FIA-FA1 Notes PDF

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BUSINESS: Any legal activity which you do to earn profit is called Business and the entity which exists for this purpose is called Business Entity. Non-business entities: It is not just businesses that will need to have accounting information and prepare financial statements also: Charities Clubs Government (or public sector) organizations TYPES OF BUSINESS. Sole Trader: The simplest form of business owned and managed by one person (although there might be any number of employees) fully and personally liable for any losses that the businesses might make. E.g. Small retailer, burglar alarm fitter, painter and decorator. Partnership: A business owned and operated by two or more people. It is a business owned jointly by a number of partners (minimum 2). Partners share profits and losses in accordance with their agreement. E.g. accounting firms, solicitors, estate agents. Company: A business owned by many people and operated by many (though not necessarily the same) people. Companies are more complex and have the following characteristics:  Owned by shareholders (or members) Limited companies are of two types:  Public (share issue to anyone)  Private (share issue restricted to friends and family) BUSINESS TRANSACTIONS. A transaction is an exchange of interest between two persons or parties or the process in which the seller transfers the goods or services to the buyer and buyer makes the payment for it is called transaction. Every business buys and sells goods or services and gets paid for what it sells and has to pay for what it buys. Many businesses have employees and have to pay for their work. All businesses incur expenses for services they receive such as electricity, water, telephone services.

Types of Transactions. 1) Cash transaction. In this transaction the buyer makes the payment immediately either in advance or at spot. 2) Credit Transaction. In this transaction the buyer is allowed to settle the payment in future time (credit period). 3) Semi-Cash Transaction. In this transaction the buyer makes the partial payment in cash and allowed a time period for the rest of payment in future time. 4) Barter transaction. In this transaction the goods & services are exchanged with the goods and services and the transaction is not settled in cash. KEEPING A RECORD Transactions are recorded in accounts. The system of recording transactions is therefore called the accounting system. It is also called the book keeping system and sometimes ledger accounts. An account is a summarized record of transaction in which transactions of similar nature are recorded. ACCOUNTING CONSISTS OF THREE MAIN STEPS. 1) Recording: in books of prime entry. 2) Classifying: the transactions according to their nature and posted them in their particular accounts. e.g. Sales transactions are posted to the sales account and expenses are posted to the expense accounts. 3) Summarizing: accounting data is transformed into meaningful form and summarized under two financial statements named as statement of comprehensive income (profit and loss) and Statement of financial position (balance sheet). FINANCIAL STATEMENTS: These are the statements which show the financial performance and financial position of the company. Types of financial statements: Statement of comprehensive income: It is a statement which shows business financial performance for a certain period by comparing its income and expenses. Statement of financial position: It is a statement which shows business financial position at a given point of time by Presenting its Assets, Liabilities and Capital.

ACCOUNTING CONCEPTS: Business Entity Concept. This principle means that the financial accounting information presented in the financial statements relates only to the activities of the business and not to those of the owner. From an accounting perspective the business is treated as being separate from its owners. Accrual Concept. This means that transactions are recorded when revenues are earned and when expenses are i ncurred. This pays no regard to the timing of the cash payment or receipt. FINANCIAL STATEMENTS. Financial statements are produced to give information to the users. As mentioned earlier the most important financial statements are the income statement and balance sheet. These are prepared under the separate entity concept. The separate entity concept means the business is treated separately from its owners. This applies to sole traders, partnerships and incorporated companies. Elements of Financial Statements.      

Assets Expenses Drawings Liabilities Income Capital

Expenses and Income are the elements of Income Statement & Rest are the elements of Balance Sheet. 1) Asset. An asset is a resource controlled by the entity as a result of past events from which future e conomic benefits are expected to flow to the entity. For example, a building that is owned and controlled by a business and that is being used to house operations and generate revenues would be classed as an asset. Types of assets:  

Non-Current assets. Current Assets.



