PRINCIPLES OF ACCOUNTING

TEACHING BOOKLET

TEACHING NOTES

FORM 3

TEACHER’S RESOURCE BANK

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 INTRODUCTION TO NEW LEARNERS

What is Accounting?
Accounting is the process of recording and summarizing financial information in a useful way .

Introducing the subject to Learners

Even if you’re new to accounting, you may have noticed some use of accounting in your daily
life.
My mom for example is the chief accountant of our family. At the start of each month, she
prepares a budget that lists all expected payments and income for the month. She then records all
payments and receipts in her personal diary such as groceries, utilities, taxes and so on. Tracking
home expenses against the monthly budget helps her avoid overspending and also gives her
peace of mind knowing where the money was spent in case she forgets. She keeps all the
invoices and bank statements in a shoe box. Once every year my Mom files her taxes and this is
where all her hard work in maintaining the financial record pays off as she has all the required
information on her finger tips (and a shoe box). Even though my mom doesn't know, she is
performing basic functions of an accountant to manage the home finances.

Accounting is just a more formal and efficient version of such processes in the context of a
business. Businesses use accounting to keep their financial information organized which helps
them in making sense of their financial data and also keeps them compliant of financial
regulations.

Book-keeping
Book-keeping , which is also known as financial accounting, is the process of recording and
summarizing financial information. Book-keeping involves the recording of transactions (e.g.
sales, purchases, and expenses) which are then summarized and presented in the form of
financial statements which show the overall health of the business.

IMPORTANCE OF ACCOUNTING

Record
Organizations need to have a reliable and systematic way of recording financial information.
Accounting is necessary to ensure that those running the business have a reliable record of
financial transactions.

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Legal
Accounting helps organizations to determine their financial rights and obligations. Without
proper accounting, it would be very difficult for a business to calculate, for example, the exact
amount a supplier needs to be paid taking into account cost of purchase, discounts, sales tax,
withholding tax, duties, refunds, etc.. Accounting is therefore necessary for a business to fulfill
its legal obligations and asserting its own legal rights.
Maintaining accounting records and preparing financial statements is also often a legal
responsibility for businesses above a certain size.

Performance
Accounting information is summarized to produce financial statements. Financial Statements
provide an overview of the financial activities of a business during a period
(e.g. cash flow, income and expenses during the year) as well as information about its financial
position on a specific date (e.g. amount of cash and inventory at the end of the year).

Financial Statements help owners in assessing the performance and position of their business
which can guide their investment decisions (e.g. whether they should invest more in the business,
diversify or dispose their investment) .

Planning and Control

Accounting helps organizations to plan their finances by developing budgets and forecasts.
Variance analysis provides a mechanism for the monitoring of expenses incurred by
organizations by comparison with the budgeted expenditure. This process helps organizations in
planning their finances ahead and controlling any deviations from the budget.

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TYPES OF ACCOUNTING

Financial Accounting
Financial Accounting , or financial reporting, is the process of producing information for
external use usually in the form of financial statements. Financial Statements reflect an entity's
past performance and current position based on a set of standards and guidelines known as
GAAP (Generally Accepted Accounting Principles). GAAP refers to the standard framework of
guideline for financial accounting used in any given jurisdiction. This generally includes
accounting standards (e.g. International Financial Reporting Standards), accounting conventions,
and rules and regulations that accountants must follow in the preparation of the financial
statements.

Management Accounting
Management Accounting produces information primarily for internal use by the company's
management. The information produced is generally more detailed than that produced for
external use to enable effective organization control and the fulfillment of the strategic aims and
objectives of the entity. Information may be in the form budgets and forecasts, enabling an
enterprise to plan effectively for its future or may include an assessment based on its past
performance and results. The form and content of any report produced in the process is purely
upon management's discretion.

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 DEFINITION OF KEY TERMS
Accounting - It is collecting, recording, analyzing and summarizing, and communicating
financial data.

Bookkeeping – is branch of accounting in which financial data is recorded.

Assets – are the resources owned by the business.

Fixed Assets or Non-Current Assets – are the assets bought for the purpose of use rather than
for sale; assets which do not change their form; and the assets remain in business for longer
period.

E.g. building (or premises), land, motor vehicle, fixtures and fittings, and equipment etc

Current Assets – are the assets which are either cash or near cash; they change their form, and
remain in the business for a period of 1 year.

E.g. Accounts receivable – also called debtors and they are the people who have to pay to the
business. Examples of current assets include inventory, cash at bank and cash in hand

Liabilities – are the debts or loans of the business.

Current Liabilities – are the debts or loans which businesses have to pay off in a period of one
year or less.

E.g. Accounts Payable – also called creditors, they are the people whom business has to pay.
Examples of current liabilities include bank overdraft, amounts owing.

Capital – money invested in the business by the owner using his own resources; capital is also
called equity. Capital is also the liability of the business because it is the liability of the business
to pay to the owner when he will wind up or close his business.

Accounting Equation – is the simple idea of financial accounting based on which whole
accounting is performed.

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Accounting Equation is:

 Assets = Liabilities + Capital

 Liabilities = Assets – Capital
 Capital = Assets – Liabilities
Double Entry System – is where each accounting transaction is recorded in two separate records.
Double entry system is based on rules of debit and credit in which:

Purchases – goods bought for resale.

Purchases Returns or Return Outwards – goods being returned after buying, they will
decrease the stocks;

Sales – goods being sold to the customers, they will decrease the stocks;

Sales Return or Return Inwards – goods being returned by the customers; they will increase
the stocks.

Expenses – are the spending by the business for running its day to day operations. They will
always be debited.

