The trial balance can be used to draw up a statement of profit or loss and a statement of financial position, without the need to create a profit and loss ledger account.
• To produce a statement of profit or loss, transfer each income and expense figure from the trial balance to the statement of profit or loss proforma. Then add down to calculate the profit (or loss) for the year.
• To produce a statement of financial position, transfer the balance for each asset, liability and capital account to a statement of financial position proforma. In the equity section, record the profit for the year (as per the statement of profit or loss). Finally, add down the asset section and add down the equity and liabilities section of the statement of financial position to show the sub-totals and total figures where appropriate.
This method is much quicker than drawing up the profit and loss ledger account, and so this is the method you are encouraged to use in the preparation of financial statement questions in the Accounting exam. A full example of this method is given in Chapter 12.
Summary and Self-test
Summary
Statement of position Statement of pr Statement of pr
Pr tements
Post transactions to ledger accounts
Debit
Produce final trial balance, then insert balances in
Open P/L ledger a/c, balance off ledger accounts and calculate net profit/loss,
then insert balances in
Statement of and position
and
EITHER
Prepare and process required adjustment journals
Expenses Income Assets Capital
OR Credit List balances on initial
trial balance
Liabilities
C H A P T E R 5
Self-test
Answer the following questions.
1 In a period, sales are £140,000, purchases £75,000 and other expenses £25,000. What is the figure for profit for the period to be transferred to the capital account?
A £40,000 B £65,000 C £75,000 D £140,000
2 During March, Chan had the following items in his cash at bank account:
£
Balance at 1 March (overdrawn) 500
Receipts from credit customers 12,000
Payments to credit suppliers 7,000
Payments for expenses 3,000
Cash drawn for own use 1,200
What is the balance on Chan's cash at bank account on 31 March?
A Debit £300 B Credit £300 C Debit £1,300 D Credit £1,300
3 Which two of the following items will be listed as a credit balance on a trial balance?
A Trade payables B Purchases C Sundry expenses D Capital
E Drawings
4 Select whether the following balances will be in the debit or the credit columns of the trial balance.
Debit Credit
Machinery Trade payables Drawings Sales
Bank overdraft Rental income
5 When an error in a debit entry is cancelled out by an error in a credit entry, this is called:
A A commission error B A compensating error C An omission error D An error of principle
6 An error has led to Erica omitting bank charges of £50 from her accounting records. This could have been caused by an error of commission.
True False
7 Tim is a sole trader. He has just realised that drawings of £100 were entered into the
accounting records as a debit to expenses and a credit to the cash at bank account. What is the journal entry required to correct this error?
A Dr Cash at bank account 100 Cr Drawings 100 B Dr Drawings 100 Cr Cash at bank account 100
C Dr Expenses 100 Cr Drawings 100
D Dr Drawings 100 Cr Expenses 100
8 Manny has a net loss of £400. This should be:
A Credited to the profit and loss ledger account and debited to the capital account B Debited to the profit and loss ledger account and credited to the capital account C Credited to the profit and loss ledger account and debited to the drawings account D Debited to the profit and loss ledger account and credited to the drawings account 9 At 31 December 20X6 Richard's total assets are £20,376 and his non-current liabilities are
£10,000. If his current liabilities are £6,290 then his capital balance at 31 December 20X6 must be:
A £4,086 B £16,666 C £24,086 D £36,666
10 Jude's profit and loss ledger account shows total entries on the debit side of £57,390 and total entries on the credit side of £84,928. What entry would Jude make in the profit and loss ledger account to transfer the profit or loss for the period to capital?
A Credit the profit and loss ledger account by £27,538 and credit the capital account by the same amount
B Credit the profit and loss ledger account by £27,538 and debit the capital account by the same amount
C Debit the profit and loss ledger account by £27,538 and debit the capital account by the same amount
D Debit the profit and loss ledger account by £27,538 and credit the capital account by the same amount
Now, go back to the Learning outcomes in the Introduction. You are unlikely to fully meet the Learning outcomes for this chapter until you have completed more of the course, however you should have satisfied yourself that you are working towards these objectives.
