FORMS OF BUSINESS ORGANIZATION

Profit-oriented enterprises can be organized in

one of three ways:
o Sole proprietorships;

o Partnerships;

o Corporations.
SOLE PROPRIETORSHIPS
Sole proprietorships are businesses that are
owned by one individual and usually operated by
that individual.
o Primary advantage is ease of formation.

o Major disadvantage is unlimited liability.

o Because of the Entity Principle, records of

the business and its owner must be kept
separate.
PARTNERSHIPS
Partnerships consist of two or more persons in
business to make a profit and these are very
similar to sole proprietorships.
o Primary advantage is ease of formation.

o Major disadvantage is unlimited liability.

o Because of the Entity Principle, records of

the business and its owners must be kept
separate.
CORPORATIONS
Corporations, unlike proprietorships or
partnerships, are separate legal entities.
o Major disadvantage is difficulty of formation.
o Primary advantage is limited liability of its
shareholders (i.e. only a shareholder's investment
in the corporation is at risk.)
o Because of the Entity Principle, records of
the business and its shareholders must be
kept separate.
FUNDAMENTALS OF ACCOUNTS

o An account is a summarized record of

relevant transactions at one place relating to
a particular head. It records not only the
amount of transactions but also their effect
and direction.
o Debit and Credit are simply additions to or
subtractions from an account.
ACCOUNTING EQUATION

Assets = Equity/ Capital + Liabilities

ASSETS
o Assets are things you own or resources a
business owns.
o The assets of a business belong to its creditors
and investors.
o Tangible assets-this you can touch like
machinery, buildings, land, computers, etc.
o Intangible assets-things you cannot tough such
as right to patents, rights to payments from
customers, copyrights or trademarks.
CLASSIFICATION OF ASSETS
o Fixed Assets;
o Currents Assets.
FIXED ASSETS
o These assets are fixed in the sense that they
are acquired to be retained in the business on
a long term basis to produce goods and
services and not for resale.
o They are long term resources and are held for
more than one accounting year.
o These assets are significant as the future
earnings/profits of the company are
determined by these.
CATEGORIES OF FIXED ASSETS
o Tangible Fixed Assets;
o Intangible Fixed Assets.
TANGIBLE FIXED ASSETS
o These assets have a physical existence and
generate goods and services.
o Examples are land, buildings, plant, machinery,
furniture, etc.
o They are shown in the balance sheet at their
cost to the firm at the time of their purchase.
o The cost of these assets are allocated over
their useful life.
o The yearly allocation is called “Depreciation”.
TANGIBLE FIXED ASSETS
o As a result of depreciation, the amount of
tangible fixed assets shown in the balance
sheet every year declines to the extent of
depreciation charged that year.
o By the end of the useful life of the asset, value
becomes nil or may be have some salvage
value.
o Salvage value signifies the amount realizable
by the sale of the asset at the end of its useful
life.
INTANGIBLE FIXED ASSETS
o These assets do not generate goods and
services directly.
o They reflect the exclusive rights of the
business.
o Intangibles are also written off over a period of
time.
o Examples – patents, copyrights, trademarks,
goodwill, etc.
CURRENT ASSETS
o Current assets are short term in nature i.e.
having the life of less than one year.
CATEGORIES OF CURRENT ASSETS
o Liquid Assets; (Having nominal Operating Cycle)
o Non-Liquid Assets.(Having Considerable Operating
Cycle)

The term “Operating Cycle” means the time span during which
the cash is converted into inventory, inventory into
receivables/cash sales and receivables into cash
LIABILITIES
o Things you owe, future obligations of the
business
o Creditor claims
o Examples include a bank loan or car loan, or
buying supplies for your business on credit
CLASSIFICATION OF LIABILITIES
o Long Term Liabilities;
o Short Term / Current Liabilities.
LONG TERM LIABILITIES
o Sources of funds included in this category are
available for periods exceeding one year.
o Such liabilities represent obligations of a
business payable after the accounting period.
o They have to be redeemed/repaid either as a
lump sum on maturity or over a period of time
in instalments.
o Example: Debentures, Bonds, Mortgages,
Secured loans from FIs and banks.
SHORT TERM / CURRENT LIABILITIES
o These Liabilities are payable to outsiders in a
short period, usually within the accounting
period or the operating cycle of the business.
o Accounts and Bills payable are considered as
Trade Credit.
o Example: Accounts payable, Bills payable, Tax
payable, Accrued expenses, Short term bank
credit.
EQUITY/CAPITAL
o Rights of stockholders/Owner or their claim on
assets
o There are two types of equity
1- Paid up Capital i.e. Investment by owner;
2- Retained earnings which is the portion of earned
assets kept in the business
CLASSIFICATION OF EQUITY/CAPITAL
o Preference Equity / Capital;
o Ordinary Equity / Capital.
PREFERENCE EQUITY / CAPITAL
o These shareholders are entitled to a stated
amount of dividend and return of principal on
maturity. In this sense, they are akin to that of a
lender.
o But, they are entitled to the dividend only if the
company has made profits. In this sense, they
are the owners.
ORDINARY EQUITY / CAPITAL
o They are the residual claimants of the profits.
o After all the external liability holders and the
preference shareholders have been paid, the
balance amount, if any, belongs to the Equity /
Capital shareholders.
o Components: Paid up capital which is the initial
investments made by this group and Retained
earnings/Reserves and Surplus which is the
undistributed part of the residual profits over the
years which has been put back in business.
 ACCOUNTING EQUATION

