Business accounting 1 - Frank Wood & Alan Sangster

An imprint of www.pearson-books.com Business Accounting Volume 1 is the world’s best- selling textbook on bookkeeping and accounting. Now in its tenth edition, it has become the standard introductory text for accounting students and professionals alike. New to this edition: ➤ Over 120 brand new review questions for exam practice ➤ Coverage of International Accounting Standards 2005 ➤ Additional and updated worked examples for areas of difficulty ➤ Treatment of VAT for companies operating within the United Kingdom ➤ Expanded introduction to the language and history of accounting Features: ➤ Easy-to-follow explanations of contemporary accounting practice, including double entry bookkeeping and the preparation of financial statements ➤ Clear and logical progression through topics ➤ Activities designed to reinforce your understanding of key concepts ➤ Over 300 review questions, including past Examination Board questions ➤ 100 multiple choice questions with answers ➤ Regularly updated Companion Website including further self-test questions and accounting standards updates Business Accounting Volume 1 is used on a wide variety of courses in accounting and business, both at secondary and tertiary level and for those studying for professional qualifications. F R A N K W O O D & A L A N S A N G S T E R 1businessaccountingT E N T H E D I T I O N F R A N K W O O D ’ S 1 T E N T H E D I T I O N F R A N K W O O D ’S W O O D & S A N G S T E R business accounting Every year, thousands of students rely on Frank Wood's best-selling books to help them pass their accountancy exams. 'A classic textbook that has set thousands of students on a straight path since it was first published, Wood & Sangster's Business Accounting can be recommended without reservation to all accounting students.' Dr George Iatridis, University of Athens, Greece and University of Manchester 'I highly recommend Business Accounting because it is clear and to the point, which makes it easy for students to understand. This is especially true for students who want to study accounting for the first time or have little knowledge of the accounting subject.' Caroline Teh, Inti College, Malaysia. Additional student support at www.pearsoned.co.uk/wood Additional student support at www.pearsoned.co.uk/wood FRANK WOOD’S business accounting 1 Visit the Business Accounting, tenth edition Companion Website at www.pearsoned.co.uk/wood to find valuable student learning material including: l Learning objectives for each chapter l Multiple choice questions to help test your learning l Review questions and answers l Links to relevant sites on the web l Searchable online glossary l Flashcards to test your knowledge of key terms and definitions BA10_A01.qxd 21/12/04 10:18 am Page i Frank Wood 1926–2000 BA10_A01.qxd 21/12/04 10:18 am Page ii F R A N K W O O D ’ S 1businessaccounting FRANK WOOD BSc (Econ), FCA and ALAN SANGSTER BA, MSc, Cert TESOL, CA TENTH EDITION BA10_A01.qxd 21/12/04 10:18 am Page iii Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE and Associated Companies throughout the world. Visit us on the World Wide Web at www.pearsoned.co.uk First edition published in 1967 Second edition published under the Longman imprint in 1972 Third edition published in 1979 Fourth edition published in 1984 Fifth edition published in 1989 Sixth edition published in 1993 Seventh edition published in 1996 Eighth edition published under the Financial Times Pitman Publishing imprint in 1999 Ninth edition published in 2002 Tenth edition published 2005 © Frank Wood 1967 © Longman Group UK Limited 1972, 1979, 1984, 1989, 1993 © Pearson Professional Limited 1996 © Financial Times Professional Limited 1999 © Pearson Education Limited 2002, 2005 The rights of Frank Wood and Alan Sangster to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP. ISBN 0 273 68149 4 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data A catalog record for this book is available from the Library of Congress 10 9 8 7 6 5 4 3 2 1 08 07 06 05 Typeset in 9.5/11.5 pt Sabon by 35. Printed and bound in China. SWTC/01 Also available: Frank Wood’s Business Accounting Vol 2 – 0273 693107 Book-keeping & Accounts – 0273 685481 Frank Wood’s A-level Accounting – 0273 685325 BA10_A01.qxd 21/12/04 10:18 am Page iv v Contents part 4 part 3 part 2 part 1 Notes for teachers and lecturers xiii Notes for students xv Introduction to double entry bookkeeping 1 The accounting equation and the balance sheet 3 2 The double entry system for assets, liabilities and capital 18 3 The asset of stock 28 4 The effect of profit or loss on capital and the double entry system for expenses and revenues 38 5 Balancing off