C H A P T E R 5
Answers to Interactive questions
Answer to Interactive question 1
Ron Knuckle: Statement of profit or loss for first trading period
£ £
Revenue (= sales) 12,500
Cost of sales (= purchases) (5,000)
Gross profit 7,500
Expenses
Rent 3,500
Bank loan interest 100
Other expenses 1,900
(5,500) Profit for the year (the balance on the profit and loss ledger account) 2,000 Answer to Interactive question 2
Ron Knuckle
Statement of financial position at end of first trading period
Assets £
Non-current assets 2,000
Current assets
Cash at bank 6,500
Total assets 8,500
Capital and liabilities
Owner's capital 7,500
Non-current liabilities
Bank loan 1,000
Total capital and liabilities 8,500
Answer to Interactive question 3
CASH AT BANK ACCOUNT
£ £
1.1.X1 Capital 400 1.1.X1 Insurance 300
1.1.X1 Loan 5,000 1.1.X1 Non-current assets 2,500
31.12.X1 Trade receivables 12,935 31.12.X1 Car expenses 650
31.12.X1 Drawings 1,250
31.12.X1 Trade payables 3,250
31.12.X1 C/d 10,385
18,335 18,335
31.12.X1 B/d 10,385
CAPITAL
£ £
31.12.X1 Drawings 1,250 1.1.X1 Cash at bank account 400
31.12.X1 C/d 9,955 31.12.X1 P/L account 10,805
11,205 11,205
31.12.X1 B/d 9,955
LOAN
£ £
31.12.X1 C/d 5,000 1.1.X1 Cash at bank 5,000
5,000 5,000
31.12.X1 B/d 5,000
NON-CURRENT ASSETS (NCA)
£ £
1.1.X1 Cash at bank 2,500 31.12.X1 C/d 4,000
1.1.X1 Trade payables 1,500
4,000 4,000
31.12.X1 B/d 4,000
TRADE PAYABLES
£ £
31.12.X1 Cash at bank 3,250 1.1.X1 NCA 1,500
31.12.X1 C/d 2,440 1.1.X1 Purchases 500
31.12.X1 Purchases 3,690
5,690 5,690
31.12.X1 B/d 2,440
INSURANCE
£ £
1.1.X1 Cash at bank 300 31.12.X1 P/L account 65300
300 300
CAR EXPENSES
£ £
31.12.X1 Cash at bank 650 31.12.X1 P/L account 650
650 650
PURCHASES
£ £
1.1.X1 Trade payables 500 31.12.X1 P/L account 4,190
31.12.X1 Trade payables 3,690
4,190 4,190
SALES
£ £
31.12.X1 P/L account 15,945 31.12.X1 Trade receivables 15,945
15,945 15,945
TRADE RECEIVABLES
£ £
31.12.X1 Sales 15,945 31.12.X1 Cash at bank 12,935
31.12.X1 C/d 3,010
15,945 15,945
31.12.X1 B/d 3,010
C H A P T E R 5
DRAWINGS
£ £
31.12.X1 Cash at bank 1,250 31.12.X1 Capital 1,250
1,250 1,250
PROFIT AND LOSS LEDGER ACCOUNT
£ £
31.12.X1 Purchases 4,190 31.12.X1 Sales 15,945
31.12.X1 Car expenses 650
31.12.X1 Insurance 300
31.12.X1 Capital 10,805
15,945 15,945
Polly: Statement of profit or loss for year ended 31 December 20X1
£
Revenue 15,945
Cost of sales
Purchases (4,190)
Gross profit 11,755
Expenses
Car expenses (650)
Insurance (300)
Profit for the year 10,805
Polly: Statement of financial position as at 31 December 20X1
£ £
Non-current assets 4,000
Current assets
Trade receivables 3,010
Cash at bank 10,385
13,395
Total assets 17,395
Capital and liabilities
Opening capital 400
Profit for year 10,805
Drawings (1,250)
Closing capital 9,955
Non-current liabilities
Bank loan 5,000
Current liabilities
Trade payables 2,440
Total capital and liabilities 17,395
Answers to Self-test
1 A PROFIT AND LOSS LEDGER ACCOUNT
£ £
Purchases 75,000 Sales 140,000
Gross profit c/d 65,000
140,000 140,000
Other expenses 25,000 Gross profit b/d 65,000
Profit for the year – to capital
a/c 40,000
65,000 65,000
B is the gross profit figure, while C is the figure for purchases and D is the figure for sales.
