International Examinations IGCSE Accounting Catherine Coucom PUBLISHEDBYTHEPRESSSYNDICATEOFTHEUNIVERSITYOFCAMBRIDGE The Pitt Building, Trumpington Street, Cambridge, United Kingdom CAMBRIDGEUNIVERSITYPRESS The Edinburgh Building, Cambridge CB2 2RU, UK 40 West 20th Street, New York, NY10011-4211, USA 477 Williamstown Road, Port Melbourne, VIC3207, Australia Ruiz de Alarcón 13, 28014 Madrid, Spain Dock House, The Waterfront, Cape Town 8001, South Africa http://www.cambridge.org © Cambridge University Press 2002 This book is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. Examination questions reproduced by the permission of the University of Cambridge Local Examination Syndicate First published 2002 Second Impression 2003 Printed in the United Kingdom at the University Press, Cambridge Designed and typeset by RHT Desktop Publishing, Durbanville Set in Utopia 10 pt A catalogue record for this book is available from the British Library. ISBN 0 521 893461 Every effort has been made to contact the owners of copyright of all the information contained in this book, but if, for any reason, any acknowledgements have been omitted, the publishers ask those concerned to contact them. ii Imprint Contents Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii Chapter 1 Introduction to accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 Double entry bookkeeping – Part A . . . . . . . . . . . . . . . . . . . . 6 3 The Trial Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 4 Double entry bookkeeping – Part B . . . . . . . . . . . . . . . . . . . 29 5 Petty cash book . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 6 Business documents and books of prime entry. . . . . . . . . 48 7 Final Accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 8 Accounting rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 9 Accruals and prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . 86 10 Depreciation and disposal of fixed asssets . . . . . . . . . . . 103 11 Bad debts and provision for doubtful debts. . . . . . . . . . . 120 12 Bank reconciliation statements . . . . . . . . . . . . . . . . . . . . . 134 13 Journal entries and correction of errors . . . . . . . . . . . . . . 145 14 Control accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159 15 Incomplete records. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 16 Accounts of clubs and societies . . . . . . . . . . . . . . . . . . . . . 184 17 Partnership accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198 18 Accounts of manufacturing businesses . . . . . . . . . . . . . . 213 19 Departmental accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223 20 Analysis and interpretation . . . . . . . . . . . . . . . . . . . . . . . . . 229 Answers to review questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 248 Examination papers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 271 Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291 Contents v CHAPTER Introduction to accounting 1 The need for business accounts Bookkeeping and accounting are both concerned with the financial records of a business. The detailed recording of all the financial transac- tions of a business is known as bookkeeping.Accountingmakes use of these records to prepare periodic financial statements, which can be used to assess the performance of the business. It is impossible, even in a small business, to remember the full details of everything that takes place, so it is necessary to make a record of every transaction which affects the business. Every business is different, so the records maintained will vary because of the different information which is required, but the basis of all the accounting systems is double entry bookkeeping. The main aim of the owner of a business is for the business to make a profit. Periodically, a Trading and Profit and Loss Account is prepared which shows the calculation of the profit earned by the business. Where a business makes a profit, the owner can receive a proper return on the money invested in the business and funds are available for expanding the business, replacing equipment, and so on. Where a business makes a loss, it may eventually result in the business being closed down as the owner’s investment in the business falls, and the business is not able to obtain up- to-date equipment and keep pace with competitors. The owner of a business also needs to know the financial position of the business, and so, periodically, a Balance Sheetis prepared. This summaris- es the position of a business, in monetary terms, on a certain date. The Balance Sheet shows what the business owns, known as assets, and what the business owes, known as liabilities. The Trading and Profit and Loss Account and the Balance Sheet collec- tively are often referred to as final accounts. Whilst these provide valuable information, they can only record the financial aspects of the business. Non-monetary factors can play an important part in the success of a busi- ness, but these cannot be recorded