Non-Current assets. These are long term assets used to generate profit. The business will hold on to these assets for more than one year. For e.g. Land & buildings, plant &machinery, fixtures & fittings, motor vehicles, car etc.



Current Assets. Short-term assets used for day-to-day operations. These assets are for less than one year. For e.g. Stock, Receivable (debtors), Prepayment, Bank, Cash etc.

2) Liability.  A liability is an obligation to transfer economic benefit as a result of past transactions or events. For example, an unpaid tax obligation is a liability.

 

Types of Liabilities: Non-Current Liabilities. Current Liabilities.



Non-Current Liabilities. These are long term liabilities over one year which are owed to third parties. For e.g. Long term Bank loan, Car Lease. etc



Current Liabilities. These are liabilities owed to third parties but which are due in less than one year’s time. For e.g. Trade payable (Trade creditor), Taxation, Bank overdraft etc.

3) Capital. The amount which is invested in the business is called capital. It is normally replaced by the word equity in the case of companies. The investment can be made in the form of Assets or cash. Equity. This is the 'residual interest' in a business and represents what is left when the business is wound up, all the assets sold and all the outstanding liabilities paid. It is effectively what is paid back to the owners (shareholders) when the business ceases to trade. 4) Income. This is the recognition of the inflow of economic benefit to the entity in the reporting period. This can be achieved, for example, by earning sales revenue or through the increase in value of an asset in other words it is the Inflow of economic benefits e.g. sales, interest earned rental income etc.

Types of Income. Direct Income. 



The earned income which is directly generated from the operations is called direct income. For examples Sales (Revenue) of the business, Salary of the employee generated from the employment. In-direct Income. The earned income which is in-directly generated from the operations is called in-direct income. For e.g. Interest earned, Rent of the rental property or any other part time income.

5) Expenses. This is the recognition of the outflow of economic benefit from an entity in the reporting period. This can be achieved, for example, by purchasing goods or services off another entity or through the reduction in value of an asset in other words Indicates money spent for rent, electricity, telephone, insurance, salaries and wages, marketing, discounts etc. TYPES OF EXPENSES Direct expense.  The Expenses which are directly related to the production are called Direct Expenses such as Direct Material cost, Direct Labour cost etc. In-direct expense.  The Expenses which are in-directly related to the production are called In-Direct Expenses such as salaries of the staff, Electricity bill, Rent expense etc. 6) Drawings Amounts or goods taken out of the business by the owner for his personal use. It directly decreases his interest (capital) in the business, as business is separate from its owner (separate entity concept). Drawings in Goods.  When goods taken out of the business by the owner for his personal use. Drawings in Cash. o When cash taken out of the business by the owner for his personal use. OTHER IMPORTANT TERMINOLOGIES:  Profit It is excess of revenue over expenditure.  Loss It is excess of expense over revenue.

Debtor/ Receivable A person to whom the business has sold items and by whom the business is owed money. A receivable is an asset of business (the right to receive payment is owned by the business) e.g. Sale of any Non-current asset (Transaction is of credit nature).  Trade debtor / Trade Receivable A person who owes the business money for debts incurred in the course of trading operations i.e. because the business has sold its goods or services. E.g. Business is involved in producing medicine and sale of those medicines on credit to its customer. All trade debtors are current assets of the business.  Creditor/ payable. A person from whom a business has purchased items and to whom a business owes money. An account payable is a liability of the business. E.g. Purchase of a plant and machinery on credit.  Trade creditor/Trade payable. A person to whom a business owes money for debts incurred in the course of trading operations. The term might refer to debts still outstanding which arise from the purchase from suppliers of materials, components or goods for resale. E.g. Purchase of stock of chairs for resale on credit. These are the current liabilities of business.  All trade payables are current liability of the business.

