A daybook in accounting terms is a book of original entry kept to record the sales, purchases and returns traditionally on a daily basis. The purpose behind the daybook is to keep the detail of the sales, purchases and returns here rather than in their respective accounts with only the totals eventually being recorded (posted) in same. The daybooks would generally record sales or purchases on credit rather than for cash as the latter would not require a “personal” account.
ACCOUNTING - The basic
Accounting is often said to be the language of business. As with all languages fluency comes with practice and once mastered that person will be able to survey the transactions and gain an insight into both how that business has operated and how it may operate in the future. An “Account”, meaning a “history of” is opened for anything that you want to record. A typical page is created with the name of the account at the top and in the centre (underlined) and the page divided into two halves (line separator) – one representing the debit (left hand side) and the other representing the credit (right hand side). The lines drawn represent a “T” – hence where the term “T Accounts” comes from. All accounts are part of the double entry system.
Ledgers are where the accounts are kept. They fall into two categories
With few accounts they can all be recorded in a single ledger. But the larger the number of accounts a sub-division of the ledger is appropriate.
Personal accounts are where the transactions for customers and suppliers are kept known as Sales Ledger and Purchase (or Bought) Ledger respectively.
Impersonal accounts are where all other accounts are kept. They can be referred to as Real, meaning Property accounts (assets, stock etc.) or Nominal, meaning income and expenditure accounts. Cash and Bank Accounts may also be separated out into a “Cash Book”. Whilst a Cash Book may give the appearance of being a daybook it is actually a ledger as it holds the cash and bank accounts.
Ledgers contain accounts and Daybooks are mere, but convenient, listing devices to prevent unnecessary detail being recorded in their relevant accounts.
Double entry is the name given to the method of recording the transactions so that the dual aspect concept is upheld.
The Daybook transactions are “posted” to the ledgers. So for example the total sales for the day from the Sales Daybook is written up in the Sales Account of the Nominal Ledger and the individual amounts are written up on the individual customers’ account on the Sales Ledger. In doing so we are creating the double entry. That is we have an entry in the Sales Account (Nominal Ledger) and an equal (and opposite) amount in the customers’ accounts in the Sales Ledger.
DEBITS AND CREDITS
A debit refers to an asset or expenditure whilst a credit refers to income or a liability. Cash being an asset and therefore a “debit” is often confused because individuals know money in their bank account is a credit. Both are correct – but the important thing to note is that each look at it from their perspective. From the bank’s point of view, it is a credit because the money belongs to you. It is the same as debtors and creditors. A debtor (debit) is someone who owes you money (e.g. the bank or a customer). A creditor (credit) is someone to whom you owe money (e.g. a supplier).
Carrying on the theme of daily entries the term journals refers to entries in the accounts that cannot be made through either the Sales Daybook, Purchase Daybook or Cash Book.
The “Trial Balance” is so called because of how it is created and what it represents. If all transactions have been recorded upholding the dual aspect concept then the total of the debit balances will be the same as the totals of all the credit balances. You can trial (test or examine) this by extracting those balances from each account. If it does not balance, you can either try again or balance it off with a suspense account. With computerised accounting the imbalance is unlikely to occur and thus there is no need for the suspense account. The trial balance is therefore a list of all the accounts (from all ledgers) with their balances by extracting those balances from each account. The trial balance always represents the balances at the time it is extracted.
These are accounts designed to prove the balances on other accounts. Typically, you would have a Sales Ledger Control account or a Purchase Ledger Control Account to verify the balances of the total of the Customer Accounts or the Supplier Accounts respectively. They are not necessarily part of the double entry system; but they can be.
In computerised systems they tend to be part of the double entry. Here the double entry of the Sales Daybook comprises a credit to the Sales Account and a debit to the Sales Ledger Control Account. There are still postings made to the Sales Ledger for the customer accounts for the purposes of recoding all customer transactions.
When they are not part of the double entry system it is used to check the main totals e.g. total sales, total refunds and total customer receipts. The balance on this control account should agree to the total balances on the Sales Ledger.
THE ACCOUNTING EQUATION
For a firm to operate it needs resources and these resources are supplied by someone. The resources are assets and are supplied by the owner (known as Capital) or some other indebtedness (known as Liabilities). Therefore Assets = Capital + Liabilities.