E.g. Rent, Salaries, Electricity / Telephone bill, Depreciation of machinery, Bad Debts
(irrecoverable loans), Carriage Inwards (Transport expense on goods purchased), Carriage
outwards (Transport expense on goods sold / Delivery Services provided to the customers)

Drawings - There are personal expenses of the owner also, which could be goods taken for
personal use, or cash withdrawn for personal use, either way they are called drawings.

Incomes

These are the direct or indirect earnings by the business, and always credited. E.g. Commission
Received, Rent Received, Salaries Received, Discount Received.

General Journal

The journal is used for recording of those transactions which are not part of other books of
original entries; and to record the correction of errors.
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In journal, the narratives are also written; narratives are the detailed statements of transactions.

The Ledger

Ledgers are the T-accounts in which records of each element of transactions are posted; Ledgers
or T-accounts are finally balanced to see the current situation of each element at a particular date.

Running balance ledgers are computerized accounts. The major benefit of such ledgers is balance
shown after each transaction.

Cash Discount – is received or allowed on prompt payments. Discount is allowed by the

business to its debtors or accounts receivable, when they pay promptly or on due dates. Discount
is received by the business from its creditors, when the business pays promptly or within due
date. Discount allowed is an expense; whereas discount received is an income.

Trade Discount – is allowed or received at the time of trading. Trade discount earns the
business a gross profit and it does not become part of books of accounts. Trade discount is the
difference between the retail (or list price), and the price paid by the business to the producers.

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 DATA PROCESSING
DATA PROCESSING METHODS.

1) Manual data processing

2) Electronic data processing

MANUAL DATA PROCESSING

Although a poor shop keeper with a small income and sale can use manual data processing even
today. A person running a shop like book shop can use calculator or computer as the resources
allow.

In manual data processing data is processed manually. No machine or tool is used.

All the calculations on data are performed manually. This is a slow method and errors may occur.
This is an old method. It was used before the invention of calculators. But data is still processed
manually in many small shops.

Example: A book seller ( a small book shop ) records his daily transactions manually. He
prepares bills by pen, paper and carbon paper ( no doubt, brain is the main data processor in this
case ). At the end of day he will use carbon copies made on a particular date to know how many
books he sold and how much income he got.

ADVANTAGES MANUAL DATA PROCESSING

 It is a low cost method of data processing since the tools required to perform manual data
processing are just pen and paper only.

DISADVANTAGES MANUAL DATA PROCESSING

 Manual Data Processing method is the slowest of all types of data processing.

 This method is more error prone. Chances of errors in results produced by manual data
processing are more than other two methods.

 Manual data processing is a time consuming process. More is the amount of data , more
is the time required to process data.

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ELECTRONIC DATA PROCESSING

It is the latest and fastest method of data processing. Data is processed with the help of computer.

First of all, data and set of instructions are given to the computer. Computer gives output results
after processing the data according to instructions. This method of data processing is very fast
and accurate. Electronic data processing is used in banks and business firms, Government offices,
colleges, schools, universities, businesses and other institutes.

Electronic data processing is being used in almost every field of life. Example: Suppose there are
800 students in a college. There is a manual library system in this college. If we want to know
which students have not returned books since one year? We will have to search registers for 800
students’ record. But computer can do this job within seconds.

ADVANTAGES ELECTRONIC DATA PROCESSING

 Electronic data processing is the fastest and most efficient method of data processing

 Electronic data processing is less time consuming of all other methods

 Electronic data processing systems can process large amounts of data easily

 Electronic data processing can present information in more attractive way

 Electronic data processing will give 100 % correct results, without any errors if input and
instructions are accurate.

DISADVANTAGES ELECTRONIC DATA PROCESSING

 Electronic data processing is the most expensive method among all other types of data
processing.
 High setup Cost: Computer systems - Hardware and software requires a lot of money to
setup and to operate further.
 Qualified Computer personnel are required to run an electronic data processing system
which results in more money requirements for employee pay roll systems.

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 GENERAL JOURNAL

What is a General Journal?

A general journal is a record of accounting entries. When a business carries out a financial
transaction, it is necessary to make a journal entry. This entry may be made either in the general
journal or in a special journal.

Special journals are usually maintained for Sales, Cash Receipts, Purchases, and Cash
Disbursements. The transactions that pertain to other accounts are made in the general journal.

What does General Journal mean?

An entry in the general journal will record a transaction in a specific format. The first column
will mention the date of the entry. The account being debited will find a place on the right-hand
side of the date column. Below this, the account being credited will be mentioned. A brief
description of the transaction will follow.

The next column is reserved for the posting reference. This will be completed when the entries
are posted to the ledger. The remaining columns are reserved for the dollar amounts of the
transaction. Remember that the figure in the debit column will always be equal to the amount in
the credit column.

DEFINITION OF SUBDIVISION:

In a large business concern a journal is divided into parts so that several clerk could work at the
same time. This is known as subdivision of journal .

PURPOSE OF SUBDIVISION:

In small concerns only one journal and one ledger may serve the purpose, because the number of
transactions is very small. But in large business concerns the number of transactions are
numerous, just one journal and one ledger will not do the job. That will cause much
inconvenience i.e., if we have only one journal in a large scale business, it is not possible for one
bookkeeper to record all the transactions in time. On the other hand, it will not be possible for
more than one person to use the same journal simultaneously with the result that the accounting
work will fall in arrear.

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There are some more factors which necessitate the use of more than one subsidiary book
(journal):

 If all the transactions are recorded in one book (journal), the book will be very large,
bulky, and difficult to handle.

 If one bookkeeper is asked to record all the transactions, the possibility of errors and
mistakes will be great. It will also create opportunities for committing fraud.

 If all the transactions are recorded in one book, it will be difficult to trace out a particular
transaction in future.

HOW MANY JOURNALS A BUSINESS SHOULD HAVE?

We know that different types of transactions take place in a business concern. Some transactions
take place repeatedly (hundreds to thousands times in a year) and some transactions take place
once or twice in a year. Obviously, it is not logical to provide a separate journal for transactions
which rarely take place.