in the accounting records (see Chapter 8). It is also important to bear in mind that, whilst most of the information recorded in the accounts is based on facts, some figures have to be based onestimates(for example how much an asset has lost in value through depreciation). The progress of a business can be measured by comparing the final accounts of one year with those of previous years, and with those of similar businesses. Various accounting ratios can be calculated to measure the relationship between figures within the final accounts, and these ratios can also be used for comparison purposes. All the terms mentioned above are explained in detail in following chapters. Chapter 1 – Introduction to accounting 1 The Balance Sheet equation A person starting a business usually provides the funds or resources neces- sary to set up the business. This is known as capital. So the resources, or assets, in the business will be equal to the resources or capital provided by the owner of the business. This means that assets = capital. Other people may also supply the business with assets. These amounts owing by the business are liabilities. Applying the same formula as above, the assets in the business will be equal to the resources provided by the owner (the capital) plus the resources provided by other people (the liabili- ties). This means that assets = capital + liabilities. Capital is also known as owner’s equilty, therefore we say: assets = owner’s equilty + liabilities and the abbreviated accounting equation is A = OE + L. This is known as the Balance Sheet equation. The two sides of the equation will alwaysbe equal. The individual amounts of assets, liabilities and capital may change, but the total assets will always equal the total of the capital plus the liabilities. The accounting equation may be expressed in the form of a Balance Sheet, which is a statement showing the financial position of a business on a certain date. It lists the assets, the liabilities and the capital. Assetscon- sist of everything that the business owns, plus any money owing to the business. Liabilitiesconsist of anything the business owes. Capitalis a form of liability as it is the amount the business owes to the owner of the business. It is important to remember that the accounting records are the records of the business, not the records of the owner of the business. A Balance Sheet must always have a heading, which should include the date on which the Balance Sheet applied. It is also usual to show the name under which the business trades (this may be the name of the owner if the business trades under that name). The Balance Sheet will be affected every time the business makes some change to the assets, liabilities and capital. ■ Example 20–2 June 1 James Jones set up a business to trade under the name of Jones Stores. He opened a business bank account and paid in $50 000 as capital. 2 The business bought premises for $30 000 and paid by cheque. 3 The business bought a stock of goods costing $4 500 on credit. 4 The business sold goods, which had cost $500, on credit. Prepare the Balance Sheet of Jones Stores, as it would appear at the close of business on each of the dates given above. 2 Accounting: IGCSE Jones Stores Balance Sheet as at 1 June 20–2 Assets $ Liabilities $ Bank 50 000 Capital 50 000 50 000 50 000 The assets of the business are equal to the liabilities of the business. Jones Stores Balance Sheet as at 2 June 20–2 Assets $ Liabilities $ Premises 30 000 Capital 50 000 Bank 20 000 50 000 50 000 The asset of bank has been reduced as money has been spent in obtaining a new asset. The individual assets have changed, but the total of the assets remains the same. Jones Stores Balance Sheet as at 3 June 20–2 Assets $ Liabilities $ Premises 30 000 Capital 50 000 Stock 4 500 Creditors 4 500 Bank 20 000 54 500 50 000 Buying goods on credit means that the business is supplied with the goods but does not pay for them immediately. The business has obtained a new asset in the form of stock of goods, but has also acquired a liability, as it now owes the supplier of the goods (known as a creditor). Chapter 1 – Introduction to accounting 3 Jones Stores Balance Sheet as at 4 June 20–2 Assets $ Liabilities $ Premises 30 000 Capital 50 000 Stock 4 000 Creditors 4 500 Debtors 4500 Bank 20 000 54 500 50 000 The asset of stock has been reduced but a new asset has been obtained in the form of money owed to the business by a customer (known as a debtor). In order to keep the example simple, the goods were sold to the cus- tomer at the price the business paid for them. It is obvious that, in prac- tice, they must be sold at a price above cost price to enable the business to earn a profit. A Balance Sheet can be displayed in different ways, and it is usual for the assets and liabilities to be divided up into different classes. Balance Sheets will be explained in more detail in Chapter 7. In the above example, a new Balance Sheet was prepared after every transaction. This is obviously