2 A CASH AT BANK
£ £
Receivables 12,000 B/d 500
Payables 7,000
Expenses 3,000
Drawings 1,200
C/d 300
12,000 12,000
B/d 300
3 A, D Purchases, sundry expenses and drawings are all debit balances.
4
Debit Credit
Machinery
Trade payables
Drawings
Revenue
Bank overdraft
Rental income
5 B A commission error (A) occurs when the double entry is complete, but the entries are made in the wrong account(s). An omission error (C) occurs when a transaction is completely omitted from the accounting records. An error of principle (D) occurs when the double entry is performed but the wrong treatment is applied to a transaction.
6 False. This is an error of omission.
7 D The £100 payment was debited to expenses when it should have been debited to drawings. To correct the error, we need to credit expenses and debit drawings.
8 A A net loss is debited to the capital account, reducing the owner's interest in the business, and is credited to the profit and loss ledger account.
9 A £20,376 – £10,000 – £6,290 = £4,086
10 D The credit column of the profit and loss account ledger exceeds the debit column by
£27,538. As such, a debit is required to clear the profit and loss ledger account and a credit is required to include the profit in capital.
Errors and corrections to accounting records and financial
statements
Introduction
Examination context TOPIC LIST
1 Reconciling to external documents 2 Bank reconciliations
3 Types of error in accounting 4 Correcting errors
5 Adjusting the initial trial balance for errors Summary and Self-test
Answers to Interactive questions Answers to Self-test
CHAPTER 6
Introduction
Learning outcomes Tick off
Prepare a trial balance from accounting records and identify the uses of a trial balance
Identify omissions and errors in accounting records and financial statements and demonstrate how the required adjustments will affect profits or losses
Correct omissions and errors in accounting records and financial statements
Prepare journals for nominal ledger entry and correct errors in draft financial statements
Specific syllabus learning outcomes are: 1f; 2a, b, c
Syllabus links
The accuracy of financial statements is the bedrock on which are built the rest of your studies for this exam, and for the Professional Level module Financial Accounting and Reporting.
Examination context
Questions on the topics in this chapter will be set as multiple choice, multi-part multiple choice or multiple-response questions, some of which may involve calculations so that the correct answer can be selected. Very often double entry questions are phrased in terms of preparing a journal. In addition, the material covered in this chapter may also be examined as part of a long form question.
In the exam you may be required to:
identify distinctions between different types of error
identify a journal to correct errors
identify the correct journal to clear a suspense account
identify the effects of correcting errors on draft gross or net profit
use the techniques of bank reconciliations to identify the correct cash at bank balance in the financial statements
use reconciliation techniques to identify the correct payables balances in the financial statements
C H A P T E R 6
1 Reconciling to external documents
Section overview
• In a computerised accounting system, at any point in time the total of the personal accounts of each credit customer and of each credit supplier will be equal to the total trade receivables and total trade payables balances respectively.
Companies may verify the accuracy of their accounting records using external documents.
Reconciliation of the ledger balances to external documents can help to identify errors in accounting records.
The external documents most commonly used for this purpose are bank statements and supplier statements. Customer statements are also sent in respect of credit customers.
It is important that we define the key terms used in this chapter.
Definitions
In the nominal ledger, the trade receivables account is used to record transactions relating to credit customers in total. The balance of the trade receivables account at any time will be the total amount due to the business from all its credit customers.
The receivables ledger is a listing of all transactions with each individual credit customer.
The receivables ledger is divided into personal accounts, one for each credit customer, and shows the total balance due from that customer at any point in time. The receivables ledger is separate to the nominal ledger and does not form part of the double entry system. It is used for record-keeping purposes only and is therefore often referred to as a
memorandum ledger.
In the nominal ledger, the trade payables account is used to record transactions involving credit suppliers in total, and the balance on this account at any time will be the total amount owed by the business to all its credit suppliers.
The payables ledger is a listing of all transactions with each individual credit supplier.
Consistent with the receivables ledger described above, the payables ledger includes a personal account for each credit supplier which shows the total amount owed to that supplier at any point in time. Consistent with the receivables ledger, the payables ledger is separate to the nominal ledger, does not form part of the double-entry system and is maintained for record-keeping purposes only.
In a manual system of accounting, the personal accounts in the receivables ledger are updated independently of the trade receivables account in the nominal ledger. This means that
differences between the two could arise. Reconciling the trade receivables account to the receivables ledger is therefore an important part of ensuring the accounting records are accurate. The same also applies to the payables ledger and the trade payables account.