For this purpose different groups of transactions are made and a separate book is provided for
each group. Each group is consisted of similar types of transactions. Journal is mainly divided
into two:

1. Special journal

2. General journal

SPECIAL JOURNAL:

By special journal we mean, a journal in which transactions relating to a certain special group or
recorded. Special journal is again subdivided into eight groups:

1. Purchases book or purchases journal

2. Sales book or sales journal
3. Purchases returns book or purchases returns journal
4. Sales returns book or sales returns journal
5. Bills receivable book
6. Bills payable book
7. Cash book or cash journal
8. Petty cash book
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GENERAL JOURNAL:

The transactions which do not fall within the scope of above mentioned books, are recorded in
this journal e.g. purchase of an asset on credit, depreciation on assets, expenses payable, bad
debts etc. It is also known as journal proper, Modern journal or principle journal. Some authors
call it only "journal".

The main function of the above books is to supply necessary information to the ledger. All the
transactions are posted in the ledger on the basis of information available from these books, so
these books are called subsidiary books

ADVANTAGES OF SUBDIVISION OF JOURNAL:

The following advantages are derived from division of journal:

 Because of subdivision the books cannot be bulky and hence there will be no difficulty in
handling them.

 Accounting work is divided amongst a large number of employees. So work is done

nicely and promptly and no work is left in arrear.

 Each employee can be held responsible for mistakes committed by him. This serves as
caution and care to the employees.

 The efficiency of the employees increases because of the division of labor.

 By keeping the book under the custody of different employees the chances of fraud and
defalcation are minimized.

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RECORDING IN THE JOURNAL

Each transaction is first recorded in the journal. The journalizing procedure follows these steps:

1. The year is recorded at the top and the month is entered on the first line of page 1. This
information is repeated only on each new journal page used to record transactions.

2. The date of the first transaction is entered in the second column, on the first line. The day of
each transaction is always recorded in this second column.

3. The name of the account to be debited is entered in the description column on the first line. By
convention, accounts to be debited are usually recorded before accounts to be credited. The
column titled Folio indicates the number given to the account in the General Ledger. For
example, the account number for Cash is 101. The amount of the debit is recorded in the debit
column.

4. The name of the account to be credited is on the second line of the description column and is
indented about one centimetre into the column. Accounts to be credited are always indented in
this way in the journal. The amount of the credit is recorded in the credit column.

5. An explanation of the transaction is entered in the description column on the next line. It is not
indented.

6. A line is usually skipped after each journal entry to separate individual journal entries and the
date of the next entry recorded. It is unnecessary to repeat the month if it is unchanged from that
recorded at the top of the page.

Format of journal

Date Details Folio Debit Credit

Account to be debited xxxx
Account to be credited xxxx
Narration of the transaction

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JOURNALISE THE FOLLOWING TRANSACTIONS

EXTRA PRACTICE 1

On April 01, 2016 Agness started business with $100,000 and other transactions for the month
are:

2. Purchase Furniture for Cash $ 7,000.

8. Purchase Goods for Cash $2,000 and for Credit $1,000 from Khalid Retail Store.

14. Sold Goods to Khan Brothers $12,000 and Cash Sales $5,000.

18. Owner withdrew of worth $2,000 for personal use.

22. Paid Khalid Retail Store $500.

26. Received $10,000 from Khan Brothers.

30. Paid Salaries Expense $2,000

EXTRA PRACTICE 2

Prepare general journal entries for the following transactions of a business called Pose for Pics in
2016:

Aug. 1: Hashim Khan, the owner, invested $ 57,500 cash and $32,500 of photography equipment
in the business.

04: Paid $3,000 cash for an insurance policy covering the next 24 months.

07: Services are performed and clients are billed for $10,000.

13: Purchased office supplies for $1,400. Cash paid $400 and remaining outstanding.

20: Received $2,000 cash in photography fees earned previously.

24: The client immediately pays $15,000 for services to be performed at a later date.

29: The business acquires photography equipment. The purchase price is $100,000, pays $25,000
cash and signs a note for the balance.

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EXTRA PRACTICE 3

On March 2017, Farhan Rahim, starts wholesaling business. Following transactions as follows:

1. He started business with capital of $15,000 and Land worth $10,000.

8. Bought goods from Bilal and Friends $1,000 and by cash from XYZ Co. $2,000.

13. Sold goods to Rehman & sons $1,500 and sale by cash $5,000.

17. Gave away charity of cash $50 and merchandising worth $30.

21. Paid Bilal and Friends cash $975; discount received $25.

28. Received cash from Rehman & Sons $1,450; allowed him discount of $50.

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 LEDGER
A ledger is a book where all ledger accounts are maintained in a summarized way. All accounts
combined together make a ledger book. Predominantly there are 3 different types of ledgers;
Sales , Purchase and General ledger.

A ledger is also known as the principal book of accounts and it forms a permanent record of all
business transactions.

Ledger format

DR CR
Date Details Folio Amount Date Details Folio Amount
$ $

1. SALES LEDGER OR DEBTORS’ LEDGER

First among different types of ledgers is “Sales or Debtors’ ledger”. It is a grouping of all
accounts related to customers to whom goods have been sold on credit (Credit Sales). The
accounts are mostly arranged in an alphabetical order. Sum of all the money owed to a business
by their customers is shown here and is termed as Trade Receivables.

2. PURCHASE LEDGER OR CREDITORS’ LEDGER

It is a grouping of all accounts related to sellers from whom goods have been purchased on credit
(Credit Purchases). Sum of all the money owed by a business to their sellers is shown here and is
termed as Trade Payables.

Total monetary amount inside the purchase ledger is shown in the trial balance and in the
statement of financial position at its appropriate place.

