An Introduction To Accounting And Finance An Introduction To Accounting

MSIN7012 An Introduction to Accounting and Finance An Introduction to Accounting and Finance

Session 3 (2008/09) Double Entry Bookkeeping

Lecturer: Andrew Scott

Bookkeeping Process • Source documents (invoices etc) recorded in source books • Source books posted to ledgers • Ledgers checked by trial balance

Source Documents • Related to sales – order form, credit approval form, advice note, delivery note, sales invoice • Related to purchases – requisition form, purchase order form, goods received note, supplier invoice

Source Books – The Journal • • • •

Purchases day book Sales day book Cash book Other transactions

Accounting applications • • • • • • •

Stock recording and control Sales Ledger Purchase Ledger Nominal Ledger Payroll Job costing Invoicing

Advantages of computerised accounts • Improved administration • Better access to management information – Is trade profitable? – Sales info – by product line, sales rep etc – Quality – repeat orders, refunds, time to complete orders – Prevention of fraud – sales to stocks comparison (theft)

Bookkeeping • Every transaction has two equal and opposite aspects • Every gift has both donor and recipient • Leads to concept of double-entry bookkeeping

Balance Sheet Equation I • Sometimes called the transaction equation • Assets - Liabilities = Equity • But negative signs disliked by accountants, therefore rewrite as: • Assets = Liabilities + Equity • Equity is the part of the Balance Sheet showing the owners’ interests = net assets

Balance Sheet Equation II • Profit = Revenue - Expenses • Equity = Share Capital + Profit • Thus: Assets + Expenses = Liabilities + Share Capital + Revenue

Balance Sheet Equation III • If assets increase then either: – Increased liabilities – or increased Share Capital – or made a profit

• Both sides of equation must always be equal

Balance Sheet Equation IV • Assets = Non-current Assets(N-CA), Debtors(D), Inventories(I), Cash(C) • Liabilities = Creditors - bank(CB), Creditors - other(CO) • Equity = Share Capital(SC), Reserves(R), Retained Earnings (RE) • (N-CA + D + I + C) - (CB + CO) = (SC + R + RE)

Balance Sheet Equation V • Removing some of the factors and replacing Retained Earnings by (Revenue Expenses): • N-CA + C + Expenses = CB + SC + Revenue • We will now use this relationship in a spreadsheet with a few transactions.

Spreadsheet Example •

N-CA + C + Exp = CB+

•

1.Set up business

2000

•

2.Get bank loan

2000

•

3.Buy computer

•

4.Hire software writer

•

5.Revenue

•

TRIAL BALANCE

•

Transfers to Inc Statement

SC+

Inc Stat

2000 2000

1500 -1500 -1500 1500 2000 1500

2000

3000 1500

2000

2000

2000

-1500

-1500

• •

Rev

-2000 CLOSING BALANCE 1500

3000

0

2000

2000

0

2000 500

Income Statement Sales Revenue Cost of goods/services sold Profit

2000 1500 500

N.B. Have ignored tax, loan interest, VAT

Balance Sheet Non-current Assets Computer Current Assets Cash

1500 3000 4,500

less Current Liabilities Bank Loan Net Assets Equity Share capital Retained earnings Total equity

2000 2000 2500 2000 500 2500

Types of Error • • • •

Single entry (rather than double entry) Incorrect double entry Addition, subtraction and transposition Suppose 35 is written as 53. Difference is 18. • If difference on trial balance is divisible by 9 may be transposition.

Basics of Modern Bookkeeping • Paccioli, Luca a franciscan friar in Italy, book on mathematics (Summa de arithmetica, …) with an appendix on bookkeeping (1494) • UCL Library catalogue spells his name as Paccioli but other sources spell the name Pacioli

Paccioli

• http://www.georgehart.com/virtual-polyhedra/pac for a painting of Paccioli. • Also known for his book (Divina Proportione – 1509) illustrated in part by Leonardo da Vinci

Paccioli

Paccioli’s approach to book-keeping • Summary of the practices of Venetian merchants • Development from simple spreadsheet approach – Split each column into two: + and – -(pluses–minuses) changes to (minuses-pluses) – New names for Left and Right columns – debit and credit

Split each column into two - I Cash + 2000 2000

Total Balance

2000 6000 -3000 3000

-

1500 1500 ____ 3000 -3000 0

N.B. Must get rid of minus signs!

Split each column Cash into two - II Total Balance c/d

Period 2 Balance b/d

+ 6000 ____ 6000

3000 3000 6000

3000

Paccioli adds 3000 to both sides. This is the preferred approach.

-(pluses-minuses) becomes (minusespluses) Equation becomes: Assets + Expenses – Liabilities – Share Capital – Revenue = 0

And including pluses and minuses Assets(pluses-minuses) + Expenses(pluses-minuses) + Liabilities(minuses-pluses) + Share Capital(minuses-pluses) + Revenue(minuses-pluses) = 0

Check that sum of LHS columns = sum of RHS columns LHS column defined as debits, RHS column defined as credits

Three Golden Rules • Debits increase assets and expenses but decrease liabilities, share capital and revenue • Credits decrease assets and expenses but increase liabilities, share capital and revenue • Every debit (LHS) has to have a corresponding credit (RHS) to retain the balance