CHAPTER NO 2: ACCOUNTING CYCLE. Transactions are recorded in accounts. The system of recording transactions is therefore called the accounting system. It is also called the book keeping system and sometimes ledger accounts, where as An account is a summarized record of transaction in which transactions of similar nature are recorded. ACCOUNTING STEPS: Day Book

1

Invoice ( Source document) 2

Trial Balance

Ledger

Journal

6

5

4

Income Statement 7

Balance Sheet 8

Transaction

3

1) TRANSACTIONS. 2) Cash transaction. In this transaction the buyer makes the payment immediately either in advance or at spot. 3) Credit Transaction. In this transaction the buyer is allowed to settle the payment in future time (credit period). 4) Semi-Cash Transaction. In this transaction the buyer makes the partial payment in cash and allowed a time period for the rest of payment in future time. 5) Barter transaction. In this transaction the goods & services are exchanged with the goods and services and the transaction is not settled in cash. 2) INVOICE: A demand for payment of the transaction

3) DAYBOOK (PRIME BOOK). All transactions are initially recorded in a book of prime (or original) entry. Entry of a transaction to a book of prime entry does not record the double entry required for that transaction. Producing a list of similar transactions means that the periodic total can be accounted for rather than ea ch individual transaction. This reduces the number of entries into the accounting system and so reduces the chances for error. BOOK OF PRIME ENTRY Sales day book Sales returns day book Purchase day book Purchase returns day book Cash book Petty cash book

DOCUMENTS RECORDED Sales invoices, credit notes sent Sales returns, credit notes Purchase invoices, credit notes Purchase returns/credit notes received Cash paid and received Notes and coin paid and received

SUMMARISED AND POSTED TO Receivables ledger/control account Receivables ledger/ control a/c Payables ledger/control account Payables ledger/ control a/c Nominal ledger Nominal ledger

SUMMARISING SOURCE DOCUMENTS NEED FOR SUMMARY Summaries need to be kept of all the transactions undertaken with an individual supplier or customer invoices, credit notes, or cash so that a net amount due or owed can be calculated. Summaries need to be kept of all the transactions undertaken with all suppliers and customers so a total for receivables and a total for payables can be calculated.

LEDGER USED Receivables ledger Payables ledger

General ledger (a) Receivables ledger control account (b) Payables ledger control account

EXPLANATION: 1) SALES DAYBOOK. Date

Invoice

Debtor

Debtor Total ledger Ref

VAT

Sales 1

VAT

Sales Net

10.10.16

2) SALES RETURN DAYBOOK. Date 10.10.16

Credit Note

Debtor

Debtor Total ledger Ref

Sales 2

 

The sale to Jones Co for $105 is also recorded on page 14 of the receivables ledger. Invoice number is unique generated by the business's sales system.

RECORDING SALES.

3) PURCHASE DAYBOOK. Date

Reference Creditor

Creditor ledger Ref

Total VAT

Purchases Expenses

Total VAT

Net

4) PURCHASE RETURN DAYBOOK. Date



Credit No

Creditor

Creditor ledger Ref

The purchase from Cook Co for $315 is also recorded on page 31 of the payable ledger.

RECORDING PURCHASE

5) CASH RECEIPT BOOK. It records:  Cash receipt from debtors  Cash Receipt from all other sources Date







Receipt from Debtors

Debtor ledger Ref Debtor

Total VAT

Sales

Rent Received

Discount allowed

Discount columns are memorandum column and do not form part of the cash book. VAT on credit sales is never recorded in CRB because it is already recorded in SDB VAT as cash sales is recoded in CRB because we are recording this transaction for the first time.

6) CASH PAYMENT BOOK. It records:  Cash payments to creditors  Cash payments to all other parties.

Date Cheque

 

Payee

Creditor Creditor Ledger Ref

Total

VAT

Purchases Interest Paid

Drawings

VAT on credit purchases is never recorded in CPB because already recorded in PDB. VAT as cash purchases is recorded in CPB because we are recording this transaction for the first time

Cash receipts Recording and Documentation. Cash receipts should be properly controlled as they are of high importance for a business to maintain a reasonable cash position.