In a computerised system, transactions entered into the personal account of a credit customer in the receivables ledger are automatically posted to the trade receivables account in the nominal ledger. Therefore there is no need to reconcile the trade receivables account to the receivables ledger because there will never be any differences between the two. The same also applies to the payables ledger and the trade payables account in a computerised system.
However, it is still useful for a business that uses a computerised accounting system to verify that the records it keeps are complete and accurate by reconciling certain information to external documents. You should be aware of the following reconciliations and how they are used by
Bank reconciliations – as discussed in Chapter 3, electronic banking now means that businesses are able to access their bank information and download transaction reports at any point in time. The terms bank transaction report and bank statement will be used throughout the Study Manual to refer to the transactions and balances recorded by the bank. The bank statements are used (1) as a source document for entries into the
accounting system; and (2) as an external record against which the accounting records of a business can be checked. The lines have blurred between using the bank statement for recording transactions and for checking the accuracy of the accounting records.
Supplier statement reconciliations – supplier statements are prepared by credit suppliers and sent to their customers on a regular basis, usually at the end of each month or each quarter, and list all transactions (invoices, returns, discounts and payments) that have occured since the date of the previous supplier statement. A business receiving a supplier statement will reconcile the transactions and closing balance on the statement to the payables ledger and any omissions or errors identified in the accounting records can then be corrected.
Worked example: Supplier statement reconciliation
Violet has received a supplier statement from Jade for the month of March 20X8 which shows the following transactions.
Jade
Supplier statement for Violet for the month ended 31 March 20X8
Date Details Debit (£) Credit (£) Balance (£)
Debit/(Credit)
1/3/X8 Balance brought forward 492.22
5/3/X8 Invoice 13287 129.40 621.62
7/3/X8 Invoice 13299 22.72 644.34
10/3/X8 Payment received 615.17 29.17
18/3/X8 Invoice 14101 394.95 424.12
31/3/X8 Balance carried forward 424.12
The supplier statement is prepared from the point of view of the supplier. Balances owed by Violet, to Jade, are shown as debit balances on the statement because they are receivables balances from Jade's point of view.
Violet has extracted a report from the computerised accounting system which shows Jade's personal account in the payables ledger.
PAYABLES LEDGER EXTRACT ACCOUNT NAME: Jade
Date Transaction (Debit)/Credit
£
Opening balance 492.22
5.3.X8 Invoice 13287 129.40
7.3.X8 Invoice 13299 22.72
10.3.X8 Payment (615.17)
10.3.X8 Early settlement discount re Inv. 13287 (6.45)
18.3.X8 Invoice 14101 394.95
19.3.X8 Returns (64.40)
Closing balance 353.27
C H A P T E R 6
The supplier statement shows that Violet has an outstanding balance of £424.12. However, Violet's payables ledger shows an outstanding balance owed to Jade of £353.27. In order to explain the difference, Violet must compare the transactions recorded in the payables ledger to those detailed on the statement received. We can see on the payables ledger extract that Violet has ticked the items that can be matched to the supplier statement.
The items that do not agree are as follows.
• The early settlement discount of £6.45 taken by Violet is not shown on the supplier statement. On further investigation, Violet confirmed that although she did not expect to take this discount when the invoice was initially recorded, payment was made within the required timeframe and therefore the discount was recorded appropriately. This issue should be raised with Jade.
• The return of £64.40 shown in the personal account is not included on the supplier statement. On further investigation, Violet identified that there is a dispute regarding the returned items. This issue should also be raised with Jade.
Supplier statement reconciliation
Account: Jade Date 31.3.20X8 £
Balance per supplier's statement 424.12
Less: Early settlement discount not on statement (6.45) Returns in dispute not on statement (64.40)
Balance per payables ledger 353.27
Also part of the reconciliation process is customer statements, which are produced by the business and sent to its credit customers. These are of course not external documents as they are produced by the business, but they can be a useful check as to the accuracy of receivables as the credit customer may respond to the business to alert it to any discrepancies or
inconsistencies in the statement. This is less useful than the supplier statement reconciliation as the business will not know if the credit customer has identified discrepancies or just not
communicated them.
2 Bank reconciliations
Section overview
The cash at bank account and the bank statement both reflect transactions through the business's bank account.
The cash at bank account needs to be regularly reconciled to the bank statement to identify any differences. Information relating to deposits and withdrawals shown on the bank statement will be used to record transactions in the cash at bank account.