (Loss) on sale of investments
• Gain (Loss) on repurchase of bonds
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• Expenses
• Cost of goods sold
• Salaries expense
• Rent expense
• Repairs and maintenance
• Office Supplies expense
• Utilities expense
• Interest expense
• Income tax expense
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End of Period Procedures
• Trial Balance
• a listing of all general ledger accounts, with
balance
• total debits must equal total credits
• if not, must correct errors before proceeding
further
• Adjusting journal entries
• record end of period adjustments that are not
supported by transactions
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• Adjusted trial balance
• another listing of general ledger accounts and
balances
• same purpose, to ensure total debits equal total
credits
• done to ensure accounts are in balance prior to
preparation of the financial statements
• done twice to make identification of the error
easier - fewer steps to review
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• Preparation of the financial statements
• Income Statement prepared first
• Statement of Retained Earnings prepared second
• need net income from income statement
• Balance Sheet prepared third
• need retained earnings balance at end of
period
• Cash Flow Statement prepared last
• uses information from other statements
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Closing Journal Entries
• journal entries prepared at the end of the fiscal year
of the business
• the temporary equity accounts (revenues, expenses,
gains and losses) are closed into Retained Earnings
• temporary account balances are reduced to zero
• retained earnings increased by net income
amount, or reduced by amount of loss
• if dividends declared are recorded in a temporary
account, it is closed to Retained Earnings,
reducing the retained earnings balance
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BALANCE SHEET
• The classified Balance Sheet was introduced last
module and will be expanded on here
• Example from text page AR - 13 from the appendix
following page 651 in volume 1
• Loblaws Consolidated Balance Sheet
• Consolidated - balance sheet is for more than
one corporation controlled by the same group of
people. (pages AR-4 and AR-5 identify the
businesses included
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Loblaws Consolidated Balance Sheet
• Balance sheet prepared as at January 3, 1998
• January 3 is the year end of the business
• this is a fiscal year end
• a calendar year end is December 31
• the fiscal year end may be a calendar year
end, it may be another date
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Loblaws Consolidated Balance Sheet
• this is a report form balance sheet
• assets are listed on top
• liabilities and equities are listed on the bottom
• assets = liabilities + equities
• 4,013 = 2,518 + 1,495
• shown right on the statement
• 4,013 = 4,013
• amounts stated in millions of dollars
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Loblaws Consolidated Balance Sheet
• Assets divided between current and non-current
• current all listed under the heading”Current”
• listed in order of liquidity
• non-current listed by type
• Franchise investment and receivables
• Fixed assets
• Goodwill
• Other assets
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Loblaws Consolidated Balance Sheet
• Liabilities divided between current and non-current
• all current liabilities reported together under the
heading of “Current”
• listed in order of maturity
• non-current listed by type
• long term debt
• other liabilities
• deferred income taxes
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Loblaws Consolidated Balance Sheet
• Equity accounts that appear on the Balance Sheet
are the permanent account balances only
• Share capital
• the amount received from selling shares when
originally issued by the company
• not affected by sales between
shareholders
• does not reflect current fair market value of
the shares
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Loblaws Consolidated Balance Sheet
• Retained earnings
• this is the balance at the end of the year, in this
case January 3, 1998 (even though it is noted as
1997 in the column above the amounts reported)
• this only agrees to the actual amount in the
Retained Earnings account in the general ledger
immediately after the temporary accounts are
closed, before any transactions for the next year
are recorded
• agrees to the amount reported on the
Consolidated Statement of Retained Earnings
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BOOKKEEPING EXAMPLE
• the text has excellent examples of bookkeeping
entries in Chapters 2, 3, and 4
• the text examples are for a proprietorship
• this example is a corporation
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Heather’s Shoe Store Ltd.
Heather’s Shoe Store Ltd. intends to begin selling
shoes on January 1, 2000. The company will have a
December 31 year end. In preparation for the opening
of the retail store on January 1, 2000, the business
carried out the following transactions during
December, 1999:
1) Heather contributed $10,000 in cash to the business
and received 1,000 common shares in return
2) Display shelves costing $4,000 were purchased on
account.
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Heather’s Shoe Store Ltd.
3) a cheque for $500 was issued to the lawyer for the
cost of incorporating the business
4) cash of $4,000 was deposited. The cash was the
proceeds of a bank loan obtained to finance the
purchase of the display shelves
5) the invoice for the display shelves was paid in full
6) shoe inventory with a cost of $12,000 was ordered
on account
7) a shipment of shoes with a cost of $5,500 was
received before the end of December; the remaining
shoes will be delivered in January
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Heather’s Shoe Store Ltd.
8) insurance premium of $2,400 was paid for insurance
coverage from January 1 to December 31, 2000
9) rent for the month of January of $2,200 was paid,
plus $2,200 for the last month’s rent in advance
10) a customer who knew the shoe store was opening
gave Heather $100 for special order shoes. The shoes
have not yet been ordered
•Required: prepare the necessary journal entries for
December 1999 and post to T-accounts. Prepare a trial
balance and balance sheet as at December 31, 1999
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Solution - Heather’s Shoe Store Ltd.