impossible in practice, as, in one single hour, there can be several changes to the business’s assets and liabilities. A system ofdouble entry bookkeepinghas been developed where all the day-to-day transactions are recorded. (This is dealt with in detail in chapters 2 and 4.) A Balance Sheet is only prepared periodically – usually at the close of business on the last day of the financial year of the business. A financial year does not necessarily run from 1 January to 31 December. A business may be started on any date. The final accounts will be prepared for twelve-month periods from that date, which are known as financial years. Review questions 1. (a) Explain the meaning of the terms – (i) assets (ii) liabilities (iii) capital (b) State whether eachof the following items is an asset or a liability: Office equipment Loan from ABC Creditor Cash Machinery Expenses owing 4 Accounting: IGCSE * 2. Redraft the following Balance Sheet to correct any mistakes. Farad Balance Sheet for the year ended 31 March 20–6 Assets $ Liabilities $ Loan from bank 220 000 Capital 265 000 Cash 222 600 Fixtures and fittings 2222 00 Machinery 234 000 Debtors 213 400 Creditors 215 400 Stock 228 400 100 400 100 400 3. Rachel had the following items in her Balance Sheet at 30 September 20–5. Capital $20 000 Equipment $12 900 Bank $2 200 Creditors $2 900 Stock $4 700 Debtor $3 100 During the first week of October Rachel had the following transactions: (a) Received $2 500 by cheque from the debtors. (b) Paid $1 000 by cheque to creditors. (c) Bought further stock costing $900 on credit. (d) Bought further equipment and paid $500 by cheque. Draw up Rachel’s Balance Sheet as at 7 October 20–5 after the above transactions have been completed. Chapter 1 – Introduction to accounting 5 CHAPTER Double entry bookkeeping – 2 Part A Introduction Chapter 1 explained that, as it is impractical to produce a new Balance Sheet after every transaction, day-to-day transactions are recorded using thedouble entry system. In the example given in Chapter 1 it was shown that every transaction affected the Balance Sheet in twoways. This dual aspect of a givingand a receivingis recorded in the day-to-day records. The business will keep a separate ledger accountfor each debtor and creditor with whom it has dealings, a separate ledger account for each type of asset, expense, liability, and so on. Every transaction concerning a par- ticular person, asset, expense, etc. is recorded in the appropriate account. The ledger can be in the form of a bound book (in which case one ledger account will appear on each page) or a file of separate sheets of paper, with an account on each. Where accounts are maintained using a computer, a ledger will consist of a computer file, which is divided into separate accounts. A typical ledger account is shown below. Account name Debit Credit Date Details Folio $ Date Details Folio $ The account is divided into two sides by the centre line. The left-hand side is the debitside (usually abbreviated to Dr.) and the right-hand side is the creditside (usually abbreviated to Cr.). On each side there are columns in which to record the date, details and amount of each transaction. The folio column is used for cross-referencing the accounts. Because there is a giving and receiving in every transaction, twoentries are made – a debit in one account and a credit in another account. The debitentry is made in the account whichgainsthe value, which can be assetsgained by the business or expensespaid by the business. The credit entry is made in the account which givesthe value, which can be liabilities incurred by the business orincomereceived by the business. 6 Accounting: IGCSE ■ Example 20–2 March 1 Abdul set up a business. He opened a business bank account and paid in $40 000 as capital. 2 Bought business premises for $20 000 and paid by cheque. Enter the transactions in the ledger of the business. Abdul Bank account Page 1 Date Details Folio $ Date Details Folio $ 20–2 20–2 (a) Mar 1 Capital 2 40 000 Mar 2 Premises 3 20 000 (b) Capital account Page 2 Date Details Folio $ Date Details Folio $ 20–2 Mar 1 Bank 1 40 000 (a) Premises account Page 3 Date Details Folio $ Date Details Folio $ 20–2 (b) Mar 2 Bank 1 20 000 Notes:1. The first transaction has been labelled (a) for reference purposes. The bank account was debited to show value being received and the capital account was credited to show value being given. 2. The second transaction has been labelled (b) for reference purposes. The premises account was debited to show value being received and the bank account was credited to show value being given. 3. In each case the details column of each account shows the name of the account where the opposite half of the double entry is made, and the folio number gives the page on which that account will be found. Care must be taken to ensure that a double entryis made for a transaction, before going on to enter the next item. Examination questions give a list of Chapter 2 – Double entry bookkeeping – Part A 7