Cash Sales and Cash Purchases are booked into the Cash Book.

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3. GENERAL LEDGER
Companies usually make a single general ledger which includes 2 additional subtypes of ledgers
i.e. nominal ledger and private ledger. These two may or may not be included in the list for
different types of ledgers in accounting.
A general ledger is a centralized compilation for all the ledger accounts of a business. It contains
all types of accounts which can be found in an organization such as assets, liabilities, capital or
equity, revenues, expenses, etc.

As per traditional the general ledger consists of all nominal & real accounts necessary to prepare
financials for a company. E.g. Building, Office equipment, Furniture and so on.

Nominal Ledger – As the name suggests it contains all nominal accounts i.e. expense, losses,
incomes and gains. Examples – Salaries, Sales, Purchases, Returns Inward/Outward, Rent,
Stationery, Insurance, Depreciation, etc.

Private Ledger – Private ledger consists of accounts which are confidential in nature such as
capital, drawings, salaries, etc. These accounts are only accessible by selected individuals.

ADVANTAGES OF DIVIDING THE LEDGER:

 It facilitates division of labour in the maintenance of ledger.

 It becomes easy to locate errors in ledger accounts.

 It helps the ledger clerks to complete their respective work in time with perfection.

 It becomes easy to refer to any particular account.

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BALANCING AN ACCOUNT:

The difference between the two sides of an account is its balance. The balance is written on the
lesser side to make the two sides equal. The process of equalizing the two sides of an account is
known as balancing .

The rules for balancing an account are stated as below:

 Add up the amount columns of both the sides of an account and write the totals in a
separate slip of paper.
 Find out the difference of the two totals.

 Write down the difference on the lesser side of the account.

 Now total up both the sides and write the totals and draw double lines under them.

 Again write the difference on the opposite side below the double line.

Examples : Balancing an account

The following account appeared in the ledger of A. Musendo.

A. Hunter Account
Date Details Folio Amount Date Details Folio Amount
2004 $ 2004 $
Jan 1 Balance b/d 2 720 Jan 6 Bank 2 702
15 Sales 1 156 18 Discount 18
19 Sales 1 366 Returns 120
25 Sales 34
29 Typewriter 2 100

Answer the following questions relating to the above account

i. Explain what the balance on 1 January means.
ii. Calculate the balance on 31 January.
iii. What name is given to the discount on January 6?
iv. In which subsidiary book was the discount originally entered?
v. For what reason would a discount be given?
vi. The entry on 25 January relates to an undercharge on the goods sold on 19 January.
What document did A. Musendo send to A. Hunter ?
vii. State the full name for the returns on 18 January.
viii. Name the subsidiary book used for the entry on January 29.
ix. In which ledger of A. Musendo is Hunter’s account found?
x. Where exactly in the balance sheet is the balance in Hunter’s Account on 1 February
found? [10]

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POSTING
The process of transferring the debit and credit items from journal to classified accounts in the
ledger is known as ‘Posting’.

Rules Regarding Posting

• Separate account is opened in ledger book for each account and entries from ledger posted to
respective account accordingly.

• Use the words ‘To” (identifies the accounts to be written on the debit side) and ‘By’ (identifies
the accounts to be written on the credit side)

• The concerned account debited in the journal should also be debited in the ledger but reference
should be of the respective credit account.

BALANCING

At the end of the each month or year or any specific day it is necessary to determine the balance
in an account. To do that, add the totals of both sides (Debit and credit sides) and find out the
difference in both the side. The difference in both the sides is ‘Balance’. If the Debit is greater
than the credit side, it is a Debit balance or vice-versa.

The Debit balance is written on the Credit side as, “By Balance c/d” (carried down) or the Credit
balance is written on the Debit side as, “To Balance c/d. By doing this, two sides will be equal.

While preparing the Ledger accounts for next period, this balance would be transferred from last
period Ledger accounts as ‘To Balance b/d’ (brought down) if there was debit balance or ‘By
Balance b/d’ if there was credit balance in the last period Ledger.

It should be noted that Nominal accounts are not balanced, instead the balance at end need to be
transferred to the Profit and Loss Account.

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 TRIAL BALANCE
Introduction

Trial Balance is a list of closing balances of ledger accounts on a certain date and is the first step
towards the preparation of financial statements. It is usually prepared at the end of an accounting
period to assist in the drafting of financial statements. Ledger balances are segregated into debit
balances and credit balances. Asset and expense accounts appear on the debit side of the trial
balance whereas liabilities, capital and income accounts appear on the credit side. If all
accounting entries are recorded correctly and all the ledger balances are accurately extracted, the
total of all debit balances appearing in the trial balance must equal to the sum of all credit
balances.

Purpose of a Trial Balance

Trial Balance acts as the first step in the preparation of financial statements. It is a working paper
that accountants use as a basis while preparing financial statements.

 Trial balance ensures that for every debit entry recorded, a corresponding credit entry has
been recorded in the books in accordance with the double entry concept of accounting. If
the totals of the trial balance do not agree, the differences may be investigated and
resolved before financial statements are prepared. Rectifying basic accounting errors can
be a much lengthy task after the financial statements have been prepared because of the
changes that would be required to correct the financial statements.

 Trial balance ensures that the account balances are accurately extracted from accounting
ledgers.

 Trial balance assists in the identification and rectification of errors.

Contents of a Trial Balance

Title provided at the top shows the name of the entity and accounting period end for which the
trial balance has been prepared.

Account Title shows the name of the accounting ledgers from which the balances have been
extracted.

Balances relating to assets and expenses are presented in the left column (debit side) whereas
those relating to liabilities, income and equity are shown on the right column (credit side).

The sum of all debit and credit balances are shown at the bottom of their respective columns.

