The equation is the foundation of double entry accounting. The accounting
equation displays that all assets are either financed by borrowing money or paying with the money of the company's shareholders. Thus, the accounting equation is: Assets = Liabilities + Shareholder Equity. The balance sheet is a complex display of this equation, showing that the total assets of a company are equal to the total of liabilities and shareholder equity. Any purchase or sale by an accounting equity has an equal effect on both sides of the equation, or offsetting effects on the same side of the equation. The accounting equation is also written as Liabilities = Assets Shareholder Equity and Shareholder Equity = Assets Liabilities. The basic equation shows that a company can fund the purchase of an asset with assets (a $50 purchase of equipment using $50 of cash) or fund it with liabilities or shareholder equity (a $50 purchase of equipment by borrowing $50 or using $50 of retained earnings). In the same vein, liabilities can be paid down with assets, like cash, or by taking on more liabilities, like debt.
B) Balance Sheet
A balance sheet should always balance. The name "balance sheet" is based on the fact that assets will equal liabilities and equity every time. The assets on the balance sheet consist of things of value that the company owns or will receive in the future and which are measurable. Liabilities are what the company owes, such as taxes, payables, salaries and debt. The equity sections displays the company's retained earnings and the capital that has been contributed by shareholders. The balance between assets, liability and equity makes sense when applied to a simpler example, such as buying a car for $10,000. In this case, you might use a $5,000 loan (debt), and $5,000 cash (equity) to purchase it. Your assets are worth $10,000 total, while your debt is $5,000 and equity is $5,000. In this simple example, assets equal debt plus equity. The major reason that a balance sheet balances is the accounting principle of double entry. This accounting system records all transactions in at least two different accounts, and therefore also acts as a check to make sure the entries are consistent. Building on the previous example, suppose you decided to sell your car for $10,000. In this case, your asset account will decrease by $10,000 while your cash account, or account receivable, will increase by $10,000 so that everything continues to balance. (This is a very simple example. If you wish to learn more, check out Reading The Balance Sheet and Breaking Down The Balance Sheet.) If the balance sheet does not balance, this should be a red flag that there is likely a problem with one or more entries. Even a small discrepancy can occur as a result of several errors that offset each other.
C) Importance of Invoices and Credit Notes
The information given on invoices and credit notes normally establishes the VAT liability of the supplier of goods or services and the entitlement of the customer to a deduction, where applicable, for the VAT charged. An accountable person (that is, a person registered for VAT) is obliged by law to issue and retain these documents. The checking of these documents forms a most important part of the periodic examination which Revenue makes of a trader's VAT position. VAT law lays down specific requirements for the issue and retention of invoices, credit notes and related documents. Persons who issue invoices and credit notes, and persons to whom these documents are issued, should ensure that the documents accurately represent the transactions to which they refer. Failure to do so may have serious consequences for all parties concerned. For example, a wholesaler issues an invoice to a retailer describing goods as zero-rated which are in reality taxable at the standard rate, the wholesaler is nonetheless liable for VAT at the standard rate. The wholesaler by neglecting to apply the correct VAT rate is also exposed to prosecution. The retailer is likewise liable at the standard rate on the subsequent supply, despite the misleading description and is exposed to prosecution should they fail to account at the correct rate. Debit notes which are often used instead of invoices and credit notes in commercial transactions, must also show the VAT registration number, if any, of the person issuing them and the VAT registration number of the supplier, in addition to all the other details required to be shown on invoices and credit notes. It is a condition that the supplier of goods or services be prepared to accept such documents for VAT purposes. If accepted, the supplier is subject to the same obligations as if they had issued an invoice or credit note.
D) Cash Discounts and Trade Discounts
An incentive that a seller offers to a buyer in return for paying a bill owed before the scheduled due date. The seller will usually reduce the amount owed by the buyer by a small percentage or a set dollar amount. If used properly, cash discounts improve the days-sales-outstanding aspect of a business's cash conversion cycle. For example, a typical cash discount would be if the seller offered a 2% discount on an invoice due in 30 days if the buyer were to pay within the first 10 days of receiving the invoice. Providing a small cash discount would be beneficial for the seller as it would allow him to have access to the cash sooner. The sooner a seller receives the cash, the earlier he can put the money back into the business to buy more supplies and/or grow the company further. Trade discounts are given to people who are purchasing goods from a company to carry out work of their own company. Trade discounts are usually given because traders will often spend large amounts of money and will return for business again and again so both businesses benefit from the arrangement. They are both trying to encourage loyalty with one another. Cash and trade discounts are given to encourage loyalty and a reason for the customers to return again and again. Many businesses like to give them because it gives them an edge over their competition and the loyalty that it inspires in customers can make them feel special and more likely to return.