Sr. No. Transaction Effect

1 Buy goods on credit Increase in Assets Increase in Liabilities
2 Buy goods by cheque Increase in Assets Decrease in Assets
3 Pay creditors by cheque Decrease in Assets Decrease in Assets
4 Owners pays more capital into the business bank account Increase in Assets Increase in Capital
5 Owner takes money out of the business back account for his own use Decrease in Assets Decrease in Capital
6 Owner pays credit from private money outside the firm Decrease in Liabilities Increase in Capital
ACCOUNTING EQUATION
Nature of Accounts To Record Entry in the Accounts
an Increase Debit
Assets
a Decrease Credit
an Increase Credit
Capital
a Decrease Debit
an Increase Credit
Liabilities
a Decrease Debit
 ACCOUNTING EQUATION
Effect Assets Capital Liabilities
To increase each item Debit Credit Credit
To decrease each item Credit Debit Debit
ACCOUNTING EQUATION
Any Assets Account Capital Account Any Liabilities Account
Debit Credit Debit Credit Debit Credit
Increase Decrease Decrease Increase Decrease Increase
+ - - + - +
CLASSIFICATION OF ACCOUNTS

o Real Accounts;
o Nominal Accounts.
CLASSIFICATION OF EXPENDITURES
o Capital Expenditure;
o Revenue Expenditure.
METHODS OF ACCOUNTING
(a) Cash basis of accounting
Revenues are recognized when cash is received and expenses
are recognized when cash is paid
(b) Accrual basis of accounting
Revenues and expenses are recognized on an economic basis
regardless of when cash is paid or received

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RECOGNISION OF REVENUE

Significant risks and benefits of ownership passes

from the seller to the buyer i.e. Transfer of title of
goods.

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RECOGNISION OF EXPENSES

Expenses are recognized when they are incurred

and helped to produce revenues.

32
ACCOUNTING PRINCIPLES
Entity - Every entity is a separate economic unit and should be kept
distinct from the activities of its owners and other stakeholders
Monetary Unit - Only economic events that have monetary
transactions will be reported in the financial statements
Cost Principle - Assets are presented at their original (historical) cost
Going Concern - Entities are established with the goal that they will
operate for an indefinitely long period of time
Periodicity - Economic activities of any firm can be divided into
discrete time periods for reporting purposes
Matching Principle - All revenues must be recorded in the accounting
period in which the goods are sold or services are rendered and all
expenses must be recorded in the accounting period in which they
are incurred to produce such revenues

33
CHART OF ACCOUNTS (COA)
o Every business entity has a chart of accounts,
sort of Table of Contents in a book.
o Each account is assigned a number as per
nomenclature defined by the management of
the entity
o Usually assets start with 1, liabilities 2, capital
3, income 4, cost of goods sold 5, other
expenses 6 etc.

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BOOKS OF ORIGINAL ENTRY
o General Journal - GJ
o Sales Journal;
o Purchases Journal;
o Returns Inwards Journal;
o Returns Outwards Journal;
o Expenses Journal etc.
o General Ledger - GL
o Sales Ledger;
o Purchases Ledger;
o Returns Inwards Ledger;
o Returns Outwards Ledger;
o Expenses Ledger etc.
o Accounts
o Separate accounts of each asset, component of capital &
liability.
ACCOUNTING CYCLE

Adjust the
Analyze and Post the accounts
record the transactions and and prepare
transactions prepare trial trial balance
balance

Prepare the
financial Close the
statements accounts and
prepare trial
balance

36
FINANCIAL STATEMENTS

Financial Statements are compilation of

accounting information for the external users.
Include:
- Profit and Loss Account
- Balance Sheet
- Notes forming part of the above
USERS OF FINANCIAL STATEMENTS
o Investors;
o Lenders;
o Suppliers;
o Customers;
o Government;
o Employees;
o Public.
USERS OF FINANCIAL STATEMENTS