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Debit entries :
Carriage inwards, carriage outwards, cash, trade receivables, equipment, interest paid,
investments, machinery, motor vehicle, petty cash, premises, purchases, rates, rent, returns
inwards, salaries, opening inventory*, sundry expenses, wages

Credit entries:
Bank loan/overdraft, capital, trade payables, discount received, mortgage, rent receivable, returns
outwards, sales, share capital, share premium

Both: Bank balance (would be debit if owned and credit if owed)

*Note closing inventory is not included in most trial balances, but is included in the debit column
if the double entry has already been completed

Characteristics and uses of trial balance

 Trial balance is prepared in tabular form only. It contains debit column for debit balance
of accounts and credit column for credit balances of accounts.
 Only the closing balances of the accounts are shown in trial balance.

 The closing balance of stock is never shown in trial balance. It is always shown as foot
note.
 Other adjustments against which no entries are passed in the books also not shown in trial
balance. They are also shown as footnotes.

 The trial balance is prepared on a particular date as required by the management or at the
end of the financial year .

 Trial balance is not an account. It is a statement only.

 The balance of all accounts is shown at one place. Thus it is the summary of all accounts.

 It shows the arithmetical mistake of the entries.

 Income Statements and Statement of financial positions are prepared with the help of trial
balance only.

Limitations of a Trial Balance

Trial Balance only confirms that the total of all debit balances match the total of all credit
balances. Trial balance totals may agree in spite of errors. An example would be an incorrect
debit entry being offset by an equal credit entry. Likewise, a trial balance gives no proof that
certain transactions have not been recorded at all because in such case, both debit and credit
sides of a transaction would be omitted causing the trial balance totals to still agree.
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 ACCOUNTING ERRORS AND CORRECTIONS
Accounting errors can occur in double entry bookkeeping for a number of reasons. Accounting
errors are not the same as fraud, errors happen unintentionally, whereas fraud is a deliberate and
intentional attempt to falsify the bookkeeping entries.

An accounting error can cause the trial balance not to balance, which is easier to spot, or the
error can be such that the trial balance will still balance due to compensating bookkeeping entries,
which is more difficult to identify.

ACCOUNTING ERRORS THAT AFFECT THE TRIAL BALANCE

Errors that affect the trial balance are usually a result of a one sided entry in the accounting
records or an incorrect addition.

Irrespective of the reasons why a trial balance may not balance, as a temporary measure the
difference in the trial balance is allocated to a suspense account and a suspense account
reconciliation is carried out at a later stage.

For example, suppose the trial balance showed total debits of 84,600 but total credits of 83,400
leaving a difference of 1,200 as shown below.

Suspense Accounts – Trial Balance Difference

Account Debit Credit

Trial Balance Totals 84,600 83,400

Difference 1,200
Total 84,600 84,600

To make the trial balance totals agree a single entry is posted to the accounting ledgers in a
suspense account.

Suspense Account Posting

Account Debit Credit

Suspense account 1,200

When the accounting error is identified a correcting entry is made. Suppose the difference was an
addition error on the rent account, then the correcting entry would be as follows:

22 | P a g e H U N T E R P O W E R C H I N G S
 Suspense Account – Accounting error correction

Account Debit Credit

Suspense account 1,200
Rent 1,200

ERRORS WHICH DO NOT AFFECT THE TRIAL BALANCE

Accounting errors that do not affect the trial balance fall into one of six categories as follows:

1. Error of Principle in Accounting

2. Errors of Omission in Accounting

3. Error of Commission

4. Compensating Error

5. Error of Original Entry

6. Complete Reversal of Entries

Error of Principle in Accounting

An error of principle in accounting occurs when the bookkeeping entry is made to the wrong
type of account. For example, if a 1,000 sale is credited to the sundry expenses account instead
of the sales account, the correcting entry would be as follows:

Accounting Errors – Error of Principle in Accounting Example

Account Debit Credit

Sundry expenses 1,000

Sales 1,000

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Error of Omission in Accounting

Errors of omission in accounting occur when a bookkeeping entry has been completely omitted
from the accounting records. If the payment 2,000 to a supplier has been omitted then the
correcting entry would be as follows:

Accounting Errors – Errors of Omission in Accounting Example

Account Debit Credit

Accounts payable 2,000

Cash 2,000

Error of Commission

An accounting error of commission occurs when an item is entered to the correct type of account
but the wrong account. For example is cash received of 3,000 from Customer A is credited to the
account of Customer B the correcting entry would be.

Accounting Errors – Error of Commission

Account Debit Credit

Accounts receivable – Cust. B 3,000

Accounts receivable – Cust. A 3,000

Compensating Error

A compensating error occurs when two or more errors cancel each other out. For example, if the
fixed assets account is incorrectly totalled and understated by 600, and the rent account is
incorrectly totalled and overstated by 600, then the posting to correct the error would be as
follows:

Accounting Errors – Compensating Error

Account Debit Credit

Fixed assets 600

Rent 600

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Error of Original Entry

An error of original entry occurs when an incorrect amount is posted to the correct account.

A particular example of an error of original entry is a transposition error where the numbers are
not entered in the correct order. For example, if cash paid to a supplier of 2,140 was posted as
2,410 then the correcting entry of 270 would be.

A good indicator for a transposition error is that the difference (in this case 270) is divisible by 9.

