TOPIC 6:

1. TOPIC 6: BOOK-KEEPING PROCEDURES

2. By the end of this chapter, you should be able to: • Explain what is meant by the accounting equation; • Understand definition of items in financial statements; • Understand the effect of business transactions on the financial position; • Define debits and credits and explain how they are used to record business transactions; • Identify the basic steps in the recording process; • Explain what a journal and ledger is and how it helps in the recording process; • Prepare a trial balance and explain its purposes;

3. By the end of this chapter, you should be able to:Continue.. • Explain the time period assumption; • Explain why adjusting entries are needed; • Explain the major types of adjusting entries; • Prepare adjusting entries for prepayments and accruals; • Understand errors and omissions and the method of rectifying them; • Prepare correcting entries; • Prepare closing entries; • Prepare reversing entries; • Explain the difference between manual and computerized accounting.

4. RULE IN BOOK-KEEPING The main objective of financial accounting is to provide the information of financial position and financial performance of the business. • Financial position Balance Sheet: provides information on – Assets; Liability; and Owner’s Equity. • Financial Performance Income Statement. Provides information on the company profitability. (Revenue – Expenses). If PROFIT the owner’s equity will increase and if LOSS will lower the owner’s equity.

5. CLASSIFICATON OF ACCOUNTS FIVE GROUP OF ACCOUNTS: • ASSETS Resources owned by a business Definition – “right or other access to future economic benefits controlled by an entity as a result of past transactions or events” Two types of assets: Non current Assets – Assets which have a long life bought with the intention to use in the business and not with the intention to simply resell them. Eg: land and building, motor vehicle, premise, furniture etc.. Current Assets – Goods for resale or items having a short life. Eg: bank, cash, stock, debtors etc..

6. 2) LIABILITY Total of funds owed for assets supplied to a business or expenses incurred not yet paid.  Two types of liabilities:  Long-term liabilities – Liabilities that do not have to be paid within twelve months of the balance sheet date. Current Liabilities – Liabilities to be paid for within a year of the balance sheet date. 3) OWNER’S EQUITY The total of resources invested and left in a business by its owner. Increase in owner’s equity: Owner increases its investment to a business either by cash or by other assets. any profits earned by the business

7. Decrease in Owner’s Equity Owner withdrawal cash or other assets from the business.  Any losses sustained by the business. 4) REVENUE The financial value of goods and services sold to customers. Earning revenue causes owner’s equity to increase. 5) EXPENSES The value of all assets that have been used up to obtain revenues.  Often cited as “cost of doing business”  Expenses always cause a decrease in owner’s equity.

8. • The business can acquire assets either provided by the owner or by other party (external sources) or combination of both. • The sum of the assets shown in balance sheet must be equal at all times to the sum of claims against those assets. • Therefore, accounting equation usually shown the relationship between assets, liabilities, and owner’s equity of a business at a certain date. THE ACCOUNTING EQUATION or THE BALANCE SHEET EQUATION

9. Example of simple accounting equations: a) ASSETS = OWNERS’ EQUITY (Resources in the business) = (Resources supplied by the owner) b) ASSETS = OWNERS’ EQUITY + LIABILITIES = (Resources supplied by the owner & other party) c) ASSETS = LIABILITIES = (Resources supplied by other party) • Advanced Accounting Equation: ASSETS = LIABILITY + OWNER’S EQUITY + REVENUES - EXPENSES – DRAWING.

10. Asset = Liabilities + Owners’ Equity + Revenues - Expenses + Gains- Losses+ Contributions - Withdrawals All are temporary accounts until the end of the accounting period, at which time they are closed to owners’ equity The accounting equation holds at all times over the life of the business. When a transaction occurs, the total assets of the business may change, but equation will remain balance.

11. Types of accounts • Permanent Accounts • Temporary Accounts • Control Accounts • Subsidiaries accounts • Contra accounts

12. The Accounting Equation – A Practical Example Mamat decides to open a bicycle repair shop. To get started he rent some shop space, purchases an initial inventory of bike parts, and opens the shop for business. Here is a listing of the transactions that occurred during the first month:

13. THE EFFECT OF TRANSACTION TOWARDS THE ACCOUNTING EQUATION

14. THE EFFECT OF TRANSACTION TOWARDS THE ACCOUNTING EQUATION – 2nd example

16. Analyzed Accounting Equation

18. DOUBLE ENTRY SYSTEM The financial transaction has two effects on the financial position of the business. This means that each transaction must be recorded twice in the books of accounts i.e. DEBIT and CREDIT. Thus, for any transaction, the amount of debit must be EQUAL with the amount of credit. Examples; If transaction reduces an asset it must also: Increase another asset,or Decrease a liability, or Decrease owner’s equity An item that increases/decrease Assets must be debit/credit; An item that increase/decrease Liability or Equity must be credit/debit.