Employees

Shareholders Trade creditors

Government Management Customers

Loan providers Public

Potential
Investors
 During the Accounting Period

Source Transaction Record in Post to

documents Analysis Journal Ledger

At the End of the Accounting Period

Financial Adjusted Record & Post Unadjusted

Statements Trial Balance Adjusting Trial Balance
Entries

Accounting
At the End Cycle
of the Year
Close Temporary Post-Closing
Accounts Trial Balance
GENERAL JOURNAL & GENERAL LEDGER
On January 1, $ 40,000 was borrowed from a bank
and a note payable was signed.

Two accounts are affected:

 Cash (an asset) increases by $ 40,000.
 Notes Payable (a liability) increases by $ 40,000.

GENERAL JOURNAL Page 1

Post.
Prepare
Date
Jan 1 Cash
the journal entry.
Description Ref.
40,000
Debit Credit

Notes Payable 40,000

GENERAL LEDGER & T-ACCOUNT
GENERAL LEDGER
Account: Acct. No. ##
Balance
Post.
Date Item Ref. Debit Credit DR (CR)

The “T” account is a shorthand format of an account

used by accountants to analyze transactions.
It is not part of the bookkeeping system.
POSTING ACCOUNTING ENTRIES

On July 1, the owners invest $60,000 in a new

business.
GENERAL JOURNAL Page 1
Post.
Date Description Ref. Debit Credit
July 1 Cash 60,000
Common Stock 60,000

Post the debit portion of the entry to the Cash

ledger account.
POSTING ACCOUNTING ENTRIES

GENERAL JOURNAL Page 1

Post.
Date Description Ref. Debit Credit
July 1 Cash 100 60,000
Common Stock 60,000

GENERAL LEDGER
Account: Cash Acct. No. 100

Post.
Date Item Ref. Debit Credit Balance
July 1 J1 60,000 60,000
POSTING ACCOUNTING ENTRIES

GENERAL JOURNAL Page 1

Post.
Date Description Ref. Debit Credit
July 1 Cash 100 60,000
Common Stock 300 60,000

We follow the same procedure to post the credit portion

of the entry to the Common Stock account.
GENERAL LEDGER
Account: Common Stock Acct. No. 300

Post.
Date Item Ref. Debit Credit Balance
July 1 J1 60,000 60,000
 After recording all entries for the period, Unadjusted Trial
Balance would be as follows:

A Trial
Unadjusted Trial Balance
July 31, 2009
Balance is a
Account Title Debits Credits listing of all
Cash $ 68,500 accounts
Accounts receivable 2,000
Supplies 2,000 and their
Prepaid rent 24,000 balances at
Inventory 38,000
Furniture and fixtures 12,000 a point in
Accounts payable $ 35,000 time.
Notes payable 40,000
Unearned rent revenue 1,000
Common stock 60,000
Retained earnings 1,000
Sales revenue 38,500
Cost of goods sold 22,000
Salaries expense 5,000
Total $ 174,500 $ 174,500 Debits = Credits
 Adjusting Entries

Prepayments Accruals Estimates

(Deferrals)

Transactions where An estimated item is a

cash is paid or received function of future
before a related events and
expense or revenue is developments.
recognized.

Transactions where
cash is paid or received
after a related expense
or revenue is
recognized.
PREPAYMENTS/DEFERRALS

Asset Expense
Unadjusted Credit Debit
Balance Adjustment Adjustment

Today, I will pay

for my first
6 months’ rent. Prepaid Expenses
Items paid for in advance
of receiving their benefits
ACCRUALS

Expense Liability
Debit Credit
Adjustment Adjustment

I won’t pay you Accrued Liabilities

until the job is done! Liabilities recorded when an
expense has been incurred
prior to cash payment.
ESTIMATES

 Uncollectible accounts
and depreciation of
fixed assets are
estimated.