Accounting Errors – Error of Original Entry

Account Debit Credit

Cash 270
Accounts payable 270

Complete Reversal of Entries

Complete reversal of entries errors occur when the correct amount is posted to the correct
accounts but the debits and credits have been reversed. For example if a cash sale is made for
400 and posted incorrectly as follows:

Accounting Errors – Incorrect posting

Account Debit Credit

Sales 400
Cash 400

Then to correct the accounting error the original entry must be reversed and the correct entry
made, this can be achieved by doubling the original amounts as follows:

Accounting Errors – Complete Reversal of Entries

Account Debit Credit

Cash 800
Sales 800

25 | P a g e H U N T E R P O W E R C H I N G S
 SUMMARY OF ACCOUNTING ERROR TYPES

Accounting Errors Description

Error of Principle in Accounting Correct amount, wrong type of account

Errors of Omission in Accounting Entry missed from accounting records

Error of Commission Correct amount and type of account but wrong

account
Compensating Error Two or more errors balance each other out

Error of Original Entry Correct accounts, wrong amounts

Complete Reversal of Entries Correct amount and account, entries reversed

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 UNDERSTANDING SUSPENSE ACCOUNT
Suspense accounts and error correction are popular topics for examiners because they test
understanding of bookkeeping principles so well

A suspense account is a temporary resting place for an entry that will end up somewhere else
once its final destination is determined. There are two reasons why a suspense account could be
opened:

1. A bookkeeper is unsure where to post an item and enters it to a suspense account pending
instructions

2. There is a difference in a trial balance and a suspense account is opened with the amount of
the difference so that the trial balance agrees (pending the discovery and correction of the errors
causing the difference). This is the only time an entry is made in the records without a
corresponding entry elsewhere (apart from the correction of a trial balance error – see error type
8 below).

Types of error

Before we look at the operation of suspense accounts in error correction, we need to think about
types of error – not all types affect the balancing of the records and hence the suspense account.

SUSPENSE
ERROR TYPE ACCOUNT
INVOLVED

1. Omission– a transaction is not recorded at all NO

2. Error of commission – an item is entered to the correct side of the NO
wrong account (there is a debit and a credit here, so the records
balance)
3. Error of principle – an item is posted to the correct side of the wrong NO
type of account, as when cash paid for plant repairs (expense) is
debited to plant account (asset)

4. Error of original entry– an incorrect figure is entered in the records NO

and then posted to the correct account.

Example: Cash $1,000 for plant repairs is entered as $100;

Plant repairs account is debited with $100

5. Reversal of entries – the amount is correct, the accounts used are NO

correct, but the account that should have been debited is credited and
vice versa

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6.Addition errors – figures are incorrectly added in a ledger account YES

7. Posting error YES

a. an entry made in one record is not posted at all
b. an entry in one record is incorrectly posted to another
Examples: cash $10,000 entered in the cash book for the purchase of a
car is:
a. not posted at all
b. posted to Motor cars account as $1,000

8. Trial balance errors – a balance is omitted, or incorrectly extracted, in YES

preparing the trial balance
9. Compensating errors – two equal and opposite errors leave the trial Yes, to correct each
balance balancing (this type of error is rare, and can be because a of the errors as
deliberate second error has been made to force the balancing of the discovered
records or to conceal a fraud).

For examination purposes we are more often concerned with the second of these –
differences and error correction.

Correcting errors

Errors 1 to 5, when discovered, will be corrected by means of a journal entry between the
accounts affected. Errors 6 to 9 also require journal entries to correct them, but one side of the
journal entry will be to the suspense account opened for the difference in the records. Type 8,
trial balance errors, are different. As the suspense account records the difference, an entry to it is
needed, because the error affects the difference. However, there is no ledger entry for the other
side of the correction – the trial balance is simply amended.

An illustrative question

The bookkeeping system of Power is not computerised, and at 30 September 2015 the
bookkeeper was unable to balance the accounts. The trial balance totals were:

Debit $1,796,100 Credit $1,852,817

Nevertheless, he proceeded to prepare draft financial statements, inserting the difference as a

balancing figure in the statement of financial position. The draft Income Statement showed a
profit of $141,280 for the year ended 30 September 2015.

28 | P a g e H U N T E R P O W E R C H I N G S
He then opened a suspense account for the difference and began to check through the accounting
records to find the difference. He found the following errors and omissions:

1. $8,980 – the total of the sales returns book for September 2015, had been credited to the
purchases returns account.

2. $9,600 paid for an item of plant purchased on 1 April 2015 had been debited to plant repairs
account. The company depreciates its plant at 20% per annum on a straight line basis, with
proportional depreciation in the year of purchase.

3. The cash discount totals for the month of September 2015 had not been posted to the general
ledger accounts. The figures were:

Discount allowed $836

Discount received $919

4. $580 insurance prepaid at 30 September 2014 had not been brought down as an opening
balance

5. The balance of $38,260 on the telephone expense account had been omitted from the trial
balance

6. A car held as a non-current asset had been sold during the year for $4,800. The proceeds of
sale were entered in the cash book but had been credited to the sales account in the general
ledger. The original cost of the car $12,000, and the accumulated depreciation to date $8,000,
were included in the motor vehicles account and the accumulated depreciation account. The
company depreciates motor vehicles at 25% per annum on a straight line basis with proportionate
depreciation in the year of purchase but none in the year of sale.

Required:

(a) Prepare the journal entries necessary to correct the errors and eliminate the balance on the
suspense account. Narratives are not required.

(b) Open a suspense account for the difference between the trial balance totals.

(c) Draw up a statement showing the revised profit after correcting the above errors.

29 | P a g e H U N T E R P O W E R C H I N G S
Discussion

The approach to the question should be:

1. Read the requirement paragraph at the end of the question.

2. Attack the question – note that narratives are not required. Begin by opening the suspense
account. Which side? More debit is needed to balance the trial balance, so debit the suspense
account with $56,717.

Then deal with the errors in order:

1. Sales returns should have been debited to the sales returns account and they have been
credited to the purchases returns account. There are two errors here – the wrong account has
been used and an entry which should have been a debit has been entered as a credit. The
suspense account entry must therefore be for 2 x $8,980 or $17,960.