accounts 49 6 The trial balance 57 The financial statements of sole traders 7 Trading and profit and loss accounts: an introduction 71 8 Balance sheets 83 9 Trading and profit and loss accounts and balance sheets: further considerations 91 10 Accounting concepts 104 Books of original entry 11 Books of original entry and ledgers 119 12 The banking system in the UK 125 13 Cash books 136 14 The sales day book and the sales ledger 153 15 The purchases day book and the purchases ledger 162 16 The returns day books 168 17 The journal 180 18 The analytical petty cash book and the imprest system 191 19 Value added tax 200 20 Columnar day books 218 21 Employees’ pay 226 22 Computers and accounting 234 23 Computerised accounting systems 244 Adjustments for financial statements 24 Capital expenditure and revenue expenditure 259 BA10_A01.qxd 21/12/04 10:18 am Page v Contents vi part 5 part 6 part 7 part 8 25 Bad debts, provisions for doubtful debts, and provisions for discounts on debtors 269 26 Depreciation of fixed assets: nature and calculations 284 27 Double entry records for depreciation 294 28 Accruals and prepayments and other adjustments for financial statements 315 29 The valuation of stock 336 30 Bank reconciliation statements 351 31 Control accounts 364 32 Errors not affecting trial balance agreement 378 33 Suspense accounts and errors 386 Scenario questions 404 Special accounting procedures 34 Introduction to accounting ratios 411 35 Single entry and incomplete records 423 36 Receipts and payments accounts and income and expenditure accounts 443 37 Manufacturing accounts 457 38 Departmental accounts 480 39 Cash flow statements 488 40 Joint venture accounts 505 Partnership accounts and company accounts 41 Partnership accounts: an introduction 515 42 Goodwill for sole traders and partnerships 533 43 Revaluation of partnership assets 548 44 Partnership dissolution 556 45 An introduction to the financial statements of limited liability companies 576 46 Purchase of existing partnership and sole traders’ businesses 608 An introduction to financial analysis 47 An introduction to the analysis and interpretation of accounting statements 623 An introduction to management accounting 48 An introduction to management accounting 657 Appendices 1 Answers to review questions 667 2 Answers to multiple choice questions 741 3 Glossary 742 Index 753 BA10_A01.qxd 21/12/04 10:18 am Page vi Supporting resources Visit www.pearsoned.co.uk/wood to find valuable online resources Companion Website for students l Learning objectives for each chapter l Multiple choice questions to help test your learning l Review questions and answers l Links to relevant sites on the web l Searchable online glossary l Flashcards to test your knowledge of key terms and definitions For instructors l Complete, downloadable Solutions Manual l PowerPoint slides that can be downloaded and used as OHTs Also: The Companion Website provides the following features: l Search tool to help locate specific items of content l E-mail results and profile tools to send results of quizzes to instructors l Online help and support to assist with website usage and troubleshooting For more information please contact your local Pearson Education sales representative or visit www.pearsoned.co.uk/wood BA10_A01.qxd 21/12/04 10:18 am Page vii Guided tour of the book THE FINANCIAL STATEMENTS OF SOLE TRADERS part 2 Introduction This part is concerned with preparing, from double entry records, the financial statements of sole traders. 7 Trading and profit and loss accounts: an introduction 71 8 Balance sheets 83 9 Trading and profit and loss accounts and balance sheets: further considerations 91 10 Accounting concepts 104 Part opening Chapter 27 l Double entry records for depreciation 295 The depreciation is posted directly into the cumulative provision for depreciation account. The double entry is: Debit the profit and loss account Credit the accumulated provision for depreciation account Exhibit 27.1 A business has a financial year end of 31 December. A computer is bought for £2,000 on 1 January 20X5. It is to be depreciated at the rate of 20 per cent using the reducing balance method. The records for the first three years are: Computer 20X5 £ Jan 1 Cash 2,000 Accumulated Provision for Depreciation – Computer 20X5 £ 20X5 £ Dec 31 Balance c/d 400 Dec 31 Profit and loss 400 20X6 20X6 Dec 31 Balance c/d 720 Jan 1 Balance b/d 400 Dec 31 Profit and loss 320 720 720 20X7 20X7 Dec 31 Balance c/d 976 Jan 1 Balance b/d 720 Dec 31 Profit and loss 256 976 976 20X8 Jan 1 Balance b/d 976 Profit and Loss Account (extracts) for the year ended 31 December £ 20X5 Depreciation 400 20X6 Depreciation 320 20X7 Depreciation 256 Activity 27.3 