19. BOOK-KEEPING RULES Debit and Credit Procedures

20. DEBITS AND CREDITS The term DEBIT AND CREDIT mean left and right Cash A/c DEBIT CREDIT

21. Use the same examples in accounting equation but change to double entry system. Date Transactions 1 Jan Winnie started business with RM15,000 cash 3 Jan Bought business furniture in cash at cost RM6500 4 Jan Bought an office supplies amounted RM3250 on credit from Aseana 8 Jan Received cash for services rendered amounted RM2250 10 Jan Paid advertising expense amounted RM750 15 Jan Services being performed to Ali Trading; received RM250 in cash and RM1500 on credit. 18 Jan Paid rent RM890, wages RM4500 and utility expenses RM450 on cash 22 Jan Paid Aseana RM1250

22. 6.2 STEPS IN ACCOUNTING CYCLE ANALYSED DATA IDENTIFY TRANSCTION (SOURCE OF DOCUMENTS) PREPARE JOURNAL ENTRY POSTING TO LEDGER PREPARE ADJUSMENT ENTRY BALANCE UP ALL ACCOUNTS TRIALBALANCE AFTER ADJUSMENT PREPARE FINANCIAL STATEMENT CLOSING ENTRY POSTING TO LEDGER REVERSING ENTRY

23. 6.2 STEPS IN ACCOUNTING CYCLE Identify the Transaction Identify the event as a transaction And generate the source document Analyze the transaction Determine the transaction amount, which accounts are affected, and which direction. Journal Entries The transaction is recorded in The journal as debit and a credit Post to Ledger The journal entries are transferred To the appropriate T-accounts In the ledger

24. Trial Balance A trial balance is calculated To very that the sum of the debits is equal to the sum of the credits Adjusting Entries Adjusting entries are made for Accrued and deferred items. The entries are journalized and Posted to the T-accounts In the ledger Adjusted Trial Balance A new trial balance is calculated after making the adjusting entries

25. Financial Statements The financial statements Are prepared Closing Entries Transfer the balances of the temporary accounts (e.g. revenues and expenses) to owner’s equity After-Closing Trial Balance A final trial balance is calculated after entries are made

26. STEPS IN ACCOUNTING CYCLE (IN DETAIL) 1. ANALYSED DATA Accounting data that is related to the business transaction only will be taken into consideration in recording process. 2. SOURCE OF DOCUMENT Any kind of document that are prepared for every business transaction. Eg: invoices, cheque butt,debit notes and credit notes etc.. Purpose: the document are prepared as a written evidence for each transaction. to be used by an accountant to support the entry made in the accounting record. 3. JOURNAL Transaction are initially recorded in chronological order in a journal before being transferred to the account. (BOOK OF ORIGINAL ENTRY)

27. Purpose: Disclose one place the complete effect of transaction Provide chronological record of transactions Helps to prevent or locate errors. Types of journal: Special Journal – make an entry on the frequently basis and from the same category. Eg; credit sales and credit purchase. General Journal – entry that are not in the special journal category. Example:Ray invested RM10,000 cash in the business on 1 Jun 2000. General Journal J1

28. Special Journal • Purchase Journal - to record purchase of inventory/stock on credit - format: Transfer to purchase ledger

29. Special Journal ….cont 2) Sales Journal - to record sales of inventory/stock on credit - format: Transfer to sales ledger

30. Special Journal ….cont 3) Sales Return Journal - to record goods return from customer - format: 4)Purchase Return Journal - to record goods return back to supplier (creditor)

31. Special Journal ….cont 5) Cash Receipt Journal - to record the receipt of payment - format: GL 15 GL 12 GL 1 Debit Credit

32. 6)Cash Payment Journal - to record payment made by company GL10 GL8 GL 1 Debit Credit

33. 4. LEDGER the entire group of account maintained by a company is referred to collectively as a ledger. Purpose: to ensure the entire recording process are distribute among workers to ensure the reference and controlling can be done easily. to increase efficiency in recording process. format of Account Ledger: Cash A/c No2 OR Cash A/c DEBIT CREDIT

34. Types of Ledger: General Leger • is a group of account that will be presented in the financial statement, such as account asset, liability and capital. • also included in the general ledger are DEBTORS or CREDITORS CONTROL account. The control account will control subsidiary ledger of each debtors or creditors. Subsidiary Ledger • is a detail ledger for a account such as debtors and creditors.