$
ESTIMATES

Expense Assets
Debit Credit
Adjustment Adjustment

We will depreciate our Esimates

plant on straight line
basis. Estimation for future events
/developments for assets.
BEHAVIOUR OF ACCOUNTS - SUMMARY
Assets = Liabilities + Owners’ Equity
+ - - + - +
Dr Cr Dr Cr Dr Cr
Expense Revenue
+ - - +
Dr Cr Dr Cr

Withdrawals/Dividends
+ -
Dr Cr
PREPARING A TRIAL BALANCE

o List the ledger account balances

in two columns on the trial
balance
 Left column = Debits

 Right column = Credits

o Trial balance proves DR = CR

THE BALANCING OF ACCOUNTS, THE TRIAL
BALANCE & FINANCIAL STATEMENTS
 You have learned the principles of double entry and how to
post to the ledger accounts. The next step in our progress
towards the financial statements is the trial balance.
 Before transferring the relevant balances at the year end to the
financial statements, it is usual to test the accuracy of the
double entry bookkeeping records by preparing a trial balance.
This is done by taking all the balances on every account. Due
to the nature of double entry, the total of the debit balances
will be exactly equal to the total of the credit balances.
THE BALANCING OF ACCOUNTS & THE TRIAL
BALANCE
• Question: Once you have closed all the accounts, what would do?
• Answer: Prepare a Trial Balance
• Question: What is a Trial Balance then? What is it for? How
does it look like?
• Answer: A Trial Balance is a list of nominal ledger account
and their balances at a given date. It is usually prepared on the
last day of the accounting period. It consists of a Debit and a
Credit balance.
• Its purposes:
(1) It is prepared to check that the total of debit balances is the
same as the total of credit balances and offer reassurance that the
double entry recording from day books has been done correctly.
• (2) For preparation of statement of income and the statement of
financial position
THE BALANCING OF ACCOUNTS & THE TRIAL
BALANCE

The rules to prepare the Trial Balance:

Total Debit Entries = Total Credit Entries

Debit Credit
Assets Income/ Revenue
Expenses Liabilities
Drawings Capital
THE BALANCING OF ACCOUNTS & THE TRIAL
BALANCE

The rules to prepare the Trial Balance:

Total Debit Entries = Total Credit Entries

Debit Credit
Assets Income/ Revenue
Expenses Liabilities
Drawings Capital
THE BALANCING OF ACCOUNTS & THE TRIAL
BALANCE
Steps to preparing the Trial Balance:

1) Balance/cast ALL the ledger accounts in the books.

2) List all the Debit balances on the debit side and add them up.

3) List all the Credit balances on the credit side and add them up.

4) Ideally the trial balance should balance after step 3

THE BALANCING OF ACCOUNTS & THE TRIAL
BALANCE
What if the trial balance shows unequal debit and credit
balances?
If the columns of the trial balance are not equal, there must be
an error in recording or processing the transactions.
Errors revealed by the trial balance:
The errors revealed are those errors which cause the Trial
Balance totals to disagree. (i.e do not balance)
Types of errors revealed by a trial balance:
1) Posting to the wrong side of an account.
2) Errors in calculation and balancing.
3) Incorrect amounts entered on one entry.
4) Omission of one entry.
5) Error of Transposition.
THE BALANCING OF ACCOUNTS & THE TRIAL
BALANCE
Question: How do we locate all of the above errors?
Answers: 1) Check day-book (journal) totals
2) Check additions of Ledger accounts, ensure
each balance is correct
3) Check all ledger account balances have been
recorded in the Trial Balance.
4) Check all balances have been entered in the
Trial Balance on the correct side.
5) Check additions have been done correctly
THE BALANCING OF ACCOUNTS & THE TRIAL
BALANCE
However, a trial balance will not disclose the following types of
errors: (Errors not revealed by the trial balance)
1) Errors of omission
Complete omission of a transaction, because neither a
debit nor a credit is made.
2) Errors of commission
This happens when original figure incorrectly
entered.(Correct double entries but incorrect amounts were
recorded)
3) Compensating errors
This happens where errors cancel out each other. (an error
of $100 is exactly cancelled by another $100 error elsewhere)
THE BALANCING OF ACCOUNTS & THE TRIAL
BALANCE
4) Errors of principles
This happens when the wrong type of account had been
used (eg the purchase of a motor van is debited to a
expense account, such as motor expenses, rather than a
fixed asset account)
5) Complete reversal of entries
This happens when an account should be debited but was
credited (and vice versa)
THE BALANCING OF ACCOUNTS & THE TRIAL
BALANCE
Question: Once you are sure there is no mistake made in the
Trial Balance, what do you do in the next step?
Answers: Prepare End of Period Adjustment & then prepare
the following statements:
1) Statement of Income / Profit & Loss Accounts
2) Statement of Financial Position / Balance Sheet

In short, these are the steps:

1) Unadjusted Trial Balance
2) End of Period Adjustments
3) Adjusted Trial Balance
4) Statement of Income / Profit & Loss Account
5) Statement of Financial Position / Balance Sheet
10 COLUMNS WORK SHEET