Chapter 3

• Steps to follow to record and report transactions:

  1. record transactions using double entry
  2. summarise debits and credits in ledger accounts
  3. close off ledger accounts and list the closing balances in a trial balance
  4. use the trial balance to create the SPL and SFP
• Traditionally the effect of a transaction are referred to as a debit and a credit. We use DEAD CLIC to determine whether is should be a debit or a credit.

  An increase in an Expense, Asset or Drawings is a Debit

  An increase in a Liability, Income or Capital is a Credit.

  Every Debit must have a corresponding and equal Credit
• Steps to record a transaction:

  1. Identify the two accounts that are affected
  2. Consider whether that are being increased or decreased
  3. Decide whether each account should be debited or credited
  4. Check that a debit entry and a credit entry for equal amounts have been made
• We should record all purchases of inventory as a Debit to Purchases and a Credit to Cash or Trade Payables

  This is because in the real world businesses will adjust their inventory figure at the year end rather than each transaction occurs.

  Inventory will increase when it is purchased but this is dealt with by adjusting cost of sales for closing inventory at year end.

  And so we should record the sale of Inventory as a Debit to Cash or Trade Receivables and a Credit to Sales Income
• Balancing off a Ledger account is done by:

  1. add up the debit and credit side of the ledger account to see which is higher
  2. take the higher total and include it as the total for both sides of the account
  3. on the side with the smaller total insert the figure needed to make it add up and call with figure 'balance c/f'
  4. On the opposite side of the ledger, below the total figure, insert the amount of the balance c/f figure and call is 'balance b/f'

  An asset, expense or drawing should have the b/f on the debit side

  A liability, income or capital should have b/f on the credit side
• Trial balance is a list of all of the closing balances (balance b/f) on the ledger account according to whether the balance is on the debit side or credit side.

  Total credits should equal total debits.

  The trial balance it then used to produce the SPL and SFP
• At the end of the financial year the statement of profit and loss ledger accounts will be cleared to nil.

  The closing c/f balances need to be removed and transferred to a new account - the profit and loss ledger account. The profit and loss ledger account is therefore a summary of the statement of profit and loss.

  Individual statement of profit and loss ledger account balances (e.g. income and expense accounts) are not c/f to next year, they start from nil again.
• At the end of the financial period Statement of financial position ledger accounts carry forward. Meaning the closing c/f balance will become the b/f balance for the next period.

  • The closing c/f balance on the drawings ledger account is transferred to the capital ledger account.
  • The closing c/f balance on the profit and loss ledger account is transferred to the capital ledger account.

  The capital account is therefore a summary of the capital section of the statement of financial position.