35. Posting procedures. Ray contributed RM10,000 cash in the business on 1 Jun 1999. General Journal J1 General Ledger

36. 5. TRIAL BALANCE Trial balance is a list of account and their balances at their given time. Purpose: to prove the mathematical equality of debit and credit. the trial balance also discovers errors in journalizing and posting useful in preparing financial statement Format in preparing Trial Balance Listing the account titles and balances at the end of the accounting period. How to know whether the accounts have DEBIT or CREDIT BALANCE?? If total debits exceed total credit, the account has a debit balance and vice versa. Totaling the debit and credit columns  Proving the equality of the two columns.

37. Eg: XYZ Company Trial Balance as at 30 Jun 2000 Debit Credit Capital 15,000 Cash 15000 15000 15000

38. 6. Adjustment Entry and Correcting Errors: Why we need to make adjustments to the financial statement? Reason: there is a timing differences and recognizing revenue and expenses. Accounting period vs Fiscal year •Fiscal year (one year period) - usually begins with the first day of the month and ends 12 month later. •Accounting period - accounting period usually coincides with calendar year (1 January until 31 December) - eg; If the company chooses to prepare their financial statement according to the fiscal year (1 July until 30 Jun); difference with the calendar year (1 Jan until 31 December)

39. Recognizing Revenue and Expenses • In order for revenue to be recorded in the period in which they are earned and for expenses to be recognized in the period in which they are incurred, adjusting entry entry are required. • Matching between revenue and expenses that are earned and charge. (MATCHING CONCEPT) • Example: Rent expense: RM1200 per year 1 Jan 31 Dec 1 Jun Accounting Period 31 May • Types of Adjusting entry: Depreciation Bad debt/Allowance for doubtful debt Prepaid Revenue & Expenses Accrued Revenue & Expenses

40. 7. CLOSING ENTRIES Closing entries formally recognize in the ledger to transfer of net income or net loss and owner’s drawing to owner’s capital. These entries will produce a zero balance in each temporary account.  Data can be accumulating to separate data in the next accounting period from data prior period.  Types of account need to be closed - ALL TEMPORARY accounts like all REVENUE accounts, all EXPENSES accounts and OWNER’S DRAWING. ALL PERMANENT accounts no need to be closed like all ASSET account, all LIABILITY accounts and OWNER’S CAPITAL account.

41. Example: - The expenses below show a balance on 31 Dec 2000 Rent RM300 and Salaries RM1200. Closed all the accounts

42. 8. REVERSING ENTRIES is an entry prepared for the beginning of the next accounting period. The entries are taking from the adjustment entries from accounting period. Purpose: to simplified and summarized the entries for preparation the new entries for the new accounting period. XYZ Enterprise paid their workers salaries every 2 weeks. On the 31 December 2001, there are unpaid salaries amounted RM6000. • Normal Entries: 31 Dec Dt Salary expense 6,000 Cr Unpaid Salary 6,000 • Reversing Entries: 1 Jan Dt Unpaid Salary 6,000 Cr Salary Expense 6,000

43. 9. CORRECTING ERRORS: a. Errors no affecting trial balance complete omission of transactions reversal entry (entry suppose to debit are credit instead) an error of commission (debit in the wrong account but with the right type) error of principle (entry made entirely wrong type of account) error at the book of prime entry a pair of compensating error b. Errors affecting trial balance error of single entry error of amount entered into the books  calculating the balance in the ledger incorrectly entirely omitting a balance from trial balance.

44. Example: A trial balance extracted from the books of a business on 31 December 2001 showed a total debit balances equal to total credit balances. However, the following errors were subsequently discovered: a) RM purchase invoice from G Smith had been credited to J Smith’s account in the purchase ledger b) A cheque for wages of RM250 had been entirely omitted from the books of account. c) A RM378 sales invoice relating to P Charles had been recorded as RM738 in the sales daybook. d) The RM8500 cost new motor vehicle had been debited to motor expenses e) A RM30 discount allowed to V Baker had been debited to V Baker’s account in the sales ledger and credited to discount allowed account in the nominal ledger.