The controls will arise from the following concerns:  Receipts must be banked promptly.  Record of receipts must be complete.  Loss of receipts through theft or accident must be prevented. Remittance advices When a cheque arrives from a trade customer, it is usually accompanied by a remittance advice. A remittance advice shows which payments the cheque covers. Procedure to compare receipts with Remittance advice    

Check that amounts shown on remittance advice add up to the total Compare total with amount of receipt In case of disagreement, mark the difference Send the cheque to be banked and then record the receipt

If there are differences, these will be dealt with by the sales ledger department. Receipts A receipt is a document given by the seller or the buyer when goods change hands in exchange for payment. It may be a till receipt, a written receipt or some other form of receipt. Till receipts Cash registers or tills are used mainly in retail shops where the money is handed over directly by the customer when the transaction takes place, in form of cash, cheques and card vouchers.

Written receipts Where a cash register is not used, a written or typed receipt may be required. The information that appears on the receipt should be same to the one produced by a till receipt.  Name of selling business  Date of transaction  Total value of goods purchased  Sales tax registration number  Amount rendered by customer  Till number Evidence of payment other than in cash  Credit card—signed credit card voucher.  Debit card—signed debit card voucher  Cheque—payment will appear on customer’s bank statement  Banker’s draft—issuing bank will hold record of items issued. Cash: physical security considerations Money Cash comprise notes and coin which make up the legal tender of a country. Risks related to cash  Forgery (Fake notes)  Theft Protective measures      

Cash register security Safes Protective glass Security guards Frequent banking Cash should never be sent by post

Segregation of duties This is where the receiving and recording functions are kept separate. One person will receive, count and perhaps bank the money, while another person will record the money received. This will reduce the possibility of fraud. It is an effective internal control. THE PETTY CASH BOOK The book of prime entry which keeps a cumulative record of the small amounts of cash received into and paid out of the cash float.

There are usually more payments than receipts, and petty cash must be ‘toppedup' from time to time with cash from the business bank account. JOURNAL: The other items which do not pass through these five books are much less common, and sometimes much more complicated. It would be easy for a bookkeeper to forget the details of these transactions if they were made directly into the ledger accounts from the source documents and, if the bookkeeper left the business, it could be impossible to understand such bookkeeping entries. What is needed is a form of diary to record such transactions, before the entries are made in the double entry accounts. This book is called the Journal. For each transaction it will contain:  the date  the name of account(s) to be debited and the amount(s)  the name of the account(s) to be credited and the amount(s)  a description and explanation of the transaction (this is called a narrative)  A folio reference to the source documents giving proof of the transaction. Some of the main uses of the Journal are listed below. It must not be thought that this is a complete list.     

The purchase and sale of fixed assets on credit. Writing off bad debts. The correction of errors in the ledger accounts. Opening entries. These are the entries needed to open a new set of books. Adjustments to any of the entries in the ledgers.

The layout of Journal:

Debit and Credit: Are the two financial indictors which show the change (increase/decrease) in elements of financial statements.

LEDGER:

ACCOUNTING EQUATION: The consequence of the separate entity concept is that a business will buy assets using borrowed funds or capital. So,  Assets = Capital + Liabilities We Can expand the above equation as following: Assets = Capital + Liabilities + Profit –Loss – Drawings Or Assets – Liabilities = Capital + Profit –Loss – Drawings  Net Assets = Capital + Profit –Loss – Drawings  Assets = Capital Introduced + Profit retained in the previous period + Profit earned in the current period – Drawings  Assets = Opening Capital + Capital Introduced in the current period + Profit retained in the previous period + Profit earned in the current period – Drawings. Or it can be changed in the business equation as:  OR

Profits earned in the current period = increase / decrease in net assets in current period + Drawings in the current period – capital introduced in the current period.

 Opening Net Assets + Capital Injections + Profit – Drawings = Closing Capital OR  Increase in Net Assets = Capital Injections + Profit – ...