2. An error of principle – no suspense account entry. Depreciation must be adjusted.

3. Items have not been posted, therefore the suspense account is involved.

4. Effectively a posting error – the suspense account is again involved.

5. A trial balance error must affect the suspense account – but no ledger entry.

6. This one needs thought. Take it one sentence at a time. Is the suspense account involved? No,
because we have an error of commission followed by some unrecorded transactions.

30 | P a g e H U N T E R P O W E R C H I N G S
Solution
Journal Entries
$ $

1. Sales returns account 8,980

Suspense account 8,980
Purchases returns account 8,980
Suspense account 8,980

2. Plant account 9,600

Plant repairs account 9,600
Depreciation (income statement) 960
Plant depreciation account 960

3. Discount allowed account 836

Suspense account 836

Suspense account 919

Discount received account 919

4. Insurance account 580

Suspense account 580
5 Trial balance (no ledger entry) 38,260
Suspense account 38,260

6 Sales account 4,800

Motor vehicles disposal account 4,800

Motor vehicles disposal account 12,000

Motor vehicles asset account 12,000

Motor vehicles depreciation account 8,000

Motor vehicles disposal account 8,000

Motor vehicles disposal account 800

Income statement 800

31 | P a g e H U N T E R P O W E R C H I N G S
 Suspense Account
$ $
Difference as per TB 56,717 Sales returns 8,980
Discount received 919 Purchases returns 8,980
Discount allowed 836
Insurance 580
Telephone (trial balance) 38,260
57,636 57,636

Adjustment to profit - +
$ $
Profit as in draft income statement 141,280
1 Sales returns adjustment (2 x $8,980) 17,960
2 Plant: reduction in repairs 9,600
depreciation – 6/12 x 20% x$9,600 960 960
3 Discount allowed 836
Discount received 919
4 Insurance – opening balance omitted 580
5 Telephone expense omitted 38,260
6 Profit on sale of car 800
Proceeds taken out of sales 4,800 -----
63,396 152,599
(63,396)
Revised net profit 89,203

Some hints on preparing suspense accounts

Does a correction involve the suspense account? The type of error determines this. Practice, and
study of Table 1 should ensure that you see immediately which errors affect the balancing of the
records and hence the suspense account.

Which side of the suspense account must an entry go? This is one of the most awkward problems
in preparing suspense accounts. The best way of solving it is to ask yourself which side the entry
needs to be on in the other account concerned. The suspense account entry is then obviously to
the opposite side.

Look out for errors with two aspects. In the illustrative question earlier, error 1 is a case in point.
An entry has been made to the wrong account, but also to the wrong side of the wrong account.
Both errors must be corrected. It is very easy to fall into the trap of correcting only one of the
errors, especially when working quickly under examination conditions.
32 | P a g e H U N T E R P O W E R C H I N G S
 ACCOUNTING CONCEPTS
There are the necessary assumptions or conditions upon which accounting is based. Accounting
concepts are postulates, assumptions or conditions upon which accounting records and statement
are based. The various accounting concepts are as follows:

1. Entity Concept:
For accounting purpose the “business” is treated as a separate entity from the proprietor(s). One
can sell goods to himself,, but all the transactions are recorded in the book of the business. This
concepts helps in keeping private affairs of the proprietor away from the business affairs. E.g. If
a proprietor invests $100 000 - in the business, it is deemed that the proprietor has given $100
000 - to the “business” and it is shown as a “liability” in the books of the business. Similarly, if
the proprietor withdraws $10 000 - from the business, it is charged to them.

2. Dual Aspect Concept:

As per this concept, every business transaction has a dual affect. For example, if Power starts
business with cash $100 000/- there are two aspects of the transaction: “Asset Account” and
“Capital Account”. The business gets asset (cash) of $100 000 - and on the other hand the
business owes $100 000 - to Power.

3. Going Business Concept (Continuity of Activity):

It is assumed that the business concern will continue for a fairly long time, unless and until has
entered into a state of liquidation. It is as per this assumption, that the accountant does not take
into account the forced sale values of assets while valuing them.

4. Money measurement concept:

As per this concept, in accounting everything is recorded in terms of money. Events or
transactions which cannot be expressed in terms of money are not recorded in the books of
accounts, even if they are very important or useful for the business. Purchase and sale of goods,
payment of expenses and receipt of income are monetary transactions which are recorded in the
accounting books however events like death of an executive, resignation of a manager are such
events which cannot be expressed in money.

5. Cost Concept (Objectivity Concept):

This concept does not recognize the realizable value, the replacement value or the real worth of
an asset. Thus, as per the cost concept
a) as asset is ordinarily recorded at the price paid to acquire it i.e. at its cost, and

b) this cost is the basis for all subsequent accounting for the asset.

33 | P a g e H U N T E R P O W E R C H I N G S
For example, if a machine is purchased for $10,000 it is recorded in the books at $10,000 and
even if its market value at the time of the preparation of the final account is $20,000 or $60,000
the same will not considered.

6. Cost-Attach Concept:
This concept is also known as “cost-merge” concept. When a finished good is produced from the
raw material there are certain process and costs which are involved like labor cost, power and
other overhead expenses. These costs have a capacity to “merge” or “attach” when they are
brought together.

7. Accounting Period Concept:

An accounting period is the interval of time at the end of which the income statement and
financial position statement (balance sheet) are prepared to know the results and resources of the
business.

8. Accrual Concept:
The accrual system is a method whereby revenue and expenses are identified with specific
periods of time like a month, half year or a year. It implies recording of revenues and expenses of
a particular accounting period, whether they are received/paid in cash or not.

9. Period Matching of Cost and Revenue Concept:

This concept is based on the period concept. Making profit is the most important objective that
keeps the proprietor engaged in business activities. That is why most of the accountant’s time is
spent in evolving techniques for measuring the profit/profitability of the concern. To ascertain
the profit made during a period, it is necessary to match “revenues” of the period with the
“expenses” of that period. Income (profit) earned by the business during a period is compared
with the expenditure incurred to earn the revenue.