Note: In this case, the depreciation for the period being posted to the profit and loss account is being described as ‘depreciation’ and not by the name of the account it is being posted from. This clearly is not the convention usually adopted when posting entries between ledger accounts and is very much ‘the exception that proves the rule’. What advantages are there in making this exception to the rule by using ’depreciation’ rather than ‘accumulated provision for depreciation’ in the profit and loss account entry? Now the balance on the Computer Account is shown on the balance sheet at the end of each year less the balance on the Cumulative Provision for Depreciation Account. A wide range of exhibits offer clear examples of accounting practice and methodology. 49 Balancing off accounts chapter 5 Learning objectives After you have studied this chapter, you should be able to: l close accounts when appropriate l balance off accounts at the end of a period and bring down the opening balance to the next period l distinguish between a debit balance and a credit balance l describe and prepare accounts in three-column format Introduction In this chapter, you’ll learn how to discover what the amount outstanding on an account is at a particular point in time. You’ll also learn how to close accounts that are no longer needed and how to record appropriate entries in accounts at the end and beginning of periods. Finally, you’ll learn that T-accounts are not the only way to record accounting transactions. 5.1 Activity 5.1 Accounts for debtors Where debtors have paid their accounts So far you have learnt how to record transactions in the accounting books by means of debit and credit entries. At the end of each accounting period the figures in each account are examined in order to summarise the situation they present. This will often, but not always, be a year if you are calculating profit. It will be at least once a month if you want to see what is happening with respect to particular accounts. Probably the most obvious reason for this is to find out how much our customers owe us for goods we have sold to them. In most businesses this is done at the end of each month. Why do you think we would want to look at the debtor accounts in the accounting books as often as once a month? Learning objectives outline what you will need to have learned by the end of the chapter. Part 3 l Books of original entry 122 11.8 Types of accounts Some people describe all accounts as personal accounts or as impersonal accounts. l Personal Accounts – these are for debtors and creditors (i.e. customers and suppliers). l Impersonal Accounts – divided between ‘real’ accounts and ‘nominal’ accounts: – Real Accounts – accounts in which possessions are recorded. Examples are buildings, machinery, fixtures and stock. – Nominal Accounts – accounts in which expenses, income and capital are recorded. A diagram may enable you to follow this better: 11.9 Activity 11.2 11.10 Nominal and private ledgers The ledger in which the impersonal accounts are kept is known as the Nominal (or ‘General’) Ledger. In order to ensure privacy for the proprietor(s), the capital, drawings, and other similar accounts are sometimes kept in a Private Ledger. This prevents office staff from seeing details of items which the proprietors want to keep secret. Why bother with books of original entry? Why don’t we just enter transactions straight into the ledgers? The accountant as a communicator The impression is often given that all that an accountant does is produce figures arranged in vari- ous ways. This has led to a perception that accountants are boring, pragmatic people with no sense of humour. While it is true that such work does take up quite a lot of an accountant’s time, it does not acount for all of a typical accountant’s work. Accountants also need to be good com- municators, not just in the way they present accounting information on paper, but also in how they verbally communicate the significance of the information they prepare. An accountant can obviously arrange the financial figures so as to present the information in as meaningful a way as possible for the people who are going to use that information. That is, Activities occur frequently throughout the book to test your understanding of new concepts. viii BA10_A01.qxd 21/12/04 10:18 am Page viii Chapter 45 l An introduction to the financial statements of limited liability companies 587 Exhibit 45.8 The following trial balance is extracted from the books of F W Ltd as on 31 December 20X5: Trial balance as on 31 December 20X5 Dr Cr £ £ 10% preference share capital 200,000 Ordinary share capital 700,000 10% debentures (repayable 20X9) 300,000 Goodwill at cost 