Accounting - Chapter 4: Ledger accounting and double entry

What is a T-account, and how are they formatted?

A T-account presents the entry of a transaction into a ledger account It is laid out as follows: - Top of the account is its name - On the left, the debit side - On the right, the credit side

What are the rules of double entry bookkeeping? (Effects of debit and credit entries)

A debit entry will: - Increase an asset - Increase an expense - Decrease a liability - Decrease capital - Decrease income A credit entry will: - Decrease an asset - Decrease an expense - Increase a liability - Increase capital - Increase income

How are early settlement discounts accounted for? For customers who usually pay early: - When they pay early - When they don't For customers who don't usually pay early: - When they pay early - When they don't

Basic rule, record what you think the customer is likely to do. Amend via journal if necessary For a typical early settlement customer: - On order: Debit Trade Receivables the discounted amount, and Credit Revenue the discounted amount - On payment: Credit Trade Receivables, Debit Cash at Bank account (If they don't pay on time, Journal Entry. Debit Cash at Bank account with full amount, Credit Trade Receivables with discounted amount, and Credit Revenue with difference) For customer who typically doesn't settle early: - On order: Debit Trade Receivable with full amount, Credit Revenue with full amount - On payment: Credit Trade Receivables, debit Cash at Bank Account (If they pay early, Journal Entry. Debit Cash at Bank with discounted amount, Debit Revenue with difference, and Credit Trade Receivables with full amount

How does the double entry work for the petty cash book?

Debit petty cash, credit cash at bank At the end of each month, total payments in petty cash book are posted to the appropriate nominal ledger accounts Next, the cash float is topped up to the imprest amount (should be equal to the receipts etc in the petty cash)

Define: Double entry bookkeeping

Each transaction has an equal but opposite effect. Every accounting event must be entered in ledger accounts both as a debit and a credit (Also knows as the dual effect, or duality concept) (Debits must always equal credits)

How does the Nominal ledger work?

It consists of a large number of difference ledger accounts, each account having its own purpose, name, and an identity or code. These accounts cover assets, liabilities, capital, income, and expenditure They are usually organised by code, e.g., all rental expenses begin with 100200 etc A computerised accounting system will then use the code assigned to each nominal ledger account to classify each account into elements of the financial statements

What is the purpose of ledgers, and how should the transactions within them be recorded?

Ledgers are used to record and analyse transactions. Allows for easy extraction of information when financial statements need to be created They should be in chronological order, and dated They should be built up in cumulative totals - Day by day (total Monday sales, etc) - Week by week - Month by month - Year by year

Whatever type of transaction is being recorded, what should the format of a journal entry be?

Line 1: Date, Debit, Credit Line 2: Account to be debited (debit amount) Line 3: Account to be credited (credit amount) A narrative explanation should accompany each journal entry. This is required for audit and control, to indicate the purpose and authority of each transaction

What are memorandum accounts?

Memorandum accounts are found in the memorandum ledgers (Receivables and Payables) This means they do not form part of the double entry bookkeeping system, and are simply a record of the individual customers/suppliers and amounts owed/owing

If you are told an amount includes VAT at 20% (the gross amount), how do you calculate the VAT element?

Multiply the gross amount by 1/6. (Divide gross amount by 6, then multiply by 5) You can also find the before VAT price by dividing the gross amount by 1.2)

How should trade discounts be accounted for?

Purchases should be recorded net of trade discounts received from suppliers Sales should be recorded net of trade discounts given to customers (Trade discounts should be deducted before any early settlement discount is calculated)

How is VAT recorded in the nominal ledger accounts?

Sales shown in the statement of profit and loss must exclude output VAT. However, trade receivables will include VAT, as they reflect the total amount due from customers. In the accounts it will look like this: - Debit Trade Receivables (Gross, inc VAT amount) - Credit Revenue (Net, exc VAT amount) - Credit VAT (VAT output amount) Expenses shown in the statement of profit and loss must exclude input VAT. However, Trade payables will include input VAT, as they reflect the total amount payable to suppliers. In the accounts it will look like this: - Debit Purchases (net, exc VAT amount) - Debit VAT (VAT input amount) - Credit Trade Payables (gross, inc VAT amount) Sales revenue received and expenses paid as cash transactions must also have the VAT recorded and posted as above Irrecoverable VAT on expenses or non-current assets must be included in the cost of the expense or non-current asset in the statement of profit and loss or statement of financial position The net amount due to (or from) HMRC should be included in other payables (or other receivables) in the statement of financial position

What are the 3 main books? And how are they used?

The Nominal Ledger: - Contained a separate ledger account (usually a page of the book) for each type of income, expense, asset and liability, and for capital The Receivables Ledger: - Contained a separate ledger account for each credit customer The Payables Ledger: - Contained a separate ledger account for each credit supplier

Define: Nominal ledger

The main accounting record in which financial transactions are recorded

What will the total of the individual accounts in the receivables ledger always be equal to? (or, should be equal to)

The total included in trade receivables (and same for payables ledger and trade payables)

What are Journal Entries used for?

To record any type of financial transaction, but are mainly used to record transactions that are one-off or unusual in nature (such as correcting an error)

As a general principle, the treatment of VAT in the trader's ledger accounts should reflect the trader's role as tax collector, so VAT should not be included in income or expenses, whether of a capital or a revenue nature However, where the trader suffers irrecoverable VAT as a cost, VAT should be included as an expense (as it cannot be claimed as input tax). List some examples of irrecoverable VAT:

Traders not registered for VAT will suffer VAT on inputs as a cost, this will increase their expenses and the cost of any non-current assets they purchase Registered traders who also carry on exempted activities may suffer VAT on certain inputs. This will increase the expense in respect of these inputs Non-deductible inputs will be borne by all traders - VAT on cars purchased and used in the business is not reclaimable (unless the car is for resale, ie, by a car trader) - VAT on business entertaining is not deductible as input tax, other than VAT on entertaining staff

How is VAT collected?

VAT is collected and paid by the traders who make up the chain, provided they are registered for VAT (though consumer ultimately bears the full VAT, each trader must assume that his customer is the final customer) Traders collect and pay over VAT at the appropriate rate on the full sales value (output tax) on the goods sold They are normally entitled to reclaim VAT paid on his own purchases of goods, expenses and non-current assets (input tax) and so makes a net payment to HMRC equal to the tax on value added by himself

Taxable outputs are chargeable at one of which three rates?

Zero rate (0% on e.g., printed books and newspapers) - Persons trading, even at a zero rate, are entitled to reclaim VAT on their inputs Reduced rate (5% on e.g., domestic fuel) Standard rate (20%) (If a person sells only exempt supplies, VAT may not be charged or recovered, and if they sell a mix, can only claim/charge on the taxable supplies)