10. Realization Concept:

According to this concept profit, should be accounted for only when it is actually realized.
Revenue is recognized only when sale is affected or the services are rendered. However, in order
to recognize revenue, receipt of cash us not essential. Even credit sale results in realization as it
creates a definite asset called “Account Receivable”. However there are certain exception to the
concept like in case of contract accounts, hire purchase etc. Similarly incomes like commission
interest rent etc. are shown in Profit and Loss A/c on accrual basis though they may not be
realized in cash on the date of preparing accounts.

11. Verifiable Objective Evidence Concept:

According to this concept all accounting transactions should be evidenced and supported by
objective documents. These documents include invoices, contract, correspondence, vouchers,
bills, passbooks, cheque etc.
34 | P a g e H U N T E R P O W E R C H I N G S
 CAPITAL AND REVENUE EXPENDITURE
CAPITAL EXPENDITURE
Capital expenditure is made when a firm spends money either to buy fixed assets, or add to the
value of an existing fixed asset. Included in such amounts should be those spent on:
(a) Acquiring fixed assets.
(b) Carriage inwards on an asset bought.
(c) Any other cost needed to get the fixed assets ready for use. These costs include
installation, freight charges, import duty, landing charges and legal costs of buying
buildings – incidental costs.

REVENUE EXPENDITURE
Expenditure, which is not for increasing the value of fixed assets, but is for the running the
business on a day-to-day basis, is known as revenue expenditure.

The difference can be seen clearly with the total costs of using a motor van for a firm. To buy a
new motor van is capital expenditure. The motor van will be in use for several years and is
therefore a fixed asset. To pay for petrol to use in the motor van for the next few days is revenue
expenditure. This is because the expenditure is used up in a few days and does not add to the
value of the fixed asset.

Examples of revenue expenditure include:

(a) Rent
(b) Repairs and maintenance
(c) Salaries and wages
(d) Utilities

Revenue expenditure is therefore chargeable to the trading and profit and loss account, whereas
capital expenditure will result in increased figure for fixed assets in the balance sheet.

New Terms:

Capital expenditure
- The money spent by a firm on buying or adding value to a fixed asset.

Revenue expenditure
- Expenses needed for the day-to-day running of the business.

35 | P a g e H U N T E R P O W E R C H I N G S
EXAMPLE

Expenditure Types of Expenditure

(a) Buying a motor van Capital

(b) Petrol costs for a motor van Revenue

(c) Repairs to a motor van Revenue

(d) Putting extra headlights on a motor van Capital

(e) Buying machinery Capital

(f) Electricity cost of using machinery Revenue

(g) We spent $1,500 on machinery - $1,000 for upgrading Capital $1,000

the machine and $500 for repairs
Revenue $500

(h) Painting outside of a new building Capital

(i) Three years later – repainting outside of the building in Revenue

(h)

EXTRA PRACTICE
1. a. Explain the difference between capital and revenue expenditure.

b. Consider the following list of expenses incurred by a company. Examine this list and
determine if each expense is revenue or capital expenditure.

a. Purchase of a motor car

ii. Claim for a meal
iii. Purchase of shares in a supplier
iv. Purchase of a new computer
v. Payment for hotel accommodation
vi. Receipt for petrol
vii. Purchase of raw materials
viii. Purchase of an autoclave
ix. Purchase of a set of spanners
x. Payment of an insurance premium
xi. Wages
xii. Purchase of a new plot of land.
36 | P a g e H U N T E R P O W E R C H I N G S
 2. Mr. Hunter bought a plant and machinery costing $50,000 on 1 December 2017. On the
same day, he incurred the following expenses when buying the machinery:

Freight charges $2,000

Import duty $1,000
Repairs and maintenance $1,500

He decided to depreciate the plant and machinery at a rate of 20% using the straight-line
method. A full year’s depreciation should be charged irrespective of the date of
purchase.

REQUIRED, the amount to be included for the year ending December 2017 as:

a. Revenue expenditure
b. Capital expenditure

3. For the business of M.Power, a wholesale chemist, classify the following between
‘capital’ and ‘revenue’ expenditure:

(i) Purchase of an extra motor van.

(ii) Cost of rebuilding a warehouse wall which has fallen down.
(iii) Building extension to a warehouse.
(iv) Painting extension to the warehouse when it was first built.
(v) Repainting extension to the warehouse three years later than that done in
(iv).
(vi) Carriage costs on bricks for new warehouse extension.
(vii) Carriage costs on purchases.
(viii) Carriage costs on sales.
(ix) Legal costs of collecting debts.
(x) Legal charges on acquiring new premises for office.
(xi) Fire insurance premium.
(xii) Costs of erecting a new machine.

4. Explain clearly the differences between capital expenditure and revenue expenditure.
State which of the following you would classify as capital expenditure, giving your
reasons:

(i) Cost of building an extension to a factory.

(ii) Purchase of filing cabinets for sales office.
(iii)Cost of repairs to an accounting machine.
(iv) Cost of installing a reconditioned engine in a delivery van.
(v) Legal fees paid in connection with the factory extension.

37 | P a g e H U N T E R P O W E R C H I N G S
 5. For the business of H. Senzere, a foodstore owner, classify the following between
‘capital’ and ‘revenue’ expenditure.

(i) Repairs to a meat slicer.

(ii) New tyres for van.
(iii) An additional shop counter.
(iv) Renewing signwriting on the store.
(v) Fitting partitions in the store.
(vi) Roof repairs.
(vii) Installing thief detection equipment.
(viii) Wages of store assistant.
(ix) Carriage on returns outwards.
(x) A new cash register.
(xi) Repairs to office safe.
(xii) Installing an extra toilet.

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