Journal entries for December 1999
Debit Credit
1) Cash
Common shares
10,000
10,000
2) Fixtures
Accounts payable
3) Incorporation costs
Cash
4) Cash
Bank loan payable
4,000
4,000
500
500
4,000
4,000
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Solution - Heather’s Shoe Store Ltd.
Debit Credit
5) Accounts payable
Cash
4,000
4,000
6) no entry is required - no liability until shoes are
received
7) Inventory
Accounts payable
5,500
8) Prepaid insurance
Cash
2,400
5,500
2,400
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Solution - Heather’s Shoe Store Ltd.
9) Prepaid rent
Cash
10) Cash
Unearned revenue
Debit Credit
4,400
4,400
100
100
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Solution - Heather’s Shoe Store Ltd.
Cash
(1) 10,000
Common shares
10,000 (1)
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Solution - Heather’s Shoe Store Ltd.
Cash
(1) 10,000
Fixtures
(2)
4,000
Common shares
10,000 (1)
Accounts payable
4,000 (2)
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Solution - Heather’s Shoe Store Ltd.
Cash
(1) 10,000
(4) 4,000
Incorporation costs
500 (3)
4,000 (5)
Bank loan payable
4,000 (4)
(3)
500
Accounts payable
(5) 4,000
4,000 (2)
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Solution - Heather’s Shoe Store Ltd.
Cash
(1) 10,000
(4) 4,000
Inventory
500 (3)
4,000 (5)
2,400 (8)
Prepaid insurance
(8)
2,400
(7) 5,500
Accounts payable
(5) 4,000
4,000 (2)
5,500 (7)
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Solution - Heather’s Shoe Store Ltd.
Cash
(1) 10,000
(4) 4,000
(10)
100
Prepaid rent
500 (3)
4,000 (5)
2,400 (8)
4,400 (9)
(9) 4,400
Unearned revenue
100 (!0)
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Solution - Heather’s Shoe Store Ltd.
Cash
(1) 10,000
(4) 4,000
(10)
100
Inventory
500 (3)
4,000 (5)
2,400 (8)
4,400 (9)
(7) 5,500
2,800
Prepaid insurance
(8) 2,400
Prepaid rent
(9) 4,400
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Solution - Heather’s Shoe Store Ltd.
Fixtures
(2) 4,000
Incorporation costs
(2)
Bank Loan Payable
4,000 (4)
500
Accounts payable
(5) 4,000
4,000 (2)
5,500 (7)
5,500
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Solution - Heather’s Shoe Store
Ltd.
Unearned revenue
100 (!0)
Common shares
10,000 (1)
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Solution - Heather’s Shoe Store Ltd.
Trial Balance
Debits
Cash
2,800
Inventory
5,500
Prepaid insurance
2,400
Prepaid rent
4,400
Fixtures
4,000
Incorporation costs
500
Bank loan payable
Accounts payable
Unearned revenue
Common shares
19,600
Credits
4,000
5,500
100
10,000
19,600
58
Heather’s Shoe Store Ltd.
Balance Sheet
as at December 31, 1999
ASSETS
CURRENT
Cash
Inventory
Prepaid insurance
Prepaid rent
$
2,800
5,500
2,400
4,400
15,100
CAPITAL
Fixtures
4,000
INCORPORATION COSTS
$
500
19,600
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Heather’s Shoe Store Ltd.
Balance Sheet
as at December 31, 1999
LIABILITIES
CURRENT
Bank loan payable
Accounts payable
Unearned revenue
$
4,000
5,500
100
9,600
SHAREHOLDER’S EQUITY
SHARE CAPITAL
Common shares
10,000
$
19,600
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TIPS TO HELP LOCATE ERRORS
Supplemental topic Chapter 2 - page 80
If total debits do not equal total credits, it is possible to
narrow down the places to look. If debits = 14,720 and
credits = 14,270, the difference is 14,720 - 14270 =
450. Since 450 is divisible evenly by 9, it is likely to be
a transposition error. 450 / 9= 50.
The result, 50, also provides guidance on where to
look. The transposed numbers are 5 digits apart, and
the transposition is between the hundreds and tens
column. For example 1,380 recorded as 1,830 or 940
recorded as 490.
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QUESTIONS FOR PRACTICE - NOT FOR MARKS
Chapter 1
6,13,14,15,17
Exercises E1-8, E1-9,
Problems P1-1, P1-4, P1-7, P1-9
Chapter 2
4,7,9,10,15,18
Exercises E2-3, E2-6, E2-8, E2-11
Problems P2- 2, P2- 4, P2- 6, P2- 8, P2-10
The problems listed always go from least to most
difficult.
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