255,000 Buildings at cost 1,050,000 Equipment at cost 120,000 Motor vehicles at cost 172,000 Provision for depreciation: buildings 1.1.20X5 100,000 Provision for depreciation: equipment 1.1.20X5 24,000 Provision for depreciation: motor vehicles 1.1.20X5 51,600 Stock 1.1.20X5 84,912 Sales 1,022,000 Purchases 439,100 Carriage inwards 6,200 Salaries and wages 192,400 Directors’ remuneration 123,000 Motor expenses 3,120 Business rates and insurances 8,690 General expenses 5,600 Debenture interest 15,000 Debtors 186,100 Creditors 113,700 Bank 8,390 General reserve 50,000 Share premium account 100,000 Interim ordinary dividend paid 35,000 Profit and loss account 31.12.20X4 43,212 2,704,512 2,704,512 The following adjustments are needed: (i ) Stock at 31.12.20X5 was £91,413. (ii ) Depreciate buildings £10,000; motor vehicles £18,000; equipment £12,000. (iii) Accrue debenture interest £15,000. In Business Accounting 2 you will be told more about the differences between ‘revenue reserves’ and ‘capital reserves’. The most important reason for the distinction has to do with deciding how much can be treated as being available for paying out to shareholders as dividends. ‘Revenue reserves’, which include the profit and loss account balance and the general reserve, can be treated as available for such dividends. ‘Capital reserves’, which will include revaluation reserves on property and land, also some reserves (which you have not yet met) which have to be created to meet some legal statutory requirement, cannot be treated as available for payment of dividends. A term which sometimes appears in examinations is that of ‘fungible assets’. Fungible assets are assets which are substantially indistinguishable one from another. A fully worked example ‘ Part 1 l Introduction to double entry bookkeeping 44 Cash £ Aug 25 Drawings 50 Sometimes goods are taken for private use. These are also known as drawings. In Section 3.2, you learnt that when goods are purchased, the purchases account is debited. As a result, when goods are withdrawn it is the purchases account which should be credited. The following example illustrates the entries for this form of drawings: On 28 August, the owner takes £400 of goods out of the business for his own use. Effect Action 1 Capital is decreased by £400 Debit the drawings account £400 2 Stock is decreased by £400 Credit the purchases account £400 Drawings £ Aug 28 Purchases 400 Purchases £ Aug 28 Drawings 400 Learning outcomes You should now have learnt: 1 How to calculate profit by comparing revenue with expenses. 2 That the accounting equation is central to any explanation of the effect of trading upon capital. 3 Why every different type of expense is shown in a separate expense account. 4 Why every different type of revenue is shown in a separate revenue account. 5 Why an expense is shown as a debit entry in the appropriate expense account. 6 Why revenue is shown as a credit entry in the appropriate revenue account. 7 How to enter a series of expense and revenue transactions into the appropriate T-accounts. 8 What is meant by the term ‘drawings’. 9 That drawings are always a reduction in capital and never an expense of a business. 10 How to record drawings of cash in the accounting books. 11 How to record drawings of goods in the accounting books. s ll Part 2 l The financial statements of sole traders 80 Review questions 7.1 From the following trial balance of A Moore, extracted after one year’s trading, prepare a trad- ing and profit and loss account for the year ended 31 December 20X6. A balance sheet is not required. Trial Balance as at 31 December 20X6 Dr Cr £ £ Sales 190,576 Purchases 119,832 Salaries 56,527 Motor expenses 2,416 Rent 1,894 Insurance 372 General expenses 85 Premises 95,420 Motor vehicles 16,594 Debtors 26,740 Creditors 16,524 Cash at bank 16,519 Cash in hand 342 Drawings 8,425 Capital 138,066 345,166 345,166 Stock at 31 December 20X6 was £12,408. (Keep your answer; it will be used later in Question 8.1) 7.2 From the following trial balance of B Lane after his first year’s trading, you are required to draw up a trading and profit and loss account for the year ended 30 June 20X8. A balance sheet is not required. Trial Balance as at 30 June 20X8 Dr Cr £ £ Sales 265,900 Purchases 154,870 Rent 4,200 Lighting and heating expenses 530 Salaries and wages 51,400 Insurance 2,100 Buildings 85,000 Fixtures 1,100 Debtors 31,300 Sundry expenses 412 Creditors 15,910 Cash at bank 14,590 Drawings 30,000 Vans 16,400 Motor running expenses 4,110 Capital 114,202 396,012 396,012 Stock at 30 June 20X8 was £16,280. (Keep your answer; it will be used later in Question 8.2) Chapter 13 l Cash books 147 account, the first part of the entry