E) Account Cycle Components
The term, accounting cycle, refers to the steps involved in accounting for all of the business activities during an accounting period. These steps are repeated each reporting period. There are nine steps to the accounting cycle. We will go through each one in detail later. But lets review the basics. Step one begins with analyze transactions. Step two journalize. Step three Post. Step four prepare unadjusted trial balance. Step five adjust. Step six prepare adjusted trial balance. Seven prepare financial statements. Step eight close. Step nine Prepare a post-closing trial balance. It is important that you realize when the steps occur. Steps 1 through 3 occur often throughout the accounting time period. Steps four through 9 occur only at the end of the accounting period. The accounting process begins with analyzing transactions. The company first looks at the source documents that describe the transactions and events. Source documents can be either hard copy or electronic. Some examples of source documents include bank statements, checks, and purchase orders. After analyzing the transactions, events and source documents, the company is now ready to complete step 2, journalize. When the company journalizes the accountant applies the rules of double-entry accounting. Double-entry accounting means that each transaction must be recorded in at least two accounts or that the debits must equal the credits. After applying the rules of debits and credits, the accountant should then record the transactions in a journal, or journalize. A journal is a complete record of each transaction. The third step in the accounting cycle is to post. This sounds complicated but its actually very easy. Posting involves transferring information from the journal to the ledger. A ledger is simply a collection of all accounts it shows all of the number detail about a companys accounts. When we post, we are simply transferring the debits and credits from the journal to the ledger. To verify that the companys debits equal credits, an unadjusted trial balance is prepared. A trial balance is a list of all accounts and their balances at a point in time. This is the fourth step of the accounting cycle. The information used in a trial balance comes from the ledger. The account balances from the ledger is used to create the trial balance. We call this trial balance an unadjusted trial balance because it is prepared before the adjusting entries. The purpose of the trial balance is to verify that the debits equal the credits. It does not guarantee that no errors were made. The fifth step in the accounting cycle is to prepare adjusting entries. Adjusting entries involve bringing an asset or liability account balance to its proper amount and updating the corresponding revenue or expense account. Adjusting entries are recorded in the general journal and then posted to the ledger. All adjusting entries are made at the end of the accounting time period. After the adjusting entries have been posted, the accountant prepares another trial balance. This trial balance is called the adjusted trial balance because it is prepared after the adjusting entries. This trial balance is used to verify that the debits equal the credits and also is used to prepare the financial statements. Now that the adjusted trial balance has been prepared the next step is to prepare the financial statements. The financial statements must be prepared in a very specific order. The order for the financial statements is: income statement, statement of retained earnings, balance sheet, and then statement of cash flows. This order is important because information provided in the income statement is used in the statement of retained earnings, and information from the statement of retained earnings is used in the balance sheet. Step eight in the accounting cycle is to prepare the closing entries. Closing entries are prepared after the financial statements are completed. The purpose of closing entries is to prepare the accounts for recording transactions and events for the next period. The accountant is now getting the books ready for next year. Step nine, and for many companies the last step in the accounting cycle, is to prepare a post-closing trial balance. A post-closing trial balance should only contain the debit and credit balance for permanent accounts, because these are the only accounts that are remaining after the closing process. Once again the purpose of this trial balance is to ensure that the debits equal the credits and that all temporary accounts have a zero balance. For many companies this is the last step in the accounting cycle, the company is now ready to start the new accounting period.
F) Books of Prime Entry
An alternative introduction is under the Journals entry. Books of Prime Entry are a more efficient variation on double-entry accounting. In basic double entry, a double entry is made in the general journal, which is posted in the general ledger accounts. Originally, the Venetian method also suggested a preceding diary step, which makes sense as no thinking is required in double entry, so it may have been faster. In a manual system, books of prime entry act as the speed entry step: instead of trying to remember which accounts to debit and which to credit, and writing the names down for each entry for each transaction in the general journal, the general journal is reserved for infrequent accrual entries; the more frequent cash entries, and the most frequent accrual entries are divided into specialized journals of cash receipts and cash payments; credit sales journal and credit purchases journal ( credit means 'on credit' here) ; and for medium frequency accrual entries , sales returns and purchase returns journal. Apart from not having to write account names each time, the column layout in these specialized journal help systemize the double entry rules; most of them can be totalled at the end of each month to provide monthly entries into control account ledgers, as well as reconciliation with summary monthly totals when a schedule of subsidiary ledger accounts is created. Cash reconciliation also is a monthly task, which is made easier by tracking with numbered transactions such as numbered cheque books where cheque numbers can be entered in the cash payments journal; for tracking cash receipts, it is recommended banking occurs daily so that end of month bank reconciliation is easier. Bank reconciliation involves looking at outstanding items from the last reconciliation then seeing which of these occurred in this period's bank statement; then a search is made for unpresented cheques , and unrecorded receipts, and then payments and receipits that occurred through the bank and not through the business. This makes the cash receipts and cash payments journal essential for reconciliation. Books of prime entry OR books of original entry are books where transactions are first recorded. These may or may not be part of the double entry system. This is the book of prime entry for credit sales, where all credit sales of the day are listed and totaled. The total is then used as a single posting entry to the sales ledger and also posted to a sales control account in a single total to tally with the underlying sales ledger. However, individual debits are posted separately in the respective sales ledger (or debtors or receivables ledger accounts).
Purchases Journal (or Purchases Book) used to record all credit purchases of goods. It is written up from invoice. Sales Journal (or Sales Book) is used to record all the credit sales of goods. It is written up from the invoice. Sales Returns Journal (or Return Inwards Book): It is used to record all returns inwards. It is written up from the copies of the credit notes send to customers. Purchases Return Journal (or Returns Outwards Book): It is used to record all purchases returns. It is written up from the credit notes received from the suppliers. Cash Book: It is used to record all receipts and payments of cash and cheques. It is been given the ruling in such a way that it acts both as a book of original entry and ledger account. General Journal (or Journal): This book is used to record all those items or transactions that cannot be recorded in any other book of original entry like: i. Correction of errors ii. Opening entries iii. Purchase or Sale of Assets on Credit etc.