THE DOUBLE ENTRY SYSTEM FOR ASSETS AND LIABILITIES
It follows from the above that every transaction effects both sides of this equation. From this arose the double entry system to show this twofold effect. Once to show the effect on one of the items and a second entry to show the effect on the other item. The Venetian merchants were the first known business people to use double entry and they just happened to select the left hand side of the page to represent the debit asset side and the right hand side to represent the credit capital and liabilities; and so it has remained ever since.
THE DOUBLE ENTRY SYSTEM FOR EXPENSES AND REVENUES. The effect of Profit or Loss on Capital
The buying and selling of goods and services will give rise to a profit or loss. The purchase of goods and services will either decrease the cash (asset) or increase a creditor (liability). The sale will either increase the cash (asset) or increase a debtor (asset). By following the same double entry principles, the resultant profit or loss must either increase or decrease the capital respectively:
Capital = Assets – Liabilities
To achieve this all of the expenses and revenue accounts for the period are closed by way of transfer to the Profit and Loss Account. This account is then part of the Capital of the business.
RESTRICTED MEANING OF SALES AND PURCHASES
Purchases in accounting terms means the purchase of items, whether added to or altered to, with the prime intention of selling. Sales means the sale of those goods in which the firm normally deals with and were bought with the prime intention of resale. It should be noted that a purchase of an asset is for its usage and not for resale. Failure to keep to these meanings would lead to inaccurate accounting.
TYPES OF ERRORS
Error of Omission
The complete omission of a transaction from the books.
Error of Commission
A transaction where the correct amount is entered but in the wrong person’s account.
Error of principle
Sometimes considered the more embarrassing error in that the entry is made in the wrong class of account. For example, the sale of an asset is recorded in the sales account rather than the asset disposal account. Another is recording purchases of items for resale to the stock account rather than the purchases account. The restricted meaning of sales and purchases applies here.
These are errors which cancel each other out. Entering the wrong amount in two separate accounts such as overcasting a credit amount by £200 and similarly overcasting another account by a debit of £200.
Error of Original Entry
Where the original figure entered is incorrect, yet double entry is still observed using this incorrect figure. For example, entering a sale of £98 as £89 in both the sales account and the personal account.
Complete reversal of entries
Where the correct accounts are used but each item is shown on the wrong side of the account, e.g. sales account debited and personal account credited instead of vice versa.
CONCEPTS AND CONVENTIONS
THE COST CONCEPT
Assets are normally shown at cost price – being the most objective valuation.
THE MONETARY MEASUREMENT CONCEPT
Accounting is only concerned with those facts that can be measured in monetary terms with a fair degree of objectivity.
THE GOING CONCERN CONCEPT
Accounting always assumes that the business will continue for an indefinitely long period. Only if a business was going to be sold would it be necessary to show how much the assets would fetch.
THE BUSINESS ENTITY CONCEPT
The accounting records are limited to those of the business and do not extend to the personal resources of its owners.
THE REALISATION CONCEPT
In accounting, profit is regarded as being earned at the time when the goods or services are passed to the customers and incurs liability for them. This is the point at which the profit is treated as being realised.
THE DUAL ASPECT CONCEPT
One is the assets of the business and the other the claims against them. In other words
Assets = Capital + Liabilities
Double entry is the name given to the method of recording the transactions so that the dual aspect concept is upheld.
THE ACCRUALS CONCEPT
Net profit is the difference between revenues and expenses not the difference between cash receipts and cash payments. This is the accruals concept and requires the matching of expenses against revenues.
Accounting does not serve a useful purpose if the effort of recording it in a certain way is not worthwhile. A bottle of ink would last a long time but would be charged in the accounting period it was bought irrespective of the fact that it would last for more than one accounting period. There is no law on materiality. It is a matter of judgement.
The convention is that when there is a choice between two figures to take for an item the figure to take is the one that understate the profit. The reason why accountants often get a bad name (although rightly so for those who deliberately mislead).
The concepts and conventions already stated are broad and vary from business to business. Once the accounting treatment of an item is decided it should remain constant. If the method is subsequently deemed to be in need of change, then the effect of the change should be noted.
The Profit and Loss Account and Balance Sheet
The profit and loss account and balance sheet are the product of all the accounting transactions made:-
PROFIT AND LOSS ACCOUNT
The balance on all of the sales, purchase and a few other accounts are created or closed by transferring them to the Profit and Loss account.
After the Profit and Loss account is prepared the only balances left will be itself and the assets, liabilities, and capital accounts. A statement is then drawn up of these remaining balances. This statement is aptly named a Balance Sheet and arranged in terms of asset balances or capital and liability balances. In contrast to the preparation of the Profit and Loss account the Balance Sheet is not part of the double entry system, and no further entry is made in these accounts. The term “account” means that it is part of the double entry system thus anything that is not an account is outside of this system. The presentation of the Balance Sheet therefore does not have to comply with the left-hand right-hand side concepts and is one of tradition or preference. In Great Britain there was a tradition of showing the assets on the right-hand side of the balance sheet and the capital and liabilities on the left-hand side i.e. the complete opposite to the double entry convention.
At a year end the final balance on the profit and loss account may be transferred to another Retained Earnings account such that the Profit and Loss account therefore represents the profit or loss for the year. The Balance Sheet is always as at the date the trial balance is extracted.
Officialdom in terms of accounting standards have renamed Profit and Loss Account with Statement of Comprehensive Income and Balance Sheet with Statement of Financial Position. If it is necessary to define it as a “Comprehensive” statement, then obviously the non-comprehensive one is worrying. However, such school-boy errors are amusing and unnecessary as the terms Profit and Loss account and Balance Sheet are appropriately descriptive, traditional and enduring.
ACCRUALS BASIS, CASH BASIS AND RECEIPTS AND PAYMENTS
These terms are used to describe a method of accounting. The accruals basis is the double entry method of recording the dual aspect concept of all transactions. The Receipts and Payment is a method of merely recording cash and bank transactions; it does not use the double entry method of recording. Cash basis means accounting only for the cash and bank transactions – regardless of whether a single or double entry method is used. Cash basis has particular relevance when accounting for taxes – income tax and Value Added Tax. An individual may account for their income tax on a cash basis rather than an accruals basis. A limited company, for example, must by law produce accounts based on the accruals basis but may, if VAT registered and eligible, account for VAT on the cash basis.
Preparation of a Receipts and Payment statement or account is more simplified than preparing accounts using the accruals basis. It follows that Receipts and Payments meets the cash basis definition, but it does not follow that cash basis is a more simplified basis. This is so when the same accounts are used to prepare the financial statements on an accruals basis as well as being used to produce a VAT Return using the cash basis.
Accounting software caters for the double entry method of recording transactions, whether restricted to cash transaction only or not. Such software is not suitable for single entry recording. Whilst it is possible to use it for the purpose by just looking at the cash account(s) there is a mistaken tendency by both bookkeepers and accountants alike to start including non-cash entries for “completeness”.
A receipts and payment account is accompanied by a Statement of Assets and Liabilities. This is an assessment of the assets and liabilities held at the date the receipts and payment statement is prepared. These are the statement being referred to when the term “a more simplified method of reporting” is used. This can be a problem for charities when over enthusiasm leads to a Receipts and Payment Account being accompanied with a Balance Sheet. A Balance Sheet is only the product of a double entry system of the dual aspect concept of Assets = Capital + Liabilities. The Charities Act requires that accounts produced in this way must be compliant with the Statement of Recommended Practice for Charities (SORP). This is an enormous undertaking compared to the Receipts and Payments account with Statement of Assets and Liabilities.
CHART OF ACCOUNTS
This term, more commonly associated with computerised accounting, can mean whatever you want it to mean. However, it typically refers to the structure of accounts used to record the transactions of the business. It could be a simple code list to a hierarchy of separate accounts, project codes or organisation reflecting the business’ operations – or anything in between. The phrase “getting the chart of accounts right” is about understanding the reporting requirements. Notwithstanding the ability to create reporting hierarchies a well-structured set of accounts will ease the production of reports and be flexible to cater for additional or changing requirements. Alas, another school-boy error is that reporting needs are too often considered after the chart of accounts is adopted!
A trial balance is a listing of balances extracted from each account at a given time. Therefore, the term “detailed trial balance” is inappropriate. For the same reason the term “period trial balance” is also inappropriate. The terms are generally used by accounting software demonstrating their lack of understanding of basic principles.
When it comes to accounting if Frank Wood says “it is” then it is.